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EXEMPTIONS AND DEDUCTIONS FROM GROSS INCOME

As to claimants I. DEDUCTIONS vs. EXCLUSIONS

his cost of doing business Can be claimed by all taxpayers, corporate or otherwise

living expenses

Can be claimed only by individual taxpayers

DEDUCTION is an outflow of wealth. EXCLUSION is an inflow of wealth but is not considered as gross income because there is a law which grants it as exempted from gross income. EXCLUSION Pertains to the computation of Gross Income Something received or earned by the taxpayer which do not form part of gross income Flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayers taxable income due to the following reasons: a. It is exempted by the fundamental law; It is exempted by a statute; and It does not fall within the definition of income. DEDUCTION Pertain to computation of Net Income Something spent or paid in earning gross income. III. BASIC PRINCIPLES GOVERNING DEDUCTIONS

(1) The taxpayer seeking a deduction must point to some specific provisions of the statute authorizing the deduction; and (2) He must be able to prove that he is entitled to the deduction authorized or allowed. Deductions have generally been deemed to be a matter of legislative grace. They are allowed only where there is a clear provision in the statute for the deduction claimed; and where particular deductions are authorized by the statute, no others may be made. Note that the taxable gross income is affected by exclusions because the latter are omitted from the former and are not reported on the income tax return but it is not affected by deductions because they are subtracted after gross income is determined and are reported on the return.

The amounts which the law allows to be subtracted from gross income in order to arrive at net income Note that deductions are outflow of income since they represent money spent or the taxpayers expenses.

IV. 1. 2. 3. 4.

KINDS OF ALLOWABLE DEDUCTIONS OPTIONAL STANDARD DEDUCTION ITEMIZED DEDUCTIONS (Section 34A K and Section 34M) PERSONAL BASIC EXEMPTIONS AND ADDITIONAL EXEMPTIONS PREMIUMS ON HEALTH AND HOSPITAL INSURANCE

b.

c.

OPTIONAL STANDARD DEDUCTION II. DEDUCTIONS vs. EXEMPTIONS Default is itemized deduction. In lieu of the itemized deduction (IDs), an individual taxpayer (i.e. resident/non-resident citizen, resident alien, taxable estate and trust) other than non-resident alien, may elect optional standard deduction (OSD) in an amount not exceeding 40% of his gross sales or gross receipts, as the case may be. If 40% OSD is higher than ID, then choose OSD in order to arrive at a lesser net income

PERSONAL EXPEMPTIONS are arbitrary amounts allowed for personal, living or family expenses of the taxpayer. The amount has been calculated to roughly equivalent to the minimum of subsistence. ALLOWABLE DEDUCTIONS As to amount Refer to actual expenses incurred in the pursuit of trade, business or practice of profession Constitute expenses business EXEMPTIONS -

Arbitrary amounts allowed by law

Who can avail? a. Citizens who are purely engaged in trade or business; Citizens who are mixed earners both compensation earners and engaged in trade, business or profession; Resident aliens but only those expenses incurred in the Philippines; TAXATION NOTES - FINALS| 404 |marukoi.mhealler

b. As to nature Pertain to expenses personal

As to purpose 1

To enable the taxpayer to recoup

Allowed to cover personal, family and

c.

d. e.

Partners in GPPs; Corporations - Only DC, RFC can claim OSD

Itemized Deductions: i. ii. iii. iv. v. vi. vii. viii. ix. x. Expenses Interests Taxes Losses Bad Debts Charitable Contributions Research and Development Contributions to Pension Trust Depreciation Depletion of oil, gas, wells and mines

Who cannot claim OSD? a. Individual taxpayer earning purely compensation income; Non Resident Aliens; Note that in IDs, NRA-ETB may claim such deduction but not NRA-NETB. As to OSD, theres no distinction. All NRAs are NOT allowed to claim such deduction. c. Special employees

b.

PERSONAL BASIC EXEMPTIONS AND ADDITIONAL EXEMPTIONS Individuals entitled to avail of PBE and AE are the following: a. b. Resident citizens of the Philippines; Non-resident citizens with respect only to income derived from Philippine sources; Resident aliens with respect only to income derived from Philippine sources; Non-resident aliens engaged in trade, business or in the exercise of a profession in the Philippines with respect to income from Philippine sources, provided there is reciprocity; Reciprocity means that the foreign country where the NRA-ETB is a citizen grants exemptions to Filipinos not residing there but doing trade or business therein. The amount granted should NOT exceed the amount of personal exemptions allowed under our laws. Example: If US grants only 24K as exemptions, then the Philippines grants US NRA-ETB only 24K as exemption. If US grants 75K as exemptions, the Philippines grants US NRA-ETB only 50K as exemption. e. Estates and Trusts RC Personal Exemption NRC within RA within NRA-ETB subject to rule on reciprocity NRANETB

Conditions or Requisites: a. OSD is available only to citizens or resident aliens; thus non-resident aliens are NOT entitled to claim the OSD; The standard deduction is OPTIONAL (i.e. Unless the taxpayer signifies in his return his intention to elect the OSD, he shall be considered as having availed himself of the IDs); Such election, when made by a qualified taxpayer, is irrevocable for the taxable year for which the ITR is made; however, he can change to IDs in succeeding year(s); The amount of standard deduction is limited to 40% of taxpayers gross income; and An individual taxpayer who is entitled to and claimed for OSD shall not be required to submit with his return such financial statements otherwise required by the Tax Code.

c.

b.

d.

c.

d.

e.

ITEMIZED DEDUCTIONS Individuals entitled to avail of IDs are the following: a. b. c. Citizens of the Philippines (RC and NRC); Resident Aliens; Non-Resident Aliens Engaged in Trade or Business in the Philippines; Estates and Trusts

d. -

NRA-NETB are taxed on the basis of their gross income, hence cannot avail of the IDs. As to corporations, only DC and RFC may claim deductions. The latter being entitled only with respect to expenses related to Philippine income only. 2

Additional Exemption

within

within

Personal Basic Exemption. Each individual is allowed a basic personal exemption of P50,000. In the case of TAXATION NOTES - FINALS| 404 |marukoi.mhealler

married individuals where only one of the spouses is deriving gross income, only such spouse shall be allowed the personal exemption Additional Exemption for Dependents. There is allowed an additional exemption of P25,000 for each qualified dependent not exceeding four (4). The additional exemption for dependents shall be claimed by only one of the spouses in case of married individuals. In the case of legally separated spouses, the additional exemptions may be claimed only by the spouse who has custody of the child or children.

PREMIUMS ON HEALTH AND HOSPITAL INSURANCE Limitations: a. It must not be more than P2,400.00 a year (or 200.00 a month). The P2,400.00 is the maximum amount that can be claimed as deductions regardless of the amount of the premiums actually paid. The family must have an income of not more than P250,000.00 a year. Family income means income of the immediate family. c. The claimant must be the spouse claiming the additional exemption.

b.

The total amount of additional exemptions that may be claimed by both shall not exceed the maximum additional exemptions for four (4) dependents (Sec. 35 [A,B]) or 100,000. Dependent means a legitimate, illegitimate or legally adopted child Conditions for a child to be considered a dependent: Chiefly dependent upon the taxpayer for support; Living with the taxpayer; Not more than twenty-one (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. V.

Note: For the deductions to be allowed, the payments should be on health and/or hospitalization insurance of the individual taxpayer including his family.

ENTITLEMENT TO DEDUCTIONS, In General DEDUCTIONS TAX BASE net income net income net income net income gross income subject to 15% tax rate on their income in the form of salaries, honoraria, wages, emoluments and remuneration and other similar income.

RC NRC RA NRA-ETB NRA-NETB SPECIAL EMPLOYEES

Change of Status (GR: interpret in favor of the taxpayer) i. If the taxpayer marries or should have additional dependent(s) during the taxable year, the taxpayer may claim the corresponding personal or additional exemption, as the case may be, in full for such year. 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 any of such dependents marries, becomes twenty-one (21) years old or becomes gainfully employed during the taxable year, the taxpayer may still claim the same exemptions as if the spouse or any of the dependents died, or as if such dependents married, become twenty-one years old or become gainfully employed at the close of such year. Who are Special Employees? These are employees occupying supervisory or management position of technical knowledge.

a.

ii.

Aliens employed by Regional Area HQ of Multinational Companies Aliens employed by Operating HQ Aliens employed by Offshore Banking Unit Aliens employed by Petroleum Service Contractors and Subcontractors

b. c. d.

iii.

Note: The same tax treatment shall apply to Filipino employees occupying the same position as an alien employed in the above-mentioned MNCs.

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Any income earned from all other sources within the Philippines shall be subject to pertinent income tax (5-32%), as the case may be, imposed under the NIRC.

interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy; A person is said to be financially interested in the taxpayers business if he is a stockholder thereof or he is to receive as his compensation a share of the property in the business.

Note: The foregoing special corporations shall be subjected to 10% tax rate on their income except for the RAHQs. RAHQs are branches established in the Philippines by MNCs and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets. RAHQs only facilitate operations and not income-earning. Hence, they are not taxable as opposed to ROHQs. ROHQs earn income from performing administrative and financial functions for affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets.

Examples: Where ABC Company paid premiums on the life of Mr. Chairman, the premiums are nondeductible if ABC is the beneficiary since it is as if it just transferred its money from one pocket to another. But where the beneficiary is the employee or his family, the premiums paid by ABC Company for the insurance of Mr. Chairman is deductible. Where a corporation is a family corporation, the premiums paid by such corporation on the life insurance policy covering the life of its president with his wife as the beneficiary are not deductible, the corporation being indirectly the beneficiary under the policy.

VI.

NON-DEDUCTIBLE ITEMS

The following are not deductible in computing taxable net income: 1. Personal, living or family expenses; These are not deductible since the same are considered as already contemplated under the personal basic exemption. 5.

Losses from sales and exchanges of property directly or indirectly. This is to prevent simulated sales between related taxpayers which results to tax avoidance. a. Between members of a family (brother, sister of half or full blood, spouse, ascendant, lineal descendants); Except in case of distributions in liquidation, between an individual and a corporation more than 50% in value of the outstanding stock of which is owned directly, by or for such an individual;
XYZ CORP A 60% C 20% B 10% D 10%

2.

Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate; These are capital expenditures which will increase the value or quality of the taxpayers property and serve as additional source of income. These costs will have to be spread out over the life of the property DEPRECIATION.

b.

3.

xxxxxx Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made; Also considered as capital expenditures. Such improvements must extend the life of the property for more than one year. In other words, such repairs must be extraordinary. Expenses for repairs are DEDUCTIBLE if such repairs are incidental or ordinary and do not materially add to value of the property nor appreciably prolong its life.

Any loss derived from the sale between XYZ and A shall be a non-deductible loss. If XYZ sells to BCD at a loss, said loss is deductible.
XYZ CORP A 10% B 10% C 10% DEF CORP D 60% E 20% F 10% G 10%

4.

Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financial 4

j D 10%

DEF 60%

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

If XYZ sells to B at a loss, it is still deductible. [10% + (60% x 60%) = 46% c. Except in case of distributions in liquidation, between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for same individual, if either one of such corporation is a personal holding company or a foreign personal holding company; or Between the grantor and a fiduciary of any trust; or Between fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with respect to each trust; or Between a fiduciary of a trust and a beneficiary of such trust II. TRUST -

ESTATES AND TRUSTS

I. ESTATE -

DEFINITION OF TERMS

d.

The mass of property, rights and obligation left behind by the decedent upon his death. For purposes of income tax, an estate may be one that is under judicial administration or one that is not under judicial administration.

e.

f.

It is an arrangement whereby the trustor grants the control of certain property in the person of the trustee for the benefit of the beneficiary.

GROSS INCOME INCLUSTIONS ESTATES & TRUSTS The gross income of an estate is practically the same as that of an individual taxpayer.

III.

INCOME OF ESTATES AND TRUSTS WHICH ARE INCLUDED FOR INCOME TAXATION 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. Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian or an infant which is to be held or distributed as the court may direct. Income received by estates of deceased persons during the period of administration or settlement of the estate. Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated.

b.

c.

d.

Ex. If there is an estate subject to settlement but not yet partitioned: Any income generated will not be subjected to any income estate tax Each heirs will be taxed on their individual tax return

If there are 4 apartments left to the heirs but the heirs added two more apartments and generated an income of 1M: 5 TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Treated as unregistered partnership, subject to the 30% tax rate.

or diverted to purposes other than for the exclusive benefit of the employees. However, any amount actually distributed to any employee or distributee shall be taxable to him in the year which so distributed to the extent that it exceeds the amount contributed by such employee or distributee.

IV.

GROSS INCOME DEDUCTIONS ALLOWED TO ESTATES AND TRUSTS a. The amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the beneficiaries. The amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct. The amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to the legatee, heir or beneficiary. NOTE: The amount so allowed as a deduction shall be included in computing the taxable income of the heirs, beneficiaries or legatees, whether distributed or not.

b.

c.

V.

EXEMPTION ALLOWED TO ESTATES AND TRUSTS P50,000 personal exemption just like an individual taxpayer

Ex. DECEDENT = 50K PBE ESTATE INCOME = can no longer claim PBE

Jan 1

Aug 4

Dec 31

VI.

EXCEPTION FROM TAXATION Employees trust which forms part of a pension, stock, bonus or profit-sharing plan of an employer for the benefit of some or all his employees shall be exempt from income tax: a. If contributions are made to the trust by such employer, or employees or both, for the purpose of distributing to such employees the earnings and the principal of the fund accumulated by the trust in accordance with such plan; and If under the trust instrument, it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be used for TAXATION NOTES - FINALS| 404 |marukoi.mhealler

b.

CORPORATE INCOME TAXATION


I. INTRODUCTION AND DEFINITION OF TERMS

CORPORATION includes partnership no matter how created or organized, joint account companies, insurance companies and other associations except: 1. 2. General professional partnership Joint Venture for the purpose of undertaking construction projects Subject to tax on their separate income If joint venture is not for construction, it will be subject to 30% income tax

JOINT VENTURE created when 2 corporations, while registered and operating separately, are 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. JOINT ACCOUNT created when 2 persons form or create a common fund and such persons engages in a business for profit. This may result in a taxable unregistered association or partnership JOINT STOCK COMPANIES the midway between a corporation and a partnership, a hybrid personality, somewhat a corporation because this is managed by a Board of directors and such persons may transfer their share/s without the consent of others, and somewhat a partnership because it is an association, and persons or members of the same contribute fund, money to a common fund. EMERGENCY OPERATION these may be formed by 2 corporations with separate personalities. If they form that emergency operation (it is a really a special activity) to engage in a joint venture. Corporation 1 may be taxed only from the income derived from such business. The income derived from such emergency operation should also be included in that taxable income subject to corporate income tax. In the same way, that corporation 2, has a separate and distinct personality; if its a part of that emergency operation, the income derived from such special activity should also be included in the income of that corporation 2, subject to corporate income tax, even if it is not registered with the Securities and Exchange Commission. CO-OWNERSHIP General Rule: As a rule, tax exempt, because a coownership is not a partnership but formed and organized not for profit but for common enjoyment of the property or for the preservation of the property. And any income as an incidence thereof is taxed at 5-32% since it forms part of the ordinary income of the co-owners. But the co-ownership itself is tax exempt. Exceptions: a. When the income of the co-ownership is invested by the co-owners in other income producing activities; or When there is no attempt to divide inherited property for more than ten (10) years and the said property was not under any administration proceedings nor held in trust, an unregistered partnership is deemed to exist, which is thereby subjected to 30% corporate income tax. TAXABLE CORPORATIONS

3.

Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government Must be with the government in order that it will be exempt from 30% corporate income tax.

PARTNERSHIP an association of two or more persons where each partner contribute money, property or industry to a common fund with the intention of dividing profits among themselves i. The partners in a partnership are considered as stockholders for tax purposes. The profits distributed to them are considered as dividends. For taxation purposes, business partnerships are taxable irrespective of whether it was orally constituted or in writing and whether or not it is registered with the SEC.

ii.

GENERAL PROFESSIONAL PARTNERSHIPS - partnerships formed by person for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business. Persons engaged in business as partners in a GPP, shall be liable for income tax only in their separate and individual capacities. i. For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the same manner as a corporation. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership. Income of a GPP is deemed constructively received by the partners. The undistributed shares will still be considered as constructive income already taxable on the part of the individual partners. Now, even if the GPP is not subject to 30% corporate tax rate on the net income, the net income is considered as earned by the partners composing the GPP. And taxable separately on such partners to 5%- 32%. The partners and the GPP are required to file individual ITR. 7 1.

b.

II.

ii.

DOMESTIC CORPORATIONS (DC) See Section 27 A corporation formed or organized under Philippine laws. It is subject to tax on its net taxable income from sources WITHIN and WITHOUT the Philippines.

2. iii.

