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UPDATED EXPLANATORY NOTES

NIRC SECTION 1 – 83
August 31, 2016
- NIRC being a special law prevails over a general law like Civil Code.
- Revenue law, is a law passed for the purpose of authorizing the levy and
collection of taxes.
- Revenue derived from taxes are exempt from execution.
- Revenue refers to all funds or income derived by the government whether
from tax or other source.
- Enforcement and collection of tax is executive in character.
La Suerte Cigar vs. CA, 134 SCRA 29 – when an administrative agency
renders an opinion by means of circular or memo, it merely interprets a pre-
existing law, and no publication is necessary for its validity. Construction by
an executive branch of government of a particular law although not binding
upon the courts must be given weight. These agencies are the one called to
implement the law.
- Rulings or interpretation while entitled to great weight, are not judicially
binding.
- BIR RULINGS and DOJ Opinions are less general interpretation of tax laws of
the administrative level issued by the BIR and the DOJ. These two will take a
character of substantive rules and are generally binding and effective, if not
otherwise contrary to law or constitution.
- It is the BIR who will seek DOJ opinion on tax laws not the taxpayer.
- Ruling of first impression means rulings, opinions & interpretations without
established precedents. Only the CIR can issue this ruling. Those with
precedents are called Ruling with established precedents.
Requisites for valid regulations. – (a) They must not be contrary to law; (b)
They must be published in the Official Gazette; (c) They must be useful, practical and
necessary for law enforcement; (d) They must be reasonable in their provisions; and (e)
They must be in conformity with the legal provisions.
Rational Basis Test - It is sufficient that the legislative classification is rationally
related to achieving some legitimate state interest. (British American Tobacco vs.
Camacho, G.R. No. 163583, April 15, 2009)
“Assessment,” meaning. – With special reference to internal revenue taxes, an
assessment is merely a notice to the effect that the amount stated therein is due as tax
and a demand for the payment thereof. It is not an action or proceeding for the
collection of taxes. It is a step preliminary, but essential to warrant of distraint, if still
feasible, and also to establish a cause for judicial action as the phrase is used in the
Revenue Code.
Even an assessment based on estimates is prima facie valid and lawful where it
does not appear to have been arrived at arbitrarily or capriciously. (Marcos vs. CA, 273
SCRA 47, 1987)
Assessment is not an action or proceeding. It is a preliminary step.
Assessment as a general rule is a condition sine quanon for the collection of
taxes but not for filing criminal actions.
An assessment fixes and determines the tax liability of a taxpayer. As soon as it
is served, an obligation arises on the part of the taxpayer concerned to pay the amount

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assessed and demanded. Hence, assessments should not be based on mere
presumption no matter how reasonable or logical said presumption may be.
In order to stand the test of judicial scrutiny, the assessment must be based on
actual facts. The presumption of correctness of assessment being a mere presumption
cannot be made to rest on another presumption x x x. (Collector vs. Benipayo, 4 SCRA
182)

A tax assessment is prima facie valid and correct and the taxpayer has the
burden of proof to impugn its validity. (Behn Meyer & Co. vs. Collector of Internal Revenue,
27 Phil. 647) The validity of a tax assessment is a disputable presumption. (Perez vs.
CTA, et al., G.R. No. L-10507, prom. May 30, 1948; Collector vs. Bohol Land Transportation,
G.R. Nos. L-13099 and L13462, prom. April 29, 1960)

All presumptions are in favor of the correctness of tax assessments. The good
faith of tax assessors and the validity of their actions are presumed. The burden of proof
is upon the taxpayer to show clearly that the assessment is erroneous, in order to
relieve himself from it.
Where a taxpayer question the correctness of an assessment against him and is
apparently not acting in bad faith or merely attempting to delay payment, but is deprived
of the best means of proving his contention because his books of accounts were lost by
the BIR agent who examined them, said taxpayer must be given an opportunity to prove
by secondary evidence that the assessment is incorrect. (Santos vs. Nable, et al., 2 SCRA
21)

As the law provides that any person who is aggrieved by an assessment issued
by the Commissioner of Internal Revenue is given only 30 days to appeal therefrom to
the Tax Court, the only effect should be that after that period, the assessment can no
longer be questioned by the taxpayer; otherwise, the assessment which has become
final, executory and demandable under Section 11 of Republic Act No. 1125 would be
an absurdity. (Republic vs. Antonio Albert, G.R. No. L-12996, prom. Dec. 28, 1961)
The taxpayer’s failure to appeal to the Court of Tax Appeals in due time made
the assessment in question final, executory and demandable. (Republic vs. Manila Port
Service, G.R. No. L-18208, prom. Nov. 27, 1964) And when the present action for collection
of the tax was instituted, said taxpayer was already barred from disputing the
correctness of the assessment or invoking any defense that would reopen the question
of its tax liability on the merits. (Republic vs. Albert, 3 SCRA 717) Otherwise, the period of
thirty days for appeal to the Court of Tax Appeals would make little sense. (Republic vs.
Lopez, 2 SCRA 566)

Acquittal in a criminal case does not exonerate taxpayer’s civil liability to pay the
tax due (Republic vs. Patanao, G.R. No. L-22317, July 21, 1967)
“Best evidence obtainable,” explained. – It refers to the findings gathered by
internal revenue examiners and agents from the records of the register of deeds,
corporations, employers, clients or patients, tenants, lessees, vendees and the like with
whom the taxpayer had previous transactions or from whom he acquired any income.
It will be noted that under Section 5 of the said Code, the Commissioner of
Internal Revenue may obtain information on potential taxpayers from government
offices or agencies.
Networth method of investigation. – As stated above, the Commissioner of
Internal Revenue may make tax assessments on the best evidence obtainable. He can
avail of methods in order to arrive at a correct and reasonable assessment of taxes.
One method is the networth method of investigation.
The power or authority of the Commissioner to choose the method of determining
taxable income is quite comprehensive, and the only limitation to the exercise of such
power of authority is that the method chosen or adopted must “clearly reflect the

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income.“ Consequently, Tax Code (Sec. 43) authorizes the Commissioner of Internal
Revenue to employ the networth method, where a taxpayer keeps no books or records
or where such books or records do not clearly reflect his income. (Commissioner vs.
Enrique Avelino, G.R. No. L-14847, prom. Sept. 19, 1961)

It is not required in networth cases that the Government prove with absolute
certainty the sources from which petitioner derived his unreported income. It is sufficient
if evidence is adduced of the likely source or sources of such income. In this case, there
is ample evidence of the probable sources from which petitioner could have derived his
undeclared income such as flourishing business in optical goods, office equipment, and
haberdashery; horse racing, and real estate transactions. (Reyes vs. Collector, G.R. Nos.
L-11534 & L-11558, prom. Nov. 25, 1968)

CIR vs. Hantex, G.R. No. L-136075, March 31, 2005


- Mere photocopies not admissible. Exert effort to get the original
- Hearsay evidence is admissible. BIR not bound by the technical rules of
evidence. It depends on trustworthiness for evidence to be admissible.

A. SECRECY OF BANK DEPOSITS


Q. What guarantees on confidentiality do depositors enjoy under the law?
A. For peso deposits, Republic Act No. 1405 (Bank Deposits Secrecy Law) declares all
deposits of whatever nature with banks in the Philippines, including investments in government
bonds, as of an absolutely confidential nature and prohibits the examination or inquiry into such
deposits or investments by any person, government official, bureau or office, as well as the
disclosure by any official or employee of a bank of any information concerning said deposits.
There are only four (4) instances under the law where bank deposits or investment in
government bonds may be disclosed or looked into, namely: (1) upon written permission of the
depositor; or (2) in cases of impeachment; or (3) upon order of a competent court in cases of
bribery or dereliction of duty; or (4) in cases where the money deposited or invested is the
subject matter of the litigation.
It may be noted that RA 1405 covers not only bank deposits but also investments in government
bonds.
For foreign currency deposits, Republic Act No. 6426 (The Foreign Currency Deposit Act)
similarly declares that these deposits are of an absolutely confidential nature and cannot be
examined, inquired or looked into by any person, government official, bureau or office whether
judicial or administrative or legislative or any other entity whether public or private. There is only
one instance for disclosure under said law and, that is, upon the written permission of the
depositor. RA 6426 also exempts foreign currency deposits from attachment, garnishment, or
any other order or process of any court, legislative body, government agency or any
administrative body whatsoever.
For investments in trust accounts or in deposit substitutes, if these are in the form of
investments in government bonds or deposits, the protection under RA 1405 and RA 6426
extends thereto accordingly. If these are in other forms of investments, the disclosure of
information related thereto is covered by Section 55 of the General Banking Law of 2000
(Republic Act No. 8791) which prohibits, unless there is an order of a court of competent
jurisdiction, the disclosure by any director, official, employee or agent of any bank any
information relative to the funds or properties in the custody of the bank belonging to private
individuals, corporations or any other entity.
NOTE:
Under par. (F) of the NIRC, it states:
(F) Authority of the Commissioner to Inquire into Bank Deposit Accounts and Other Related
Information Held by Financial Institutions. – Notwithstanding any contrary provision of Republic
Act No. 1405, Republic Act No. 6426, otherwise known as the Foreign Currency Deposit Act of
the Philippines, and other general or special laws, the Commissioner is hereby authorized to
inquire into the bank deposits and other related information held by financial institutions of:

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(1) A decedent to determine his gross estate; and
(2) Any taxpayer who has filed an application for compromise of his tax liability under
Sec. 204(A)(2) of this Code by reason of financial incapacity to pay his tax liability.
In case a taxpayer files an application to compromise the payment of his tax liabilities on his
claim that hi financial position demonstrates a clear inability to pay the tax assessed, his
application shall not be considered unless and until he waives in writing his privilege under
Republic Act No. 1405, Republic Act No. 6426, otherwise known as the Foreign Currency Act of
the Philippines, or under other general or special laws, and such waiver shall constitute the
authority of the Commissioner to inquire into the bank deposits of the taxpayer.
(3) A specific taxpayer or taxpayers subject of a request for the supply of tax
information from a foreign tax authority pursuant to an international
convention or agreement on tax matters to which the Philippines is a signatory
or a party of: Provided, That the information obtained from the banks and other
financial institutions may be used by the Bureau of Internal Revenue for tax
assessment, verification, audit and enforcement purposes.1
In case of a request from a foreign tax authority for tax information held by banks and
financial institutions, the exchange of information shall be done in a secure manner to
ensure confidentiality thereof under such rules and regulations as may be promulgated
by the Secretary of finance, upon recommendation of the Commissioner.
The Commissioner shall provide the tax information obtained from banks and financial
institutions pursuant to a convention or agreement upon request of the foreign tax
authority when such requesting foreign tax authority has provided the following
information to demonstrate the foreseeable relevance of the information to the request:
(a) The identity of a person under examination or investigation;
(b) A statement of the information being sought including its nature and the form
in which the said foreign tax authority prefers to receive the information from
the Commissioner;
(c) The tax purpose for which the information is being sought;
(d) Grounds for believing that the information requested is held in the Philippines
or is in the possession or control of a person within the jurisdiction of the
Philippines;
(e) To the extent known, the name and address of any person believed to be in
possession of the requested information;
(f) A statement that the request is in conformity with the law and administrative
practices of the said foreign tax authority, such that if the requested
information was within the jurisdiction of the said foreign tax authority then it
would be able to obtain the information under its laws or in the normal course
of administrative practice and that it is in conformity with a convention or
international agreement; and
(g) A statement that the requesting foreign tax authority has exhausted all means
available in its own territory to obtain the information, except those that would
give rise to disproportionate difficulties.
The Commissioner shall forward the information as promptly as possible to the
requesting foreign tax authority. To ensure a prompt response, the Commissioner shall
confirm receipt of a request in writing to the requesting tax authority and shall notify the
latter of deficiencies in the request, if any, within sixty (60) days from receipt of the
request.
If the Commissioner is unable to obtain and provide the information within ninety (90)
days from receipt of the request, due to obstacles encountered in furnishing the
information or when the bank or financial institution refuses to furnish the information,
he shall immediately inform the requesting tax authority of the same, explaining the
nature of the obstacles encountered or the reasons for refusal.

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As amended by RA 10021, entitled “An Act to Allow the Exchange of Information by the BIR on Tax Matters
Pursuant to Internationally-Agreed Tax Standards, otherwise known as “Exchange of Information on Tax Matters
Act of 2009”, Amending Secs. 6(F), 71, and 270 of the NIRC of 1997, as Amended, and for Other Purposes” march
5, 2010

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The term “foreign tax authority,” as used herein, shall refer to the tax authority or tax
administration of the requesting State under the tax treaty or convention to which the
Philippines is a signatory or a party of.

Q. How do banks respond to an order of a competent court?


A. For peso deposits, banks comply with orders for disclosure in court cases subject to these
requirements: (a) there must be a court order; (b) the order must be issued by a competent
court specifically directing the bank concerned to disclose the required information; and (c) the
bank should check and satisfy itself that the deposits or investment in government bonds being
inquired into are either the subject of a case of bribery or dereliction of duty of public officials, or
of a case where the deposit or investment itself is the subject matter of the litigation. If these
requirements are not met, there would be basis for the bank to request the court to excuse
compliance with the court order.
In impeachment cases, it is necessary that there be an order issued by the impeachment court
or by its authorized officer. For foreign currency deposits, the law does not provide an instance
for disclosure upon a court order. As mentioned above, there is only a single instance for
disclosure under RA 6426 and, that is, upon written permission of the depositor. Thus, for
foreign currency deposit accounts subject of a court order, the bank can invoke RA 6426 to
excuse compliance.

Q. What is the liability of the banks and/or its officers and employees for violating the
laws against disclosure?
A. Violations of the prohibitions against disclosures under RA 1405, RA 6426 and under the
General Banking Law of 2000 are subject to stiff criminal penalties.
Under RA 1405, the offender is subject to imprisonment of not more than five years or a fine of
not more than P20,000, or both, in the discretion of the court. Under RA 6426, the penalty is
imprisonment of not less than one year not more than five years or a fine of not less than
P5,000 nor more than P25,000, or both, in the discretion of the court. The violation of Sec. 55 of
the General Banking Law of 2000, the penalty is imprisonment of not less than two years nor
more than 10 years or a fine of not less than P50,000 nor more than P200,000, or both, in the
discretion of the court; and in addition, if the offender is a director or officer of a bank, he is
subject to suspension or removal by the Monetary Board.

B. USE OF ALIAS OR NUMBER IN OPENING DEPOSIT ACCOUNTS


Q. Are banks allowed to open accounts using an alias or a number?
A. There is no specific banking law up to the present prohibiting banks from opening deposit
accounts using an alias or a number. Prior to July 7, 2000, there is also no banking regulation
providing for such prohibition. On July 7, 2000 and in seeking the adoption of anti-money
laundering measures, the Bangko Sentral ng Pilipinas (BSP) issued a regulation, Circular No.
251, providing that, unless otherwise prescribed under existing laws, anonymous accounts or
accounts under fictitious names are prohibited.
The exception referred to under Circular No. 251 was RA 6426 (The Foreign Currency Deposit
Act) which explicitly allows the keeping of numbered accounts for the recording and servicing of
deposits.
For peso accounts, when banks allow the opening of deposit accounts under pseudonyms, it is
assumed that: (1) they have exercised due diligence to ascertain the identity of their clients; and
(2) they are aware of the legal provisions and requirements on the use of pseudonyms.
The above notwithstanding, it may be pointed out that in the Manual of Regulations issued by
BSP, or even before the issuance of Circular 251, there were already regulations requiring the
banks to: (a) adopt systems to establish the identity of their depositors; and (b) require to set a
minimum of three (3) specimen signatures from each of their depositors subject to regular
updating. Even for numbered accounts as authorized under RA 6426, BSP has required banks,
under Circular 258, to take necessary measures to establish and record the true identity of their
clients, which identification may be based on official or other reliable documents and records.

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Q. Are there other laws governing the use of pseudonyms or aliases?
A. Art. 178 of the Revised Penal Code penalizes the: (a) publicly using of a fictitious name for
the purpose of concealing a crime, evading the execution of a judgment, or causing damage;
and (b) concealment by any person of his true name and other personal circumstances.
On the other hand, there is also Commonwealth Act No. 142, as amended by Republic Act No.
6085 (Regulating the Use of Aliases) which provides that, except only as a pseudonym for
literary purposes and athletic events, it is unlawful for any person to use an alias, unless the
same is duly recorded in the proper local civil registry. Related thereto, Articles 379 and 380 of
the Civil Code provide that no person shall use different names and surnames except the
employment of pen and stage names provided it is done in good faith and there is no injury to
third persons.
What can be noted is that the above provisions allow the use of aliases under certain
circumstances. Conversely stated, the use of aliases is not absolutely disallowed. Moreover, the
sanctions for any violation of the above provisions on aliases are mainly directed to the one
using the unauthorized alias.

Q. How does Circular No. 251 apply to existing numbered accounts?


A. For peso accounts, the banks should have their respective programs of compliance with the
Circular. For foreign currency deposit accounts, they are allowed to continue maintaining
numbered accounts opened in accordance with RA 6426 subject to the requirement that the
banks shall take necessary measures to establish and record the true identity of their clients.

