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TAXATION

1 ATTY. BELLO

I.

INTRODUCTION AND GENERAL PRINCIPLES

A. GENERAL PRINCIPLES

Taxation - Power by which the sovereign through its law-making body, raises revenue to
defray the necessary expenses of the government

- As a symbiotic relationship: in exchange for the protection of that the citizens get from
the Government, taxes are paid
o Rationale: Taxes are what we pay for civilized society and w/out it,
the government will be paralyzed
o This theory dispels the erroneous notion that it is an arbitrary
method of exaction by those in the seat of power

Taxes - Enforced proportional contributions from persons and property levied by the
law-making body of the State by virtue of its sovereignty for the supports of the
government and for public needs.

Characteristics of Taxation

Enforced
Proportionate Contribution
Levied by the legislature
Within taxing jurisdiction
o Nationality
o Residence
o Source (territoriality)
Personal in nature
Primary purpose is to raise revenue

Attributes/Characteristics of Taxes (Aban)
1. As a forced charge, imposition or contribution it operates in invitum
It is in no way dependent on the will or contractual assent, express or
implied, of the taxpayer
They are also not contracts but positive acts of the government
2. As a pecuniary burden payable in money
A tax is not necessarily confined to those payable in money
E.g. backpay certificates under RA 304 could be used as payment of
taxes
3. As creations by law
4. Assessed in accordance w/ some reasonable rule of apportionment
Progressive so based on ability to pay

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Evolve a progressive system of taxation resort to indirect taxes


should be minimized but not avoided entirely
5. Imposed by the State on persons, property or services within its jurisdiction
6. Levied for a public purpose
It is the primarily a civil liability but non-payment thereof creates a
criminal liability
Importance of Taxes
Taxation is the lifeblood of the government so they should be calculated w/out
necessary hindrance; thus, taxes should be paid and collected without delay
Primary purpose is to generate funds for the state to finance the needs of the
citizenry and to advance common weal

Taxes, personal to taxpayer
Corporations delinquency cannot be enforced against its stockholders
Stockholders may be held liable for unpaid taxes of a dissolved corporation if it
appears that the corporate assets have been passed into their hands
Estate taxes must be paid out of the estate and cannot be enforced against the
heirs
Exception: if properties have already been distributed to the beneficiaries prior
payment of the state tax due, beneficiaries shall be subsidiarily liable

Nature of the taxing power
It is an attribute of sovereignty and inherent in the State
Unlimited in its range, acknowledging in its very nature no limits, so that
security against its abuse is to be found only in the responsibility of the
legislature which imposes the tax on the constituency who are to pay it
An awesome power that must not be exercised arbitrarily
Power emanating from necessity preservation of States sovereignty
Not granted by the Constitution
Legislative in character

Purpose and Objectives of Taxation
1. Primary to raise revenues fir the support of the govt
2. Secondary
a. Regulation: Illustrated in the case of taxes levied on excises or
privileges or for the rehabilitation and stabilization of threated
industries

TIO v. VIDEOGRAM REGULATORY BOARD, 151 SCRA 208 (1987)
PD 1987 (Act Creating the VRB) imposes 30% tax on sales. Videogram operators
assail the constitutionality of the said provision claiming that the said tax imposed
is harsh, confiscatory, oppressive and/or unlawful and is a restraint on trade. Court
upheld its constitutionality.

TAXATION 1 ATTY. BELLO



30% tax on sale, lease or disposition of videograms is for a public purpose. Taxation
could be a tool to implement the States public power. Tax was imposed primarily
to answer the need to regulate the video industry due in part to rampant film
piracy, violation of IP rights and proliferation of porn.
A tax does not cease to be valid merely because it regulates, discourages or even
definitely deters the activities taxed.