RESIDENT FOREIGN CORPORATION (RFC) See Section 28A A corporation formed, organized, authorized or existing under the laws of any foreign country, and TAXATION NOTES - FINALS| 404 |marukoi.mhealler

engaged in trade or business WITHIN the Philippines. It is subject to tax on its net taxable income from sources within the Philippines. Being engaged in business implies continuity of commercial transactions or dealings; continuity of business or continuity of intention to conduct continuous (regular) business. For tax purposes, for as long as it is formed, organized, authorized under foreign laws and engaged in business in Philippines, it is considered as RFC even if 100% owned by Filipinos.

Income Tax Base Expense Deductions Allowed Tax Rate

DC Within and Without Net Taxable Income Expense Deduction Within and Without 30%

RFC Within Net Taxable Income Expense Deduction Within 30%

NRFC Within Gross Income None Allowed

30%

What makes a foreign corporation Resident and what makes it a non-resident corporation? If it is registered as a Philippine branch of a foreign company, it is automatically considered as a resident foreign corporation. However, non-registration is not necessary to be considered as RFC. The criteria is WON you are DOING BUSINESS IN THE PHILIPPINES o Doing business in the Philippines would require the determination of whether the activity you are doing in the Philippines is done in a continuous basis or regular basis.

3.

NON-RESIDENT FOREIGN CORPORATIONS (NRFC) See Section 26B A corporation formed, organized, authorized, or existing (foae) under the laws of any foreign country. It is subject to tax on its gross income from sources WITHIN the Philippines. Such gross income may include interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic, or casual gains, profits, and income and capital gains, EXCEPT, capital gains from the sale of shares of stock not traded in the stock exchange.
CORPORATION

Filing of an Income Tax Return (ITR) Domestic corporations are required to declare their income in a quarterly basis. These are mere estimates and at the end of the year it is annualized. Done through Selfassessment (without waiting to be assessed by BIR) Resident foreign corporations are also required to file an ITR at the end of the year and/or a quarterly basis. Non-resident foreign corporations do not file quarterly or annual ITR. Any payments made to non-resident foreign corporations are subjected to final withholding tax. Income remitted to NRFCs is already net of the withheld tax in the Philippines. Payments to: o o Non-RFC - withhold 30% of the tax Non-resident aliens not engaged in trade or business withhold 25% (RFC will receive 70% free from tax already or 75% for NRA-NETB) REASON: the Philippine government does not have jurisdiction over these taxpayers, hence, the government cannot expect them to declare their income at the end of the year or on a quarterly basis. Any payor of the income, meaning to whom these persons is transacting with has the obligation of a withholding agent. As a withholding agent, he will be liable for nonwithholding. Withholding with finality it is the final withholding tax considered as the full and final payment of the tax. TAXATION NOTES - FINALS| 404 |marukoi.mhealler

DOMESTIC FOREIGN

1. Philippine Laws (formed and organized) 2. Within and Without 3. NET Taxable income (allowed to deduct expense within and without)

1. Foreign Laws 2. Abroad 3. Within If allowed to deduct expense depends on:

Resident Foreign Corporation

Non-Resident Foreign Corporation

1. 2.

3.

Taxed at NET Allowed to deduct expenses WITHIN Tax Rate: 30%

1. 2. 3.

Taxed at GROSS NOT Allowed to deduct expenses Tax Rate: 30%

Non-Resident Foreign Corporation Gross income of non-resident foreign corporations includes the same gross income that has been enumerated in non-resident aliens not engaged in trade or business, such as (a) interests, (b) dividends, (c) rents, (d) royalties, (e) salaries, (f) premiums (except reinsurance premiums), (g) annuities, (h) emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and (i) capital gains, except capital gains subject to tax under subparagraphs (C) and (d) Except: Capital gains on sale of shares of stocks which are not listed and traded, which will be subject to the same rate of: 5% and 10% It did it not include in the exception the capital gains on the sale of real property unlike NRANETB because NRFCs are not expected to have real properties in the Philippines.

7. Cemetery company owned and operated exclusively for the benefit of its members (must be a non-profit cemetery) Requisites: a. Owned and operated exclusively for the benefit of its owners b. Not operated for profit 8. Non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans; no part of its income or asset shall belong to or inure to the benefit of any member, organizer, officer, or any specific person 9. Business league, chamber of commerce, or board of trade, not organized for profit, and no part of the net income of which insures to the benefit of any private stockholder or individual Requisites: a. This must be established for common business interest b. No part of the income shall inure to the benefit of a particular individual 10. Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare 11. Farmers associations or like associations, organized and operated as a sales agent, for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity produce finished by them (must be a non-profit association) 12. Farmers cooperative or other mutual typhoon or fire insurance company, mutual ditch or irrigation company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members of the sole purpose of meeting its expenses 13. Government educational institution 14. Non-stock and non-profit educational institution General Rule: All corporations, agencies or instrumentalities owned and controlled by the government shall pay such rate of tax upon their taxable income as are imposed upon corporations or associations engaged in a similar business, industry of activity. Exceptions: 15. GSIS (Government Service Insurance System) 16. SSS (Social Security System) 17. PHIC (Philippine Health Insurance Corporation) 18. PCSO ( Philippine Charity Sweepstakes Office)

III.

INCOME TAX EXEMPT ENTITIES, Section 30 a. b. c. Sec. 22 Sec. 30 Sec. 72

1. General Professional Partnership 2. Joint venture for the purpose of undertaking construction projects. 3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government 4. Labor, agricultural or horticultural organization not organized principally for profit May derive income from such business as long as it is merely incidental (the organization is still exempt). It is important that in the articles of incorporation of this tax-exempt organization, it must be clearly provided that it is not formed or organized for profit.

5. Mutual savings bank not having capital stock represented by shares and cooperative bank without capital stock organized and operated for mutual purposes and without profit 6. A beneficiary society, order or association, operating for the exclusive benefits of the members such as fraternal organization operating under the lodge system (one which must operate under a parent and subsidiary associations), or a payment of life, sickness, accident, or other benefits exclusively to the members of such society, order or association, or non-stock corporation or their dependents

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19. NAPOCOR (Special Law)

C.

From number 15-19 of outline, their exemption does not come from Section 30, but from Section 27(c) which covers domestic corporations. GR: GOCCs are taxable entities EXC: GSIS SSS PHIC PCSO NAPOCOR

Condominium Corporations General Rule: Condominium Corporations are not subject to 30% income tax. Collection of association dues, utility, common charges expense are not for profit Exception: Once collections of condominium corporations exceed more than that which they require for the maintenance of the building, it will be subject to tax. (only the difference will be subject to tax) 3 Categories of Tax-Exempt Entities: A. Those which do not come within the definition of a corporation Tax Exempt Entities under Section 30 Except: 1. Income from the use of properties, real or personal Income from activities conducted for profit

Filing of ITR These exempt entities are still required to file ITR. Even if it is among the tax exempt entities, but you are registered for BIR purposes, you are expected to file an ITR year in year out. All you have to do is simply put there the details, whatever proceeds there is, the expense, and at the bottom that it is exempt. If you want to avoid the reportorial requirements, anyway you are not liable for income tax, you have to prove before the BIR, get a ruling that you are exempt so that you will be taken out from the coverage of those who are required to file an ITR.

B.

2. Example:

If there is a cemetery, and there is a big space rented out for a concert, will the proceeds be subject to tax? YES, it is taxable. Regardless of the use of the proceeds. Legal basis There is a caveat in the last paragraph of Section 30, that notwithstanding that these exempt entities have been granted exemption from income taxes, they will still be subject to income tax if and when they realize income coming from any of these three: 1. The usage of a real property, whether it is regular or not.

IV.

TYPES/CLASSIFICATION OF INCOME

1. Gross Income, Inclusions a) b) COMPENSATION FOR SERVICES GROSS INCOME FROM TRADE OR THE EXERCISE OF A PROFESSION GAINS DERIVED FROM DEALINGS IN PROPERTY INTERESTS May or may not be subject to final withholding tax. Interest on bank deposit/deposit substitutes/trust fund and similar arrangement (subj. to FWT) Interest from lending/interest income from bonds Interest on foreign bonds/government bonds Interest on treasury bills Interest earned from deposits maintained under the FCDU system (subj. to FWT) Interest income of pawnshop operators

c) d)

2. The usage of a personal property, whether regular or not. Any activity made for profit, which is regular. -

3.

These are subject to income tax regardless of how the proceeds will be used or utilized.

Determine if interests form part of the corporations active or passive income: 10 TAXATION NOTES - FINALS| 404 |marukoi.mhealler

If Passive Income subject to 20% fwt If Active Income subject to 30% corporate income tax e) RENTS (2 Types) Operating Lease

a.

Refer to Tax Code Section 42 (4) for complete list. Royalties include supply of scientific, technical, industrial or commercial, knowledge or information. If you purchase a software, it can be covered as royalty payment or not. It will be royalty payment if what you purchase is customized, with the transfer of technical knowledge. But the software you purchase is an offshelf available to all. You are not required to pay royalty fees for that. It is simply the purchase of an item. So royalties are more on the privilege of having the right to use a scientific or technical knowledge.

b.

a contract under which the asset is not wholly amortized during the primary period of the lease, and where the lessor does not rely solely on the rentals during the primary period for his profits, but looks for the recovery of the balance of his costs and for the rest of his profits from the sale or the re-lease of the returned assets at the end of the primary lease period. Normal rent/lease that we know. What you are paying is for the temporary use of property without the transfer of ownership at the end of the lease period. The owner of the property does not foresee relinquishing ownership over it at the end of the contract period, while the one using it is only paying for the temporary usage of it. It is for the operation of the business of the one leasing it.

c.

If you purchase a franchise, it may be subjected to the normal 30% income tax if it becomes part of the corporations regular activity. (i.e. McDonalds franchises)

g)

DIVIDENDS Any distribution made by a corporation to its shareholders out of its earnings on profits and payable to its shareholders, whether in money or in other property.

Financial Lease also called the full payout lease, a contract involving payment over an obligatory period (also called the primary or basic period) of specified rental amounts for the use of a lessors property, sufficient in total to amortize the capital outlay of the lessor and to provide for the lessors borrowing costs and profits. Obligatory period is primary non-cancellable period of the lease which in no case shall be less than 730 days. Lessee exercises choice over the asset. Lease to own in common term; A purchase of the property The owner will relinquish ownership over the property at the end of the contract, while the one leasing it will become the owner of the property. The owner of the property is expecting that over the lease period not to go below 730 days, he will recover the full value of the property. So if youre in a financial lease, whatever you are paying to the lessor is an advance to the purchase price, you dont recognize it as an expense in your books. If youre into business and you lease out under financial lease, whatever payments you are making is not an expense, but is an advance payment, part of the purchase price.

Requirements for dividend declaration, in general: 1. 2. 3. Unrestricted retained earnings Board of Directors declaration Absence of prohibition in any loan agreement

Types of dividends 1. Cash dividends cash given as dividends. If the recipient of the disguised dividend is an individual 10% - for Resident citizens, Non-resident citizens and resident aliens 20% - for non-resident aliens engaged in trade or business 25% - for non-resident aliens NOT engaged in trade or business If the recipient is a domestic corporation or resident foreign corporation payments to such corporations of dividends ARE NOT AS YET TAXABLE. (to be discussed in succeeding topic) If the recipient is a NRFC, dividends are subjected to 30% fwt

f)

ROYALTIES

11

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

2. Property dividends Property in kind (All encompassing; whatever property you would wish to give to your stockholders it will be taxable.) These are dividends paid in securities or other property, in which the earnings of a corporation have been invested are income to recipients to the amount of the full market value of such property when receivable by individual stockholders. Note: A dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. It may also be in the form of common stocks held by AA Corporation in BB Corporation that are given to stockholders of AA Corporation. These common stocks are held by AA Corporation as investments or assets. Hence, assets/property of a corporation that are distributed as dividends are property dividends even if they may be stocks in another corporation. Corporation will remit the FWT (final withholding tax) in behalf of the recipient. The corporation will have to collect in cash from the stockholders the value of the FWT but the withholding agent is still the corporation. Before the dividends will be given out, 10% will be remitted to BIR, such being paid by the stockholder to the corporation, who will in turn remit it to the government. How much is deducted from the books of the Corporation? Its really the value in the books (Book Value), not the fair market value. For tax purposes, 10% will be computed in the fair market value. But for the books of the corporation, what will be deducted is the actual cost that went out of its ownership. 3. Stock Dividends - transfer from profits to the capital. General Rule: Stock Dividends are NOT taxable. Stock Dividend representing the transfer of surplus to capital account shall not be subject to tax. Exception: Stock dividends will be taxable when: 1. If subsequently cancelled and redeemed by the corporation - If in order to avoid the tax on dividends, you declare stock dividends and the corporation will cancel or redeem it right after. Imagine 20M will be declared as stock dividend. As a rule, it is not taxable. But if behind that, there is already an agreement that after declaration it will be cancelled or redeemed by the corporation, meaning as stockholders you 12

will surrender that, and the corporation will redeem that thereafter, in lieu of Php1 M each in cash. This amounts to circumventing the law wherein instead of declaring outright the cash dividend, you went through the path of stock dividends first then exemption. That is subject to tax, as if it was an automatic declaration of cash dividends. 2. If it leads to a substantial alteration in the proportion of tax ownership in a corporation.

Capital Million Profits Million

40

360

Declared 42 Million as Stock Dividends

Illustration: 42 M as stock dividend Beginiing Investment 39 (classmates) = 1 M each =1M

Declared SD 1M 3M 2 Million

= Total New investment = 2M = 4M

1 (X)

TAXABLE!!!

Say you want 42 M to be declared as stock dividend. But the problem is, you are 40. All of you 39 classmates will receive 1 M each. But the 1 person, X, will receive the 2 M remaining. It will lead to an alteration of the interest of proportional holdings in the corporation. Instead of all of you equally owning the corporation through shares, she will now have an advantage. Her total investment will be 4 M. Her original 1 M plus the 3 M stock dividends. All the rest will be having only 2 M. Since it lead to a substantial alteration or dilution in your interest or ownership, it will now be subject to tax. But what is subject to tax is only the difference of 1 M. Rationale: Because she received an income more than the other stockholders. What she will be receiving is more than what you will be receiving in the future. Substantial Alteration (as long as there is dilution in the original proportion of ownership) 4. Disguised dividends TAXATION NOTES - FINALS| 404 |marukoi.mhealler

These are payments which are equivalent to dividend distribution. In the case of excessive payment by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be a distribution of earnings or profits, the excessive payments will be treated as dividends. Disguised dividends are payments made by the corporation to the stockholders in any other form, other than dividend payment. Examples: a. 1M for honorarium of BODs b. Buying motor vehicles and distributing to stockholders but recorded as an expense and not as dividends The point is, whenever there are huge amounts of payments to the owners not considered as dividends, they are actually disguised dividends.

k)

PARTNERS DISTRIBUTIVE SHARE FROM THE NET INCOME OF THE GPP OTHERS

l)

2. Gross Income Exclusions Refer to NIRC Section 32 (B) [i.e. Life insurance, Amount Received by Insured as Return of Premium, Gifts, Bequests, and Devises, Compensation for Injuries or Sickness, Income Exempt under Treaty, Retirement Benefits, Pensions, Gratuities, etc.]

V.

DEDUCTIONS

Fundamental Principles i. The taxpayer must prove that there is a law authorizing deductions ii. The taxpayer must prove that he is entitled to deductions (requisites are met) iii. If the law provides for requirement that the amount or the expense payment needs to be withheld of tax, a tax should have been withheld, otherwise, the deduction is not allowed iv. Always, we construe it strictly against the taxpayer (strictissimi juris) Deductions and/or exemptions are available to individual taxpayers 1. Personal and additional exemptions 2. Premiums on health and hospitalization insurance 3. Itemized deductions, or in lieu of such, optional standard deductions (OSD)

Are disguised dividends taxable? Yes. If given to stockholders, same as cash dividends If given to non-stockholders, then it depends. If given as compensation to employee, then it will be subjected to 5-32% and appropriate withholding tax should be withheld from such compensation.

5. Liquidating Dividends Whenever a corporation dissolves, liquidates and winds up its business operations, it may happen that assets will be left after paying all the creditors and these assets will be distributed to the stockholders in accordance with the proportion of ownership that they have in the business and its called liquidating dividends. It is taxable. Liquidating dividends given can be in the form of cash or properties or other remaining assets of the corporation. It is NOT subject to the FWT of 10%, 20% or 25%. Liquidating dividends are treated as Capital Gains or Losses but NOT the type which is subject to capital gains tax. It si also not subject to FWT. They will be considered as OTHER INCOME of the corporation. Hence, for individuals it will be treated as OTHER INCOME subject to 5-32% or 25% if NRA-NETB and for corporations it is subject to 30%. If the value you receive is less than your investment then it is a loss while if it is higher than your investment then it is a gain. The liquidating dividend is not automatically treated as income but still needs to be compared with your investment to determine if it is gain or loss.

Deductions and/or exemptions are available to corporations YES, But only DC and RFC. No deductions allowed for NRFC. Itemized Expenses or in lieu of such, optional standard deductions [EX.IN.TA.LO.BA.DEP.DEP.CHA.RE.PEN] o Rationale: Corporations venture into activities which are for profit. Therefore, it is for business and with it comes the incurrence of business expenses. Exemptions are not available because it covers personal and family living expenses and corporations are not natural persons.