Q. What penalties/sanctions are applicable for violating the laws/regulations?


A. Article 178 of the Revised Penal Code is directed to the person concealing his identity
publicly or using a fictitious name and the penalty would range from one day up to six months
imprisonment and/or a fine up to P500,000. For violation of Commonwealth Act 142, which is
likewise directed to the person using an unauthorized alias, the penalty is imprisonment from
one year to five years and a fine of P5,000 to P10,000. For the violation of Circular 251, it is
subject to the administrative sanction on the bank and/or responsible directors/officers of fine up
to P30,000 per transaction.

C. CONTINUED CONFIDENTIALITY/SECRECY OF DEPOSIT TRANSACTIONS


Q. Is confidentiality/secrecy of deposit accounts compromised with the issuance of
Circular 251?
A. No. Circular 251 merely disallowed the opening of fictitious and anonymous accounts and
has not in any way modified nor lessened the safeguards and protection to depositors under RA
1405. This means that, notwithstanding Circular 251, deposit accounts cannot be examined or
looked into except under the limited circumstances provided for in RA 1405.

Q. Why are the BSP and the BAP advocating the amendment to bank secrecy laws?
A. The proposal of BSP and BAP is for access to deposit accounts only under exceptional
circumstances, such as deposits only above the P50-million level and in relation to the
commission of serious offenses like racketeering and illicit drug trade. Except for these
instances, depositors and those with legitimate transactions remain protected under RA 1405.
The objective of the proposal is to institute this measure as an anti-money laundering campaign
so as to delete the Philippines as a non-cooperative country in the list of the Financial Action
Task Force against money laundering

INCOME TAX

A. Income Tax Systems


 There are three kinds of income tax systems:
o Global (unitary) tax system

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 Here, all items of gross income, deductions, personal and additional exemptions
are reported in one income tax return and a single tax is imposed on all income
received or earned, regardless of the activities which produced the income.
 It is akin to putting all income into one basket and taxing the entire basket.

o Schedular tax system


 Here, different types of activities are subjected to different types of tax rates.
The tax rates depend on the classification of the taxable income ant the
activities which produced the income.

o Semi-global, semi-schedular system


 Certain passive income and capital gains are subject to final taxes while other
income are added to arrive at the gross income (where deductions are used to
arrive at the taxable income)
 We follow the semi-global/semi-schedular system in the Philippines.
 Schedular can also mean that tax rates will differ based on the tax base.
 For instance, global is usually applied to corporations, as corporations are
taxes at a single rate, regardless of the tax base; while the schedular system
is applied to individuals as they are subjected to different tax rates based on
their tax bracket.

D. Situs of Taxation
Now that we know that only resident citizens and domestic corporations are
taxed from income sources worldwide, it is important to determine whether such income
is realized in the Philippines or abroad. This brings us to Section 42.

 This section is NOT relevant to domestic corporations and resident citizens


because they are taxed worldwide anyway. This section comes into play when it
comes to problems related to the income sources of taxpayers who are only
taxed for income sourced within the Philippines.
 The following are treated as gross income from sources within the Philippines
(Secs. 152-165, Revenue Regulations No. [“R.R.”] 2-1940:

1. Interests – including interests on bonds, notes and other interest bearing


obligations:
a. The loan was used here in the Philippines, or
b. The debtor is in the Philippines

2. Dividends –
a. From a domestic corporation; and
b. A foreign corporation, unless less than 50% of the gross income of the
foreign corporation was derived from the Philippines for the three-year
period (the amount will be based on the same ratio to dividends as the
gross income for such period derived from sources within Philippines to
its gross income from all sources.)
i. For example, We make kaijus, Inc., a Japanese corporation, derives
more than 50% of its gross income in the Philippines from the sale of
kaiju action figures for the past three years. If it declares dividends to
a non-resident Filipino, the dividend income will be considered
sourced within the Philippines.
3. Services – compensation for labor or personal services performed in the
Philippines.
4. Rentals and Royalties – from property located in the Philippines or from any
interest in such property for:
a. The use of any copyright, patent, design or model, plan, secret formula
or process, goodwill, trademark, trade brand or other similar stuff
b. The use of any industrial, commercial or scientific equipment

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c. The supply of scientific, technical, industrial or commercial knowledge or
info
d. The supply of services by a non-resident person in connection with those
of property or rights, or the installation or operation of any brand,
machinery, or other apparatus purchased form such non-resident person
e. Technical advise, assistance or services rendered in connection with
technical management of any scientific, industrial or commercial
undertaking
f. The use of motion picture films, films for TV, tapes for radio broadcast
5. Sale of real property – the gains, profits and income from sale of real property
located in the Philippines.
6. Sale of personal property – gains, profits and income from sale of personal
property, determined by subsection (E).

 The place of the signing of a contract is NEVER an issue or a factor for determining
the source of income.
 Do not forget the “turnkey contract” case of CIR v. Marubeni (G.R. No. 137377,
December 18, 2001), when it comes to situs problems.
 Expenses of a multinational corporation directly allocated or identified with the
operations of the Philippine branch. So, the company can claim as its deductible
share a ratable part of such expenses based upon the ratio of the local branch’s
gross income to the total gross income, worldwide, of the multinational corporation.
(CIR v. CTA and Smith Kline & French Overseas Co., G.R. No. L-54108, January
17, 1984)
 The source of income is the property, activity, or service that produced the income.
o It is the place of activity creating the income which is controlling, and not the
place of business or residence of a corporation.
 Hence, reinsurance premiums ceded to foreign reinsurers are considered
income from Philippine sources. (Howden & Co., Ltd. V. CIR, G.R. No. L-
19392, April 14, 1965)
 Also, the sale of airline tickets through a general sales agent in the
Philippines is considered income from Philippine sources, even if the tickets
pertain to an airline company which does not maintain any flights to and from
the Philippines. (CIR v. British Overseas Airways Corporation, G.R. No. L-
65773, April 30, 1987, wherein the Court considered the sale of the tickets
as the source of income, and not the activity of actually transporting
passengers)
 When the sale is consummated within the Philippines (as in the title to the
property was transferred in the country), the situs of the sale is in the
Philippines and is therefore taxable here. (A. Soriano Y Cia v. CIR, G.R. No.
L-5896, August 31, 1955)

Income Test of Source of Income


Interest income Residence of DEBTOR
Dividend Income: Income within

1) From domestic corporation Income within, if 50% or more of the gross


income of the foreign company (for the
2) From foreign corporation past 3 years) was derived from sources
within the Philippines

Income without, if less than 50% of the


gross income of the foreign company (for
the past 3 years) was derived from
sources within the Philippines
Service Income Place of performance

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Rent income Location of Property
Royalty income Place of use of intangible
Gain on sale of real property Location of property
Gain on sale of personal property Place of sale
Gain on sale of domestic shares of stock Income within

Gross income from sources outside (without) the Philippines.


1. Interests other than those derived from sources within
2. Dividends other than those derived from sources within
3. Compensation for labor or personal services performed outside the Philippines
4. Rentals or royalties from property located outside the Philippines or any interest
in such property
5. Gains, profits, income from sale of real property located outside the Philippines

Income from sources partly within and partly without the Philippines.
 For the gross income items allocated to sources partly within and partly without
the Philippines,
o There shall be deducted the expenses, losses and other deductions properly
apportioned, and
o A ratable part of other expenses, losses and deductions which cannot
properly be allocated to some item of gross income.
 If there is any remainder, it shall be included in full as taxable income from
sources within the Philippines

Situs of sale of personal property


 Gains, profits and income derived from purchase of personal property within and
sold without, or from purchase without and sale within, are treated as derived
entirely form sources with the country in which it is SOLD.

Situs of sale of stocks in a domestic corporation


 Gains from sale of shares of stock in a domestic corporation are treated as
DERIVED ENTIRELY from sources within the Philippines regardless of where
the said shares are sold.

E. Income Tax on Individuals


Now that we know how to determine where income is sourced, it is time to focus
on the different kinds of taxpayers. Let us begin with individual taxpayers.

Individual taxpayers are classified into:


1. Citizens, who are divided into:
 Resident citizens – those citizens whose residence is within the Philippines; and
 Non-resident citizens – those citizens whose residence is not within the
Philippines.
2. Aliens, who are divided into:
 Resident aliens – those individuals whose residence is within the Philippines and
are not citizens thereof; and
 Non-resident aliens – those individuals whose residence is not within the
Philippines but temporarily in the country and are not citizens thereof. They are:
 Those engaged in trade or business within the Philippines; and
 Those who are not so engaged. (see NIRC, Sections 23-25)

It is important to know the definition of each kind of individual taxpayer because the
tax liability of each differs (as we shall see later).

Resident aliens

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 Resident alien is an individual:
1. Whose residence is within the Philippines, and
2. Who is not a citizen
 Mere physical or body presence is enough, not intention to make the country one’s
abode. (Garrison v. CA, G.R. No. L-44501, July 19, 1990)
 An alien actually present in the Philippines who is not a mere transient or sojourner
is a resident of the Philippines for purposes of income tax. Whether he is a transient
or not is determined by his intentions with regard to the length and nature of his
stay.
o A mere floating intention indefinite as to time, to return to another country is not
sufficient to constitute him a transient.
o If he lives in the Philippines and has no definite intention as to his stay, he is a
resident. One who comes to the Philippines for a definite purpose which in its
nature may be promptly accomplished is a transient.
o But if his purpose is of such a nature that an extended stay may be necessary for
its accomplishment, and to that end the alien makes his home temporarily in the
Philippines, he becomes a resident, though it may be his intention at all times to
return to his domicile abroad when the purpose for which he came has been
consummated or abandoned. (R.R. 2-1940)

 The BIR has ruled that there is intention on the part of an alien to stay in the
Philippines indefinitely when the alien:
o Had a Special Resident Retiree’s Visa;
o Acquired real property and is actually present most of the time in the Philippines;
and
o Registered as a taxpayer with the BIR. (BIR Ruling No, 252-11)

Non-resident citizens
 Meaning of non-resident citizen:
1. Citizens who establishes to the satisfaction of the Commissioner the fact of his
physical presence abroad with a definite intention to reside therein;
2. Citizen who leaves the Philippines during the taxable year to reside abroad,
either as an immigrant or for employment on a permanent basis;
3. Citizen who works and derives from abroad and whose employment thereat
requires him to be physically present abroad most of the time during the taxable
year;
4. Citizen who has been previously considered as nonresident citizen and who
arrives in the Philippines at any time during the taxable year to reside
permanently in the Philippines shall likewise be treated as a nonresident 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.

 Who are non-resident citizens? (R.R. 1-1979)


1. Immigrant – one who leaves the Philippines to reside abroad as an immigrant
for which a foreign visa has been secured.
2. Permanent employee – one who leaves the Philippines to reside abroad for
employment on a more or less permanent basis.
3. Contract worker – one who leaves the Philippines on account of a contract of
employment which is renewed form time to tome under such circumstance as to
require him to be physically present abroad most of the time (not less than 183
days)

 Non-resident citizens who are exempt from tax with respect to income derived from
sources outside the Philippines shall no longer be required to file information
returns from sources outside the Philippines beginning 2001. (R.R. 5-2001)

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 The phrase “most of the time” shall mean that the said citizen shall have stayed
abroad for at least 183 days in a taxable year.
o However, citizens who work outside of the Philippines for at least 183 days in a
taxable year due to a contract of employment with a Philippines employer (such
as employees seconded to a foreign country) is not considered a non-resident
citizen because they are not considered employed abroad. They do not fall
within Section 22(E)(3) because their employment remains with the Philippines
employer. (BIR Ruling No. 116-12)

 The wage or income of an OFW/OCW which is earned from outside the Philippines
is exempt from income tax.
o An OCW is a Filipino citizen who:
 Holds a job outside the Philippines;
 Is physically present in that foreign country where the job is;
 Is registered with the POEA;
 Has valid overseas employment certificate;
 Their salaries and wages are paid by an employer abroad and is not borne by
any entity or person in the Philippines. (R.R. 1-2011)

Non-resident aliens engaged in business in the Philippines


 Who are non-resident aliens?
1. An individual whose residence is not within the Philippines, and
2. Not a citizen of the Philippines

 One who comes to the Philippines for a definite purpose which in its nature may be
promptly accomplished is a transient or non-resident. (R.R. 2-1940)

 Non-resident aliens are either:


o Engaged in trade or business, such as:
 One who actually derives income in the Philippines, or
 Stays in the Philippines for more than 180 days during any calendar year
(deemed to be a non-resident alien engaged in the Philippines, Section 25[A])
o Not engaged in trade or business.

 Less of residence by alien


o An alien who has acquired residence in the Philippines retains his status until he
abandons the same and actually departs from the Philippines.
o A mere intention to change his residence does not change his status from
resident alien to non-resident alien. An alien who has acquired a residence is
taxable as a resident for the remainder of his stay in the Philippines. (Section 6,
R.R. 2-1940)

Minimum wage earner


 Fixed by the Regional Tripartite Wage and Productivity Board.
 Minimum wage earner:
o Private sector – paid the statutory minimum wage
o Public sector – not more than the statutory minimum wage in the non-
agricultural sector where he/she is assigned

Senior Citizens
 Senior Citizens are
o Resident citizens of the Philippines, and
o Who are at least 60 years old
 They are not exempt from income taxes unless they are considered minimum
wage earners. (R.A. 9994)

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 Senior citizens are granted a 20% discount from select establishments.
o Sales of goods and services by select establishments to senior citizens are also
exempt from VAT. (R.R. 7-2010)

 Discounts for senior citizens are now treated as tax deductions for business, as per
The Expanded Senior Citizens Act of 2003 (R.A. 9257). This can be very bad for
the taxpayer because he doesn’t get the “peso for peso” benefit which he would
have gotten if it were considered a tax credit as before. (M.E. Holdings Corp. v. CIR
& CTA, G.R. No. 160193, March 3, 2008)

Persons with Disability


 Persons with Disability (PWD) are:
o Individuals suffering from restriction or different abilities,
o As a result of mental, physical or sensory impairment to perform an activity in a
manner or within the range considered normal for human beings.

 PWD are granted a 20% discount from selected establishments.


o These discounts can likewise be claimed as a deduction for businesses. (R.R.
1-2009)

Kinds of income and income tax of individuals


Before we get into the smallest details of the tax liabilities of each kind of
individual, let’s set down some basic rules which will be helpful to remember:
 Only resident citizens (and domestic corporations as we shall see later) are taxed
on income derived from abroad. Worldwide taxable!
 For income received from sources within the oh and which are not subject to final
withholding tax (like passive income to be discussed below), a resident citizen, a
non-resident citizen, a resident alien, and a non-resident alien individual engaged in
trade or business in the Philippines are all subject to the graduated income tax
rates in Section 24.
o But what about non-resident aliens not engaged in trade or business?
 For non-resident aliens not so engaged, the tax rate is:
 25% of the entire or gross income received from sources within the
Philippines or
 15% of the gross income received as compensation, salaries, and other
emoluments by reason of his employment by:
o Regional or area headquarters and regional operating headquarters of
multinational corporations;
o Offshore banking units establishment by a foreign corporation in the
Philippines; or
o By foreign petroleum service contractor or sub-contractors operating in
the Philippines. (Section 25[A-E])

Income tax formula for individuals


It is important to note the basic formula to determine the taxable income of an
individual. Think of it as a road map where the different provisions of the code will plug
into. The basic formula to determine the taxable income of an individual is as follows:

Gross Income
Less: Deductions (either itemized of optional standard deduction)
Less: Personal/Additional Exemptions and Premium Payments on Insurance
Taxable Income
Tax Rate
Tax Due

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Deductions
 Individuals, except those who earn purely compensation income can claim
deductions in two ways:
o Itemized deductions (which we will discuss in more detail), or
o Availing of the optional standard deduction (which is discussed below).
“Engaged in trade or business”, explained. – The phrase “engaged in trade or
business within the Philippines” includes the performance of the functions of a public
office or the performance of personal services within the Philippines. (Sec. 8, Rev. Regs.
No. 2)

“To engage in business” is uniformly construed as signifying to follow the


employment or occupation which occupies the time, attention, and labor for the purpose
of a livelihood or profit.
A nonresident alien who shall come to the Philippines and stay there in an
aggregate period of more than one hundred eighty days during any calendar year shall
be deemed a nonresident alien doing business in the Philippines. (Sec. 25A)
The length of stay is the criterion. Hence, a non-resident alien shall not be
considered engaged in trade or business in the Philippines if he stays in the Philippines
for less than 180 days notwithstanding the fact that during such stay he actually
performs personal services, or engages in a commercial activity therein. And the whole
period of more than 180 days must cover a calendar year.
The entire gross income of non-resident aliens not engaged in trade or business
received from all sources within the Philippines is subject to income tax. He must not be
engaged in trade or business in the Philippines.
The sources of the income are interests, dividends, rents, salaries, wages,
premiums, annuities, compensations, remunerations, emoluments, or other fixed or
determinable annual or periodical or casual gains, profits and income, and capital gains.
Tax Liability of Members of General Professional Partnerships (GPP). (Sec. 26)
The GPP as a juridical entity is exempted from income taxes. It would be the
individual members who will be liable on their net income share from the GPP.
A partner in a general professional partnership shall report in his income tax
return, whether distributed or not, his share of the profits of the partnership. If he reports
his net share in the profits, he shall be deemed to have elected the itemized deduction
and may no longer claim the optional standard deduction. In case he declares his
distributive share in the gross income undiminished by his share in the deduction, he
may avail the 40% optional standard deduction in lieu of the itemized deduction.
Professional partnership. – Your professional partnership of Certified Public
Accountants is exempt from income tax pursuant to Section 26 of the Tax Code, as
amended. Accordingly, payments to said partnership for professional services rendered
are exempt from the withholding tax provisions of Revenue Regulations No. 13-78 as
amended by Revenue Regulations No. 6-79, both implementing Section 50 (now 43) of
the Tax Code, as amended by Presidential Decree No. 1351. (BIR Ruling No. 84-142)
Professional partnership are not required to file income tax return. – Requesting
confirmation of your opinion to the effect that professional partnerships are not required
to file quarterly returns of their income; and that individual partners of a professional
partnership should not be required to file quarterly returns if they received their shares
in the net income of the partnership at the end of the calendar year or the fiscal year of
the partnership.

