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TAXATION LAW | Income Taxation

SEC. 22-23
DEFINITION AND PRINCIPLES
of tax rates and covered by different tax
returns (global system).
INCOME all such gains or profits from
whatever source. It is a flow of services
rendered by capital by the payment of money
from it or any benefit rendered by a fund of
capital in relation to such fund through a
period of time (Madrigal v. Rafferty, G.R. No.
12287, August 8, 1918).
An income is an amount of money coming to a
person or corporation within a specified time,
whether as payment for services, interest or
profit from investment. Unless otherwise
specified, income means cash or its equivalent
(Conwi v. Commissioner, G.R. No. 48532
August 31, 1992).
Income includes earnings, lawfully or
unlawfully acquired, without consensual
recognition, express or implied, of an
obligation to repay and without restriction as to
their disposition (James v. U.S., 366 U.S.
213).
Features of Philippine Income Tax
1. Direct tax tax burden is borne by the
income tax recipient upon whom the tax is
imposed
2. Progressive tax tax rate increases as the
tax base increases. It is founded on the
ability to pay principle.
3. Comprehensive system adopts the
citizenship
principle,
the
residence
principle, and the source principle.
4. Semi-schedular or semi-global taxable
income (i.e. gross income less allowable
deductions and exemptions) is subjected
to one graduated tax rates (if an individual)
or normal corporate income tax rate (if a
corporation) (scheduler system); Passive
investment incomes subject to final tax
and capital gains from sale of shares of
stocks of a domestic corporation and real
properties remain subject to different sets

5. American in origin- Great weight should be


given to the construction placed upon a
revenue law, whose meaning is doubtful,
by the department charged with its
execution (Madrigal v. Rafferty, supra).
Functions of Income Tax
1. To provide large amounts of revenues
2. To offset regressive taxes
3. To mitigate the evils arising from
inequalities in the distribution of income
and wealth which are considered
deterrents to social progress, by a
progressive scheme of taxation. (Report of
the Tax Commission of the Phil., vol. II,
1938, p. 12)
Basis of the right of the government to
tax income: PARTNERSHIP THEORY
The right of the government to tax income
emanates from its partnership in the
production of income by providing the
protection, resources, incentive and proper
climate
for
such
production.
(CIR v. Lednicky, G.R. L-18169, July 31,
1964)
Tests in determining income
1. Flow of Wealth Test The test of
taxability is the "source"- the property,
activity or service that produced the
income. Determine whether any gain was
derived from the transaction.
2. Realization/Severance Test also
known as the Macomber test. There is no
taxable income until there is a separation
from capital of something of exchangeable
value, thereby supplying the realization or
transmutation which would result in the
receipt of income. The essence of the test
is that in order for income to be taxed, it is
to be severed from the property from
which it was derived.

EXECUTIVE COMMITTEE:
MIKHAIL MAVERICK TUMACDER overall chairperson, ARTHUR JOHN ARONGAT chairperson for academics, JASSEN RALPH LEE
chairperson for hotel operations, KIMBERLY JOY BARAOIDAN vice-chairperson for operations, KATRINA AYN AYZA FALLORINA CUE
vice-chairperson for secretariat, IAN MICHEL GEONANGA vice-chairperson for finance, JOSE ANGELO DAVID vice-chairperson for
electronic data processing, IAN LUIS AGUILA vice-chairperson for logistics
SUBJECT COMMITTEE:
RAHABANSA DAGALANGIT subject chair, ARIANNE MALABANAN assistant subject chair, ARMIDA GERONIMO edp, DIANA
FAJARDO general principles, AVRIL ELAINE GAMBOA income taxation, MADONNA LYN CASARES tax administration and
enforcement, BRYANT CANASA value-added tax, SHERWIN MARASIGAN transfer taxes, APRIL MANUEL and GABRIEL GUY
OLANDESCA nirc remedies, ARNALDO MALABANAN JR. court of tax appeals, JOSE MARI ANGELO DIONIO real property and local
taxation, RAY ANN CO tariff and customs laws
MEMBERS:
Baby Perian Arcega, Ethel Joy Arriola, Adrian Aumentado, Paula Tricia Bagnes , Benedicto Beley, Jingle Chua, Luis Voltaire
Formilleza, Aiza Gonzales, Roniel Muoz, Gerwin Panghulan, Maria Katrina Rivera, April Salamatin, Eve Hazel Santos, Salvador
Andrew Tugade, Neo Valerio, and Janice Ivy Valparaiso

Income Taxation | TAXATION LAW


The Court analogized "capital" as being
separate from "income" in the way that a
tree is separate from its fruit. It requires
the presence of a tax event which is an
event which triggers a transfer of
ownership of property. (Eisner v.
Macomber, 252 US 189)
3. Claim of Right Doctrine a taxable gain
is conditioned upon the presence of a
claim of right to the alleged gain and the
absence of a definite unconditional
obligation to return or repay that which
would otherwise constitute a gain.
The taxpayer needs unlimited control on
the use or disposition of the funds, and the
taxpayer must hold and treat the income
as his own.
Notes:
The claim of right doctrine typically
applies where a taxpayer receives an
income item in one year and reports it
as income, even though there is a
chance that the taxpayer will have to
repay the amount in a future year. If
the amount is repaid in a future tax
year, the doctrine allows the taxpayer
an income tax deduction in the year of
REPAYMENT.
The money received under a mistake
of fact is a realized income. Though
embezzled funds are not included in
the enumeration, the same is taxable
under the claim of right doctrine. This
is an exception to the rule that if there
is an obligation to return, there is a
mere return of capital. In the case of
embezzled funds, there is no
consensual agreement that there is an
obligation to return.
Principle of Constructive Receipt of
Income - Income which is credited to the
account of, or set apart for a taxpayer and
which may be drawn upon by him at any
time is subject to tax for the year during
which so credited or set apart, although
not then actually reduced to possession.
Examples of income constructively
received are:
a. Matured interest coupons, due and
payable, not yet collected by the
taxpayer;
b. Interest credited on savings bank
deposit;

c.

Dividends applied by the corporation


against the indebtedness of a
stockholder;
d. Intended payment deposited in court
(e.g. rental payments refused by the
lessor, when the lessee tendered
payment and the latter made a judicial
deposit of the rental due.)
e. Share in the profits of a partner in a
general professional partnership.
4. All-events Test For income or expense
to accrue, this test requires: (1) fixing of a
right to income or liability to pay; and (2)
the availability of the reasonable accurate
determination of such income or liability.
The amount of liability does not have to be
determined exactly; it must be determined
with reasonable accuracy. (CIR v.
Isabela Cultural Corporation, G.R. No.
172231, Feb. 12, 2007)
5. Economic benefit test or doctrine of
proprietary interest. It states that any
economic benefit to the employee that
increases his net worth, whatever may
have been the mode by which it is
effected, is taxable. Thus, in stock options,
the difference between the fair market
value of the shares at the time the option
is exercised and the option price
constitutes
additional
compensation
income to the employee at the time of
exercise (not upon the grant or vesting of
right) (Commissioner v. Smith, 324 US
177)
6. Control Test power to procure the
payment of income and enjoy the benefit
thereof (Helvering v. Horst, 311 U.S. 112)

Capital vs. Income (Madrigal v. Rafferty,


supra)
Income
Capital
Denotes a flow of
wealth during a definite
period of time. All
wealth other than as a
mere return of capital.
Service of wealth
Income is subject to
tax
Fruit

Fund or property,
existing at one distinct
point of time, which
can be used in
producing goods or
services
Wealth
Return of capital is not
subject to tax
Tree

Requisites for taxability of income


1. There must be a gain or profit whether in
cash or its equivalent;
2. The gain must be realized or received;

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TAXATION LAW | Income Taxation


Exception: If by reason of appraisal, the
cost basis of property is increased and the
resulting basis is used as the new tax
base for purposes of computing the
allowable depreciation expense, the net
difference between the original cost basis
and new basis due to appraisal is taxable
under the economic benefit principle. (BIR
Ruling No. 029-98)
Note: There is difference between a
realized income and a recognized income.
An income is realized if there is a gain or
profit derived from a closed and completed
transaction. An income is recognized if
there is a provision of law recognizing or
taxing that income. Thus, not all realized
income is taxable. To be taxable, an
income must be realized and at the same
time, recognized.

2.

3.

4.

5.
3. The gain must NOT be excluded by law or
treaty from taxation.
6.
Types of Taxable Income
1. Compensation Income income derived
from the rendering of services under an
employer-employee relationship.
2. Professional Income fees derived from
engaging in an endeavor requiring special
training as professional as a means of
livelihood, which includes, but is not
limited to the fees of CPAs, doctors,
lawyers, engineers and the like.
3. Business Income gains or profits
derived from rendering services, selling
merchandise, manufacturing products,
farming and long-term construction
contracts.
4. Passive Income income in which the
taxpayer merely waits for the amount to
come in, which includes, but is not limited
to, interest income, royalty income,
dividend income, winnings and prizes.
5. Capital Gain gain from dealings in
capital assets.
Significance of Knowing the Type of
Income
It is important to know the types of income
realized by the taxpayer since the Philippines
has adopted the semi scheduler/ semi-global
tax system, thus some types of income are
subjected to a graduated tax rates others are
not.
General Principles of Income Taxation
(Sec. 23, NIRC)
1. A citizen of the Philippines, residing
therein is taxable on all income derived

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from sources within and without the


Philippines.
A non-resident citizen is taxable only on
income derived from sources within the
Philippines.
An individual citizen of the Philippines who
is working and deriving income from
abroad as an Overseas Contract Worker
is taxable only on income from sources
within the Philippines: Provided, that a
seaman who is a citizen of the Philippines
and receives compensation abroad as a
member of the complement of a vessel
engaged exclusively in international trade
shall be treated as an overseas contract
worker.
An alien individual, whether a resident or
not of the Philippines is taxable only on
income derived from sources within the
Philippines.
A domestic corporation is taxable on all
income derived from sources within and
without the Philippines.
A foreign corporation, whether engaged
or not in trade or business in the
Philippines is taxable only on income
derived
from
sources
within
the
Philippines.

Criteria in Imposing Philippine Income Tax


1. Citizenship Principle A citizen taxpayer
is subject to income tax:
a. On his worldwide income, if he resides
in the Philippines; or
b. Only on his income from sources
within the Philippines, IF he qualifies
as non-resident citizen. Hence, his
income from sources outside the
Philippines shall be exempt from
Philippine income tax.
2. Residence Principle a resident alien is
liable to pay income tax on his income
from sources within the Philippines but
exempt from tax on his income from
sources outside the Philippines.
3. Source Principle a non-resident alien is
subject to Philippine income tax because
he derives income from sources within the
Philippines such as dividend, interest, rent,
or royalty.
Classification of Sources of Income (Sec.
42, NIRC)
1. Income
from
sources
within
the
Philippines;
2. Income from sources without the
Philippines;
3. Income from sources partly within and
partly without the Philippines.

Income Taxation | TAXATION LAW


Factors in determining the source of
income (Source Rules)
1. Interests Residence of the debtor
2. Dividends Residence of the corporation
paying the dividend
3. Services Place of performance of the
service
4. Mining income location of the mines
5. Farming income place of farming
activities
6. Rentals and royalties Location of
property or interest in such property
7. Sale of real property Location of the
property
8. Sale of personal property
Rule:
a. Personal
property
PURCHASED
within and sold without or purchased
without and sold within - Country in
which sold
b. Personal property PRODUCED (in
whole or in part) by the taxpayer within
and sold without or produced (in whole
or in part) without and sold within Sources partly within and partly
without the Philippines
Exception: Sale of Shares of Stock in a
Domestic Corporation shall be treated as
derived entirely from sources within the
Philippines regardless of where said
shares are sold.

CLASSIFICATION OF TAXPAYER
TAXPAYER means any person subject to
tax imposed by Title II (Sec. 22 (N), NIRC)
I.

Individual
A. Citizen
1. Resident citizen (RC)
2. Non-resident citizen (NRC)
3. Filipinos occupying managerial
and/or
technical
positions
employed
by
Regional
Headquarters
(RHQ)
and
Regional Operating Headquarters
(ROH)
of
Multinational
Companies; by Offshore Banking
Units (OBU); or by petroleum
service
contractor
and
subcontractor
4. Minimum Wage Earner
B. Aliens
1. Resident aliens (RA)
2. Non-resident aliens (NRA)

a. Engaged in trade or business


within the Philippines (NRAETB)
b. Not engaged in trade or
business within the Philippines
(NRA-NETB)
3. Alien
individual
occupying
managerial
and/or
technical
positions employed by Regional
Headquarters
(RHQ)
and
Regional Operating Headquarters
(ROH)
of
Multinational
Companies; by Offshore Banking
Units (OBU); or by petroleum
service
contractor
and
subcontractor
II. Corporations
A. Domestic (DC)
Special Domestic Corporations
1. Proprietary
Educational
Institutions and Non-Profit
Hospitals
2. Government
Owned
and
Controlled
Corporations
(GOCC),
agencies
or
instrumentalities
3. Domestic Depositary Banks
(Foreign Currency Deposit
Units)
B. Foreign
1. Resident
foreign
corporation
(RFC)
Special Resident Foreign
Corporations
a. International Carriers
b. Offshore Banking Units
authorized by the BSP
c. Resident
Depositary
Banks (Foreign Currency
Deposit Units)
d. Regional
or
Area
Headquarters
of
Multinational Companies
e. ROH
of
Multinational
Companies
2. Non-resident foreign corporation
(NRFC)
Special Non-Resident Foreign
Corporations
a. Non-resident
Cinematographic
film
owners,
lessors
or
distributors
b. Non-resident owner or
lessor
of
vessels

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TAXATION LAW | Income Taxation

c.

chartered by Philippine
nationals
Non-resident owner or
lessor of aircraft and other
equipment

III. Estates the taxable estate entity is one


under administration or judicial settlement.
If not under judicial, testamentary or
intestate proceedings, it is not a taxable
entity. The income thereof is taxable
directly to the heir or beneficiary.
IV. Trusts taxable trust:
A. Trust, the income of which is
accumulated
B. Trust, in which the fiduciary may, at
his discretion, either distribute or
accumulate the income
V. Partnerships
A. General Professional Partnership
B. Taxable or Business Partnership
C. General Co-partnership
INDIVIDUALS
A. Resident Citizen (RC) - citizen of the
Philippines residing therein is taxable on
all income derived from sources within and
without the Philippines.
B. Non-Resident Citizen (NRC) - taxed on
income derived from sources within the
Philippines. He is a citizen of the
Philippines who: (WELP)
1. Establishes to the satisfaction of the
Commissioner the fact of his physical
presence abroad with a definite
intention to reside therein;
2. Leaves the Philippines during the
taxable year to reside abroad, either
as an immigrant or for employment on
a permanent basis;
3. Works and derives income from
abroad and whose employment
thereat requires him to be physically
present abroad most of the time
during the taxable year;
Notes:
Exception: Overseas Contract
Worker (OCW) (OCWs are
OFWs not all OFWs are OCWs)
(See following discussion)

52

The phrase most of the time


means at least 183 (365 2)
days.
His presence abroad
however, need not be continuous.

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(Mamalateo, Philippine
Taxation, p. 27)

Income

4. Has been previously considered as a


non-resident and who arrives in the
Philippines at anytime during the
taxable year to reside thereat
permanently shall be considered nonresident for the taxable year in which
he arrives in the Philippines with
respect to his income derived from
sources abroad until the date of his
arrival (Sec.22 (E), NIRC)
An OCW is an individual who is
physically present abroad most of the
time during the taxable year and
taxable only on income derived from
sources within the Philippines. (Sec.
23 (C), NIRC)
Note: To be considered as an OCW
they must be duly registered as such
with the POEA. (R.R. No. 1-2011)
Furthermore, they must have a valid
working contract to work abroad.
TNTs are therefore not covered.
Those who do not meet the above
qualifications
(and
are
nonimmigrants) are considered RC
because they work abroad without a
contract and they have not manifested
their intention to permanently reside
abroad.
Seaman is considered as an OCW
provided the following requirements
are met:
a. Receives
compensation
for
services rendered abroad as a
member of the complement of a
vessel; and
b. Such
vessel
is
engaged
exclusively in international trade.
Note: The taxpayer shall submit proof to
the Commissioner to show his intention of
leaving
the
Philippines
to
reside
permanently abroad or to return to and
reside in the Philippines as the case may
be.
C. Resident Alien (RA) - an individual who is
not a citizen of the Philippines but a
resident thereof is taxable only on income
derived from sources within the Philippines
(Sec.22 (F), NIRC).
One who comes to the Philippines for
a definite purpose which in its nature

Income Taxation | TAXATION LAW

would require an extended stay, and


makes his home temporarily in the
country becomes a resident alien.
Length of stay is indicative of intention
(alien who shall have stayed in the
Philippines for more than one year by
the end of the calendar year is a
resident alien).
One who considers the Philippines as
his domicile.

D. Non-Resident Alien Engaged in Trade


or Business (NRA-ETB) - an individual
whose residence is not within the
Philippines and who is not a citizen thereof
but doing business therein is taxable only
on income from sources within (Sec.22(G),
NIRC).
The term trade or business includes
the performance of the functions of a
public office (Sec. 22(S), NIRC) but
excludes performance of services by
the taxpayer as an employee (Sec. 22
(CC), NIRC).
A NRA who shall come to the
Philippines and stay for an aggregate
period of more than 180 days during
any calendar year shall be deemed a
non-resident alien doing business in
the
Philippines
Section
22(G)
notwithstanding. (Sec. 25(A)(1), NIRC)
R.R. 2-98 has expanded the coverage
of the term, engaged in trade or
business to include the exercise of a
profession.
E. Non-Resident Alien Not Engaged in
Trade or Business (NRA-NETB) - an
individual whose residence is without the
Philippines and who is not a citizen and
not doing business therein is liable for
income derived from sources within the
Philippines.
F. Special
Classes
of
Individual
Employees (see. p. 62 for complete list)
CORPORATIONS
A. Domestic Corporation (DC) - a
corporation created or organized in the
Philippines or under its laws and is liable
for income from sources within and
without. (Sec. 22(C), NIRC)
B. Resident Foreign Corporation (RFC) - a
corporation which is not domestic and
engaged in trade or business in the
Philippines is liable for income from
sources within.

The term doing business includes:


1. Soliciting orders, service contracts,
opening offices, whether called
"liaison" offices or branches;
2. Appointing
representatives
or
distributors
domiciled
in
the
Philippines or who in any calendar
year stay in the country for a period or
periods totaling one hundred eighty
(180) days or more;
3. Participating in the management,
supervision or control of any domestic
business, firm, entity or corporation in
the Philippines;
4. Any other act or acts that imply a
continuity of commercial dealings or
arrangements, and contemplate to
that extent the performance of acts or
works, or the exercise of some of the
functions normally incident to, and in
progressive
prosecution
of,
commercial gain or of the purpose and
object of the business organization;
(Sec. 3 (d), R.A. No. 7042, Foreign
Investments Act of 1991)
In order that a foreign corporation may
be regarded as doing business within
a State, there must be continuity of
conduct and intention to establish a
continuous business, such as the
appointment of a local agent, and not
one of a temporary character (CIR v.
British Overseas Airways Corp., G. R.
No. L-65773-74, April 30, 1987)
C. Non-Resident
Foreign
Corporation
(NRFC) - a corporation which is not
domestic and not engaged in trade or
business in the Philippines is liable for
income from sources within. (Sec. 22(I),
NIRC)
D. Special Types of Corporations
1. Proprietary educational institutions
and non-profit hospitals;
2. GOCCs, agencies or instrumentalities
of the government;
3. Domestic depositary bank (foreign
currency deposit units);
4. Resident on-line international air
carriers;
5. Offshore banking units;
6. Regional or Area Headquarters and
Regional Operating Headquarters of
multinational companies;
7. Non-resident cinematographic film
owners, lessors or distributors;

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TAXATION LAW | Income Taxation


8. Non-resident owners or lessors of
vessels chartered by Philippine
nationals;
9. Non-resident lessors of aircraft,
machinery and other equipment.
Corporation Includes
1. Partnerships, no matter how created or
organized;
No matter how created or organized even if the partnership was created
pursuant to law or not, whether non-stock,
nonprofit, it is still deemed a corporation
because of the possibility of earning profits
from sources within the Philippines.
2. Joint-stock companies;
3. Joint accounts (cuentas en participacion)
4. Associations;
5. Insurance companies (Sec. 22(B), NIRC)
Corporation Excludes
1. General professional partnerships (GPPs);
A partnership formed by persons for the
sole
purpose
of
exercising
their
profession, NO part of the income of which
is derived from any trade or business.
Rule: a partnership is a corporation and
thus, subject to corporate income tax.
Exception: GPP
Exception to the exception: if the GPP
derives income from other sources, it is
considered a corporation, thus liable to
pay corporate income tax.
2. Joint venture or consortium formed for the
purpose of:
Undertaking construction projects; or
Engaging
in
petroleum,
coal,
geothermal
and
other
energy
operations pursuant to an operating or
consortium agreement under a service
contract with the Government.
Corporations Exempt from Income Tax
1. Those enumerated under Sec. 30, NIRC.
(see p. 73 for complete list)
Exempt corporations are subject to
income tax on their income from any
of their properties, real or personal, or
from any other activities conducted for
profit, regardless of the disposition
made of such income. They are only
exempt for income realized as such.

2. With respect to GOCCs:


Rule: These corporations are taxable as
any other corporation.
Exceptions:
a. Government
Service
Insurance
System (GSIS);
b. Social Security System (SSS);
c. Philippine
Heath
Insurance
Corporation (PHIC);
d. Philippine Charity Sweepstakes Office
(PCSO)
Note: PAGCOR is now subject to income
tax under R.A. No. 9337 but remains
exempt from the imposition of valueadded-tax (PAGCOR v. BIR, G.R. No.
172087, March 15, 2011)
3. Regional or Area Headquarters under Sec.
22 (DD), NIRC they are exempted
because they do not earn or derive income
from the Philippines
Note: Regional Operating Headquarters
under Sec. 22(EE) shall pay a tax of 10%
of their taxable income.
ESTATES AND TRUSTS
A. Estate refers to the mass of properties left
by a deceased person.
Note: The status of the estate is
determined by the status of the decedent
at the time of his death; so an estate, as
an income taxpayer can be a citizen or an
alien.
Rules on Taxability of Estate
When a person who owns property dies,
the following taxes are payable under the
provisions of the income tax law:
1. Income tax for individuals under Sec.
24 and 25 (to cover the period
beginning January to the time of
death);
2. Estate income tax under Sec. 60 if the
estate is under administration or
judicial settlement.
For Estates under Judicial Settlement
1. During the Pendency of the
Settlement
Rule: Subject to income tax in the
same manner as individuals
Exceptions:
a. Entitlement to personal exemption
is limited only to P20, 000;

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Income Taxation | TAXATION LAW


Note:
ST
1
VIEW R.A. No. 9504
amended the NIRC increasing the
basic
personal
exemption
amounting to Fifty thousand pesos
(P50,000) for each individual
taxpayer. Estates and trusts are
considered in the Tax Code as
individual taxpayers and therefore
the exemption allowed to them
should also be increased from
P20,000 to P50,000.
nd

2 VIEW Tax exemptions


strictly construed.
Section
NIRC explicitly provides that
exemption allowed to estates
trusts is P20,000.

are
62,
the
and

nd

Better VIEW 2 View. One


must not read into the law what
obviously was not intended by
Congress. That would be nothing
less than judicial legislation.
b. No additional exemption is
allowed;
c. Distribution to the heirs during the
taxable year of estate income is
deductible from the taxable
income of the estate (distributed
income shall form part of the
respective heirs taxable income)
Where no such distribution to the
heirs is made during the taxable
year when the income is earned,
and such income is subjected to
income tax payment by the estate,
the subsequent distribution thereof
is no longer taxable on the part of
the recipient.
Summary
The taxable year is 2011.
Distributions were made in 2011.

Taxpayer
in 2011
Corpus or principal of the estate
Income in 2010

NONE
NONE

Income in 2011
Retention by the estate of the
income of 2011

HEIR
ESTATE

2. Termination of Judicial Settlement


(where the heirs still have NOT
divided the property)
If the heirs contribute to the estate
money, property, or industry with

intention to divide the profits


between/among them, an unregistered
partnership is created and the estate
becomes liable for the payment of
corporate income tax (Evangelista v.
Collector, G.R. No. L-9996, October
15, 1957)
If the heirs, without contributing
money, property or industry to improve
the estate, simply divide the fruits
thereof between/among themselves, a
co-ownership
is
created,
and
individual income tax is imposed on
the income received by each of the
heirs, payable in their separate and
individual capacity
(Pascual v.
Commissioner, G.R. No. L-78133,
October 18, 1988)
For Estates NOT under Judicial
Settlement
Pending the extrajudicial settlement, the
income tax liability depends on whether or
not the unregistered partnership or coownership is created.
B. Trusts
A right to the property, whether real or
personal, held by one person for the
benefit of another.
The status of a trust depends upon the
status of the grantor or trustor or creator of
the trust. Hence, a trust can also be a
citizen or an alien.
When Trusts Taxable:
1. Trust income is to be accumulated;
2. Trust income is to be distributed
currently by the fiduciary to the
beneficiaries;
3. Income collected by a guardian of an
infant which is to be held or distributed
as the court may direct;
4. Trust in which the fiduciary may, at his
discretion,
either
distribute
or
accumulate the income.
Taxability of the Income of a Trust
Rules:
1. If income is distributed to beneficiaries,
the beneficiaries shall file and pay the
tax;
2. If income is to be accumulated or held
for future distribution, the trustee or
beneficiary shall file and pay the tax

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TAXATION LAW | Income Taxation


Exceptions:
1. In a revocable trust, the income of the
trust shall be included in computing the
taxable income of the grantor.
Revocable trust - where at any time the
power to revest in the grantor title to any
part of the corpus of the trust is vested
a. in the grantor either alone or in
conjunction with any person not
having a substantial adverse interest
in the disposition of such part of the
corpus or the income therefrom, or
b. in any person not having a
substantial adverse interest in the
disposition of such part of the
corpus or the income therefrom.
(Sec. 63, NIRC)
Note: The trustor, not the trust itself, is
subject to the payment of income tax on
the trust income
2. In a trust where the income is held for
the benefit of the grantor, the income of
the trust becomes income to the grantor;
3. In a trust administered in a foreign
country, the income of the trust,
undiminished by any amount distributed
to the beneficiaries shall be taxed to the
trustee.
Irrevocable Trusts irrevocable both as to
corpus and as to income
The trust itself, through the trustee or
fiduciary, is liable for the payment of
income tax.
Taxed exactly in the same way as
estates under judicial settlement and its
status as an individual is that of the
trustor.
It is entitled to the minimum personal
exemption (P20,000) and distribution of
trust income during the taxable year to
the beneficiaries is deductible from the
trusts taxable income.
Consolidation of Income of Two or More
Trusts

Where two or more trusts are created by the


same grantor, and the beneficiary in each
instance is the same person, the fiduciaries
shall file a separate return for, and pay the
income tax of, each trust, but the CIR shall
cause the income tax to be computed on the
consolidated taxable income of the several
trusts, allowing one exemption only of
P20,000.

The income tax computed on the


consolidated taxable income shall be
allocated between the several trusts in
proportion to their respective taxable income.

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Summary

Income Is

Taxpayer

For the benefit of the grantor

GRANTOR

Retained by the trust

FIDUCIARY

Distributed to beneficiary

BENEFICIARY

Employees Trust is Exempted provided:


1. Employees trust must be part of a pension,
stock bonus or profit sharing plan of the
employer for the benefit of some or all of his
employees;
2. Contributions are made to the trust by such
employer, or such employees, or both;
3. Such contributions are made for the purpose of
distributing to such employees both the
earnings and principal of the fund accumulated
by the trust; and
4. The trust instrument makes it impossible for
any part of the trust corpus or income to be
used for or diverted to, purposes other than the
exclusive benefit of such employees (Sec.
60(B), NIRC).
Tax exemption is likewise to be enjoyed by the
income of the pension trust; otherwise, taxation
of those earnings would result in a diminution
of accumulated income and reduce whatever
the trust beneficiaries would receive out of the
trust fund (Commissioner v. CA, G.R. No.
95022, March 23, 1992).
Any amount actually distributed to any
employee or distributee shall be taxable to him
in the year in which so distributed to the extent
that it exceeds the amount contributed by such
employee or distributee.

Table of Comparison Between Taxable


Estates and Taxable Trusts
Taxable Estate
Taxable Trust

The taxable income


shall be determined in
the same way as that
of individuals, but with
a special deduction for
any amount of income
paid,
credited
or
distributed to the heirs.

The taxable income


shall be determined in
the same way as that
of individuals, but with
A special deduction
for any amount of
income
paid,
credited
or
distributed to the
heirs.
A special deduction
for any amount of
the income applied
for the benefit of the
grantor.

The
exemption
is
20,000
The income tax rates
for individuals apply.
There is a creditable
withholding tax on the
heir of 15%.
The income tax return
shall be filed if the

The
exemption
is
20,000
The income tax rates
for individuals apply.
There is a creditable
withholding tax on the
heir of 15%.
The income tax return
shall be filed if the

Income Taxation | TAXATION LAW


Taxable Estate

Taxable Trust

gross
income
is
P20,000 or more and
the tax paid by the
executor
or
administrator.

gross
income
is
P20,000 or more and
the tax paid by the
fiduciary.

PARTNERSHIPS
Kinds of Partnership under the NIRC
A. General Professional Partnerships
formed by persons for the sole purpose of
exercising a common profession and no
part of the income of which is derived from
engaging in any trade or business. (Sec.
22 (B), NIRC).
B. Taxable OR Business Partnership:
1. All other partnerships no matter how
created or organized;
2. Includes unregistered joint ventures
and business partnerships
However,
unregistered
joint
ventures are not taxable as
corporations when:
a. Undertaking
construction
projects;
b. Engaged in petroleum, coal
and other energy operation
under a service contract with
the government.
C. General Co-Partnerships (GCP) or
companies
colectivas
are
legally
contemplated as corporations.
The partnership itself is subject to
corporate taxation while individual partners
are
considered
stockholders
and,
therefore, profits distributed to them by the
partnership are taxable as dividends
The taxable income for a taxable year,
after deducting the corporate income tax
imposed therein, shall be deemed to have
been actually or constructively received by
the partners in the same taxable year and
shall be taxed to them in their individual
capacity whether actually distributed or not
(Sec. 73(D), NIRC)

Liability of a Partnership
1. General Professional Partnership - not
subject to income tax, but the partners are
required to file returns of their income for
the purpose of furnishing information as to
the share of each partner in the net gain or

profit, which each partner shall include in


his individual return.
Partnership acts as withholding agent;
Net income (income for distribution)
shall be computed in the same
manner as a corporation and the
return is filed on or before April 15 of
each year.
The partners themselves are liable for
the payment of income tax in their
individual capacity computed on their
distributive shares of the partnership
profit.
2. Taxable or Business Partnership - income
tax is computed and taxed like that of a
corporation which is required to file a
quarterly corporate income tax return and
annual return due on or before April 15 of
the following year.
Liability of a Partner
Share Of A Partner
In GPP

Share of A Partner
In Taxable or
Business
Partnership

If net income, it shall


form part of the gross
income of each partner
based on his agreed
ratio subject to 10%
creditable withholding
tax.

If net income, it shall


be treated as dividend
and shall be subject to
a final tax as follows:
a. RC, NRC, RA 10%
b. NRA-ETB 20%
c. NRA-NETB 25%

If net loss, it may be


taken by the individual
partner in his return of
income.

If net loss, it may be


taken by the individual
partner in his return of
income;
Payments made to a
partner for services
rendered
shall
be
considered
as
compensation income
subject to Sec. 24(A).

Payments made to a
partner for services
rendered
shall
be
considered as ordinary
business
income
subject to Sec. 24(A).

Notes:
As a result of the application of the
Constructive Receipt of dividends by the
partners of a business partnership, they
are placed at a disadvantaged position vis-vis the stockholders of a corporation,
who would be subject to the 10% dividend
tax only when there is an actual
declaration of dividends and payment
thereof.
Compared to their counterpart partners of
a GPP, the partners of a business
partnership are placed at an even more
disadvantageous position because there is
a second-tier of taxation imposed on their

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TAXATION LAW | Income Taxation


shares
of
the
partnership
profit.
(Mamalateo, Philippine Income Tax, 2004,
p. 42).
CO-OWNERSHIP
There is co-ownership when:
1. Two or more heirs inherit an undivided
property from a decedent;
2. A donor makes a gift of an undivided
property in favor of two or more donees.
Before partition of property:
It is NOT TAXABLE when the activities are
limited to the preservation of the co-owned
property and the collection of the income
therefrom. Each co-owner is taxed individually
on his distributive share. Before partition and
distribution, all the income belongs to all the
heirs.
After partition of property:
Should the co-owners invest the income of the
co-ownership
in
any income-producing
properties after partition, they would be
constituting themselves into an unregistered
partnership which is subject to income tax as a
corporation.

SEC. 24-26 TAX ON


INDIVIDUALS

subject to FINAL TAX, derived for each


taxable year by:
1. Resident citizen (RC) from all sources
within and without;
2. Non-resident citizen (NRC) including OCW
from all sources within;
3. Resident alien (RA) from all sources
within;
4. Non-resident alien engaged in trade or
business (NRA-ETB) from sources within;
(Sec. 24(A), NIRC)
Note: NRA-NETB is NOT subject to the
graduated rates. All income (except capital
gains) received by him from sources within are
considered as gross income subject to 25%
final withholding tax and no deductions are
allowed. On the other hand, the special
classes of employees (e.g. managerial
employees of RHQ/RAH) are subjected to a
preferential tax rate imposed on their gross
income.
Formula
Gross Compensation Income
Less:
Personal Exemptions
Premium Payments on Health and/or
Hospitalization Insurance (if qualified)
= Net Compensation Income

TAXABLE INCOME
Pertinent items of gross income specified in
the NIRC, less deduction and/or personal and
additional exemptions, if any (Sec. 31, NIRC).
EXEMPTION
OF
MINIMUM
WAGE
EARNERS (MWEs)
Minimum Wage Earners worker in the
private sector paid the statutory minimum
wage OR an employee in the public sector
with compensation income of not more than
the statutory minimum wage in the nonagricultural sector where he/she is assigned
MWEs shall be exempt from the payment of
income tax on their taxable income. The
holiday pay, overtime pay, night shift
differential pay and hazard pay received by
such minimum wage earners shall likewise be
exempt from income tax.

Income Subject to Graduated Rates


Taxable income, OTHER than PASSIVE
INCOME AND CAPITAL GAINS which are

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Add:
Net business income or
Net professional income*
Other income
= Taxable Income subject to graduated rates
* Net Business Income or Net Professional
Income
Gross Business / Professional Income
Less: Itemized deductions or optional
standard deduction (OSD)
= Net business / professional income
Income Subject to Graduated Rates:
1. Compensation income;
2. Business and professional income;
3. Capital gains not subject to final tax;
4. Passive income not subject to final tax;
5. Other income.

Income Taxation | TAXATION LAW


Graduated Tax Table - Top marginal rate
shall be 32% effective January 1, 2000.
Tax
Due
5%
500
2,500
8,500

Plus

10,000
30,000
70,000

But
Less
Than
10,000
30,000
70,000
140,000

140,000

250,000

22,500

25%

250,000

500,000

50,000

30%

125,
000

32%

Income
Over

500,000

10%
15%
20%

Of
Excess
Over
10,000
30,000
70,000
140,
000
250,
000
500,
000

CONSOLIDATED RULES ON PASSIVE


INCOME SUBJECT TO FINAL TAX
Final Tax means tax withheld from source,
and the amount received by the income earner
is the net income after the final tax has been
withheld already. The tax withheld by the
income payor is remitted by him to the BIR.
The income having been tax-paid already, it
need not be included in the income tax return
at the end of the year because the (passive).
Income tax withheld constitutes the full and
final payment of the income tax due from the
payee on the said income.
Note: Passive investment incomes subject to
withholding taxes are taxed on the gross
amount, without any deduction of cost and
expenses of sale.
A. Interest Income
1. From any currency bank deposit and
yield or any other monetary benefit
from deposit substitutes and from trust
funds and similar arrangements.
Yield the difference between the
amount
the
lender/investor
loaned/placed and the amount he
received upon maturity of the
deposit/debt instruments which shall in
no case be lower than the interest rate
prevailing at the time of the issuance
or renewal of said debt instruments.
(R.R. No. 12-80)
Deposit substitute - shall mean an
alternative form of obtaining funds
from the public (20 or more lenders)
other than deposits
Final Tax Rate:
RC, NRC, RA, NRA-ETB 20%
NRA-NETB 25%

Exceptions:
1. If the loan is granted by a foreign
government or an international or
regional
financing
institution
established by governments, the
interest income of the lender shall
NOT be subject to the final
withholding tax.
2. If the depositor is an employee
trust fund or other accredited
retirement plan, such interest
income, yield or other monetary
benefit is exempt from the final
withholding tax. (CIR v. CA & GCL
Retirement Plan, G.R. No. 95022,
March 23, 1992)
Note:
The above rule on interests only
applies if the interest income is
derived from banks. If the interest
income is derived from a source
other than a bank (e.g., interest
paid on 5-6 business), then the
graduated rates shall apply.
Interests must be derived from a
bank located within the Philippines
to be considered as passive
income.
If the bank from which the interest
is derived is located outside the
Philippines:
a. Graduated rates in the case
of an RC
b. Exempt NRA-NETB NRC,
RA, NRA-ETB.
2. From a depositary bank under the
Expanded Foreign Currency Deposit
System
Final Tax Rate:
RC, RA - 7
NRC, NRA-ETB, NRA-NETB =exempt
Note: Only resident
subject to this tax

individuals

are

3. From long-term deposit or investment


in the form of:
a. Savings,
b. Common or individual trust funds,
c. Deposit substitutes,
d. Investment management accounts
and

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TAXATION LAW | Income Taxation


e. Other investments evidenced by
certificates
in
such
form
prescribed by the BSP.
Final Tax Rates:
RC, NRC, RA, NRA-ETB
Held for 5 years or more exempt
In case of pretermination, where the
HOLDING PERIOD was:
4 years to less than 5 years 5%
3 years to less than 4 years 12%
Less than 3 years
20%
NRA-NETB 25%

60

Characteristics/conditions that should


be present to enjoy income tax
exemption of interest income derived
from long term deposit or investment
(RMC No. 18-2011)
1. The depositor or investor is an
individual citizen (resident or nonresident) or resident alien or
nonresident alien engaged in
trade or business in the Phil. and
not a corporation.
2. The
LTD
or
investments
certificates should be under the
name of the individual and not
under the name of the corporation
or the bank or the trust
department/unit of the bank.
3. The LTD or investments must be
in the form of savings, common or
individual trust funds, deposit
substitutes,
investment
management accounts and other
investments
evidenced
by
certificates
in
such
form
prescribed by the BSP.
4. The LTD or investments must be
issued by banks only and not by
other financial institutions
5. The LTD or investments must
have a maturity period of not less
than 5 years.
6. The LTD or investments must be
in denominations of P10,000 and
other denominations as may be
prescribed by the BSP.
7. Only the interest income from LTD
or investments certificates are
covered by the income tax
exemption.
8. Income tax exemption does not
cover any other income such as
gains
from
trading,
foreign
exchange gain.