OSD (optional standard deductions) can be claimed by corporations except NRFC. o REASON for exception: Such corporation is taxed at gross. It is not allowed deductions hence, since OSD is in lieu of deductions, therefore NRFCs are not allowed OSD also. TAXATION NOTES - FINALS| 404 |marukoi.mhealler

h) i) j)

ANNUITIES PRIZES AND WINNINGS PENSIONS 13

Optional Standard Deduction A standard deduction available to corporation, except non-resident, in an amount not exceeding forty percent (40%) of the gross income, in lieu of itemized deductions. Unless the taxpayer signifies in its return its intention to elect the optional standard deduction, it shall be considered as having availed of the itemized deductions. Such election when made in the return shall be irrevocable for the taxable year in which the return is made. A taxpayer who is entitled to and claimed for the optional standard deduction shall not be required to submit with its tax return such financial statements otherwise required in the Tax Code. Can OSD be allowed as a deduction if the corporation is not allowed to claim itemized deductions? NO, OSD is in lieu of itemized deductions. So if a corporation or any taxpayer is not allowed to claim itemized deductions, there is no OSD allowed. Exception: NRA-ETB in the case of individuals, allowed itemized deductions but not OSD Benefit of claiming OSD is that there is no need to substantiate it with receipts unlike if itemized deductions then your books will be audited to determine whether you really have incurred such and whether it is substantiated with official receipts, or invoices or in contracts.

VI. 1. EXPENSES

ITEMIZED DEDUCTIONS

Ordinary Expenses vs. Necessary Expenses Ordinary expenses (OE) refers to the expenses which are normal, usual or common to the business, trade or profession of the taxpayer. An expense is ordinary when it is commonly incurred in the trade or business of the taxpayer as distinguished from capital expenditures. The payments, however, need not be normal or habitual in the sense that the taxpayer will have to make them often. The payment may be unique or non-recurring to the particular taxpayer affected. Necessary expenses (NE) one which is useful and appropriate in the conduct of the taxpayers trade or profession. Extra-Ordinary Expenses - these are amortized or depreciated. They are deductible as amortization or depreciation expense.

Business Expense vs. Capital Expense o Business Expense - refer to all ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or the exercise of a profession. Capital Expenses - are expenditures for the extraordinary repairs which are capitalized and subject to depreciation. These are expenses which tend to increase the value or prolong the life of the taxpayers property. Not deductible OUTRIGHT.

Who are NOT allowed to claim itemized deductions? 1. Individuals, whoever that individual is, if he is purely earning income from ER-EE relationship, forget about itemized deduction because itemized deduction is only in business, trade, or profession. 2. If the individual is a NRA-NETB, no itemized deduction. 3. NRFC are never allowed itemized deduction or OSD.

What important requisite for the deductibility of an expense is not complied with by a capital expenditure making it non-deductible on the year of incurrence? Capital expenditures are extraordinary expenses which prolong the life of an asset that has been repaired. It either increases the value or increases the life or prolongs the life of the asset such that it violates the rule for an expense to be deductible, it must be paid or incurred during the taxable year. Taking into consideration the Matching Principle, only a fraction of such capital expenditures are treated as deductible each year. They are deductible in the form of amortization and depreciation expense.

The default choice is ITEMIZED DEDUCTIONS, unless you expressly opt for OSD. Option of choosing OSD is irrevocable for one year. The option is made at the beginning of the year on the ITR report of the first quarter. For GPPs, the option of the GPP will also be the option of the individual partners.

Common Requisites for Deductibility of Ordinary and Necessary Expenses i. ii. The expenses must be ordinary and necessary; It must be paid or incurred during the taxable year (whether calendar or fiscal year); Exception: NET OPERATING LOSS CARRY-OVER If the expense that youre claiming as a deductible item this year is an expense for the operation of TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Additional Requirement for Deductibility of Certain Payments Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR. (Section 34k)

14

the previous year, it is not deductible expense. So your expense claims must be paid this year or if not paid this year, it must have been incurred. iii. It must be paid or incurred in connection with the trade, business or profession of the taxpayer; It must be reasonable in amount; As a rule, the only proscription as regards the amount claimed as deductible expense is that said amount is reasonable. Except: Entertainment, Amusement and Recreation expense (EAR expense) has a limit as provided by tax rules and regulations since this type of expense has been abused. o The limits are: to the extent only of 1% of the net sales if the corporation is engaged in services. And 0.5% of the net sales if the corporation is into the sale of goods or properties. REASON for the difference: Because those engage in services usually needs more representation expense to entertain their clients or treat them over meetings, lunch meetings, etc. But if it is goods or properties, so long as you have the product, you can sell it. If you are engaged in both sale of goods and services, then still apply the formula to the corresponding nature of sale. vi.

then it can be supported by contracts or acknowledgment receipts. However: Under the COHAN RULE, some expenses need not be supported by official receipts or sales invoice for as long as it can be substantiated with other adequate records proving that in fact it has been purchased by the company and the goods received by the company were actually converted to the product sold. Such are enough proof that expenses had been paid or incurred. But this does not apply in all instances. This requisite need not be complied with if claiming for OSD because the law in OSD says, whether or not you have incurred actual expenses.

iv.

It must not be against law, morals, public policy or public order Example: Bribes and kickbacks given to government personnel and revolutionary taxes given to rebels are not deductible

Compensation For Services Rendered Special Requisites for Deductibility of these Expenses: i. This must be reasonable, meaning, this must not be ostensible; and ii. These are, in fact, payments for personal services actually rendered. Special Requisites for Deductibility of Bonuses to Employees: i. The bonuses are made in good faith;

Salaries or bonuses of directors as provided under the Corporation Code should not exceed 10% of the net income of the corporation because if it exceeds, it will be considered already as disguised dividends.

ii. They are given for personal services actually rendered; and iii. They do not exceed a reasonable compensation for the services rendered, when added to the stipulated salaries, measured by the amount and quality of services performed in relation to the taxpayers business. Bonuses must be given in good faith and in determining whether bonuses will form part of the compensation for services rendered, you have to consider the (1) nature of the business, (2) the financial capacity of the taxpayer and (3) the extent of the services rendered. Advertising And Promotional Expense (APE) It must be reasonable. As long as it is beneficial for the current year, it is deductible. Advertising expense to build the goodwill of the business, or creating a name for the company, future recall, etc (usually if it is excessive i.e. CLEAR advertisements) are TAXATION NOTES - FINALS| 404 |marukoi.mhealler

v.

It must be substantiated by sufficient evidence such as official receipts and other official records; Official receipts Adequate records Amount of expense being deducted Date and place where such expense is paid or incurred Nature of expense direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business, or profession of the taxpayer The evidence must be recognized or produced by the third party. If the evidence solely comes from the company, it is self-serving so it is not sufficient evidence. If no OR or invoice

15

NOT DEDUCTIBLE for the current year but such expense is amortized up to the useful life of the advertisement Rental Expenses This only pertains to Operating Leases

Litigation Expenses Litigation expenses defrayed by a taxpayer to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business. However, litigation expenses that are incurred in the defense or protection of title are capital in nature and not deductible.

i. The rental payment is required as a condition for continued use or possession; The purpose is for trade, business or profession; The taxpayer must not be the owner of the property or he has no equitable title over the property. The taxpayer must not be taking title to the property. This is subject to withholding tax.

ii. iii.

Travel Expenses (TE) Special Requisites for Deductibility of Traveling Expenses: i. ii. The expenses must be reasonable and necessary; They must be incurred or paid while away from home; and They must be paid or incurred in the conduct of trade or business. TE are deductible even if its not receipted because theyre TE that we incur without having a receipt from the carriers, etc

iv.

Entertainment, Amusement And Representation Expenses (EAR) iii. Special Requisites for Deductibility of EAR Expenses: i. ii. iii. Reasonable in amount; Incurred during the taxable period; Directly connected to the development, management and operation of the trade, business, or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his or its trade, business or profession; Not to exceed such ceiling as the Secretary of Finance may, by rules and regulations, prescribe; and - of 1% of net sales for sellers of goods - 1% of net sales for sellers of services v. Any expense incurred for entertainment amusement or recreation which is contrary to law, morals, public policy, or public order shall in no case be allowed as a deduction. iv.

Option To Private Educational Institution (OPEI) In addition to the allowable deductions, a private educational institution may, at its option, elect either: A. Deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities; or B. To deduct allowance for depreciation thereof. PEIs have the option to deduct capital expenditures in the year it was paid or incurred or the other option is to depreciate the expense over the useful life of the asset.

iv.

2.

INTEREST EXPENSE (IE) The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayers profession, trade or business shall be allowed as deduction from gross income.

Repairs And Maintenance Expense Expenses for repairs are deductible if such repairs are incidental or ordinary, that is, made to keep the property used in the trade or business of the taxpayer in an ordinarily efficient operating condition. Repairs in the nature of replacement to the extent that they arrest deterioration and prolong the life of the property are capital expenditures and should be debited against the corresponding allowance for depreciation. NOTE: if the cost of the repair increases the life of an asset for a period of more than (1) year, that amount is considered extra-ordinary repair. Otherwise, it is considered ordinary repair. Supplies And Materials This must be actually consumed during the taxable year. 16

Requisites for Deductibility i. This must be paid or incurred during the taxable year; This must be incurred in connection with the trade, business or profession of the taxpayer; There must be an obligation which is valid and subsisting; There must be an agreement in writing to pay interest; This must observe the limitation under the arbitrage rule; and

ii.

iii.

iv.

v.

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

vi.

This must not be between related taxpayers. Additional requisites:

b.

vii.

There must be an obligation which is valid and subsisting There must be an agreement in writing to pay the interest It must observe the limitation under the Arbitrage Rule This must not be between related taxpayers d.

Between 2 corporations owned or controlled by one individual. He must have a controlling interest over these 2 corporations. OR if one corporation is considered as personal holding company of another corp. Controlling interest means more than 50%

viii.

c.

ix.

Between a corporation and an individual; that individual owns or controls more than 50% of the outstanding capital stock of such corporation Parties to a trust; d.1. grant or fiduciary d.2. fiduciary of one trust and fiduciary of another trust but there is only one grantor d.3. beneficiary and fiduciary

x.

Delinquency Interest on Tax Payments Allowed as a deduction. This type of interest meets the above requisites. Only the interest is deductible and does not include the compromise and surcharge. iv.

Interest Expenses which are Non-Deductible i. Interest expense on preferred stock. As a rule, interest on preferred stock is not deductible because there is no obligation to speak of. It is in effect an interest on dividend. Reason: the payment is dependent upon the profits of the corporation. It will only be paid if the corporation earns profits. Not an actual loan of money. BUT if it is not dependent upon corporate profits or earnings, it is deductible. If it is payable on a particular date or maturity without regard to the corporate profits, it is deductible. SCRIP DIVIDEND is a dividend given by a corporation in the form of a promissory note. The interest paid thereon is actually interest on the corporations indebtedness to the stockholder. As such, the interest paid on scrip dividend is a deductible expense on the part of the corporation.

Interest paid purposes.

or

calculated

for

cost-keeping

v.

Interest paid in advance through discount or otherwise by an individual taxpayer reporting income on the cash basis. Such interest shall be allowed as a deduction in the ear the indebtedness is paid. Interest on exploration obligation to finance petroleum

vi.

vii. viii.

Interest on unclaimed salaries of the employees 33% of the interest income subjected to final tax (arbitrage rule when applicable)

Arbitrage Rule The taxpayers allowable deduction for IE shall be reduced by an amount equal to 33% of the interest income earned by him which has been subjected to final tax. The arbitrage rule automatically limits the deductibility of the IE by reducing 33% of the interest income subject to final tax, whether or not engaged in back-to-back loan transactions. [Only applicable when there is interest income subject to final tax i.e. interest income from deposits in banks and other financial institutions or FCDUs] Example: Lets say that the company has an IE of 600K but it has no interest income, is the IE deductible fully? YES. Say for example, Co. A (earning interest income of 100K subject to 20% final tax), Co. B (earning 100K interest income from loans to employees) and Co. C (no interest income). All of them obtained the 1M loan running for 10 years wherein they would be liable each for 600K annually as IE. Which of the 3 corporations can claim the full 600K as expense and which cannot? Co. A cannot claim fully the 600K as a deductible IE but only 567K (600K [33% x 100K]). The TAXATION NOTES - FINALS| 404 |marukoi.mhealler

ii.

When there is no agreement in writing to pay interest. This does not meet the requisite for deductibility

iii.

Interest expense on loan entered into between related taxpayers Related taxpayers: a. Members of the same family which includes: a.1. spouses a.2. brothers and sisters a.3. descendants and ascendants

17

arbitrage rule applies since Co. A is earning interest income subjected to final tax. If there is no such interest income, the arbitrage will not apply, hence, automatically deduct interest payment in full. Co. B can fully claim the 600K as a deductible IE since its interest income is not subjected to final tax. Interest income subjected to final tax is only those coming from the banking institutions. Co. C can fully claim the 600K as a deductible IE since it is not earning interest income. RATIONALE: To discourage Back-to-Back loan transactions obtaining loan from one bank and invest it to another bank in order to benefit the difference between the tax due on interest income and the tax benefit from the IE.

claimed because IE must be stipulated in writing and there is no interest payment made. But the BIR can impute an interest based on the legal rate of 12% and subject such interest income on the part of Co. A to tax. But Co. B is absolutely not allowed to claim the IE for no interest has been paid and there is no stipulation in writing. Ergo, one company can be compelled to pay taxes on interest income but the other company cannot claim such as interest expense.

Optional treatment of IE (OTIE) At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure. Same concept as capitalizable repairs and maintenance.

3.

TAXES

If the IE is 100K, interest income subject to final tax is 100K, do you have a deductible IE? YES. You have a deductible IE of 67K (100K [33% x 100K]). If the interest income is 500K subject to final tax, IE is 100K, do you have a deductible IE? NO. 33% of 500K is 165K. So the 165K will be deducted to 100K, which results to no deductible IE.

General Rule: All taxes, national or local, paid or incurred within the taxable year in connection with the taxpayers trade, business or profession are deductible from gross income. Exception: i. Special Assessment on Real Properties tax imposed on the improvement of a parcel of land ii. Income Tax Philippine and Foreign Income Tax - However, Foreign Income tax, at the option of the taxpayer, may be claimed as tax expense (if RC or DC, bec. They are taxable for global income) or tax credit If the foreign tax is claimed as credit, you cannot claim it as expense. But if you claim it as expense, you cannot claim it as credit. a a a a tax tax tax tax

Theoretical interest Its an interest which is computed or calculated, not paid or incurred, for the purpose of determining the opportunity cost of investing in a business. Its not real. Theres no payment at all. Thus, its neither deductible nor taxable.

Imputed interest Sec. 50 of the tax code Allocation of Income and Deductions In the case of 2 or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses. Such provision is powerful in the sense that the BIR can do anything with it so long as it sees relationships between corporations. Example: If Co. A is related to Co. B as the controlling or fully owning the other corporation, any expense loan (lets say 1M) to Co. B, which is interest-free, so Co. A did not earn any interest income. Can Co. B deduct IE? Here, no IE can be

Claiming it as a tax credit, you can claim the full benefit of the tax paid abroad since tax credit is a deduction from Philippine income tax. But if you claim it as an expense, only to the extent of 30% of that foreign tax will it reduce the tax due since tax deduction, as an expense, is a deduction from gross income in computing the net income. Thus, tax credit is more beneficial.

iii. Taxes which are not connected with the trade, business or profession of the taxpayer -Example: Revolutionary taxes iv. Transfer Estates Estate Tax and Donors Tax; not related to trade or business TAXATION NOTES - FINALS| 404 |marukoi.mhealler

18

v. Value-Added Tax indirect tax, tax that is shouldered by the customers vi. Electric Energy Consumption Tax (BP No. 36) Requisites for deductibility of taxes a. b. This must be paid or incurred within the taxable year; and This must be taxes paid or incurred in connection with the trade, business or profession of the taxpayer.

3. It has been paid or incurred during the taxable 4. It has been paid or incurred in connection with trade, business or profession 5. Substantiated with O.Rs 6. Its not contrary to law, public policy or morals

Tax Deduction v. Tax Credit a. Taxes, as deductions include those taxes which are paid or incurred in connection with the trade, business or profession of the taxpayer. However, the source of a tax credit is foreign income tax paid, war profit tax, excess profit tax paid to a foreign country. b. Taxes, as deductions, may be claimed as deductions from gross income in computing the net income WHILE tax credit is a deduction from Philippine Income Tax. c. The foreign income tax paid to the foreign country is not always the amount that may be claimed as tax credit because under the limitation provided under the Tax Code, it must not be more than the ratio of foreign income to the total income multiplied by the Philippine Income Tax. TAX DEDUCTION Sales Less: Direct Cost ____________ Gross Income Less: Expenses (incl. taxes as deduction) __________ Taxable income Tax rate 30% ___________ Tax Due TAX CREDIT Sales Less: Direct Cost ____________ Gross Income Less: Expenses __________ Taxable income Tax rate 30% ___________ Tax Due Less: Tax Credit ___________ Tax Payable

What type of taxpayer can offset the foreign taxes directly by 100% against the Philippine tax due? i. Resident Citizens since liable of income within and without to avoid double taxation NRC not included because liable of income within only no double taxation

ii. Domestic corporations since liable of income within and without to avoid double taxation iii. Members of GPPs iv. Beneficiaries of estates and trusts NRC, NRAs, RFC and NRFCs cannot claim as deductions foreign tax expenses paid since they pertain to income earned outside the Philippines.