In reply thereto, I have the honor to inform you that pursuant to Sections 2 & 3,
Revenue Regulations No. 7-93 prescribing the procedures for the filing of quarterly
returns and payment of the quarterly income tax by individuals receiving self-
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employment income, a return of summary declaration or gross income and deductions
(BIR Form No. 1701 Q) for each of the first three quarters of the calendar year, and a final
or adjustment return (BIR Form No. 1701) shall be filed by all individuals, including
estates and trusts. The tax returns shall be filed on or before indicated dates:

First quarterly return - May 15 of the current year;


Second quarterly return - August 15 of the current year;
Third quarterly return - November 15 of the current year;
Final return - April 15 of the following year.

The corresponding income tax, as computed, shall be paid at the same time that
the returns are filed based on declarations of actual income and deductions for the
particular quarter. The filing of the returns and payment of taxes shall be in lieu of the
filing of a declaration of estimated income for the current taxable year and the payment
of the estimated tax as provided for in Section 67(a) and (b) (now 60) of the NIRC
primarily for the reason that the procedure prescribed in Section 67 (now 60) of the NIRC
of estimating the amount of income and tax to be paid by the individual.

Such being the case, your opinion that professional partnerships are not required
to file quarterly returns of their income is hereby confirmed. However, individual partners
of a professional partnership are required to file a return of summary declaration of
gross income and deduction for each of the first three quarters of the calendar year and
a final or adjustment return. The corresponding tax, as computed, shall be paid at the
same time that the returns are filed based on declarations of actual income and
deductions for the particular quarter. (BIR Ruling No. 94-60)

Joint venture. – A joint venture was created when two corporations while
registered and operating separately were placed under one sole management which
operated the business affairs of said companies as though they constituted a single
entity thereby obtaining substantial economy and profits in the operation. (Collector vs.
Bantangas Transportation, et al, 102 Phil. 822; See also BIR Ruling Nos. 020(b)-020-80-187-82
dated June 3, 1982; 24-000-00-115-86 dated July 17, 1986; 069-90 dated May 9, 1990)

Thus, Empire Venture which has been constituted as a single entity whereby
Empire and Uniphil agreed to pool their resources for the development of a parcel of
land and the construction of condominium units thereon as well as the eventual sale of
said units is a joint venture which is subject to the 35% Section 27 of the Tax code, as
amended. However, the respective 70% and 30% shares of Uniphil and Empire from
the profits of the joint venture are not subject to income tax Section 27 of the Tax Code,
as amended. (BIR Ruling No. 91-254)

Note: The term “corporation” mentioned in joint venture refers to a corporation as


defined by the corporation law.

Unregistered partnerships. – They, in order to be subject to corporate income


tax, must be engaged in joint venture for profit. To constitute said unregistered
partnership, the character of habituality peculiar to business transactions for the
purpose of gain must be present. (BIR Ruling No. 89-124)

STOCK DIVIDEND
- The payment by a corporation of a dividend in the form of shares usually of its
own stocks without change in per value.
- The stock distributed is a stock dividend. It is not subject to a dividend tax or
passive income. However, if the stockholder owns a common stock and the
stock dividend is preferred stock or vice – versa, then the stock dividend is
subject to tax because there is already change of interest. -

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Dividends out of quarterly profits. – This refers to your letter requesting opinion
as to whether your company can declare cash and/or stock dividends out of quarterly
profits and/or surplus.
It is represented that your company has been issuing cash and stock dividends
for the last five (5) years; that during the early part of this year, you have issued 50%
dividend out of accumulated retained earnings; and that since your company has been
making profits as early as the first quarter of this year, you intend to declare cash and/or
stock dividend out of quarterly profit.
Ruling: An ordinary dividend is the most common type of corporate distribution,
and is defined as (1) a distribution of property by a corporation to its stockholder (2)
made in the ordinary course of its business (3) out of its earnings and profits. (par. 2251,
2d Am. Jur. 33) Thus, a dividend is a corporate profit set aside, declared and ordered by
the directors to be paid to the stockholders on demand or at a fixed time. (Fisher vs.
Trinidad, 43 Phil. 973)
It is distinguished from “profits” for the profits in thousands of a corporation do not
become dividends until they have been set apart, or at least declared, as dividends and
transferred to the separate property of the individual stockholders. Such being the case,
your company can declare cash and/or stock dividends out of its quarterly profit. (BIR
Ruling No. 87-172)
Domestic Corporations and Foreign Corporations
The term “domestic,” when applied to a corporation means created or organized
in the Philippines or under its laws (Se. 22[C], NIRC), while the term “foreign,” when
applied to a corporation, means a corporation which is not domestic (Sec. 22[D], NIRC).
The branches of a domestic corporation, whether located in the Philippines or abroad,
are merely extensions of the local head office. Accordingly, their incomes in the
Philippines and abroad of the head office and foreign branches are to be reported by
the Philippine head office in its corporate income tax return, and the branch profits
remitted by its foreign branches to the Philippine head office shall no longer be subject
to the branch profit remittance tax because (a) the income of the foreign branch had
already been subjected to Philippine income tax, and (b) the branch profit remittance tax
applies only to Philippine branches of foreign corporations operating in the Philippines
operating in the customs territory and exempts from the tax profits remitted by the
Philippine branch operating in special economic zones to their head offices abroad.
A “resident foreign corporation” is a foreign corporation engaged in trade or
business within the Philippines (Sec. 22[H], NIRC), and a “nonresident foreign
corporation” is a foreign corporation not engaged in trade or business within the
Philippines (Sec. 22[I], NIRC).
Test in determining Status of Corporations
Following the above provisions, it can be said that the Philippines adopted the
“law of incorporation test” under which a corporation is considered (a) as a domestic
corporation,, if it is organized or created in accordance with or under the laws of the
Philippines, or (b) as a foreign corporation, if it is organized or created in accordance
with or under the laws of a foreign country. Corollarily, a domestic corporation may be
formed or organized by foreigners under the Philippine Corporation Code, provided that
it is organized under the laws of the Philippines. On the other hand, a corporation
established by Filipino citizens under the laws of a foreign country will be treated as a
foreign corporation, and the branch that such foreign corporation sets up in the
Philippines is a resident foreign corporation. In other words, the nationality of the
owners of the corporation has no bearing in ascertaining the status or residence of
corporations, for income tax purposes.
Doing Business

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The term “doing business” implies a continuity of commercial dealings and
arrangements, and contemplates, to that extent, the performance of acts or works or the
exercise of some of the functions normally incident to, and in progressive prosecution of
commercial gain or for the purpose of business organization. In order that a foreign
corporation may be regarded as doing business within a State, there must be
continuity of conduct and intention to establish a continuous business, such as
the appointment of a local agent, and not one of a temporary character (BOAC v.
Commissioner, 149 SCRA 395).

Partnerships
Except for a general professional partnership and an unincorporated joint venture
or consortium in construction or energy-related projects, which in reality are also
partnerships, Section 22(B) of the 1997 Tax Code considers any other type of
partnership (described here as “business partnership”) as a corporation subject to
income tax. Indeed, Section 24(B) of the 1997 Tax Code places a business partnership
and an ordinary corporation on a similar footing, by imposing the 10% dividend tax on
the cash and/or property dividends actually or constructively received by an individual
stockholder of a corporation, or in the distributable net income after tax of a partnership
of which he is a partner, except a general professional partnership, received by a
partner. The term “after-tax net profit” means the net profit of the partnership
computed in accordance with generally accepted principles of accounting, less the
corporate income tax imposed in Section 27 of the Tax Code (Sec. 2 Rev. Regs. No. 2-84,
January 16, 1984). Sec 73(D) of the 1997 Tax Code, however, provides that “the taxable
income declared by a partnership for a taxable year which is subject to tax under
Section 27(A) of this Code, after deducting the corporate income tax imposed therein,
shall be deemed to have been actually or constructively received by the partners in the
same taxable year and shall be taxed to them in their individual capacity, whether
actually distributed or not.”
Joint Ventures
Elements of joint venture. – To constitute a “joint venture,” certain factors are
essential. Thus, each party to the venture must make a contribution, not necessarily of
capital, but by way of services, skill, knowledge, material or money; profits must be
shared among the parties; there must be a joint proprietary interest and right of mutual
control over the subject matter of the enterprise; and usually, there is single business
transaction (BIR Ruling No. 317-92).
Exempt joint venture or consortium is an unincorporated joint venture or
consortium engaged in construction activity or energy-related project. – The term
“joint venture or consortium,” referred to in Section 22(B) of the 1997 Tax Code that
is not considered as a separate taxable entity, means an unincorporated entity formed
by two (2) or more persons (individuals, partnerships or corporations) for the purpose of
undertaking construction project (P.D. 929, May 4, 1976), or engaging in petroleum and
other energy operations with operating contract with the government. The term “joint
venture” was clarified by the Secretary of Finance when he issued Revenue
Regulations No. 10-2012 on June 1, 2012. In said Regulation, the joint venture that is
not taxable as a corporation must comply with the following requisites: (a) the joint
venture or consortium is formed for the purpose of undertaking construction activity; (b)
It involves jointing or pooling of resources by licensed local contractors; i.t., licensed as
a general contractor by the Philippine Contractors Accreditation Board (PCAB) of the
Department of Trade and Industry; (c) the local contractors are engaged in construction
business; and (d) the joint venture itself is licensed as such by PCAB. If all the above
requisites are not met, the joint venture becomes liable to the corporate income tax.
Each member of the joint venture not taxable as a corporation shall report and pay
taxes on their respective shares to the joint venture profit. Since it is not considered as a
separate taxable entity, the net income or loss of the joint venture or consortium is taken
up and reported by the co-venturers or consortium members in accordance with their

16
participation in the project as set forth in their agreement. The participation in the project
as set forth in their agreement. The two (2) elements – unincorporated entity (or entity
not registered with the Securities and Exchange Commission) and for the purpose of
undertaking construction or energy-related project – must be present in order that the
joint venture or consortium may not be considered as a separate taxable entity.
Tax-exempt joint venture shall not include those who are mere suppliers of
goods, services or capital to a construction project.
Joint Venture (JV) involving foreign contractors may be treated as non-taxable
corporation only if:
1. Member foreign contractor is covered by a special license as contractor by
PCAB; and
2. Construction project is certified by the appropriate Tendering Agency
(government office) that the project is a foreign-financed/internationally-
funded project and that international bidding is allowed under the Bilateral
Agreement entered into by and between the Philippine government and the
foreign/international financing institution, pursuant to the rules and regulations
of R.A. 4566 (Contractor’s License Law)
Each member of the joint venture not taxable as corporation shall report and pay
taxes on their respective shares on the joint venture profit, received by a joining
corporation.
All licensed local contractors must enroll to BIR’s eFPS at the RDO where local
contractors are registered as taxpayers.
Foreign joint venture or consortium that does not sell goods nor perform
services in the Philippines. – A joint venture or consortium formed among non-
resident foreign corporations in connection with a local project in the Philippines is not
subject to Philippine income tax, where said foreign joint venture or consortium does not
sell goods nor perform any service in the Philippines. This rule is anchored on the fact
that a foreign corporation is taxable only on income from sources within the Philippines
(BIR Ruling No. 23-95). Accordingly, no withholding tax is required to be deducted and
withheld by the Philippine payor from income payments from foreign sources made to
the foreign joint venture or consortium.
Exempt joint venture or consortium may become taxable partnership. – An
exempt joint venture or consortium undertaking a construction of office tower project
may subsequently become subject to income tax as a separate joint venture or
consortium, where after the construction period, the joint venture partners engaged in
the business of leasing the building floors or portions thereof separately owned by them
(BIR Ruling No. 317-92, October 28, 1992). The tax exemption of the joint venture granted
under the law is valid only up to the completion of the construction project and does not
extend to the subsequent sale or lease of the developed condominium floors or units to
customers.
BIR Rulings prior to Revenue Regulations No. 10-2012:
Corporations does not include joint venture undertaking construction
activity; allocation of floors, units, or lots is a mere return of capital. – The joint
ventures described above are not subject to corporate income tax under Section 27 of
the 1997 Tax Code, since the term “corporation” does not include a joint venture or
consortium formed for the purpose of undertaking construction projects pursuant to
Section 22(B) of the 1997 Tax Code. Accordingly, the memorandum of agreement, joint
venture agreement, or exclusive development and marketing agreement between or
among the contracting parties, as the case may be, will not give rise to a taxable joint
venture, and the allocation of specific floors or units or subdivision lots in the project is
not a taxable event and is not subject to income tax and expanded withholding tax,
because the allocation is a mere return of the capital that each party has contributed to
the project.

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Transfer of land to joint venture is similar to capital contribution;
distribution of developed lots/units is merely an act of partitioning commonly
owned property. – Joint venture agreements for the construction and development of
real property may or may not be treated as a separate taxable unit, depending on
whether or not a separate taxable unit, depending on whether or not a separate taxable
entity is established by the joint venture partners. If the parties did not form nor register
a separate entity and merely agreed to pool their resources to a common fund, no
separate taxable unit is created. In this case, each joint venture partner has to account
for his respective share in the net revenue earned from the joint venture project
separate income tax returns partners. Hence, the partners may file separate income tax
returns for its net revenue for the project less its respective proportionate share in the
joint venture expenses. The contribution of land to the joint venture is not a taxable
event that will give rise to capital gains tax on sale or transfer of land. Such transfer is
similar to a capital contribution that does not give rise to income tax. The distribution of
developed lots/units is merely an act of partitioning the commonly owned property. It is
nothing more than an act of terminating the co-ownership by making each partner
specific owner of the identifiable lot or unit. At this stage, no taxable sum has yet been
realized by the joint venture partners. That act of allocation or assigning portions of the
developed lots to each member of the joint venture cannot be treated as a taxable
event. The same is true despite the fact that the shares allocated to or received by the
partners may not necessarily correspond to the lot area originally contributed by them to
the joint venture. Hence, the titling of the land back to the joint venture partners is not
subject to income tax, expanded withholding tax, and value added tax (BIR Ruling DA-
165-03-18-99).

Sale of developed floor, unit or lot is subject to income tax. – Should the
corporate landowner or developer sell any of the floors or portions of the floors allocated
to them to third parties, the gain that may be realized by them from such sale will be
subject to the regular corporate income tax and to the expanded withholding tax under
Revenue Regulations No. 6-85 (now Rev. Regs. No. 2-98), as amended (BIR Ruling No.
274-92, September 30, 1992). This rule applies even if the sale takes place before or
during the construction period.
Taxable Joint Ventures
There are two (2) instances when a joint venture becomes a taxable entity. First,
a domestic corporation jointly owned by individuals and by two or more existing
domestic corporations and/or foreign corporations that is incorporated under the laws of
the Philippines (e.g., D.M. Consunji, Inc.), or duly registered with or licensed by the
Securities and Exchange Commission [e.g., Marubeni Corporation – Philippine Branch]
is a taxable corporation, even if it is engaged in the business of construction or energy-
related activity. Second, if the unincorporated joint venture or consortium (or
unregistered partnership) is engaged in any other line of business than construction or
energy-related activity with operating contract with the government, the same will also
be treated as a taxable corporation. The income and expenses of the taxable joint
venture must be reported by it during the taxable year.
Immediacy Test – Improperly Accumulated Earnings Tax (Cyanamid vs. CA,
G.R. No. 108067, January 20, 2000)
Taxation of Co-ownership (Read)
1. Ona vs. Commissioner, 45 SCRA 74
2. Pascual vs. Commissioner, 166 SCRA 560
3. Obillos vs. Commissioner, 139 SCRA 436

Section 30 - Exemption from Tax on Corporations. The corporations covered by this


section are exempted from income tax because it is generally organized not for profit
but exclusively for the benefit of their respective members. So that no income inuring to
the benefit of the individual members but for the benefit of the organization as a whole.

18
However, a corporation is not simply exempted from tax because it is not organized
and operated for profit, it is still subjected to income tax no matter how these
corporation are created. Hence, if they will have income of whatever kind and character
from any of their properties real or personal or from any of their activities conducted for
profit regardless of the disposition made of such income, they will be liable for income
tax.

For instance a non-profit corporation will sell their property and derive income
therein, that income would be subjected to income tax.

The rule that “regardless of their disposition made of such income” do not apply to
non-profit educational institution, because under the constitution all revenues and
assets of these institutions it actually, directly and exclusively used for educational
purposes will make these institution exempted from all taxes. Thus, if Xavier University,
for example, who is a non-stock, non-profit educational institution will use their rental
income from the gym for education purposes, the same is not subject to income tax.
However, if the gym rental is used for charitable purposes it would already be subjected
to income tax because what the constitution provides is only to educational purposes.

READ : 1) CIR vs. Court of Appeals, 298 SCRA 83


2) Commissioner vs. YMCA, G.R. No. 124043, October 14, 1998
3) CIR vs. St. Luke, G.R. No. 195909 – 60, September 26, 2012

Section 31 - Taxable Income means “Gross Income”, less deductions and/or


personal and additional exemptions.