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9. The LTD or investments should


not be terminated by the investor
th
before the 5 year, otherwise it
shall be subjected to the
graduated rates of 5%, 12%, or
20% on interest income earnings.
B. Royalties
1. Royalties in General (e.g. patents and
franchises) Fixed sum either in cash
or property equivalent, to be paid at a
definite period for the use or
enjoyment of a thing or right.
Final Tax Rate:
RC, NRC, RA, NRA-ETB 20%
NRA-NETB 25%
Exception: From books, literary works
and musical compositions.
Final Tax Rate:
RC, NRC, RA, NRA-ETB 10%
NRA-NETB 25%
Note:
Royalties must be derived from
sources within the Philippines to be
considered as passive income.
If royalty is derived from sources
outside the Philippines:
a. graduated rates in the case of a
RC,
b. exempt NRA-NETB NRC, RA,
NRA-ETB.
It covers both payments made: (1) under a
license; and (2) compensation which a
person would be obliged to pay for
fraudulently copying or infringing the right.
C. Prizes and Winnings
Prizes results of efforts
Winnings products of chance or luck
Note:
In case of doubt, a game is
deemed to be one of chance.
Prizes: exceeding P10,000;
Winnings: regardless of amount
Final Tax Rates:
RC, NRC, RA, NRA-ETB 20%
Note:
NRA-NETB 25% (prizes
winnings regardless of amount)

AND

Exception: PCSO and lotto winnings are


NOT subject to final tax.

Income Taxation | TAXATION LAW


Note:
Prizes amounting to P10,000 or less,
although exempt from final tax, are to
be included in gross income and
subject to the graduated rates.
Prizes and winnings from sources
without are included in the gross
income.
D. Dividends
Any distribution made by a corporation to
its stockholders out of its earnings or
profits and payable to its shareholders,
whether in money or other. (par. 1, Sec.
73(A), NIRC)
Forms of Dividend Income
1. Cash dividend;
2. Property dividend;
3. Stock dividend;
4. Scrip dividend;
5. Indirect dividend; and
6. Liquidating dividend.
Scrip Dividend is issued in the form of
promissory note and is taxable to the
extent of its fair market value. It is taxable
in the year when the warrant was issued.
(Sec. 25, R.R. No. 2)
Liquidating Dividend - Where a
corporation distributes all of its assets in
complete or partial liquidation or
dissolution, the gain realized or loss
sustained by the stockholders whether
individual or corporate, is a taxable income
or deductible loss, as the case may be.
(par. 2, Sec. 73(A), NIRC)
The reckoning point is the time of
declaration and NOT the time of payment
of dividends as it is taxable whether
actually or constructively received.
Dividends declared are considered to have
been made from the recently accumulated
profits.
The previously accumulated
profits NOT declared as dividends may be
subjected to improperly accumulated
earnings tax (IAET) if accumulation was
done to evade taxation.
Tax on income is different from tax on the
dividends; therefore, there is no double
taxation (Afisco Insurance Corp. v. CA,
G.R. No.112675, Jan. 25, 1999)
1. Cash and/or property dividends from a
domestic corporation or from a joint

stock company, insurance or mutual


fund
companies
and
regional
operating
headquarters
of
multinational companies.
2. Share in the distributable net income
after tax of a taxable or business
partnership.
3. Share in the net income after tax of an
association, a joint account, or a joint
venture or consortium taxable as a
corporation of which he is a member
or co-venturer.
Final Tax Rates:
RC, NRC, RA 10%
NRA-ETB 20%
NRA-NETB 25%
4. Cash and/or property dividends from a
foreign corporation.

Tax Rates:
RC graduated rates
NRC, RA (if considered from sources
within) graduated rates
Note: The above rule with respect to
NRC and RA is subject to Sec.
42(A)(2)(b), NIRC which provides
that: If for the 3-year period
preceding the declaration of such
dividend,
the
ratio
of
such
corporations Philippine income to the
world (total-within and without)
income is:
a) Less than 50% - entirely without;
b) 50% to 85% - proportionate; and
c) more than 85% entirely within
Formula:
Philippine Gross Income x Dividend
Received Entire Gross Income
= Income Derived Within
Rule: A stock dividend representing the
transfer of surplus to capital account shall
NOT be taxable. (Sec. 73(B), NIRC)
Rationale:
Stock
dividends,
strictly
speaking, represent capital and do not
constitute income to its recipient. So that
the mere issuance thereof is not subject to
income tax as they are nothing but
enrichment through increase in value v.
capital investment.

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TAXATION LAW | Income Taxation


Exceptions: (DDUROG)
1. When
there
is
Redemption
or
Cancellation essentially equivalent to
distribution of taxable dividends (Sec.
73(B), NIRC);
2. It gives the shareholder an interest
Different from that which his former
stock represented;
3. The recipient is Other than the
shareholder;
4. Dividends declared in the Guise of
treasury stock dividend to avoid the
effects of income taxation (CIR v.
Manning, G.R. No. L-28398, Aug. 6,
1975);
5. Stock
dividend
is
taxable
to
Usufructuary; and
6. Different classes of stocks that were
issued.
Proceeds from redemption of shares is:
a. NOT TAXABLE, if its source is the
original capital subscription or initial
capital investment as it is considered not
as an income but a mere return of
capital;
b. TAXABLE, if from other than initial
capital investment, as the proceeds of
redemption is additional wealth.
E. Capital Gains
Note: See Consolidated Rules on Capital
Gains and Losses, p.127.
SPECIAL
CLASSES
OF
INDIVIDUAL
EMPLOYEES
Individuals whether FILIPINO or ALIEN
employed by:
1. Regional or area headquarters and
regional operating
headquarters
of
multinational companies in the Philippines.
2. Offshore banking units established in the
Philippines;
3. Foreign service contractor or subcontractor
engaged
in
petroleum
operations in the Philippines.
Note: Multinational Company - a foreign firm
or entity engaged in international trade with
affiliates or subsidiaries or branch offices in
the Asia-Pacific Region and other foreign
markets.
Tax Rate: 15%
Tax Base: Gross income received as salaries,
wages, annuities, compensation, remuneration
and other emoluments, such as honoraria and
allowances.

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Does Not Apply To: Rank-and-file employees


of said establishments.
Rationale: Only alien individuals occupying
managerial and technical positions in said
establishments are subject to the 15% final
income tax under R.R. No. 2-98.
Note: The term technical position is limited
only to positions which are:
1. Highly technical in nature;
2. Where there are no Filipinos who are
competent, able, and willing to perform the
services for which aliens are desired.
(RMC No. 41-2009)
The same tax treatment shall apply to Filipinos
employed and occupying the same positions
as those of aliens employed by these
multinational companies, offshore banking
units and petroleum service contractors and
subcontractors.
Note: Regardless of whether or not there is an
alien executive occupying the same position.
(RMC No. 41-2009)
Filipinos employed in said establishments
have the option to pay by way of:
1. 15% Final income tax; or
Tests to be met by Filipino to be
allowed the option to be taxed at 15%
(R.R. No. 11-2010):
a. Position and Function Test must
occupy managerial and technical
position
AND
actually exercise
managerial and technical functions
pertaining thereto;
b. Compensation Threshold Test must
have received, or is due to receive
under a contract of employment, a
gross annual taxable compensation of
at least P975,000 (whether or not
actually received); and,
c. Exclusivity Test the Filipino
managerial or technical employee
must be exclusively working for the
RHQ or ROHQ as a regular employee
and not just as a consultant or
contractual personnel.
2. Regular income tax rate on taxable
compensation income. (R.R. No.12-01)
Note: For other sources within the Philippines,
income shall be subject to pertinent income
tax (graduated tax rates, final tax on passive

Income Taxation | TAXATION LAW


income, capital gains, depending whether a
citizen or an alien), as the case may be.

Capital Assets Subject to Capital Gains Tax


and Corresponding Exemptions
(see discussion under Consolidated Rules,
Capital Gains and Losses Sale or Other
Disposition of Real Property, p.128)
Capital Gains and Losses Other Capital
Assets (NOT subject to capital gains tax)
(see discussion under Consolidated Rules,
Capital Gains and Losses Other Capital
Assets, p. 130)

SEC. 27-29
TAX ON CORPORATIONS
OUTLINE
OF
THE
TAXES
ON
CORPORATIONS:
A. Normal Corporate Income Tax (NCIT)
B. Capital Gains Tax
C. Final Tax on Passive Income
D. Minimum Corporate Income Tax (MCIT)
E. Gross Income Tax (GIT)
F. Improperly Accumulated Earnings Tax
(IAET)
G. Branch Profit Remittance Tax
H. Final Tax on (other) Gross Income From
Sources Within the Philippines
A. NORMAL CORPORATE INCOME TAX
(NCIT)
Corporations Liable: DC and RFC
Tax Rates: 30% effective Jan. 1, 2009
Net Income Tax Formula
Gross Sales
Less: Sales Returns
Sales Allowances
Sales Discounts
------------------------------------------------------NET SALES
Less: Cost of Goods Sold
------------------------------------------------------GROSS INCOME FROM SALES
Add:
Incidental income/ Other income
------------------------------------------------------NORMAL TAX GROSS INCOME
Less: Allowable deductions
------------------------------------------------------NET TAXABLE INCOME
Multiplied by: Applicable tax rate
------------------------------------------------------= NET INCOME TAX DUE
===============================

B. CAPITAL GAINS TAX


Corporations Liable: DC, RFC, NRFC
Same rules as those imposed on
individuals
Note: There is no provision for capital
gains tax on sale or disposition of real
properties for RFC and NRFC because
foreign corporations cannot own real
properties in the Philippines.
C. FINAL TAX ON PASSIVE INCOME
Corporations Liable: DC, RFC, NRFC
Same rules as those imposed on
individuals
Rules on Inter-corporate Dividends:
1. Received by a DC
a. From a domestic corporation
exempt
b. From a foreign corporation 30%
normal corporate income tax
Note: Foreign income tax paid or withheld
on such dividend may be credited against
the Philippine income tax due.
2. Received by a RFC
a. From a domestic corporation
exempt
b. From a foreign corporation:
i. If from sources within 30%
normal corporate income tax
ii. If from sources without exempt, as a general rule
Note: Dividends received by a RFC from a
FC are not automatically exempt from
taxation. Sec. 42(A)(2)(b) of the NIRC
which provides that: If for the 3-year
period preceding the declaration of such
dividend, the ratio of such corporations
Philippine gross income to the world gross
income (total-within and without) is:
a. Less than 50% - entirely without;
b. 50% to 85% - proportionate; and
c. more than 85% entirely within
Formula
Normal Corporate Income
X Dividend
Received Entire Gross Income
= Dividends derived from within
3. Received by a NRFC from a Domestic
Corporation

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TAXATION LAW | Income Taxation


Rule: It is subject to final tax of 15%,
as long as the country in which the
NRFC is domiciled allows a tax credit
for taxes deemed paid in the
Philippines equivalent to 15% or does
not impose tax on dividends.
Deemed paid does not imply tax
credit actually granted by the foreign
government. The fact that the country
in which the NRFC is domiciled does
not impose any tax on the dividends
received by such corporation should
be held as a full satisfaction of the
condition for the availment of the 15%
final tax. (CIR v. Wander Philippines
Inc., G.R. No. L-68375, April 15, 1988)
Exception: It is subject to final tax of
30% IF the country within which the
NRFC is domiciled does NOT allow a
tax credit.
Rationale: For the purpose
encouraging foreign investors
conduct business in the country.

of
to

Tax Sparing Rule The 15%


represents the difference between the
regular income tax of 30% on
corporations and the 15% tax on
dividends. It is the amount of tax
forgone by the Philippine government
in
favor
of
the
non-resident
corporation.
Rationale: The source country has
provided a tax holiday or other tax
incentive to foreign investors as an
encouragement to invest or conduct
business in the source country.
Note: The same rule on dividends
under Sec. 42(A)(2)(b) received by a
RFC from a FC applies to the
dividends received by a NRFC from a
FC.
D. MINIMUM CORPORATE INCOME TAX
(MCIT)
Corporations Liable: DC and RFC
Tax Rate: 2%
Tax Base: Gross income EXCEPT income
exempt from income tax and income
subject to final withholding tax
Rationale: It was devised as a relatively
simple and effective revenue-raising
instrument compared to the normal

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income tax which is more difficult to


control and enforce. It is a means to
ensure that everyone will make some
minimum contribution to the support of
public sector.
It is designed to forestall the prevailing
practice of corporations of over claiming
deductions (TAX SHELTERS) in order to
reduce their income tax payments.
Limitations:
1. MCIT does NOT apply if the DC or
RFC is not subject to NCIT;
2. For DC whose operations are partly
covered by the NCIT and partly
covered under a special income tax
system, the MCIT shall apply on
operations covered by the NCIT;
3. For RFC, only the gross income from
sources within the Philippines shall be
considered
for
determining
applicability of MCIT.
MCIT FORMULA for Sale of Goods
Gross Sales
Less: Sales Returns
Sales Allowances
Sales Discounts
---------------------------------------------------------NET SALES
Less: Cost of Goods Sold
---------------------------------------------------------Gross income from Sales
Add: Other Income
---------------------------------------------------------GROSS INCOME
Multiplied by: 2%
---------------------------------------------------------= MCIT PAYABLE
MCIT FORMULA for Sale of Services
Gross Receipts
Less: Sales Returns
Sales Allowances
Sales Discounts
---------------------------------------------------------NET SALES
Less: Cost of Services
---------------------------------------------------------Gross income from Sales
Add: Other income
---------------------------------------------------------GROSS INCOME
Multiplied by: 2%
--------------------------------------------------------= MCIT PAYABLE

Income Taxation | TAXATION LAW


Cost of Goods Sold includes all
business expenses directly incurred to
produce the merchandise and bring them
to their present location such as direct
labor, direct materials, and overhead
expenses
Cost of Services all direct costs and
expenses necessarily incurred to provide
the services required by the customers
and clients including:
1. Salaries and employee benefits of
personnel, consultants, and specialists
directly rendering the service; and
2. Cost of facilities directly utilized in
providing the service
Gross income - includes all items of
gross income enumerated under Section
32(A) of the Tax Code, as amended,
except income exempt from income tax
and income subject to final withholding tax
described (R.R. No. 12-2007).
Certainly, an income tax is arbitrary and
confiscatory if it taxes capital because
capital is not income. In other words, it is
income, not capital, which is subject to
income tax. However, the MCIT is not a
tax on capital. The MCIT is imposed on
gross income which is arrived at by
deducting the capital spent by a
corporation in the sale of its goods, i.e. the
cost of goods and other direct expenses
from gross sales. Clearly, the capital is
not being taxed. (Chamber of Real Estate
and Builders Associations, Inc., v. The
Honorable Executive Secretary, G.R. No.
160756, March 9, 2010 )

2. It can be credited against the NCIT


due in the next 3 immediately
succeeding taxable years;
3. Any excess not credited in the next 3
years shall be forfeited;
4. Carry forward (annually or quarterly) is
possible only if NCIT is greater than
MCIT;
5. The maximum amount that can be
credited is up to the amount of the
NCIT.
Illustration:
A domestic corporation had the following data
on computation of the normal corporate
income tax (NCIT) and the minimum corporate
income tax (MCIT) for five years.
Year4 Year5 Year6 Year7 Year8
MCIT 80k
50k
30k
40k
35k
NCIT 20k
30k
40k
20k
70k
The excess MCIT over NCIT carry-forward is
shown below:
Year4 Year5 Year6 Year7 Year8
MCIT
80k
50k
30k
40k
35k
NCIT
20k
30k
40k
20k
70k
NCIT is n/a
higher
Less:
MCIT
carryforward

40k

n/a

(40k)*

70k

(20k)
(20k)

From Y4
From Y5
From Y7
____________________________________
Tax Due 80k

When MCIT is applicable


1. IF taxable income is zero or negative;
OR
2. IF MCIT is greater than NCIT due.

n/a

When does MCIT commence?


th
MCIT is imposed beginning the fourth (4 )
taxable year immediately following the
year
in
which
such
corporation
commenced its business operations,
which is the year when the corporation
registers with the BIR and NOT when the
corporation started commercial operation.

Rules on Carry Forward of the Excess


MCIT:
1. The excess of MCIT over the NCIT
can be carried forward on an annual
and quarterly basis;

50k

40k

30k

Arrow pointing downward means that


the NCIT is higher so that there can
be an excess MCIT carry-forward
against it.
The figure with asterisk (*) - Cannot
carry-forward an amount higher than
NCIT, hence only the 40k of the
excess of 60k from Year4 was may be
carried forward against the NCIT in
Year 6. The unused 20k remaining
from Year4 cannot be used in Year8
because Year 8 was beyond three
years from Year 4.
In year 4, the taxpayer will pay the
MCIT of 80k because the MCIT is
higher than the regular income tax.
The excess MCIT of 60k (80k-20k)

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TAXATION LAW | Income Taxation

can be carried forward in the next


three years.
In year 5, the taxpayer will pay the 50k
MCIT since it is still higher than the
regular income tax rate. The excess
MCIT of 60k in year 4 cannot be used
in this instance. But the excess MCIT
of 20k can be carried forward in the
next three years.
In year 6, where the regular income
tax of 40k is higher than the MCIT of
30k, the taxpayer is allowed to claim
as credit the excess MCIT of year 4
but up to 40k only. Hence, the
taxpayer will not be liable to pay any
tax. The remaining MCIT in year 4 of
20k (60k-40k) may still be carried
forward in year 7 and the excess
MCIT in year 5 of 20k may still be
carried up to Year 8.

Imposition of MCIT may be suspended


if substantial losses are sustained due
to any of the following (Sec. 27(E)(3),
NIRC); Memorandum No. 6-2002):
1. Prolonged labor dispute losses
arising from a strike by the employees
for more than 6 months within a
taxable period causing temporary
shutdown of business operations
2. Force majeure cause due to an
irresistible force as by "act of god" like
lightning, earthquake, storm, flood and
the like; also include armed conflicts
like war and insurgency
3. Legitimate business reverses
include substantial losses sustained
due to fire, robbery, theft, or
embezzlement, or for other economic
reasons as determined by the
Secretary of Finance
Entities EXEMPT from MCIT:
1. Domestic proprietary
educational
institutions;
2. Domestic non-profit hospital;
3. Domestic depository banks under the
expanded foreign currency deposit
system;
4. Resident foreign international carrier;
5. Resident foreign offshore banking
units;
6. Resident foreign regional operating
headquarters; and
7. Firms enjoying special income tax rate
under
the
PEZA
law,
Bases
Conversion and Development Act of

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1992 and those enjoying income tax


holiday incentives.
The entities enumerated above are
exempt from MCIT because they are not
subject to NCIT.
Note: MCIT shall likewise apply to the
quarterly corporate income tax but the final
comparison between the NCIT due and
the MCIT shall be made at the end of the
taxable year taking into consideration
quarterly tax payment made (R.R. No. 122007).
MCIT is an estimate of the normal
corporate income tax, it cannot be claimed
as deduction.
E. GROSS INCOME TAX
Corporations Liable: DC and RFC
Tax Rate: 15% optional rate beginning
January 1, 2000
Tax Base: Gross Income
Available only to firms whose ratio of cost
of sales to gross sales or receipts from all
sources does not exceed 55%.
It is irrevocable for 3 consecutive years
during which the corporation is qualified
under the scheme.
Its application in lieu of the NCIT must be
authorized by the President upon
recommendation by the Secretary of
Finance
Note: To date, NO authority has been
given by the President.
Conditions Precedent to Grant of
Presidents Authority:
1. Tax effort ratio = 20% of GNP
2. Ratio of Income tax collection to total
revenues = 40%
3. VAT tax effort = 4% of GNP
4. Ratio of Consolidated Public Sector
Financial Position (CPSFP) to GNP =
0.9%
F. IMPROPERLY
ACCUMULATED
EARNINGS TAX (IAET)
Corporations Liable: DC
Improperly Accumulated Earnings
profits of a corporation that are permitted
to accumulate instead of being distributed
to its shareholders for the purpose of

Income Taxation | TAXATION LAW


avoiding the income tax with respect to its
shareholders or the shareholders of
another corporation.

corporation has accumulated income


beyond the reasonable needs of the
business, 10% IAET shall be imposed.

Tax Rate: 10%

Note: The imposition of IAET is NOT a


defense in the imposition of tax on
dividends.

Tax Base: Improperly Accumulated


Taxable Income (in addition to other
taxes).

IAET FORMULA
Taxable Income for the current year
Add: Income exempt from tax
Income excluded from gross income
Income subject to final tax
Amount of NOLCO deducted
---------------------------------------------------------TOTAL
Less:
Income tax paid/payable for the
taxable year
Dividends actually or constructively
paid
Amount reserved for the reasonable
needs of the business
---------------------------------------------------------IMPROPERLY ACCUMULATED
TAXABLE INCOME
Multiplied by: IAET RATE (10%)
---------------------------------------------------------= IMPROPERLY ACCUMULATED
EARNINGS TAX (IAET)
Rationale: If profits were distributed,
shareholders would be liable to income tax
thereon, whereas if there is no distribution,
they would incur no tax in respect to the
undistributed earnings and profits of the
corporation. Thus, a tax is being imposed:
1. As
penalty
for
the
improper
accumulation of its earnings (penalty
tax), and
2. As a form of deterrent to the
avoidance of tax upon shareholders
who are supposed to pay dividends
tax.
Touchtone of the liability: It is the
purpose behind the accumulation of the
income and not the consequences of the
accumulation. Thus, if the failure to pay
dividends is due to some other causes,
such as the use of undistributed earnings
and profits for the reasonable needs of the
business, such purpose would not
generally make the accumulated or
undistributed earnings subject to the tax.
However, if there is a determination that a

Coverage:
Imposed on improperly
accumulated taxable income earned
starting January 1, 1998 of domestic
corporations
and
closely-held
corporations.
Closely-held corporations at least 50%
in value of the outstanding capital stock or
at least 50% of the total combined voting
power of all classes of stock entitled to
vote is owned directly or indirectly by or for
not more than 20 individuals.
Corporations Exempted from IAET
(PET-NI-GF-B)
1. Publiclyheld
corporations
(Sec.
29,NIRC) - domestic corporations
NOT falling under the definition of
closely-held corporations. (R.R. No.
02-01, Sec. 4)
2. Banks and other non-banks financial
intermediaries (Sec. 29, NIRC);
3. Insurance companies (Sec. 29, NIRC);
4. Taxable partnerships (deemed to have
actually or constructively received the
taxable income under Sec. 73(D),
NIRC;
5. General professional partnerships
(exempt; taxable against the partners);
6. Non- taxable joint ventures;
7. Enterprises duly registered with the
Philippine Economic Zone Authority
(PEZA) under R.A. 7916 (Philippine
Special Economic Zone Act of 1995),
and enterprises registered pursuant to
R.A. 7227 (Bases Conversion and
Development Act of 1992), as well as
other enterprises duly registered
under
special
economic
zones
declared by law which enjoy payment
of special tax rate on their registered
operations or activities in lieu of other
taxes, national or local; and
8. Foreign corporations (R.R. No. 022001)
Note:
a. For nos. 1-3: exempted without
qualification;
b. For nos. 4-7: qualification that IAE
must be for the reasonable needs of
the business should be satisfied;

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TAXATION LAW | Income Taxation


c.

For no. 8: not covered.

Evidence of purpose to avoid income


tax:
1. Being a mere holding or investment
company is a prima facie evidence of
a purpose to avoid the tax upon its
shareholders as indicated by the
following:
a. Investment of substantial earnings
and profits of the corporation in
unrelated business or in stock or
securities of unrelated business;
b. Investment in bonds and other
long-term securities;
c. Accumulation of earnings in
excess of 100% of paid-up capital,
not otherwise intended for the
reasonable needs of the business.
2. Accumulation of profits beyond the
reasonable needs of the business
UNLESS the contrary is proven by
clear preponderance of evidence.
Immediacy Test the reasonable needs
of the business are the immediate and
reasonably anticipated needs supported
by a direct correlation of anticipated needs
to such accumulation of profits. If the
corporation did not prove an immediate
need for the accumulation of the earnings
and profits, the accumulation was not for
the reasonable needs of the business, and
the IAET would apply.
What constitutes reasonable needs of
the business? (PLACES)
1. Allowance for the increase in
accumulation of earnings up to 100%
of the Paid-up capital;
The basis of the 100% threshold of
retention (considered within the
reasonable needs of the business)
shall be the paid up capital or the
amount contributed to the corporation
representing the par value of the
shares of stock. Any excess capital
over
and
above
the
par
(APIC/Premium) shall be excluded.
(RMC NO. 35-2011)
2. Earnings
reserved
for
definite
corporate Expansion approved by the
Board of Directors or equivalent body;
3. Reserved for building, plants or
equipment Acquisition as approved by
the Board of Directors or equivalent
body;

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4. Reserved for Compliance with any


loan
covenant
or
pre-existing
obligation;
5. Earnings required by Law or
applicable regulations to be retained;
6. In case of Subsidiaries of foreign
corporations in the Philippines, all
undistributed earnings intended or
reserved for investments within the
Philippines.
The CONTROLLING INTENTION OF THE
TAXPAYER is that which is manifested at
the time of accumulation, not subsequently
declared intentions, which are merely the
product of afterthought. A speculative and
indefinite purpose will not suffice.
Definiteness of plan/s coupled with
action/s taken towards its consummation
is essential.
Limitation: The profit that has been
subjected to IAET shall no longer be
subjected to IAET in later years even if not
declared as dividend. However, profits
which have been subjected to IAET, when
declared as dividends, shall be subject to
tax on dividends except in those instances
where the recipient is not subject thereto.
Period for Payment of Dividend/
Payment of IAET
Dividends must be declared and paid or
issued not later than 1 year following the
close of taxable year.
Otherwise, IAET (if any) should be paid
within 15 days thereafter. (R.R. No. 02-01,
Sec.6)
If a taxable partnership does NOT declare
dividends, it is not subject to IAET
because under Sec. 73(D), NIRC, the net
share
of
a
partner
is
deemed
constructively received.
(Constructive
distribution)
G. BRANCH PROFIT REMITTANCE TAX
(BPRT)
Corporation Liable: RFC
It covers any profit actually or
constructively remitted by a branch to its
head office.
Tax Rate: 15%
Tax Base: Total profit applied or
earmarked for remittance without any
deduction for the tax component thereof.

Income Taxation | TAXATION LAW


Exceptions:
1. Those activities which are registered
with the Philippine Economic Zone
Authority (PEZA).
2. Enterprises registered with the Subic
Bay Metropolitan Authority (SBMA)
and Clark Development Authority
(CDA) covered by R.A. 7227 (Bases
Conversion and Development Act of
1992)
Rationale: To equalize the tax burden on
foreign corporations maintaining, on one
hand, local branch offices, and organizing,
on the other hand, a subsidiary domestic
corporation where at least a majority of all
the latters shares of stock are owned by
such foreign corporations. (Bank of
America N.T. & S.A. v. CA, G.R. No.
103106, July 21, 1994).
Single Entity Concept
As a rule, the head office of a foreign
corporation is the same juridical entity as
its branch in the Philippines.
But when the head office of a foreign
corporation independently and directly
invested in a domestic corporation without
the funds passing through the Philippine
branch, the taxpayer with respect to the
tax on dividend income would be the nonresident foreign corporation itself and the
dividend income shall be subject to the tax
similarly imposed on non-resident foreign
corporation (Marubeni Corporation v. CIR,
G.R. No. 76573, September 14, 1989).
Income Treated as Branch Profit
Interests, dividends, rents, royalties,
including remuneration for technical
services, salaries, wages premiums,
annuities, emoluments or other fixed or
determinable annual, periodic or casual
gains, profits, income and capital gains
received by a foreign corporation during
each taxable year from all sources within
the Philippines shall not be treated as
branch profits UNLESS the same are
EFFECTIVELY CONNECTED with the
conduct of its trade or business in the
Philippines. Conversely, the income is not
subject to BPRT if not effectively
connected with the conduct of its business
within the Philippines. (Attribution Rule)
Note: If income is not effectively
connected with the conduct of the
corporations
business
within
the
Philippines, then the corporation is liable
for the 30% NCIT.

H.

TAX ON (other) GROSS INCOME


FROM
SOURCES
WITHIN
THE
PHILIPPINES
Corporations Liable: NRFC
Rationale: a NRFC is not subject to
NCIT on its taxable income but instead
subject to final tax on gross income
without the benefit of any deduction.
Tax Rates: 30%, effective January 1,
2009
Tax Base: gross income received from
all sources within the Philippines, such as
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 resulting from the sale of
shares of stock of a domestic corporation
not listed and traded through a local stock
exchange, held as a capital asset.

GOVERNMENT
OWNED
AND
CONTROLLED CORPORATIONS (GOCC)
(Sec. 27(C), NIRC)
Rule:
The
rules
governing
domestic
corporations engaged in a similar business,
industry, or activity shall apply. In short, they
are taxable.
Exceptions:
1. Government Service Insurance System
(GSIS)
2. Social Security System (SSS)
3. Philippine Health Insurance Corporation
(PHIC)
4. Philippine Charity Sweepstakes Office
(PCSO)
If the GOCC is not included in the above
enumeration does it follow all of its income
is automatically subject to tax?
NO. Under Sec 32(B)(7), NIRC
income
derived from any public utility or from the
exercise of essential government function
accruing to the government of the Philippines
or to any political subdivision are therefore
exempt from income tax. Therefore, even if the
GOCC is not one of those enumerated under
Sec. 27(C) it may still be exempt under Sec.
32(B)(7) if its performing governmental
function/s.

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TAXATION LAW | Income Taxation


What is the difference between Sec. 27(C)
and Sec 32(B)(7) of the NIRC?
Sec 27 C exempts from income tax those
enumerated without any qualification while in
Sec 32(B)(7)
qualification (i.e. income is
derived from any public utility or from exercise
of any essential governmental function) must
concur before it may be exempted.

SPECIAL DOMESTIC CORPORATIONS


1. Proprietary Educational Institutions
and Non-profit Hospitals (Sec. 27 (B),
NIRC)
Tax Rates
Rule: 10% on taxable income
Requisites for Applicability of 10% rate:
a. Stock AND non-profit institutions;
b. Private educational institution or
hospital;
c. Gross income from unrelated trade,
business, activity does not exceed
50% of gross income from all sources
(predominance theory);
d. For educational institutions, issued a
permit to operate from DepEd, CHED,
or TESDA (Sababan, Taxation Law
Review, 2008)
Exceptions:
a. 30% IF the gross income from
unrelated trade, business or other
activity exceeds 50% of the total gross
income derived from all sources
b. Exempt IF a non stock, non-profit
educational institution
Tax Base: net income EXCEPT on
income subject to capital gains tax and
passive income subject to final tax within
and without the Philippines.
Unrelated trade, business or other
activity undertakings that are NOT
substantially related to the exercise or
performance
by
such
educational
institution or hospital of its primary
purpose or function.
Proprietary educational institution
any private school maintained and
administered by private individuals or
groups with an issued permit to operate
from the Department of Education
(DepEd), or the Commission on Higher
Education (CHED), or the Technical

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Education
and
Skills
Authority (TESDA).

Development

Note: The exemption does not cover


withholding taxes. As an educational
institution, they are constituted as
withholding agents for the government
required to withhold the tax on
compensation income of their employees,
or the withholding tax on income payments
to persons subject to tax pursuant to
Section 57, NIRC.
May a school or hospital be exempt
from paying tax?
YES provided that:
1. It is non- stock and non- profit
2. Its assets, property and revenues are
used actually, directly, and exclusively
for the primary purpose
Basis: Sec. 30, NIRC
2. Depositary Banks (Foreign Currency
Deposit Units) (Sec. 27(D)(3) as amended
by R.A. 9294)
Tax Rate: 10%
Rule: Exempt from all taxes on income
derived under the Expanded Foreign
Currency Deposit System (EFCDS) from
foreign currency transactions with:
a. Non-residents
b. Offshore Banking Units
c. Local commercial banks, including
branches of foreign banks that may be
authorized by the BSP to transact
business with foreign currency deposit
system units; and
d. Other depositary banks under the
EFCDS
Exceptions:
a. Net income from such transactions as
may be specified by the Secretary of
Finance, upon recommendation by the
Monetary Board to be subject to the
normal corporate income tax payable
by banks;
b. Final tax of 10% on interest income
from foreign currency loans granted by
such depository banks under said
expanded system to:
i. Residents other than offshore
units in the Philippines; or
ii. Other depository banks under the
expanded system.
Note: Income of NONRESIDENTS,
whether individual or corporation, from

Income Taxation | TAXATION LAW


transactions with depositary banks under
FCDS is EXEMPT from final tax.
SPECIAL
RESIDENT
CORPORATIONS
1. International Carriers

In case of a stopover, it is still considered


as uninterrupted if the stopover does not
exceed 48 hours.

FOREIGN

Kinds:
a. Air Carrier
b. Ships/Vessels
Tax Rate: 2.5%
Note: However, there are bilateral tax
treaties which the Philippines has
concluded with other contracting states
that may have different tax treatments with
respect to income and rates of taxes.
(Mamalateo, Philippine Income Tax.,
2004, p.11)
Tax Base: Gross Philippine Billings
Note: Sec. 28(A)(3)(a) only applies to an
international air carrier which is a RFC. If
the international air carrier is a DC or a
NRFC (i.e., offline air carrier) then it shall
be subject to the 30% NCIT or the 30%
final tax on gross income, respectively.
(Sababan, Taxation Law Review, 2008)
International Air Carrier foreign airline
corporation doing business in the
Philippines having been granted landing
rights in any Philippine port to perform
international
air
transportation
services/activities or flight operations
anywhere in the world (R.R. No. 15-2002).
Gross
Philippine
Billings
(for
international air carrier) includes:
Gross revenue derived from carriage of
persons, excess baggage, cargo and mail
originating from the Philippines in a
continuous and uninterrupted flight,
irrespective of the place of sale or issue
and the place of payment of the ticket or
passage document.
(ORIGINATION
RULE)
Requisites:
1. The persons, excess baggage, cargo,
and the mail must be originating in the
Philippines;
2. In a continuous and uninterrupted
flight or shipment; and
3. Irrespective of the place of sale or
issue and the place of payment of the
ticket or passage document.

The place of sale shall only be material in


case requisites (1) and (2) above are not
present. (Sababan, Taxation Law Review,
2008)
a. Gross
revenue
from
tickets
revalidated,
exchanged
and/or
indorsed 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.
b. For a flight which originates from the
Philippines, but transshipment of
passenger takes place at any port
outside the Philippines in another
airline, only the aliquot portion of the
cost of the ticket corresponding to the
leg flown from the Philippines to the
point of transshipment shall form part
of Gross Philippine Billings.
A foreign airline company selling
tickets in the Philippines through their
local agents shall be considered as
RFC engaged in trade or business in
the country. The absence of flight
operations within the Philippine
territory cannot alter the fact that the
income received was derived from
activities within the Philippines. The
test of taxability is the source, and the
source is that activity which produced
the income (Air Canada v. CIR, CTA
Case No. 6572, December 22, 2004).
To reiterate, the correct interpretation
of the above provisions (Sec. 28(A)(1)
and Sec. 28(A)(3)(a), NIRC) is that, if
an international air carrier maintains
flights to and from the Philippines, it
shall be taxed at the rate of 2 1/2% of
its Gross Philippine Billings, while
international air carriers that do not
have flights to and from the
Philippines but nonetheless earn
income from other activities in the
country (such as having general sales
agents in the Philippines for the sale
of passage documents) will be taxed
at the rate of 32% (now 30%) of such
income. (South African Airways v.
CIR, G.R. No. 180356, February 16,
2010)

Note:

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TAXATION LAW | Income Taxation


Gross
Philippine
Billings
(for
international shipping) gross revenue
whether for passenger, cargo or mail
originating from the Philippines up to final
destination, regardless of the place of sale
or payments of the passage or freight
documents.
2. Offshore Banking Units authorized by
the BSP (Sec. 28 (A)(4) as amended by
R.A. 9294)
Offshore Banking Unit shall mean a
branch, subsidiary or affiliate of a foreign
banking corporation which is duly
authorized by the BSP.
Tax Rate: 10%

5. Regional Operating Headquarters of


Multinational Companies
Tax Rate: 10%
Tax Base: Taxable income within the
Philippines

Rule: Exempt from all taxes on income


derived under the Expanded Foreign
Currency Deposit System (EFCDS) from
foreign currency transactions with:
a. Non-residents;
b. Offshore Banking Units; and,
c. Local commercial banks, including
branches of foreign banks that may be
authorized by the BSP to transact
business with foreign currency deposit
system units.
Exception: It is subject to final tax of 10%
on interest income derived from foreign
currency loans granted to residents other
than offshore banking units or local
commercial
banks,
including
local
branches of foreign banks that may be
authorized by the BSP to transact
business with offshore banking units.
Note: Income of NONRESIDENTS,
whether individual or corporation, from
transactions with OBUs is EXEMPT from
final tax.
3. Resident Depository Bank (FCDU) (Sec.
28(D)(7)(b) as amended by R.A. 9294)
Note: Same Rules as Discussed Above
under Special Domestic Corporations, no.
2.
4. Regional or Area Headquarters
Multinational Companies

Regional or Area Headquarters (RHQ)


an office whose purpose is to act as an
administrative branch of a multinational
company engaged in international trade
which principally serves as a supervision,
communications and coordination center
for its subsidiaries, branches or affiliates in
the Asia-Pacific Region and other foreign
markets and which does not derive income
in the Philippines.

Regional
Operating
Headquarters
(ROHQ) foreign business entity which is
allowed to derive income in the Philippines
by performing qualifying services to its
affiliates, subsidiaries or branches in the
Philippines, in the Asia-Pacific Region and
in other foreign markets and may engage
in the following activities:
a. General administration and planning;
b. Business planning and coordination;
c. Sourcing and procurement of raw
materials and components;
d. Corporate finance advisory services;
e. Marketing
control
and
sales
promotion;
f. Training and personnel management;
g. Logistic services;
h. Research and development services
and product development;
i. Technical support and maintenance;
j. Data processing and communications,
and
k. Business development.
SPECIAL
NON-RESIDENT
FOREIGN
CORPORATION (subject to preferential tax
rates)
1. Non-resident cinematographic film owners,
lessors or distributors.
Tax Rate: 25%

of

Tax Base: Gross income from all sources


within the Philippines

Tax Rate: EXEMPT from Income Tax


Note: Also exempt from all kinds of Local
Taxes, Fees, or Charges imposed by a
local government unit except real property
tax on land improvements and equipment.