Promotion of General Welfare: E.g. for strengthening industries



LUTZ v. ARANETA, 98 PHIL. 148 (1955)
Petitioners in this case assail the legality of taxes imposed by CA 567 (Sugar
Adjustment Act). Lutz, Judicial Administrator of Ledesmas estate goes to court to
recover from CIR taxes paid on the ground that the said tax is unconstitutional for
being levied exclusively for the benefit of the sugar industry; thus, there is no public
purpose to speak of.
Tax collected on land devoted to cultivation of sugar cane, which tax shall accrue
exclusively and for the aid and support of the sugar industry, is valid. Tax levied
with a regulatory purpose, to provide means for the rehabilitation and stabilization
of the threatened sugar industry. Since sugar production is one of the great
industries of the nation, its promotion, protection and advancement therefore
redounds greatly to the general welfare.
The protection of a large industry constituting one of the great sources of the
states wealth and therefore directly of indirectly affecting the welfare of so great a
portion of the population of the State is affected to such extent by public interests
as to be within the police power of the sovereign

c. Reduction of Social Inequality: Made possible by progressivity
those who are able to pay should shoulder the bigger portion of the
tax burden
d. Encourage Economic Growth: Tax exemptions and tax reliefs are
granted as incentives or exemptions in order to encourage
investments and thereby promote economic growth
e. Protectionism: E.g. Taxes like protective tariffs and customs duties

Theory and Basis of Taxation

1. Lifeblood theory:

COMMISSIONER OF INTERNAL REVENUE v. ALGUE, 241 Phil. 829 (1988)
Algue declared in his income tax return promotional fees as expenses that are
deductible to his gross income. CIR disallowed the deduction but Algue was able to
prove that such was a legitimate expense that is necessary and reasonable.
The burden is on the taxpayer to prove that validity of a claimed deduction, in

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correlation with the lifeblood theory.


Without revenue raised from taxation, the government will not survive, resulting in
detriment to society. Without taxes, the government would be paralyzed for lack of
motive power to activate and operate it.


2.


b.

3.

4.

Necessity Theory: The existence of government is a necessity that it cannot


continue w/out the means to pay its expenses so it has the right to compel all
citizens and property within its limits to contribute.
The Benefits-Protection Theory
So called Symbiotic Relationship theory
Reciprocal duties of protection and support between State and
inhabitants
Inhabitants pay taxes and in return receive benefits and protection from
the State
Jurisdiction over subject and object
The person or property taxed must be within the competent authoritys
taxing jurisdiction
o Situs, source or territoriality (location of economic activity,
location of property, source of income)
o Citizenship
o Residence


Scope of the Legislative Taxing Power
1. Person, property or occupation to be taxed
2. Amount or rate of the tax
3. Purposes for which taxes shall be levied (public purposes)
4. Kind of tax to be collected
5. Apportionment of the tax
6. Situs of taxation
7. Method of collection

Is the power to tax the power to destroy?
Power to tax involves the power to destroy but this principles is pertinent only
when there is no power to tax a particularly subject and has no relation to a
case where such right to tax exists
This principles does not refer to the purposes for which taxing power may be
used but to the degree of vigor with which the taxing power may be employed
in order to raise revenue

Constitutional Restrains Re: Taxation is the power to destroy
The power to tax is unlimited because a legislative body having the power to
tax a certain subject matter actually imposes such a burdensome tax as
effectually destroy the right to perform the act or to use the property subject

TAXATION 1 ATTY. BELLO



to the tax, the validity of the enactment depends upon the nature and
character of the right to destroy.
The power to tax is not the power to destroy in accordance with constitutional
restrains
It must be used justly and not treacherously
Power of Judicial Review in Taxation
Courts cannot acquire into the wisdom of a taxing act
As long as the legislature does not violate applicable constitutional limitations,
courts have no concern with the wisdom or policy of the exaction, the political
or other collateral motives behind it, the amount to be raised or the persons,
property or other privileges to be taxed.
Courts power in taxation is limited only to the application and interpretation
of the law
This principles of judicial non-interference also extends into the administration
realm

Aspects of Taxation
1. Levy - a legislative power which includes the determination of persons,
property or excises to be taxed, the sum or sums to be raised, the due date
thereof and the time and manner of levying and collecting taxes
2. Collection manner or enforcement of the obligation on the part of those who
are taxed

Basic Principles of Sound Tax System
1. Theoretical Justice
Principles mandate that taxes must be just, reasonable and fair
Taxation must be based on TPs ability to pay (progressive)
Violation of this principle could result in unconstitutionality of the tax
imposition (under the Constitution, taxes shall be uniform and equitable)
2. Fiscal adequacy
Sources of government revenue should be sufficient to meet government
expenditures and other public needs
Even if the tax law fails to observe this principle, in that tax proceeds are
insufficient to meet spending, the tax law is still valid
3. Administrative Feasibility
Should be capable of being effectively enforced
Tax laws should close loopholes for tax evasion and deter corruption of
tax officials
No law requiring compliance with this principle