The following are the deductions under the tax code:

1. Business deduction (Sec. 34, par. A – J and M): available to corporations or


individual taxpayer who are taxed on taxable income derived from business,
trade, or exercise of profession.
2. Optional standard deduction (Sec. 34, par. L); available to corporations or
individual taxpayer who are taxed on taxable income derived from business,
trade, or exercise of profession.
3. Personal exemptions (Sec. 35): only individuals allowed who are also taxable
based on taxable income.
4. Premium on health insurance / Hospitalization insurance: only individuals allowed
who are also taxable based on taxable income.

Section 32 - Gross Income

(A) General Definition – the term “all income derived from whatever source means
from legal or illegal sources.

The enumeration of items of income from no. 1 to 11 is not exclusive. Meaning that
incomes that are not mentioned in the enumeration are also included as part of gross
income.

Sources of income might be from the following activity:


1. Exercise of profession;
2. Services rendered;
3. Rentals;
4. Profits from sale or exchange of asset;
5. Business or trade;
6. And from other sources such as interest in bank deposits, dividends, and
royalties.

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Definition of Income

“Income” means an amount of money coming to a person or corporation within a


specified time, whether as payment for services, interest or profit from investment.
Unless otherwise specified, income means cash or its equivalent (Conwi v. CTA and
Commissioner, 213 SCRA 83). Income is a flow of service rendered by capital by the
payment of money from it or any other benefit rendered by a fund of capital in relation to
such fund through a period of time (Madrigal v. Rafferty, 38 Phil. 414). Income covers gain
derived from capital, from labor, or from both combined, provided it be understood to
include profit gained through a sale or conversion of capital assets (Fisher v. Trinidad,
supra). Income includes earnings, lawfully or unlawfully acquired, without consensual
recognition, express or implied, of an obligation to repay and without restriction as to
their disposition (James v. U.S., 366 U.S. 213). Thus, income from illegal drug and
gambling activities is taxable as well.

Income may include: (a) increase in inventory at the end of the taxable year;
however, mere increase in the value of property is not income but increase in capital;
(b) transfer of appreciated property to employee for services rendered; and (c) just
compensation paid by government for property acquired by expropriation.

Income is an amount of money coming to a person within a specified time, whether


as payment of services, interests or profits from investments.

Presumed Gain (Capital Gains on Sale of Real Property) is also income.

Gain is synonymous with income.

Gain may be derived from capital, labor or both.

“Income in taxation does not solely mean profit. Hence, SP may be considered an
income if provided by law. But capital is never treated as “Income”.

Profits or gain may also derive through sale or conversion of an asset.

There is no statutory definition of income under the tax code. However, under
Section 36 of the Revenue Regulation No. 2, income is defined that in its broad sense,
means all wealth which flows into the taxpayer, other than as a mere return of capital.

An income to be considered as taxable must be:

1. Actually or constructively received;


2. It must be realized.

Test in determining INCOME.

a. Realization test. – There is no taxable income until there is a separation from


capital of something of exchangeable value, thereby supplying the realization
or transmutation which would result in the receipt of income (Eisner v.
Macomber, 252 U.S. 189). Thus, stock dividends are not income subject to
income tax on the part of the stockholder, because he merely holds more
shares representing the same equity interest in the corporation that declared
the stock dividends (Fisher v. Trinidad, supra).
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. To
collect a tax would give the government an unjustified preference as to the
part of the money that rightfully and completely belongs to the victim. The
embezzler’s title is void (Commissioner v. Wilcox, 286 U.S. 417, 424).

20
On May 27, 1977, Dolores Ventosa requested the transfer of US$1,000
from the First National Bank, West Virginia to Victoria Javier in Manila
through the Prudential Bank. Accordingly, the First National Bank
requested the Mellon Bank to effect the transfer. Unfortunately, the wire
sent by Mellon Bank to Manufacturers Hanover Bank, a correspondent
bank of Prudential Bank, indicated the amount transferred as
“US$1,000,000.00” instead of US$1,000.00. Hence, Manufacturers
Hanover Bank transferred one million dollars less bank charges to
Prudential Bank for the account of Victoria Javier. On June 3, 1977, Javier
opened a new dollar account (No. 343) in the Prudential Bank and
deposited $999,943.70. Immediately thereafter, Victoria Javier and her
husband, Melchor Javier, Jr. made withdrawals from the account,
deposited them in several banks only to withdraw them later in an
apparent plan to conceal, lauder and dissipate the erroneously sent
amount. Spouses Melchor and Victoria Javier filed their consolidated
income tax return for the ear with the notation “The taxpayer was the
recipient of some money from abroad which he presumed to be a gift but
turned out to be an ‘error’ and is now subject of litigation,” but they did not
declare it as income. The court ruled that the amount received is income
subject to tax, but the tax return filed cannot be considered as fraudulent
because petitioner literally “laid his cards on the table” for respondent to
examine. Error or mistake of fact or law is not fraud (Commissioner v. Javier,
199 SCRA 824).
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 (Blas Gutierrez v. Collector, 101 Phil. 713).
d. Economic benefit test. – Any economic benefit to the employee that
increases his networth (i.e., total assets less total liabilities), whatever may
have been the mode by which it is effected, is taxable. Thus, in stock options,
the difference between the fair market value of the shares at the time the
option is exercised and the option price constitutes additional compensation
income to the employee at the time of exercise (not upon the grant or vesting
of the right) (Commissioner v. Smith, 324 US 177).
e. Severance test – as capital or investment is not income subject to tax, the
gain or profit derived from the exchange or transaction of said capital by the
taxpayer for his separate use benefit or disposed income subject to tax.
f. Substantial alteration of interest lost – income to be returnable for taxation
must be fully and completely realized. When there is no separation of gain or
profit, or separation of the increase in value from capital, there is no income
subject to tax.
g. Flow of wealth test –anything/implying existence of capital
a) Capital is fund income is the flow;
b) Capital is wealth income service of wealth;
c) Property is tree income is fruit;
d) Labor is tree income is fruit.

All of the following tests are followed in the Philippines for purposes of
determining whether income is received by the taxpayer of not during the year.
Significance of knowing the Type of Character of Income

In general, it is important to know the types of income realized by the taxpayer,


since the Philippines has adopted the semi-global or semi-schedular tax system. Under
this tax system, compensation income, and other income not subject to final income tax,
are added together to arrive at the amount of gross income of an individual, and after
deducting the allowable deductions from business and professional income, capital
gains, passive income, and other income not subject to final income tax as well as

21
personal and additional exemptions, if qualified, the graduated income tax rates ranging
from five percent (5%) to 32% are applied in the resulting net taxable income to arrive at
the income tax due and payable.

The passive investment income are generally subject to the final withholding tax;
hence, the income recipient does not file a tax return covering such passive investment
incomes, although the withholding agent-payor of income is held responsible under the
law to deduct, withhold and remit the final income tax thereon to the BIR.

Capital assets subject to the final capital gains tax such as shares of stock of a
domestic corporation and real property located in the Philippines, except when sold or
transferred by a dealer in securities or real estate dealer, are covered by the capital
gains tax return; hence, not included in the taxable income of the individual taxpayer
subject to the global tax system and the graduated income tax rates.

The rules for individuals discussed above apply also to a corporation, except that
the corporation does not receive compensation income and are not entitled to deduct
personal and additional exemptions from their gross income during the year.

Compensation Income

In general, the term “compensation” means all remuneration for services


performed by an employee for his employer under an employer-employee relationship
(See Sec. 2.78.3, Rev. Regs. No. 2-98, as amended), unless specifically excluded by the
Tax Code. In determining the existence of an employer-employee relationship, the
elements that are generally considered are: (a) the selection and engagement of the
employee; (b) the payment of wages; (c) the power of dismissal; and (d) the employer’s
power to control the employee with respect to the means and methods by which the
work is to be accomplished. It is the so-called “control test” that is the most important
element (Brotherhood Labor Unity Movement of the Philippines v. Zamora, L-48645, January 7,
1987).

Who is an employee?

For taxation purposes, a director is considered an employee under Section 5 of


Revenue Regulations No. 12-86, to wit: “An individual, performing services for a
corporation, whether as an officer and director or merely as a director whose duties are
confined to attendance at and participation in the meetings of the Board of Directors, is
an employee.” The non-inclusion of the names of some of petitioner’s directors in the
company’s Alpha List for 1997 does not ipso facto create a presumption that they are
not employees of the corporation, because the imposition of withholding tax on
compensation hinges upon the nature of work performed by such individuals in the
company. Moreover, Section 2.57.2.A(A) of Revenue Regulations No. 2-98 cannot be
applied to this case as the latter is a later regulation, while the accounting books
examined were for the year 1997 (First Lepanto Taisho Insurance Corporation v. CIR, G.R.
No. 197117, April 10, 2013). [NOTE: Beginning 1998, a director who is not an officer or
employee of a corporation is NOT an employee of said corporation; hence, the
applicable withholding tax to be deducted from such income shall be 10% EWT, which
is creditable against his ordinary income tax liability for the year, provided it is
evidenced by BIR Form 2307. However, said director’s fee is taxed also under the
global tax system].
The term “employee” refers to any individual who is the recipient of wages and
includes an officer, employee or elected official of the government or any political
subdivision, agency or instrumentality thereof. It includes also an officer of a
corporation. Thus, a juridical entity that performs services to another person is not an
employee of the latter. Accordingly, the proper withholding tax on such income payment
is the expanded withholding tax (not withholding tax on compensation income). To
create an employer-employee relationship, the person that performs the service to
another must be an individual.

22
The term “compensation income” means all remuneration for services
performed by an individual employee for his employer, including the cash value of all
remuneration paid in any medium other than cash. There are various types of taxable
compensation income, such as salaries, wages, bonus, remuneration, honorarium,
benefits and allowances (including representation and transportation allowance (RATA),
personal emergency relief allowance (PERA), longevity pay, subsistence allowance,
hazard pay, annuities, pensions, etc. Additional compensation allowance (ACA) given to
government employees pursuant to E.O. 219 shall not be subject to withholding tax
pending its formal integration into the basic pay. While its nature shall continue to be
that of compensation, it shall be treated as part of the “other benefits” which are
excluded from compensation income, provided that the total amount does not exceed
₱30,000 (BIR ruling No. 034-2002, August 16, 2002 modified BIR ruling No. 179-99, November
22, 1999). BIR Ruling Nos. 120-96, November 8, 1996 and 062-2000, November 20,
2000 exempt benefits and allowances such as longevity pay, subsistence allowance,
and hazard pay granted to uniformed policemen and jail guards under R.A. 6975
(DILG Act of 1990). However, if the recipient is an AFP personnel, all remunerations
(monetary and non-monetary) are taxable, except allowances for quarters, clothing and
subsistence which are exempt from income tax pursuant to RMC 15-87 (BIR Ruling No.
143-96, December 24, 1996).

Compensation Income of Philippine Nationals and Aliens Employed by Foreign


Governments and International Organizations in the Philippines

Section 23 of the Tax Code lays down the general principles in taxing citizens
and alien individuals. Resident citizens are taxed on worldwide income, while resident
aliens are taxed only on their Philippine-source income. As an exception to the general
rule, most international agreements which grant withholding tax immunity to foreign
governments/embassies/diplomatic missions and international organizations also
provide exemption to their officials and employees who are foreign nationals and/or
non-Philippines residents from paying income taxes on their salaries and other
emoluments.

Since the withholding tax is merely a method of collection of income tax, the
exemption from withholding taxes on compensation income of foreign
governments/embassies/diplomatic missions and international organizations does not
equate to the exemption from paying the income tax itself by the recipients of said
income.

Foreign Embassies and Diplomatic Missions

Articles 34 and 37, Vienna Convention on Diplomatic Relations, exempts: (a)


diplomatic agents who are not nationals or permanent residents of the Philippines; (b)
members of family of diplomatic agent forming part of his/her household who are not
Philippine nationals; (c) members of administrative and technical staff of the mission
plus members of their families who are not Philippine nationals or permanent residents
of the Philippines; (d) members of service staff of the mission who are not Philippine
nationals or permanent residents of the Philippines; and (e) private servants of
members of the mission who are not Philippine nationals or permanent residents of the
Philippines. The applicable rules are as follows:
Aid Agencies of Foreign Governments
JICA: Only JICA resident representatives and his/her staff who were “dispatched
from japan” shall not be subject to Philippine income tax.
GIZ: (Germany): Only German specialist of German construction and consulting
firms shall be exempt.
AUSAID: Salaries and other remuneration paid by the Government of Australia
or by Australian personnel, firms, institutions or organizations to any person
performing work under the Memorandum shall be exempt.

23
CIDA: Only Canadian personnel who derive income from Canadian aid funds as
provided under the subsidiary agreement shall be exempt.

Advisory Committee on Voluntary Foreign Aid-USA


CARE: Only Care employees who are not Philippine nationals are exempt.
FPPI or PLAN: Only non-Filipino staff members of the PLAN who receive
salaries and stipends in US dollars shall be exempt.

Aid Agencies
Ford Foundation, Rockefeller Foundation, Agricultural dev Council, and Asia
Foundation: only non-Filipino staff members thereof who receive salaries
and stipends in US dollars shall be exempt.
IRRI (PD 728 and RA 3538)
Catholic Relief Services – NCWC and Tools for Freedom Foundation (R.A. 4481)

Asian Development Bank (ADB) – Section 45(b), Article XII of the Agreement
between ADB and RP: Only officers and staff of ADB who are not Philippine nationals
shall be exempt from Philippine income tax (because exemption is “subject to the
power of the Government to tax its nationals.” Any exemption from Philippine
income tax must be granted under duly recognized international agreements or
particular provisions of existing law. Affected individuals (of foreign embassies and
international organizations) who were not granted such exemption must file their income
tax returns and pay the tax due thereon on or before the 15 th day of April following the
close of the taxable year (RMC 31-2013, April 12, 2013).

Statutory Minimum Wage

Compensation income falling within the meaning of “statutory minimum wage”


(SMW) under R.A. 9504, effective July 6, 2008, as implemented by Revenue
Regulations No. 10-2008 dated July 8, 2008, shall be exempt from income tax and
withholding tax. Holiday pay, overtime pay, night shift differential pay, and hazard pay
earned by Minimum Wage Earner (MWE) shall likewise be covered by the above
compensation such as commissions, honoraria, fringe benefits. Benefits in excess of
the allowable statutory amount of ₱30,000, taxable allowances and other taxable
income other than the SMW, holiday pay, overtime pay, hazard pay and night shift
differential pay, shall not enjoy the privilege of being a MWE and, therefore, his/her
entire earnings are not exempt from income tax and withholding tax.

Hazard pay shall mean the amount paid by the employer to MWE’s who were
actually assigned to danger or strife-torn areas, disease-infested places, or in distressed
or isolated stations and camps, which expose them to great danger of contagion or peril
to life. Any hazard pay paid to MWE’s which does not satisfy the above criteria is
deemed subject to income tax and withholding tax.

When an award of backwages is made, there is an acceptance that the


employee was illegally or unjustly dismissed, and the backwages are the salaries he
was supposed to have earned had he not been dismissed. It is as though he was not
separated from employment, and as though he actually rendered service (Escareal v.
Court of Tax Appeals, et al., CA-GR SP No. 41989, September 30, 1998). In this connection,
RMC 39-2012 dated August 3, 2012 provides that the employee should report as
income and pay the corresponding income taxes by allocating or spreading his back
wages, allowances and benefits through the years from his separation up to the final
decision of the court awarding the backwages. The said backwages, allowances and
benefits are subject to withholding tax on wages. However, when the judgment awarded
in a labor dispute is enforced through garnishment of debts due to the employer or other
credits to which the employer is entitled, the person owning such debts or having in
possession or control of such credits (e.g.., banks or other financial institutions) would

24
normally release and pay the entire garnished amount to the employee. As a result,
employers who are mandated to withholding taxes on wages pursuant to Section 79 of
the Tax Code, as implemented by Revenue Regulations No. 2-98, cannot withhold the
appropriate tax due thereon. In this regard, the “employer” also refers to the person
having control of the payment of the compensation in cases where the services are or
were performed for a person who does not exercise such control. Thus, the person
owning or having possession or control of the credit shall withhold the required tax.

Backwages, Allowances, and Benefits Awarded in Labor Dispute

Backwages, allowances, and benefits awarded in a labor dispute constitute


remuneration for services that would have been performed by the employee in the year
when actually received, or during the period of his dismissal from the 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.

The backwages, allowances, and benefits are subject to withholding tax on


wages.

However, when the judgment awarded in a labor dispute is enforced thru


garnishment of debts or having in possession or control of such credits (e.g., banks or
other financial institutions) would normally release and pay the entire garnished amount
to the employee. As a result, employers who are mandated to withhold taxes on wages
cannot withhold the appropriate tax due thereon.

In order to ensure the collection of the appropriate withholding tax on wages,


garnishees of a judgment award in a labor dispute are constituted as withholding agents
with the duty to withhold tax on wages equivalent to five percent (5%) of the portion of
the judgment award, representing the taxable backwages, allowances and benefits
(RMC 39-2012, August 3, 2012).

Items Not Included as Compensation Income

Compensation shall not include remuneration paid: (a) for agricultural labor paid
entirely in products of the farm where the labor is performed; or (b) for domestic service
in a private home; or (c) for causal 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 an international organization (Sec. 78[A], NIRC).