2. Non-resident owner or lessor of vessels


chartered by Philippine nationals

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Tax Rate: 4.5%

Income Taxation | TAXATION LAW


Tax Base: Gross rentals, lease or charter
fees from leases or charters to Filipino
citizens or corporations, as approved by
the Maritime Industry Authority (MARINA).
3. On-resident owner or lessor of aircraft and
machineries and other equipment.
Tax Rate: 7.5%
Tax Base: Gross rentals or fee
EXEMPT CORPORATIONS (SEC. 30, NIRC)
The following organizations shall not be
taxed in respect to income received by them
as such:
1. Labor,
agricultural
or
horticultural
organization not organized principally for
profit;
Provincial fairs and like association of a
quasi-public
character
designed
to
encourage
development
of
better
agricultural and horticultural products
through a system of awards, prizes and
premiums, and whose income derived
from gate receipts, entry fees, donations,
etc. is used exclusively to meet necessary
expenses of upkeep and operation are
thus taxable.
On the other hand, the holding of
periodical race meets by associations, the
profits from which inure to the benefit of
their stockholder are not tax exempt.
Similarly, corporations engaged in growing
agricultural or horticultural products or
raising livestock or similar products for
profits are subject to tax. (Sec. 25, R.R.
No. 2)
2. Mutual savings bank not having a capital
stock represented by shares and
cooperative bank without capital stock
organized and operated for mutual
purposes and without profit;
Requisites for exemption:
a. No capital represented by shares;
b. Earnings less only the expenses of
operating are distributable wholly
among the depositors (Sec. 26, R.R.
No.2)
c. Exemption applies to both foreign and
domestic banks
d. Not qualified as mutual savings bank if
deposits are made compulsory under
contract between the bank and the
depositors and is operated for
speculation rather for savings

3. A beneficiary society, order or association,


operating for the exclusive benefit of the
members such as a fraternal organization
operating under the lodge system, or a
mutual aid association or a non- stock
corporation organized by employees
providing for the payment for life, sickness,
accident, or other benefits exclusively to
the members of such society, order or
association, or non-stock corporation or
their dependents;
Requisites for exemption:
a. The fraternal beneficiary society order
or association must be operated under
lodge system or for exclusive benefit
of the members of society they
have parent and local organizations
which are active.
b. There must be an established system
of payment to its members or their
dependents of life, sick, accident, or
other benefits.
c. No part of the net income inures to the
benefit of the stockholders/members.
Note: A grand lodge established for
the care of the members, their
dependents, and members of an
affiliated lodge unable to earn a
livelihood by reason of the infirmities
of age was held tax exempt.
Mutual protective societies NOT
operating under the lodge system and
travelers association providing for
fixed
death
benefits
to
the
beneficiaries or members are NOT tax
exempt.
4. Cemetery company owned and operated
exclusively for the benefit of its members;
Requisites for exemption:
a. Owned and operated exclusively for
the benefit of its owners
b. Not operated for profit
Any cemetery corporation chartered
solely for burial purposes and not
permitted by its charter to engage in
any
business
not
necessarily
incidental to its purpose is exempt
from income, provided no part of its
net earnings inures to the benefit of
any private shareholder or individual.
Cemeteries which fulfills the other
requirements of the Statute may be
exempt even though it issues

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TAXATION LAW | Income Taxation


preferred stock entitling stockholders
to dividend at a fixed rate, provided
that its articles of incorporation
require:
a. That the preferred stock shall be
retired at par as soon as the
sufficient funds are realized from
sales; and
b. That all funds not required for the
payment of dividends upon or for
the retirement of preferred stock
shall be used by the company for
the care and improvement of the
cemetery/property.

and no part of the net income of which


inures to the benefit of any private
stockholder or individual;

Cemetery having a capital stock


represented by shares, or which is
operated for profit or for the
benefit of persons other than its
members, does not come within
the exempted class.

It ceases to be tax exempt if it engages in


a regular business for profit even if it
conducts business on a cooperative basis
or produces only sufficient income to be
self assessing.

5. Non-stock corporations or association


organized and operated exclusively for
religious, charitable, scientific, athletic or
cultural purposes, or for the rehabilitation
of veterans, no part of its net income or
asset shall belong to or inure to the benefit
of any member, organizer, officer or any
specific person;
Requisites for exemption:
a. Organized and operated for one or
more specified purposes
b. No part of the net income inures to the
benefit of the private stockholders or
individuals.
In case of religious activities, income from
the conduct of strictly religious activities,
such as fees received for administering
baptismal,
solemnizing
marriages,
attending burials, holding masses, and the
like is exempt.
Charitable
corporation
includes
association for the relief of the families of
clergymen, even though the latter make
contributions to the fund established for
this purpose, or for furnishing the series of
trained nurses to persons unable to pay
for them or for aiding the general body of
litigants
Scientific
corporation
includes
an
association for the scientific study of law
with a view to improving its administration.
6. Business league, chamber of commerce,
or board of trade, not organized for profit

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Requisites for exemption:


a. Association of persons having some
common business interest
b. Limited its activities to work for such
common interests
c. Not engaged in a regular business for
profit
d. No part of the net income inures to the
benefit of any private stockholder or
individual

An association engaged in furnishing


information to prospective investors to
enable them to make sound investment, is
NOT exempt, since its members have no
common business interests even though
all its income is devoted to the purpose
stated.
Clearing house association exempt if not
organized for profit, no part of income
inures to the benefit of any private
shareholder or individual and provided that
its activities are limited to the exchange of
checks and similar work for the common
benefit of its members.
Makati Stock Exchange is NOT a business
league, chamber of commerce, or board of
trade within the purview of Sec. 30(f) of
NIRC, and must pay income tax on its
taxable income.
7. Civic league or organization not organized
for profit but operated exclusively for the
promotion of social welfare;
Requisites for exemption:
a. Not organized for profit but operated
exclusively for purposes beneficial to
the community as a whole. In general,
organizations engaged in promoting
the welfare of mankind.
b. Sworn affidavit with the BIR showing
the following:
1. Character of the league or
organization;
2. Purpose for which it was
organized;
3. Actual activities;

Income Taxation | TAXATION LAW

c.

4. Sources of income and disposition


thereof; and
5. All facts relating to the operation
of the organization which affects it
right to exemption.
The copy of articles of incorporation,
by laws and financial statements
should be attached to the sworn
affidavit.

8. A non-stock and non-profit educational


institutions;
Notes:
Exemption refers to internal revenue
taxes (IRT) imposed by the National
Government on all revenues and
assets used actually or exclusively for
educational purpose
Revenues derived from assets used in
the operation of cafeterias/canteens
and bookstores are exempt from
taxation provided they are owned and
operated by the educational institution
as ancillary activities and the same
are located within the school
premises.
They shall be subject to IRT on
income from trade, business or other
activity, the conduct of which is NOT
related to the exercise or performance
by such educational institutions of
their educational purposes or function
(e.g. rental payment from their
building/premises)
Unlike
non-stock,
non-profit
corporations, their interest income
from currency bank deposits and yield
from deposit substitute instruments
used actually, directly and exclusively
in pursuance of their purposes as an
educational institution, are EXEMPT
from 20% final tax and 7.5% tax on
interest income under the expanded
FCDS, subject to the compliance with
the conditions that as tax-exempt
educational institution, they shall on
annual basis submit to the RDO
concerned an annual information
return and duly audited financial
statement together with the following:
a. Certification from their depository
banks as to the amount of interest
income earned from passive
investment not subject to 20%
Final Withholding Tax and 7.5%
tax on interest income under
FCDS

b. Certification of actual utilization of


the said income; and
c. Board resolution by the school
administration
on
proposed
projects to be funded out of the
money deposited in banks or
placed in money markets, on or
th
th
before the 14 day of the 4
month following the end of its
taxable year.
Exemption does not cover withholding
taxes. As an educational institution,
they are constituted as withholding
agents for the government are
required to withhold the tax on
compensation
of
their
employees.(RMO No. 76-2003)

9. Government educational institution;


The University of the Philippines (and
other SCUs) is subject to 20% final tax.
Rationale: Income from properties, real or
personal, or from any of their activities
conducted for profit, regardless of the
disposition made of such income shall be
subject to tax.
10. Farmers or other mutual typhoon or fire
insurance company, mutual ditch or
irrigation company, mutual or cooperative
telephone company, or like organization of
a purely local character, the income of
which consists solely of assessments,
dues or fees collected from members for
the sole purpose of meeting its expenses;
Requisites for exemption:
a. Income is derived solely from
assessments, dues, fees collected
from members
b. Fees collected from members are for
the sole purpose of meeting its
expenses
11. Farmers, fruit growers or like association
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 of produce finished by them.
Requisites for exemption:
a. Formed and organized as sales agent
for the purpose of marketing the
product of its members
b. No net income to the members
c. Proceeds of the sale shall be turned
over to them less necessary selling

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TAXATION LAW | Income Taxation


expenses on the basis of the quantity
of goods produced by them
Like associations is construed as
referring only to association whose
activities are similar to farming and fruit
growing.
Note: Exempt corporations are subject to
income tax on their income from any of their
properties, real or personal, or from any of
their activities conducted for profit, regardless
of the disposition made of such income (CIR v.
CA, G.R. No. 124043, Oct. 14, 1998).
Common Requisites
1. Not organized and operated principally for
profit;
2. No part of the income inures to the benefit
of any member or individual;
3. No capital represented by shares or stock;
and
4. Educational or instructive in character.
Common Limitation: The income of whatever
kind and character of the qualified
organizations from any of their properties, real
or personal or from any activities conducted
for profit, regardless of the disposition made of
such income shall be subject to tax. (This
common limitation applies to all exempt
corporations)
Illustration:
YMCA, established as a welfare educational
and charitable non-profit corporation is subject
to income tax on the rental income derived
from the lease of its properties even if such
income is exclusively used for the
accomplishment of its objectives (CIR v. CA,
G.R. No. 124043, October 14, 1998)
Exception: When earned by a non-stock, nonprofit educational institution, the income of
which sought to be exempted from taxation is
used actually, directly, and exclusively for
educational purposes.
Objectives: Betterment of the conditions
engaged in such pursuits, the improvement of
the grade of their product and the
development of a higher degree of efficiency in
their respective occupations.
Tax exempt corporations under special
laws:
Cooperatives, subject to certain conditions
R.A. 6938

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Foundation
created
for
scientific
advancement (Sec. 24, R.A. 2067)

RULES ON EXCHANGE OF PROPERTY


Rule: Upon the sale or exchange of property,
the entire gain or loss, as the case may be,
shall be recognized. (Sec. 40 (C)(1), NIRC)
Gross Income from dealings in personal
property include all income derived from the
disposition of property whether real, personal,
or mixed, for money (sale), for property
(exchange) or for combination of both which
results in gain (loss) because of the difference
between taxpayers investment in what the
disposed of and the value in what he received.
Exceptions:
A. Sales or Exchanges Where No gain or
loss shall be recognized (Section
40(C)(2), NIRC)
1. Between corporations which are
parties to merger or consolidation.
2. Between stockholders of a corporation
parties to a merger or consolidation
and the other party corporation.
3. Between security holder of a
corporation party to a merger or
consolidation
and
the
other
corporation.
4. Transfer or exchange of property for
stock resulting in acquisition of
corporate control.
Rationale: To prevent double taxation.
Where no gain or loss is recognized if
there is an exchange of property and there
is a gain, the resulting gain is exempt from
tax. If there is a loss, the loss could not be
used as a deduction from gross income.
B. Sales or Exchanges Where Gain is
Recognized but Not the Loss
1. Transactions between related parties.
(Sec. 36(B), NIRC)
2. Where the sale is not solely in kind.
(Sec. 40(C)(3), NIRC)
Where gain is recognized but not the
loss If there is an exchange if property
and there is a gain, the resulting gain is
not subject to tax but if there is a loss, the
loss is allowed as a deduction from gross
income.
Settled Rules on Sales and Exchange
1. Distribution in complete liquidation has
been held to be an exchange, for the

Income Taxation | TAXATION LAW

2.

3.

4.

5.

purpose of determining whether or not


gain or loss has been realized or
sustained.
Conveyance of property in consideration
of the transferees assumption of accrued
taxes for which the transferor was
personally liable, as a compromise of tax
liability on other realty, has been
construed to be a sale or exchange within
the meaning of the law.
The words sale or exchange is construed
liberally. Thus, forced sale such as
foreclosure sale and tax sale, have been
held to be embraced within the meaning of
the law.
A sale or exchange will ordinarily occur
upon consummation thereof and not the
perfection of the contract. That is when
transfer of title over the asset is effected.
In condemnation proceedings, the sale
occurs at the time of the taking of the
property rather than receipt of proceeds of
the judgment.

Control ownership of stocks in a corporation


amounting to at least 51% of the total voting
power of all classes of stocks entitled to vote.
Note: This rule does not contemplate
momentary control. Otherwise, the exchange
might not be considered tax free.
Exchange solely in kind an exchange of
property with property and no money is
involved. (e.g., shares of stock exchanged for
shares of stock) (Domondon, Taxation, Vol. 2,
2009)
Note: Technically, there is no tax exemption
even if the exchange is solely in kind. The
exemption refers only to the INITIAL
EXCHANGE. Where the parties to the
exchange subsequently dispose of the
property they received as a result of the
exchange, then a gain or loss would be
recognized. There is merely a deferral of the
income tax. (Domondon, Taxation, supra)
Exchange SOLELY IN KIND in legitimate
mergers and consolidation includes:
1. Between the corporations which are
parties to the merger or consolidation
(property for stocks);
2. Between a stockholder of a corporation
party to a merger or consolidation and the
other party corporation (stock for stock);
3. Between a security holder of a corporation
party to a merger or consolidation and the
other party corporation (securities for
securities).

Note: Stocks issued for services shall not be


considered as issued in return for property.
Merger or consolidation means the
ordinary merger or consolidation, OR the
acquisition by one corporation of all or
substantially all the properties of another
corporation solely for stock undertaken for a
bona fide business purpose and not solely for
the purpose of escaping the burden of taxation
Bona fide purpose each and every step of
the transaction shall be considered and the
whole transaction or series of transaction shall
be treated as a single unit.
Gain is recognized but loss is NOT in: (IWARN)
1. Transactions between Related taxpayers
(Sec.36)
2. Illegal transactions (Sec. 96, R.R. 2)
3. Wash sales by non-dealers of securities
and when not subject to the stock transfer
tax.
4. Sales and exchanges that are NOT Arms
length.
5. Exchanges of property, NOT solely in kind,
in pursuance of corporate mergers and
consolidation.
RULES ON EXCHANGES OF PROPERTY
NOT SOLELY IN KIND
Exchanges not solely in kind exchanges
of property for shares of stock or securities
PLUS money and/or other property including
assumption of liability.
1. If the INDIVIDUAL, a shareholder, a
security holder or a corporation receives
not only stock or securities but also money
and/or property:
a. The gain, if any, shall be recognized in
an amount not in excess of the sum of
the money and fair market value of
such other property received.
b. However, any loss is not recognized
Note: In case of a shareholder, if the
money and/or other property received has
the effect of a distribution of a taxable
dividend, there shall be taxed as dividend
to the shareholder an amount of the gain
recognized not in excess of his
proportionate share of the undistributed
earnings and profits of the corporation;
The remainder, if any, of the gain
recognized shall be treated as a capital
gain.

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77

TAXATION LAW | Income Taxation


2. If the TRANSFEROR CORPORATION
receives not only stock permitted to be
received without the recognition of gain or
loss but also money and/or other property,
then:
a. If the corporation receiving such
money
and/or
other
property
distributes it in pursuance of the plan
of merger or consolidation, no gain to
the corporation shall be recognized
from the exchange.
b. Otherwise, the gain, if any, but not the
loss to the corporation shall be
recognized but in an amount not in
excess of the sum of such money and
the fair market value of such other
property so received, which is not
distributed.
3. If the taxpayer receives stock or securities
PLUS ASSUMPTION OF LIABILITIES:
a. Then such assumption or acquisition
shall NOT be treated as money and/or
other property, and the exchange is
considered as an exchange solely in
kind.
b. However, if the amount of the liabilities
assumed plus the amount of the
liabilities to which the property is
subject exceed the total of the
adjusted basis of the property
transferred, then such excess shall be
considered as a gain from the sale or
exchange of a capital asset or of
property which is not a capital asset.
COMPUTATION OF THE AMOUNT OF GAIN
OR LOSS
GAINS amount realized from the sale or
disposition exceeds the basis
LOSS amount realized from the sale or
disposition is less than the basis
Money received in the sale or disposition
Add: FMV of the property received
----------------------------------------------------Amount REALIZED
Less: Basis of the property sold or disposed
----------------------------------------------------= GAIN or LOSS
from the sale or disposition
1. Original basis of the property to be
transferred. (Sec. 40(B), NIRC)
a. The cost thereof in the case of property
acquired on or after March 1, 1913, if

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such property was acquired BY


PURCHASE; or
b. The fair market price or value as of the
date of acquisition, if the same was
acquired BY INHERITANCE; or
c. If the property was acquired BY GIFT,
the basis shall be the same as if it
would be in the hands of the donor or
the last preceding owner by whom it
was not acquired by gift,
Exception: If such basis is greater
than the FMV at the time of the gift
then, for the purpose of determining
LOSS (only), the basis shall be such
FMV; or
d. If the property was acquired FOR LESS
THAN
AN
ADEQUATE
CONSIDERATION
in
money
or
money's worth, the basis of such
property is the amount paid by the
transferee for the property; or
e. The substituted basis, if the property
was acquired in a previous TAX FREE
EXCHANGE.
2. Substituted basis of stock or securities
received by the transferor in cases of
tax-free exchanges (Sec. 40(C)(5)(a),
NIRC)
Original basis of the stock or
securities exchanged
LESS:
1. Money received (including the liability
assumed by the transferee of
property or the amount of liability on
the property)
2. FMV of other property received
ADD:
1. Amount treated as Dividend
2. Amount of any Gain recognized on
the exchange
-------------------------------------------------------= SUBSTITUTED BASIS
of the stocks or securities
Note: The property received as "boot"
shall have as basis its fair market value:
Boot money and/or other property
received in excess of the stock or
securities received by the transferor on a
tax-free exchange.
If the transferor receives several kinds of
stock or securities, the CIR is hereby
authorized to allocate the basis among the
several classes of stocks or securities.

Income Taxation | TAXATION LAW


3. Substituted basis of the property
transferred in the hands of the
transferee (Sec. 40(C)(5)(b), NIRC)
The basis of the property transferred in the
hands of the transferee shall be the same
as it would be in the hands of the
transferor increased by the amount of the
gain recognized to the transferor on the
transfer.
4. Basis for determining gain or loss on a
subsequent sale or disposition of
property subject of the tax free
exchange
Same with substituted basis of stock or
securities received by the transferor in
cases of tax-free exchanges AND
substituted basis of the property
transferred in the hands of the transferee
(2) and (3) above. (R.R. No. 6-2008)
5. Basis of the stock or securities
received by the transferor where the
taxpayer exchanges property plus
assumption of liabilities.
Same with substituted basis of stock or
securities received by the transferor in
cases of tax-free exchanges (2) above.

SEC. 32 GROSS INCOME


Gross Income all income derived from
whatever source (except those excluded or
exempted by law), including but not limited to
the following (Sec. 32, NIRC): (CARD-GRIPPPP)
1. Compensation;
2. Annuities;
3. Rents;
4. Gross income from Profession, trade or
business;
5. Dividends;
6. Royalties;
7. Interests;
8. Prizes and winnings;
9. Gains from dealings in property;
10. Pensions; and
11. Partners share in the net income of the
general professional partnership
Notes:
Gross Income under Sec. 32 is different
from the limited meaning of Gross Income
for purposes of Gross Income Tax (GIT),
which means Gross Sales less Sales

Returns, Discounts, and Allowances and


Cost of Goods Sold.

The definition of gross income is broad


enough to include all passive income
subject to specific rates or final taxes.
HOWEVER, since these passive incomes
are already subject to different rates and
taxed finally at source, they are no longer
included in the computation of gross
income, which determines taxable income.
(CIR v. PAL, G.R. No. 160528, October 9,
2006)
The amount to be derived from all the
items to be included shall be subject to the
5%-32% rates (for individual, estate, and
trust taxpayers) or the 30% NCIT or 2%
MCIT (for corporate taxpayers)
On the other hand, net/taxable income is
gross income less statutory deductions
and exemptions. It is the pertinent items
of gross income specified in the NIRC,
less deductions, and/or personal and
additional exemptions, if any, authorized
for such types of income by the NIRC or
other special laws.
The definition of gross income includes a
catch-all clause (i.e. from whatever
source) to supplement the enumeration by
including any non-enumerative items
which can properly be defined as income.
(Valencia and Roxas, Income Taxation:
Principles and Laws with Accounting
Applications, 2007, p. 161)

Concept of Income from whatever source


derived all income not expressly excluded
or exempted from the class of taxable income,
irrespective of the voluntary or involuntary
action of the taxpayer in producing the income.
(Gutierrez v. CIR, CTA Case No. 65, Aug. 31,
1995)
Example of Sources of Income from
Whatever Source:
1. Treasure found or punitive damages
representing profits lost;
2. Amount received by mistake (Javier v.
CA, G.R. L-78953, July 31, 1991);
3. Cancellation
of
the
taxpayers
indebtedness on account of service
rendered;
4. Payment of usurious interest;
5. Illegal
gains

(e.g.
extortion,
embezzlement) must be claimed as
deduction from gross income in the
preceding year. The tax must be a
deductible one;

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TAXATION LAW | Income Taxation


6.
7.

Tax refund claimed as deduction from


gross income in the preceding year; and
Bad debts recovery - must be claimed as
a deduction from gross income in the
preceding year. It assumes that the
taxpayer has a net income, not a net loss.

Note: The source of income may be legal or


illegal (Domondon, Taxation, Vol. 2, 2009)
Illegally Obtained Income
Income obtained through illegal means is
included in the wrongdoers gross income
even though he is obligated to return it when
discovered. (D.A. Kahn, p. 87.)
Rationale: The money or other proceeds of
the sale or other disposition of stolen property
is subject to income tax because the proceeds
are received under a "claim of right doctrine."
(Domondon, supra)
From a practical standpoint, it is often difficult
to determine the amount of taxable gains or
losses from the taxpayers illegal activities
since there are usually very few records
available. Accordingly, income derived from
illegal sources is taxable IF discovered.
The courts have sustained the BIR
Commissioners determination of the illegal
gains from such records as bank deposits, or
on the basis of commissions paid out, and
even from a formula determination based upon
the nationwide experience. The burden is on
the taxpayer to offer independent evidence to
contradict such determination. (Humprey v.
Commissioner, 162 F. (2d.)853; Nellis v.
Commissioner, 232 F. (2d.) 89)
Embezzled funds are income without consent
with an obligation to repay. If the embezzler
reaps the fruit of his crime without restriction
as to disposition, he is in receipt of income
though it may be claimed he is not entitled to
the money and may be adjudged liable to
restore its equivalent. However, actual
repayment of embezzled fund will give rise to
deduction. (James v. U.S., 366 US 313)

ITEMS OF INCLUSION
A. Compensation
All remunerations for services performed
by an employee for his employer under an
employer-employee relationship UNLESS
specifically excluded by the Code.

80

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Examples of exclusion:
1. NRA-NETB (subject to 25% Gross
Income Tax)
2. Employees
of
Multinational
Companies, Offshore Bank Units and
Petroleum
Service
Contractors
(subject to 15% Final Tax)
Requisites: (RAP)
1. Personal services Actually rendered;
2. Payment made for such services; and
3. Payment was Reasonable
Rules on the Inclusion as Income from
Compensation of the Corresponding
Amount Paid for Services Rendered;
1. Is payment is made in cash, the full
amount received is subject to tax.
2. If the services are paid for with
something other than money, the fair
market value (FMV) of the thing taken
in payment is the amount to be
included as income.
3. If the services were rendered at a
stipulated price, in the absence of
evidence to the contrary, such price
shall be presumed to be the FMV of
the compensation received.
4. Compensation paid an employee of a
corporation in its stocks is to be
treated as if the corporation sold the
stock for the market value and paid
the employee in cash. (Sec. 41, R.R.
2). This means the measure of the
income to the recipient is the FMV of
the stock at the time he received it.
5. Where the living quarters are
furnished in addition to cash salary,
the rental value of such quarters
should be reported as income.
6. Bonuses
representing
additional
payments for satisfactory services
rendered should also be reported as
income. They are, however, not
taxable as income if given in the
nature of outright gifts. (de Leon and
de leon Jr., Comprehensive Review of
Taxation, 2010, p. 47)
B. Annuities
Refer to annuity policies sold by insurance
companies, which provide installment
payments for life or for a guaranteed fixed
period of time whichever is longer.

The portion representing return of


premium is not taxable while that
portion that represents interest is
taxable.

Income Taxation | TAXATION LAW


Example:
Mr. A purchased a life annuity for
P500,000
which will pay him
P120,000 per year. Assume that the
life expectancy of Mr. A is five years,
reckoned from the date of purchase.
Mr. A will receive a total of P600,000
(P120,000 per year x 5). Out of the
P600,000 to be received
by
A,
P500,000 shall be EXCLUDED from
gross income as it represents the
return of premiums paid, the excess
P100,000 thereof, shall be TAXABLE.
(Compare with the concept of Annuity
as an EXCLUSION IN GROSS
INCOME)

Failure
to
comply
with
the
requirements of a tax-exempt annuity
makes it taxable and included in the
gross income.

C. Rents
Amount or compensation paid for the use
or enjoyment of a thing or a right and
implies a fixed sum or property amounting
to a fixed sum to be paid at a stated time
for the use of the property.

SCOPE:
all amount or property
received from lease contract, whether
used in business or not.
Items considered as rental income:
1. Agreed amount per month or per
year
2. Obligations of lessor to third
parties
which
the
lessee
undertakes to pay as further
consideration of the lease, such
as:
a. Real estate taxes on leased
premises paid by the lessee
b. Insurance premiums paid by
lessee on policy covering
leased property
c. Dividends paid by lessee to
stockholders
of
lessorcorporation, in lieu of rent.
d. Interest paid by lessee to
holder of bonds issued by
lessor-corporation, instead of
rent.

EXCLUDED RENT (not to be


considered part of gross income):
1. Those paid to non-resident owner
or lessor of vessels chartered by

Philippine nationals 4.5% of


gross rentals.
2. Those paid to non-resident owner
or lessor of aircraft, machineries
and other equipment 7.5% of
gross rentals or fees.
Notes:
Prepaid or advance rental is taxable
income to the lessor in the year
received, if so received under a claim
of right and without restriction as to
its use, REGARDLESS of method of
accounting employed.
Security deposit applied to the rental
of the terminal month or period of
contract must be recognized as
income at the time it is applied.
If security deposit is to ensure contract
compliance (security deposit with
acceleration clause), it is not income
to the lessor UNTIL the lessee violates
any provision of the contract.
Income from Leasehold Improvements
When the lessee erected or built
permanent improvements in the leased
property which will become the property of
the lessor upon the expiration of the
lease, the value of the improvements
should be reported as income of the
lessor. (Sec. 49, R.R. No.2)
Method of Reporting Income from
Leasehold Improvements
1. Outright method recognized as
income to lessor at the time when
such buildings improvements are
completed at fair market value
2. Spread-out method the lessor
spread over the life (or remaining
period) of the lease, the estimated
depreciated value of such buildings or
improvements at the termination of the
lease and report as income for each
year of the lease, an aliquot part
thereof.
Example: Mr. X leased his land to Ms. Y
for 3 years. It was stipulated that Ms. Y
shall construct a building thereon. The
building was completed at the end of the
st
1 year of the lease. It has a fair market
value of P1.5 Million and an expected life
of 5 years. In addition to the annual rent of
P50,000 paid by Ms. Y, Mr. X shall report
the value of the improvement as additional
income. In reporting, Mr. X may choose
between the two methods:

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TAXATION LAW | Income Taxation


a. Under the Outright Method, Mr. X shall
report the ENTIRE P1 Million at the
st
end of the 1 year of the lease.
Value of Building
Add: Annual rental
Total Lease Income to be
reported

P1,500,000
50,000
P1,550,000

Note: It shall be Mr. X that shall


record and claim the depreciation of
the building
b. Under the Spread Out Method, Mr. X
shall report an additional income of
st
P200,000 annually for the 1 year
and the remaining years of the lease
contract. The P200,000 additional
income is derived as follows:
Value of Building
Less:
Accumulated Depreciation
at the end of the lease
(P1,500,000/5 yrs.) x 3 yrs.
Value of Improvement at
the end of the lease
Divide:
Term of the lease
Annual
income
on
leasehold improvement
Add:
Annual rental
Total lease income to be
reported

P 600,000

3 (yrs.)
P 200,000
P

50,000

P 250,000

D. Gross Income From Profession, Trade,


Or Business
PROFESSIONAL INCOME -refers to
the fees received by a professional
from the practice of his profession,
provided that there is no employeremployee relationship between him
and his clients.
Profession is primarily any field or
work requiring specialized training in
the field of learning, art or science
engages in as a means of livelihood or
profit of an individual or group of
individuals.
BUSINESS INCOME - refers to
income derived from merchandising,
mining, manufacturing, farming, and
other similar operations.

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Business is any activity that entails


time and effort of an individual or
group of individuals for purposes of
livelihood or profit.

Classification of Gross Income from


Business (MM-SeLF)
1. Manufacturing;
2. Merchandising or trading;
3. Servicing;
4. Farming; and
5. Long-term contract.
E. Dividends
(see p. 61, Dividend for more discussion)

Only dividend ISSUED BY A


FOREIGN CORPORATION to an
individual taxpayer (citizen or alien) is
included in the computation of gross
income since those issued by a
domestic corporation are subject to
final tax.

Disguised Dividends are those


income payments made by a DC,
which is a subsidiary of a NRFC, to
the latter ostensibly for services
rendered by the latter to the former,
but
which
payments
are
disproportionately larger than the
actual value of the services rendered.
In such case, the amount over and
above the true value of the service
rendered shall be treated as a
dividend, and shall be subjected to the
corresponding tax of 30% on
Philippine sourced gross income, or
such other preferential rate as may be
provided under a corresponding tax
treaty.

P1,500,000
P 900,000

Note: No income accrues to the lessor


if the improvements are subject to
removal by the lessee. (Dizon, Q & A
in Taxation)

82

Example: Royalty payments under a


corresponding royalty agreement.
Note: While liquidation gains are
characterized as gains from sale or
exchange of shares, they are still subject
to the ordinary income tax rates provided
under Sec. 24(A)(1)(c), 25 (A)(1) and (E),
28(A)(1) and (2) and (B)(1) of the NIRC,
depending on the status of the
stockholder, and not to the 5% / 10% final
tax on capital gains (Dizon, Q & A in
Taxation)
SUMMARY OF RULES ON DIVIDENDS
With respect to dividends declared by a
FOREIGN corporation, it is important to know

Income Taxation | TAXATION LAW


the source of gross income, out of which the
dividends are declared. This must be
correlated to Sec. 42(A)(2)(b) which provides
that: If for the 3-year period preceding the
declaration of such dividend, the ratio of such
corporations Philippine income to the world
(total-within and without) income is:
a. Less than 50% - entirely without
b. 50% to 85% proportionate
c. More than 85%- entirely within
*Philippine Gross Income
World Gross Income

Dividend

G. Interests
Amount of compensation paid for the
use of money, goods, or credit or
forbearance from such use.

= Income WITHIN

Taxpayer

Dividend
Paid By a
Domestic
Corporation

RC

10%

NRC

10%

RA

10%

NRA-ETB

20%

NRANETB

25%

DC

EXEMPT

RFC

EXEMPT

NRFC

15% - w/ tax
sparing
30% - w/o tax
sparing

Dividend Paid
By a Foreign
Corporation
5%-32%
Source within5-32%
Source withoutEXEMPT
Source within5-32%
Source withoutEXEMPT
Source within5-32%
Source withoutEXEMPT
Source within25%
Source withoutEXEMPT
30%
Source within30%
Source withoutEXEMPT
Source within30%
Source withoutEXEMPT

F. Royalties
It is the payment for the use and
exhaustion of property such as earnings
from copyrights, patents, trademarks,
formulas and natural resources under
lease.
Included in the gross income if
derived from sources outside the
Philippines; otherwise, it is subject to
final withholding tax.

If the recipient of the royalty paid by a


DC is either a NRA-NETB or NRFC, a

lower tax rate may be allowed under


an existing treaty.
If the taxpayer is a NRA-NETB or a
NRFC, the royalty is NOT INCLUDED
since these taxpayers are liable by
way of gross income tax. (Sababan,
Taxation Law Review, 2008)

Interest from bank deposits are


included in the gross income if
they are derived from sources
outside the Philippines (i.e., bank is
located outside the Philippines).
Interests from LOANS (both local and
foreign) are ALWAYS INCLUDED in
the gross income.

Income
Payment
Interest from any
currency deposit,
yield or any other
monetary benefit
from
deposit
substitutes and
from trust funds
and
similar
arrangements
derived
from
Philippine
sources
Interest from long
term deposit or
investment in the
form of savings,
common
or
individual
trust
funds,
substitutes,
investment
management
accounts
and
other
investments
evidenced
by
certificates
in
such
form
prescribed
by
BSP.
Interest income
from
FCDU
deposits
Interest
from
foreign currency
loans granted by
FCDUs
to

Tax Rate

Payee

20%

DC,
RC,
RA,
ETB

RFC,
NRC,
NRA-

Holding
Period:
5% - 4 to
less than 5
years
12%- 3 to
less than 4
years
20%less
than 3 years

RC,
RA,
ETB

NRC,
NRA-

7.5%

10%

RC, RA,
DC, RFC

RC,
RA,
DC, RFC

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TAXATION LAW | Income Taxation


Income
Payment
residents other
than OBUs or
other depositary
under
the
expanded
system
Interest
from
foreign currency
loans granted by
OBUs
to
residents other
than OBUs or
local commercial
banks, including
branches
of
foreign
banks
that
may
be
authorized
by
BSP to transact
business
with
OBUs
Interest income
on foreign loans
contracted on or
after August 1,
1986
Any
interest
income
from
transactions with
depositary banks
under FCDs

Tax Rate

10%

Payee

J.

Pensions
Amount of money received in lump sum or
on staggered basis in consideration of
services rendered given after an individual
reaches the age of retirement.

NRFC
20%

EXEMPT

NRC, NRA,
NRFC

Items Included
1. Prizes
DERIVED
FROM
SOURCES WITHIN and NOT
EXCEEDING
P10,000. If it
exceeds
P10,000, it is subject
to
final
tax
on
passive
income.
Note: Winnings derived from
within are not included in the
gross income because it is subject
to final tax regardless of amount.
2. Prizes and Winnings DERIVED
FROM SOURCES OUTSIDE THE
PHILIPPINES, REGARDLESS OF
AMOUNT.

84

Gains From Dealings In Property


Considered As Ordinary Asset
Includes all income derived from the
disposition of property (real, personal
or mixed) for:
1. Money, in case of sale;
2. Property, in case of exchange; or
3. Combination of both sale and
exchange, which results in gain
because of the difference between
the taxpayers investments of what
he disposed of and the amount or
value of what he received.
(see Consolidated Rules on Capital
Gains and Losses, p. 127, for more
discussion on ordinary assets)

RC,
RA,
DC, RFC

H. Prizes and Winnings


Amount of money in cash or in kind
received by chance or through luck
are generally taxable except if
specifically mentioned under the
exclusions from the computation of
gross income under Sec. 32 (B),
NIRC.

I.

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Pensions to be included in the Gross


Income are those RECEIVED FROM A
PENSION PLAN WHICH IS NOT BIR
APPROVED.
Otherwise,
they
are
excluded.
K. Partners Distributive Share In The Net
Income Of General Professional
Partnership (GPP)
GPP is not taxable as an entity but the
share of each partner in the net
income of the GPP is included in each
partners gross income
Share of a partner in the distributable
net income after tax of a business
partnership is subject to final income
tax and is NOT included in the gross
income of such partner.
Sale of Goodwill Gain or loss from
a sale of goodwill results only when
the business, or part of it, to which the
goodwill attaches is sold, in which
case the gain or loss will be
determined by comparing the sales
price with the cost or other basis of
assets, including goodwill. It is
immaterial that goodwill may never
have been carried on the books as an
asset, but the burden of proof is on the
taxpayer to establish the cost or fair
market value of the goodwill sold (Sec.
47, R.R. 2).
Rules for Recognition of Gain or Loss from
the Retirement or Sale of Corporate Bonds
(Sec. 39(E), NIRC)

Income Taxation | TAXATION LAW

Note: Taxpayer is the issuer of the bond


A. If bonds are issued at face value, no
premium or discount is recognized
1. Excess of Purchase
Price
(PP)
over Issuing Price (IP) = Loss
2. Excess of Issuing Price over
Purchase Price = Gain
B. If bonds are issued above face value,
the premium is recognized
Such premium is NOT RECOGNIZED as a
gain; it is to be amortized or prorated as a
reduction to interest expense. The said
premium is initially added to the face
value, of the bonds and gradually
amortized over the term of the bonds.
1. Excess of Purchase Price (PP) over
Adjusted Issuing Price (AIP) (i.e., after
amortization of premium) = Loss
2. Excess of Adjusted Issuing Price over
Purchase Price = Gain
C. If bonds are issued below face value,
discount is recognized
Such discount is NOT RECOGNIZED as a
loss; it is to be amortized or prorated as an
addition to interest expense. The said
discount is initially deducted from the face
value of the bonds and gradually
amortized over the term of the bonds.
1. Excess of Purchase Price
over
Adjusted Issuing Price (i.e.,
after
amortization of discount) = Loss
2. Excess of Adjusted Issuing Price over
Purchase Price= Gain
In all three cases, should the purchase
price be equal to the adjusted price or
issuing price or issuing price per se, then
no gain or loss shall be recognized.
Note: In amortizing a discount, a portion
thereof is transferred to be added to the
interest expense of the bonds. As a result
thereof, the discount is reduced thus resulting
to an increase adjustment to the issuing price.
In amortizing a premium, a portion thereof is
transferred to be deducted from the interest
expense of the bonds. As a result thereof, the
Premium is reduced thus resulting to a
decrease adjustment to the issuing price.
In both premium and discount amortization, it
should be observed that the adjusted issuing
price will be equal to the face value of the
bonds after the amortization of the whole
premium or discount.
Comprehensive Example:

X Corporation issues 100 Bonds with a face


value of P1000 each. The bonds are due after
2 years.
Scenario 1: If the cash received totaled
P100,000, then it is said that the bonds are
issued at face value.
Scenario 2: If the cash received is P80,000,
then the bonds were issued at a discount of
P20,000.
Scenario 3: Lastly, if cash received is
P120,000, then they are said to be issued with
a premium of P20,000.
Assume that the annual amortization of any
premium or discount is thereof per year.
One year thereafter, the bonds were
repurchased back for (a) P115,000 or (b)
P85,000
Under Scenario 1
a. If the purchase price is P115,000, then a
loss of P15,000 is to be recognized.
b. If the purchase price is P85,000, then, it
results to a gain of P15,000.
Solution:
a.
Issue Price (IP)
Less: Purchase Price (PP)
Loss

P 110,000
P 115,000
P (15,000)

b.
Issue Price (IP)
Less: Purchase Price (PP)
Gain

P 100,000
P 85,000
P (15,000)

Under Scenario 2
a. If the purchase price is P115,000, then a
loss of 25,000 is recognized.
b. If the purchase price is P85,000, then it
results to P5,000 Gain.
Solution:
a.
Issue Price (IP)
Add:
Amortization of discount (P
20,000 x )
Book Value
Less: Purchase Price (PP)
Loss
b.
Issue Price (IP)
Add:
Amortization of
(P20,000 x )

80,000

10,000

P 90,000
P 115,000
P (25,000)

P 80,000
discount

P 10,000

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TAXATION LAW | Income Taxation


Book Value
Less: Purchase Price (PP)
Gain

P 90,000
P 85,000
P (5,000)

Under Scenario 3
a. If the purchase price is P115,000 then a
loss of P5,000 results.
b. If the purchase price is P85,000, then a
gain of P25,000 results
Solution:
a.
Issue Price (IP)
Less:
Amortization of premium
(P20,000 x )
Book Value
Less: Purchase Price (PP)
Loss
b.
Issue Price (IP)
Less:
Amortization of premium
(P20,000 x )
Book Value
Less: Purchase Price (PP)
Gain

P 120,000
P

10,000

P 110,000
P 115,000
P (5,000)

P 120,000
P

10,000

P 110,000
P 85,000
P (25,000)

Non-taxable Tax Refunds


1. Philippine Income tax, EXCEPT fringe
benefits tax;
2. Estate or donors tax;
3. Special assessment;
4. Income tax paid or incurred to a
foreign country, if the taxpayer
claimed a credit for such tax in the
year it was paid or incurred;
5. Stock transaction tax; and
6. The refund of these taxes is not
taxable because such taxes are not
deductible from the gross income,
hence there is no tax benefit.
Cancellation of Indebtedness
Considered as
1. Taxable Income if the creditor
cancels the debt as a consideration of
the services performed by the debtor
to the creditor.
2. Gift if the creditor cancels the debt
without any consideration.
3. Capital
Transaction

if
the
corporation forgives the debt of its
stockholder, it has the effect of
payment of an indirect dividend.