Limitations on deductions for NRA-ETB and RFC: In the case of a NRA-ETB in the Philippines and a RFC, deductions for taxes shall only be allowed only if and to the extent that they are connected with income from sources within the Philippines. Foreign tax credit can only be claimed or offsetted against the Philippine tax due if the Philippine tax due is that of a resident citizen or domestic corporation because these two types of taxpayers are taxable on income within and income without. If you say within and without, the Philippine tax already comprises of tax on the Philippine income and tax on the foreign income. Therefore, component of that is a foreign tax, which should rightfully be managed. Say for example, this is a resident citizen, lets say income within is 1M, income without is 1M. Philippine tax is still at 300,000, for income within and without. Foreign tax paid is 300,000. Can the taxpayer claim the foreign income tax as an expense deduction or offsetted as a tax credit? Yes, since a resident citizen is taxable within and without, and required to declare the total global income, he can also claim it as an expense or as a tax credit, directly offsetted against the Philippine income tax due.

Is the real property tax (local tax) payment made by the corporation on its real property used in trade or business a deductible expense for purposes of computing income tax liability, not real property tax liability? YES. Real property taxes (and other taxes allowed as expenses i.e. custom duties) are deductible so long as: 1. It is ordinary and necessary 2. Reasonable in amount

19

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Same facts, can Mr X claim 300,000 as foreign tax credit? The amount claimed is subject to Global and Per Country limitations

Per Country Limitation LIMIT Actual Lower Amount

MR. X, Resident Corporation:


Tax Due Within = 1,000,000 = 300,000 Without = 1,000,000 = 300,000 1 million 2 million

Country A Per Country Income Global Income

1,000,000 6,000,000

x 1,800,000

= 300,000

400,000

300,000

X 300,000 = Max 150,000

Therefore, of 300,000 is recognized by Philippine government.

Country B Per Country Income Global Income

200,000 6,000,000

x 1,800,000

= 600,000

500,000

500,000

800,000

Formula: -The tax credit that shall be allowed only be to the extent of the foreign tax component in the Philippine tax due. [since it will decrease taxes to be paid to the government, amount claimed as tax credit is whichever is lower; Lifeblood doctrine]

Global Limitation Lower Amount (PCL) 800,000 Tax Credit 800,000

LIMIT All Foreign Income Global Income 3,000,000 6,000,000 x 1,800,000 = 900,000

Limitations on Credit The amount of the credit taken shall be subject to each of the following limitations: Per country Limitation the amount of credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which the credit is taken, which the taxpayers taxable income from sources within such country bears to his entire taxable income for the same taxable year; and Global Limitation the total amount of credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayers taxable income from sources without the Philippines taxable under this title bears to his entire taxable income for the same taxable year.
Per Country Limit 300,000 600,000

Hence, the tax credit allowed is 800,000. In effect, you will only be liable to tax amounting to 1,000,000 to the BIR Tax Due Less: Tax Credit Tax Payable Proof of Credits (Tax Credits) The credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following: a. The total amount of income from sources without the Philippines The total amount of income derived from each country, paid or incurred to which is claimed as a credit; and All other information necessary for the verification and computation of such credits. 1,800,000 800,000 1,000,000

Country A B Phils

Taxable Income 1,000,000 2,000,000 3,000,000

Tax Due 400,000 500,000 1,800,000

Global Limit 900,000

Tax Credit allowed 300,000 500,000

b.

c.

Tax Subsequently Refunded of Credited


Total: 800,000

*1M + 2M + 3M = 6M * 30% = 1.8M

Taxes previously allowed as deductions, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of such deduction.

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TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Sales Cost

Year 2008 10,000,000 7,000,000 3,000,000 2,000,000 Tax 1,000,000

YEAR 1 Sales Less: Cost Gross Income Less: Expenses Net Taxable Income Taxable Income 10,000,000 8,000,000 2,000,000 5,000,000 (3,000,000) -0-

YEAR 2 10,000,000 8,000,000 2,000,000 4,000,000 (3,000,000) -0-

YEAR 3 10,000,000 4,000,000 6,000,000 2,000,000 4,000,000 -0-

Gross Income Less: Expenses

Net Taxable Income 1,000,000

Lets put that into illustration. In 2008, you have overpaid 500K in Real property taxes. If, such amount is refunded in year 2009, the whole 500K would be taxable.
Year 2010 10,000,000 9,000,000 1,000,000 2,000,000 Tax 1,000,000

Sales Cost

No taxable income because: Net Taxable Income: 4,000,000 Less: Loss on Year 1: 3,000,000 Loss on Year 2: 1,000,000 No Taxable Income -0-

Gross Income Less: Expenses Net Taxable Income 0

Assuming in 2010, you have overpaid 500K in Real property taxes. If, such amount is refunded in year 2011, the whole 500K would NOT be taxable. You have not benefitted from the claiming of Real property tax (RPT) as deductions since even without the RPT, you would still have a taxable income of zero.

The 3M loss in year 1 and year 2 is carried over to the next 3 consecutive years. Consequently, the NOLCO can be fully applied in year 3. Therefore, your taxable income would be zero. The NOLCO can only be applied in the year you obtain an income (that is why in year 2, you just accumulate it). If the loss in the first year, is not used up the next 3 years, whether fully or partially, it goes down the drain, it is no longer th usable in the 4 year after it has been suffered as a loss. Only 3 years at a time. Year 1 is allowed 3 years. Year 2 has a life of 3 years. *Running of NOLCO is not tolled by the use of OSD

However, if the amount of a tax refunded is a tax which is nondeductible (i.e. VAT or income tax), then such will surely not be taxable in the year they are refunded since you did not receive a benefit from them (they are non-deductible). 4. LOSSES Classification of Losses a. Ordinary Losses losses sustained in the course of trade, business or profession of the taxpayer - can be claimed as deductible expense Net operating loss the excess allowable deduction over gross income of the business in a taxable year Net operating loss carry over (NOLCO) shall be carried over as a deduction from the gross income for the next 3 consecutive taxable years immediately following the year of loss. Such loss shall be allowed as a deduction if it had not been previously offset as a deduction from gross income. However, any loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction.

Lets change the facts. This is XYZ Corporation, it has been given 4 years income tax holiday. For the first 4 years of operation, it th totally suffered annual operating losses. In the 5 year of operation, it earned income. Can the losses suffered in the previous years be used up to offset against the taxable income th in the 5 year? No. Why? Whats the reason? Whenever a corporation is at a stage or it is granted exemption from income taxes, any losses suffered during those years covered by the exemption cannot be considered as a loss or carry over. It will not benefit years that the corporation will subsequently be taxable.

NOLCO shall be allowed only if there has been no substantial change in the ownership of the business or enterprise. There is no substantial change when: i. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or Not less than 75% of the paid up capital of the corporation, if the business is in the name of the

ii.

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corporation, is held by or on behalf of the same persons. XYZ Corporation and ABC Corporation, both companies owned 80% by A. Shown below are the list of shares in each company.

ii.

Securities becoming worthless (investment in a corporation which is dissolving; can be in the form of Liquidating dividends that is lesser than your initial investment) Exc. If you are into trading of securities Abandonment losses in the case of natural resources (wherein you have invested in a property hoping to find natural resources or minerals only to find out that there is none. So abandonment losses are treated as capital loss because you are not yet in the operation of the mining business. You are still in the exploratory stage.) Loss from wash sale or stock securities

iii.
A 80% XYZ Corp U 5% V 5% W 5% X 5% Year 1 LOSS Year 1 INCOME Year 5 ABC Corp A 80% B 5% C 5% D 5%

iv.
E 5%

Year 5

A total of 100% ownership for both companies. Year 1 until year 5, operate at a loss. Year 1 to year 5 for ABC Corporation operated positive. The stockholders of XYZ Corporation could not use the losses suffered in year 1 to the next 3 years nor the losses in year 2 to the next years. Why? Because it consistently operated at a loss. In this case, ABC has been paying huge income taxes. So what stockholders of both corporation decided was to merge in the hope of using the losses of XYZ Corporation to offset against the income of ABC Corporation and claim it as a deductible expense. Is it allowed? Yes as long as the change in ownership is not less than 75%. Should it be more than 75%? Which means? Not less than 75% is 75% or above.

Wash sale occurs where it appears that within a period beginning 30 days before the date of the sale or disposition of shares of stock or securities ending 30 days after such date, the taxpayer has acquired (by purchase or exchange) or has entered into a contract or option to so acquire, substantially identical stock or securities. No deduction for loss shall be allowed for wash sales unless the claim is made by a dealer in stock or securities and with respect to a transaction made in the ordinary course of the business of such dealer. Capital Loss Carry Over. Carry over of Losses from sale or exchange of capital assets for one year (only to the next year not 3 years) which can only be availed of by individuals There are only 3 types of capital assets which can give rise to capital transactions. o Sale of real properties classified as capital assets. Sale of shares of stock wherein you are not a broker of securities subject to capital gains tax. And ALL other capital assets.

So if the facts above is changed to 75% ownership: Can the loss be considered as deductible in the merged corporation? Yes. It is still deductible because after the merger, the ownership is still owned by A at 75%. Combining corporations in order to use up the losses suffered by 1 corporation is allowed so long as there is no substantial change in ownership from the individual corporations down to the merged corporation. Capital Losses governed by rules on loss from sale or exchange of capital assets. Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges. - cannot be claimed as deductible expenses -

b.

Real properties are taxable on the gross selling price or fair market value whichever is higher. So any loss that you suffered from the sale of this property cannot be carried over because it is on a per transaction basis and you are never taxed on the profit alone. You are taxable on the gross selling price or the fair market value itself. But on the other 2, you can have capital losses. (Meaning capital losses can only arise in sales of shares of stocks and all other capital assets. Never on the sale of real properties.) o Motor vehicle that you personally own. So if you sell a motor vehicle that you personally own. You are not in the business of leasing or buying or selling of motor vehicles. You bought it at Php 4million and sold it at Php 2Million, you suffered a loss. This is capital loss. And there is also what we call as, NET CAPITAL LOSS CARRY OVER.

Net Capital Loss the excess of capital loss over capital gains Net capital loss carry over (NCLCO) not available to corporate tax payers Capital Losses include the following: i. Loss arising from failure to exercise privilege to sell or buy property (option money not availed)

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CAPITAL ASSETS: Applicable NCLCO? 1. Real Property 6% Capital Gains Tax X 2. Shares of Stock 5% / 10% 3. All other MV (personally own) Bought 4Million Sold 2Million Capital Loss 2Million NCLCO can only be carried over the NEXT YEAR ONLY!

the amount not compensated by insurance is deductible 5. The loss is not claimed as a deduction for estate tax purposes; and If it is a casualty loss, the taxpayer has filed a sworn declaration of loss within 45 days after the date of discovery of the casualty or robbery, theft or embezzlement. [state the nature or event, the property lost or damaged, value estimation and insurance, if any] MATCHING PRINCIPLE the losses if incurred in past year should only be claimed as expense during that year and not on the year of discovery. If loss is caused by an employee, remedy is to treat that as a bad debt expense against the erring employee in the year of discovery. 5. BAD DEBTS These debts are due to the taxpayer which are usually ascertained to be worthless and charged off within the taxable year. (meaning it is very much doubtful that the borrower will pay. Therefore you must take the necessary steps to prove worthlessness and support it by proper substantiation in order to claim it as expense)

6.
Carry this over the NEXT YEAR!

NOLCO Operating Loss Carried over to the next 3 succeeding years Allowed to both individual and corporate taxpayer

NCLCO Capital Loss Carried over only to the next succeeding year Not allowed for corporations, only individual taxpayer

c.

Wagering or gambling losses the amount that is deductible must not exceed the gains. Capital losses can NEVER BE DEDUCTED AGAINST ORDINARY INCOME. Capital losses can be charged against capital gains to the extent of the gain. Any excess so long as it is NOT ILLEGAL losses can be carried over as an individual taxpayer to the next year. Casualty losses include losses from fire, storm shipwreck, other casualty losses, robbery, embezzlement and theft. Must meet the requirements below in order to be deductible. Abandonment losses in the event that a contract area where petroleum operations are undertaken is partially or wholly abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as deduction. (only pertains to Petroleum operations) Special losses i.e. loss arising from voluntary removal of buildings as an incident to renewal or replacement

*The death of the borrower does not render the payable worthless since you can still go after the estate. Requisites for deductibility of bad debts

d.

a.

It must be indebtedness

for

valid

and

subsisting

b.

Must be ascertained to be worthless (if you are an insurance company, the borrower should be declared insolvent or dissolved)

e.

c.

Must be charged off and uncollectible within the taxable year Must be uncollectible in the near future and Must arise from trade, business or profession of the taxpayer Must not be between related taxpayers

f.

d. e.

Common Requisites for deductibility of losses 1. The loss must be incurred by the taxpayer in the course of his trade, business or profession Loss must be actually sustained and charged off within the taxable year, and not mere anticipated losses; Must be evidenced by a closed and complete transaction (fixed identifiable event) Must not be compensated by insurance or other forms of indemnity. If it is partly compensated, only f.

Steps to prove worthlessness 1. There must be a statement of account sent to the debtor A collection letter If he failed to pay, refer the case to a lawyer If lawyer may send a demand letter to the debtor TAXATION NOTES - FINALS| 404 |marukoi.mhealler

2.

3.

2. 3. 4.

4.

23

5.

If the debtor still fails to pay the same, file an action in court for collection

Agreement as to useful life on which Depreciation Rate is based where the tax payer and the CIR (Commissioner of Internal Revenue/ BIR Commissioner) have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of the property, the rate so agreed upon shall be binding on both the taxpayer and the National Government in the absence of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and circumstances shall rest with the party initiating the modification. *If there is a change in Estimated Useful Life G.R. No need for approval from BIR Exception : When there was previous agreement with CIR *If the property is appraised and you found out that the value of the property has substantially increased. You will not change the amount of depreciation. The appraisal will only affect the value of the property when sold but not for depreciation purposes. Deduction for obsolescence if the whole or any portion of physical property is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its natural life, so that depreciation deductions alone would be insufficient to return the cost at the end of its economic terms of usefulness, a reasonable deduction for obsolescence, in addition to depreciation, may be allowed.

Bad debts charged off subsequently collected If the recovery of bad debts, resulted in a tax benefit to the tax payer, that is taxable. If it did not result in any tax benefit to the taxpayer, that is not taxable. Here, follow the rule in TAX REFUNDS

6. DEPRECIATION The gradual diminution of the useful value of the property used in trade, business or profession of the taxpayer, arising from wear or tear or natural obsolescence. The term is also applied to amortization of the value of intangible assets, the use of which in trade or business is definitely limited in duration.

Requisites for deductibility of depreciation a. The property must be used in the trade, business or profession of the taxpayer There must be depreciable properties The non-depreciable properties are: i. Personal property not used in trade business or profession of the taxpayer Inventoriable stock and securities Land Mining and other natural resources

b.

ii. iii. iv. c.

Depreciation of patent or copyright In computing a depreciation allowance in the case of patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or copyright. The allowance should be computed by an apportionment of the cost or other basis of the patent or copyright over the life of the patent or copyright since its grant, or since its acquisition by the taxpayer, or since March 1, 1913 as the case may be.

The allowance for depreciation must be reasonable This must be charged off during the taxable year A statement on the allowance must be attached to the return The method in computing the allowance for depreciation must be in accordance with the method prescribed by the Secretary of Finance upon the recommendation of the BIR Commissioner. This method includes: i. ii. iii. iv. Declining Balance Method Sum of Years Digit Method Straight line Method Any other method as may be prescribed by the Secretary of Finance upon the recommendation of the BIR Commissioner.

d. e.

f.

NOTE : If tangible property depreciation expense; if intangible (i.e. patents/copyright, purchased goodwill) amortization expense

7. DEPLETION The exhaustion of natural resources like mines and oil and gas wells as a result of production or severance from such mines or wells. These are non-replaceable assets.