As a general rule, the income recipient is the person liable to pay the income tax.
In order to improve the collection of income on the compensation income of employees,
the State requires the employer to withhold the tax upon payment of the compensation
income, such that at the end of the calendar year, the employee needs only to file a tax
return and no tax is paid, because his total withholding tax during the year is equal to
his income tax liability. [Beginning 2002, qualified employees need not file their income
tax returns and the employer may file a substituted return for its employees.]
Other Income

Income from any source whatever


The phrase “income from any source whatever” is broad enough to cover
gains contemplated here. These words disclose a legislative policy to include all income
not expressly exempted within the class of taxable income under our laws, irrespective

25
of the voluntary or involuntary action of the taxpayer in producing the gains (Blas
Gutierrez v. Collector, supra).

Any economic benefit to the employee, whatever may have been the mode
by which it is implemented, is income subject to tax. Thus, in stock options, the
difference between the fair market value of the shares at the time the option is
exercised and the option price constitutes additional compensation income to the
employee (Commissioner v. Smith, supra). A stock option is a right, but not an obligation,
to purchase (call option) or sell (put option) a specified number of shares at a fixed price
before or at a certain date in the future
The principle underlying the taxability of an increase in the net worth of a taxpayer
rests on the theory that such an increase in net worth, if unreported and not
explained by the taxpayer, comes from income derived from a taxable source. In
this case, the increase in net worth was not the result of the receipt by it of taxable
income. It was merely the outcome of the correction of an error in the entry in its books
relating to its indebtedness to the insurance company. The income tax law imposes a
tax on income; it does not tax any or every increase in networth whether or not derived
from income (Fernandez Hermanos, Inc. v. Commissioner, CTA Case 787, June 10, 1963)
READ : Madrigal vs. Rafferty , 38 Phil. 414
The tax code did not indicate the source of income (Blinds Sources). What it
enumerates are specific items of income.
Are the following items considered income?
1. Found treasure – other forms of gain;
2. Punitive damages/damages for breach of promise or alienation of affection;
3. Recovery of bad debts;
4. Tax refund;
5. Non-cash benefits;
6. Income from illegal sources;
7. Prizes, scholarship, fellowship;
8. Forgiveness of debt.
In the case of Commissioner vs. Tours Specialist, 183 SCRA 402, the Supreme
Court stated that taxable income, however, does not include items received which do
not add to the taxpayer’s net worth or redound to his benefit such as amounts merely
deposited or entrusted to him.
The following are not income: (a) deposit of property that does not increase
networth of taxpayer (e.g., the increase in asset has a corresponding increase in
liability); (b) increase in networth is due to correction of errors in book entries; (c)
voluntary assessments by a corporation paid by its shareholders under Revenue
Regulations No. 2; (d) security deposit paid to a lessor until it is applied in payment of
accrued rent; (e) contributions by lot owners for the memorial park care fund; and (f)
loan proceeds received by the borrower.
(B) Exclusion from Gross Income – an income can be exempted from taxes based
on the following reasons:
1. Exemption by the fundamental law of the land;
2. Exempted by the statute;
3. It does not come within the definition of income such as stock dividend or
increase in the appraisal of the FMV of the property.
Some Principles:

A tax free income is different from a tax free organization.

26
Doctrine of Constructive Receipt of Income means that it was already set aside,
without limitations, restrictions or conditions for its withdrawal. Example share of the
partner in a general partnership.

Doctrine of Cash Equivalent in Transaction means that if a property is exchanged


with another property the difference of a Fair Market Value (FMV) would be considered
income.

The Material Benefit rule (CIR vs. Javier, 199 SCRA 824), means that under the
solutio indebiti rule, if the holder of the property has the obligation to return it and
instead use it for his own benefit, the amount to be returned would be considered an
income.

Exclusions from Gross Income simply means that these incomes are not subject to
income tax:
 There are only instances an item of income would not be subjected to income
tax:
1. If it is exempted by the Constitution.
2. If it is exempted by the statute or law.
3. When it does not come within the definition of income.
Example: increase of appraisal value of the property

1. Life Insurance – proceeds of life insurance being only an indemnity of life lost is
not subject to income tax. However, it can be subjected to estate tax if the rules
of the estate taxes will apply. If it is an accident insurance and it includes
coverage of life insurance the proceeds would not be subjected to income tax.
2. Return of Premium not subject to income tax because it is just a mere return of
capital.
3. Gifts, Bequests, and Devises not subject to income tax but subject to estate tax
or donor’s tax.
4. Compensation for Injuries or Sickness includes physical, moral and psychological
injuries.

Lost profits recovered are subject to income tax.

5. Income Exempt under Treaty would not be subject to tax because of the treaty
(International Comity) entered into by the government with other countries.
6. Retirement Benefits covered by a private benefit plan maintained by the
employer would be exempted from income tax if the following conditions will be
present:

(1) The retiring employee is in the service of the same employer for at least ten
(10) years;
(2) He is not less than fifty (50) years of age at the time of retirement.
(3) You retired under the private benefit plan of the employer.

The aforestated conditions would be applicable if there is a reasonable private


benefit plan of the employers.

Retiring person which has no private retirement plan by the employer:


A. Private Employee - labor code will govern. Requirements are the following:

(1) At least sixty (60) years old but not more than sixty-five (65) years old.
(2) Has served at least five (5) years of service with the same employer.
(3) Entitled retirement ½ salary for every year of service but not less than one
month salary.

27
If it is a government employee, retirement will be governed either by the retirement
plan of the government agency or by the GSIS.

B. Pseudo retirement, or involuntary retirement, or compulsory retirement.

Involuntary retirement is present if the employee did not ask, did not initiate, and it is
not of his own choice that he is retired. The reasons may be because of the death,
sickness or other physical disability, or for any cause beyond the control of the said
official or employee. Some other grounds like retrenchment, redundancy, closure of
business, are also other forms of involuntary retirement. The retirement benefits
received from involuntary retirement not subject to income tax.

BIR Ruling No. 071-95, April 11, 1995 – retirement under CBA is taxable for being
voluntary. If the company has no BIR approved retirement plan an employee who is
separated against his will but who signed a CBA, the retirement benefits under the CBA
is taxable because by signing the CBA it will make his separation voluntary.

C. Foreign retirement benefits gratuitously received by a resident or non-resident


citizen of the Philippines or alien who come to reside permanently in the Philippines are
exempted from income tax.

D. Benefits given to persons residing in the Philippines whether alien or citizen by


the USVA exempted from income tax.

SSS and GSIS benefits are exempted from income tax.

7. Miscellaneous Items (READ: CIR vs. Mitsubishi, G.R. No. 54908, Jan. 22, 1990).

a) Income Derived from Foreign Government are exempt because of


reciprocity between countries, if there is a treaty or law that exempts it. Take
note of the source of income.
b) Income Derived by the Government or its Political subdivisions not subject
to tax because it is an inherent limitation, provided that the government
agency is performing governmental function.
c) Prizes and Awards – conditions to exempt from income tax:

I. The award is primarily:


(1) religious;
(2) Charitable;
(3) Scientific;
(4) Educational;
(5) Artistic;
(6) Literary;
(7) Or civic achievement;
II. There was involuntary participation by the recipient
III. The award is unconditional meaning he is not required to render
substantial future service as a condition to receiving the prize or
award.

All the three (3) conditions must be present to be exempted from income tax.

Mnemonics to remember: R E L A C C S

READ: R.A. 7549, May 22, 1992

E. 13th Month Pay and Other Benefits – Gross benefits received by officials and
employees of public and private entities: Provided, however, that the total exclusion
under this subparagraph shall not exceed ₱82,000.00. (R.A. 10653, February 12, 2015)

28
13th month pay are exempted if received by public or private entities. The first
₱82,000.00 would be exempted, the excess would be subjected to income tax.

The term other benefits includes Christmas bonus, monthly bonus, quarterly bonus,
etc.

Nota Bene – take note of the tax provisions for minimum wage earners which
exempt compensation and other benefits.

F. GSIS, SSS, Medicare, Pag-IBIG contributions (which are employer’s share) are
exempted from income tax including union dues but not including contributions made by
employers which are not enumerated in par. F to be exempt.

G. Self-explanatory.

H. Self-explanatory.

Section 33 - Fringe Benefit – this tax is imposed to the employee but payable by the
employer under the withholding tax system.

Rank and file employees are exempt from Fringe Benefit Tax (FBT)

Only supervisory or managerial employee are liable to pay FBT, except if:

1) The FB is required by the nature of the employment;


2) Necessary to the trade, business or profession of the employer;
3) FB is for the convenience and advantage of the employer.

The tax base is grossed up monetary value of the FB.

FB given to employees which are non-residents alien individual not engaged in trade
or business within the Philippines including the special alien individuals under Section
25 shall not be subject to FBT but the regular rates imposed under Section 25.

Memorize definition of FB under Sec. 33.

FB means employees benefits supplementary to a money wage or salary.

Example of FB - see par. B, Section 33, no. 1-10

FB that are not taxable – refer to par. C, Section 33. (memorize)

If the FB is already subjected to FBT it is no longer subject to tax as compensation


income. So that if the FB is exempted from FBT it would still be subject to compensation
income tax unless if the employee is also exempted from the income tax.

De minimis benefits (benefits of small value) is exempted both from FBT and
compensation income tax.

Examples of De minimis benefits:

1) monetized unused vacation leave not exceeding ten (10) days for private
employees; for public employees no limit.
2) Medical cash allowance to dependents not exceeding ₱700.00/semester or
₱125.00/month;
3) Rice subsidy ₱1,000.00/month or less;
4) Uniform allowance ₱3,000.00/annum;
5) Medical benefits ₱1,000.00/annum;
6) Laundry allowance ₱300.00/month.

29
READ: Revenue Regulation No. 1-2015

CHAPTER VII. Allowable Deductions.

A. Business Expenses in general: (Sec. 34 A)

I. Ordinary and Necessary Trade, business or Professional Expenses.


Requisites:

1. Ordinary and necessary


2. Paid or incurred during the taxable year (fiscal or calendar year)
3. Connected and related to the taxpayer’s business
4. Substantiated by receipts or invoices’ (par b(1)A)
5. To be deducted in the category it belongs (e.g. taxes cannot be deducted
as losses)
6. Reasonable expense
7. Not contrary to law, morals, public policy, public order, good customs.

Bribes, kickbacks and other similar payments NOT ALLOWED as expense.

Private Educational Institutions (Proprietary) is given the option to deduct the


expenditures which are capital outlay for expansion of school facilities either:

1. Deduct the entire amount of expenditures during the taxable year, or


2. Deduct as depreciation expense

II. Itemized Deductions (the same requisites with the ordinary but with additional
conditions):

1. Interest Expense (4 requisites)


- there must be an indebtedness
- proceeds of the loan is utilized in the business
- there must be a legal liability to pay interest
- indebtedness must be that of the taxpayer
- Tax Arbitrage Scheme – the amount of interest of loans will be
deducted from business income net of the interest income received by the
taxpayer from his bank deposits subject to Final Tax

Example:

Interest Expense ₱ 60,000


Less : Bank deposit interest income
₱50,000 x 38% (effective Jan. 1, 2000) ₱ 19,000
Deductible interest expense ₱ 41,000

- Different treatment if the taxpayer used the CASH METHOD and


the interest on loans was prepaid interest expense. The entire prepaid
interest expense will not be deducted on the year the loan was incurred.
The interest to be deducted must be prorated with the payment of the
principal loan.
- Sec. 36(b). interest expense on loans obtained from related
persons [Sec. 36(b)] NOT DEDUCTIBLE.

- Interest on indebtedness incurred to finance petroleum exploration


NOT DEDUCTIBLE.

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- Optional treatment of Interest Expense when loans are incurred to
acquire property to be used in business:
1. Deduct the interest as outrightly; or
2. Treat the interest as capital expenditures. To be deducted
through depreciation.

2. Taxes

The following cannot be deducted:


1. Income Tax
2. Foreign Income Tax (if Foreign Tax credit is not utilized)
3. Estate and Donor’s Taxes
4. Transfer Tax on sale of shares of stocks (Sec. 127d)
5. Special Assessments

Taxes that are not enumerated above are deductible from business income provided
it is connected.

Foreign Tax Credit – is a portion of foreign income tax which can be used as a
deduction from the Philippine Income Tax due.

Two approaches:
1. Gross Income (within and without) ₱xxx
Less : Deductions (including Foreign Income Tax) ₱xxx
Taxable income ₱xxx
OR
2. Gross Income (within and without) ₱xxx
Less : Deductions (not including Foreign Income Tax) ₱xxx
Taxable income ₱xxx

Phil. Income Tax Due ₱xxx


Less : Foreign Tax Credit (FTC) ₱xxx
Tax still due ₱xxx

FTC will only arise if the taxpayer is taxable in the Philippines of income derived
within and without the Philippines

C – to determine FTC there is a Formula. The entire foreign tax paid cannot be used
as FTC.

3. Losses

Kinds of Losses
A. Ordinary losses – operation of the business
- NOLCO will apply
- connected with business

B. Casualty losses - properties used in business


- loss arises from fires, storms, shipwreck, or other
casualties, robbery, theft or embezzlement.
- to be reported to the BIR not less than 30 days and
not more than 90 days.
- not used as a losses deduction for estate tax
purposes
- proof of loss (par. 2 of par. D). study carefully.
- should not be compensated by insurance to be
deductible.

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C. Capital losses - (to be discussed with Capital Gains)

D. Losses from Wash Sales - (to be discussed in Sec. 38)

E. Wagering losses (gambling) – to be deducted only from gambling


gains [Sec. 39 (a)]

F. Abandonment losses – read

4. Bad Debts (A/R that cannot be collected)


READ : Pareño vs. Sandigan. 256 SCRA 242
- Connected to business
- Actual bad debts or write-offs, not the estimated bad debts
- If recovered later after it was deducted, then the recovered bad
debts to be included as part of gross income in the taxable year it
was recovered. This is the Tax Benefit Rule.
- The tax benefit rule applies also to taxes previously used as a
deduction and later the taxpayer was able to get a refund.

5. Depreciation
- property, plant and equipment are normally usable for a number of
years. A point will be reached when such property may not be
useful anymore in the business die to exhaustion, wear and tear.
- the owner will be able to recover the cost of the property because
it will gradually or periodically deducted from his gross income as
deduction called depreciation.
- depreciation will only apply to extraordinary expenditures or capital
expenditures.

Depreciation – for income tax purposes, depreciation means the reduction in service
value or property used in business or trade arising from exhaustion, wear and tear, and
obsolescence. (Sec. 195, Rev. Reg. No. 2)

Depreciation commences with the acquisition of the property or with its erection.

Depreciation of properties used in petroleum operations is allowable.

Requisites for claiming depreciation deductible are as follows:

(a) It must be charged off


(b) Must be deducted directly from the book value of the assets
(c) Must be reasonable allowance
(d) Property must be used or employed in business or trade or must be determined
if it is not being used.

The proper allowance for depreciation of any property used in trade or business, or
out of its not being used, is that sum which should be set aside for the taxable year in
accordance with a reasonable consistent plan whereby the aggregate of the sums so
set aside, plus salvage value, will, at the end of the useful life of the property, suffice to
provide an amount equal to the original cost. (Sec. 195, Rev. Regs. No. 2)
Depreciation – a deduction from gross income for depreciation is allowed but limits
the recovery to the capital invested in the asset being depreciated. The law does not
authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction
over and above such cost cannot be claimed and allowed. The reason is that
deductions from gross income are privileges not matters of right. They are not created
by implication but upon clear expression of the law. (Basilan Estates, Inc. vs.
Commissioner, G.R. No. L-22492, Sept. 5, 1967)

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Goodwill, trademarks, formulas.
(1) Business and income producing property other than land, generally depreciates
or loses its usefulness and value with the passage of time. A deduction for such
depreciation is allowed in computing taxable income. As such, your opinion that the
assigned cost on the plant as determined at the time of purchase can be depreciated for
tax purposes is hereby confirmed.
(2) Goodwill, including trademarks, trade names, and trade brands, are not such
property as are subject to exhaustion. Accordingly, the value assigned on the
trademarks which is computed on the basis of future sales cannot be discounted to its
present value at the time of acquisition and cannot be amortized for tax purposes over
the average remaining lives of the different trademarks purchased.
(3) Right to receive royalties over a given term is depreciable. Accordingly, your
opinion that discounted or present value at the time of acquisition and that it is
acceptable for tax purposes to amortize the said present values and royalties to be paid
on the basis of future sales may be discounted, to determine the present values and
may be paid at said price (i.e., the cash price as discounted) over the agreed period
(say 5 to 8 years) when royalties will have to be paid is hereby confirmed. Moreover,
said royalty payment is subject to the 20% final withholding tax.
(4) Formulas are not subject to annual depreciation. If, however, after acquisition, a
formula is found to be worthless, its cost may be deducted in full as a loss for the year in
which the formula is abandoned as being worthless. Accordingly, the cost of the
different formulas cannot be amortized over the (a) remaining life of the trademarks
purchased or (b) the expected period within which your client proposes to continue
manufacturing said products using the said formulas.
(5) Amounts paid for an agreement not to compete in a trade or business, where
the taxpayer can prove the existence of such an agreement, are capital expenditures
and subject to allowances for depreciation ratably spread over the period mentioned in
the agreement but only where the elimination of competition is for a definite and limited
term may the cost be exhausted over such a term. Accordingly, your opinion that the
value agreed between your client and seller may not compete in the same line of
business that was sold to your client is hereby confirmed.
(6) Goodwill is not such property as is subject to exhaustion. Accordingly, your
opinion that any amount of goodwill paid for by your client may not be deducted for tax
purposes unless the same business or the assets related to the said goodwill is sold by
your clo9ent is hereby confirmed. (BIR Ruling No. 88-206)
Patents, copyrights, etc. – Intangibles, the use of which in the trade or business is
definitely limited in duration, may be the subject of a depreciation allowance. Examples
are patents, copyrights and franchises. Intangibles, the use of which in the business or
trade is not so limited, will not usually be a proper subject of such an allowance. If,
however, an intangible asset acquired through capital outlay is known from experience
to be of value in the business for only a limited period, the length of which can be
estimated from experience with reasonable certainty, such intangible asset may be the
subject of a depreciation allowance provided the facts are fully shown in the return or
prior thereto the satisfaction of the Commissioner of Internal Revenue. (Sec. 107, Income
Tax Regulations)
Such being the case, the value assigned on the trademarks which is computed on
the basis of future sales can be discounted to its present value at the time of acquisition
and can be amortized for tax purposes over the average remaining lives of the different
trademarks purchased. Moreover, the cost of the different formulae can be amortized
over the (a) remaining life of the trademarks purchased or (b) the expected period within
which your client proposes to continue manufacturing said products using the said
formulae.