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EXCLUSIONS
DEFINITION
Exclusions - income received or earned but is
not included in the determination of gross
income and thus not taxable either because:
1. They represent RETURN OF CAPITAL or
are not income, gain or profit;
2. They are SUBJECT TO SOME KIND OF
INTERNAL REVENUE TAX; or
3. They are income, gain or profits that are
EXPRESSLY EXEMPT FROM INCOME
TAX under the constitution, tax treaty, tax
code, or a general or special law.
Rationale: Some receipts are excluded from
gross income because they are not income
(e.g. gift). Even if they are by definition
income, the exclusions are not subject to tax
because of policy considerations such as to
avoid the effects of double taxation, or to
provide incentives for certain socially desirable
activities (e.g. prizes and awards granted to
athletes). (Domondon, Taxation Vol. II, 2009,
p. 185)
ALL KINDS OF TAXPAYERS may avail of
such exclusions.
Notes:
Exclusions are in the nature of tax
exemptions, and it BEHOOVES UPON
THE TAXPAYER TO ESTABLISH THEM
CONVINCINGLY (CIR v. Mitsubishi, G.R.
No. L-54908, January 22, 1990)
Items of Exclusions (Sec. 32(B), NIRC)
(MAC-GIRL)
1. Life Insurance
2. Amount received by insured as return of
premium
3. Gifts, bequests, and devises
4. Compensation for injuries or sickness
5. Income exempt under treaty
6. Retirement benefits, pensions, gratuities
7. Miscellaneous items
A. PROCEEDS OF LIFE INSURANCE
Paid by reason of the death of the insured
to his estate or to any beneficiary
(individual, partnership, or corporation, but
not a transferee for a valuable
consideration) directly or in trust.
Rationale: Considered as
rather than as gain or profit

indemnity

Income Taxation | TAXATION LAW


Conditions for Exclusion: It must be
paid to the heirs or beneficiaries upon the
death of the insured, whether in a single
sum or otherwise.
Notes:
If such amounts are held by the
insurer under an agreement to pay
interest thereon, the interest payments
shall be included in gross income.
When the insured outlives the policy,
the proceeds from life insurance less
the total amount of premiums paid
should be included in the gross
income since death is an essential
element for the exclusion.
This exclusion is applicable to group
life insurance proceeds, death benefit
payments under the workmens
compensation insurance contract, and
health or accident insurance contract
having the characteristics of life
insurance proceeds payable by
reason of death.
Unlike in estate taxation where the
concept of revocability or irrevocability
in the designation of the beneficiary
may determine whether the insurance
proceeds form part of the gross estate
for estate tax purposes, there is no
need for such determination for
purposes of exclusion of the life
insurance proceeds from the gross
income for income taxation.
Same analogous application to the
example mentioned in annuities as part
of gross income (see example on page
80)
Life Insurance Proceeds are NOT
excluded in the following instances:
1. Where the life insurance policy is used
to secure a money obligation.
2. Where the life insurance policy was
transferred
for
a
valuable
consideration.
Example: Mr. A insured his life for P1
Million. He assigned the insurance to
B for valuable consideration
of
P800,000. A then died and B was able
to collect the proceeds of P1 Million. In
the present scenario, B shall
recognize an income of P200,000
(proceeds of P1 Million less the
consideration of P800,000). However,
the income recognized shall be
reduced further by the premiums paid

by B reckoned from the time of the


assignment of the said policy. Hence,
should B pay premium of P100,000
after the transfer of the policy to him,
B shall recognize an income of
P100,000 only (The proceeds of P1
Million less the consideration
of
P800,000, further lessened by the
premium payment of P100,000).
3. The recipient of the insurance
proceeds is a business partner of the
deceased and the insurance as to
compensate the partner-beneficiary
for any loss in income that may result
as the death of the insured partner.
4. The recipient of the insurance
proceeds is a partnership in which the
insured is the partner and the
insurance was taken to compensate
the partnership for any loss in income
that may result from the dissolution of
the partnership caused by the death of
the insured partner
5. The recipient of the life insurance
proceeds is a corporation in which the
insured was an employee or officer.
(Domondon, Taxation Vol. 2, 2009, p.
196-197)
B. RETURN OF INSURANCE PREMIUM
Rationale: Amounts to a return of capital.
Conditions for Exclusion: The same
must be received as a return of premiums
paid by him under life insurance,
endowment or annuity.
If the total premium returns exceed the
aggregate premiums paid, the excess
shall be included in the gross income
Same analogous application to the
example mentioned in annuities as part
of gross income (see example on page
80)
In case of a transfer for a valuable
consideration of a life insurance,
endowment or annuity contract, or any
interest therein, only the actual value of
such consideration and the amount of the
premiums and other sums subsequently
paid by the transferee are exempt from
taxation
No loss is realized on surrender of a life
insurance policy for its surrender value.

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TAXATION LAW | Income Taxation


Endowment The insurer agrees to pay
a sum certain to the insured if he outlives
a designated period; if he dies before that
date, the proceeds are to be paid to the
designated beneficiary.
Tax treatment of proceeds received
under endowment policies:
1. If the insured dies, and the beneficiary
receives the life insurance proceeds,
these are not taxable income because
they are excluded from gross income.
2. If the insured does not die and
survives the designated period:
a. The amount pertaining to the
premiums he paid are excluded
from gross income; and
b. The excess shall be considered
part of his gross income.
(Domondon, ibid., p. 199)
Annuity the aleatory contract of life
annuity binds the debtor to pay an annual
pension or income during the life of one or
more determinate persons in consideration
of a capital consisting of money or other
property whose ownership is transferred to
him at once with the burden of the income.
C. GIFT, BEQUEST, DEVISE or DESCENT
Rationale: Gifts are excluded because
they are subject to DONORS tax; Bequest
and Devise are excluded because they are
subject to ESTATE tax.
Notes:

Income from the property received as


gift is subject to income tax.
If the amount received is on account
of services rendered, the receipt is
income (Pirovano v. Commissioner,
G.R. No. 15865, July 31, 1965)
Only donated property is excluded
from gross income. Donations of
income are included as part of gross
income and not excluded.
Rationale: Strictissimi juris. The
wording of sec. 32(B)(3), NIRC is
explicit that, gift, bequest, devise or
descent of income from any property,
in case of transfers of divided interest
shall be included in the gross income.
Gift tax test
1. If there is NO legally demandable
obligation to give the gift not taxable
2. If there is a legally demandable
obligation to give, there is income

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taxable (Domondon, Taxation Vol. 2,


2009, p. 208)
D. COMPENSATION FOR INJURIES OR
SICKNESS (whether by suit or
agreement)
Rationale: This is just an indemnification
for the injuries or damages suffered. The
legal theory of personal injury damages is
that the amount received is intended to
make the injured party AS HE WAS
BEFORE THE INJURY.
Notes:
The term injury includes death, even if
not injured, if the person dies this
compensation received on account of
his death is also excluded from the
gross income.
Personal injuries refer only to
PHYSICAL INJURIES; hence, it
DOES NOT INCLUDE DAMAGES
ARISING
FROM
LIBEL
OR
SLANDER.
The fact that payment was voluntary
does not change its exempt status.
Damages under the Civil Code (Art.,
2179) are also excluded from the
gross income.
Rule: All damages awarded are tax
exempt.
Exception: damages representing loss of
income because they would have been
taxable income had the taxpayer not been
injured or became sick.
E. INCOME EXEMPT UNDER TREATY
Rationale: Public policy and comity
between the Philippines and various
countries.
F. RETIREMENT BENEFITS, PENSIONS,
GRATUITIES
Rationale: Retirees are most deserving of
compassion and should not be
given
a strict interpretation under the
law.
Retirement laws aim to assist retirees in
his old age, not to punish
him for having
survived.
a. Retirement benefits under R.A. 4917
(Act
Providing
that
Retirement
Benefits of Employees of Private
Firms Shall Not be Subject to
Attachment etc.) where:
1. Retiree employed for at least 10
years by the same employer;

Income Taxation | TAXATION LAW


Note: The phrase causes beyond the
control connotes involuntariness on
the part of the official or employee.
The separation from the service of the
official or employee MUST NOT BE
ASKED or INITIATED BY HIM. (Sec.
2(b), R.R. 12-86)

2. Retiree at least 50 years old;


Avails of the benefit only once;
3. BIR approved private benefit plan
(R.R. 2-98)
b. Retirement benefits under R.A. 7641
(amendment to the Labor Code)
where:
1. NO private benefit plan;
2. Must have served the company for
at least five (5) years;
3. Retiree at least 60 years BUT not
more than 65 years of age at the
time of retirement
c.

Monetized
value
of
retirees
accumulated vacation leave (VL) and
sick leave (SL) subject to the following
rules:
1. For compulsory retirement (60 yrs.
for private corp.; 65 yrs. for
government.; 70 yrs. for judiciary)
ALL
2. For optional retirement (10 yrs. of
service and 50 yrs. of age) up to
10 days only while the excess of
VL and all SL is taxable
The money value of accumulated
leave credits/terminal leaves given
to a retiring government official or
employee is NOT subject to tax.
Rationale:
Terminal leave pay is applied for
by an employee who is no longer
working;
it
is
no
longer
compensation
for
services
rendered.
Terminal leave pay is applied for
by an employee who retires,
resigns or is separated from the
service through no fault of his
own
Compulsory retirement may be
considered as a cause beyond the
control of the retiring employee
Terminal leave pay may be
viewed as a retirement gratuity
received
by
government
employees (Borromeo v. CSC,
G.R. No. 96032, July 31, 1991)

d. Separation pay because of death,


sickness or other physical disability
OR for any cause beyond the control
of the employee;

Rule: Separation pay is not tax


exempt.
Exceptions:
1. Automatic exclusions:
a. illness
b. death
c. physical incapacity or injury.
2. Conditional exclusion:
a. causes beyond the control of
the employee excluded
(e.g. installation of labor saving
devises or bankruptcy)
b. within employees control
included.
e. Social security benefits, retirement
gratuities, pensions and other similar
benefits received by citizens and
aliens
who
come
to
reside
permanently
here
from
foreign
government agencies and other
institutions, private or public;
Gratuity An additional benefit or
compensation paid in recompense for
previous services rendered or as an
inducement to perform additional
services.
Pension A stated, certain and
periodic
allowance
paid
in
recompense for previous services
rendered or as an inducement to
perform additional services.
f.

Benefits due to residents under the


laws of the U.S. administered by the
U.S. Veterans Administration;
g. SSS benefits; and
h. GSIS benefits.
G. MISCELLANEOUS ITEMS
1. Passive income derived by:
a. Foreign governments;
b. Financing
institutions
owned,
controlled, or enjoying refinancing
from foreign government; and
c. International
or
regional
institutions established by foreign
governments.

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TAXATION LAW | Income Taxation


2. Income derived by the Philippine
government and its subdivisions from:
a. Any public utility; or
b. The exercise of any essential
governmental function.
3. Prizes and awards made primarily in
recognition of religious, charitable,
scientific, educational, artistic, literary,
or civic achievement.
Requisites:
a. Recipient was selected without
any action on his part; and
b. Recipient is not required to render
substantial future services.
4. Prizes and awards granted to athletes
in sports competitions locally or
abroad and sanctioned by their
national sports association
Note: National Sports Associations
are those duly accredited by the
Philippine Olympic Committee (POC).
5. 13th month pay and other benefits up
to P30,000.00;
6. GSIS, SSS, Medicare (now Philhealth)
and Pag-ibig contributions and union
dues of individuals;
7. Gains
derived
from
bonds,
debentures, or other certificate of
indebtedness with a maturity of more
than 5 years;
Why 5 years? - Certificate of
indebtedness is similar to bank
Interest in a long term deposit.
8. Gains from redemption of shares in
Mutual Fund.

Fringe Benefit means any good, service, or


other benefit furnished or granted by an
employer, in cash or in kind, in addition to
basic salaries, to an individual employee.
It is given instead of an increase in basic pay
because it may be discounted or adjusted
downward as the financial condition of the
employer dictates.
Rationale for Granting Fringe Benefits:
Incentive
to
encourage
employees
productivity and loyalty to employer.
TAX RATE AND BASE
Tax Base: The grossed up monetary value
(GMV) of the fringe benefit
GMV of Fringe Benefits Represents:
1. The whole amount of income realized
by the employee which includes the net
amount of money or net monetary value of
property which has been received; plus
2. The amount of FBT thereon otherwise
due from the employee but paid by the
employer for and in behalf of the
employee.
GMV of the fringe benefit shall be
determined by dividing the monetary value of
the fringe benefit by the grossedup divisor.
The grossedup divisor is the difference
between 100% and the applicable rates.
Comprehensive Formula
Actual Monetary Value (AMV)
Grossed Up Divisor
= Grossed Up Monetary Value (GMV)
(see rates below)

SEC. 33 FRINGE BENEFITS TAX


Fringe Benefits Tax (FBT) -

final
withholding tax imposed on the grossed-up
monetary value (GMV) of fringe benefit
furnished, granted or paid by the employer to
the employee, except rank and file
employees, whether such employer is an
individual,
professional
partnership
or
corporation, regardless of whether the
corporation is taxable or not, or the
government and its instrumentalities.
FBT is paid by the employer but he is allowed
by law to deduct the tax as a business
expense in determining his taxable income.

Grossed Up
Monetary Value

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Fringe Benefits
Tax Rate

= Fringe Benefit Tax (FBT)

Tax Rates
Year

Grossed
Up
Divisor

Fringe
Benefit
Tax Rate

2000 onwards

68%

32%

Employee

Grossed
Up
Divisor

Fringe
Benefit
Tax Rate

Citizen, RA, NRA-ETB


68%
NRA-NETB
Individuals

90

employed

75%
85%

32% FBT
(2000
onwards)
25% FBT
15% FBT

Income Taxation | TAXATION LAW


by RHQ or RAHQ;
OBU; Foreign service
contractor or foreign
service subcontractor
engaged in petroleum
operations
in
the
Philippines.

Basic Rules
1. Fringe benefit given to a rank and file
employee (whether under a collective
bargaining agreement or not) is not
subject to FBT (fringe benefit tax).
Note: Fringe benefits given to a rank-andfile employee are treated as part of his
compensation income subject to income
tax and withholding tax on compensation.
2. Fringe benefit given to a supervisory or
managerial employee is subject to the
FBT.
3. De minimis benefit, whether given to rank
and file employee or to supervisory or
managerial employee is not subject to any
tax, whether FBT or Withholding tax on
Compensation.
4. Exemption from FBT is an not an
exemption from other income taxes,
unless such benefit is also stated
expressly to be exempt from that other
income tax.
Notes:
Rank and File employees means all
employees who are holding neither
managerial nor supervisory position

Valuation of Fringe Benefits


1. If fringe benefit is granted in money or is
directly paid for by the employer
Value: Amount granted or paid for
2. If fringe benefit granted or furnished in
property other than money and ownership
is transferred to employee
Value: FMV of the property
3. If fringe benefit granted or furnished in
property other than money but ownership
is not transferred to employee
Value: Depreciation value of the property
FRING BENEFITS SUBJECT TO FRINGE
BENEFIT TAX (FBT)
1. Housing
Rule: The value to the employee of
quarters and meals given by the employer
shall be subject to FBT.
Exception: If living quarter/meals are
furnished to an employee for the
convenience of the employer.

Case

Monetary Value

Employer
leases
residential property

Monthly rental paid x


50%
MV= R x 50%
Monthly monetary value:
50% of 5% of the higher
amount between:
a. The FMV in the Real
Property
Tax
Declaration, or
b. The zonal value of
the CIR,
Divided by: 12 months

Employer owns the


residential property

Managerial employees refer to those who


are vested with powers or prerogatives to
lay down and execute management
policies and/or to hire, transfer, suspend,
lay-off, recall, discharge, assign or
discipline employees.
Supervisory employees are those who
effectively recommend such managerial
actions if the exercise of such authority is
not merely routinary or clerical in nature
but requires the use of independent
judgment. (R.R. No. 3-98)
Deduction for the Employer
1. If fringe benefit is given to rank-and-file
employee OR to a managerial/supervisory
employee, but is not subject to FBT, the
deduction for the employer is the actual
monetary value of the fringe benefit.
2. If fringe benefit is given to managerial or
supervisory employee and is subject to
FBT, the deduction for the employer is the
GMV of the fringe benefit.

Employer purchases
the
residential
property in installment

MV=
FMV or ZV x 50% x 5%
12
Monthly monetary value:
50% of 5% of the
Acquisition cost,
exclusive of interest,
divided by 12 months
MV=
AC x 50% x 5%
12

Employer purchases
the
residential
property, with the
ownership transferred
to the employee
Housing unit inside or
adjacent (within 50
meters)
from
the
perimeter
of
the
business premises

Acquisition cost or zonal


value whichever is higher
MV= AC or ZV

Not a taxable fringe


benefit

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TAXATION LAW | Income Taxation


Temporary housing
for a stay in the
housing unit for 3
months or less

Not a taxable fringe


benefit

Nontaxable Housing Fringe Benefit


a. Housing privileges of military officials
of the AFP consisting of officials of the
Phil. Army, Phil. Navy and Phil. Air
Force shall not be treated as taxable
fringe benefit.
Rationale: The State shall provide its
soldiers with necessary quarters which
are within or accessible from the
military camp so that they can readily
be on call to meet the exigencies of
their military service.
b. A Housing unit which is situated inside
or adjacent (50m. from the perimeter
of the business premises) to the
premises of a business or factory shall
not be considered as a taxable fringe
benefit.
c. Temporary housing for an employee
who stays in a housing unit for three
(3) months or less.
2. Expense Account
Rule: Fixed and variable transportation,
representation and other allowances are
subject to FBT.
Exception: If incurred or reasonably
expected to be incurred by employee in
the performance of his duties, subject to
the following conditions:
a. ORDINARY AND NECESSARY in the
pursuit of employers business and
paid or incurred by employee;
b. LIQUIDATED OR SUBSTANTIATED
by receipts or other adequate
documentation.
Personal expenses of the employee
whether paid by the employer or
reimbursed to the employee shall be
treated as fringe benefit.
3. Motor Vehicle of any kind

Case
Employer purchases
the vehicle in the name
of the employee
Employer
furnishes
employee with cash for
the purchases of the
vehicle, and ownership
is placed in the name
of the employee
Employer shoulders a
portion of the amount
of the purchase price

92

Monetary Value
Acquisition cost

of the vehicle and


ownership is placed in
the name of the
employee
Employer purchases
the
vehicle
in
installment
and
ownership is placed in
the name of the
employee
Employer owns a fleet
of vehicles for use of
the
business
and
employees

Employer leases a
fleet of vehicles for use
of the business and
employees

Acquisition cost,
exclusive of interest,
(Divided by) : 5 years
MV= AC/5
Acquisition cost of all
the vehicles not
normally used for sales,
freight, delivery service
and other non-personal
use,
(Divided by) : 5 years,
and
(Multiplied by) : 50%
MV= AC x 50%
5
Rental payments for
motor vehicles not
normally used for sales,
freight, delivery service
and other non-personal
use,
(Multiplied by) : 50%
MV= 50% x value of the
benefit

Notes:
a. The use of aircraft (including
helicopters) owned and maintained by
the employer shall be treated as
business use and NOT SUBJECT to
the fringe benefits tax. (R.R. No. 398)
b. The use of yacht whether owned and
maintained or leased by the employer
shall be treated as fringe benefit. The
value of the benefit shall be based on
the depreciation of a yacht at an
estimated useful life of 10 years (R.R.
No. 3-98)
4. Household Expense
Expenses for employees which are borne
by the employer for household personnel,
such as salaries of household help,
personal driver of the employee, or other
similar personal expenses (like payment
for homeowners association dues,
garbage dues, etc.) shall be taxable as
fringe benefits.

Cash received

Amount shouldered by
the employer

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5. Interest on loan at less than market rate


to the extent of the difference between
the market rate and actual rate granted
If the employer lends money to his
employee free of interest or a rate lower

Income Taxation | TAXATION LAW


than 12%, such interest foregone by the
employer or the difference of the interest
assumed by the employee and the rate of
12% shall be treated as taxable fringe
benefit.
Principal x (12% - Interest Rate Assumed)

8. Holiday and Vacation Expenses


9. Educational
Assistance
employee or his dependents

to

the

Rule: The assistance is a taxable fringe


benefit.

= Market Value (MV)


The rule shall apply to installment
payments or loans with interest rate lower
than 12% starting January 1, 1998.
6. Membership fees, dues, and other
expenses borne by the employer for the
employee in social and athletic clubs
and similar organizations.
7. Expenses for Foreign Travel
Rule: Fixed and variable transportation,
representation and other allowances are
subject to FBT.
Exception: If incurred or reasonably
expected to be incurred by employee in
the performance of his duties, subject to
the following conditions:
a. ORDINARY AND NECESSARY in the
pursuit of employers business and
paid or incurred by employee;
b. LIQUIDATED OR SUBSTANTIATED
by receipts or other adequate
documentation.
Inland travel expenses such as expenses
for
food,
beverages
and
local
transportation except lodging cost at a
hotel or similar establishments amounting
to an average of US$300 or less per day,
shall NOT be subject to fringe benefit tax.
In the absence of documentary
evidence showing that the employees
travel abroad was in connection with
business meetings for conventions, the
entire cost of the ticket, including cost of
hotel
accommodations
and
other
expenses incident thereto shouldered by
the employer shall be treated as taxable
fringe benefits. (R.R. No. 3-98)
Note: If employee is given a first class
airplane ticket, the monetary value of the
benefit is equal to 30% of the cost of the
first class airplane ticket.
The full amount of the travelling
expenses of the family members of the
employee which are paid for by the
employer is subject to FBT.

Exceptions:
a. Education/study is directly connected
with employers trade or business;
b. With a written contract that employee
shall remained employed with the
employer for a period of time mutually
agreed upon by the parties; or
c. The assistance was provided through
a competitive scheme under the
scholarship program of the company
employer.
Note: The education or study involved
must be directly connected with the
employers trade, business, or profession
and there is a written contract between
them that the employee is under obligation
to remain in the employ of the employer
for the period of time that they have
mutually agreed upon. (R.R. No. 3-98)
In such case, the expenditure shall be
treated as incurred for the convenience
and furtherance of the employers trade or
business. (R.R. No. 3-98)
10. Insurance Premium
Rule: The premiums paid for life or health
insurance and other non-life insurance
borne by the employer are FBT.
Exceptions:
a. Cost of premiums borne by the
employer for the group insurance of
employees;
b. Contributions of the employer for the
benefits of the employee to the SSS,
GSIS, and similar contributions arising
from provisions of any existing law.
Stock Options are Subject to Fringe Benefit
The basis is the difference between the fair
market value and the exercise price at the time
of exercise.
FRINGE BENEFITS NOT SUBJECT TO FBT
1. Fringe benefits not considered as gross
income:
a. If it is required or necessary to the
business of the employer; or
b. If it is for the convenience or
advantage of the employer.

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TAXATION LAW | Income Taxation


Convenience of the Employer Rule
grants exemption to the benefits which are
given for the exclusive benefit or
convenience of the employer.
2. Fringe Benefit that is not taxable under the
NIRC (Sec. 32 (B) Exclusions from
Gross Income)
3. Fringe benefits NOT SUBJECT TO
FRINGE BENEFITS TAX:
a. Fringe benefits which are authorized
and exempted under special laws,
such as the 13th month pay and other
benefits with the ceiling of P30,000;
b. Contributions of the employer for the
benefit of the employee to retirement,
insurance and hospitalization benefit
plans;
c. Benefits given to the rank and file
employees, whether granted under a
collective bargaining agreement or
not; and
d. De minimis benefits benefits which
are relatively small in value offered by
the employer as a means of promoting
goodwill, contentment, and efficiency
of employees.
Rationale: If the FMV of any property
or a service that otherwise would be a
fringe benefit includible in gross
income is so small that accounting for
the property or service would be
unreasonable
or
administratively
impractical, the value is excluded.

Managerial /
Supervisory
Employees

Rank And File


Employees

Compensation / Salaries / Wages


Subject to Income Tax

Subject to Income Tax

Fringe Benefits
Subject to fringe
benefit tax (FBT)

Forms part of
compensation
therefore subject to
income tax;
Subject to exceptions

De Minimis Benefits
Income but not
compensation, hence
not taxable

Income but not


compensation hence
not taxable

De Minimis Benefits NOT Subject to FBT


(R.R. No. 5-2011):
1. Monetized unused vacation leave credits
of private employees NOT EXCEEDING
TEN (10) DAYS during the year;

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Rule: Paid vacation leave and sick leave


are subject to FBT
Exception:
Monetized value of unutilized VL credits of
10 days or less are NOT subject to FBT.
However, monetization of sick leave
credits even if not exceeding 10 days are
subject to TAX.
2. Monetized value of vacation AND sick
leave credits paid to government officials
and employees (no limit as to the number
of credits);
3. Medical cash allowance to dependents of
employees NOT EXCEEDING P750.00
per employee per semester or P125 per
month;
4. Rice Subsidy of P1,500 or one (1) sack of
50kg rice per month amounting to not
more than P1,500;
5. Uniform and clothing allowance NOT
EXCEEDING P4,000 per annum;
6. Actual yearly medical benefits
EXCEEDING P10,000 per annum;

NOT

7. Laundry Allowance NOT EXCEEEDING


P300 per month;
8. Employees achievement awards, e.g. for
length of service or safety achievement,
which must be in the form of a tangible
personal property other than cash or gift
certificate, with an annual monetary value
of NOT EXCEEDING P10,000 received by
the employee under an established written
plan which does not discriminate in favor
of highly paid employees;
9. Gift given during Christmas and major
anniversary
celebrations
NOT
EXCEEDING P5,000 per employee per
annum;
10. Daily meal allowance for overtime work
and
night/graveyard
shift
NOT
EXCEEDING 25% of the basic minimum
wage on a per region basis.
Note: Flowers, fruits, books or similar
items given to employees under special
circumstances, which had been included
in the list of de minimis benefits in the
previous regulations (R.R. Nos. 8-2000,
10-2000 and 10-2008), was omitted in the

Income Taxation | TAXATION LAW


latest revenue regulation, R.R. No. 52011.
If De Minimis Benefit EXCEEDS the ceiling
prescribed
1. If the excess is within the P30,000 limit
th
under Sec. 32(b)(7)(e) (13 Month Pay
and Other Benefits) of the NIRC - NOT
taxable
2. If excess is beyond the P30,000 limit
taxable

SEC. 34
DEDUCTIONS FROM GROSS
INCOME
Deductions items or amounts which the
law allows to be deducted from gross income
in order to arrive at the taxable income.
OVERVIEW:

In other words, there are two limits for the


taxability of a fringe benefit:
Limit 1- The thresholds mentioned (see
preceding amounts)
Limit 2 In excess of limit 1, the total of
th
all excesses shall be added plus the 13
month pay.
The total will be subjected to a P30,000 limit,
the excess thereof shall be TAXABLE
Example:
Mr. A, a rank and file employee, received a
rice subsidy of P2,000 per month. He also
th
receives a 13 month pay of P25,000.
In the present scenario, the rice subsidy
received exceeded P500. Before determining
whether the excess is taxable, the total
th
excesses thereof must be added to his 13
month pay. Should the total amount exceed
P30,000, the excess is taxable.
Hence, in the present problem, the excess of
P500 multiplied by 12(representing 12 months)
th
plus the 13 month pay amounts to P31,000.
Hence, the P1000 excess is taxable.
Note: Representation and Transportation
Allowance (RATA) and Personnel Economic
Relief Allowance (PERA) are not subject to
Income Tax and Withholding Tax. Additional
Compensation Allowance (ACA) is part of
other benefits under Sec. 32(b)(7)(e), NIRC
which are excluded from gross compensation
income provided the total amount of such
benefits does not exceed P30,000. It is also
not subject to withholding tax pending its
formal integration into basic pay.

Income from All Sources


Less: Exclusions
Gross Income
Less: Deductions
Exemptions
Taxable Income
Multiplied by: Tax Rate
Tax Due
Less: tax Credits

xxx
(xxx)
xxx
xx
xx

Tax Due and Payable

(xxx)
xxx
x%
xxx
(xxx)
xxx

Basic Principles
1. The taxpayer seeking a deduction must
point to some specific provision of the
statute authorizing the deduction.
2. He must be able to prove that he is
entitled to the deduction authorized or
allowed. (Atlas Consolidated Mining &
Devt. Corp. v. Commissioner, G.R. No. L26911, January 21, 1981)
3. 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 deduction
only if it is shown that the tax required to
be deducted and withheld therefrom
has been paid to the BIR. (Sec. 34(K),
NIRC)
4. Deductions for income tax purposes
partake of the nature of tax exemptions;
hence, if tax exemptions are to be strictly
construed, then it follows that deductions
must also strictly be construed.
Note: The taxpayer is mandated to deduct
amounts only within the limits allowed by law.
He could choose to avail only of a lesser
amount or even none at all. (CIR v. Phoenix
Assurance Co., Ltd., G.R. L-19727, May 20,
1965)
Matching Concept for Deductibility posits
that the deductions must match the income,

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TAXATION LAW | Income Taxation


(i.e. helped earn the income) (Domondon,
Taxation Vol. 2, 2009, p. 522)
Thus, the requisite that the ordinary and
necessary expense that is being deducted
must have been paid or accrued or paid or
incurred during the taxable year. A taxpayer
who is authorized to deduct certain expenses
and other allowable deductions for the current
year but failed to do so cannot deduct the
same for the next year. (CIR v. Isabela
Cultural Corp., G.R. No. 172231, Feb. 12,
2007)
Summary Rules on Claimable Deductions
For Individuals (see also discussions on the
preceding section)
1. With gross compensation income from
employer employee relationship ONLY:
a. Personal and additional exemptions;
b. Premium payments on health and/or
hospitalization insurance
2. With gross income from business or
practice of profession:
a. Optional standard deduction (OSD)
OR itemized deductions
b. Premium payments on health and/or
hospitalization insurance
c. Personal and additional exemptions
For Corporations
1. Optional Standard Deduction OR
2. Itemized Deductions

Exclusions vs. Deductions vs. Personal


Exemption
Personal
Exclusion Deduction
Exemption
Refer to flow
of wealth not
treated as
part of gross
income
because
exempted by
the
Constitution,
statute, or do
not come
within the
definition of
income
Generally a
receipt which
is excluded
from taxable
income.

96

Refer to the
amounts which
the law allows
to be
subtracted
from gross
income in
order to arrive
at net income

Are arbitrary
amounts
allowed by law
to an individual
taxpayer,
theoretically to
provide for
personal and
living expenses

Is not a receipt
but is generally
an expenditure
which is
permitted to be
subtracted
from income to
determine the

It is an
immunity or
privilege, a
freedom of
charge or
burden to
which other are
subjected.

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Exclusion

Something
earned or
received by
the taxpayer
which do not
form part of
gross income
Allowed for
all kinds of
taxpayers,
whether
natural or
juridical
May be
availed of by
a NRA-ETB
whether or
not there is
reciprocity.

Deduction
amount subject
to tax.
Something
spent or paid
in earning
gross income

Personal
Exemption
Theoretical
provision of law
for the personal
and living
expenses of
the individual.

Generally
allowed for all
kinds of
taxpayers,
whether
natural or
juridical
May be availed
of by a NRAETB whether
or not there is
reciprocity.

Allowed ONLY
to Individuals
(RC, NRC, RA)

May be
subtracted
ONLY from
income derived
from trade,
business or
exercise of
profession.

May be
subtracted from
both:
a. Compensatio
n income; or
b. income
derived from
trade,
business or
exercise of
profession.

May be availed
of by NRA-ETB
only upon the
basis of
reciprocity.

Kinds of Deduction
1. Optional Standard Deduction (OSD)
2. Special Deductions
3. Itemized Deductions
Taxpayers
Who
CANNOT
Avail
of
Deductions from Gross Income whether
OSD or Itemized Deductions:
1. RC, NRC, and RA whose income is
purely compensation income (except for
premium payments on health and/or
hospitalization insurance);
2. NRA-ETB cannot avail of the optional
standard deductions (except for itemized
deductions) (Sec. 34 (L), NIRC)
3. NRA-NETB since their gross income from
sources within is subject to a final tax of
25%.
4. NRFC since their gross income from
sources within is subject to final tax of
30%
5. (See Table of Summary of Allowance of
Optional Standard Deductions)

Income Taxation | TAXATION LAW


OPTIONAL STANDARD DEDUCTION (Sec.
34 (L), NIRC)
A fixed percentage deduction without regard to
any actual expenditures, in lieu of the itemized
deductions. It is merely a privilege that may be
enjoyed by certain taxpayers.

4.

5.
Rules:
1. Rate does not exceed 40%
a. An individual subject to tax under
Section 24, other than a non-resident
alien, may elect a standard deduction
in an amount not exceeding forty
percent (40%) of his gross sales or
gross receipts;
b. In the case of a corporation subject to
tax under section 27(A) and 28(A)(1),
it may elect a standard deduction in an
amount not exceeding forty percent
(40%) of it gross income as defined in
Section 32, NIRC. (as amended by
R.A. 9504)
Example:
A retailer of goods, who signified his
intention to avail of the OSD, has a Gross
Income of P1 Million and a Cost of Sales
amounting to P800,000. (Amounts that are
enclosed with a parenthesis signifies that
said amounts are to be deducted)
In case the retailer is an INDIVIDUAL
Gross Income
P1,000,000
OSD rate (maximum)
40%
OSD Amount
P 400,000
Hence, his taxable income would be
Gross Income
P1,000,000
Allowable Deduction (OSD) (P 400,000)
Taxable Income
P 600,000

In case the retailer is a CORPORATION


Gross Sales
P1,000,000
Cost of Sales
P 800,000
Gross Income
P 200,000
OSD rate (maximum)
40%
OSD Amount
P 80,000
Hence, its taxable income would be
Gross Income
P1,000,000
Cost of Sales
(P 800,000)
Allowable Deduction (OSD) (P 80,000)
Taxable Income
P 120,000
2. OSD is available only to RC, NRC, RA,
DC, and RFC; it is not available to NRA
and NRFC.
3. Unless the taxpayer signifies in his
return his intention to elect OSD, he is

6.

7.

considered as having availed of the


itemized deductions;
Such election, when made by the qualified
taxpayer, is irrevocable for the year in
which made; however, he can change to
itemized deductions in succeeding years;
OSD
is
not
available
against
compensation income arising out of an
employer-employee relationship;
Proof of actual expenses is not required,
but the taxpayer should keep records
pertaining to his gross income.
Corporations who avail of the OSD should
still submit financial statements when it
files its annual ITR and to keep such
records pertaining to its gross income.
(R.R. No. 16-2008)

Notes:
1. In the filing of the quarterly income tax
returns, the taxpayer may opt to use either
the itemized deduction or the OSD. The
taxpayer is, thus, NOT allowed to use a
hybrid method of claiming its/his
deduction for one taxable year. (Sec. 7,
R.R., 16-2008)
2. A GPP may avail of the OSD of 40% of
its gross income in computing its net
income, since under Sec. 26 For
purposes of computing the distributive
share of the partners, the net income of
the GPP shall be computed in the same
manner as a corporation.
a. If the GPP uses the OSD in computing
its net income distributable to the
partners, the partners shall not be
allowed any deductions from such
share (whether OSD or itemized
deductions), since the OSD which the
GPP claimed is in lieu of the itemized
deductions allowed in computing
taxable income; it will answer for both
the items of deduction allowed to the
GPP and its partners.
b. If the GPP uses the itemized
deductions in computing its net
income, the partners may only avail of
the other itemized deductions which
are in the nature of ordinary and
necessary expenses for the practice of
profession which were not claimed by
the GPP. The partners cannot claim
the OSD against their share in the net
income since the OSD is in lieu of the
items of deductions claimed by both
the GPP and its partners. (R.R. No. 22010)
In fine, it may be implied from R.R.
No. 2-2010 that the partners of a GPP

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TAXATION LAW | Income Taxation


could never avail of the OSD against
their share in the net income of the
GPP, regardless of the deductions
availed of by the GPP. The only time
they may avail of the OSD is if they
also
earn
other
business
or
professional income, in which case the
OSD shall only be computed and
deducted against such other business
or professional income.

Summary of Allowance of Optional


Standard Deductions
Optional
Individual
Standard
Taxpayer
Deduction
RC
NRC
RA
NRA-ETB
NRA-NETB

DC
RFC
NRFC

Resident
Aliens
employed by and who
receive compensation
income from:
1. Regional or area
headquarters
or
regional operating
headquarters
of
multinational
corporations
established in the
Philippines
2. Offshore
banking
units established in
the Philippines
3. Petroleum service
contractors
and
subcontractors
in
the Philippines.

Allowed
Allowed
Allowed
Not Allowed
Not Allowed
Rationale: they are
taxed
on
Gross
Income
Allowed
Allowed
Not Allowed
Rationale: they are
taxed
on
Gross
Income
Not allowed
Rationale: they are
taxed
on
Gross
Income

SPECIAL DEDUCTIONS
A. Private
proprietary
educational
institutions (Sec. 34 (A)(2), NIRC) in
addition to the expenses allowed as
deduction, it has the option to treat the
amount utilized for acquisition of
depreciable assets for expansion of school
facilities as:
1. OUTRIGHT EXPENSE (the entire
amount is deducted from gross
income); OR

98

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2. CAPITAL ASSET AND DEDUCT


ONLY FROM THE GROSS INCOME
an
amount
equivalent
to
its
depreciation for the year
B. Insurance companies - (Sec. 37, NIRC)
can deduct the following:
1. NET ADDITIONS REQUIRED BY
LAW TO BE MADE within the year to
reserve funds; AND
2. SUMS OTHER THAN DIVIDENDS
PAID WITHIN THE YEAR on policy
and annuity contracts.
C. Estates and trusts (Sec. 61, NIRC) - can
deduct the following:
1. AMOUNT
OF
INCOME
PAID,
CREDITED OR DISTRIBUTED to the
heirs/beneficiaries; AND
2. AMOUNT
APPLIED
FOR
THE
BENEFIT OF THE GRANTOR.

ITEMIZED DEDUCTIONS (BIRD2 CLE


P2T)
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.