Power of Taxation Compared with Other State Powers



Taxation
Eminent Domain
Purpose
To support govt
For public use

Compensation Protection and


benefits received
from govt
Persons
Operate upon a
Affected
community or a class
of individuals
Authority w/c Exercised only by the
exercises
govt or its political
power
subdivisions

Amount of
imposition

Generally no limit to
the amount of tax
that may be imposed

Just compensation

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Police Power
Promote general
welfare, public
health, public
morals and public
safety
Maintenance for
public order

Operates on individual Operate upon a


property owner
community or a
class of individuals
May be exercised by
Exercised only by
public services
the govt or its
corporation or public
political subdivisions
utilities if granted by
law
No imposition; rather Limited to cost of
it is the property
regulation
owner of who will be
paid just
compensation



Taxes Distinguished From Other Impositions

Toll
Toll is a demand of ownership; tax is a
demand of sovereignty
Penalty
Tax is a civil liability and it only becomes a
criminal liability when there is non-
payment; penalty is a punishment for the
commission of a crime
Compromise or compromise penalty
An amount collected as a compromise in
cases involving violations of the Tax code,
rules or regulations. It cannot be imposed
by the commissioner
Special assessment
1) levied only on a land 2) cannot be made
a personal liability 3) based wholly on a
benefit and 4) is exceptional both as to
time and locality; tax exemptions under
Sec. 28(3) of Art VI of the Constitution do
not apply to special assessments; LGC

TAXATION 1 ATTY. BELLO



License fee

Margin Fee

Debt

Regulatory Fees
Subsidy

Custom duties and fees

Revenue


provides that SAs do not apply to
properties exempt from the basic real
property tax under Sec. 234
a) License fee emanates from the
police power; taxation is a power
b) Purpose is to regulate not to
raise revenue
c) Amount of exaction or charge
*motor vehicle registration was ruled to
be a tax because such was collected for
the construction and maintenance of
highways plus expenses of LTO
**3 kinds of licenses:
1) licenses for the regulation of
useful occupations
2) licenses for the regulation or
restriction of non-useful
occupations or enterprises
3) licenses for revenue only
Not a tax but a currency measure designed
to stabilize the currency such as the
exaction of a certain fee under RA 2069 on
the remittance of profits earned in the
country
Debt is an obligation that is created by
contract while tax is imposed by law. Thus,
taxes cannot be set-off or compensated
under the Civil Code.
An exaction may both be a tax and a
regulatory fee. (Tio v. Videogram)
A subsidy is a legislative grant of money in
aid of private enterprise deemed to
promote public welfare. It is not tax
although it may be necessary to raise the
money to pay the subsidy by means of a
tax. Subsidies are sometimes given in lieu
of tax exemptions.
They are taxes but charged upon
commodities on their being
imported/exported but tax is a broader
term which includes other taxes as well
It is a broad term and it includes not only
taxes but other incomes as well

Tribute

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Synonymous with tax but. Implied as


something from the government to some
form of sovereignty
In the general sense, it signifies any tax,
tribute or duty; in the limited sense, it
means a duty on imported goods and
merchandise

Impost


Classification of Taxes
Personal Tax

Property Tax

Direct Tax

Indirect Tax

a)

b)

c)

Also known as capitation or poll


Taxes of a fixed amount upon al persons of a certain class
within the jurisdiction of the taxing power w/out regard to
the amount of their property or the occupations or
businesses which they may be engaged
Assessed on all property or all property of certain class within
the jurisdiction of the taxing power
e.g. real property tax
Taxes wherein both the incidence of or liability for the
payment of the tax as well as the impact or burden of the tax
falls on the same person
E.g. income tax where the person subject to tax cannot shift
the burden of the tax to another person -> estate and donors
gift taxes
Taxes within the incidence of or the liability of the payment
of the tax falls on one person, but the burden thereof can be
shifted or passes on to another person
E.g. sales tax (VAT)
When the seller passes on the burden to the buyer, it is not
against the rule that provides that taxes are personal
liabilities so payment thereof cannot be transferred. He is
only shifting the tax burden and not the liability to pay it to
the purchaser as part of the cost of the goods or services sold
When consumer or end-user is tax exempt, such exemption
covers only those which he is directly liable; hence, he cannot
claim for exemption for the payment of sales tax or refund
such tax passed on to him
When the transaction itself is the one that is tax-exempt but
through error seller pays the tax and shifts it to the buyer, he
seller gets the refund but he must hold it in trust for the
buyer
When the exemption from the indirect tax is given to the
contractee but the evident intention is to exempt the
contractor so that such contractor may no longer shift or pass