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- Methods
Cost – Salvage Value
1. Straightline method - Life (years)

2. Declining balance method


3. Sum of the years digit method. Read very well par. 4 (petroleum
operations) and par. 6.

6. Depletion
- it is the cost or value of the exhaustion of natural resources, such
as mines and oil and gas wells, as a result of severance of
production. Only persons having an economic interest in a mineral
land or oil gas wells are entitled to a depletion allowance (which
should not be more than the capital invested). To acquire an
economic interest, the taxpayer must have a capital investment in
the property and not a mere economic advantage.

7. Charitable and Other Contributions (par. H)


Two kinds
1) Deductible in Full (see par 2(a), (b), (c), and (d)
2) Deductible subject to limitation on the following:
1. Public purpose
2. Religious, charitable, scientific, youth, sports development,
cultural or educational purposes

Individual donor – not in excess of 10% of taxable income without


including the charitable contribution as a deduction, whichever is
lower with the original contribution.
Corporate donor – the same rule above except the rate is 5%

In both cases (full or with limitation) the contribution is given to a juridical


person.

8. Research and Development – self-explanatory (read)

9. Pension Trust
Requisites:
1. Employer contributes for the pension trust for the payment of
reasonable pension for employees. The contribution is a deductible
business expense.

10. Optional Standard Deduction (OSD)


- in lieu of the business deductions which required receipts
- non-resident alien cannot claim OSD
- NRFC not allowed OSD
- election of OSD is irrevocable for the taxable year for which the
return was made
- deduction rate is 40% of Gross Income/Gross Sales/Gross Receipt
- there is no need to support the deduction with receipts
- a source of tax avoidance

34
If the taxpayer failed to elect the kind of deduction in his income tax return, he shall
be considered as having availed himself of the itemized deduction. Deduction elected
for one taxable year is irrevocable for that year. If the taxpayer elected both deductions
in one taxable year, the optional standard deduction will be disregarded. It must be
emphasized that for one taxable year, a taxpayer must elect only one kind of deduction.

11. Premium Payments on Health and/or Hospitalization insurance


- only individuals (except NRA not doing business) can claim as
deduction if taxable under the schedular rates.
- a deduction whether engaged in business or compensation earner.

Query: (1) How much is the amount deductible?


(2) What is the ceiling of gross income to be allowed?
(3) Who can claim if the taxpayers are married?

12. Personal Exemptions


- For individuals only whose tax base is TAXABLE INCOME (Sec.
24-A)
- Regardless of STATUS BASIC P50,000.00
- Additional Exemptions for Dependent ₱25,000.00 for each but not
more than four (4) dependents.

Additional Exemptions for Dependents. –There shall be allowed an additional


exemption of ₱25,000.00 for each dependent not exceeding four (4) children.

The additional exemption for dependents shall be claimed by only one of the
spouses in the case of married individuals.

In the case of legally separated spouses, additional exemptions may be claimed only
by the spouse who has custody of the child or children. Provided, that the total amount
of additional exemptions that may be claimed by both shall not exceed the maximum of
four (4) children allowed.

For purposes of this subsection, a ‘dependent’ means a legitimate, illegitimate or


legally adopted child chiefly dependent upon and living with the taxpayer if such
dependent is not more than 21 years of age, unmarried and not gainfully employed or if
such dependent, regardless of age, is incapable of self-support because of mental or
physical defect.

Dependent (to be qualified to the claim of ₱25,000)


- refers only to children who are legitimate, illegitimate or legally adopted
- chiefly dependent upon: more than 50% support
- living with: does not mean residing in the same house or roof or the same
place
- not more than 21 years old and unmarried
- not gainfully employed
- regardless of age: incapable of self-support because of mental/physical
defect

Change of Status – If the taxpayer marries or should have additional dependent(s)


as defined above during the taxable year, the taxpayer may claim the corresponding
additional exemption, as the case may be, in full for such year.
Note: The change of status rule as single, HF or married is already irrelevant because
the BASIS is now ₱50,000.00 regardless of STATUS.

35
If the taxpayer dies during the taxable year, his estate may still claim the personal
and additional exemptions for himself and his dependent(s) as if he died at the close of
such year.
If the spouse or any of the dependents dies or if any of such dependents marries,
becomes 21 years old or becomes gainfully employed during the taxable year, the
taxpayer may still claim the same exemptions as if the spouse or any of the dependents
died, or as if such dependents married, became 21 years old or became gainfully
employed at the close of such year.
Example: Jan. 1, 2010 X is single; June 2, 2010 X got married; December 1, 2010 X
became a widower when the wife died after she delivered twin babies. On
December 10, one of the twins died. How much basic exemption for the
2010?
Personal Exemption Allowable to Nonresident Alien Individual – a nonresident
alien individual engaged in trade, business or in the exercise of a profession in the
Philippines shall be entitled to a personal exemption in the amount equal to the
exemptions allowed in the income tax law in the country of which he is a subject or
citizen, to citizens of the Philippines not residing in such country not to exceed the
amount fixed in this Section as exemption for citizens or residents of the Philippines.
Provided, that said nonresident alien should file a true and accurate return of the total
income received by him from all sources in the Philippines, as required by this Title.
Rules to observe
1. Reciprocity Rule
2. Whichever is lower rule
3. Can avail only basic personal exemption
Senior Citizen
- those 60 years old and above
- Exemption from the payment of individual income tax provided that their
annual taxable income does not exceed the poverty level of P60,000.00 or
such amount as may be determined by the NEDA for a certain taxable year.
Taxability of senior citizen to other internal revenue taxes.
a. A senior citizen whose annual taxable income exceeds the poverty level of
₱60,000 or such amount as may thereafter be determined by the NEDA for a
certain taxable year shall be liable to the individual income tax in the full amount
thereof on his taxable income net of allowable deductions.
b. Regardless of the amount of taxable income, a senior citizen who derives
income from self-employment, business and practice of profession shall be
subject to other internal revenue taxes which include but are not limited to the
value-added tax, caterer’s tax, documentary stamp tax, overseas
communications tax, excise taxes, and other percentage taxes. He shall,
therefore, file the corresponding business tax returns in accordance with existing
laws, rules and regulations.
c. He shall be subject to the 20% final withholding tax on interest income from
Philippine Currency bank deposit, yield and other monetary benefit from deposit
substitutes, trust fund and similar arrangements; royalties, prizes (except prizes
amounting to ₱3,000 or less which shall be subject to income tax at the rates
prescribed under Section 21, par. (a) or (f), NIRC) as the case may be, and
winnings (except Philippine Charity Sweepstakes winnings).
d. Capital gains from sales of shares of stock (Sec. 21(d), [now Sec. 24], NIRC)
e. Capital gains from sales of real property (Sec. 21(e), [now Sec. 24], NIRC)

Basic personal exemption only for benefactor – a qualified senior citizen living
with and taken cared of by a benefactor whether related to him or not, shall be treated
as a dependent and his benefactor shall be entitled to the basic personal exemption of

36
₱20,000 as head of the family, as defined in Section 2(e) of these regulations. (This rule
no longer applicable because of the ₱50,000.00 exemptions regardless of status.)

For purposes of claiming personal exemption as head of the family with dependent
senior citizen, the identification card number issued by the OSCA shall be indicated in
the ITR to be filed by the benefactor. The senior citizen shall indicate in a certification to
be submitted to the RDO and the OSCA his benefactor who will be granted the
exclusive right to claim him as dependent for income tax purposes.

Caring for a dependent senior citizen shall not, however, entitle the benefactor to
claim the additional exemption allowable to a married individual or head of family with
qualified dependent children under Sec. 29(1) (2) (now 34) of the NIRC, as amended.

Section 36. - Items not deductible

1. Absorb by personal exemptions


2. Capital expenditures absorb by depreciation
3. Extraordinary repairs. To be deducted through depreciation. The cost of repair
added to the value of the property to be depreciated.
4. Not allowed if the taxpayer is the beneficiary of the life insurance. If the
beneficiary is not the employer the premium is a deductible business expense.

Query: A lawyer, exercising his profession, paid premium for his own life insurance. If
he dies the proceeds will go to his estate. Premium is deductible? How about if
the beneficiary is his GF and he is married?

5. Not allowed in order to avoid evasion and collusion. The prohibition is on losses.
It includes also interests on loans. See notes on interest expenses.

Why? (Sec. 36B)


1. Between members of the family. Take note of the degree of relationship being
covered.

No. 2-6 -- considered one (1) personality in the eyes of the law.

Section 38 – Losses from Wash Sales (WS)

- WS is a taxpayer scheme to recognize a deductible loss in his tax return by


selling shares at a loss when the shares sold are substantially identical stock
or securities of that which were purchased or acquired beginning 30 days
before the date of sale and ending 30 days after the sale.

- wash sales losses are not deductible from gains derived from wash sales
transactions

- this rule applies only to securities (e.g., bonds) which are capital assets. Not
on the stocks because of the capital gains on sale of stocks rule on taxation.

- wash sales gains are to be reported and recognized as income

- this rule of nondeduction does not apply if the dealer’s transaction of stocks
and securities is made in the ordinary course of business.
- loss of WS is disallowed to prevent the taxpayer from manipulating a
“pretended” or “engineered” loss purely to establish a tax deduction

- WS gains are taxable under schedular rates (individual) and regular corporate
tax (corporation).

37
READ: Calasanz vs. CIR, 144 SCRA 664

Section 39 – Taxation of Capital Gains and Losses on Capital Assets


- the rules do not apply to sale of capital assets (real property) of an individual
and sale of capital assets (land or buildings) of corporations, which are
subject to Final Taxes. This rule will not also apply to capital gains on sale of
shares of stocks, because subject also to final taxes (5% or 10% rates).

- if the capital gain/net capital gain arise the applicable tax rates would be
schedular rates (individual) and the regular corporate tax (corporation)

- memorize the following:


1. Ordinary Assets (four groups)
a. Stock in Trade and Inventories for sale in the regular conduct of
business.
b. Properties primarily held for sale in trade or business.
c. Property used in trade or business subject to depreciation.
d. Real property used in business.
2. Net Capital Gain (NCG)
3. Net Capital Loss (NCL)
4. Net Capital Loss Carry Over (NCLCO)

- Rules Individual Corporation


1. A capital loss is only deductible Applicable Applicable
from a capital gain
2. Percentage of gain or loss to
be recognized
- 100% Gain/Loss recognition if
held not more than 12 months
- 50% Gain/Loss recognition if
Held more than 12 months -do- Not Applicable
Holding Period Rule
3. Net Capital Loss Carry Over -do- -do-
- Difference

NOLCO NCLCO
- losses from business operation - arise from capital assets
transaction [Sec. 39(D)]
- has a carry over of 3 years - to be carried over only once,
following the year of such loss following the year the NCLCO
Ex. Business operating losses in 2010 was sustained.
Can be carried over to 2011, 2012, and
2013. Ex. Net capital loss in 2010
can be deducted from the net
- Sec. 34 (D-3) NOLCO capital gain in 2011. If after
the deduction there is still a
balance of the 2010 net capital
loss, it can no longer be
carried over to 2012.
- the entire Net operating loss - subject to limitation. What can
can be carried over be carried over is not more
than the ordinary net income of
that year the net capital loss
was sustained (2010) or the
actual net capital loss,
whichever is lower, that can be

38
carried over to the following
taxable year and will be a
deduction from the net capital
gains of that year it was carried
over (2011)
- applies to corporate and - applies only to individual
individual

Section 39 (F) – Gains and Losses from Short Sales

- Short Sales (SS) is the taxpayer’s advanced sale of shares of stocks to


another person even before the seller actually owns the said shares. A SS can
be at the same time a WS whenever the selling and the subsequent buying (to
meet the commitment to sell) happens within the 30 day period rule of WS.
- Any loss from SS is deductible from the gain of SS except it is a WS. (Not
applicable under the present tax laws)
- SS a typical capital asset transaction in the stock market.
- Short Sale – For income tax purposes, a short sale is not deemed to be
consummated until the delivery of property to cover the short sale. If the short
sale is made through a broker and the broker borrows property to make
delivery, the short sale is not deemed to be consummated until the obligation
of the seller created by the short sale is finally discharged by delivery of the
property to the broker to replace the property borrowed by such broker.

Section 40.

(A) Query: How is the gain or loss computed?


What includes the amount of gain or loss to be realized?
(B) What are the basis?
(C) - No gain or loss to be recognized if it’s a merger or consolidation.
Merger/Consolidation are forms of business combinations for corporations
(corporations as defined by the Corporation Code)
Merger - two corporations combined and one of the name survived.
Consolidation - two corporations combined and a new name emerged.

Forms of exchange which are exceptions (par. c(2), Sec. 40)


a. Property vs. Stock
b. Stock vs. Stock
c. Securities (bonds or debentures) vs. Stocks/Securities

Reason : They became one entity after the combination.

(3) Exchanges not solely in kind

- Exchanges where it not only involves property (stocks/securities) but also


cash and/or properties (which are not stocks/securities), the gains will be
recognized but not the losses. The gain to be recognized is in an amount
not in excess of the cash and the FMV of such properties (e.g., tangible
properties, lands or buildings)
Memorize the terms in par. 6 (Definitions)

Source Rules – Section 42

The source rules to determine whether income shall be treated as income from
within or outside the Philippines can be found in Section 42 of the 1997 Tax Code.

39
There are different source rules for different types of income. The following incomes are
considered as income from sources within the Philippines:
1. Interests: Residence of the debtor or obligor. – If the obligor or debtor
(corporation or otherwise) 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 dividend. – Dividends
received from a domestic corporation or from a foreign corporation are treated
as income from sources within the Philippines, unless less than 50% of the
gross income of the foreign corporation for the three (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 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
performed in the Philippines, the income is treated as from sources within the
Philippines.

Gross income from sources within the Philippines includes compensation for
labor or personal services performed within the Philippines, regardless of the residence
of the payor, of the place in which the contract for service was made, or of the place of
payment. If a specific amount is paid for labor or personal services performed in the
Philippines, such amount shall be included in the gross income. If there is no accurate
allocation or segregation of compensation for labor or personal services performed in
the Philippines, the amount to be included in the gross income shall be determined on
apportionment of time basis; i.e., there shall be included in the gross income an amount
which bears the same relation to the total compensation as the number of days of
performance of the labor or services within the Philippines bears to the total number of
days of performance of labor or services for which the payment is made. Wages
received for services rendered inside the territorial limits of the Philippines and wages of
an alien seaman earned on a coastwise vessel are to be regarded as from source within
the Philippines (Sec. 155, Rev. Regs. No. 2).

A non-resident alien is taxed only on her commission income for services


rendered in the Philippines. – Baier-Nickel, a non-resident German, is the President
of Jubanitex, Inc., a domestic corporation engaged in manufacturing, marketing,
acquiring, importing and exporting and selling embroidered textile products. Through its
General Manager, the corporation engaged the services of Baier-Nickel as commission
agent, who will receive 10% sales commission on all sales actually concluded and
collected through her efforts. In 1995, Baier-Nickel received commission income, which
Jubanitex withheld 10% and remitted to the BIR. Baier-Nickel filed her income tax return
on October 17, 1997 and on April 14, 1998, she filed a claim for refund, contending that
her commission income is not taxable in the Philippines because it was compensation
for her services rendered in Germany.

Non-resident aliens, whether or not engaged in trade or business, are subject to


Philippine income tax on their income received from all sources with the Philippines.
The underlying theory is that the consideration for taxation is protection of life and
property and that the income rightly to be levied upon to defray the burdens of the
Government is that income which is created by activities and property protected by the
Government or obtained by persons enjoying that protection. The important factor,
therefore, which determines the source of income of personal services is not the
residence of the payor, or the place where the contract for service is entered into, of the
place of payment, but the place where the services were actually rendered (Baier-Nickel
v. Commissioner, G.R. No. 156305, February 17, 2003).