Ordinary and necessary Expenses;


Interests;
Taxes;
Losses;
Bad debts;
Depreciation of property;
Depletion of oil and gas wells and mines;
Charitable and other contributions;
Research and development;
Pension trust contributions of employees;
and
K. Premium payments on health and/or
hospitalization insurance. (This is the only
deduction which a compensation income
earner may claim as a deduction.)
KINDS OF ITEMIZED DEDUCTIONS
A. ORDINARY AND NECESSARY TRADE,
BUSINESS,
AND
PROFESSIONAL
EXPENSES
Requisites for Deductibility:
1. It must be ordinary and necessary
Necessary Expense appropriate
and helpful in the development of the
taxpayers business and are intended
to minimize losses or to increase
profits. These are the day-today
expenses.
Ordinary Expense normal or usual
in relation to the taxpayers business
and the surrounding circumstances
Note:
If
the
expenses
are
extraordinary, the expenditures shall

Income Taxation | TAXATION LAW


be capitalized for which depreciation
allowance may be claimed.
2. It must be paid or incurred within
the taxable year.
Effect of ACCRUAL METHOD of
Accounting
(see p. 134 for further discussion on
Methods of Accounting)
The requisite that it must have been
paid or incurred during the taxable
year is further qualified by Sec. 45 of
the NIRC which states that: [t]he
deduction provided for in this Title
shall be taken for the taxable year in
which paid or accrued or paid or
incurred, is dependent upon the
method of accounting upon the
basis of which the net income is
computed x x x.
The accrual method relies upon the
taxpayers right to receive amounts or
its obligation to pay them, in
opposition to actual receipt or
payment, which characterizes the
cash method of accounting. Amounts
of income accrue where the right to
receive them become fixed, where
there is created an enforceable
liability.
Similarly, liabilities are
accrued when fixed and determinable
in amount, without regard to
indeterminacy merely of time of
payment.
For a taxpayer using the accrual
method, the determinative question is:
When do the facts present themselves
in such a manner that the taxpayer
must recognize income or expense?
The accrual of income and expense is
permitted when the ALL-EVENTS
TEST has been met.
This test
requires:
a. fixing of a right to income or
liability to pay; and
b. the availability of the reasonable
accurate determination of such
income or liability.
The all-events test requires the
right to income or liability be fixed,
and the amount of such income or
liability be
determined
with
reasonable accuracy. However,
the test does not demand that the
amount of income or liability be

known absolutely, only that a


taxpayer has at his disposal the
information necessary to compute
the amount with reasonable
accuracy.
3. It must be reasonable (not lavish,
extravagant or excessive under the
circumstances).
4. Must be paid in connection with the
conduct of trade or business, or the
exercise of profession by the
taxpayer, or attributable to the
development,
management,
or
operation of the trade business or
profession.
5. It must be substantiated
adequate proofs.

with

Substantiation Rule it is required


that before business or professional
expenses are allowed as deductions
from gross income, the taxpayer must
satisfy the BIR that the deductions
being claimed are indeed ordinary and
necessary expenses incurred during
the taxable year carrying on any trade
or business.
How expense being deducted is
substantiated:
With
sufficient
evidence such as official receipts or
other adequate records showing the;
a. Amount of the expense being
deducted; and
b. Direct connection or relation of the
expense being deducted to the
development,
management,
operation and/or conduct of trade,
business or profession of the
taxpayer. (Sec. 34(A)(1)(b), NIRC)
Lack of receipts excused the lack
of supporting vouchers, receipts and
other documentary proof, however,
may be excused under Sec. 337 (now
Sec. 235) of the Tax Code. This
provision requires the preservation of
the books of accounts and other
accounting records for a period of
three (3) years from the date of last
entry
(Basilan
Estates
v.
Commissioner, G.R. No. L-22492,
September 5, 1907).
Cohan Rule Principle if there is
showing that expenses have been
incurred but the exact amount thereof

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TAXATION LAW | Income Taxation


cannot be ascertained due to the
absence of documentary evidence, it
is the duty of the BIR to make an
estimate of deduction that may be
allowed in computing the taxpayers
taxable income bearing heavily
against
the
taxpayer
whose
inexactitude is of his own making. (see
Cohan v. Commissioner, 39 F. 2d 540
(2d Cir. 1930))
Note: The Cohan Rule is subject to
the 50-50 limit on the claim of
deductions.
6. If subject to withholding taxes, have
been properly withheld and remitted
on time to the BIR.
7. Not contrary to law, public policy or
morals.
While illegal income will form part of
income of the taxpayer, expenses
which constitute bribe, kickback and
other similar payment, being against
law and public policy are not
deductible from gross income (Sec 34
(A)(1)(c), NIRC).
Note: Interestingly, although the
payment of illegal bribes or kickbacks
are
non-deductible
expenses,
expenses incurred in an illegal activity
are generally deductible if they are
ordinary, necessary and reasonable
(CIR v. Sullivan, et al., AFTR 2d
1158).
Kinds of Business Expenses
1. Compensation
for
Services

Personal

Requisites for Deductibility:


a. Personal services ACTUALLY
RENDERED;
b. Compensation paid is FOR SUCH
SERVICES RENDERED;
c. Must be REASONABLE (if same
amount will be paid for similar
services by similar enterprise
under similar circumstance)
Factors
in
determining
reasonableness of compensation
for services:
a. Type and extent of services
rendered
b. Qualifications of employee

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Volume or amount of taxpayers


earnings
d. Compensation policy of the
taxpayer; and
e. General economic conditions (BIR
Ruling, 1959)
c.

It includes
a. Salaries, wages, commissions,
professional fees, vacation-leave
pay, retirement pay and other
compensation;
b. Bonuses are deductible expenses
IF paid in good faith as additional
compensation
for
services
rendered AND subjected to
withholding tax
c. Pensions and compensation for
injuries, if not compensated for by
insurance or otherwise; and
d. Grossed-up
monetary
value
(GMV) of fringe benefit provided
for, as long as the final tax
imposed has been paid.
Test for Deductibility of Bonus
a. Payment made in good faith;
b. Character of the taxpayers
business;
c. Volume and amount of its net
earnings;
d. Its locality;
e. Type and extent of the services
rendered;
f. Salary policy of the corporation;
g. Size of the particular business;
h. Employees
qualification
and
contributions to the business
venture, and
i. General economic conditions (CM
Hoskins & Co. v. CIR, G.R. No. L24059, November 28, 1969).

2. Travelling Expenses
Requisites for Deductibility:
a. Incurred or paid while away from
home;
b. In the pursuit of trade or business.
c. Must
be
reasonable
and
necessary.
Note:
The term away from home means
away from the location of the
employees
principal
place
of
employment regardless of where the
family residence is maintained like
business trips.

Income Taxation | TAXATION LAW


It includes transportation, meals and
lodging. (Sec. 65, 66, R.R. No. 2)
Transportation expenses from main
office to branch or from branch to
main office deductible
Transportation expenses from office to
home; home to office not deductible
If company car is utilized both for
business or personal use proportion
to the use.
3. Rental Expenses
Requisites of Deductibility:
a. Made as a
condition to the
continued use or possession of
property;
b. Taxpayer has not taken or is not
taking title to the property or has
no equity other than that of a
lessee, user or possessor;
c. Property must be used in trade or
business; and
d. Subject to withholding tax of 5%,
otherwise it shall be disallowed as
a deduction.
It includes a. Aliquot part of the amount used to
acquire
leasehold
over the
number of years the lease will run
b. Taxes and other obligations of the
lessor paid by the lessee
c. Annual depreciation of the cost of
leasehold
improvements
introduced by the lessee over the
remaining term of the lease, OR
over the life of the improvements,
whichever period is shorter.
Note: It is NOT the cost of the
leasehold improvements but only its
annual depreciation that is considered
as rental expense.
Amounts paid for the "right of
occupancy" or "goodwill", do not
qualify as rental expense being in the
nature of capital advance to secure
the lease of the premise which is
similar to a purchased goodwill.
Taxes paid by a tenant to or for a
landlord for business property are
additional rent and constitute a
deductible item to the tenant and
taxable income to the landlord; the
amount of tax being deductible by the
latter (Sec. 74, R.R. No. 2)

The cost borne by the lessee in


erecting
buildings
or
making
improvements on the ground of which
he is a lessee is held to be a capital
investment and not deductible as a
business expense. (Sec. 74, R.R. No.
2)
4. Entertainment, Amusement and
Recreation (EAR) Expenses
Requisites for Deductibility:
a. Must be paid or incurred DURING
THE TAXABLE YEAR;
b. DIRECTLY CONNECTED to the
development, management, and
operation of the trade, business or
profession of the taxpayer; or
directly related to or in furtherance
of the conduct of trade, business,
or profession;
c. Is REASONABLE;
d. NOT CONTRARY to laws, morals
and policy or public order;
e. Does NOT constitute as a BRIBE,
KICKBACK or other similar
payments; and
f. SUBSTANTIATED
WITH
SUFFICIENT PROOF indicating
the amount of expense, date and
place of expense, purpose of
expense, professional or business
relationship of expense, and name
of person or company entertained
with contact details.
It shall not exceed
a. For taxpayers engaged in sale of
goods/properties one half of one
percent (.50%) of net sales;
b. For taxpayers engaged in sale of
services one percent (1%) of
net revenues; and
c. For taxpayers engaged in both
sale of goods/properties and
services determined using an
apportionment formula, taking
into consideration the percentage
ceiling prescribed above.
Apportionment Formula:
Net Sales (or Revenues)
Total Sales and Revenues
Example:
Net Sales
Net Revenues
Total
EAR Expense

EAR

P200,000
P100,000
P300,000
P 3,000

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TAXATION LAW | Income Taxation


EAR, as apportioned
P 200,000 x P3000 = P2000 EAR for
P 300,000
Net Sales
P100,000 x P3,000 = P1000 EAR for
P300,000
Net Revenues

EAR, taking into


percentage ceiling

It excludes
a. Expenses
treated
as
compensation or fringe benefits;
b. Expenses for charitable or fund
raising activities;
c. Expenses for bona fide business
meeting of stockholders, partners
or directors;
d. Expenses
for
attending
or
sponsoring an employee to a
business league or professional
organization;
e. Expenses for events organized for
promotion,
marketing
and
advertising including concerts,
conferences,
seminars,
workshops, conventions and other
similar events; and
f. Other expenses of similar nature.

P200,000
P100,000

account

the

x .5% = P1000 EAR for


Sales
x 1% = P1000 EAR for
Revenues

Hence, the total allowable EAR is


P2000 (P1000 for Sales and P1000
for Revenues). The excess P1000
arising from EAR of Sales is not
deductible.
It includes
a. Representation expenses;
b. Depreciation or rental expenses
relating to entertainment facilities.
Representation
Expenses

expenses incurred by a taxpayer in


connection with the conduct of his
trade, business or exercise of
profession, in entertaining, providing
amusement and recreation to or
meeting with guest/s at a dining place,
place of amusement, country club,
theater, concert, play, sporting event
and similar events or places. (R.R. 102002)
It
shall
not
refer
to
fixed
representation allowances that are
subject to withholding tax on wages
pursuant to appropriate revenue
regulations
Entertainment Facilities shall refer
to:
a. A yacht, vacation home, or
condominium; and
b. Any similar item of real or
personal property used by the
taxpayer
primarily
for
the
entertainment, amusement or
recreation of guests or employees.
(Sec. 2, R.R. 10-2002)
Guests persons or entities with
which the taxpayer has direct
business relations, such as but not
limited to clients / customers or
prospective clients/customers.

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The term shall not include


employees, officers, partners,
directors, stockholders, or trustees
of the taxpayer. (Sec.2, R.R.102002)

Notwithstanding the foregoing,


such items of exclusions MAY,
nonetheless, qualify as items of
deductions under Sec. 34, NIRC,
subject
to
conditions
for
deductibility therein. (Sec. 3,
R.R.10-2002)

5. Cost of Materials and Supplies


Deductible only to the amount
ACTUALLY CONSUMED or USED in
operation during the taxable year.
6. Cost of supplies deductible by a
Professional
a. COST OF SUPPLIES USED in
the practice of a profession;
b. Expenses
paid
in
the
OPERATION AND REPAIR of
transportation;
c. EQUIPMENT used in making
professional calls, subscription to
professional journals;
d. The RENT paid for offices;
e. Expense for UTILITIES such as
electricity, water, telephone, etc. in
connection with the profession,
salaries of employees, etc.; and
f. Cost of BOOKS, FURNITURE and
PROFESSIONAL EQUIPMENT,
the useful life of which is short.
(R.R. No. 68)

Income Taxation | TAXATION LAW


Note: If the life of the foregoing
extends beyond one year, they are
not to be reported as deductible
expenses but are to be subject to
depreciation.
7. Repair Expenses
Minor or ordinary repairs
DEDUCTIBLE
FROM
GROSS
INCOME because it keeps the assets
in its ordinary working condition.
Major or extraordinary repairs - are
NOT DEDUCTIBLE as an expense
since major repairs tend to prolong the
life of the asset (these are capitalized
or added to the cost of the asset
subjected to repair)
8. Advertising Expenses
Advertising includes the use of
spoken or written word in printed
matter, movies, radio, and television to
acquaint the public with the taxpayers
merchandise or services. (General
Foods Inc. v. CIR, CTA Case No.
4386, February 8, 1994)
Three Kinds of Advertising and
their Deductibility:
a. Advertising to stimulate the
current sale of merchandise or
use of services is DEDUCTIBLE
as business expenses. (General
Foods, Inc v. CIR, CTA Case No.
4386, February 8, 1994)
b. Advertising to stimulate future
sale of merchandise or use of
services is NOT DEDUCTIBLE as
expense but is to be spread over a
reasonable
period
of
time,
irrespective
of
whether the
taxpayer is on the cash or accrual
basis. (Ibid)
c. Advertising to promote the sales
of shares of stocks or to create
a favorable image is NOT
DEDUCTIBLE.
Rationale: Efforts to establish
reputation are akin to acquisition
of capital assets and, therefore,
expenses related thereto are not
business expense but capital
expenditures. (Atlas Consolidated
v. CIR, G.R. L-26911, January 27,
1981)
9. Miscellaneous Expenses
It includes
a. Amortization of organization costs
over the life of the corporation;

Pre-Operating Expenses
May be treated as deferred
expenses and deducted from
gross income for not more
than sixty (60) months.
Amortization
period
commences with the month in
which the business begins.
Expenditure must be one that
is paid or incurred in
connection with creating or
investigating the creation or
acquisition of an active trade
or business entered into by
the taxpayer.
Expenses must be paid or
incurred before, and in
anticipation of the business in
an activity for profit or the
production of income.
A corporation is considered to
begin business when it
commences the activities for
which it was organized and
reckoned from the time the
certificate of registration or
license to do business is
issued.
Note: Investigatory expenses and
start-up costs, interest on loan
obtained to purchase land and
other incidental costs, and project
development costs of real estate
developers, cannot be considered
as part of the pre-operating
expenses.
b. Cost of defending a civil suit
affecting
the
business
IRRESPECTIVE of the success of
the defense. (Judgment or other
binding adjudication, on account
of
damages
for
patent
infringement, personal injuries, or
other causes, are deductible when
the claim is adjudicated and paid.)
Note:
Margin Fees paid to the BSP on
profit remittances to the taxpayers
head office abroad are NOT
considered as deductible business
expenses.
Rationale: Margin fees are not
expenses incurred in connection
with the production of the
taxpayers
income
in
the
Philippines. They are expenses

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incurred in the disposition of said
incomes. (Esso Standard Eastern,
Inc v. CIR, G.R. Nos. L-28508-9,
July 7, 1989)
Expenses on passive investments
are NOT DEDUCTIBLE. They do not
come within the purview of carrying on
any trade or business. (Hospital de
San Juan de Dios v. CIR, G.R. No.
31305, May 10, 1990)
Political campaign expenses are not
deductible either as business expense
or as contribution (Felix Montenegro
Inc v. CIR, CTA Case No. 695, April
30, 1969)
But contributions to political
parties
registered
with
the
COMELEC are deductible (New
Election Code)
Expenses incurred partly for the
taxpayers trade or business and in
part for other purposes shall be
APPORTIONED
correspondingly
(Jamir v. Collector, G.R. No. L-16552,
March 30, 1962)
B. INTEREST
Interest is the compensation for the use or
forbearance or detention of money,
regardless of the name it is called or
denominated. It includes the amount paid
for the borrower's use of money during the
term of the loan as well as for his
detention of money after the due date for
its repayment. (R.R. 13-2000)
Requisites for Deductibility
1. There must be an indebtedness
incurred by the taxpayer based on a
bona fide debtor-creditor relationship;
There must be a bona fide DEBTORCREDITOR RELATIONSHIP based
on a valid and enforceable obligation
wherein
the
debtor
is
under
unconditional obligation to repay the
creditor. (Philex Mining Corporation v.
Commissioner, CTA Case No. 5200,
August 21, 1998).
2. The indebtedness MUST BE THAT
OF THE TAXPAYER;
3. The interest must be legally due;
If there exists no obligation or where
the obligation is unenforceable,
interest paid thereon is not deductible.
(Collector v. Prieto, G.R. No. L-13912,
September 30, 1960)

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4. The interest must be stipulated in


writing (Art. 1956, NCC);
5. The interest expense must have been
paid or incurred during the taxable
year;
6. The indebtedness must be connected
with the taxpayers trade, business, or
profession;
7. The interest arrangement must not be
between
related
taxpayers
as
provided under Sec. 36(B), NIRC; and
8. The interest must not be incurred to
finance petroleum operations.
Rules on Deductibility of Interest
Expense
Rule: The entire amount shall be allowed
as deduction from the taxpayer's gross
income.
Interest Expense Limitation: The
taxpayers otherwise allowable deduction
for interest expense shall be reduced by
33% of the interest income which have
been subjected to final withholding tax.
Thus, the amount of interest expense
equivalent to 33% of interest income
subjected to final tax will be nondeductible,
and only the remaining portion of the
interest expense can be claimed as
expense in the income tax computation.
Effective Jan. 1, 2009 33%
(30% NIT 20% FT)
30% NIT

= 33%*
Where:
NIT normal income tax
(individual/corporation)
FT- final tax
*rounded off from 33.33%
Aim of the Limitation: To discourage tax
arbitrage wherein back-to-back loan is
used to take advantage of the lower rate of
tax on interest income and a higher rate of
tax on interest expense deduction.
Illustration:
Tax arbitrage could be explained as
follows: Corporation X borrowed from
ABC Bank an amount of P500,000 at a
10% annual interest (resulting to interest
expense). Immediately thereafter, the
proceeds of the loan were placed in a local
bank deposit account which earns a 10%
annual interest rate (resulting to interest
income).

Income Taxation | TAXATION LAW

Assuming that the rule on interest expense


limitation is not yet in place, the interest
expense of P50,000 (10% of P500,000)
will result to a tax benefit of 30% or
P15,000; while the interest income of
P50,000 (10% of P500,000), being a
passive income will only be subjected to
final withholding tax of 20% or P10,000.
The taxpayer would derive a net benefit of
P5,000 from the combined effect of a
lower rate of final tax liability and a higher
rate of tax deductibility.
Realizing the negative impact of tax
arbitrage on revenue generation, the
interest expense limitation was legislated.
Note: The limitation on the allowable
interest expense shall apply, regardless of
whether or not a tax arbitrage scheme was
entered into by the taxpayer, or regardless
of the date when the interest bearing loan
and the date when the investment was
made for as long as, during the taxable
year, there is an interest expense incurred
on one side and an interest income earned
on the other side, which interest income
had been subjected to final withholding tax
(R.R. 13-2000).
Optional Treatment of Interest Expense
At the option of the taxpayer, interest
incurred to acquire property used in the
trade, business or exercise of a profession
may be allowed as:
1. Interest expense deductible to gross
income; OR
2. Treated
as
capital
expenditure
wherein the amount of interest is
added to the cost of the property
(Capitalize the interest as part of the
acquisition cost of the property and
subsequently avail of the deduction
from business income in the form of
depreciation.
Note: Should the taxpayer elect to deduct
the interest payments against its gross
income, the taxpayer cannot at the same
time capitalize the interest payments.
(PICOP v. CA, G.R. No. 106949-50,
December 1, 1995)
Deductible Interest Expense
1. Interest on taxes, such as those paid
for deficiency or delinquency, since
taxes are considered indebtedness
(provided that the tax is a deductible
tax, except in the case of income tax).

However,
fines,
penalties,
and
surcharges on account of taxes are
not deductible.
Note: Interest incurred or paid on all
unpaid business-related taxes shall be
fully deductible from gross income and
shall not be subject to the limitation on
deduction.
2. Interest paid by a corporation on scrip
dividends.
3. Interest
on
deposits
paid
by
authorized banks of the BSP to
depositors, if it is shown that the tax
on such interest was withheld.
4. Interest paid by a corporate taxpayer
who is liable on a mortgage upon real
property where the said corporation is
the legal or equitable owner, even
though it is not directly liable for the
indebtedness.
Non-Deductible Interest Expense
1. If an individual reporting income on
cash basis incurs an indebtedness on
which an interest paid in advance
through discount or otherwise, the
interest may only be deductible
(Sec.34(B)2a, NIRC):
a. In the year the indebtedness is
paid
b. If the indebtedness is payable in
periodic
amortization,
the
amortized amount of interest paid
during the year shall be allowed
as deduction in such taxable year.
2. If indebtedness is incurred to finance
petroleum operations. The interest
incurred in capitalized as deferred
exploration cost.
Note: The non-deductible interest
herein referred to pertains to interest
or other consideration paid or incurred
by a Service Contractor engaged in
the discovery and production of
indigenous
petroleum
in
the
Philippines in respect of the financing
of its petroleum operations, pursuant
to Section 23 of P.D. No.8 as
amended, otherwise known as the Oil
Exploration and Development Act of
1972 (Sec. 4(3), R.R. 13-2000)
3. Interest on preferred stock, which in
reality is a dividend
4. Interest calculated for cost of keeping
on account of capital or surplus
invested in business which does not

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represent charges arising under
interest bearing obligations
5. Interest paid when there is no
stipulation for the payment thereof.
6. Interest paid on earned and unclaimed
salary. (Kuenzle & Streiff, Inc. v.
Collector, G.R. Nos. L-12010 and L12113, October 20, 1959)
7. Interest paid on indebtedness used to
purchase securities by one who is not
a dealer in securities.
Rationale: Such interest is part of the
acquisition of a capital asset.
8. Interest
paid
on
indebtedness
between related taxpayers.
Who are related taxpayers? (Sec. 36(B),
NIRC)
1. Between members of the family;
Family includes only the brothers,
sisters (whether by the whole or half
blood), spouse, ancestors, and lineal
descendants of the taxpayer.
Note: Not related parties are relatives
by affinity and collateral relatives,
other than brothers and sisters.
Hence, interest payments made to
parents-in-law, brothers or sisters-inlaw, as well as made to all kinds of
cousins, uncles and aunts may be
deductible
from
gross
income.
(Domondon, Taxation Vol. 2, 2009)
2. Except in the case of distributions in
liquidation, between an individual
and corporation more than fifty
percent (50%) in value of the
outstanding stock of which is owned,
directly or indirectly, by or for such
individual;
3. Except in the case of distributions in
liquidation,
between
two
corporations more than fifty percent
(50%) in value of the outstanding
stock of which is owned, directly or
indirectly, by or for the same individual
if either one of such corporations, with
respect to the taxable year of the
corporation preceding the date of the
sale of exchange was under the law
applicable to such taxable year, a
personal holding company or a foreign
personal holding company;
4. Between the grantor and a fiduciary
of any trust;
5. Between the fiduciary of a trust and
the fiduciary of another trust if the

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same person is a grantor with respect


to each trust; or
6. Between a fiduciary of a trust and
beneficiary of such trust
The fact that the President of one
corporation is the Chairman of the
Board of another does not mean that
he has controlling ownership of such
corporations. (Oranbo Realty Corp. v.
CIR, CTA Case No. 5222, April 7,
1997)
Determination of Taxable Income of
Intercompany Loans or Advances,
Applying Sec. 50, NIRC (RMO NO. 6399)
The BIR adopted the arms length
bargaining standard as the ultimate
test for determining the correct gross
income and deductions between two
or more enterprises under common
control.
Coverage:
1. Loans or advances of money or
other consideration (whether or
not evidence by a written
instrument);
2. Indebtedness arising in the
ordinary course of business out of
sales, leases, or the rendition of
services by or between members
of the group, or any other similar
extension;
3. This DOES NOT APPLY to
alleged indebtedness which was
in fact a contribution of capital or a
distribution by a corporation with
respect to its shares.

Applying arms length principle to


Sec. 50 Sec. 50 empowers the CIR
to rectify abnormalities and distortions
in income brought about by common
control through the adoption of
standards considered fair, reasonable
or at arms length.

Determination of taxable income on


inter-company loans or advances
1. In General The Commissioner
can make appropriate allocations
to reflect an arms length rate
when one member of a group of
controlled entities makes a loan or
advances directly or indirectly, or
otherwise become a creditor of
another member of such group
and:

Income Taxation | TAXATION LAW


a. Charges no interest; or
b. Charges interest at a rate
which is not equal to an arms
length rate
2. Arms Length Interest Rate
a. The rate of interest which was
charged or would have been
charged at the time the
indebtedness
arose
in
independent transaction with
or between unrelated parties
under similar circumstances;
or
b. The Bank Reference Rate
(BRR) prescribed by the BSP.
Note: The fact that the interest
rate actually charged on a loan or
advance is expressly indicated on
a written instrument does not
preclude the application of Sec.50
to such loan or advance.
3. Interest Period
a. Generally, the interest period
commences at the date the
indebtedness arises.
b. Except with respect to
business out of sales, lease,
or supply of goods and
services which are considered
as
trade
accounts
or
receivables or payables
The interest period shall not
commence if the taxpayer is able
to establish that the normal
practice in a given industry is to
allow balances, in the case of
similar transactions with unrelated
parties, to remain outstanding for
a longer period without charging
interest.
C. TAXES
Rule: All taxes, whether national or local,
paid or accrued, within the taxable year in
connection with the taxpayers trade or
business, shall be allowed as deduction.
Exceptions:
1. Philippine income tax;
2. Foreign income tax, provided the
taxpayer avails of the foreign tax
credit. If not availed: may be claimed
as deduction from gross income;
(see General Principles, p.26 for
illustration)
3. Estate and donors tax;

4. Special assessments and taxes


assessed against local benefits of a
kind that tends to increase the value of
the property assessed;
Note: If it does not tend to increase
the value of the property, the special
assessments are deductible as taxes.
(Domondon, Taxation Vol. 2, 2009)
5. Electric energy consumption tax;
6. Final taxes, being in the nature of
income tax.
7. Value-added tax (VAT)
8. Taxes on sale, barter or exchange of
shares of stock listed and traded
through the local stock exchange or
through initial public offering (Sec. 127
(D), NIRC)
9. Taxes paid for commodity not
connected
with
the
taxpayers
business.
(Dimaampao,
Basic
Approach to Income Taxation, 2011)
Note: In the case of a NRA-ETB and a
RFC deduction is allowed only if and to the
extent that the taxes for which deduction is
claimed are connected with income from
sources within the Philippines. (Sec.
34(C)(2), NIRC)
Requisites for Deductibility
1. Payments must be for taxes
The word taxes means taxes proper
and no deduction should be allowed
for amounts representing interest,
surcharge, or penalties incident to
delinquency. Postage and Automobile
registration fees are not considered
taxes.
2. Tax must be imposed by law on,
and payable by the taxpayer
Taxes are deductible as such only by
the persons upon whom they are
imposed by law. Indirect taxes, like the
VAT, are not deductible by the buyers
from their gross income.
3. Paid or incurred during the taxable
year in connection with taxpayers
trade, business or profession; and
In the case of contingent tax liability,
the obligation to deduct arises only
when the tax is finally determined.
4. Taxes must not be specifically
excluded by law from being
deducted from the taxpayers gross
income.

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Note: Under Section4(a), R.A. No. 9257
(Expanded Senior Citizens Act), the 20%
discount granted to senior citizens shall
be allowed as tax deduction from gross
income for the same taxable year that the
discount is granted.
Rules on Deductibility and Nondeductibility of Special Assessments
as Taxes:
1. Where the assessments are made for
the purpose of MAINTENANCE or
REPAIR of local benefits, if the
payment of such assessments is
ordinary and necessary in the
conduct of trade, business, or
profession may be deducted as an
expense.
2. Where the assessments are made for
the purpose of CONSTRUCTING local
benefits or benefits of a kind tending
to increase the value of the property
assessed, and the payments are in
the nature of a capital expenditure
not deductible.
3. Where the assessments are made
both
for
the
purpose
of
maintenance
or
repairs
AND
construction, the burden is on the
taxpayer to show the allocation of the
amounts assessed to the different
purposes.
If the allocation cannot be made,
none of the amounts so paid is
deductible (Sec. 83, R.R. No. 2)
Examples of Deductible Taxes:
1. Privilege and license taxes
2. Documentary stamp taxes
3. Excise taxes
4. Automobile registration fees
5. Real property taxes
6. Occupation taxes
7. Business taxes
8. Import duties
Alternative treatments for income taxes
paid to any foreign country:
1. Claim as foreign TAX CREDIT against
Philippine income tax due of citizens
and domestic corporations.
2. Claim as DEDUCTION from gross
income of citizens and domestic
corporations;

Tax Credit

Deduction

Reduces the
Phil. income tax
liability
It is subtracted
from the tax

Reduces taxable income


upon which tax liability is
calculated from
Subtracted from gross
income before tax is

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(net) amount to
be paid

computed (M.E. Holdings


Corporation v. CIR, CTA
Case No. 5314, August
17, 1998)

TAX CREDIT
It is the amount subtracted from an
individuals or entitys tax liability to arrive
at the total tax liability, which was paid or
accrued to a foreign country.
Who Can Claim Tax Credit?
1. Resident citizens;
2. Resident aliens under the principle of
reciprocity;
3. Domestic
corporations
including
partnerships except GPPs;
4. Beneficiaries of estates and trusts;
and
5. Members of general professional
partnerships. (Sec. 34(C), NIRC)
Who Are Not Entitled To Tax Credit?
1. Non-resident citizens;
2. Resident aliens if without reciprocity;
3. Non-resident aliens;
4. Foreign
corporations,
whether
residents or non-residents
Rationale: These taxpayers are subject to
Philippine income tax only on income
derived
from
sources
within
the
Philippines.
BIR requirements include proof of:
1. Total amount of income derived from
foreign sources;
2. The amount of income derived from
each country, the foreign tax paid or
incurred, which is claimed as a credit;
and
3. All other information necessary for the
verification and computation of such
credit.
Limitations on availing Tax Credit
Limitation A: Per country limitation
Taxable Income
From foreign country
Philippine
---------------------------- x
Income
Taxable income
Tax
From all sources
Limitation B: Over-all Limitation
Taxable Income
From outside sources
Philippine
----------------------------- x
Income
Taxable income
Tax
From all sources

Income Taxation | TAXATION LAW


c.
Application:
One foreign country the allowed credit
is the one lower between the result of limit
A and the foreign income tax paid or
accrued.
Two or more foreign countries
determine first the one lower between limit
B and the total foreign income taxes paid
or accrued. Then compare the result with
limit A, the lower amount is the allowed
credit.
Administrative
Conditions
for
allowance of Credit:
1. The taxpayer must signify his desire to
claim tax credit in his income tax
return;
2. The return must be accompanied by a
form, carefully filled in
and duly
signed and sworn to or affirmed;
3. If the credit is sought for taxes paid,
the original, duplicate original, duly
certified or authenticated copy or a
sworn copy of the receipt or return
must be attached;
4. If the receipt or return is in a foreign
language, a certified translation must
be furnished;
5. If the credit is sought for taxes
accrued
and
not
paid,
the
Commissioner may require a bond
and shall be conditioned for the
payment by the taxpayer of the tax
due.
When Credit for Taxes may be Taken:
The credit for taxes may ordinarily be
taken either in the return for the year in
which the taxes accrued or on which the
taxes were paid, depending on the
taxpayers accounting method being
adopted. After election, such must be
followed for all subsequent years.
D. LOSSES
Losses actually sustained during the
taxable year and not compensated for by
insurance or other forms of indemnity shall
be allowed as deductions.
Kinds of Losses:
a. Ordinary losses -those incurred in a
trade or business for profit;
b. Those incurred in any transaction
entered into for profit, although not
connected with the trade or business;

Casualty losses- those incurred by


property connected with the trade,
business or profession that results
from unforeseen, identifiable events
that are sudden, unexpected and
unusual in character such as fire,
storm, shipwreck, or other casualties
or
from
robbery,
theft
or
embezzlement;
d. Capital losses deductible only to the
extent of capital gains;
e. Losses from Short Sale of property
f. Losses due to failure to exercise
privilege or option to buy or sell
property;
g. Abandonment losses (oil exploration)
Requisites for Deductibility
1. The loss must be that of the taxpayer.
The loss is personal and NOT
transferable to another.
Note: The loss of predecessor
partnership is not deductible by a
successor corporation.
The loss of the parent company may
not be deducted by its subsidiary. But
the loss of the branch within or outside
the Philippines is deductible from the
gross income of the head office
located in the Philippines, since the
branch is only an extension of its head
office and there is only a single entity.
If the taxpayer is engaged in several
businesses, loss sustained in one line
of business cannot be claimed as a
deduction of its line of business (BIR
Ruling No. 123-87, 4 May 1987.)
2. Actually sustained and charged off
during the taxable year;
The taxpayers failure to record in his
books the alleged loss proves that the
loss had not been suffered, hence, not
deductible (City Lumber v. Domingo
and Court of Tax Appeals, G.R. No. L18611, January 30, 1964).
3. Evidenced by a close and completed
transaction - there should be an
identifiable event that fixes the loss
like the delivery of the thing
purchased;
Closed and completed transaction
one which the facts indicate that the
transaction is sufficiently final to

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ascertain that loss has occurred.
(Mertens, Law of Federal Income
Taxation)

OCCURRENCE OR DISCOVERY of
the casualty or robbery, theft or
embezzlement.

Proof of Loss:
a. Casualty loss - documentary proof
of the cost, photograph showing
extent of damage, condition or
value of the property after it was
repaired, restored or replaced.
Robbery, theft or embezzlement
losses amount of loss, police report
is necessary, although not conclusive
of the loss.

Determination of Amount of Loss


Deductible
The amount of loss deductible is limited to
the difference between the value of the
property immediately preceding the loss
and its value immediately thereafter (both
ascertained via appraisal), BUT shall not
exceed an amount equal to the cost or
other adjusted basis of the property, or
depreciated cost reduced by any
insurance or other compensation received.
(see R.R. No. 12-77)

4. Not claimed as a deduction for estate


tax purposes (for individuals) - the
taxpayer cannot claim double benefits
arising from the same casualty loss for
income tax and estate tax purposes.
He can only choose one;
Note: Losses within six (6) months
after the death of the decedent can be
claimed as itemized deduction of
losses under Sec. 34(B). However, it
may be claimed as deduction under
estate tax return provided that the
same are not claimed as itemized
deduction of losses under Section
34(B).
5. Not compensated for by insurance or
other form of indemnity;
Rule: Loss is deductible in the year
the loss happens.
Exception: However, if the loss is
compensated
by
insurance
or
otherwise, the loss is postponed to a
subsequent year in which it appears
that no compensation at all can be
had, or there is a remaining net loss
(or there is no full compensation).
(Plaridel Surety & Insurance Co. v.
Collector,
G.R.
No.
L-21520,
December 11, 1967).
6. For individuals, the loss must be
connected with his trade, business or
profession or incurred in any
transaction entered into for profit
though not connected with his trade,
business or profession;
7. For CASUALTY LOSSES, declaration
of loss must be filed with the BIR via a
sworn declaration of loss(i.e. within 45
days)
from
the
DATE
OF

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CLASSIFICATION OF LOSSES
1. Ordinary Losses (deductible from
gross income)
A. Incurred in trade or business, or
practice of profession
B. Of property connected with trade,
business, or profession, if the loss
arises
from
fires,
storms,
shipwreck or other casualties, or
from
robbery,
theft,
or
embezzlement
i.
Total Destruction - The
basis of the loss is the net
book value immediately
preceding the casualty to be
reduced by the amount of
insurance or compensation
received.
ii.
Partial Destruction The
replacement cost to restore
the property to its normal
operating condition, but in
no case shall the deductible
loss be more than the net
book value of the property
as a whole, immediately
before casualty. The excess
over the net book value
immediately
before
the
casualty
should
be
capitalized,
subject
to
depreciation
over
the
remaining useful life of the
property.
2. Capital
Losses
(losses
are
deductible only to the extent of
capital gains)
A. Losses from sale or exchange of
capital assets
B. Losses resulting from securities
becoming worthless and which are
capital assets.

Income Taxation | TAXATION LAW

Requisites:
i. It becomes worthless upon the
happening of an identifiable event.
If the loss is due to fluctuation of
market price, the amount of loss is
not deductible until it is disposed;
ii. Must be claimed in the year the
worthlessness
occurs

considered as a loss from the sale


or exchange of capital assets on
the last day of the taxable year in
which it occurred.
C. Losses from
property

short

sales

of

Short sales - Any sale of a security


which the seller does not own or any
sale which is consummated by the
delivery of a security borrowed by, or
for the account of the seller.

Note: The excess of the loss over


the gain is not deductible, but the
excess of the gain over the loss is
taxable.
Cost of unsold tickets of a
sweepstakes agent constitutes his
investment
in
a
wagering
transaction. Losses he may incur
therefrom can be allowed as
deduction only up to the extent of
the gains realized.
Losses from illegal transactions
are not deductible and they cannot
be offset against gains from legal
transactions.
B. Losses on wash sales of stocks
NOT deductible because these
are considered to be artificial loss.
(see p. 126 for further discussion)

A person shall be deemed to own a


security if:
1. He or his agent has title to it
2. He has purchased or has entered
into an unconditional contract,
binding on both parties thereto, to
purchase it and has not yet
received it
3. He owns a security convertible
into or exchangeable for it and has
tendered
such
security
for
conversion or exchange
4. He has an option to purchase or
acquire it and has exercised such
option; or
5. He has rights or warrants to
subscribe to it and has exercised
such rights or warrants provided
however, that a person shall be
deemed to own securities only to
the extent he has a net long
position in such securities (R.A.
8799, SRC).

C. Abandonment
losses
in
petroleum operation all
accumulated
exploration
and
development
expenditures
pertaining thereto shall be allowed
as a deduction.

D. Losses due to failure to exercise


privilege or option to buy or sell
property

E. Losses
due
to
voluntary
removal of building incident to
renewal or replacements
deductible expense from gross
income

3. Special Losses
A. Wagering Losses deductible
only to the extent of gain or
winnings (Sec. 34(D)(6), NIRC);
deemed to apply only to
individuals. A wager is made when
the outcome depends upon
CHANCE.

D. Abandonment
losses
in
producing well the unamortized
cost thereof, as well as the
undepreciated cost of equipment
directly used therein, shall be
allowed as deduction in the year
the well, equipment or facility is
abandoned. Provided, if such
abandoned well is reentered and
the production is resumed, or if
such equipment or facility is
restored into service, the said
costs shall be included as part of
the income in the year or
resumption or restoration and
shall be amortized or depreciated.

Note: If an entity buys a land with


a building with a view of erecting
another building, the value and the
cost of demolishing the old
building are NOT deductible
losses BUT added instead to the
cost of the land.

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TAXATION LAW | Income Taxation

Involuntary demolition such as


that
ordered
by
the
City
Engineers
Office,
which
considered the building as a fire
hazard, may result to deductibility
of the buildings value if the loss is
not compensated for by insurance
(CIR v. Priscilla Estate, G.R. L18282, May 20, 1964)
F. Loss of useful value of capital
assets due to changes in
business conditions and a
capital asset is terminated
deductible expense only to the
extent of actual loss sustained
after
adjustments
for
improvement, depreciation, and
salvage value. This is an
exception to the rule requiring the
sale or disposition of the property
to determine the loss.
G. Losses
from
sales
or
exchanges of property between
related taxpayers losses of this
nature is NOT deductible but
gains are taxable
H. Losses of farmers Losses
incurred in the operation of farm
business are deductible. No
deduction on account of shrinkage
in weight or physical value unless
such was reflected in an inventory
to determine profits.
I.

Loss in shrinkage in value of


stock:
a. No deduction from gross income
on loss due to market fluctuation
or otherwise, until the stock has
been disposed of
b. The loss may be deducted in the
taxable year they became
worthless,
provided
a
satisfactory showing of its
worthlessness be made.