Requisites for deductibility of depletion Same as that of depreciation, except that the properties involved are natural resources Depletion v. depreciation TAXATION NOTES - FINALS| 404 |marukoi.mhealler

24

Depletion and Depreciation are predicated on the same basic premise of avoiding tax on capital. Deletion is based upon the concept of the exhaustion of a natural resource whereas depreciation is based upon the concept of the exhaustion of the property, not otherwise a natural resource, used in a trade or business or held for the production of income. Thus, depletion and depreciation are made applicable to different types of assets.

corporation of the taxpayers taxable income (except where donation is deductible in full) to be determined without the benefit of the contribution b. Special those which are deductible in full from gross income

Requisites for deductibility of charitable and other contributions 1. The contribution must actually be paid or made to the Philippine Government or any political subdivision or to any of the domestic corporations or associations specified by the Tax Code; No part of the Net Income of the beneficiary must inure to the benefit of any private stockholder or individual It must be made within the taxable year It must not exceed 10% in the case of an individual and 5% in the case of a corporation of the taxpayers taxable income (except where the donation is deductible in full) to be determined without the benefit of the contribution; and It must be evidenced by adequate record or receipts

Determination of amount of depletion cost Essential Factors: a. b. The basis of the property

2. The estimated total recoverable units in the property; and 3. c. The number of units recovered during the taxable year. 4.

Intangible cost in petroleum operations any cost incurred in petroleum operations which in itself has no salvage value and which is incidental to and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum.

5.

Charitable and other contributions which are fully deductible If the Contributions are given to the following: c. Government or to any of its agencies or political subdivisions, including GOCCs, exclusively to finance, to provide for, or to be used in undertaking priority projects (SHE): i. Sports Development, Invention Science and

NOTE: Depletion refers only to natural resources. It is easier to depreciate than to deplete. Because depreciation is an exact computation. You only have a formula. If it will exist for 10 years, then divide it for ten years. But natural resources sometimes is undetermined. You will have to depend on how much the estimated produce from that parcel of land. If you think you can produce 10 truck loads of diamonds in 10 years, you cannot divide it for over 10 years. The only thing that you can do if you expect 10 truckloads of diamonds is if you can produce this year 2 truckloads, over 10 expected, then 20% of your cost of your property should be depleted already. o If you produce 5 truckloads in the first year, estimated is 10. So of the natural resources should be depleted as of that year.

ii. iii.

Health and Human Settlement Educational Development and Economic

d.

Foreign government or institution and international civic organizations (i.e UNICEF, WHO) Accredited NGO

e. -

NGO means non-profit Domestic Corporation which are formed and organized for any of the following purposes i. ii. iii. iv. Research Health Education Charitable, Cultural, Character Building Sports Development Welfare and Social

8. CHARITABLE CONTRIBUTIONS Kinds of Charitable contributions a. Ordinary those which are subject to limitations as to the amount deductible from gross income 25 Limitations: it must not exceed 10% in the case of an individual and 5% in the case of a

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

*Who accredits them? DepEd, (corresponding govt branch)

CHED,

DSWD,

DOST

have a different depreciable life. For R & D, it must be 5 years) Non-deductible Research and Development Expenditures a. Amount spent for the acquisition or improvements of land or for the improvement or development of natural resources (capitalized hence not deductible outright)

For NGO to be accredited - Not more than 30% of its funding or donations or contributions would be used for administrative purposes.

1 2 3 4 5

Special Contributions Deductible Govt, Foreign Govt, Accredited NGO Not inure to benefit of a private stockholder Within Taxable Year Adequately Supported Fully Deductible (100%)

Ordinary Contributions Deductible NGOs Not inure to benefit of a private stockholder Within Taxable Year Sufficient Records Partially Deductible (5%, 10%)

Contributions NonDeductible All others (i.e. to politicians)

b. Amount paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any natural resources like deposits of ore or other minerals including oil gas.

10. PENSION TRUST CONTRIBUTIONS a) Contributions

If fully deductible: Sales Cost Gross Income Less: Expenses Taxable/ Net Income CD Tax Due 11Million 9 Million 2 Million 1 Million 1 Million (1Million) - 0 cNote: Expenses here do not include charitabl e donation s

If OC-D (partially deductible): Sales Cost 11Million 9 Million

a.

Current Year the contribution is considered as ordinary and necessary expenses fully deductible Past Years if it refers to the services rendered for the past 10 years, the contribution is deductible but apportioned over the next 10 years (i.e. 1/10 deductible every year)

b.

Gross Income 2 Million Less: Expenses 1 Million Taxable/ Net Income CD Tax Due 1 Million 50,000 950,000

b)

Requisites for deductibility of Contributions to Pension Trusts a. There must be a pension or retirement plan established by the employer (reasonable private benefit plan) - must be approved by the BIR b. The pension must be reasonable and actually sound Contribution must be given by the employer to that pension plan The amount contributed must no longer be subject to the control or disposition of the employer The payment has not yet been allowed as a deduction This must be for the benefit of the employees This deduction is apportioned in equal parts over a period of ten (10) consecutive years beginning with the year in which the transfer or payment is made

Another exception provided by your special law is when you adopt a school [ adopt-a-school program]. You provide books, computer equipments etc, and whenever you do that, have yourself accredited and whatever your donation to that school is, its fully 100% deductible plus 50% deductible. This is beyond the tax code, this is special law. So if you donate 1M in books to a school that you have adopted, your deductible donation is 1.5M.

c.

9. RESEARCH AND DEVELOPMENT EXPENSES Research and Development Expense can be capitalized or deducted as expense outright

d.

e.

- if capitalized, it is claimed as expense in 5 years as amortization expense (expense / 5) Amortization of Certain Research and Development Expenditures (capitalized) a. Paid or incurred by the taxpayer in connection with his trade, business or profession; Not treated as an expense Chargeable to capital account but not chargeable to property of a character which is subject to depreciation or depletion (bec. the property may

f. g.

b. c.

Every corporation is encouraged to have a retirement plan in order to provide for retiring employees

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Corporation

Retirement Plan Separate Entity Deductible Expense? Yes!

Employees

Past service cost = divide by 10 ( claim only 1/10 for the year)

2010

2011 1Million For Current Year 1Million For Past year 2Million

100% Deductible 1/10 DR

This is the retirement plan, this is the corporation. If you have a retirement plan, any money that is placed by the corporation here, for whose benefit is this? For the employees. This is a separate entity from the corporation. If the corporation puts in money to this retirement plan for the exclusive benefit of its employees, this is totally a separate entity and any income earned from this plan is not an income of the corporation. Mind you, the income of this retirement plan is totally tax free. Would the transfer of funds to this retirement plan by the corporation be a deductible expense? Yes. In order for the contributions to be deductible, the amount contributed to the plan must be: o Reasonable, the contribution must be given by the employer and the amount contributed must no longer be under the control of the corporation. Once the corporation has transferred the money, the corporation may no longer get back the money or use it in their operations. Second requisite, the payment has not yet been allowed as a deduction it cannot be deducted twice. And plan is for the benefit of the employees and deductions apportioned in equal portions over 10 consecutive years beginning in the year in which the transfer was first made.

Contribution:

Ex. In your retirement plan, 1M must be contributed per year. If you skipped the 2010 contributions and contributed 2M in 2011, then your deductible expense for 2011 is 1.1M (1M + 100K which is 1/10 of 1M)

VII.

TAX RATES
Sources Tax base Entitled Deduction Yes Tax Rate

Classifications

DC

Within & without Within

Taxable Income Taxable Income Gross Income

30%

RFC

Yes

30%

NRFC

Within

No

30%

General Rule: 30% effective January 1, 2009 (except in special cases) Optional: Domestic Corporations and Resident Foreign Corporations have the option to be taxed at 15% of gross income, provided certain conditions are satisfied. Conditions before exercising the option: 1. 2. 3. 4. A tax effort ratio of 20% of the GNP A ratio of 40% of income tax collection to total tax revenues A VAT tax effort ratio of 4% of the GNP A 0.9% ratio of the Consolidated Public Sector Financial Position to GNP

Are all contributions made by a corporation to a retirement plan deductible? No. Distinguish between CURRENT SERVICE COST and PAST SERVICE COST

If it is for that year, it can be deductible if it is considered as ordinary expense for that year. But if such deductions were made for services that have been rendered for the past years, you can have it amortized over a period of 10 years. Divide the amount to be paid over the next 10 years. Current service cost = deductible in full -

This is available to firms whose ration of cost of sales to gross sales or receipts from all sources do not exceed 55%. Once elected by the corporation, the option shall be irrevocable for the 3 consecutive years (NOTE: not next three consecutive years but 3 consecutive years which means it includes the current year). Where shall you apply the 15%?

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Sales Cost 15% Gross Income Less 30% Net Income

11,000,000 9,000,000 2,000,000 = 300,000 500,000 1,500,000 = 400,000

Ex. If the business started on 2009, MCIT is applicable beginning 2013

Commencement of business operation shall mean the registration of the business with the BIR An entity liable for 30% NCIT is liable for MCIT; entities NOT liable for 30% NCIT is not liable for MCIT If the corporation is not subject to the 30% normal corporate income tax (NCIT), then it will not also be subject to the MCIT. Hence, if the corporation is under another tax regime other than 30% NCIT, then MCIT will not apply. MCIT will not apply in the following instances a. The corporation is a Private Educational Institution or Nonprofit Hospital subject to 10%. However, if income from unrelated activities exceeds 50% of total income then it will now be subject to 30%. Consequently, MCIT will now apply. [Predominance test] Subject to Income Tax Holiday (ITH). However, after the ITH, it will now be subject to NCIT and also MCIT if applicable. Subject to 5% income tax for PEZA-registered or Subic Bay free Port-registered corporation for registered activities. If company ventures into unregistered activities, subject to 30% NCIT and 2% MCIT.

55% of 11M is 6,050,000.

Since the cost of sales exceed 55% or P6,050,000, then Gross Income Taxation cannot be availed.

Would everybody be allowed to choose 15% gross income taxation? NO. Only available to domestic corporations and resident foreign corporations. Non-resident foreign corporations are not expected to file these tax returns and are subject to final withholding tax of 30%.

Exceptions to the General Rule: a. MCIT- a minimum corporate income tax of 2% of the gross income as of the end of the taxable year. It is imposed on a taxable corporation beginning on the 4ht taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the normal income tax. The 30% rate may not be applied if it is lower than the 2% of gross income of such corporate taxpayer. Special Rates i.e. Proprietary Educational Institution 10% etc. MINIMUM CORPORATE INCOME TAX

b.

c.

b.

A corporation is required to pay the MCIT if: The minimum corporate income tax rate of 2% of gross income means that the corporate income taxpayer must pay corporate income tax not lower than 2% of its gross income. If the normal corporate income tax (subjected to 30%) is lower than the 2% MCIT, the corporation must pay the 2% minimum. In other words, the normal income tax rate of 30% shall not be applied if this results to a lower tax due than when the 2% MCIT is applied on gross income Applicable only to DOMESTIC CORP. and RESIDENT FOREIGN CORP. 2% of the gross income as of the end of the taxable year is th imposed on a taxable corporation beginning the 4 taxable year immediately following the year in which the corporation commenced its business operations, when the minimum income tax is greater than the normal income tax. 28 a. the normal corporate income tax (30% of taxable income) is less than the 2% of gross income tax [NCIT < MCIT] or b. the corporation is operating at a loss. NCIT and MCIT are mutually exclusive. You cannot be liable for both at the same time. Your actual tax liability to the government is always the 30% tax. But in years wherein the corporation is operating at a loss, you dont have 30% tax, you will have to pay the 2% MCIT. Or in years wherein the corporations regular tax on net income is lower than 2% MCIT, you have to pay the 2% MCIT. Whichever is more favorable and higher in taxes to the government for your operations, you have to pay it to the

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

government. (Life-blood doctrine). MCIT is only a temporary tax, in the long run, unless there are expired MCIT, the taxes paid over the years will always equal the NCIT paid since the excess of MCIT over NCIT can be carried-over. Rationale: Corporations are abusing the claiming of expenses. They bloat the expenses (overstate) resulting to either minimal net taxable income or they bloat this to the extent of reporting a loss, therefore there will be no income tax. And normally you dont exist for 10 years at a loss, you should have closed your business already. This is what the BIR was looking into since there are corporations which were operating at a loss for more than 10 years. The problem was there was over-claiming of expenses, now at least the BIR is assured, if you report a loss, there is still collection of 2% of gross income. When do you begin to impose the MCIT? In the fourth taxable year immediately following the year the corporation has commenced (pertains to registration with BIR) business operations. So, in 2005 December 24: you registered your business. When should you start comparing your 2% MCIT against your 30% normal corporate tax? In 2009. Its the fourth year after 2005. Beginning the fourth taxable year following the year in which you commenced your business operations. You registered your business with BIR in 2005, assuming you follow the calendar year, when is the year after you commenced business operations 2006. So fourth year is 2009. [Tip: Just add 4 to the year you registered your business with the BIR. No need to count ^_^ i.e 2005 + 4 = 2009] The 2% MCIT is based on gross income. Relief from MCIT under certain conditions: The Secretary of Finance may suspend the imposition of the MCIT on any corporation which suffers losses on account of: (1) prolonged labor dispute (more than 6 months); (2) force majeure; and (3) legitimate business reverses Definition of Terms GROSS INCOME derived from business shall equivalent to gross sales less sales returns, discounts and allowances and cost of goods sold (Sec. 27A and 27E) For taxpayers engaged in sale of services, gross income means gross receipts less sales returns, allowances and discounts, and cost of services 29
Sale Less: Cost

COST OF GOODS shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use (Section 27A and 27E) For trading concern: Cost of goods sold shall include the invoice cost of goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit. (Section 27A and 27E) For manufacturing concern: Cost of goods manufactured and sold shall include all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance and other costs incurred to bring raw materials to the factory/warehouse. (Section 27A and 27E) For a service concern: Cost of services shall mean all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including: (A) salaries and employee benefits of personnel, consultant specialists directly rendering the service and (B) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies. Provided, however, that in case of banks, cost of services shall include interest expense. Carry Forward of Excess Minimum Tax Any excess of the minimum corporate income tax over the normal income tax shall be carried forward and credited against the normal income tax for the 3 immediately succeeding taxable years. Can you offset the excess MCIT against MCIT? o
4th year 10M 5M 5M 5M 0 5th year 10M 2M 8M 7.8M 200K

NO. Only to the NCIT


6th year 10M 2M 8M 7.7M 300K 7th year 10M 3M 7M 6.8M 200K 8th year 10M 4M 6M 5.5M 500K 9th year 10M 4M 6M 5.6M 400K

Gross income (2% MCIT) Less: Expenses Net income NCIT) taxable (30% due

30% tax (NCIT)

0 0 0 0

60K 160K 160K 100K

90K 160K 160K 170K

60K 140K 140K 250K

150K 120K 0 100K

120K 120K 20K 0

MCIT (2%) Paid to the government Excess MCIT

Technically, you apply MCIT on the 5 year which is the 4 year immediately following the year you commenced business operation.

th

th

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Given the table above, in the 4 year, how much are you going to pay to the government? Remember, when do we commence computing MCIT? Beginning the 4 taxable year following the year that you commence business operations or which means to say, following the year you registered your business for BIR purposes.
th th

th

offsettable against the 150K NCIT, so the remaining reserve is 100K [250K-150K]. First-in, First-out (FIFO) In the 9 year, how much will you pay to the government? How much is your MCIT? 120K. How much is your NCIT? 120K. So, therefore, you pay 20K to the government [120K100K] You only pay the MCIT if the company is operating at a loss or when NCIT is lower than MCIT. In this case, its equal, so you still pay the NCIT. But since you have an excess reserve still of 100K coming from the prior years, you can offset it against the 120K, which is the NCIT, so therefore, you only pay 20K.
th

So in the 4 year, how much is your tax liability? ZERO. MCIT is zero. At this point, youre not yet liable th to MCIT because MCIT will commence at the 4 taxable year following the year that you commence th business operations, which in fact is the 5 year. In th this case, it is still the 4 year.
th

Lets go to the 5 year. How much is your liability to the government? 160K. Whichever is HIGHER between MCIT & NCIT How much is your excess MCIT to be carried forward? 100K. Your true tax liability to the government is only the NCIT, but you paid the MCIT of 160K because MCIT is higher than NCIT. Therefore, you have a reserve of 100K that is creditable against your future tax liability in the succeeding 3 consecutive years. However, this can only be creditable against NCIT not against MCIT.
th

At any point, did any excess MCIT expire? Was there an expiration of excess MCIT, meaning, it was carried forward for 3 years but was never used? NO How much is your total tax due (NCIT) from the 5 year to the th 9 year? 480K How much did you actually pay to the government? 480K still. (They are equal as long as there is no expired MCIT) The difference is that your true tax liability is always the 30% NCIT. But at any point that you operated at a loss or your NCIT is lower than MCIT, you will be required by the government to pay MCIT as an advance payment for future years. Whatever excess MCIT that you pay to the government will be creditable to the next 3 years.
th

Lets go to the 6 year. How much will you pay to the government? 160K because MCIT is higher than NCIT Can you not deduct your reserve of 100K? NO, because excess MCIT is only offsettable against the NCIT. It cannot be credited against the MCIT. You always have to pay the MCIT, whatever it is. But once you reach to the point that your liability is already the NCIT, its when you can use the reserve. In this case, your payment to the government is MCIT so, therefore, you cannot deduct the reserve yet.