40
In this case, however, the appointment letter of Baier-Nickel, as agent of
Jubanitex, stipulated that the activity or the service which would entitle her to 10%
commission income, are sales actually concluded and collected through her efforts.
What she presented as evidence to prove that she performed income-producing
activities abroad were copies of documents she allegedly faxed to Jubanitex and
bearing instructions as to the sizes of, or designs and fabrics to be used in the finished
products as well as samples of sales orders purportedly relayed to her by clients.
However, these documents do not show whether the instructions or orders faxed
ripened into concluded or collected sales in Germany. At the very least, these pieces of
evidence show that while Baier-Nickel was in Germany, she sent instructions/orders to
Jubanitex. Thus, claim for refund was denied (Commissioner v. Baier-Nickel, G.R. No.
153793, August 29, 2006).

Income from turnkey contract with onshore and offshore portions. – While
the construction and installation work were completed within the Philippines, the
evidence is clear that some pieces of equipment and suppliers were completely
designed and engineered in Japan. The two (2) sets of ship unloader and loader, the
boats and the mobile equipment for the NDC project and the ammonia storage tanks
and refrigeration units were made and completed in Japan. They were already finished
products when shipped to the Philippines. The other construction supplies listed under
the Offshore Portion such as steel sheets, pipes and structures, electrical and
instrument apparatus, were not finished products when shipped to the Philippines.
They, however, were likewise fabricated and manufactured by the sub-contractors in
Japan. All services for the design, fabrication, engineering and manufacture of the
materials and equipment under Japanese Portion Yen I were made and completed in
Japan. These services were rendered outside the taxing jurisdiction of the Philippines
and are therefore not subject to tax on the part of a foreign corporation (Commissioner v.
Marubeni Corporation, G.R. No. 137377, December 18, 2011).

A tax sparing credit is a credit granted by the residence country for foreign taxes
that for some reasons were not actually paid to the source country but that would have
been paid under the country’s normal tax rules. The usual reason for the tax not being
paid is that the source country has provided a tax holiday or other tax incentive to
foreign investors as an encouragement to invest or conduct business in the country. In
the absence of tax sparing, the actual beneficiary of a tax incentive provided by a
source country rather than the foreign investment may be the residence country rather
than the foreign investor. This result occur whenever the reduction in source-country tax
is replaced by an increase in residence-country tax.

In the leading case of Commissioner v. Procter & Gamble PMC (160 SCRA 560),
the court ruled that the preferential 15% tax on dividend paid to a non-resident foreign
corporation is inapplicable because of the failure of the claimant to show the actual
amount credited by the U.S. government, to present the U.S. income tax returns of
PGMC-USA, and to submit a duly authenticated document evidencing the tax credit of
the 20% differential. Upon motion for reconsideration, the Supreme Court in an en banc
resolution reversed the earlier decision of the court. It pronounced that the 15%
preferential tax rate was applicable to the case at bar, because it was established that
the Philippine Tax Code only requires that the U.S. shall “allow” Procter & Gamble USA
“deemed paid” the tax credit equivalent to 20%. Clearly, the “deemed paid” which must
be allowed by U.S. law to P&G USA is the same “deemed paid” tax credit that Philippine
law allows to a Philippine corporation with a wholly-or-majority-owned subsidiary in the
U.S. The “deemed paid” tax credit allowed in Section 902, U.S. Tax Code, is no more a
credit for “phantom taxes” than is the “deemed paid” tax credit granted in Section
30(C)(8) (now Sec. 28[B][5][b], NIRC). The legal question should be distinguished from
questions of administrative implementation arising after the legal question has been
answered. (Commissioner v. Procter & Gamble PMC, 204 SCRA 377)

41
The fact that Switzerland does not impose any tax on the dividends received
from a domestic corporation should be considered as full satisfaction of the condition
that the 20% differential is deemed credited by the Swiss government (as against the
Commissioner’s contention that the tax-sparing credit should apply only if the foreign
country allows a foreign tax credit). The court observed that to deny private respondent
the privilege to withhold only 15% provided for under P.D. 369 would run counter to the
very spirit and intent of said law and definitely will adversely affect foreign corporations’
interest and discourage them from investing capital in our country (Commissioner v.
Wander Philippines, 160 SCRA 573).

What are disguised dividends in income taxation? Give an example.


Disguised dividends are 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 payments are
disproportionately larger than the actual value of the services rendered. In such case,
the amount over and above the true value of the service rendered shall be treated as a
dividend, and shall be subjected to the corresponding tax of 35% on the Philippine
sourced gross income, or such other preferential rate as may be provided under a
corresponding Tax Treaty.
Example: Royalty payments under a corresponding licensing agreement.

(A) Gross Income (GI) from sources within the Philippines.


- this provision enumerates certain kinds of income that would be considered
derived within the Philippines.

Example:
1. X is an American residing in Canada but he has bank deposits in the
Philippines. His interest income from the bank deposits will be considered
derived within the Philippines. – this is an application of the territoriality
rule as source of income.

2. Supposing X is also a stockholder of SMC. The dividend he will receive is


also taxable in the Philippines.

3. If the dividend is from a FC Corporation (doing business in the Philippines)


(1) General rule: considered derived within the Philippines;
(2) Pro-rata rule: if less that 50% of the FC gross income was derived in
the Philippines for the three (3) year period preceding the declaration
of the dividend.

Example: In the 2010 FC declared dividend. The accumulated gross


income FC derived in the Philippines for the years 2007, 2008 and 2009
was P1 Million. FC total gross income (2007, 2008 and 2009) within and
without the Philippines was P3 Million. The dividend declared would be
prorated to get the portion taxable within the Phils. Thus:
₱1 million
Dividend declared x ₱3 million

b. Services – read par. 3

c. Rentals and Royalties – read par. 4


.
d. Sale of Real Property – read par. 5

e. Sale of Personal Property (PP)

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- PP is bought within the Phil., then sold outside the Phil. OR PP is bought
outside of the Phil. then sold within the Phil. = Gains or profits derived will
be considered DERIVED within the Phil.

- Gain from the sale of SS of a domestic corporation always treated derived


within the Phil. even if it is sold outside the Phil.
Rationale : Protection/benefit rule.

f. Taxable Income within the Philippines


General Rule: The deductions/business expenses must be connected/related
to the income derived within the Philippines.

Hence, Gross Income within the Philippines (trade, business or profession) shall
only be deducted by expenses incurred within the Philippines. Application of the
connected/related rule on expenses.

Except : Interest paid on loans abroad, the proceeds of the loans is actually used
in connection with the conduct or operation of the business in the Philippines.

(B) GI from sources without the Philippines.


- self-explanatory (par. C of Sec. 42)
- Taxable income means GI without the Philippines less expenses without
the Philippines.

(C) Sources Partly within and Partly without the Philippines


- Allocation rule will apply on gross income and expenses.

GI Partly within
Example: GI partly within and without x GI within and without

- same computation for expenses

Section 43 – 50. - Accounting Periods and Methods of Accounting

- Method and Accounting Period (Fiscal or Calendar) as basis of computing taxable


income and the method of accounting, it is the taxpayer who will choose. If no
period or method is used or the method used do not clearly reflect the income, the
CIR will compute using the method in the opinion of the CIR clearly reflects the
income.
- No uniform method of accounting can be prescribed for all taxpayers.

METHODS OF ACCOUNTING – There are two main methods generally followed


by taxpayers. They are (a) the cash method, and (b) the accrual method.

“Cash method” is nearly used by individuals. All items of taxable income whether
cash, property, or services actually or constructively received are classed as
receipts. Only amounts actually paid for deductible expenses are classed as
disbursements. Business expenses must be paid within the taxable year. There is no
such thing as constructive payment.

CASH METHOD in Accounting is different from CASH METHOD for Taxation.


Under the cash method for taxation purposes, there is constructive receipt of
income to be reported but no constructive payment of expenses to be reported.

“Accrual method” is used mostly by business concerns. Under this system, net
income is measured, in a broad sense, by the excess of income over expenditures.
Cash, property, or services earned during the taxable year, though not received

43
have accrued to the taxpayer, and are classed as income. In the same way,
expenses incurred during the taxable year are usually deductible even if they are not
received during that year.

All events test means all events fixing an accrued method, taxpayer’s right to receive
income, or incur expenses must occur before the taxpayer can report an item of income
or expense. (CIR vs. Isabela Cultural Corp., G.R. No. 172231, February 12, 2007)

All events test (deductions) is met:


1. All events have occurred that fix the fact of liability
2. The liability can be determined with reasonable accuracy.

- Computation of Business deductions based on accrual method

TAXABLE PERIOD – the rule is that the taxable period of a taxpayer covers a
period of 12 months. The exceptions are as follows:

(a) In case of dissolution of a corporation.


(b) In case of change of accounting period.
(c) In case of corporation newly established.
(d) Final return of decedent.
(e) Return for the decedent’s estate.
(f) In case the Commissioner of Internal Revenue terminates the tax period of a
taxpayer.

Other accounting methods. –

(a) “Percentage of completion basis” is a method available in the case of


building, installation or construction contracts covering a period in excess of one year,
where there should be deducted from gross income all expenditures made during the
taxable year on account of the contract, account being taken of the materials and
supplies on hand at the beginning and end of the taxable period for use in connection
with the work done under the contract but not yet so applied.

(b) “Completion of contract basis” is a method available to contractors for


building, installation or construction covering a period more than one year where income
is reported in case the contract is finally completed and accepted.

(c) “Crop year basis” is a method where a farmer engaged in producing crops
which take more than a year from the time of planting to the process of gathering and
dispositions, the law allows expenses deducted to be determined upon such basis and
such deductions must be taken in the year in which the gross income from the crop has
been realized.

(d) “Installment plan or method” is a method which is available to sales by


dealers of personal property on the installment basis, where the returnable income in
the taxable year which the gross profit realized or to be realized when payment is
completed bears to the total contract price expressed in the following formula:

Gross profit times installments received divided by total contract price equals returnable
income.

The method applies also to sales of realty where the initial payment does not exceed
25% of the selling price; if the initial payment of the selling price exceeds 25% thereof,
then the income shall be reported in full.

44
This applies further to casual sales of personality (other than property includible in
the taxpayer’s inventory) for a price exceeding ₱1,000 and where the initial payment
does not exceed 25% of the selling price.

Methods of determining taxable income.


(a) Percentage method
(b) Net-worth expenditure method
(c) Excess cash expenditure method
(d) Bank deposits

Requirements for use of net-worth method


(a) That the taxpayer’s books do not clearly reflect the income, or the taxpayer
has no books, or if he has books, he refuses to produce them.

(b) That there is evidence of a possible source or sources of income to account


for the increases in the networth or for expenditures.

(c) That there is a fixed starting point or opening networth, a date beginning with
the taxable year or prior to it at which the taxpayer’s financial condition can be
affirmatively established, with same definiteness; and

(d) That the circumstances are such that the method does clearly reflect the
taxpayer’s income with reasonable accuracy and certainty, and proper and just
additions of personal expenses and other non-deductible expenditures were
made, and correct, fair and equitable credit adjustments were given by way of
eliminating non-taxable items.

- Period for which deductions and credits taken = apply as “paid or incurred rule”

Section 51-59. – Returns and Payment of Taxes

Individuals
A. Required to file Income Tax Return
1. RC – within and without income
2. NRC – within income
3. RA – within income
4. NRA – within income

B. NOT REQUIRED
1. If the gross income does not exceed his personal or additional
exemptions. But this rule does not apply if engaged in trade, business
or exercise of profession.
2. Compensation earners purely derived in the Phil. and the income tax
correctly withheld. This rule does not apply if deriving compensation
income from two (2) employers within the taxable year.
3. Those whose sole income is subject to the final withholding taxes.
4. Minimum wage earner
Question:
1. How many copies of tax return will be filed?
2. Where to file the income tax returns?
3. When to file?
4. If both H and W are working, who will file?
5. If the child is a minor, but has income, who will file his return?
How about persons under disability?

Financial Statements Attached to the Income Tax Returns upon Filing

45
The financial statements required to be attached with the income tax returns:
1. Statement of Net Worth and Operations. This statement is to be attached with
the income tax return of individual taxpayers if the gross sales, receipts or output
from business does not exceed ₱50,000 in any one quarter.

2. Balance Sheet and Profit and Loss Statements. These statements are to be
attached with the income tax return of individual taxpayers if the gross sales,
earnings, receipt or output from business in any one quarter exceed ₱150,000.

a. Balance Sheet and Profit and Loss Statement certified by an independent


Certified Public Accountant.
b. Comparative profit and Loss Statements for the current and preceding taxable
years.
c. Schedule of income producing properties and corresponding income
therefrom.

The said taxpayer’s books of accounts shall be audited and examined yearly by an
independent Certified Public Accountant and their income tax returns accompanied with
a duly accomplished Account Information lifter from certified balance sheets, profit and
loss statements, schedules listing income producing properties and the corresponding
income therefrom and other relevant statements.

Annual Declaration and Quarterly Payments of Income tax for Individual


Taxpayers.(Applies only to those who are engage in trade, business or exercise
of their profession).

1. On or before April 15 of the following year for the taxable income of the previous
year.
2. April 15 of the same taxable year for the estimated income of the current year.

In general, except as otherwise provided by the law, every individual subject to


income tax under Sections 24 and 25 (A) of the National Internal Revenue Code who is
receiving self-employment income, whether it constitutes the sole source of his income
or in combination with salaries, wages and other fixed or determinable income, shall
make and file a declaration of estimated income for the current taxable year on or
before April 15 of the same taxable year.

3. Return and Payments of Individual’s Estimated Income tax.

FILING OF DECLARATIONS
AND PAYMENTS DATES
First April 15 of the current taxable year

Second August 15 of the current taxable year

Third November 15 of the current taxable year

Fourth April 15 of the following calendar year


When final adjusted income tax return
Is due for filing.
B. Corporation/Partnership
Read Sec. 52 – 56. Self-explanatory

CORPORATE RETURNS

Section 52 (A) of the National Internal Revenue Code provides that every
corporation subject to the tax herein imposed, except foreign corporations not engaged

46
in trade or business in the Philippines, shall render, in duplicate, a true and accurate
quarterly income tax return and final or adjustment return.

The return shall be filed by the president, vice president or other principal officers
and shall be sworn to by such officer and by the treasurer or assistant treasurer.

Taxable Year of Corporation


A corporation may employ either calendar year or fiscal year as a basis for filing its
annual income tax return.

A corporation shall not change the accounting period employed without prior
approval from the Commissioner in accordance with the prohibitions of Section 47 of the
Tax Code.

Rules in filing and payment of corporate income tax:

1. The corporate quarterly return shall be filed within sixty (60) days following the
close of each of the first three quarters of the taxable year. (three times)

Example:
Calendar Year – Jan., Feb., Mar. = File in the months of April and May
Fiscal Year – June, July, Aug. = file in the months of Sept. and Oct.

2. The income tax due on the corporate quarterly returns and the final adjusted
income tax returns computed in accordance with Section 75 and 76 shall be paid
at the time the declaration or return is filed. (Pay as you file system)
3. The final adjustment return shall be filed on or before the 15 th day of April, or on
before the 15th day of the fourth month following the close of the fiscal year, as
the case may be.

Note : Corporate Returns are filed four (4) times a year. Three quarterly and one
final adjustment return

CORPORATE QUARTERLY TAX

To ease the burden of paying taxes for a lump-sum amount, income tax expense of
a corporation may be paid in an aggregate quarterly periodic payment.

Rules:
1. A corporation files a quarterly income tax return within 60 days after the end of
each first three quarters of the taxable year.
2. A final income tax return covering the total taxable income of the taxable year
should be filed on or before April 15 of the following year. The amount of total
income tax computed thereof shall be reduced by income taxes paid during the
first three quarters of the taxable year.
3. The amount of tax previously paid for the preceding quarters should reduce the
amount of tax computed on the cumulative taxable income.
4. If the total quarterly tax paid during the taxable year is more than the tax due on
the final return the corporation may claim tax credit carry over or refunded with
the excess amount.

Section 57 to 59. – Withholding Taxes

Withholding of taxes is a systematic way of collecting taxes at source. It is an


indispensable method for collecting taxes in order that the government can obtain
adequate revenue. The withholding tax agent who is usually an employer or a person

47
from whom the income is derived does this process through withholding the appropriate
amount of taxes from taxpayers. It is designed to ensure the collection at source of
income taxes.

If withholding tax is not withheld from income payments, there will be a disallowance
of deductible business expenses claimed by the withholding agent in this income tax
return or a penalty shall be imposed on withholding tax agent for failure to withhold the
tax.

Withholding Tax at Source

A taxation at source is that part of tax system which collects through withholding
agents or employers the appropriate income taxes due as they are earned and before
earnings are paid to the employees.

The income paid to the employees is the net amount after deducting the taxes
withheld which is based on the taxable income after adjustments with respect to
personal, additional exemptions and or other adjustments allowed by the law, if any.

The primary objective of the system is to ensure accurate payment of taxes and to
be able to use taxes collected at an earlier time to finance the operations and projects of
the government.

Classification of Withholding Tax at Source

Withholding tax may be classified into two categories such as


1) Final Withholding Tax, and
2) Creditable Withholding Tax

Final Withholding Tax (FWT)

Under the final withholding tax system the amount of income tax withheld by the
withholding agent is constituted as a full and final payment of the income tax due from
the payee on the said income. The liability for the payment of the tax rests primarily on
the payor as a withholding agent. Thus, in case of failure to withhold or in case of under
withholding, the deficiency tax shall be collected from the payor/withholding agent. The
payee is not required to file an income tax return for the particular income, the final tax
on which has been withheld.