Marcelo Steel Doctrine a loss in


one line of business is not permitted
as allowable deduction from gain in
another line of business, if one of the
two lines is exempted from tax.
4. Non-deductible Losses
A. Losses in dealings between
related taxpayers; (see p.105 for
complete list of related taxpayers)

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B. Losses on wash sales of stock


and securities. (Sec.38, NIRC ;
C. Loss due to voluntary removal of
building if purchased with a view
to erect another building not
existing and not incident to
renewal. (R.R. No. 2);
D. Gambling losses not covered by
gambling gains. (Sec.34(D)(6),
NIRC);
E. Capital loss not covered by capital
gains. (Sec. 34(D)(4), NIRC);
F. Losses
from
exchanges
of
property
in
corporate
readjustments. (Sec. 40, NIRC);
G. Losses from illegal transactions.
(R.R. No.2); and
H. Losses not incurred in trade,
business or profession or in any
transaction entered into for profit.
(Sec.36(A), NIRC)
NET OPERATING LOSS CARRY-OVER
(NOLCO) (Sec. 34(D)(3), NIRC)
It is the excess of allowable deductions
over gross income of the business for any
taxable year, which had not been
previously offset as deduction from gross
income.
Rule: Loss shall be carried over as a
deduction from gross income for the next
three (3) consecutive taxable years
immediately following the year of such
loss.
Exception: Any net loss incurred in a
taxable year during which the taxpayer
was exempt from income tax shall not be
allowed as a deduction under NOLCO.
Requisites for deductibility of NOLCO:
1. It is from the net operating loss of the
business,
2. For any taxable year immediately
preceding the current taxable year,
3. Which has not been previously offset
as deduction from gross income,
4. Shall be carried over as a deduction
from gross income,
5. For the next 3 consecutive taxable
years immediately following the year
of such loss,
6. No deduction shall be allowed for the
net loss in a taxable year during which
the taxpayer was exempt from income
tax,
7. There has been no substantial change
in the ownership of the business or
enterprise.

Income Taxation | TAXATION LAW


Substantial change not less than 75%
in nominal value (par value or stated
value) of outstanding shares issued or not
less than 75% of the paid-up capital of the
corporation, if the business is in the name
of the corporation, is held by or on behalf
of the same person as a result of a merger
or consolidation.
Notes:
A taxpayer who claims the 40% OSD
or is subject to MCIT shall NOT
simultaneously claim deduction of the
NOLCO.
The (3) three-year reglementary
period
shall
continue
to
run
notwithstanding the fact that the
aforesaid taxpayer availed of the OSD
or is liable under the MCIT during the
said period.
Estimated losses or expenses are not
allowed for tax purposes.
REVENUE REGULATION NO. 14-2001:
NOLCO AS DEDUCTION FROM GROSS
INCOME
General Policies and Principles
1. Deduction for NOLCO shall be limited
only to net operating loss accumulated
beginning January 1, 1998.
2. NOLCO shall be allowed as a
deduction from the gross income of
the same taxpayer who sustained or
accumulated the net operating losses
regardless of the change in its
ownership. This rule shall also apply in
case of a merger where the taxpayer
is the surviving entity.
Illustration: A Corp. has NOLCO. It
is a wholly owned subsidiary of X
Corp. Subsequently, A Corp. was
purchased by Y Corp.
A Corp.s
NOLCO will still be allowed as
deduction despite the change in its
ownership since the NOLCO is
claimed by the same taxpayer, A
Corp.
3. Unless otherwise provided by the
regulations, NOLCO of the taxpayer
shall not be transferred or assigned to
another person, whether directly or
indirectly, such as but not limited to,
the transfer or assignment through
merger, consolidation or any other

form of business combination of such


taxpayer with another person.
4. NOLCO shall also be allowed if there
has been no substantial change (in
case of business combinations) in
the ownership of the business or
enterprise. (75% Equity Rule)
a. Not less than 75% in the nominal
value of the outstanding issued
shares, if the business is in the
name of the corporation, is held by
or in behalf of the same person;
b. Not less than 75% of the paid up
capital of the corporation, if the
business is in the name of the
corporation, is held by or on behalf
of the same person.
Note: Remember, the 75% equity
rule shall only apply to a transfer
or assignment of the taxpayers
net operating losses as a result of
or arising from the said taxpayers
merger
or
consolidation
or
business combination with another
person.
By or on behalf of the same
persons refer to the maintenance of
ownership despite changes as when:
a. No actual change in ownership is
involved in case the transfer
involved change from direct
ownership to indirect ownership,
or vice-versa;
b. No actual change in ownership is
involved as in the case of merger
of the subsidiary into the parent
company.
5. An individual (including estates and
trusts) engaged in trade or business or
in the exercise of profession or a
domestic
or
resident
foreign
corporation are allowed to claim
NOLCO as deduction.
6. The 3 year reglementary period for
claiming NOLCO will continue to run
despite the fact that the corporation
paid income tax under the MCIT.
7. NOLCO is on a first in, first out basis
(FIFO).
8. The net operating loss
taxpayer in the year
substantial change in
such taxpayer occurs

incurred by a
in which a
ownership in
shall not be

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TAXATION LAW | Income Taxation


affected by such change in ownership,
notwithstanding number 3 and 4.
Taxpayers Entitled to Deduct NOLCO
from Gross Income:
1. Individuals engaged in trade or
business or in the exercise of his
profession;
2. DC and RFC subject to the normal
income tax
3. Special corporations subject to
preferential tax rates (e.g. private
educational institutions, hospitals, and
regional operating headquarters)
4. Estates and trusts
Taxpayers NOT entitled to NOLCO:
1. Offshore banking units (OBU) of a
foreign banking corporation, and
Foreign
Currency
Deposit
Unit
(FCDU) of domestic or foreign banking
corporation duly authorized by the
BSP;
2. An enterprise registered with the
Board of Investment with respect to its
BOI registered activity enjoying
Income Tax Holiday Incentive.
3. An enterprise registered with the
Philippine Economic Zone Authority
(PEZA) with respect to its PEZAregistered activity.
4. Enterprises registered with the Bases
Conservation and Development Act,
e.g. SBMA-registered enterprises with
respect to its registered business
activity.
5. Foreign Corporations engaged in
international shipping or air carriage
business in the Philippines; and
6. Any person, natural, juridical, enjoying
exemption from income tax.
Note: An individual who claims the
optional standard deduction shall not
simultaneously claim deduction of the
NOLCO, provided that the 3-year
reglementary period shall continue to run
notwithstanding the fact that the aforesaid
individual availed of the optional standard
deduction during the said period (Sec. 2.5,
R.R. 14-2001)
Quarterly and Annual Availment of
NOLCO
1. NOLCO shall be allowed as deduction
in computing the taxpayers income
taxes per quarter and annual final
adjustment income tax return;
2. If the taxpayers final annual
adjustment, the entire operations for

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the year resulted to a net operating


loss, such net operating loss may be
claimed as NOLCO deduction in the
immediately succeeding taxable year;
3. NOLCO can be claimed as deductions
only within a period of 3 consecutive
taxable years immediately following
the year the net operating loss was
sustained or incurred.
Rule for Mines OTHER than Oil and Gas
Wells
Net operating loss incurred in any of the
first 10 years of operation may be carried
over for the next 5 years immediately
following the year of such loss.
Presentation of NOLCO in Tax Return
The NOLCO shall be shown separately in
the return while the Unused NOLCO shall
be presented in the Notes to the Financial
Statements in detail as to year of
operating loss and any amount claimed
thereof.
NOLCO in relation to MCIT
The rule of whether the corporation shall
pay either MCIT or NCIT shall be based
on the amount of 2% MCIT of its gross
income or the normal corporate income
tax due (30% of Net Income), computed
with the benefit of NOLCO, if any,
whichever is higher.
Note: The 3-year reglementary period
shall continue to run though the
corporation is liable to pay MCIT.
E. BAD DEBTS
Debts resulting from the worthlessness or
uncollectibility, in whole or in part, of
amounts due the taxpayer by others,
arising from money lent or from
uncollectible amounts of income from
goods sold or services rendered.
Requisites for Deductibility
1. Existing,
valid,
and
legally
demandable indebtedness due to the
taxpayer;
2. Connected with the taxpayer's trade,
business or practice of profession;
3. Must not be sustained in a transaction
entered into between related parties;
4. Actually charged off in the books of
accounts of the taxpayer as of the end
of the taxable year of worthlessness;
The amount of money lent must be
previously recorded in the books of

Income Taxation | TAXATION LAW


the taxpayer as receivable and later
cancelled and written-off. (Sec. 2, R.R.
5-99 as amended by RR 25-02).
5. Actually ascertained to be worthless
and uncollectible as of the end of the
taxable year; and;
A debt is not worthless simply
because it is of doubtful value or
difficult to collect. An account is
worthless
when
after
taking
reasonable steps to collect the debt,
there is no likelihood of recovery at
anytime in the future.
A mere recording in the books of
account of estimated uncollectible
accounts does not constitute a writeoff of the said receivable. In no case
may any bad debt reduction be
allowed unless the facts pertaining to
the money or property lent and its
cancellation or write off from the
taxpayers accounting records, after
having been determined that the same
has ACTUALLY become worthless,
have been complied with by the
th
taxpayer (6 par., Sec.2, R.R. No. 599)
Factors affecting worthlessness:
1. Bankruptcy or insolvency of the
debtor;
2. Insufficiency of the collateral;
3. Statute of limitation;
4. Death of the debtor leaving no
assets;
5. Injury of the debtor making it
impossible for him to earn a living;
6. Meager amounts involved and
further action on the accounts
would entail expenses exceeding
the amounts sought to be
collected;
7. Improbability of success of judicial
collection;
8. Destruction by fire of original
invoices evidencing indebtedness
(Goodwill International Rubber Co.
v. Collector, CTA Case No. 468,
June 8, 1963)
Good faith on the part of the taxpayer
is not enough. He must show that he
had reasonably investigated the
relevant facts and had drawn a
reasonable
inference
from
the
information thus obtained by him.
(Collector v. Goodrich International

Rubber, G.R. No. L-22265, December


22, 1967).
Steps to be undertaken by the
taxpayer to prove undertaking of
diligent efforts to collect the debt:
1. Sending of statement of accounts
2. Sending of Collection letters
3. Giving the account to a lawyer for
collection
4. Filing a collection case in court
(Philippine Refining Corp. v. CA,
G.R. No. 118794. May 8, 1996)
A
debt
is
worthless
and
uncollectible in the following cases:
a. Considering the small amounts
involved, unsuccessful efforts at
collection suffice to warrant writeoff
b. The debtor is in strained financial
condition with no attachable or
leviable properties.
6. Must have been reported as receivables in
the income tax return of the current or
prior years.
Rule: The determination by the CIR as to
the worthlessness of bad debt is
adequate.
Exceptions:
a. For insurance or surety company,
no bad debts deduction UNLESS such
company has been declared closed
due to insolvency or for any such
similar reason by the Insurance
Commissioner
b. For banks, the taxpayer shall submit
to the BSP/Monetary Board the written
approval of the writing off of the
indebtedness from banks books of
accounts at the end of the taxable
year. (R.R. No. 25-2002)
TAX BENEFIT RULE:
The recovery of bad debts previously
allowed as deduction in the preceding
year(s) shall be included as part of the
taxpayers gross income in the year of
such recovery to the extent of the
income tax benefit of said deduction.
The total bad debts recovered will not
necessarily form part of the taxpayers
income but only to the extent that he was
benefited.
Equitable Doctrine of Tax Benefit a
recovery of bad debt previously deducted

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from gross income constitutes taxable
income IF in the year the account was
written off, the deduction resulted in a tax
benefit, that is, the reduction of taxable
income of the taxpayer.
Basis: Under the Sec. 34(E)(1),NIRC, the
recovery of bad debts previously allowed
as deduction in the preceding years shall
be included as part of the gross income in
the year of recovery to the extent of the
income tax benefit of said deduction.
In a case where securities are ascertained
to be worthless and charged off within the
taxable year, and are capital assets, the
loss to the taxpayer (other than a bank or
trust company incorporated under the laws
of the Philippines a substantial part of
whose business is the receipt of deposits)
will NOT be treated as bad debts, but as
capital loss on the last day of the taxable
year. The date that the securities were
written off is immaterial. (Sec. 34(E)(2),
NIRC),
Bad Debts sustained in a transaction
between related parties are NOT
deductible under Sec. 34(E)(1) in relation
to Sec. 36(B), NIRC.
Where under the foreclosure of a
mortgage, the mortgagee buys the
mortgaged property and credits the
indebtedness with the purchase price, the
difference between the purchase price
and the indebtedness is not allowable
as a deduction for a bad debt because
in such case the property which was
security for the debt stands in place of the
debt. The determination of loss in such
case is deferred until the disposal of the
property. (Sec. 103, R.R. No. 2)
In case the debt is PARTIALLY SECURED
by a mortgage, that portion not covered by
the collateral may be considered as a bad
debt (Phil. Trust Co. v. Collector of Internal
Revenue, CTA Cases Nos. 411 & 610,
April 20, 1966)
F. DEPRECIATION
Gradual diminution in the service or useful
value of tangible property, used in trade,
profession or business, resulting from
exhaustion, wear and tear, and normal
obsolescence.
The term is also applied to the
amortization of the value of the intangible

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assets the use of which in trade or


business is of limited duration. (Basilan
Estates, Inc. v. CIR, G.R. No. L-22492,
September 5, 1967)
Amortization and depreciation both refer to
the devaluation of assets over time. As an
asset loses its value, the loss of the value
is charged as an expense, which is
allowed as a deduction from the gross
income.
Amortization is used to recover the cost
of intangible assets such as goodwill,
patents, franchise etc.
Rationale: Property gradually approaches
a point where its usefulness is exhausted.
By using the property, a gradual sale is
made of it; and the depreciation charged is
the measure of the cost which has been
sold. (see U.S. v. Ludey, 274 T.J.S. 295)
Requisites for Deductibility:
1. The allowance for depreciation must
be reasonable.
2. It must be for property arising out of its
use in the trade or business, or out of
its not being used temporarily during
the year.
If the property is being used partly for
personal and partly for business,
depreciation expense must be prorated and only the portion attributable
to business use is deductible.
Depreciation is allowed on depreciable
property that is not being used
temporarily during the year (Conwell
Bros. Co. v. Collector, CTA Case No.
411).
3. The allowance must be charged off
within the taxable year.
4. Statement on the allowance must be
attached to the return.
Commencement of Depreciation
Depreciation
commences
with
the
acquisition of the property and its owner is
not bound to see his property gradually
waste, without making provision out of
earnings for its replacement. It is entitled
to see that from earnings the value of the
property invested is kept unimpaired, so
that at the end of any given term of years,

Income Taxation | TAXATION LAW


the original investment remains as it was
in the beginning. Accordingly, the law
permits the taxpayer to recover gradually
his capital investment in wasting assets
free from income tax. (Basilan Estates,
Inc. v. CIR, supra)
Determination of the Useful Life on
Which Depreciation Rate Is Based
General Rule: BIR and the taxpayer may
agree in writing on the useful life of the
property to be depreciated subject to
modification IF justified by facts or
circumstances. Any change shall not be
effective prior to the taxable year on which
notice in writing by certified mail or
registered mail is served by the party
initiating.
Exception: If there is no agreement and
the BIR does not object to the rate and
useful life being used by the taxpayer, the
same shall be binding.
Who Can Claim Depreciation Expense?
Rule: The person who sustains an
economic loss from the decrease in
property value due to depreciation which is
usually the owner.
For NRA and FC, depreciation shall be
permitted only when such property is
located within the Philippines.
Special Rules:
1. In case the property is held by life
tenant (beneficial owner) one person
for life with remainder to another
person (naked title) deduction shall
be computed as if the tenant was the
absolute owner of the property and, as
such, the expense shall accrue to him.
2. For property held in trust deduction
shall be apportioned between the
income beneficiaries and the trustees
in accordance with the pertinent
provisions of the instrument created or
in the absence of such provisions, on
the basis of the trust income allowable
to each.
Properties Subject to Depreciation
1. Property that is used for trade,
business or exercise of a profession or
held for the production of income.
2. All kinds of tangible property (other
than land) with life of more than one

year and do not form part of the stock


in trade that are part of the inventory.
3. All kinds of intangible property (other
than shares of stock) with life of more
than one year, such as patents,
copyrights and franchises.
4. Properties subject to exhaustion within
a determinable period of time, that is it
has a limited useful life. (Italian Thai
Development Public Company Ltd. v.
CIR, CTA Case No. 6172, November
12, 2002.)
Properties NOT subject to Depreciation
1. Land apart from the improvements of
physical development added to it
cannot be depreciated. (Limpan
Investment Corp. v. CIR, L-21570,
July 26, 1966; Sec. 106, RR No.2)
2. Inventories or stock in trade. (Ibid)
3. Personal effects or clothing, except
costumes used in theatrical business.
(Ibid)
4. Bodies of minerals which through the
process of removal were already
subject to depletion allowance.
5. Automobiles and other transportation
equipment used solely by the taxpayer
for pleasure.
6. Buildings used solely by the taxpayer
as his residence.
7. Furniture or furnishings used in the
building used solely by the taxpayer
as his residence. (Sec. 106, R.R.
No.2)
8. Intangibles, the use in trade, business
or exercise of a profession is not of
limited duration. (Sec. 107, ibid)
9. Incidental repairs which neither
materially add to the value of the
property nor appreciably prolong the
life, but keep it in an ordinary efficient
operating condition.
METHODS
OF
DEPRECIATION

COMPUTING

1. Straight-line
Method
the
depreciation
expense
which
is
deductible for each year of the
propertys useful life is constant in
amount and computed by dividing the
cost less salvage value over the
estimated useful life of the property.
Formula:
(Cost of property
Salvage Value
at the end of useful life)

Deductible
Depreciation

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TAXATION LAW | Income Taxation


---------------------------------- =
Estimated Useful life

expense
for the taxable
year

2. Declining Balance Method (Double


Declining Balance or Diminishing
Balance Method) Depreciation
expense declines as the years go by
during the useful life of the property.
Depreciation is largest in the first year
and decreases towards the end of the
useful
life
of
the
property.
Computation is based on the book
value of the property at the multiplied
with a constant rate and salvage value
is ignored in the computation.
Steps:
a. Determine the rate of depreciation
under the straight line method

Illustration:
Asset has a value of P1 million with
salvage value of P100,000 and an
estimated useful life of 5 years.
Computation:
st

For the 1 year


(P1M - P100,000)

5
------------------------(1+2+3+4+5) or 15

= P300,000
st
depreciation expense for the 1 year
For the 2

nd

year

(P1M - P100,000)

4
----------15

= P240,000
Formula:
100%
---------------------------------- =
Estimated Useful life

Straight line
rate in %

b. Multiply the straight line rate by 200%


(or double the straight line rate) to get
the declining balance rate.
c. The declining balance rate (Straight
line rate x 200%), which remains the
same throughout, is multiplied by the
book value of the property, which
varies from year to year, to get the
deductible
depreciation
expense.
Book value is computed by deducting
all accumulated depreciation from the
original cost.

Formula:
(Cost accumulated depreciation) x
declining balance rate
= depreciation expense for the year
3. Sum-of-the-Years-Digit Method an
accelerated method of depreciation
that provides higher depreciation
expense in the earlier years and lower
charges in the later years

4. Unit of production and hours of use


method - Usually applied for
machines or equipment, the method is
based on the expected use or output.
The useful life is based on the rate per
unit of product or hour of use.
Formula: Units of production method
(cost salvage value)
no. of
----------------------------------------- x output for
Estimated total no. of units
the year
Produced or hours of use
= depreciation expense
Illustration:
A machine with a cost of P1million and
salvage value of P100,000 is estimated to
produce a total output of 450,000 units.
For year 1, it produced 150,000 units.
Computation:
(P1M P100,000)
-------------------------------- x 150,000 units
450,000 units
= P2 x 150,000
st
= P300,000 depreciation expense for 1
year

Formula:
(cost
Salvage x
value)

years digit,
largest first
depreciation
----------------- = expense
sum of the
for the year
years digits

5. Any other method which may be


prescribed by the Department of
Finance upon recommendation of the
Commissioner of Internal Revenue.
Useful Life

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Income Taxation | TAXATION LAW


a. The period of time over which an asset
is expected to be available for use by
an entity; or
b. The number of production or similar
units expected to be obtained from the
asset by an entity. (units of production)
Note: Depreciation method used shall be
regularly reviewed to present a true picture
of its assets and the results of its
operations. If there has been a significant
change in the expected pattern of
consumption, the method shall be
changed to reflect the changed pattern.
Any change of method shall be applied
prospectively.
Special Types of Depreciation:
Petroleum Operation
For property directly related to
production shall use Straight Line
(SL) Method OR Declining Balance
(DB) method over 10 years OR
shorter
as
allowed
by
the
Commissioner
May shift from DB to SL method
For property not directly related to
production: 5 years under Straight
Line method
Mining Operations
Depreciation on all properties in
mining
operations
other
than
petroleum operations at the normal
rate IF expected life is less than 10
years
IF expected life is more than 10 years,
depreciation shall be any number of
years between 5 years and the
expected life.
G. DEPLETION OF OIL AND GAS WELLS
AND MINES
It is the removal, extraction, or exhaustion
of natural resources (wasting assets) as in
mines, oil, and gas wells as a result of
production or severance from such mines
or wells.
Theory and Purpose of Depletion
Allowance - As in the case of
depreciation, it is that, as the product of
the mine is sold, a gradual sale is being
made of the taxpayers capital interest in
the property. Depletion allowance enables
the taxpayer to recover that capital interest
free of income tax, at its cost on some
other basis.
Depletion

Depreciation

Assets subject to
depletion could NOT
be replaced.
Natural resources

Assets subject to
depreciation MAY be
replaced.
Depreciable assets

Depletion Method (similar to units-ofproduction-method of depreciation) - the


total of the accumulated exploration and
development expenses is divided by the
number of recoverable units to arrive at a
per unit depletion cost.
Features:
1. Intangible
exploration
and
development drilling cost in petroleum
exploration shall be treated either as:
a. revenue expenditures; or
b. capital expenditures
2. The total amount deductible for
exploration
and
development
expenditures shall not exceed 25% of
net income from mining operation. The
excess shall be carried forward to the
succeeding year until fully deducted.
Who
are
entitled
to
depletion
allowance?
Only those persons having ECONOMIC
INTEREST in the property subject to
depletion allowance. To acquire an
economic interest, the taxpayer must have
a capital investment in the property and
not a mere economic advantage. (Gen.
Cir. No. V-332, Jan. 6, 1961)
Note: Annual depletion deductions are
allowed only to mining entities which own
an economic interest in mineral deposits.
Mere economic or pecuniary advantage to
be derived by production by one who has
no capital investment in the mineral
deposit does NOT amount to economic
interest.
Intangible
costs
in
petroleum
operations any cost incurred in
petroleum operations which in itself has no
salvage value and which is incidental to
and necessary for the drilling of wells and
preparation of wells for the production of
petroleum.
H. CHARITABLE
AND
OTHER
CONTRIBUTIONS
Rationale
of
exemption:
The
fundamental ground upon which all
exemptions in favor of charitable
institutions are based is the benefit
conferred upon the public by them, and a

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consequent relief, to some extent, of the
burden upon the state to care for and
advance the interests of its citizens. (Lung
Center of the Phil. v. Quezon City, G.R.
No. 144104, June 29, 2004)
Valuation the amount of any charitable
contribution of property other than money
shall be based on the acquisition cost of
the property.
Common Rules for Deductibility
1. The contribution or gift must be
actually paid;
2. It must be made within the taxable
year.
Note: Irrespective of the accounting
method used by the donor, donation is
recognized as a deduction only when
it was actually paid or made, not in the
year the deed of donation was
perfected.
The
deductibility
of
donation is not governed by the
ordinary ruled on deductibility of the
expense. Donation must be BOTH
perfected and consummated before it
can be allowed as a deduction. (PSE
v. CIR, CTA Case No, 5995, Oct. 15,
2002)
3. It must be evidenced by adequate
receipts or records. (substantiation
requirement)
Note: Attachment of receipts to the
return is merely administrative device
for the convenience and facility of the
BIR in verifying the income tax return
and the requirement cannot deprive
the taxpayer of his right to prove his
contribution in accordance with the
rules of evidence. (Ramirez v. Com.,
CTA Case No. 544, September 14,
1959)
Kinds:
A. ORDINARY/Partial deductibility
Those which are subject to limitation
as to the amount deductible from
gross income.
Additional
Requisites
for
Deductibility
1. Recipient must be:
a. The government of the
Philippines; or
b. Any of its agencies or political
subdivision exclusively for
public purposes; or

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c.

Accredited
domestic
corporations or associations
organized
exclusively
for
2
(SEC-SY- CR ):
Religious
Charitable
Scientific
Youth
&
sports
development
Cultural
Educational
Rehabilitation of Veterans
Social welfare

d. Nongovernment organizations
These are NGOs other than
those defined under Sec.
34(c),NIRC).
Limitation to Deductibility:
a. Corporate taxpayer except NRFC
5% of the net income before
charitable contribution
b. Individual Taxpayer except NRANETB 10% of the net income
before charitable contribution.
B. SPECIAL/Full Deductibility
Donations which are deductible in full
from the gross income.
Additional
Requisites
for
Deductibility
1. Recipient must be:
a. The government of the
Philippines; or
b. Any of its agencies or political
subdivision including fullyowned
government
corporations exclusively to
finance, to provide for, or to be
used in undertaking priority
2
activities in: (SEC-H EY):
Education
Health
Youth
&
Sports
Development
Human Settlements
Science
Culture
Economic Development
Rule: The above activities must
conform with the development
plan according to NEDA in
consultation with the appropriate
government agencies.

Income Taxation | TAXATION LAW


Effect
of
noncompliance:
Allowed deduction will be subject
to the 10% or 5% limitation.
c.

Foreign
institutions
or
international
organizations
pursuant
to
agreements,
treaties or commitments by
the Philippine government and
such
institutions
or
in
pursuance of special laws; or

d. Accredited NGO, organized and


operated for (SEC-CHR-SC):
NGO here means non-profit
domestic corporation:
No part of its net income
inures to the benefit of any
private
stockholder
or
individual;
Organized
and
operated
exclusively following purposes
3
3
(SEC - HR )
Scientific Research
Educational
Character building and
youth
&
sports
development
Cultural
Charitable
Social welfare
Health
Research
(Sec. 34(c),NIRC).

Makes utilization directly not


later than the 15th day of the
third month (unless extended)
after the close the taxable
year in which contributions are
received;
Utilization cash or kind paid
or used OR amount paid to
acquire an asset used directly
to accomplish the purpose/s
for which the NGO was
created or organized

Annual
Administrative
expense does not exceed
(30%) of its total expenses;
and

Its assets in the event of


dissolution,
would
be
distributed to another NGO
organized for similar purpose
or purposes, OR to the state

for public purpose, OR would


be distributed by a court to
another organization to be
used in such manner as in the
judgment of said court shall
best accomplish the general
purpose
for
which
the
dissolved organization was
organized.
Note: Whether deductible in full or
subject to limitation, the recipient
NGO must be ACCREDITED by
the Philippine Council for NGO
Accreditation (E.O. No.720, April
11, 2008).
C. Contributions deductible in full
under SPECIAL LAWS- Donations to
(the)
1. Integrated Bar of the Philippines
(P.D. 81)
2. Development Academy of the
Philippines (P.D. 205)
3. Aquaculture Department of the
Southeast Asian Fisheries and
Development Center (SEAFDEC)
(P.D. 292)
4. National Social Action Council
(P.D. 294)
5. National Museum, Library and
Archives (P.D. 373)
6. University of the Philippines and
other
state
colleges
and
universities
7. Philippine Rural Reconstruction
Movement
8. Cultural Center of the Philippines
9. Trustees of the Press Foundation
of Asia
10. Humanitarian Science Foundation
11. Artesian Well Fund (R.A.1977)
12. International
Rice
Research
Institute
13. National Science Development
Board (now the DOST) and its
agencies and to public or
recognized non-profit, non-stock
educational
institutions
(R.A.
3589)
14. Donations of prizes and awards to
athletes (R.A 7549)
Requisites for Deductibility:
a. Granted to athletes in local
and international tournaments
and competitions held in the
Philippines or abroad; and
b. Said
tournaments
and
competitions
must
be
sanctioned by their respective

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national sports associations.
(vis--vis taxpayer as recipient
of the donated prizes and
awards)
I.

RESEARCH
AND
DEVELOPMENT
(R&D)
All costs incident to the development of
an experimental or pilot model, a plant
process, a product, a formula or invention,
or similar property, and the improvement
of already existing property of the type
mentioned (U.S. IRS Reg., Sec.1.1742(a)(1))
Research - is original and planned
investigation undertaken by the taxpayer
with the prospect of gaining new scientific
or technical knowledge and understanding
Development- is the application of
research findings or other knowledge to a
plan or design for the production of new or
substantially improved materials, devices,
products, processes, systems or services
before the start of commercial production
or use.
May be expenditures for:
1. Acquisition or improvements of
property subject to depreciation or
depletion used in research and
development;
2. Other research and development
costs.
Treatment of R&D Expense
Rule: R&D expenditures incurred in a
taxable year may be treated as ordinary
and necessary expenses and deducted
during the taxable year
Option: The following R&D expenditures
may be treated as deferred expenses:
1. Paid or incurred by the taxpayer in
connection with his trade, business or
profession;
2. Not treated as (ordinary and
necessary) expenses; AND
3. Chargeable to capital account but not
chargeable to property of a character
which is subject to depreciation or
depletion.
Note: In computing taxable income, such
deferred expenses shall be allowed as
deduction ratably distributed over a period
of not less than 60 months (beginning with
the month in which the taxpayer first
realizes benefits from such expenditures).

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Deferred expense (or prepaid expense)


refers to an item that will initially be
recorded as an asset (hence charged to
the capital account) but is expected to
become an expense over time and/or
through the normal operations of the
business. Here, payment has already
been made, but it is not yet reported as an
expense until a future accounting period
(e.g. 60 month period).
Note: The option to amortize and the
period of amortization shall be irrevocable
and changing to a different method may
be allowed only with the authorization of
the CIR.
Deductibility
of
research
and
development expenditures shall NOT
apply to:
1. Expenditure for the acquisition or
improvement of land or for the
improvement of property to be used in
connection
with
research
and
development subject to depreciation
and depletion
2. Expenditure paid or incurred for the
purpose of ascertaining the existence,
location, extent or quality of any
deposit of ore or other mineral
including oil or gas.
J. PENSION TRUST CONTRIBUTION
Nature applicable only to the employer
on account of its contribution to a private
pension plan for the benefit of its
employees.
It is purely business in
character.

Requisites for Deductibility


1. Employer must have established a
pension or retirement plan for the
payment of reasonable pension to its
employees;
2. Pension plan is reasonable and
actuarially sound;
3. Funded by the employer (employer
contributes cash)
4. Amount contributed must no longer be
subject to the control of the employer;
5. Payment has not yet been allowed as
deduction.
Note: There is no need of a special permit
from the BIR to put up a pension plan for
the benefit of employees. However, the

Income Taxation | TAXATION LAW


provision of Sec. 118 of R.R. No.2 must be
complied with.
Deductible Payments to Pension Trust
1. Employers current liability (amount of
contribution during the taxable year or
present service cost) deductible as
ordinary and necessary expense;
2. Employers liability for past services
(past service cost requires lump sum
to the pension fund) one-tenth of the
reasonable amount paid by the
employer to cover pension liability
applicable to prior 10 years shall be
deductible as payment to pension
trust.
Income from Pension Trust:
a. Not taxable to the employee.
b. If any portion reverts back to the
employer, it becomes part of the
income of the employer during the
taxable year of reversion.
Note: It is evident that tax-exemption is
likewise to be enjoyed by the income of
the pension trust. Otherwise, taxation of
those earnings would result in a diminution
of accumulated income and reduce
whatever the trust beneficiaries would
receive out of the trust fund. This would
run afoul to the very intendment of the law.
(Miguel J. Ossorio Pension Foundation,
Inc. v. CIR, G.R. No. 162175, June 28,
2010)

SEC. 35 ALLOWANCE
OF PERSONAL EXEMPTION FOR
INDIVIDUAL TAXPAYER
Deductions Available To Individuals
1. Business Expenses and Expenses from
Practice of Profession deductible only
from gross business income and
professional income, respectively but NOT
from compensation income. The expenses
to be deducted may either be itemized
deductions OR the optional standard
deduction.
2. Special Deduction for Actual Premium
Payments
for
Health
and/or
Hospitalization Insurance taken by an
individual taxpayer provided that the

following requisites are met: (Sec. 34(M),


NIRC)
a. Insurance must have actually have
taken.
b. The taxpayers family gross income
does not exceed P250,000 in a
taxable year.
c. The amount deductible should only be
limited to P2,400 per family or P200
per month.
d. In case of a married taxpayer, this can
only be claimed by the spouse
claiming the additional exemption.
3. Personal Exemptions fixed and
arbitrary amounts intended to substitute
for personal and living expenses. They are
roughly the equivalent of the taxpayers
minimum subsistence and those of his
dependents (Madrigal vs. Rafferty, supra).
They include the additional exemptions
for dependents.
Taxpayers who are allowed personal and
additional exemptions
1. Citizens of the Philippines;
2. RA;
3. NRA-ETB (only the basic personal
exemption) under the following conditions:
a. Exemption allowed is equal to that
allowed in the income tax law in the
country of which NRA-ETB is a
subject or citizen, to citizens of the
Philippines not residing in such
country.
b. Not exceed the P50,000 limit
applicable to citizens and RA
c. NRA-ETB filed a return of the total
income received by him from all
sources in the Philippines.
4. Estates and trusts, which are treated for
purposes of personal exemptions as
individuals. (see discussion on Estate and
Trusts on p. 54)
Kinds of Personal Exemptions
1. Basic Personal Exemptions (Sec. 35(A),
NIRC)
There shall be allowed a BASIC
PERSONAL EXEMPTION of P50,000 for
each individual taxpayer, regardless of
status (i.e. married or single, with or
without depended) (R.A. No. 9504, July 6,
2008)
Note: Married individuals (husband and
wife) who are BOTH earning are allowed a
basic exemption of P50,000 each on their
respective incomes or a total of P100,000;

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otherwise, only the earning spouse is
entitled to the exemption. The law treats
husband and wife as separate taxable
units.
2. Additional Exemptions (Sec. 32(b),
NIRC)
There shall be allowed an additional
exemption of P25,000 for each dependent
child not exceeding four (4) children.
Who is a Dependent Child?
A legitimate, illegitimate, or legally
adopted child chiefly dependent upon
AND living with the taxpayer:
A dependent is not more than 21 yrs.
old, unmarried AND not gainfully
employed; or
Regardless of age, is incapable of
self-support because of mental or
physical defect.
Who
will
claim
the
additional
exemption?
Rule: The husband shall be the proper
claimant
Exception: When the husband is
1. Unemployed;
2. Working abroad; or
3. Explicitly waived his right in the
withholding exemption certificate for
ALL dependents.
In case of legally separated spouses, it
shall be claimed ONLY BY THE SPOUSE
HAVING CUSTODY.

Summary of Allowance of Personal


Exemptions
Individual
Taxpayer
RC
NRC
RA
NRA-ETB
NRA-NETB

Basic
Personal
Exemptions
Allowed
Allowed
Allowed
Allowed
(reciprocity)
Not allowed

Additional
Exemptions
Allowed
Allowed
Allowed
Not allowed
Not allowed

Status-at-the-end-of-the-year Rule
Rule: Whatever is the status of the taxpayer at
the end of the calendar year shall be used for
purposes of determining his personal and
additional exemptions.
1. If the taxpayer should die during the
taxable year, his estate may claim the
corresponding exemptions as if he died at
the close of such year.

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2. If the spouse or any dependent should


die or any dependent should marry or
become twenty-one years old during the
year, or should become gainfully
employed, the taxpayer may claim the
exemptions as if the spouse or dependent
died or as if such dependent married,
became twenty one years old or became
gainfully employed at the close of such
year.
3. For any other event and for which there
are no specific rules applicable
Exception: If the taxpayer should have
additional dependents during the taxable
year, he may claim the corresponding
exemptions in FULL for such year.
A Senior Citizen is:
1. Any RC of the Philippines
2. At least 60 years old, including those who
have retired from both government offices
and private enterprises, and
SENIOR CITIZENS DISCOUNT (RR No. 72010, Implementing R.A. 9994)
1. Only portion of gross sales exclusively
used, consumed or enjoyed by the senior
citizen shall be eligible for the deductible
sales discounts.
2. Gross selling price and sales discount
must be separately indicated in the official
receipt or sales invoice issued by the
establishment for the sale of goods or
services to the senior citizen
3. Only the (1) actual amount of the discount
granted or a (2) sales discount not
discount not less that 20%, whichever is
higher, based on the gross selling price
can be deducted from the gross income,
net of value added tax, if applicable, for
income tax purposes, and from gross
sales or gross receipts of the business
enterprise concerned, for VAT or other
percentage tax purposes.
4. The seller must record its sales inclusive
of the discount granted.
5. The discount can only be allowed as a
deduction from gross income for the same
year that the discount was granted.
6. The business establishment giving the
sales discounts to qualified senior citizen
is required to keep separate and accurate
record of sales, which shall include the
name of the senior citizen, OSCA ID,
gross sales/receipts, sales discounts
granted, dates of transactions and invoice
number for every sale transaction to senior
citizen.

Income Taxation | TAXATION LAW


7. Only selected establishments mentioned
in R.R. No. 7-2010 may claim the said
discount granted as deduction from gross
income.
8. The seller must not claim the OSD during
the said taxable year.
Deductions from Gross Income of Private
Establishments for Compensation Paid to
Senior Citizens
Requisites:
1. Employment shall have to continue for a
period of at least 6 months
2. Annual taxable income of the senior
citizen does not exceed the poverty level
as may be determined by the NEDA thru
the NSCB. The senior citizen must submit
a sworn certification that his annual
taxable income does not exceed the
poverty level.
3. Expenses otherwise deductible may be
allowed as a deduction only if the tax
required to be deducted and withheld
therefrom has been paid to the BIR.
DOCTRINES
1. The term cost in Section 4(A) of R.A.
7432 refers to the amount of the 20%
sales discount extended by private
establishments (not 20% of the acquisition
cost of the medicines) to senior citizens in
their purchase of medicines. (Bicolandia
Drug Corporation (Formerly Elmas Drug)
Corp. v. CIR, G.R. No. 142299, June 22,
2006)
2. There is a difference between the
treatment of the 20% discount considered
as tax credit under the Old Senior Citizens
Act and Tax Deduction under the
Expanded Senior Citizens Act. (Carlos
Superdrug Corp v. DSWD, DOF, and DOJ
G.R. No. 166494 June 29, 2007)
Contrary to the provision in R.A. 7432
where the senior citizens discount granted
by all covered establishments can be
claimed as tax credit, R.A. 9257 now
specifically provides that this discount
should be treated as tax deduction. With
the effectivity of R.A. 9257 on March 21,
2004, there is now a new tax treatment for
senior citizens discount granted by all
covered establishments. This discount
should be considered as a deductible
expense from gross income and no longer
as tax credit. (CIR v. Central Luzon Drug
Corporation, G.R. No. 159610, June 12,
2008)

Note: Congress enacted a new law, R.A.