Example: Where MCIT expires


4th year Sale Less: Cost Gross income (2% MCIT) Less: Expenses Net taxable income (30% NCIT) 30% tax due (NCIT) MCIT (2%) Paid to the government Excess MCIT 10M 5M 5M 5th year 10M 2M 8M 6th year 10M 2M 8M 7th year 10M 3M 7M 8th year 10M 4M 6M 9th year 10M 4M 6M

So how much is your reserve at this point? 170K.


th

5M

7.8M

7.7M

6.8M

5.7M

5.4M

. Lets go to the 7 year. How much is MCIT? 140K


0 200K 300K 200K 300K 600K

How much are you going to pay to the government? 140K because MCIT is higher than the NCIT. How much is your reserve now? 250K.
th

60K

90K

60K

90K

180K

In the 8 year, how much will you pay to the government? ZERO. Here, the NCIT is higher than the MCIT, therefore, you dont need to pay the MCIT. You pay the NCIT supposedly. But since in this case, you have an existing 250K total of excess MCIT, such excess is

0 0

160K 160K

160K 160K

140K 140K

120K 120K

120K 0

100K

170K

250K

180K*

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*Excess MCIT as of 7 year Less: Expired MCIT from 5 year Add: Excess MCIT for 8 year (120K 90K) Excess MCIT as of 8 year
th th th th

th

250 K (100K) 30 K __ 180K


th

activity exceeds 50% of its total gross income)

Proprietary Educational Institution any private school maintained and administered by private individual or group with an issued permit to operate from DECS or CHED or TESDA as the case may be. If government educational institutions exempt (one of the exempt entities)

The 100K excess MCIT from the 5 year expires in the 8 year if unused. [Can only be carried forward to next 3 consecutive years] When excess MCIT expires, your total tax payment over the years will no longer correspond to your NCIT for such years because some of the MCIT paid were not offsetted from the NCIT. This is the reason why if rd some companies feel that on the 3 year of the excess MCIT, something is expiring, report a higher NCIT so you can utilize your excess MCIT MCIT means that you are required to pay regularly to the government. Its just an advance payment. You can utilize it afterwards. Its in order to plug the loophole in the tax code wherein the taxpayer is abusing the expenses that they claim as deductible. You can zero out your net taxable income by claiming huge expenses then when you zero out your net taxable income, youre not required to pay any income tax due. But because of the MCIT, you will be paying MCIT due. And in order to avoid expiring the rd MCIT, at some point, in the 3 year, you will be honest enough to declare your true income tax in order to be liable for NCIT.

Non-Profit Hospitals (should be non-profit) same rule as Proprietary Educational Institutions NPH can be tax exempt if they operate for charitable purposes (Lung Center case)

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

SPECIAL DOMESTIC CORPORATIONS


Sources 1. ProprietaryEducational Institution Within without and Tax base Taxable Income Tax Rate 10% (if its income derived from unrelated trade, business or activity does not exceed 50% of its total gross income); or 30% (if its income from unrelated trade, business or activity exceeds 50% of its total gross income) 10% (if its income derived from unrelated trade, business or activity does not exceed 50% of its total gross income); or 30% (if its income from unrelated trade, business or

Note: Use the PREDOMINANCE TEST (whichever income is greater). Hence, if equal, apply 10%. All or nothing. Do not apportion 10% or 30%. Everything subjected to 10% or 30% depending on which income is greater. ALWAYS base on GROSS INCOME not net income. RATIONALE: Because of the vital social functions these corporations perform, the law encourages them to engage in unrelated trade, business or activity, subject to limitation, while enjoying a lower rate of 10%

SPECIAL RESIDENT FOREIGN CORPORATIONS


Sources 1. 2. International Carrier International Shipping Within Tax Base Gross Billings Phil. Tax Rate 2.5%

Within Gross Billings Phil.

2.5%

2.

Non-Profit Hospital

Within without

and -

Taxable Income

For purposes of International Air carrier, Gross Philippine Billings refer to the amount of gross revenue derived from (a) carriage of persons, (b) excess baggage, (c) cargo and (d) mail originating from the Philippines in a continuous and uninterrupted flight irrespective of the place of sale or issue, and the place of payment of the ticket or passage document. Tickets revalidated, exchanged and/or endorsed to another international airline form part of the Gross Philippine Billings if the passenger boards a plane in a port or point in the Philippines. (Refuelling is not considered an interruption) For purposes of International Shipping, Gross Philippine Billings means gross revenue whether from (a) passenger, (b) cargo or (c) mail originating from

31

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the Philippines up to final destination, regardless of the place of sale or payments of the passenger or freight documents. 3. Offshore Banking Units Within Income derived from foreign currency transactions with nonresidents, offshore banking units in the Phils., local commercial banks, inc. branches of foreign banks that may be authorized by the BSP to transact business with OBUs. Exempt

already engaged in selling tickets. On the normal basis, it becomes subject to the 30% tax. If the existence of such corporation is really to sell tickets, whatever the port of origin or airport of origin is, it will be subject to the normal tax of 30% because the 2.5% on GPB refers only to the revenues based on a flight originating from the Phil. in a continuous and uninterrupted flight.

Regional Operating Headquarters (ROHQs) 10%

Income derived from foreign currency loans granted to residents.

Exempt

A branch established in the Philippines by multinational companies which are engaged in any of the ff. services: general administration and planning; business planning and coordination; sourcing and procurement of raw materials and components; corporate finance advisory services; marketing control and sales promotion; training and personnel management; logistic services; research and development services and product development; technical support and maintenance; data processing and communications; and business development. They are subject to 10% tax. They generate profits. However, if they perform activities not related to the purpose for which they were established, they will now be subject to 30%. 10% special rate only applies to activities for which they were established. Remember also that employees of these ROHQs of multinational corporations are given the preferential rate of 15% so long as theyre occupying, if foreigner, managerial or technical, if Filipino, managerial and technical positions. (ROHQs still required to withhold on compensation of their employees)

Income of nonresidents (individual/ corporation) from OBUs 4. Tax on branch profits remittances Total profits applied or earmarked for remittance, without deduction for the tax component s thereof. N/A Within Taxable Income 15%

Regional or Area Headquarters (RAHQs) Exempt 10%

5. 6.

RAHQs ROHQs

A branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets. Being non-operational, it is not subject to income tax.

International Air Carrier (IAC) and International Shipping (IS) taxable within on their tax base of Gross Phil. Billings (GPB) at the tax rate of 2.5%. What is important is that the flight or voyage originates from the Philippines irrespective of place of sale or payment Now, if and when a foreign corporation, like SILKAIR or QATAR AIRWAYS, open up an agency or outlet here in the Phil. selling tickets, whatever the destination is or the port of origin or airport of origin, it will already be covered by the normal tax rate for RFC, not the special rate. Why? Its

Off-shore Banking Units (OBUs) extensions of foreign banks They are RFCs and thus taxable only on income derived within the Philippines But what type of income is subject to tax? Income derived by the OBUs from foreign currency loans to residents is subject to the preferential rate of 10%. If derived from foreign currency loans or transactions to

32

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a. non-residents, b. other OBUs, c. local commercial banks - it will be exempt. If income derived from investments or deposits or other loans to non-residents, whether individual or corporation, it is exempt. Rationale: If it is a loan, situs is the residence of the borrower G.R. If income derived from non-residents (incl. Other OBUs) exempt. Exception local commercial banks (even if local, it is still exempt)

2. Non Resident Owner or Lessor of Vessels Chartered to Filipino nationals or Corporations The Charter Agreement of which is approved by Marine Industry Authority 3. Non-Resident Owner or Lessor of aircraft, Machinery and Equipment

Within

Gross rentals, lease or charter fees

4.5%

Within

Gross rentals or fees

7.5%

Non-Resident Cinematographic Film Owner, Lessor Or Distributor BRANCH PROFITS REMITTANCE TAX (BPRT) Tax on profits remitted by branches of NRFC. Hence, it presupposes a Head Office (NRFC) Branch (RFC) relationship. NRFC can either: 1. Establish a subsidiary corporation in the Phils which is a domestic corporation (has its own set of stockholders and own set of Board of Directors and is a separate corporation distinct from the parent corp) or 2. Create a branch in the Phils. which is a resident foreign corporation (do not have its own stockholders or BOD). Branch profit remittance tax only apply to a Head Office (NRFC) Branch (RFC) relationship (Single Entity Concept) The relationship of NRFC with domestic corp is called parent-subsidiary relationship and not subject to BPRT Hence, if profits are remitted by branch to head office (NRFC), then it is subject to 15% BPRT. However, if it is the subsidiary corporation who would remit to the parent, such will be considered as dividends subject to 15% tax. taxed at 25% on their gross income derived from within. o A cinematographic film owner, lessor or distributor does not include leasing out DVDs or CDs. What it includes is only films one which is used for movies.

Non-Resident Owner Or Lessor Of Vessels Chartered To Filipino Nationals Or Corporations taxed at 4.5% on gross rentals, lease or charter fees derived from within o The Charter Agreement of which is approved by Maritime Industry Authority. Whatever the arrangement is with the lease, whether it be by bareboat charter or demise charter, whether its with crew or not, its covered by the 4.5% on gross income for the lease payments.

Non-Resident Owner Or Lessor Of Aircraft, Machinery And Equipment taxed at 7.5% on gross rentals or fees derived from within

REMEMBER: These are NRFC so these taxes are withheld in advance. Income pertains to income derived within the Phils.

NOTE: If there is a conflict between a tax treaty and a municipal law, that which benefits the taxpayer shall prevail SPECIAL NON-RESIDENT FOREIGN CORPORATIONS (NRFCS)
Sources 1. Non Resident Cinematographic Firm Owner, Lessor Distributor or Within Tax base Gross Income Tax Rate 25%

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PASSIVE INCOME (These incomes must be derived from the Philippines)


DC 1. Interest Income on bank Deposit 20% If income is derived from outside sources, it is treated as OTHER INCOME subj. to 30% bec. there is no w/holding agent abroad RFC 20% If it is an OBU and earns interest from a NRFC, then it is exempt. Such will be considered income derived w/out NRFC This should be included in its gross income subjected to 30% tax. BUT in the case of interest on loans which have been made on or after August 1, 1986, the same is subject to 20% final tax.

2.

Interest income on Bank Deposit Under the Expanded Foreign Currency Deposit System FCDU (Foreign currency deposit unit)

7.5%

7.5%

Tax exempt Rationale: Just like placing your deposit or investment in an OBU. Its offshore. Its outside the jurisdiction of the Phils.

3.

A. Royalties Derived Within the Philippines (General)

20%

20%

30%

B. Royalties Derived Within the Philippines (Literary works, books and musical composition) 4. a. Capital Gains Derived From its Sale of Shares of Stock If it is listed and traded thru local stock exchange: of 1% of the Gross Selling Price b. If it is NOT listed or traded thru local stock exchange: Not over P100,000: 5% Over P100,000: 10% 5. Capital gains Derived from the Sale of Real Property Which is not Used in Trade or Business Branch Profit remitted by a branch office (Exception: If you are enjoying income tax holiday or PEZA-

10%

10%

30%

This rule applies BOTH to corporate and individual taxpayers. Note: Only the first sale for the year amounting to 100K is subject to 5%; the subsequent sales are subject to 10%

6% of the GSP or ZV (or FMV) whichever is higher Not Applicable

Should be treated as OTHER INCOME SUBJECT TO 30%

6.

Subject to Branch Profit Remittance tax of 15%, the basis of the tax is the amount applied for or earmarked for remittance

Not Applicable

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7.

registered or special economic zones not subject to 15% BPRT but 5% special tax, unless for unregistered activities) Dividends Received from Domestic Corporation

Exempt

Exempt

These dividends received from DC by NRFC is subject to 15% Final tax IF: the foreign government of that foreign corp. allows a tax credit at least 15% of the taxes deemed paid in the Philippines by NRFC.

NOTE: Royalties should be considered first as a passive income before you apply the special rates of 10%, 20% and 30%. If the royalty income is already an active income that is earned in the usual course of trade or business of the corporation, it will be subject to the ordinary tax rate of 30%. (i.e. McDo franchises are considered as active income)

Branch Profits Remittance Tax (BPRT) Can a DC be liable for the 15% BPRT? NO. BPRT is only applicable to RFC. DC Can never be subject to BPRT. When is BPRT due to the government? o BPRT is due to the government when a RFC, which is a home-office branch here in the Philippines of a NRFC remits profits to such NRFC.

For capital gains derived from the sale of shares of stock: o If it is listed and traded thru local stock exchange: of 1% of the GSP - listed means enlisted with the Philippine Stock Exchange o If it is not listed or traded thru local stock exchange: Not over 100K 5% and over 100K 10% Same rate applicable to individual taxpayers. Note that whether the seller is DC, RFC or NRFC, the same rate applies. This is an exception for NRFCs.? If you have many transactions for the year, the 5% is applied only to the first 100,000. The subsequent sales are already subjected to 10%. -

BPRT vis--vis intercorporate dividends or under the tax sparing credit rule. What is the difference between the two?
NRFC

100%

DC Subsidiary Corp.

RFC Phil. Branch

A. Relationship between NRFC and DC is Parentsubsidiary relationship. Remittance of income to NRFC is considered a dividend subject to 15% B. relationship between NRFC and RFC is Head Office- Branch relationship applying the SINGLE ENTITY CONCEPT. Here, remittance of income is subject to 15% BPRT. So either way, the amount received by the NRFC will be net of the 15% tax.

Capital gains derived from the sale of real property. o For DC 6% of the GSP or Zonal Value, whichever is higher For RFC and NRFC should be treated as OTHER INCOME subject to 30%

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Would all Phil. branches of a NRFC, when it earmarks profits for remittance abroad, be liable for the 15% BPRT? o As a rule, Phil. branches of a NRFC is liable for 15% BPRT on the total profits that it earmarks for remittance abroad except if the Phil. branch is located within the economic zone that is legally recognized by the government. NOTE: The basis of BPRT is not the actual amount remitted but the profits that are EARMARKED or APPLIED FOR Remittance. Ex. It could be that the RFC will earmark 2M as remittance but will only actually remit to the NRFC 1.5M. The 500K will be used by the RFC to further its operations. The amount subject to BPRT is the 2M profit that was earmarked. NOTE: There was a case decided by BIR pertaining to remittance by a branch (RFC) to Head Office (NRFC) wherein such amount included previous advances given by the Head Office pertaining to construction projects. Such amount is not subjected to 10% BPRT since they are not profits remitted but consists of return of excess funds previously advanced The reason why intercorporate tax on dividends is at 15% are: 1. In order to equal the rate of the BPRT (also 15%) 2. As a rule, NRFC will be taxed at 30% on gross income including dividends earned from a DC. But if there is a tax credit that is granted by the foreign country to Phil. corporations, not a resident there, equivalent to 15% then, we can only impose tax of 15% as well. It means to say that 30% tax rate of NRFC less the tax credit that is expected to be granted by the foreign country to Phil. corporations at 15% so the difference is 15%. The difference of 15% is the rate of intercorporate tax on dividends. TAX SPARING CREDIT PRINCIPLE

Inter-Corporate Dividends NOTE: Intercorporate dividends of (a) DC to DC or (b) DC to RFC are exempt from taxes. These will further be distributed to individuals and it is upon such distribution wherein tax will be applied. It has not yet reached the ultimate recipient which are the stockholders/individuals. Otherwise, there will be double taxation. TAX SPARING CREDIT (Sections 28B (5)b)- 15%

NOTE: In a case, where there is a RFC owned by a NRFC and then both of them invested in a DC, the SINGLE ENTITY CONCEPT will not apply to dividends distributed by DC to both RFC and NRFC. The dividends distributed by DC to RFC is exempt while the dividends distributed by DC to NRFC is subject to 15% intercorporate dividends. NRFC cannot say that it should also be exempt under justification that the RFC and NRFC is a single entity concept.

VIII. Purpose: To attract investors in the Philippines There is no statutory provision that requires actual grant of tax credit by the foreign government. Neither is there a Revenue Regulation requiring actual grant. It is clear that the provision of the law says allows. (As long as allowed, you can already claim the tax credit, it need not be actually granted) So, it is enough to prove that the foreign government allows tax credit. It is not incumbent upon the foreign government to prove the amount actually granted. o All income received by a NRFC will be subject to 30% tax except capital gains from the sale of shares of stock, not traded in the stock exchange. However, for dividends declared and paid by a subsidiary corporation to a NRFC, such amount will be subject to 15% tax. If the foreign government of such NRFC allows or grants tax credit to Phil. corporations located abroad, the intercorporate dividends would be subject to 15% tax, not the 30% tax. (Even before when our tax was 35%, the tax sparing credit rule still applied and 15% tax was still applicable on dividends but the tax credit was 20%) 36

TAX ON IMPROPERLY ACCUMULATED EARNINGS

Sec. 29, Tax Code. See also similar provision in the Corporation Code. In addition to the other income taxes, there is hereby imposed for each taxable year on the improperly accumulated taxable income of each corporation an improperly accumulated earnings tax equal to 10% of the improperly accumulated taxable income. NOTE: BIR subjects 10% of Improperly accumulated earnings NOTE: SEC subjects you to 10,000 fixed rate for every year of violation (for improperly accumulating earnings) 1. Coverage For corporations using the calendar basis, the accumulated earnings tax shall not apply on improperly accumulated income as of December 31, 1997. For corporations adopting the fiscal year accounting period, the improperly accumulated income not subject to this tax shall be reckoned as of the end of the month comprising the 12-month period of FY 1997-98 Average for the dividends or accumulated earnings that is a probable area for imposing the 10% IAET would only start from 1998. Your dividends or accumulated earnings

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

from Dec. 31 down would still be free from the IAET because this kind of tax has already been effective Jan. 1, 1998. And if youre operating on a fiscal year basis, which means that you start at any day other than Jan. 1, your free coverage from IAET would be starting from the last month in 1998 which is the end of your fiscal year. So if your fiscal year is Nov. 1 ending in Oct. 31. Oct. 31, 1998 down would still be free from IAET. So you will be subject to IAET starting Nov. 1, 1998. 2. Corporations Subject to Improperly Accumulated Earnings Tax (IAET) The IAET shall apply to every corporation formed or availed for the purpose of avoiding the income tax with respect to shareholders or the shareholders of any other corporations, by permitting earnings and profits to accumulate instead of being distributed or divided.