The finality of the withholding tax is limited only to the payee or recipient’s income
tax liability on the particular income. It does not extend to the payee’s other tax liability
on said income, such as when the said income is further subject to a percentage tax.

Creditable Withholding Tax (CWT)

Under the creditable withholding tax system, taxes withheld on certain payments are
intended to equal or at least approximate the tax due of the payee on said income. The
income recipient is still required to file his income tax return as prescribed in the Section
51 of the NIRC, either to report the income and/or pay the difference between the tax
withheld and the tax due on the income. A tax withheld in income payments covering
the expanded withholding tax from compensation income is creditable in nature.

Diferrence between FWT and CWT


- in FWT no more tax liability if properly withheld. In CWT it may or may not result
to a balance of tax liability.

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Taxes withheld on compensation is an example of CWT.

Section 60 to 66. - Estates and Trusts

TAX ON INCOME OF ESTATE

The estate is composed of all properties, rights and obligations including those
properties, earnings or obligations that have accrued thereto since the opening of the
succession. The estate is to be transferred from the decedent to his successors.

During the period when the title to the properties is not yet finally transferred to the
successors, there may be earnings generated from the estate. These earning are
subject to income tax.

Estates’ or Trusts Taxable Income and Tax

For taxation purposes, the taxable income of the estate/trust shall be determined in
the same manner and basis as in the case of individual taxpayers. The items
composing the taxable income and tax of the income from estates/trusts are as follows:

Treated as Individual Taxpayers

1. Gross Income
The items of gross income of the estate are the same items with the items of
gross income of individual taxpayers.

2. Deduction
Deductions from the gross income of the estates/trusts are the same with the
items of deduction allowed to individual taxpayer.

3. Special Deduction
In addition to the allowable deductions under Section 34 of the Tax Code, the
estate is also allowed to deduct the amount of income of the estate during the
taxable year that is paid or credited to the legatee, heir or beneficiary, subject
to a creditable withholding tax of fifteen percent (15%)

However, the amount so allowed as a deduction shall be a part of the taxable


income of the legatee, heir or beneficiary. It is to be noted that any portion of
the gross estate paid to the heir is not deductible from the gross income of the
estate.

4. Exemption
Generally, the income from estate/trusts is allowed for an exemption of
₱20,000.

5. Tax Rate
The tax rate applicable is the tax rate prescribed for individual taxpayers.

TAX ON INCOME OF TRUSTS

A trust is an obligation imposed or a right to administer over a property given to a


person for a benefit of another.

This is a legal institution used to administer funds in behalf of individuals or


organizations. Trust device is used frequently to transfer property from one generation
to another.

49
Illustration.
Suppose Juan wants his wife to have the income from his estate as long as she
lives. Juan may place his property in a trust, the income of which would go to his wife
for life; the trust might be dissolved at her death and the property distributed to the
children. The trust is assigned to be administered by Attorney Nilo, a trustee.

Under this arrangement, the trustee is required by law to manage the trust strictly in
accordance with the terms of the trust instrument.

When a trust is created, a new entity comes into being, for which returns must be
filed and taxes paid.

Income accumulated in trust and/or to be distributed to beneficiary are subject to


income tax.

A trust created by a written instrument other than a will is known as a “trust inter-
vivos,” if created by will is known as a “testamentary trust.”

Income Derived from Trusts.

Tax imposed upon individual taxpayers shall apply to the income of any property
held in trust, including:

1. Income accumulated in trust for the benefit of unborn or unascertained person/s


with contingent interests, and income accumulated or held for future distribution
under the terms of the will or trust;

2. Income that is to be distributed currently by the fiduciary to the beneficiaries, and


income collected by a guardian of an infant that is to be held or distributed as the
court may direct; and

3. Income that, in the discretion of the fiduciary, may be either distributed to the
beneficiaries or accumulated.

The trust, or the beneficiaries or the grantor may pay the tax on income derived from
trusts.

Computation of Trust’s Income Tax

The computation of the net taxable income of trust shall be in the same manner with
the net taxable income of estate. The net taxable income shall be taxed by using the
scheduler tax of an individual taxpayer based on Sec. 24 A of the Tax Code.

Two or More Trusts

In the case of two or more trusts created by the same person, for the same
beneficiary, the taxable income of all trusts shall be consolidated and the tax shall be
computed based on the consolidated income.
The proportionate amount of the tax computed based on the consolidated income
shall be assessed and collected from each trustee which should be equal to the
proportion of the taxable income of the trust administered by the trustee to the
consolidated income of the several trusts.

REVOCABLE TRUSTS

Generally, revocable trusts exist when the trustor (grantor) reserves the power to
change at any time any part of the terms of the trust. For tax purposes, the rule is that

50
the grantor is liable for the income of a revocable trust (because the revocable trust by
itself is not subject to income tax except if the trust is irrevocable (because irrevocable
trust is subject to income tax, so that the grantor is already exempted from income tax
on the income derived from the irrevocable trust).

Illustration:
Mrs. Caduda Duda created a trust naming his eldest son as revocable beneficiary
who will receive the income of the trust. If the eldest son could not abide with the rules
provided in the trust instrument, Mrs. Duda could change outright the terms of the trust.
For the year, the trust earned a total income of ₱200,000. How much would be the
taxable income of the trust?
There is no taxable income of the trust because it is a revocable trust. The income
should be reported as taxable income of the grantor, Mrs. Caduda Duda.

“Trusts”, explained. – These are taxable entities created by will or trust deeds
where the transfer of property to such trusts is irrevocable and the income of which is to
be accumulated for designated beneficiaries other than the grantor.

Estates and trusts are subject to the rates of income tax applicable to individuals.
Income of estate or trust includes the following:

(a) Income accumulated in trust for the benefit of unborn or unascertained person
or persons with contingent interests, and income accumulated or held for future
distribution under the terms of the will or trust.

(b) Income which is to be distributed currently by the fiduciary to the beneficiaries,


and income collected by a guardian of an infant which is to be held or distributed
as the court may direct.

(c) Income received by estates of deceased persons during the period of


administration or settlement of the estate; and

(d) Income which, in the discretion of the fiduciary, may be either distributed to the
beneficiaries or accumulated.

Trusts not subject to tax. –

(a) Revocable trusts the income of which is held or distributed for the benefit of the
grantor
(b) Employee’s pension trusts.

The taxable income of the estate or trust shall be computed in the same manner and
on the same basis as in the case of an individual. However, when it comes to allowable
deductions, the guidelines in Section 61 of the Tax Code, should be followed.

Exemption allowed to estates and trusts. –

(a) ₱20,000.00 is allowed as an exemption.


Revocable trusts. – Where at any time the power to revest in the grantor title to any
part of the corpus of the trust is vested (a) in the grantor, either alone or in conjunction
with any person not having a substantial adverse interest in the disposition of such part
of the corpus or the income therefrom, or (b) in any person not having a substantial
adverse interest in the disposition of such part of the trust shall be included in
computing the net income of the grantor.

Income for the benefit of grantor. – Where any part of the income of a trust –

51
(a) is, or in the discretion of the grantor or of any person not having a substantial
adverse interest in the disposition of such part of the income may be held or
accumulated for future distribution to the grantor;

(b) may, in the discretion of the grantor or of any person not having a substantial
adverse interest in the disposition of such part of the income, be distributed to
the grantor;

(c) is, or in the discretion of the grantor or of any person not having a substantial
adverse interest in the disposition of such part of the income may be, applied to
the payment of premiums upon policies of insurance on the life of the grantor;
such part of the income of the trust shall be included in computing the net
income of the grantor.

Requisites for exemption of employee’s pension trust. –

(a) The employee’s trust must be part of a pension, stock bonus or profit-sharing
plan of an employer for the benefit of some or all of his employees;

(b) Contributions are made to the trust by such employer, such employees, or both;

(c) Such contributions are made for the purpose of distributing to such employees
both the earning and principal of the fund accumulated by the trust;

(d) The fund is accumulated by the trust in accordance with the plan of which the
trust is a part;

(e) The trust instrument makes it impossible for any part of the trust corpus or
income to be used for, or diverted to, purposes other than for the exclusive
benefit of such employees.

It may be noted that under Republic Act No. 4917, retirement benefits received by
officials and employees of private firms under a reasonable private benefit plan
maintained by the employer are exempt from all taxes.

Section 78 to 83. – Withholding on Wages

INCOME TAX COLLECTED AT SOURCE ON COMPENSATION INCOME

Basic Rules on Withholding Taxes

As a general rule, all salaries earned by persons as government or non-government


employees are subject to withholding tax, except of the following items:

1. Commissions paid by an insurance agent to his sub-agents.


2. Compensation for services by a citizen or resident of the Philippines for a
foreign government or an international organization.
3. Remuneration for causal labor not in the course of employer’s trade or business.
4. Remuneration for private service performed by maids, cooks, gardeners, family
drivers and the like.
5. Remuneration paid to agricultural labor and paid entirely in products of the farm.

Requirement of Withholding Tax Due

Every employer must withhold taxes from compensation paid arising from employer
employee relationship. However, no withholding of tax shall be required where the total

52
compensation income of an individual does not exceed the statutory minimum wage of
₱5,000.00 monthly or ₱60,000.00 a year, whichever is higher.

It is to be noted that employees whose total annual compensation does not exceed
₱60,000.00 in a year shall be given two options with which to pay his income tax due as
follows:

1. His compensation shall be subjected to withholding tax, but he shall not be


required to file the income tax return, or
2. His compensation income shall not be subject to a withholding tax but he shall
file his annual income tax return and pay the tax due thereon, annually.

Where the employee has opted to have his compensation income subjected to
withholding so as to be relieved of the obligation of filing an annual income tax return
and paying his tax due on a lump sum basis, he shall execute a waiver in a prescribed
BIR form of his exemption form withholding which shall constitute the authority for the
employer to apply the withholding tax table provided under these Regulations.

The employee who opts to file the Income Tax Return shall file the same not later
than April 15 of the year immediately following the taxable year.

Cumulative Average Method

This method is used if the compensation of a particular employee is exempt from


withholding because the amount thereof is below the compensation level, but
supplementary compensation is paid during the year; or the supplementary
compensation is equal to or more than the regular compensation to be paid; or the
employee was newly hired and had a previous employer(s) within the calendar year,
other than the present employer doing this cumulative computation, the present
employer shall determine the tax to be deducted and withheld in accordance with the
cumulative average method.

The cumulative average method, once applicable to a particular employee at any


time during the calendar year shall be the same method to be consistently used for the
remaining payroll periods of the same calendar year.

Annualized Withholding Tax Method

This method is used when an employer – employee relationship is terminated before


the end of the calendar year and when computing for the year-end adjustment the
employer shall determine the amount to be withheld from the compensation on the last
month of employment or in December of the current calendar year in accordance with
the following procedures.

PERSONS REQUIRED TO DEDUCT AND WITHHOLD

Section 2.57.3 enumerated the following persons who are hereby constituted as
withholding agents for purposes of the creditable taxes that are required to be withheld
in income payments enumerated in Section 2.57.2:
1. In general, any juridical person, whether or not engaged in business or trade;
2. An individual, with respect to payments made in connection with his trade or
business. However, insofar as taxable sale, exchange or transfer of real
property is concerned, individual buyers who are not engaged in trade or
business are also constituted as withholding agents;
3. All government offices including government-owned or controlled corporations,
as well as provincial, city and municipal governments.

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Time of Withholding

The obligation of the payor to deduct and withhold the tax under Section 25.7 of
these regulations arises at the time an income is paid or payable, whichever comes first.
The term “payable” refers to the date the obligation becomes due, demandable or
legally enforceable.

Exemption from Withholding

The withholding of creditable withholding tax prescribed in these Regulations shall


not apply to income payments made to the following:

1. The National government and its instrumentalities, including provincial, city or


municipal governments;
2. Persons enjoying exemption from payment of income taxes pursuant to the
provisions of any law, general or special such as but not limited to the following:

a. Sales of real property by a corporation which is registered and certified


by the Housing and Land Use Regulatory Board (HLURB) or HUDCC
as engaged in socialized housing project where the selling price of the
house and lot or only the lot does not exceed ₱180,000.00 in Metro
Manila and other highly urbanized areas and ₱150,000.00 in other
areas or such adjusted amount of selling price for socialized housing as
may later be determined and adopted by the HLURB, as provided under
Republic Act No. 7279 and its implementing regulations.

b. Corporations registered with the Board of Investments and enjoying


exemption from the income tax provided by R.A. No. 7916 and the
Omnibus Investment Code of 1987.

c. Corporations which are exempt from the income tax under Section 10 of
NIRC, to wit: The GSIS, the SSS, the Phil. Health Insurance Corp., the
PCSO and the PAGCOR; However, the income payments arising from
any activity is conducted for profit or income derived from real or
personal property shall be subjected to a withholding tax as prescribed
in these regulations.

Where to File

Creditable and final withholding taxes deducted and withheld by the withholding
agent shall be paid upon filing a return in duplicate with the authorized agent banks
located within the Revenue District Office (RDO) having jurisdiction over the residence
or principal place of business of the withholding agent. In places where there is no
authorized agent banks, the return shall be filed directed with the Revenue District
Officer, Collection Officer or the duly authorized Treasurer of the city or municipality
where the withholding agent’s residence or principal place of business is located, or
where the withholding agent is a corporation, where the principal office is located except
in cases where the Commissioner otherwise permits.

When to file

The withholding tax return, whether creditable or final shall be filed and payments
should be made within 10 days after the end of each month except for taxes withheld for
December, which shall be filed on or before January 25 of the following year.

For large taxpayers, the filing of the return and the payment of tax shall be made
within 25 days after the end of each month.

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The return for final withholding taxes on interest from any currency bank deposit and
yield, or any other monetary benefit from deposit substitutes and from trust funds and
similar arrangements shall be filed and the payment made within 25 days from the close
of each calendar quarter.

Withholding Tax Statement

Every payer required to deduct and withhold taxes under there regulations shall
furnish each payee, whether individual or corporate, with a withholding tax statement,
using the prescribed form (BIR Form 2307) showing the income payments made and the
amount of taxes withheld there from, for every month of the quarter within 20 days
following the close of the taxable quarter employed by the payee in filing his/its quarterly
income tax return. Upon request of the payee, simultaneously with the income payment.
For final withholding taxes, the statement should be given to the payee on or before
January 31 of the succeeding year.

Annual Information Return for Income Tax Withheld

The payor is required to file to the Commissioner, Revenue Regional Director,


Revenue District Officer, Collection Agent in the city or municipality where the payor has
his legal residence or principal place of business, where the government office is
located in the case of a government agency, on or before January 31 of the following
year in which payments were made, and Annual Information Return of Income Tax
Withheld at Source (Form No. 1604), showing among others the following information:

1. Name, address and taxpayer’s identification number (TIN);


2. Nature of income payments, gross amount and amount of tax withheld from
each payee and such other information as may be required by the
Commissioner.

If the payor is the Government of the Philippines or any political subdivision or


agency thereof, or any government-owned or controlled corporation, the return shall be
made by the officer or employee having control of the payments or by any designated
officer or employee.

DUE DATES

Due dates refer to the last day for filing return and payment of tax. The following are
the due date prescribed by laws for filing of return and payment of taxes.

Events Due Date


1. Income tax (taxpayer is individual) …………………………… April 15 succeeding year
2. Income tax (taxpayer is individual, in
Business/practice of profession)
a. First quarter (Jan-March) …………………………………. April 15 same year (new)
b. Second quarter (April-June) ……………………………… August 15 same year
c. Third quarter (Jul-Sept) …………………………………… November 15 same year
d. Annual (final return) ……………………………………… April 15 succeeding year
3. Income tax (corporate taxpayers)
a. First quarter ………………………………………………… 60th day after end of quarter
b. Second quarter ……………………………………………. 60th day after end of quarter
c. Third quarter ……………………………………………….. 60th day after end of quarter
d. Final/adjustment return …………………………………… 15th day of the 4th month after
close of taxable year

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4. Estate tax
a. Notice of death …………………………………………….. 2 months after death
b. Estate tax return …………………………………………… 6 months after death
5. Donor’s tax ……………………………………………………… 30th day after each donation
6. Value-added tax:
a. On sale of goods, services or property
(1) Monthly declaration …………………………………. 25th day after month’s end
(2) Quarterly return ……………………………………… 25th day after quarter’s end
b. On importation …………………………………………….. Before release from Customs
7. Other percentage taxes (quarterly return) …………………… 25th day after quarter’s end
8. Capital gains tax on sale of shares of stock
(not traded through local stock exchange)
a. Per transaction return …………………………………….. 30th day after sale
b. Final/consolidated return …..……………………………. 15th day of 4th month after close
of taxable year
9. Capital gains tax on sale of real property
(capital asset) by individual
a. Cash sale ………………………………………………….. 30th day after sale
b. Installment sale …………………………………………… 30th day after receipt of installment
10. Remittance of tax withheld
a. In general
January to November ……………………………………. On or before 10th day of the
which withholding was made
December …………………………………………………. Not later than January 25 of the
succeeding year
b. Large taxpayers …………………………………………… On or before 25th day of the month
following the month in which
withholding was made

Nota Bene – A withholding agent (WA) is a “taxpayer” but not a statutory taxpayer.
WA can claim a tax refund if there is overpayment.

Take note of the following:

Meaning of : 1. Employee (Sec. 78(a))


2. Employer (Sec. 78(d))
3. Husband and Wife (Sec. 79 F)
4. Sec. 80b

pc3
Updated August 2016

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