9994, further amending R.A. 7432. (For more,
see the discussions at the end)

SEC. 36 ITEMS NON-DEDUCTIBLE


1. Personal, living or family expenses
these are personal expenses and not
related to conduct of trade or business;
2. Amount paid out for new buildings

or for permanent improvements, or


betterment made to increase the
value of any property or estate these are capital expenditures added to
the cost of the property and the periodic
depreciation is the amount that is
considered as deductible expense;
Capital Expenditure A cash outlay, or
exchange of property, that does not
decrease a taxpayers assets but merely
changes its form. It results in obtaining
benefits of a permanent nature such as
lands, building, and machineries.
Examples
1. Cost of defending or perfecting title to
property as it constitutes a part of its
cost;
2. Architects fees as they constitute a
part of the cost of the building
constructed;
3. Commission paid in selling securities
as they form part of the cost of the
securities purchased (R.R. No. 2);
4. Efforts to establish reputation are akin
to acquisition of capital assets and
expenses related thereto;
5. Public relations fees for promoting
subscriptions to the capital stock and
enhancing
the
image
of
the
corporation.
Rule: Capital expenditures are not
deductible because they do not help earn
income when it is incurred.
However, the proportion of capital
expenditures which would help earn
income for future periods are allowed as
deductions for depreciation or as
amortization. (Domondon, Taxation Vol.2,
2009)

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Exceptions:
a. Intangible drilling and development
costs (Sec. 36(A)(2) in relation to Sec.
34(G)(1), NIRC
b. Expenditures considered as capital
outlays of depreciable assets incurred
during the taxable year for the
expansion of school facilities or to
deduct allowance for depreciation
thereof. (Sec. 34(A)(2), NIRC)
Notes:
Expenditures
for
replacements,
alterations, improvements or additions
which prolong the life of the property is
capital in nature. (Alhambra Cigar v.
Collector, G.R. No. L-23226, November
28, 1967)
3. Amount expended in restoring property or
in making good the exhaustion thereof for
which an allowance has been made
same reason as number 2;
4. Premiums paid on any life insurance policy
covering the life of any officer or
employee, or of any person financially
interested in any trade or business carried
on by the taxpayer, individual or corporate,
when the taxpayer is directly or indirectly a
beneficiary under such policy, otherwise it
is deductible;
Note: 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 profits of the business.
Premiums paid by a family corporation on
the life insurance policy covering the life of
its president where the wife is the
beneficiary is NOT DEDUCTIBLE since
the corporation is the indirect beneficiary.
Premiums paid by a corporation on life
insurance policies covering the lives of 2
executives naming each other as
beneficiary is DEDUCTIBLE since the
corporation is not directly or indirectly
benefited.
5. Losses from sales or exchanges of
property between related taxpayers.

Rationale:
To prevent avoidance on income tax by
means of a simulated sale or exchange.

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Note: Provision between related parties


apply to the following deductions:
i. Losses;
ii. Interests;
iii. Bad Debts.
6. Bribes, Kickbacks and other similar
payments (Sec. 34(A)(1)(c), NIRC)

SPECIAL
PROVISIONS
REGARDING
INCOME and DEDUCTIONS of INSURANCE
COMPANIES
whether
DOMETIC
or
FOREIGN (Sec. 37, NIRC)
1. (NON-LIFE) INSURANCE COMPANIES
whether domestic or foreign doing
business in the Philippines are allowed to
deduct in addition to the itemized
deductions the following:
a. Net additions, required by law to be
made within the year to reserve funds.
b. Sums other than dividends paid within
the year on policy and annuity
contracts.
2. MUTUAL INSURANCE COMPANIES
Mutual fire and mutual employers liability
and mutual workmens compensation and
mutual casualty insurance companies
requiring members to make premium
deposits to provide for losses and
expenses are allowed to deduct from
gross income:
a. Any portion of the premium deposits
returned to the policyholders.
b. Such portion of the premium deposits
as are retained for the payment of
losses, expenses, and reinsurance
reserves.
When mutual insurance companies
receive premium deposits (intended to
cover losses and expenses) from their
policyholders, they are not required to
report these as part of their income. The
same is true for premium deposits retained
for the payment of losses, expenses, and
reinsurance reserve. However, upon
return of said premium payments to the
policy holders, MICs are permitted to
deduct from their gross income the
premiums returned. On the other hand, all
other income received by them plus
premium deposits retained for purposes
other than payment of losses and
expenses and reinsurance reserve shall
be considered taxable income.

Income Taxation | TAXATION LAW


3. MUTUAL
MARINE
INSURANCE
COMPANIES
MMICs shall include in their gross income
the gross premiums collected and
received by them less
b. Amounts repaid to policy holders on
account of premiums previously paid
by them;
a. Interest paid upon those amounts
between the ascertainment and
payment thereof.

Rule: Losses from sales or exchanges of


stock or securities are deductible.

4. ASSESSMENT
INSURANCE
COMPANIES May deduct from their
gross income the actual deposit of sums
with the officers of the Government of the
Philippines pursuant to law, as additions to
guarantee or reserve funds.

Rationale: Loss was incurred in the ordinary


course of business or trade.

LOSSES FROM WASH SALES OF STOCKS


OR SECURITIES (Sec. 38, NIRC)
Wash Sales - A sale of stock or securities
where substantially identical securities are
acquired or purchased within 61-day period,
beginning 30 days before the sale and ending
30 days after the sale.
Substantially Identical stock or securities
stock or securities of the same class or which
are similar on their important features. For
example, bonds or preferred stock of the same
corporation are ordinarily not considered
substantially identical to the common stock of
the same corporation. However, a preferred
stock is substantially identical to a common
stock if the preferred stock;
Is convertible into common stock;
Has the same voting rights as the common
stock;
Is subject to the same dividend
restrictions;
Is unrestricted as to convertibility. (U.S.
Department of Treasury, IRS, Publication
550, Jan. 17, 2012)
Elements of Wash Sales
1. The sale or other disposition of stock
resulted to a loss;
2. There was an acquisition or contract or
option for acquisition of stock or securities
within 30 days before the sale or 30 days
after the sale; and
3. The stock or securities sold were
substantially the same as those acquired
within the 61-day period.
Note: The acquisition must be by purchase or
exchange upon which the entire amount of
gain or loss was recognized by law.

Exception: Loss from wash sales is not


deductible.
Exception to the exception: If the taxpayer is
a dealer in securities, and the transaction from
which the loss resulted was made in the
ordinary course of business of such dealer, the
loss from wash sales is deductible in full.

CONSOLIDATED RULES ON
CAPITAL GAINS AND LOSSES
ORDINARY ASSETS
Are those assets that are used primarily in the
ordinary course of trade or business.
1. Stock in trade of the taxpayer or other
properties of a kind which would properly
be included in the inventory of the
taxpayer (e.g: supplies on hand,
merchandise inventory)
2. Property held by the taxpayer primarily for
sale to customers in the ordinary course of
business (e.g. subdivision lots by a real
estate developer, groceries by a retail
store)
3. Personal property used in trade or
business subject to depreciation (e.g.
delivery truck, store and office equipment)
4. Real property used in trade or business
(e.g. warehouse, factory, office building)
(Sec. 39(A)(1),NIRC)
Treatment of Ordinary Gains and Losses
1. Ordinary gains are included in the gross
income.
2. Ordinary losses are deductible from gross
income.
CAPITAL ASSETS
Include all property held by the taxpayer
whether or not connected in trade or business
but not including those enumerated above as
ordinary assets. (Sec. 39(A)(1),NIRC)
Capital Asset OR Ordinary Asset?
1. A taxpayer originally registered as
engaged in real estate business shall
continue to consider its realties for sale as
ordinary asset notwithstanding the fact
that it subsequently failed to operate its
business;

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TAXATION LAW | Income Taxation


2. Real property used by an exempt
corporation in its exempt business shall
not be considered used for business
purposes and shall be considered as
capital asset;
3. Real property not used in trade or
business shall be treated as capital asset;
4. A taxpayer changing business from real
estate to non-real estate shall not result in
the reclassification of property held by it
from ordinary asset to capital asset;
5. Abandoned and idle properties of taxpayer
engaged or previously engaged in real
estate business shall continue to be
treated as ordinary asset;
6. Involuntary transfer has no effect on the
classification of such real property in the
hands of the involuntary seller;
7. Property purchased for future use in the
business, although this purpose is later
thwarted by circumstances beyond
taxpayers control, does not lose its
character as ordinary asset.
Rule: Once an ordinary asset, always an
ordinary asset. (see R.R. No. 7-2003 for the
guidelines in determining whether a particular
property is capital or ordinary asset)
Exception: Properties classified as ordinary
assets for being used in business by taxpayer
engaged in business other than real estate
business are automatically converted into
capital assets upon showing that the same
have not been used in business for more than
two (2) years prior to the consummation of the
taxable transactions involving said properties.
Change of Purpose when a taxpayer
purchases a property for one purpose and
subsequently change his purpose for holding
the property, the determining factor in
classifying the asset held (i.e. whether
ordinary or capital asset) is the purpose at the
time of sale.
Importance
of
Determining
the
Classification of Assets
It is important to determine the correct
classification of an asset because the
preferential treatment for the gains or
losses from sales or exchanges of capital
assets which does not apply to the gains or
losses from sales or exchanges of ordinary
assets. (see Capital Gains and Losses Other
Capital Assets, p.130 for further discussion)

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Treatment of CAPITAL Gains and Losses


1. Capital gains derived from sale of stocks
of a domestic corporation are subject to
capital gains tax.
2. A capital gain derived from sale of real
property in the Philippines is subject to
capital gains tax but NO loss is recognized
because gain is presumed.
3. For other capital assets, the rules on
capital gains and losses apply in the
determination of the amount to be included
in gross income and NOT subject to
capital gains tax.
Note: The rules on capital gains and losses
shall apply only if the transaction on capital
asset is either a sale or exchange.
Kinds of Capital Assets
1. Shares of stocks of a DC not listed and
traded through a stock exchange
2. Real property in the Philippines not falling
under the enumeration of ordinary assets
3. Other capital assets.
Note: Not all capital gains are subject to
capital gains tax. Capital gains under number
1 and 2 above are subject to capital gains tax
while number 3 above is included in the gross
income subject to graduated rates for
individuals and normal corporate income tax
for corporations.
The following are considered as sale or
exchange of capital assets:
1. Retirement of bonds;
2. Short sales of property;
3. Failure to exercise privilege or option to
buy or sell property;
4. Securities becoming worthless;
5. Distribution in liquidation of corporations;
and
6. Readjustment of interest in a general
professional partnership.
A. Capital Gains And Losses Sale of
Shares of Stock of a Domestic
Corporation (subject to capital gains
tax)
Coverage: It involves the sale of shares of
stock of a domestic corporation which is
not listed and not traded in the stock
exchange by a non dealer in securities.
What is controlling is whether or not the
shares of stock are traded in the local
stock exchange and not where the actual
sale
happened
(Del
Rosario
v.
Commissioner, CTA Case No. 4796,
December 1, 1994).

Income Taxation | TAXATION LAW


If the stock is traded in the stock
exchange, it is NOT subject to capital
gains tax BUT to stock transaction tax of
of 1% on its gross selling price.
If the sale is made by a dealer in
securities, the resulting gain or loss is
considered as ordinary subject to
graduated rates (5-32%) for individuals
and normal corporate income tax (30%)
for corporations.
Tax Base: Net Capital Gains on a per
transaction basis (gross selling price or
consideration less cost or adjusted basis).
Basis of the Selling Price (BIR Ruling
146-98):
1. The selling price (SP) shall be the fair
market value (FMV) of the shares of
stock transferred or exchanged;
2. If traded through local stock exchange
FMV is the actual SP;
3. If not traded but listed in one or more
stock exchanges FMV is the highest
closing price when shares were sold,
transferred or exchanged OR when no
sale is made, the FMV shall be the
highest selling price on the day
nearest to the day of sale, transfer or
exchange;
4. If not listed FMV shall be the book
value nearest the valuation date
Tax Rates:
1. 5% for the first P100,000;
2. 10% for the amount in excess of
P100,000;
Persons Liable:
1. Individuals citizen or alien (RC,
NRC, RA, NRA-ETB, NRA-NETB);
2. Corporation domestic or foreign
(DC, RFC, NRFC);
3. Other taxpayers such as estate, trust,
trust funds and pension among others.
Important Features:
1. No capital loss carry-over for capital
losses sustained during the year (not
listed and traded in a local stock
exchange) shall be allowed but capital
losses may be deducted on the same
taxable year only.
2. The entire amount of capital gain and
capital loss (not listed and traded in a
local stock exchange) shall be
considered without taking into account
the holding period irrespective of the
type/kind of taxpayer.

3. Non-deductibility of losses on wash


sales and short sales.
4. Gains from sale of shares of stock in a
foreign corporation are NOT subject to
capital gains tax but to graduated
rates either as capital gain or ordinary
income depending on the nature of the
trade or business of the taxpayer.
B. Capital Gains and Losses Sale or
Other Disposition of Real Property
(subject to capital gains tax)
Coverage: It involves the sale or other
disposition of real property classified as
capital asset located in the Philippines by
a non-dealer in real estate.
If the sale is made by a dealer in securities
or if the real property is an ordinary asset,
the resulting gain or loss is considered as
ordinary subject to graduated rates (532%) for individuals and normal corporate
income tax (30%) for corporations.
Tax Base: The higher between:
1. The gross selling price; and
2. Prescribed zonal value of real
properties as determined by the CIR
the fair market value as shown in the
schedule of values of the Provincial
and City assessors whichever is
higher.
Note: Gain or loss is immaterial, there
being a conclusive presumption of gain.
Tax Rate: 6%
Notes:
The taxpayer has the option to treat
the capital gain as subject to 6%
capital gains tax or to the graduated
rates (5-32%) IF the buyer of real
property classified as capital asset is
the government or any of its political
subdivisions or agencies, or GOCC.
In case of sale of real property which
is subject to the right of redemption
(i.e., extrajudicial foreclosure sale of
capital assets initiated by banks,
finance and insurance companies),
the final tax is due upon the expiration
of the redemption period without the
mortgagor having exercised such right
to redeem.
In this case, the capital gains tax
shall be based on the bid price of
the highest bidder.

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TAXATION LAW | Income Taxation

In case the mortgagor exercises


his right of redemption within one
year from the issuance of the
certificate of sale, no capital gains
tax shall be imposed because no
capital gain was derived by the
mortgagor and no sale or transfer
of real property occurred.

Persons Liable:
1. Individuals citizen or alien (RC,
NRC, RA, NRA-ETB, NRA-NETB)
2. Corporation- Domestic (DC)
3. Other taxpayers such as estate and
trust
Note: Regarding the transactions affected
by the 6% capital gains tax, the NIRC
speaks of real property with respect to
individual taxpayers, estate and trust. On
the other hand, NIRC only speaks of land
and building with respect to domestic
corporations. (Sec. 24 (D)(1); Sec.
27(D)(5), NIRC)
Exemption from Capital Gains tax from
Income Realized by Natural Persons
from Sale of Principal Residence (Sec.
24(C)(2), NIRC)
Principal Residence refers to the
dwelling house, including the land on
which it is situated, where the individual
and members of his family reside, and
whenever absent, the said individual
intends to return. Actual occupancy is not
considered interrupted or abandoned by
reason of temporary absence due to travel
or studies or work abroad or such other
similar circumstances (R.R. No. 14-00).
Rule: The address shown in the ITR is
conclusively presumed as the principal
residence.
Exception: If not required to file a return,
certification from Barangay Chairman or
Building Administrator (for condominium
units) shall suffice.
Requisites for Exemption:
1. Sale or disposition of the old actual
principal residence;
2. By a citizen or resident alien;
3. Proceeds of which is FULLY utilized in
acquiring or constructing a new
principal residence within 18 calendar
months from date of sale or
disposition;

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a. Notify the Commissioner within 30


days from the date of sale or
disposition through a prescribed
return of his intention to avail the
tax exemption;
b. Can be availed of only once every
ten (10) years;
c. The historical cost or adjusted
basis of his old principal residence
shall be carried over to the cost
basis of his new principal
residence; and,
d. The 6% capital gains tax due shall
be deposited with an authorized
agent bank subject to release
upon certification by the RDO that
the proceeds of the sale have
been utilized.
Note: If there is no full utilization, the
portion of the gains presumed to have
been realized shall be subject to capital
gains tax. The GSP or FMV at the time of
sale, whichever is higher, shall be
multiplied by a fraction which the unutilized
amount bears to the gross selling price in
order to determine the taxable portion; and
Formula:
Unutilized
amount
GSP

(higher
of GSP
or FMV)

Taxable
Portion

Notes:
If the taxpayer constructed a new
residence and then sold his old house,
the transaction does not fall under the
exemption because the law is clear
that the proceeds should be used in
acquiring and constructing a new
principal residence. Therefore, the old
residence should first be sold before
acquiring or constructing the new
residence and not vice-versa. (Dizon,
Q & A in Taxation)
If the land is leased, only the dwelling
house can be treated as principal
residence. However, where both the
owner of the land and owner of the
dwelling house actually reside in the
said dwelling house, then both said
land and the dwelling house shall be
treated as their Principal Residence.
If the principal residence is co-owned,
the exemption applies only to the
extent of his proportionate share.
ONLY a RC, NRC, and RA are entitled
to exemption from payment of capital
gains tax in case of sale of Principal

Income Taxation | TAXATION LAW


residence. A NRA is not entitled to the
exemption.
Rationale: R.R. No. 13-99 as
amended by R.R. 14-00 (Rules
governing exemption of sale of
principal residence from capital gains
tax) did not include nonresident aliens
in the definition of natural persons
covered therein. It defined a natural
person as a citizen or resident alien
individual taxable under Sec. 24,
NIRC. (Dizon, ibid)
Aliens may acquire REAL PROPERTIES
in the Philippines under the following
instances:
1. Alien who is a legal or compulsory heir
may acquire land through succession.
2. Aliens may have acquired real
properties before adoption of the 1935
constitution;
3. Aliens may acquire condominium units
subject to 60-40% limit;
4. Former natural born Filipino citizens
may acquire real properties under BP
Blg. 185 and R.A. 8179 (Foreign
Investments Act of 1991).
C. Capital Gains and Losses Other
Capital Assets (NOT subject to capital
gains tax)
Coverage: it involves sale or exchange or
one considered as equivalent to a sale or
exchange of property classified as capital
asset except:
1. Shares of a domestic corporation;
2. Real property in the Philippines held
as capital asset.
Note: The sale or exchange of property
must be consummated not just perfected.

Tax Base: Net Capital Gains (excess of


the gains from sales/exchanges of capital
assets over the gains from such
sales/exchanges)
Tax Treatment and Rate: net capital
gains are included in the gross income
subject to graduated rates (5-32%) for
individuals and normal corporate income
tax (30%) for corporations.
Rules on the Recognition of Capital
Gains or Losses from the Disposition
of Property Classified as Capital Asset
Where the Taxpayer
1. Holding Period
The percentages of gain or loss to be
taken into account shall be the
following:
100% if the capital assets has been
held for 12 months or less (short-term
assets); and
50% if the capital asset has been
held for more than 12 months (longterm assets).
Note: The holding period applies only
to individuals
2. Non-Deductibility of Net Capital
Loss (Loss Limitation Rule)
Rule: Capital losses are allowed only
to the extent of capital gains; hence,
the net capital loss is NOT deductible
Rationale: To ensure the matching of
costs against revenues consistent with
the rule that only business expenses
are deductible from gross income.
Capital loss is not a business
expense.

Tax Formula:
For sale of property
Selling price (in terms of money)
Less: Cost
GAIN OR LOSS
For exchange of property
FMV of the property received in exchange
Less: Cost
GAIN OR LOSS
The property received in exchange must
have a market value and essentially
different from the property disposed of.

Note: If the taxpayer is a corporation,


capital gains and losses are
recognized to the extent of 100%
(i.e. not subject to holding period), 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), any loss shall NOT be
included
in
determining
the
applicability of the limitation.

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TAXATION LAW | Income Taxation


3. Net Capital Loss Carry-Over
If any taxpayer, other than a
corporation, sustains in any taxable
year a net capital loss, such loss (in
an amount not in excess of the net
taxable 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 twelve (12) months.
Note: The rule on net capital loss
carry-over for the next succeeding
year applies only to individuals. NO
carry-over allowed for corporations.
DETERMINATION
OF
AMOUNT
AND
RECOGNITION OF GAINS AND LOSS (Sec.
40, NIRC)
Gain excess of the amount realized over the
basis or adjusted basis.
Loss excess of the basis or adjusted basis
over the amount realized.
Amount realized from sale or disposition
sum of money received plus the fair market
value of the property (other than money), if
any, received
1. Basis on sale of property
a. Acquisition by purchase - cost of
acquisition
b. If acquired by inheritance fair market
value as of the date of acquisition
c. If acquired by gift basis shall be the
same as if it would be in the hands of
the donor or the last preceding owner
by whom it was not acquired by gift or
the fair market value at the time of the
gift, whichever is lower
d. If acquired for less than an adequate
consideration in money or moneys
worth amount paid by the transferee
2. Basis for exchange of property
Rule: The entire amount of the gain or
loss shall be recognized
Exception:
In pursuance of a plan of merger or
consolidation
a. A corporation exchanges property
solely for stock in a corporation
(PROPERTY FOR STOCKS)
b. A shareholder exchanges stock in
corporation solely for the stock of
another corporation, both party to the
merger or consolidation (STOCK FOR
STOCK)

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c.

A security holder of a corporation


exchanges his securities in such
corporation, solely for stock or
securities in another corporation, both
a party to the merger or consolidation
(SECURITIES FOR SECURITIES OR
STOCK)
d. Property is transferred to a corporation
by a person in exchange for stock or
unit of participation in such a
corporation of which as a result, not
exceeding 4 persons, gains control of
said corporation, Provided, stocks
issued for services shall not be
considered as issued for return for
property (PROPERTY FOR STOCK)
3. Gains are recognized but losses are
not in
a. transactions not solely in kind
b. illegal transactions
c. transactions between related taxpayers
d. wash sale transactions
INVENTORIES (Sec. 41,NIRC)
The CIR may prescribe the best accounting
practice in the trade or business, the method
of valuing inventory, whenever the use of
inventories is necessary in order to determine
clearly the income of the taxpayer
Once a taxpayer uses a particular method,
it shall be used in the subsequent years,
unless:
a. the CIR authorized the change to a
different method;
b. the CIR, subject to the approval of
Secretary of Finance, finds it necessary to
modify the valuation method for purposes
of ascertaining the income, profits, or loss
in a more realistic manner
Note: The CIR shall not exercise his authority
to require a change in inventory method more
often than once every 3 years
INCOME FROM SOURCES WITHIN THE
PHILIPPINES (Sec. 42, NIRC)
A. Gross Income from Sources WITHIN
the Philippines
1. Interests (a) interest derived from
sources within (location of the bank),
or (b) residence of the debtor
2. Dividends amount received as
dividend from a domestic corporation
or from a foreign corporation (subject
to the 50% rule)
50% rule: If for the 3-year period
preceding the declaration of such

Income Taxation | TAXATION LAW


dividend,
the
ratio
of
such
corporations Philippine gross income
to the world gross income (total-within
and without) is:
a. less than 50% entirely without
b. 50% to 85% proportionate
c. more than 85% entirely within
3. Services services performed in the
Philippines.
4. Rents and Royalties in case of
rentals, those properties located in the
Philippines. In case of royalties, on
properties used in the Philippines
5. Sale of Real Property - sale of real
property located in the Philippines
6. Sale of Personal Property in case
of sale of personal property, the
following rules apply:
a. Production and Sale
Produced in whole within and
sold within income purely
within
Produced in whole without
and sold without income
purely without
Produced within or sold
without income partly within
and income partly without
Produced without and sold
within income partly within
and partly without
b. Buy and Sell (No Production)
Place of Market Rule (place of
sale) applies.
Exception:
If
the personal
property sold is shares of stock of
DOMESTIC CORPORATION, the
income is purely within even if the
seller sells it abroad.
B. Gross Income from Sources WITHOUT
the Philippines
1. Interests other than those derived
from sources within the Philippines
2. Dividends other than those derived
from sources within the Philippines
3. Compensation for labor or personal
services performed without the
Philippines;
4. Rents and Royalties from property
located without the Philippines or from
any interest in such property including
rentals or royalties for the use of or for
the privilege of using without the
Philippines, patents, copyrights, secret
processes and formulas, goodwill,
trademarks, trade brands, franchises
and other like properties; and

5. Gains, profits and income from the


sale of real property located without
the Philippine
6. Sale of Personal Property in case
of sale of personal property, the same
rules under No. 6 of the immediately
preceding discussion on Income from
Sources Within apply.

ACCOUNTING PERIODS
AND METHODS
ACCOUNTING PERIOD
Rule: The accounting period of a taxpayer is a
period of 12 months.
1. Calendar year accounting period from
January 1 to December 31 which is
allowed if:
a. Taxpayer is an individual;
b. Taxpayer is a partnership;
c. Accounting period is other than a
fiscal year;
d. Taxpayer has no accounting period;
e. Taxpayer does not keep books.
2. Fiscal year accounting period of 12
months ending on the last day of any
month other than December which is
allowed ONLY to corporations.
Exception: A taxpayer may have a
taxable period of less than 12 months
where:
1. Taxpayer dies;
2. Corporation is newly organized;
3. Corporation changes its accounting
period;
4. Corporation is dissolved.
5. Tax period is terminated by the CIR by
authority of law. (see Sec.(D),NIRC)
Change of Accounting Period
A corporation may change its accounting
period wherein the net income shall, with the
approval of the CIR, be computed on the basis
of such new accounting period, subject to the
provisions of Sec. 47,NIRC.
A separate adjustment or final return shall be
made for the period between the close of the
original accounting period and the date
designated as the close of the new accounting
period

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TAXATION LAW | Income Taxation


Documentary Requirements for changing
the Accounting period (taxpayer other than
individual)
1. Letter Request addressed to the Revenue
District Officer (RDO) having jurisdiction
over the place of business of the taxpayer,
indicating:
a. Original accounting period and the
proposed new accounting period to be
adopted; and
b. The reason for desiring the change in
accounting period (R.R. No. 9-2011);
2. Duly filled-up BIR Form No. 1905;
3. Certified true copy of the SEC approved
Amended By-Laws showing the change in
accounting period;
4. Sworn certification of non-forum shopping
stating that such request has not been filed
or previously acted upon by the BIR
National Office, signed by the taxpayer or
duly authorized representative; and
5. A sworn undertaking by a responsible
officer of the taxpayer (partner, president,
general
manager,
branch
manager,
treasurer or officer-in-charge), to file a
separate final or adjustment return for the
period between the close of the original
accounting period and the new accounting
th
period on the 15 day of the fourth month
following the end of the taxable period.
Failure to comply with such requirement will
invalidate the approval of the change of
accounting period and the taxpayer will be
subject to a criminal offense. (R.R. No. 32011)
Notes:
The request for change of accounting
period should be filed at anytime not less
than 60 days prior to the beginning of the
proposed new accounting period.
The certification approving the adoption of
a new accounting period must be released
within 30 working days from receipt of the
complete documentary requirements.
METHODS OF ACCOUNTING
There is no uniform method of accounting
prescribed for all taxpayers. The law
contemplates that each taxpayer shall adopt
such forms and systems of accounting as are
in his judgment best suited to his purpose.
Rule: Net income shall be computed in
accordance with the method of accounting
regularly employed in the books of the
taxpayer.

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Exception: Computation shall be made in


such method as in the opinion of CIR clearly
reflects the income:
1. If no such method has been so employed
by the taxpayer;
2. If the method of accounting employed
does not clearly reflect the income.
Methods
Recognized
Regulations

by

Law

and

1. Cash Method income is reported in the


year payments are received while
expenses are deducted in the year paid.
2. Accrual Method income is reported in
the year it is earned while expense is
deducted in the year it is incurred
regardless of receipt or disbursement of
cash.
All Events Test under the accrual
method, an expense is deductible for the
taxable year in which all the events had
occurred which determined the fact of
liability and the amount thereof can be
determined with reasonable accuracy.
3. Installment Method appropriate when
collections of the proceeds of sales and
incomes extend over relatively long
periods of time and there is strong
possibility that full collection will not be
made
4. Percentage or Completion Method
applicable in the case of a building,
installation or construction contract
covering a period in excess of 1 year
whereby gross income derived from such
contract may be reported upon the basis
of percentage of completion
5. Crop Year Method applicable only for
farmers engaged in the production of
crops which take more than a year from
the time of planting to the process of
gathering and disposal of the harvest;
Expenses paid or incurred during the year
are deductible from the gross income
realized from the sale of the crops.
Changes in accounting method
A taxpayer who changes the method of
accounting employed shall secure first the
consent of the CIR. Application for permission
to change the method shall be filed within 90
days after the beginning of the taxable year to
be covered by the return. It shall be
accompanied by a statement specifying all

Income Taxation | TAXATION LAW


amounts which would be duplicated or entirely
omitted as a result of the proposed change.
Allocation of Income and Deductions
In the case of two 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
determined
that
such
distribution,
apportionment or allocation is necessary in
order to prevent evasion of taxes or clearly to
reflect the income of any such organization,
trade or business.

from
sources
within
the
Philippines, the income tax on
which has been correctly withheld;
c. Individual whose sole income has
been subjected to final withholding
income tax; and
d. Individual who is exempt from
income tax.
Note: Individuals not required to file an
income tax return may nevertheless be
required to file an information return.

TAX RETURN AND PAYMENT

If impracticable to file one return: each


spouse shall file a separate return of
income but the return so filed shall be
consolidated by the Bureau for the
purpose of verification for the year.

Tax Return this is a report made by the


taxpayer to the BIR of all gross income
received during the taxable year, the allowable
deductions including exemptions, the net
taxable income, the income tax rate, the
income tax due, the income tax withheld, if
any, and the income tax still to be paid or
refundable.
Persons Required To File Income Tax
Return (ITR):
1. INDIVIDUAL
Individuals Required to File ITR
a. RC with income from within and
without
b. NRC for income from within
c. RA for income from within
d. NRAETB for income from within
e. Individual (citizens/aliens) engaged in
business or practice of a profession
within the Phil. regardless of the
amount of gross income;
f. Individual
deriving
compensation
income concurrently from two or more
employers at any time during the
taxable year; and
g. Individual whose pure compensation
income derived from sources within
the Phil. exceeds P60, 000.
Individuals EXEMPT from Filing ITR:
a. Individual whose gross income
does not exceed total personal
and additional exemptions;
b. Individual with respect to pure
compensation income derived

Special rules
Return of Husband and Wife
File one (1) return for the taxable year if
the following requisites are complied;
a. Married individuals (citizens, resident
or nonresident aliens)
b. Do not derive income purely from
compensation.

Unmarried Minor
Income of unmarried minors derived from
property received by the living parent shall
be included in the return of the parent,
except:
a. When donors tax has been paid on
such property, or
b. When transfer of such property is
exempt from donors tax.

Persons under Disability


If a taxpayer is unable to make his own
return, it may be made by his:
a. Duly authorized agents;
b. Representative;
c. By guardian; or
d. Other person charged with the care of
his person or property who will
assume the responsibility of making
the return and incurring penalties
provided for erroneous, false or
fraudulent return.
Note: Under R.R. No. 2-2011, the
following are required to file AIR (Annual
Information Return), which shall include
income subject to final withholding tax and
those exclusions from gross income:
a. an individual whose income is purely
compensation derived within the
Philippines, which has been correctly
withheld, whose annual taxable

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TAXATION LAW | Income Taxation


income exceeds P500,000, provided,
that if derived from 2 or more
employers, must file an ITR;
b. Individuals, estates, and trusts whose
sole income has been subjected to
FWT with the aggregate tax withheld
exceeding P125,000, remitted or not;
c. Individual whose sole income is
exempt from Income tax but total
annual income exceeds P500,000.
2. TAXABLE ESTATE AND TRUST
The fiduciary shall file a return IF gross
income is at least P20,000 on or before
April 15.
3. GENERAL
PROFESSIONAL
PARTNERSHIP
The income tax return shall be signed and
filed, in duplicate, by the principal officer
on or before April 15 and shall set forth:
a. Items of gross income and deductions
allowed;
b. Name, address, and share of each
partners;
c. TIN No.
4. CORPORATON
The following shall make a return and filed
by the president, vice-president or other
principal officer, and shall be sworn to by
such officer and by the treasurer or
assistant treasurer.
a. Not exempt from income tax;
b. Exempt from income tax under Sec.
30, NIRC but has NOT shown proof of
exemption;
c. Corporation subject to tax having
existed during the taxable year,
whether with income or not;
d. Corporation in the process of
liquidation or receivership;
e. Insurance company doing business in
the Philippines or deriving income
therein; and
f. Foreign corporation having income
from within the Philippines.
When may individual returns be filed?
1. On or before April 15 of each year
covering income of the preceding taxable
year.
2. Within 30 days following each sale or
disposition covering capital gains from the
sale or disposition of real property;
3. Within 30 days after each transaction and
a final consolidated return on or before
April 15 of each year covering all stock
transactions of the preceding year as to
the net capital gains from sale or

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exchange of share of stock not traded thru


a local stock exchange. (Sec. 51(C),
NIRC)
SUBSTITUTED FILING
Substituted filing is when the employers
annual return may be considered as the
substitute Income Tax Return (ITR) of
employee inasmuch as the information
provided in his income tax return would exactly
be the same information contained in the
employers annual return.
Non-filing applicable to certain types of
individual taxpayers who are not required
under the law to file an income tax return.
Substituted filing of Income tax Returns by
Employees
Receiving
Purely
Compensation Income (Sec. 4, R.R. No. 32002; RMC 01-03)
Requisites:
1. Employee receives purely compensation
income (regardless of amount);
2. The income is only from one employer;
3. Amount of tax due from the employee
equals the amount of tax withheld by the
employer;
4. Employee's spouse also complies with all
three (3) conditions stated above;
5. Employer files the annual information
return (BIR Form No. 1604-cf); and
6. Employer issues BIR Form 2316 to each
employee.
Individuals NOT Qualified For Substituted
Filing (Still Required To File):
1. Individuals deriving compensation from
two or more employers concurrently or
successively;
2. Employees
deriving
compensation
income, the income tax of which has not
been withheld correctly.
3. Employees
whose
monthly
gross
compensation income does not exceed
P5,000 or the statutory minimum wage,
whichever is higher, and opted for nonwithholding of tax on said income;
4. Individuals deriving other non-business,
non-profession-related income in addition
to compensation income not otherwise
subject to final tax;
5. Individuals receiving purely compensation
income from a single employer although
the income tax of which has been correctly
withheld, but whose spouse falls under 1
to 4 above;
6. NRA-ETB deriving purely compensation
income, or compensation income and

Income Taxation | TAXATION LAW


other
non-business,
related income.

non-profession-

Note: Filing of ITR, for employees who are


qualifies for the substituted filing is now
MANDATORY.
Requirement of Banks for Submission of
an ITR for Loan or Credit Card
Applications:
Banks may require the submission of BIR
Form No. 1700 (for employees not entitled to
substituted filing of ITR). However, for
employees entitled to substituted filing of ITR,
the submission of the Joint Certification will
suffice.
Joint Certification - It is a sworn statement
made by the employer and employee, which
serve the following purposes:
1. It contains the employee's consent that
BIR Form No. 1604-CF may be
considered his substituted return, in lieu of
BIR Form No. 1700, which the employee
no longer filed.
2. It contains the employer's certification that
he has reported the employee's income to
the BIR and that he has remitted the taxes
on the employee's income, as indicated in
BIR Form No. 1604-CF.
3. It serves as proof of financial capacity in
case the employee decides to apply for a
bank loan or a credit card, or for any other
purpose, as if he had in fact filed a BIR
Form No. 1700.
MANNER OF PAYMENT
Rule: Pay-as-you-file-system, the income tax
shown on the return should be paid at the time
the return is filed.
Exception: Individuals may pay in two equal
installments if the income tax due on the
annual return exceeds Two thousand pesos
(P2,000).
First Installment At the time the return is
filed.
Second Installment On or before July 15,
following the close of the calendar year.
Any creditable withholding tax shall be
credited against the tax due, or the first
installment of the tax, if the taxpayer desires to
pay on installment.
Extension of Time to File Return:
The Commissioner may on meritorious cases
grant a reasonable extension of time for filing

income tax return and may subject the


imposition of twenty (20) percent interest per
annum from the original due date.
ELECTRONIC FILING AND PAYMENT
SYSTEM (EFPS)
Large taxpayers shall e-file their final
adjustment income tax returns for the
calendar/fiscal year and shall e-pay their
taxes on or before the 15th day of the
fourth month following the close of the
taxable year.
The taxpayer must be enrolled in the
EFPS
Electronic signatures of the taxfiler shall
be affixed in the return
The taxpayer that will e-pay shall enroll
with any authorized agent bank where he
intends to pay
LARGE TAXPAYER - a taxpayer, regardless
of its location in the country, which has been
classified and notified in writing by the BIR as
one that has satisfied the criteria for
determining large taxpayers. A taxpayer shall
be classified as a candidate to be a large
taxpayer if it satisfies any or a combination of
the following criteria: add
I.

As to Tax Payment
Value Added Tax Any taxpayer with
a net VAT paid or payable of at least
P200,000 per quarter for the
preceding year.
Excise Tax Any taxpayer with an
annual excise tax paid or payable of at
least P1Million for the preceding
taxable year.
Income Tax - Any taxpayer with
annual income paid or payable of at
least P1Million for the preceding
taxable year.
Withholding tax any taxpayer with
annual
income
tax
payment/remittance from all types of
withholding taxes (i.e. compensation,
expanded, final and government
money payments) of at least P1Million
for the preceding taxable year. For
taxpayers, business establishments
and government offices with branches.
units, the basis is the total annual
taxes withheld per quarter for the
preceding year.
Percentage tax Any taxpayer with
percentage taxes paid or payable of at
least P200,000 per quarter for the
preceding year.

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Percentage taxes Any taxpayer with


an aggregate annual documentary
stamp taxes of at least P1Million; or

II. As to Financial Condition and Results


of Operation:
Gross sales/Receipts Any taxpayer
with total annual sales/receipts of at
least P1Billion for the preceding year;
Net Worth Any taxpayer with a total
net worth at the close of each
calendar or fiscal year of at least
P300Million;
Gross Purchases Any taxpayer with
total annual gross purchases of at
least P800Million for the preceding
year;
Top corporate taxpayers listed and
published by the SEC. (R.R. No. 172010)
Taxpayers Automatically Classified as
Candidate to be a Large Taxpayer
1. Branches of a taxpayer under the
Large Taxpayer Service;
2. Subsidiaries, affiliates and entities of
conglomerates/group of companies of
a large taxpayer;
3. Surviving company in case of
merger/consolidation involving a large
taxpayer;
4. Any corporation that absorbs the
operation/business in case of spin
off/s of any large taxpayer;
5. Corporations with an authorized
capitalization of at least P300 million;
6. Multi-national enterprises with an
authorized capitalization or assigned
capital of at least P300 million;
7. Publicly listed corporations; and
8. Universal, commercial and foreign
banks. (R.R. No. 17-2010)
Reportorial Requirements (R.R. No. 212002)
Submission of Financial Statements (FS) is
mandatory even if there is no income.
FS shall be composed of the balance
sheet, income statement, statement of
retained earnings, statement in changes in
financial position, and schedules attached
to the aforementioned statements
FS filed WITH accompanying auditors
certificate shall show the comparative
figures of the current year and the
previous year
The independent CPA who audited the
records and certified the FS of taxpayer,
equally as taxpayer, has the responsibility

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to maintain and preserve copies of audited


and certified FS for a period of 3 years
from due date of filing the annual ITR or
the actual date of filing, whichever comes
later.
Taxpayers are mandated to maintain
books and records that would reflect the
reconciling items between FS figures
and/or data with those reflected/presented
in the filed Income Tax Return (ITR).

Statement of Management Responsibility


(R.R. No. 3-2010)

Since the Annual Income Tax Return is


primarily the responsibility of the
management of the taxpayer, this shall
be accompanied by a statement of
management responsibility.

All taxpayers required to file annual


income tax return under the NIRC, as
amended, shall be required to submit a
statement
of
managements
responsibility. (in the form indicated in the
Revenue Regulation)

Aside from Individual Taxpayer, President


and Managing Partner, the CEO and the
CFO or any officer performing similar
functions regardless of their designation
are also required to affix their signatures
in the said Statement.