3.

Exceptions to IAET

The IAET shall not apply to: a. Publicly held corporations (PHC) Rationale: IT is difficult to come into agreement to retain / accumulate earnings. Usually earnings are declared as dividends Includes all publicly listed companies (all PLC are PHC but not all PHC are PLC) A PHC is such that is not a closely held corporation. A closely held corporation is one where at least 50% of the capital stock or voting power is held by not more than 20 individuals. Closely held corporations are subject to 10% IAET. It is important to differentiate because only Publicly held corporations are not subject to IAET All family corporations are closely-held corporation but not all closely held corporations are family corporations

Assets Liabilities Net worth

100M 80M 20M


50% 50% 1 individual CLOSELY-HELD CORPORATION

Capital Stock 1M

1M as capital stock

More than 20 individuals

Profits (retained earnings) 19M 18M for future expansion

RATIONALE FOR IAET: Improper accumulation of profits. Profits could have been distributed to stockholders and thereby subjected to 10% tax for such dividends. This serves as a penalty. Profits improperly accumulated which are already subjected to 10% tax when distributed as dividends are still subject to 10% on such dividends or 20%/25% (depending on recipient). This will not constitute double taxation because they are taxed for different purposes. If you accumulate profits more than 100% of your paid-in capital (1M in the illustration), then it will serve as an indicator or red flag that you may be improperly accumulating earnings. However, the tax base is not the whole profits. (See formula below) So the basis of the 10% IAET is not the retained earnings in the illustration given above but the formula on the TAX BASE (IAE).

b.

Banks and other non-bank financial intermediaries - For liquidity purposes. Liquidity pertains to the availability of cash to pay sudden withdrawals of clients

c.

Insurance companies - Not covered by IAET because theyre required to maintain some reserves and regulated with the Insurance Commission

d.

Revenue Regulations No. 2-01 i. ii. iii. Taxable partnerships [no capital stock] GPP [exempt under tax code] Non-taxable Joint ventures [exempt under tax code]

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TAXATION NOTES - FINALS| 404 |marukoi.mhealler

iv.

Branch (RFC) of NRFC, since they do not have capital stock Enterprise Duly Registered With PEZA (RA 7916) And Pursuant To Bases And Conversion Development Act Of 1992 (RA 7227) And Under Special Economic Zones They are subject to 5% on registered activities in lieu of national taxes, but if they opt to be subjected to 30% then they will now be subject to 10% IAET. Reason they may opt to be subject to 30% is when they have huge operating expense

Subsidiaries required to maintain certain amount to make investments in other corporations

v.

5.

Computation of Improperly Accumulate Taxable Income Taxable Income adjusted by (these items are added): These are added to reflect the true earnings of the Corporation. Letter A-C are income that are not included in the computation of the taxable income so they should be added back. Letter D results to a deduction in the present taxable income based on losses from previous years. This should be added back to reflect the true income for the year. a. b. Income exempt from tax Income excluded from gross income Income subject to final tax Amount of net operating loss carry over deducted (NOLCO)

4.

Evidence of Purpose to Avoid Income Tax Prima Facie evidence: The fact that any corporation is a mere holding company or investment company Evidence Determinative of Purpose: The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence, shall prove the contrary.

c. d.

And reduced by the sum of (these items are deducted): Dividends are deducted from the time of the date of declaration in the books of the Corporation. Income tax is a non-deductible expense in the computation of taxable income however it should be deducted for purposes of computing IAE. a. b. Formula: Taxable Income + Income exempt from tax + Income excluded from gross income + income subject to final tax + amount of NOLCO deducted dividends actually or constructively paid income tax paid for the taxable year = Tax base subjected to 10% IAET Remedy (to avoid being subjected to IAET): 1. Having a Board resolution for expansion projects (supported by blue prints, etc.) 2. Having a Board Resolution for declaring dividends within one year after taxable year (date of declaration of dividends already decreases the amount of earnings) IAET when paid? 15 days after the end of the taxable period Dividends actually or constructively paid; and Income tax paid for the taxable year.

The term reasonable needs of the business includes the reasonably anticipated needs of the business. Immediate needs of the business including reasonably anticipated needs Corp. should prove an immediate need for the accumulation or direct correlation of anticipated needs to such accumulation of profits

Examples: Allowance for the increase in the accumulation of earnings up to 100% paid-up capital of the corporation Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body (should be proven by board resolution, blueprints and other sufficient supporting documents) Building, plants or equipment acquisition as approved by Board of Directors (in a board resolution) Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement Required by law to be retained Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution

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CAPITAL TRANSACTIONS

the real estate business of the deceased parent, such properties which are ordinarily held for sale for customers maybe converted into capital assets. B. Capital Assets a. Properties not considered as ordinary assets (all assets other than the 4 things mentioned above) Properties used in trade or business classified as capital assets: Accounts receivable 1. Unless you are in a business of selling accounts receivable, it is considered as capital asset. If you have an accounts receivable or collectible from your customer and you are short of cash and would like to assign that receivable or collectible to another corporation by selling your right to collect. Even if the Accounts receivable pertains to collectibles arising from trade, business or profession but because youre not into selling receivable or collectible, its still considered as capital transaction.

I.

INTRODUCTION

CAPITAL TRANSACTIONS Involve the sale or exchange of capital assets: 1. 2. Real Properties (6% CGT) Shares of Stock (1/2 of 1% of GSP or 5%/10%) Other Capital Assets (5-32% if individual; 30% if corporation)

b.

3.

CAPITAL ASSET Property held by the taxpayer whether or not connected with his trade or business except ordinary assets.

2.

CAPITAL GAIN Gain from the sale or exchange of capital asset

CAPITAL LOSS Loss incurred from the sale or exchange of capital asset

NET CAPITAL GAIN The excess of capital gain over capital loss

NET CAPITAL LOSS The excess of capital loss over capital gain

Property for investment in stock 1. If you have a business and youd like to invest in another business, so long as youre not a holding company engaged in investing another business, the investment in capital stock is still considered as capital asset if you are not into trading shares. But if youre a broker of shares, thats automatically considered as ordinary assets.

II. A.

ASSETS

Ordinary Assets, Section 39 (A)(1) a. Stock in trade or property of the taxpayer which may be properly included in the inventory at the end of the taxable. Property primarily held for sale to customers in the ordinary course of trade or business Property used in trade or business subject to depreciation, which means that this must be depreciable property Real property used in trade or business

b.

c.

Subdivision lots to tenants at the instance of the government Interest of a partner in a partnership Note: All properties not used in trade or business are generally considered as Capital Assets Can a CA be converted into an OA?

d.

Can an OA be converted into a CA? YES. The properties of a taxpayer engaged in real estate business are considered as ordinary assets. If the taxpayer dies, these properties will be transmitted to the heirs. Should the heirs discontinue 39

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

YES. Land inherited by the heirs from their deceased parents is considered as capital asset. In the event that this property is substantially improved by the heirs and sold at a profit, said capital asset may be converted into an ordinary asset. The profit derived from the sale of the land is already considered as ordinary gain. Even if you are not registered as engaging in real estate business, real assets can still be considered as ordinary asset if you have been regularly selling real assets Therefore, if you sold house and lots 12 times last year every month, can you already be subject to the OT of 5-32% as an individual or will you still be covered 6% CGT? Because of the regularity and the continuity of the conduct of the buying and selling of real estate properties, you will already be considered as engaging in ordinary transactions of buying and selling real estate properties. CGT of 6% will no longer apply. Registration of activities as real estate business is not necessary for you to be covered by 5-32%. 6.

identical the same stocks or securities. Sale may also include exchange or option to sell securities. Tax Consequence: The gain is taxable as capital gain, because the seller is not engaged in such business (the seller here is not a dealer in securities). If there is a loss, since it is classified as capital transaction, such is considered capital loss. The capital gain is taxable but the capital loss incurred from wash sale transaction is not deductible. A different rule applies if it is entered into by a dealer in securities, as it becomes a transaction made in the regular course of trade or business. (This is an exception, where loss is not deductible) Your reckoning point is WON 30 days before the sale, you acquired the same or substantially similar shares or 30 days after. Its a wash sale. It is in effect a simulated sale. Is the gain taxable or is the loss deductible in this kind of transaction? In all cases, the question whether the gain is taxable or not, lifeblood doctrine, the gain is taxable and the loss, being a simulated sale, is not deductible.

BIR has already set the limit. If you are able to sell at least 6 real properties in one year on your individual capacity without registration, you will be considered as in the regular conduct of selling real properties ordinary transactions. If you sell lower than 6 during the calendar year, still capital transactions, without BIR registration. So you stop at 5.

Short Sale A transaction wherein a person sells securities which he does not own yet (provided however, that he has ownership of the securities at the time of delivery he has the right to transfer ownership) Selling something you do not own yet however when you are going to transfer the property, you should have the right of ownership (because you cannot sell what you do not own) Is the gain taxable and is the loss deductible? YES. The gain is taxable and the loss is deductible.

NOTE: Mere amendment of the purpose of its business does not convert OA to CA. As long as you were initially engaged in real Estate Business, abandonment of the assets does not convert OA to CA. On the other hand, if you were never into real estate business, then 2 years abandonment of the property, or if the property was idle 2 years before the sale, the property if initially treated as OA can be converted into CA (upon showing of proof). C. Special Capital Transactions 1. Failure to exercise option or privilege to buy or sell property Distribution of assets or shares of stock to stockholder upon liquidation of a corporation (5-32% if individual; 30% if corporation) Readjustment of partners interest in a partnership Retirement bonds So long as taxpayer is not a dealer of bonds. Otherwise, it is an ordinary transaction. Wash Sale 61 days sale 30 days before the sale, the seller acquired substantially identical securities OR 30 days after the sale, he acquired identical or substantially

Tax Consequence: Gains or losses from short sales of property shall be considered as gains or losses from sales or exchanges of capital assets. If there is a gain, the gain is taxable. If there is a loss, the loss is deductible. Wash Sale vs. Short Sale Both may be classified as capital transactions.

2.

3. 4.

5.

- In wash sale, the loss that may be incurred is not deductible, whereas in short sale, the loss is deductible.

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RULE: Capital transactions, whenever a loss is deductible, only offset it against the capital gains. Do not cross the border of offsetting the capital losses from ordinary income. D. Rules Governing Capital Transactions

1. Holding-period rule Applies only to individual taxpayers because the capital gain derived from capital transaction of corporate taxpayers is always 100% recognized irrespective of the number of months during which the property was in the possession of the corporate taxpayer. - For capital transactions of corporations, always 100% If the property has been held by the taxpayer for a period of not more than 12 months, the gain or loss is 100% recognized. RATIONALE: To penalize you for selling it early (within 12 months), since capital assets are supposed to be kept for a long period of time If the property has been held for more than 12 months, the gain or loss is 50% recognized.

property was with the seller the holding period (for how many months was it with the taxpayer whos selling it). If the taxpayer sold it within a few months, 12 months or less, everything is taxable and deductible (100%). If the property has been held on to by the taxpayer for more than 12 months, only 50% is taxable or 50% is deductible. In the case of the 1 parcel of land, you gained 500K and 100% of 500K, which is 500K, is taxable because such land was held on to for 12 months. While nd the 2 parcel of land, you gained 1M but only 50% of 1M, which is 500K, is taxable because such land was held for more than 12 months. The reason for such rule is that whenever you purchase a personal property, you are not expected to dispose of it easily. When you dispose of personal property more often within 1 year, you are considered to be in trade or business but not necessarily. So gain 100% is taxable or 50% is taxable. Its the same way that the loss is only 50% deductible or 100% deductible.
nd st

2 parcel of Lands acquired on June 31, 2009 each having a

Cost of 1M Gain

1) December 31, 2009 Selling price 1.5M 2) October 5, 2010 Selling price 2M Change of facts: 1) Dec. 31, 2009 Selling price 1.5M 2) Oct. 5, 2010 Selling price .5M

100% of 500K 50% of 1M

500K 500K

Another example: Lets change the facts. The 2 parcel of land was sold for .5M. Other facts are the same with the preceding example. What will happen?
nd

100% of 500K 50% of (500K)

500K (250K)

In this case, the sale of the 2 parcel of land constitutes a loss of (500K). 50% of (500K) is (250K). Is the (250K) recognized loss deductible on the capital gain of 500K from the sale of st the 1 parcel of land? NO. The loss is deductible but not against such 500K. The loss is deductible against the capital gain that has been earned in 2010 but not against the 500K because such 500K was earned a year ago, in 2009.

Not deductible against 500K bec. not on the same year

Example: You have 2 parcels of land. Youre not engaged in the real estate business or in any other businesses wherein the land is used in trade or business. You purchased such lands Jan. ST 31, 2009 for a cost of 1M each. The 1 parcel of land, you sold it at Dec. 31, 2009 for the selling nd price of 1.5M. The 2 parcel of land, you sold it on Oct. 5, 2010 for the selling price of 2M. For individual taxpayers holding capital assets which they sell, you have to consider the period within which the

Assuming that you had no other transactions in 2010, no other sale, you have a loss of (250K), can you carry forward such loss? NO. The net capital loss carry-over rule cannot be applied.

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TAXATION NOTES - FINALS| 404 |marukoi.mhealler

The net capital loss carryover rule provides that if any individual taxpayer sustains in any taxable year a net capital loss, such loss (in an amount not in excess of the net income for such year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months. In this case, since the loss of (250K) was from the sale of a capital asset held for more than 12 months, the net capital loss carry-over rule cannot be applied.

a loss from the sale or exchange of a capital asset held for not more than 12 months. General Rule: Expenses must be paid or incurred during the taxable year. Exception: Net Capital Loss Carry-Over. REQUISITES 1. Its a capital loss. Its the excess of the loss over the capital income or capital gains. 2. It only applies to individuals. 3. It only applies to capital assets held for not more than 1 year. 4. It can be carried over only to the succeeding next year by an individual. If it remain unutilized, it will no longer be nd usable the 2 year succeeding. 5. Limited to an amount NOT in excess of the net income in the year incurred. You have to consider that it should not exceed the net income from the ordinary transactions of the year when such loss is incurred. You have to look into how much is the net income from ordinary transactions in the year such loss is incurred. Example: Assuming that the (250K) net loss arose from the sale of capital assets held for not more than 12 months. If the ordinary net income in 2010 is 250K, you can carry-over such (250K) loss in the succeeding taxable year. If the ordinary net income is only 200K in 2010, you can carry-over only 200K. If the ordinary net income is 500K, you can carry-over 250K it should not exceed.