In the case of a foreign corporation with


branch office in the Philippines, the
Statement shall be signed by its local
manager who is in charge of its
operations.
Returns of Corporations Contemplating
Dissolution/Reorganization
Within thirty (30) days after the adoption of a
resolution or plan for its dissolution, or for the
liquidation of the whole or any part of its
capital stock, or notified of possible involuntary
dissolution by the SEC or for its
reorganization, shall render a correct return to
the Commissioner, verified under oath, setting
forth the terms of such resolution or plan and
such other information.
Prior to the issuance by the SEC of the
Certificate of Dissolution or Reorganization,
shall secure a certificate of tax clearance from
the BIR.
Excess Tax Credits
Upon filing the fiscal adjustment return and the
sum of quarterly tax payments made during
the year exceeded the tax due on the entire
taxable income of the year, the corporation is
entitled tax credit or refund of the excess tax

Income Taxation | TAXATION LAW


credits. The excess amount may be carried
over and credited against the estimated
quarterly income tax liabilities for the taxable
quarters of the succeeding taxable years.
Once the option to carry-over and apply has
been made, such option shall be irrevocable
for that taxable period and no application for
cash refund or issuance of a tax credit
certificate shall be allowed.

WITHHOLDING TAX SYSTEM


Taxes imposed or prescribed by the NIRC are
to be deducted and withheld by the payorcorporations and/or persons from payments
made to payees-corporation and/or persons
for the former to pay the same directly to the
BIR. Thus, the taxes are collected practically
at the time the transaction is made or when
the taxable act occurs (taxation at source).

The controlling factor for the operation of the


irrevocability rule under sec. 76 of the Tax
Code is that the taxpayer chose an option; and
once it had already done so, it could no longer
make another one. Consequently, after the
taxpayer opts to carry over its excess tax
credit to the following tax period, the question
of whether or not it actually gets to apply said
tax credit is irrelevant. (CIR v. Bank of
Philippine Islands, G.R. No. 178490, July 7,
2009)

Withholding tax is not a tax. It is an advance


payment of tax due which may be income tax,
VAT, percentage tax, etc.

Section 76 of the 1997 NIRC wrought two


changes to its predecessor, Section 69 of the
1977 NIRC: first, it mandates that the
taxpayers exercise of its option to either seek
refund or crediting is irrevocable; and second,
the taxpayers decision to carry-over and apply
its current overpayment to future tax liability
continues until the overpayment has been fully
applied, no matter how many tax cycles it
takes. (CIR v. Mc George Food Industries,
G.R. No. 174157, October 20, 2010)

How Withheld and Remitted? It is withheld


by withholding agents and covered by a return
and paid to (except in cases where the
Commissioner
otherwise
permits)
an
authorized agent bank, RDO, collection agent,
or duly authorized treasurer of the city or
municipality where the withholding agent has
his legal residence or principal place of
business, or where the withholding agent is a
corporation, where the principal office is
located.

Once the taxpayer opts to carry-over the


excess income tax against the taxes due for
the succeeding taxable years, such option is
irrevocable for the whole amount of the excess
income tax, thus, prohibiting the taxpayer from
applying for a refund for that same excess
income tax in the next succeeding taxable
years. The unutilized excess tax credits will
remain in the taxpayers account and will be
carried over and applied against the taxpayers
income tax liabilities in the succeeding taxable
years until fully utilized. (Asiaworld Properties
Philippine Corporation v. CIR, G.R. No.
171766, July 29, 2010)

The taxes deducted and withheld by the


withholding agent shall be held as a special
fund in trust for the government until paid to
the collecting officers (Sec. 58(A), NIRC).

Note: All tax Credit Certificates (TCCs) issued


by the BIR shall not be allowed to be
transferred or assigned to any person. (Sec. 4,
R.R. No. 14-2011)

WITHHOLDING TAXES

When Withheld?
It arises at the time an income payment is
PAID or PAYABLE or ACCRUED or recorded
as an expense or asset whichever is
applicable in the payors books, whichever
comes first. (R.R. 2-98 as amended by R.R.
12-2001).

Rationale:
1. To provide the taxpayer a convenient
manner to meet his probable income tax
liability.
2. To ensure the collection of the income tax
which could otherwise be lost or
substantially reduced through the failure to
file the corresponding returns.
3. To improve the governments cash flow.
4. To minimize tax evasion, thus resulting in
a more efficient tax collection system.
Withholding Agent
A separate entity acting no more than an
agent of the government for the collection of
tax in order to ensure its payment.
He is merely a tax collector, NOT a taxpayer.
If a withholding agent was assessed for
deficiency withholding tax under the Code, as
such, it is being held liable in its capacity as a

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withholding agent and not its personality as a
taxpayer (CIR v. CA, G.R. No. 104151, March
10, 1995).
Is taxpayer answerable for the nonperformance of the withholding agent?
NO. Unless there is collusion and bad faith,
the taxpayer could not be deemed to have
evaded the tax had the withholding agent
performed its duty.
In case of a corporate employer with branch
offices, the branch manager or other
representative may actually withhold the tax.
Nevertheless, the legal responsibility for
withholding, paying and returning the tax and
furnishing such statements rests with the
corporate employer (R.R. 2-98, as amended).
Persons Required to Withhold:
1. Juridical Person whether or not engaged
in trade or business
2. Individual with respect to payments
made in connection with his trade or
business
3. Individual buyers not engaged in trade or
business insofar as taxable sale,
exchange or transfer or real property is
concerned
4. All government offices including GOCCS
as well as provincial, city and municipal
governments and barangays.
Withholding of Tax shall NOT apply to
income payment to the following:
1. National
government
and
its
instrumentalities, including provincial, city,
or municipal governments, as well as
GOCCs
2. Persons enjoying income tax exemptions
3. Exempt organizations EXCEPT income
derived from real or personal property, or
from any activity conducted for profit
Consequences for Failure to Withhold:
1. Liable for surcharges and penalties;
2. Liable upon conviction to a penalty equal
to the total amount of the tax not withheld,
or not accounted for and remitted (Sec.
251, NIRC); and
3. Any income payment which is otherwise
deductible from the payors gross income
will not be allowed as a deduction if it is
shown that the income tax required to be
withheld is not paid to the BIR (Sec.
2.58.5, R.R. No. 2-98).
Withholding agent has authority to file a
Claim for Refund
A withholding agent has a legal right to file a
claim for refund for two reasons. First, he is

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considered a taxpayer under the NIRC as he


is personally liable for the withholding tax as
well
as
for
deficiency
assessments,
surcharges, and penalties, should the amount
of the tax withheld be finally found to be less
than the amount that should have been
withheld under law. Second, as an agent of
the taxpayer, his authority to file the necessary
income tax return and to remit the tax withheld
to the government impliedly includes the
authority to file a claim for refund and to bring
an action for recovery of such claim. In this
connection, it is however significant to add that
while the withholding agent has the right to
recover the taxes erroneously or illegally
collected, he nevertheless has the obligation
to remit the same to the principal taxpayer. As
an agent of the taxpayer, it is his duty to return
what he has recovered; otherwise, he would
be unjustly enriching himself at the expense of
the principal taxpayer from whom the taxes
were withheld, and from whom he derives his
legal right to file a claim for refund. (CIR v.
Smart Communications, Inc., G.R. Nos.
179045-46, August 25, 2010)
KINDS OF WITHHOLDING TAX
A. Withholding Tax at Source
1. Final Withholding Tax
2. Creditable Withholding Tax
B. Withholding Tax on Compensation
1. Withholding Tax on Wages
2. Withholding Tax on Fringe Benefit
C. Withholding Tax on Creditable VAT
D. Withholding of Percentage Tax
A. Withholding Tax at Source
Arises at the time an income is paid or
payable, whichever comes first. The term
payable refers to the date the obligation
becomes due, demandable or legally
enforceable (Sec. 2.54.4 R.R. No. 2-98).
1. Final withholding tax
Effects to the income, which is
subjected to final withholding tax:
a. Constituted as a full and final
payment of the income tax due
from the payee
b. No longer subject to the net
income
tax
(hence,
the
corresponding final tax cannot be
claimed as tax credit)
c. Limited only to the payees income
tax liability and does not extend to
other taxes that may be imposed
on said income

Income Taxation | TAXATION LAW


d. Liability for the payment of the tax
rests primarily on the payor as
withholding agent
e. Withholding agent files the return
(not the payee)
Formula:

refunded to him, subject to Section 204


(abatement, refund/credit taxes).

Return on Creditable Withholding Tax


The income payor who withheld a
creditable income tax should file a return
and pay the tax withheld.

Final tax rate x Gross Income = Final Tax


(deductions and/or personal and additional
exemptions NOT allowed)
2. Creditable Withholding Tax
Withholding
taxes
on
ordinary
business income which is still
subjected to income tax and therefore,
it is deductible as tax credit
Tax-Free
Covenant
57(C),NIRC)

BOND

(Sec.

Covenant Bonds bonds, mortgages,


deeds of trust and other similar obligations
of domestic/resident foreign corporation,
which contain a contract/provision by
which the obligor agrees:
a. To pay any portion of the tax imposed
upon the obligee;
b. To reimburse the obligee for any
portion of the tax; or
c.

To pay the interest without deduction


for any tax which the obligor may be
required/permitted to pay or to retain
therefrom.
Obligor shall deduct and withhold
a tax equal to 30% of the interest
and other payments whether
interest or other payments are
payable annually or at a shorter
period; whether bonds, securities,
obligations had been/will be
issued/marketed and the interest
and other payments paid within
and without the Philippines if the
interest or other payment is
payable to a non-resident alien or
a citizen or resident of the
Philippines.

Income of Recipient (Sec. 58(d), NIRC)


Income which any creditable tax is
required to be withheld at source shall be
included in the return of its recipient.
The excess of the amount of tax withheld
over the tax due on his return shall be

B. Withholding Tax on Compensation


It applies to all employed individuals
whether citizens or aliens, deriving income
from compensation for services rendered
in the Philippines wherein the employer is
constituted the withholding agent.
The income recipient (i.e. employee) is the
person liable to pay the income tax, yet to
improve the collection of compensation
income of employees, the State requires
the employer to withhold the tax upon
payment of the compensation income.
Requisites:
1. Employer-employee relationship;
2. Payment of compensation or wages
for services rendered; and
3. Payroll period
Compensation Includes:
1. Salaries and wages
2. Commissions
3. Tips
4. Allowances
5. Bonuses
6. Fringe Benefits of rank
employees

and file

Compensation Exempted:
1. Remunerations received as an
incident of employment;
2. Remunerations
paid
for
agriculture/labor;
3. Remunerations paid for domestic
services;
4. Remunerations for casual not in the
course of an employer's trade or
business;
5. Compensation for services of a
citizen, resident of the Philippines, for
a
foreign
government
or
an
international organization;
6. Damages;
7. Life insurance;
8. Amount received by the insured as
return of premium;
9. Compensation
for
injuries
and
sickness;
10. Income exempt under treaty;

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11. Thirteenth (13th) month pay and other
benefits; and
12. GSIS, SSS, Philhealth and other
contributions.

Final
Withholding Tax
System

Creditable
Withholding Tax
System

Amount of Tax Collected


Constituted as a full
and final payment of
the income due from
the payee on the said
income [Sec. 2.57 (a),
R.R. No. 2-98].

Intended to equal or at
least approximate the
tax due from the payee
on the said income

Who is primarily liable


Liability rests primarily
on the withholding
agent

Liability rests upon the


taxpayer

Need to File A Return


Payee is not required
to file an income tax
return for the particular
income

Income recipient is still


required to file an
income tax return
and/or pay the
difference between the
tax withheld and the
tax due on the income

Coverage
a.

b.
c.

All income subject


to final taxes (e.g.
passive, gross
income of NRANETB)
Fringe benefit
Informers reward
to Persons
instrumental in the
discovery of
violations of the
NIRC and the
discovery and
seizure of
smuggled goods.

Those income
payments covered by
the expanded
withholding tax (R.R.
2-98)
Examples:
Professional fees,
talent fees
Fees paid to medical
practitioners
Income payments to
partners of GPP

C. WITHHOLDING TAX ON CREDITABLE


VAT
D. WITHHOLDING TAX ON PERCENTAGE
TAX
Bureaus, offices, instrumentalities of the
government, including GOCCs as well as
their subsidiaries, provinces, cities,
municipalities making any money payment
to private individuals, corporations,
partnership or association are required to
deduct and withhold taxes due from the
payees on account of such money
payment.
Remedies of withholding agent if expense
is disallowed (R.R. 2-98 as amended by
R.R. 14-2002):

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1. Pay the tax due thereon, including the


interest incident to failure to withhold tax,
and surcharges, if applicable, at the time
of the audit investigation or
2. Reinvestigation provided the payees
reported the income.
3. Pay the amount that should have been
withheld, including the interest incident to
the failure to withhold the tax, and
surcharges if applicable, at the time of the
audit investigation or reinvestigation if the
payees did not report the income and pay
the tax.
4. In case of under withholding, pay the
difference between the correct amount
and the amount of tax withheld, including
the interest, incident to such error, and
surcharges if applicable, at the time of
audit investigation or reinvestigation.
If above remedies are availed of, the
expenses NOT previously subjected to
withholding tax will be allowed as a
deduction for income tax purposes.
Section 6 of R.R. 17-2003: items for
deduction representing return of capital
such as those pertaining to purchase of
raw materials forming part of finished
product or purchases of goods for resale,
shall be allowed as deductions upon the
withholding agents payment of the basic
withholding tax and penalties incident to
non-withholding or under withholding.

Income Taxation | TAXATION LAW

ILLUSTRATIVE COMPREHENSIVE PROBLEMS ON INCOME TAXATION

PART I- KINDS OF TAXPAYERS


PROBLEM 1
Mr. A, the taxpayer is married with two qualified dependent children. The taxable year is 2012. The
following data are available:
Gross Compensation Income half of which was
earned outside the Philippines
Premium Payment on Health Insurance

P240,000
P10,000

Compute the Taxable Income of Mr. A if


a. He is a Resident Citizen
Gross Compensation Income
Less: Personal Exemptions
Basic Personal Exemption
6
Additional Exemptions (25,000 x 2)
Total
Less: Deductions for Health and Hospitalization
Premium Payments
Taxable Income
b. He is a Non Resident Citizen
Gross Compensation Income (240,000 x )
Less: Personal Exemptions
Basic Personal Exemption
Additional Exemptions (25,000 x 2)
Total
Less: Deductions for Health and Hospitalization
Premium Payments
Taxable Income
c.

P 240,000
P50,000
50,000

( 100,000)
P 140,000
7

( 2,400)
P 137,600

P 120,000
P 50,000
50,000

(100,000)
P 20,000
7

(2,400)
P 17,600

He is a Resident Alien
Gross Compensation Income (P240,000 x )

Less: Personal Exemptions


Basic Personal Exemption
Additional Exemptions (25,000 x 2)

P120,000

P50,000
50,000

100,000

Total

P 20,000

Less: Deductions for Health and Hospitalization


Premium Payments
Taxable Income

2,400
P 17,600

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d.1 He is a Non Resident Alien Engaged in Trade or Business.
Assume that his country of origin allows a basic exemption
equal to P40,000 only
Gross Compensation Income (240,000 x )
Less: Personal Exemptions
Basic Personal Exemption (whichever is lower)
Taxable Income
d.2 He is a Non Resident Citizen Not Engaged in Trade or
Business
Gross Compensation Income (P240,000 x )
9
Taxed at GROSS (25%)
e. He is a Non Resident Alien employed by Regional Operating
Headquarter of a multinational company, or by a Regional
Area Headquarter, or by an Offshore Banking Unit, or by a
Foreign Petroleum Service Contractor
Gross Compensation Income (P240,000 x )
4
Taxed at GROSS (15%)

P120,000

8)

(40,000
P 80,000

P120,000

P120,000

Explanations:
1
A citizen of the Philippines, residing therein is taxable on all income derived from sources within and
without the Philippines.
2

A non-resident citizen is taxable only on income derived from sources within the Philippines.

An alien individual whether a resident or not of the Philippines is taxable only on income derived
from sources within the Philippines.

Special Classes of Individual Employees (taxed at 15% of gross income)


Alien individuals, and their Filipino counterparts, employed by:
1. Regional headquarters and regional operating headquarters of multinational companies in the
Philippines;
2. Offshore banking units established in the Philippines;
3. Foreign service contractor or sub-contractor engaged in petroleum operations in the Philippines.

Summary of Allowance of Personal Exemptions


Individual
Taxpayer

Basic Personal
Exemptions

Additional
Exemptions

RC
NRC
RA
NRA-ETB

Allowed
Allowed
Allowed
Allowed
8
(reciprocity)
Not allowed

Allowed
Allowed
Allowed
Not allowed

NRA-NETB

Not allowed

Under R.A. No. 9504, there shall be allowed a BASIC PERSONAL EXEMPTION of P50,000 for each
individual taxpayer.

Under R.A. No. 9504, there shall be allowed an ADDITIONAL EXEMPTION of P25,000 for each
dependent child not exceeding four.

Under Sec. 34(m), NIRC, Special Deduction for Actual Premium Payments for Health and/or
Hospitalization Insurance is deductible up to P2,400 per family per year.

NRA-NETB are subject to 25% tax on gross income with no benefits of deduction.

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PROBLEM II
Mr. B, a resident citizen with two qualified dependent children, works as an employee of Company Z.
During the taxable year of 2012, he had the following data:
Salaries and Bonuses
Thirteenth Month Pay
Christmas Bonus
Midyear Bonus
Payroll Deductions:
SSS Premiums
Philhealth Contributions
PAGIBIG Contributions
Labor Union Dues

P 240,000
20,000
20,000
20,000
P

3,000
1,200
4,000
1,000

Determine the taxable income of Mr. B


Salaries and Bonuses
Less: SSS Premiums
Philhealth Contributions
PAGIBIG Contributions
Labor Union Dues
Total
Thirteenth Month Pay
Christmas Bonus
Midyear Bonus
Threshold Amount
Total
Less: Personal Exemptions
Basic Personal Exemption
Additional Exemption
Taxable Income

P 240,000
P 3,000
1,200
4,000
1,000
P 20,000
20,000
20,000
P 60,000
1
P 30,000

P 50,000
50,000

9,200
P 230,800

P 30,000
P 260,800

100,000
P 160,800

Explanations:
The following items are excluded from the gross compensation income of an individual employee.
1

13th month pay and other benefits up to P30,000;

GSIS, SSS, Medicare (now Philhealth) and Pag-ibig contributions and union dues of individuals;

PROBLEM III
Y University, a private educational institution and a stock corporation. It is recognized by CHED and is
at its tenth year of operation. It had the following data for 2012:
Tuition Fees received
Miscellaneous and Other Fees received
Expenses of the Operation
Expenditure for building library facility (useful life: 50 yrs.)

P 200,000,000
1,000,000
100,000,000
20,000,000

Determine the tax due and payable of Y University if (A) the expenditure for the building
facility was treated as an outright deduction and (B) the expenditure for the building facility
was treated as a depreciable capital expenditure
A.
A. Tuition Fees received
P 200,000,000
Miscellaneous Fees received
1,000,000

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Total
Less: Expenses of the Operation
Expenditure for building library facility
Taxable Income
Tax Rate:
Tax Due and Payable
B. Tuition Fees received
Miscellaneous Fees received
Total
Less: Expenses of the Operation
Depreciation of the Library Facility
Taxable Income
Tax Rate:
Tax Due and Payable

P 201,000,000
P100,000,000
20,000,000

120,000,000
P 81,000,000
10%*
P
8,100,000
P 200,000,000
1,000,000
P 201,000,000

P100,000,000
400,000**

100,400,000
P 100,600,000
10%*
P 10,600,000

Explanations:
Proprietary Educational Institutions and Non-profit Hospitals Tax Rates
*Rule: 10%
Requisites for Applicability of 10% Rate:
a. Stock and non-profit institution;
b. Private educational institution or hospital;
c. Gross income from unrelated trade, business, activity does not exceed 50% of gross income from
all sources;
d. For educational institutions, issued a permit to operate from DECS, CHED, or TESDA
Exceptions: 30% IF the gross income from unrelated trade, business or other activity exceeds 50%
of the total gross income derived from all sources; and Exempt IF a non stock non-profit educational
institution
**20,000,000/50 years = P400,000 annual depreciation expense
NOTE: SPECIAL DEDUCTIONS
Private proprietary educational institutions (Sec. 34 (A) (2), NIRC) in addition to the expenses
allowed as deduction, it has the option to treat the AMOUNT UTILIZED FOR THE ACQUISITION OF
DEPRECIABLE ASSETS FOR EXPANSION OF SCHOOL FACILITIES as:
1. OUTRIGHT EXPENSE (the entire amount is deducted from gross income); OR
2. CAPITAL ASSET AND DEDUCT ONLY FROM THE GROSS INCOME an amount equivalent to
its depreciation for the year

PROBLEM IV
AB, a partnership formed by Partner A and Partner B, had the following data with respect to its
income. Partner A is single while Partner B is married. They have separate businesses aside from the
partnership they formed.

Gross Income
Expenses Related to the Income
Drawings (withdrawals) Made

AB
P 700,000
P 500,000
P 24,000

A
P200,000
P 90,000

B
P600,000
P500,000

Determine the taxable income of Partner A, of Partner B and the AB partnership if the said
partnership is A) a business partnership or B) a general professional partnership Assume that
the profit and loss division of the partnership is equal.

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A. AB Partnership
Gross Income
Expenses
Taxable Income
Partner A
Gross Income
Expenses
Total
Less: Personal Exemptions
Basic Personal Exemption
Taxable Income
Partner B
Gross Income
Expenses
Total
Less: Personal Exemptions
Basic Personal Exemption
Taxable Income
B. AB Partnership
Gross Income
Expenses
Income to be distributed
Taxable Income
Partner A
Gross Income
Expenses
Total
Add: Income from Partnership
Total
Less: Personal Exemptions
Basic Personal Exemption
Taxable Income
Partner B
Gross Income
Expenses
Total
Add: Income from Partnership
Total
Less: Personal Exemptions
Basic Personal Exemption
Taxable Income

700,000
(500,000)
P 2 00,000*

P
P

200,000
(90,000)
110,000

50,000
60,000

600,000
(500,000)
P 100,000

50,000
50,000

60,000
(500,000)
P 200,000
0**

200,000
(90,000)
P 110,000
100,000***
P 210,000
50,000
P 160,000

P 600,000
(500,000)
P 100,000
100,000
P 200,000
50,000
P 160,000

Explanations:
* Taxable or Business Partnership - income tax is computed and taxed like that of a corporation
which is required to file a quarterly corporate income tax return and annual return due on or before
April 15 of the following year.
** General Professional Partnership - not subject to income tax, but are required to file returns of their
income for the purpose of furnishing information as to the share of each partner in the net gain or
profit, which each partner shall include in his individual return.

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*** The partners themselves are liable for the payment of income tax in their individual capacity
computed on their distributive shares of the partnership profit.
LIABILITY OF A PARTNER

Share Of A Partner In GPP


If net income, it shall form part of the gross
income of each partner based on his agreed
ratio subject to 10% creditable withholding tax.
If net loss, it may be taken by the individual
partner in his return of income.
Payments made to a partner for services
rendered shall be considered as ordinary
business income subject to Sec.24(A) (Effective
January 1, 1982)

Share of A Partner In Taxable or


Business Partnership
If net income, it shall be treated as dividend and shall
be subject to a final tax as follows:
a. RC, NRC, RA 10%
b. NRA-ETB 20%
c. NRA-NETB 25%
If net loss, it may be taken by the individual partner in
his return of income;
Payments made to a partner for services rendered
shall be considered as compensation income subject
to Sec.24(A).

PROBLEM V
The estate of Mr. C is under the administration of Administrator D. During the taxable year, it had the
following data with respect to its income:
Gross Income from the properties of the estate

P400,000

Expenses on the properties


Distribution of income to each of the two heirs

200,000
20,000

Determine the taxable income of Mr. Cs estate


Gross Income
Less: Expenses
Distribution of Income
Personal Exemption
Taxable Income

P 400,000
P 200,000
40,000**
20,000*

P 260,000
P 140,000

Explanations:
Rule: During the Pendency of the Settlement, an estate is subject to income tax in the same manner
as individuals
Exceptions:
* Entitlement to personal exemption is limited only to P20, 000;
ST

1 VIEW Republic Act No. 9504 amended the Tax Code increasing the basic personal exemption
amounting to Fifty thousand pesos (P50,000) for each individual taxpayer. Estates and trusts are
considered in the Tax Code as individual taxpayers and therefore the exemption allowed to them
should also be increased from P20,000 to P50,000.
nd

2 VIEW Tax exemptions are strictly construed. Section 62 of NIRC explicitly provides that the
exemption allowed to estates and trusts is P20,000.
nd

Better VIEW 2 View. One must not read into the law what obviously was not intended by
Congress. That would be nothing less than judicial legislation.
No additional exemption is allowed;
** Distribution to the heirs during the taxable year of estate income is deductible from the taxable
income of the estate (distributed income shall form part of the respective heirs taxable income).

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Where no such distribution to the heirs is made during the taxable year when the income is earned,
and such income is subjected to income tax payment by the estate, the subsequent distribution
thereof is no longer taxable on the part of the recipient.

PROBLEM VI
Two trusts, with a common grantor and a common beneficiary:

Net Income (before distribution of the property held in trust


Distribution of the beneficiary

Trust 1
P150,000
P 30,000

Trust 2
P 240,000
P 20,000

Determine the taxable income of A) Trust 1 and Trust 2 and B) Both Trust, after consolidation
A. Net Income
Less: Distributions to the beneficiary
Basic Personal Exemptions
Taxable Income

P 150,000
(30,000)**
(20,000)
P100,000**

B. Net Income
Less: Total Distributions to the beneficiary
Basic Personal Exemptions
Taxable Income

P 240,000
(20,000)
(20,000)
P200,000**

P 390,000**
(50,000)
(20,000)
P 320,000*

Explanations:
Rules on Taxability of the Income of a Trust
Rules:
**If income is distributed to beneficiaries, the beneficiaries shall file and pay the tax;
Consolidation of Income of Two or More Trusts
****Where two or more trusts are created by the same grantor, and the beneficiary in each instance is
the same person, the fiduciaries shall file a separate return for, and pay the income tax of, each trust,
but the Commissioner of Internal Revenue shall cause the income tax to be computed on the
consolidated taxable income of the several trusts, allowing one exemption only of P20,000.
* The income tax computed on the consolidated taxable income shall be allocated between the
several trusts in proportion to their respective taxable income.

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PART II- GROSS INCOME, EXCLUSIONS AND DEDUCTIONS FROM GROSS INCOME
PROBLEM I
Mr. and Mrs. Es wealth come from the income producing properties, i.e., the condominium owned by
Mr. E and the farm inherited by Mrs. E. During the taxable year, they received the following items.
Assume that they use the accrual basis of accounting.
Mr. E
Inheritance received
Monthly rentals from the condominium owned
Advance rental , received June 2011from which was recognized
as revenue for 2 months, not included in the monthly rentals
above
Security deposits from new tenants
From lessees who violated the terms of the lease
From lessees who had not violated the terms of the lease
Real estate tax on the property of the lessor and was paid by the
lessee
Leasehold improvement made by a lessee, with a useful life of 8
years( lessees remaining term is 5 years; income to be
recognized using the spread out method)
Depreciation of Buildings
Other operating expenses
Mrs. E
Sale of livestock and farm products raised
Sale of livestock and farm products
Expenses in raising livestock and farm products
Cost of livestock and farm products sold
Rent income of farm equipment
Sale of farm equipment
Book value of farm equipment sold
Proceeds of livestock and crop insurance
Expenses of raising livestock and farm products destroyed
flood (not included in the P1,800,000)
Increase in the inventory

P8,000,000
1
P100,000,000
2
200,000

80,000
120,000
50,000
200,000

20,000,000
10,000,000

P3,000,000
500,000
P1,800,000
200,000
80,000
850,000
750,000
500,000
600,000

by

20,000

Determine the taxable income of (A) Mr. E and (B) Mrs. E.


A. Revenues from monthly rentals
Advance Rental
Security deposits earned
Real estate tax paid by the lessee
Income from the leasehold improvement
Total Gross Income
Less: Depreciation of the Condominium
Other operating expenses
Personal Exemptions
Taxable Income

P100,000,000
2
200,000
3
80,000
50,000
15,000
P100,345,000
P 20,000,000
10,000,000
50,000

(30,050,000)
P 70,295,000

Explanations:
Items considered as rental income:
1

a. Agreed amount per month or per year


b. Obligations of lessor to third parties which the lessee undertakes to pay as further consideration of
the lease, such as:
1. Real estate taxes on leased premises paid by the lessee

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2. Insurance premiums paid by lessee on policy covering leased property
2

Prepaid or advance rental is taxable income to the lessor in the year received, if so received under a
claim of right and without restriction as to its use, and regardless of method of accounting employed.
3

Security deposit applied to the rental of the terminal month or period of contract must be recognized
as income at the time it is applied. If security deposit is to ensure contract compliance, it is not income
to the lessor UNTIL the lessee violates any provision of the contract.
B. Sale of livestock and farm products raised
Sale of livestock and farm products
Rent income of farm equipment
Gain from sale of farm equipment:
Proceeds from sale of farm equipment
Less: Book value of farm equipment sold
Proceeds of livestock and crop insurance
Total
Less: Cost of livestock and farm products sold
Expenses of raising livestock and farm products
Cost of livestock and farm products lost in flood
Personal Exemptions
Taxable Income

P3,000,000
500,000
80,000
P 850,000
(750,000)

200,000
1,800,000
600,000
50,000

100,000
500,000
P4,180,000

2,650,000
P1,530,000

Note: all income should be included in the computation of the taxable income, unless they are
specifically excluded by law.

PROBLEM II
V Corporation, a domestic corporation, had the following data for the taxable year 2012
Net Sales
Damages received in actions:
Predatory pricing
Tortuous injury to delivery equipment
Tax Refunds, as follows:
Fringe Benefits Tax
Normal Corporate Tax
Motor Vehicle registration fees
Value Added Tax
Prize won for having the best display
Bad Debt Recovery:
Written off when there was a net
income of P800,000 before write off
Written off when there was a net loss
of P200,000 before write off
Cost of Sales
Other operating expenses

P5,000,000

500,000
400,000
30,000
64,000
2,000
20,000
10,000
50,000
30,000
2

1,500,000
2,000,000

Compute the taxable income of V Corporation


Net Sales
Cost of Sales
Gross Profit from sales
Damages awarded (predatory pricing)
Refund of Fringe Benefit Tax
Refund of Motor Vehicle registration fees
Prize won

P 5,000,000
2
1,500,000
P 3,500,000
P500,000*
30,000**
2,000
P 10,000***

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Bad debt recovery
Gross Income
Less:
Taxable Income
Explanations:

P50,000****

592,000
4,092,000
2,000,000
P2,092,000

* Damages for Personal injuries refer only to PHYSICAL INJURIES are excluded from gross income.
Damages from all other forms of injuries are NOT EXCLUDED.
**As a rule, refunds of TAXES are NOT TAXABLE. An exception thereto however is the refund of
fringe benefit, subject to the Tax Benefit Rule.
***A corporation is not subject to FWT on winnings, and on prizes not exceeding P10,000. Hence, all
winnings and prizes it receives are subject to corporate tax.
****Recovery of Bad Debts WRITTEN OFF, as a rule is taxable. However, it is subject to the Tax
Benefit Rule. Hence, should the writing off of bad debts result in a tax benefit, i.e., a reduction of the
tax due and payable of the taxpayer for a period, the recovery thereof is TAXABLE. Otherwise, such
recovery, if such did not result in the reduction of tax due, is NOT TAXABLE.

PROBLEM III
Taxpayer U is an individual on the cash basis of accounting. For the taxable year 2012, he has the
following data with respect to its net income:
Gross profit on sales
Interest income on Philippine Bank Deposit
Dividend income from a Domestic Corporation
Other business expenses
Interest paid on Bank Loan 1
Interest paid on Bank Loan 2, on a net Proceeds of
P80,000, payable in two installments, 2011 and 2
Interest paid on a trade note payable
Interest paid to a brother on a loan related to
business
Income tax of the preceding year
Value Added Tax
Registration Fee of Business with the BIR
Local Taxes and License
Community Taxes
Interest paid for late payment of taxes
Penalties for payment of taxes

P1,600,000
6,000
5,000
1,800,000
40,000
20,000
5,000
6,000
35,000
35,000
500
12,000
4,205
3,520
20,000

Determine A) Deduction for Interest Expense and B) Deduction for Taxes and Licenses
A. Interest paid on Bank Loan 1
Interest paid on Bank Loan 2
Interest paid on a trade note payable
Interest paid for late payment of taxes
Total
Less: 33% of Interest income on Philippine Bank Deposits
Deductions for Interest
Explanation:
*Rules on Deductibility of Interest Expense

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P 40,000
10,000
5,000
3,520
P 58,520
(2,000)*
P 56,520

Income Taxation | TAXATION LAW


Rule: The ENTIRE AMOUNT shall be ALLOWED AS A DEDUCTION from the taxpayer's gross
income.
Limitation: The amount of deductible interest shall be REDUCED BY THE FOLLOWING RATES of
the INTEREST INCOME EARNED WHICH HAD BEEN SUBJECTED TO FINAL WITHHOLDING
TAX.
Nov. 1, 2005 to Dec. 31, 2008 42%
Effective Jan. 1, 2009 33%
B. Registration Fee
Local Taxes and License
Community Taxes
Total

500
12,000
4,205*
P 16, 705

Explanation:
*Requisites for Deductibility of TAXES and LICENSES
1. Payments must be for taxes.
2. The word taxes means taxes proper and no deduction should be allowed for amounts
representing interest, surcharge, or penalties incident to delinquency.
3. Tax must be imposed by law on, and payable by the taxpayer.
4. Taxes are deductible as such only by the persons upon whom they are imposed by law.
Indirect taxes, like the VAT, passed on by sellers are not deductible by the buyers from their
gross income.
5. Paid or incurred during the taxable year in connection with taxpayers trade, business or
profession; and
6. Taxes are not specifically excluded by law from being deducted from the taxpayers gross
income.
Taxes NOT Deductible
1. Philippine income tax;
2. Foreign income tax, IF taxpayer avails of the foreign tax credit;
3. Estate and donors tax;
4. Special assessments and taxes assessed against local benefits of a kind that
tends to increase the value of the property assessed;

PROBLEM IV
Corporation T, a domestic corporation, has the following data with respect to its income
2011
Gross profit from sales
Operating expenses
Dividend from Domestic Corporation
Interest income from trade notes payable
Capital Gains from the Direct Sale to Buyer of Shares of Stock

2012
Gross Profit from sales
Other operating expenses
Loss by fire of a Warehouse
Cost
Accumulated Depreciation
Insurance Recovery
Loss by embezzlement, recovered 50,000 from the bonding
company, and filed a case in court for the whole amount
of the embezzlement

P1,600,000
1,800,000
20,000
15,000
100,000

P 3,000,000
1,200,000
2,000,000
800,000
700,000
150,000

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Loss by accident of a delivery equipment
Cost
Accumulated Depreciation
Cost to restore back to normal working condition
Insurance recovery

1,500,000
800,000
250,000
180,000

Determine A) Net operating loss that may be carried-over to the next three (3) consecutive
years and B) Casualty loss for 2012
A.

Gross profit from sales


Interest income from trade notes payable
Total
Less: Operating expenses
Net Operating Loss

P1,600,000
15,000
1,615,000
(1,800,000)
(185,000)*

Explanation:
* The NOLCO to be carried over shall be the excess of the expenses over the income of a previous
year.
B.

Warehouse
Cost
Less: Accumulated Depreciation
Net book value
Less: Insurance recovery

P2,000,000
P(800,000)
1,200,000
(700,000)

Delivery Equipment
Cost
Less: Accumulated Depreciation
Net book value
Cost to Restore

1,500,000
(800,000)
700,000 (a)
250,000 (b)

Indicated Loss (lower of a or b)


Less: Insurance Recovery
Deduction for Losses

250,000
180,000

P 500,000*

70,000**
P570,000

Explanation:
* If the loss it total - the basis of the loss is the net book value immediately preceding the casualty to
be reduced by the amount of insurance or compensation received.
** if the loss is partial - the replacement cost to restore the property to its normal operating condition,
but in no case shall the deductible loss be more than the net book value of the property as a whole,
immediately before casualty. The excess over the net book value immediately before the casualty
should be capitalized, subject to depreciation over the remaining useful life of the property.

PROBLEM V
Corporation S, a domestic corporation, is in a manufacturing business. Data, with respect to its
income, are as follows:
Gross profit from sales
Depreciation of buildings-manufacturing
Amortization of Patents
Contributions to a pension trust
For Past Service Cost
For Present Service Cost

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2012 CENTRALIZED BAR OPERATIONS

P20,000,000
200,000
300,000
2,000,000
50,000

Income Taxation | TAXATION LAW


Provision for Bad Debts (those written off amounted to P60,000)
Research and development costs, the benefits to be received from
nd
it beginning the 2 semester of the year
Expenditure for leasehold improvement
useful life - 30 years; Lease term - 20 years
Contributions:
To the Government, for a priority activity in housing
To the Quiapo Catholic Church
To NGOs organized and operated for charitable purposes
To rape victims
Other Expenses of Operations
Determine the Taxable Income
Gross profit from sales
Less: Depreciation of buildings
Depreciation of Leasehold Improvements
Amortization of Patents
Contributions to Pension Trust
Past Service Cost
Present Service Cost
Bad Debts write-off
Research and Developments cost
Other Operating Expenses
Taxable Income before Contributions
Less: Contributions
Fully Deductible
To the government
Deductible, subject to limitations
To Quiapo Church
5,000
To the N
500,000
Total
P505,000
5% of P9,030,000
P451,500
Allowed
P451,500
Taxable Income

70,000
100,000
1,200,000

200,000
5,000
500,000
12,000
10,000,000

P20,000,000
P200,000
60,000*
300,000
200,000**
50,000**
60,000***
100,000
10,000,000

(10,970,000)
P9,030,000

200,000****

451,500*****

(651,500)
P8,378,500

Explanations:
* P1,200,000/20 years lease term
** Contributions of employers for Pension Trust of employees for past and present service cost are
deductible contributions, conditions complied with.
*** Debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the
taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold
or services rendered shall be deductible once written-off in the books.
**** all donations to the government are fully deductible
***** all donations to accredited NGOs, which does not comply with requirements for full deduction
shall be subject to limitations for partial deductions

PROBLEM VI
A corporate taxpayer has the following gross income or deductions for five consecutive years.

Gross Income
Deductions

2010
P1,050,000
P1,225,000

2011
P875,000
822,500

2012
P350,000
315,000

2013
P525,000
472,500

2014
P875,000
595,000

San Beda College of Law 155


2012 CENTRALIZED BAR OPERATIONS

TAXATION LAW | Income Taxation

Compute the TAX DUE AND PAYABLE for the said taxable years

Gross Income
Deductions
Taxable Income:
before NOLCO
Less: NOLCO
Taxable Income
subject to NCIT
Income Tax under
30% NCIT
Income Tax under
2% MCIT
INCOME TAX DUE
and PAYABLE

2010
P1,050,000
P1,225,000

2011
875,000
822,500

2012
350,000
315,000

2013
525,000
472,500

2014
875,000
595,000

52,500
52,500

35,000
35,000

52,000
52,000

280,000
0**

280,000

84,000

P21,000

17,500

7,000

10,500

17,500

P21,000****

P17,500***

P7,000

P10,500

P84,000*

(175,000)
0

Explanations:
* P280,000 x 30% NCIT = P84,000
**NOLCO can be carried over only up to three years subsequent to the year which Loss was incurred.
*** The tax payable for the year is the NCIT after applying NOLCO and MCIT, whichever is higher.
**** MCIT is computed by multiplying the gross income before deductions with 2% (P1,050,000 x 2%
= P21,000).

156 San Beda College of Law


2012 CENTRALIZED BAR OPERATIONS