2. Net Capital Loss Carry Over Rule applies only to assets held for not more than 12 months It only applies to capital transactions subjected to 100% under the Holding Period rule and not to those subjected to 50%. (Please see immediately preceding example)

3. Capital loss limitation rule Capital losses are deductible only to the extent of capital gains during the year on a yearly basis. There is a wall between capital transactions and ordinary transactions. You cannot commingle them. Capital loss can be deductible only up to capital gain. So if you have capital loss of 2M and capital gain of 1M. Only 1M of capital loss should be applied to the capital gain to have a net capital gain of zero. If you are an individual, you can carry over the capital loss (subject to requisites), however if you are a corporation, then you cannot carry over excess capital loss and such will no longer be deductible. Can capital loss limitation rule apply to corporations as well? YES. Such rule applies to both individual and corporate taxpayers, EXCEPT on banks and trust companies (because they are considered as dealer in securities)

TWO IMPORTANT LIMITATIONS IN NCLCO Limit as to period applied only to next succeeding year Limit as to amount applied only in an amount not exceeding net income (from ordinary transactions) in the year incurred The difference between net operating loss carryover (NOLCO) and net capital loss carry-over (NCLCO) is that: a. NOLCO can be carried over for the succeeding 3 consecutive years but net capital loss carry-over can be carried only to the next year. b. NOLCO involves loss arising from ordinary transactions while net capital loss carry-over involves loss arising from capital transactions. c. Net capital loss carry-over can only be availed of by individual taxpayers while NOLCO can be TAXATION NOTES - FINALS| 404 |marukoi.mhealler

4. Net capital loss carry-over rule Applies only to individual taxpayers If any individual taxpayer sustains in any taxable year a net capital loss, such loss (in an amount NOT in excess of the net income for such year) shall be treated in the succeeding taxable year as

42

availed of both by individual and corporate taxpayers so long as theyre registered for business. d. NCLCO is limited as to amount while NOLCO has no such limitation E. Gains Derived from Dealings in Property

would result to a higher consequently higher taxes.

income

and

This may include sale or exchange of goods or properties. if the property is sold for cash: sale If its property for another property: exchange

The basic formula in determining the gain that you derived from selling your real property or property, in general, is the amount that you received as consideration for the property. This is basically the GSP or any consideration. It may be exchange of property or may be sale of property. But as to how much is subject to tax, you have to determine what the basis of the cost of the property is. The cost of the property that youre selling or exchanging would differ according to how you acquired your property. It simply means that if youre selling a property today, Oct. 5, 2010. Youre selling it at 1M. The property that youre selling has been donated to you. The law says that the amount that you have to deduct as cost in determining your income subject to tax would be the amount as if it is in the hands of the donor. It means at the time it was donated. If at the time it was donated, its value was 500K. Then you deduct it from the 1M, so you get an income of 500K taxable. But theres an exception to the rule. If the 500K that youre deducting (FMV at the time of donation) is greater than the FMV today, Oct. 5, 2010, say for example, the FMV of the property today is 200K so you use such 200K. Lifeblood doctrine. Why? If you use 200K, the taxable income is 800K. [This is from last year. NO example given by Ms. Tiu. Im not sure if this is how the exception should be interpreted, basta bottom line, use the lower FMV as cost. The law is in favor of higher profits] What type of property do you think that the FMV is lower today than the time it was donated? Depreciable assets. Example: Motor vehicles.

Gains from Exchange of Property, Requisites a. b. the property received must have a fair market value; the property disposed of must be substantially different from the property received.

Basic Formula in Determining the Gain or Loss (Sale or Exchange of Property) Amount Received or Realized LESS Cost or Adjusted Basis Determination of the Cost or Adjusted Basis, Section 40B It depends upon the manner of acquisition: a. b. If it was acquired through purchase: cost of property. If the property sold was previously acquired through inheritance: the fair market value (FMV) of the property at the acquisition. (acquisition in inheritance is at the moment of death) If the property sold was acquired through donation: the same as if it would be in the hands of the donor (this is not necessarily the same as the FMV at the time of donation) Exception to the General Rule: if the basis is greater than the FMV of the property at the time of the donation/gift then, for the purpose of determining loss, the basis shall be such FMV. RATIONALE for the exception: The lesser FMV is used. This would result to a higher profit from such transaction since the minuend is lesser. Higher profit results to higher taxes. d. If the property sold was acquired for less than an adequate consideration in money or moneys worth: the amount paid by the transferee for the property. Ex. Acquisition cost = Php 10, Selling price = 1M, Fair Market value = 500K Profit from this sale is computed using this formula: SP AC. Hence profit is 999,990 (1M 10). Use the acquisition cost of the property. This 43

c.

No Gain, No Loss Recognized General Rule: in the sale or exchange of property, the gain is taxable and the loss is deductible. Exception: No gain or loss shall be recognized a) Transactions made pursuant to plan of merger or consideration. Otherwise known as Tax Exempt Transactions or Transactions Solely in Kind i. A corporation, party to a merger or consolidation exchanges its properties solely for stock in a corporation, which is a party to the merger or consolidation.

TAXATION NOTES - FINALS| 404 |marukoi.mhealler

ii.

A stockholder of a corporation party to a merger or consolidation exchanges his stock solely for stock in another corporation, party to that merger or consolidation. - this is analogous to transaction between related taxpayers

ABC Corp. 7M 2M 9M 7 U&6 7 people 5 people 12 people LAND 7M

b) If a person (natural or juridical), alone or together with others or not exceeding four (4), exchanges his property for stock in a corporation and this person or persons, after this exchange, acquired controlling interest over that corporation. This means that they acquired at least 51% of the shares of stock of such corporation. This is also a transaction solely in kind.

ABC Corp. (5M cap)

46M 5M 51M

4 ( U & 3) exch. Land for stocks

4 people 5 persons (ABC) 9 people LAND 46M

Change of facts: ABC Corp. has a capitalization of 2M owned equally by 5 people/stockholders. You together with 6 others have a 7M parcel of land. You want to invest in ABC Corp. So you want to put in the parcel of land so youll be given 7M worth of shares of stock. So the total capitalization of ABC Corp. is 9M [2M + 7M] owned by 12 people [5 + 7]. Is the gain from the exchange of property subject to CGT? Is it covered under the tax-free exchange? YES, but partially. If more than 5 people contribute, do not automatically consider it as already not under the exception. First, determine whether any 5 of them meet the requisite. Use any 5 of them (first highest 5). If at most 5 of them contribute at least 51% of the total shares of stock then, the gain or loss is not taxable/deductible.

So that the facts would be that there are 4 people who invested 46M parcel of land in exchange for the 46M shares in ABC Corp. So the total capitalization is 51M and there are already 9 people owning ABC Corp. In this case, the 5 people acquired controlling interest over ABC Corp. because they own 46M shares out of the total 51M shares from the exchange of property (more than 51%), so therefore, this case is covered by the exception, and as such, the 46M parcel of land is exempted from the 6% CGT and documentary stamp tax. *Note: maximum of 5 persons, not necessarily 5 *Note: at least 51%, not just more than 50%. If 50.5% then it did not meet the requisite.

In this case, the first 5 transfers amounts to 5M (1M each individual). 5M over 9M total capital stock is 55.55%. [5M/9M = 55.55%]. Thus, the first 5 transfers acquired more than 51% so that they have acquired controlling interest over the capital stock of ABC Corp. Therefore, even if the transfer numbers more than 5 people, so long as the first highest 5, would acquire controlling interest over the new capital stock of the corporation, they (the first highest 5) will be granted exemption from the 6% CGT. Since in this case, the 7M is equally owned by the 7 people, so you know that the first 5 would have 5M. And 5M/9M is more than 51%. Therefore, the gains from the exchange of property will not be subject to the 6% CGT with respect only to the first 5.

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Instances where gain is recognized and loss is not recognized: o o o o 1. Wash sale 2. Illegal transactions 3. Those transactions involving related taxpayers 4. Transactions not solely in kind I. It means to say that transactions not solely in kind is when the transfer involves cash. If cash, in addition to property, is transferred, in exchange for shares, its no longer exchange solely in kind, therefore, no exemption from CGT. 1.

ACCOUNTING PERIODS METHODS OF ACCOUNTING TAX RETURNS AND TAX PAYMENTS

ACCOUNTING PERIODS Two Kinds a. b. Calendar year January 1 to December 31 Fiscal Year an accounting period of 12 months ending on the last day of any month other than December (starting any day of the year and ending 365/366 days after) 2. Taxable Year The calendar or the fiscal year ending during such calendar year, upon the basis of which the net income is computed.

INDIVIDUAL HOLDING PERIOD The percentages of gain or loss to be taken into account shall be the ff: a. 100% - if the capital assets have been held for 12 mos or less; and b. 50% - if the capital asset has been held for more than 12 mos. Capital losses are allowed only to the extent of the capital gain; hence, the net capital loss is NOT deductible

CORPORATION Capital gains and losses are 100% recognized. (There is no holding period)

3.

When Calendar Year is Used a. If the taxpayer chooses the calendar year If the taxpayer has no annual accounting period If the taxpayer does not keep its books If the taxpayer is an individual (if individual, no choice. It would only be Calendar Year)

NONDEDUCTIBI LITY OF CAPITAL LOSSES

NET CAPITAL LOSS CARRY OVER

ALLOWED The net capital loss (in an amount not in excess of the taxable income before personal exemption for such year) shall be treated in the succeeding year (but not beyond 12 months) as a deduction as short-term capital loss (at 100%) from the net capital gains.

Capital losses are allowed to the extent of the capital gains; hence, the net capital loss is NOT deductible. Except: If any domestic bank or trust company, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note or certificate or other evidence of indebtedness issued by any corporation (including one issued by a government or political subdivision) NOT ALLOWED

b. c. d.

4.

When the Commissioner is Authorized to Terminate the Taxable Period (the CIR can implement Jeopardy assessment) a. When the taxpayer retired form business subject to tax When he intends to leave the Philippines When he removes his property from the Philippines When he hides or conceal his property When he performs any act tending to obstruct the proceedings for the collection of the tax for the past or current quarter or year When he renders the collection of the tax totally or partly ineffective

b. c.

d. e.

f.

II. 1. 45

METHODS OF ACCOUNTING Two Kinds TAXATION NOTES - FINALS| 404 |marukoi.mhealler

a. b.

Calendar year January 1 to December 31 Fiscal Year an accounting period of 12 months ending on the last day of any month other than December (starting any day of the year and ending 365/366 days after)

d.

Every non-resident alien engaged in trade or business or in the exercise of a profession in the Philippines

NOTE: Only NRA-NETB are not required to file returns. They are subject to final withholding tax. Tax with finality hence, no need to file returns. 2. Instances when Individuals are Not Required to File Returns a. An individual whose gross income does not exceed his total personal and additional exemptions. However, a Filipino Citizen and any alien individual engaged in business or practice of profession within the Philippines shall file an income tax return, regardless of the amount of gross income. An individual with respect to pure compensation income derived from sources within the Philippines, the income on tax on which has been correctly withheld. HOWEVER, an individual deriving compensation concurrently from two or more employers at any time during the taxable year shall file an income tax return. Further, an individual whose pure compensation income derived from sources within the Philippines exceeds P60,000 shall also file an income tax return. c. An individual whose sole income has been subjected to a final withholding tax. An individual who is exempt from income tax (i.e. minimum wage-earners)

2.

Taxable Year The calendar or the fiscal year ending during such calendar year, upon the basis of which the net income is computed.

3.

When Calendar Year is Used a. b. c. d. If the taxpayer chooses the calendar year If the taxpayer has no annual accounting period If the taxpayer does not keep its books If the taxpayer is an individual (if individual, no choice. It would only be Calendar Year) b.

4.

When the Commissioner is Authorized to Terminate the Taxable Period (the CIR can implement Jeopardy assessment) a. When the taxpayer retired form business subject to tax When he intends to leave the Philippines When he removes his property from the Philippines When he hides or conceal his property When he performs any act tending to obstruct the proceedings for the collection of the tax for the past or current quarter or year When he renders the collection of the tax totally or partly ineffective 3.

b. c.

d.

d. e.

Substituted Filing of Income Tax Returns Individual taxpayers receiving purely compensation, regardless of amount, from only one employer in the Philippines for the calendar year, the income tax of which has been withheld correctly by the employer (tax due = tax withheld) shall not be required to file the Individual Income Tax Return. Requisites: 1. Employer-Employee relationship (you are an employee) 2. One employer 3. Taxes correctly withheld A senior citizen who is a compensation income earner deriving from only one employer an annual taxable income exceeding the poverty level or the amount determined by the NEDA thru the NSCB on a particular year, but whose income had been subjected to the withholding tax on compensation, shall, although not exempt from TAXATION NOTES - FINALS| 404 |marukoi.mhealler

f.

III. 1.

RETURNS AND PAYMENT OF TAX Individuals Required to File Returns

General Rule: a. b. Every Filipino Citizen residing in the Philippines Every Filipino citizen residing outside the Philippines, on his income from sources within the Philippines Every alien residing in the Philippines, on income derive for sources within the Philippines

c.

46

income tax, be entitled to the substituted filing of income tax return under Revenue Regulations No. 2-98, as amended. 4. Individuals Not Qualified for Substituted Filing a. Individuals deriving compensation form 2 or more employers concurrently or successively at anytime during the taxable year (it includes changing jobs within the year) Employees deriving compensation income, regardless of the amount, whether from a single or several employers during the calendar year, the income tax of which has not been withheld correctly, resulting to collectible or refundable return. Employees whose gross compensation income do not exceed the statutory minimum wage or P 5,000 per month (P60,000 a year), whichever is higher, including employees of the government of the Philippines, or any of its political subdivisions, agencies or instrumentalities, with salary grades 1 to 3. The statutory minimum wage of minimum wage earners, including overtime pay, holiday pay, night differential and hazard pay, are exempt from income tax. 7. d. Individuals deriving other non-business, nonprofessional-related income in addition to compensation income not otherwise subject to final tax. Individuals receiving purely compensation income from a single employer, although the income tax of which has been correctly withheld, but whose spouse fails under a), b), c) and d) above.

of income but the returns so filed shall be consolidated by the BIR for the purposes of verification foe the taxable year. Return of parent to include the income of children The income of unmarried minors derived from property received form a living parent shall be included in the return of the parent, except when the donors tax has been paid on such property or when the transfer of such property is exempt from donors tax. 6. Self-employed Individuals Every individual subject to income tax, 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 his estimated income for the current taxable year on or before April 15 of the same taxable year. Non-resident Filipino citizens with respect to income from without the Philippines and nonresident aliens not engaged in trade or business in the Philippines are not required to render a declaration of estimate income tax. When to File Returns a. On or before April 15 of each year covering income from the preceding taxable year Thirty (30) days from each transaction and a final consolidated return on or before April 15 covering all stock transactions of the preceding year in case of sale or exchange of stock not traded through a local stock exchange Thirty (30) days following each sale or other disposition in case of sale or disposition or real property.

b.

c.

b. e.

c. f. Non-resident aliens engaged in trade or business in the Phils deriving purely compensation income, or compensation income and other nonbusiness, non-professional-related income.

8.

Payment of Estimated Income Tax by Individuals Four (4) installments: Estimated Tax the amount which the individual declared as income tax in his final adjusted and annual income tax return for the preceding year minus the sum of the credits allowed against said tax. If, during the current taxable year, the taxpayer reasonably expects to pay a bigger income tax, he shall file an amended declaration during any interval of installment payment dates. a. Quarterly income tax return; and The tax computed shall be decreased by the amount of tax previously paid or assessed during the preceding quarters and shall be paid not later than 45 days from the close of each of the TAXATION NOTES - FINALS| 404 |marukoi.mhealler

Employees not qualified for substituted filing but are required to file the Income Tax Return shall file the same not later than April 15 of the year immediately following the taxable year. Provided, that employees with previous/successive employer/s within the taxable year shall furnish their new employer with BIR Form No. 2316 issued by the previous employer/s. 5. Husband and Wife Married individuals, whether citizens, residents or non-resident aliens, who do not derive income purely from compensation, shall file a return for the taxable year to include the income of both spouses. However, if it is impracticable for the spouses to file one return, each spouse, may file a separate return 47

first 3 quarters of the taxable year. Whether calendar or fiscal year b. Final or adjusted return If the sum of the quarterly tax payments made during the said taxable year is not equal to the total tax due on the entire taxable income of that year, the corporation shall either: i. ii. iii. Pay the balance of tax still due; or Carry-over the excess credit; or Be credited or refunded with the excess amount paid.

- only if income tax due exceeds 2,000 and applies only to INDIVIDUALS and not to corporations - 1 payment on/or before April 15 - 2 payment on/or before July 15 b. Payment of Capital Gains Tax
nd st

It shall be paid on the date the return is filed. In case the taxpayer elects and is qualified to report the gain by installments, the tax due from each installment shall be paid within the 30 days from the receipts of such payments. Every corporation deriving capital gains from the sale or exchange of shares of stock not traded through a local stock exchange shall file a return within thirty (30) days after each transaction and a final consolidated return of all transactions th during the taxable year on or before the 15 day th of the 4 month following the close of the taxable year. - PAY AS YOU FILE

9.

Return and Payment of Estimated Income Tax by Corporations Every corporation subject to income tax, except foreign corporations not engaged in trade or business in the Phils, shall render in duplicate, a true and accurate: A. Quarterly income tax return; and The tax computed shall be decreased by the amount of tax previously paid or assessed during the preceding quarters and shall be paid not later than 60 days from the close of each of the first 3 quarters of the taxable year, whether calendar or fiscal B. Final or adjusted return If the sum of the quarterly tax payments made during the said taxable year is not equal to the total tax due on the entire taxable income of that year, the corporation shall either: i. ii. iii. Pay the balance of tax still due; or Carry-over the excess credit; or Be credited or refunded with the excess amount paid.

c.

Where to file Returns a. b. c. d. Authorized agent bank Revenue district officer Collection agent Duly-authorized treasurer of the city or municipality in which such person has his legal residence or principal place of business in the Philippines Office of the CIR if there be no legal residence or place of business in the Philippines.

e.

- END -

NOTE: if individuals file quarterly returns 45 days after end of quarter (April 15, August 15, November 15 and April 15 (annual ITR)) If Corporation file quarterly returns 60 days after end of quarter a. Installment Payments

A taxpayer, other than a corporation, may opt to pay the tax in 2 equal installments when the tax due is in excess of Php 2,000. In such cases, the first installment shall be paid at the time the return is filed and the second installment on or before July 15 following the close of the calendar year. 48 TAXATION NOTES - FINALS| 404 |marukoi.mhealler