TAXATION 1 ATTY. BELLO



d)

Excise Tax

General Tax

Special Tax

Specific Tax

Ad Valorem
Tax
Custom
Duties

National Tax

Local Tax

Progressive
Tax
Regressive
Tax
Proportionate
Tax

on any tax on the contractee, the contractor may claim tax


exemption on the transaction
When a it is the intention of the law to exempt an indirect
tax, the buyer has the right to be reimbursed the amount of
the taxes the sellers passed to him
Laid upon the manufacture, sale or consumption of
commodities or even upon licenses to purse certain
occupations and upon corporate privileges
Levied for the general or ordinary purposes of the
government.
E.g. internal revenue taxes
Taxes levied for special purposes
E.g. additional 1% real estate tax levied under RA 5447 for the
benefit of the public school system
All money collected on any tax levied for a special purpose
shall be treated as a special fund and paid out for such
purpose only
A tax imposed on specific sum by the hear or number or by
some standard or weight or measurement and which requires
no assessment beyond a listing and classification of the
subject to be taxed
E.g. alcohol, tobacco
Tax upon the value of the article or thing subject to taxation
E.g. real property tax
Duty sometimes used in the general sense as synonymous
with tax
Duties charged upon commodities imported/exported
Taxes levied by the national government
Local governments have a just share in these taxes which are
automatically released to them
Levied by LGUs subject to guidelines and limitations provided
by the Congress
Taxes imposed whereby the rate or amount of tax increases
as the amount of income or earning to be taxed increases
Taxes whereby the tax rate decreases as the amount of
income or earning to be taxed increases
Tax based on a fix proportion of the value of the subject being
taxed
E.g. real estate tax which is a fixed proportion of the value of
the property assessed

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Taxpayers Suit

The taxpayer has the right to file an action questioning the validity or
constitutionality of a statute or law on the theory that the expenditure of
public funds by an officer or the Government for the purpose of administering
or implementing an unconstitutional or invalid law constitutes a misapplication
of such funds
A duly elected Senator and taxpayer has the legal capacity to file an action
questioning the legality of a claimed refund of indirect taxes (Maceda v.
Macaraig)
A derivative or representative suit filed by a group of taxpayers who are
also concilors of a city where it appeared that there was an illegal
disbursement of public funds emanating from such taxes was held valid (City
Council of Cebu City v. Cuizon et al.)
In order to justify such suit, public funds should be involved so an action will
fail if what are alleged to be illegally disposed are objects which were acquired
from private sources (Joya et al v. PCGG et al)

B. LIMITATIONS ON TAXING POWER
1. Inherent Limitations on Taxing Power
They proceed from the very nature of the taxing power itself
Such limitations exist whether declared or not declared in the written
constitution
a. Public purpose of taxes
o Legislature is without the power to appropriate revenues for
anything but for public purposes
o Public money can only be spent for a public purpose
o Tests:
WoN thing to be furthered by the appropriation of public
revenue is something which is the duty to the state as a
government to provide
WoN the proceeds of the tax will directly promote the
welfare of the community in equal measure
o E.g. infrastructure, charity, self-help projects for the destitutes,
tax levied for the upliftment of the sugar industry
b. Inherently legislative
o To whom can be delegated:
i. President
Authorization of President to fix
a. Tariff rates
b. Improt and export quotas
c. Tonnage an wharfage dues

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Other duties and imposts within the development


program of the Government
Flexible tariff clause (Sec. 401 TCCP): in the interest of
national economy, general welfare and/or national
security, the President upon the recommendation of
the NEDA is empowered:
o To increase, reduce or remove existing
protective rates of import duty, provided that
the increase should not be higher than 100%
ad valorem
o To establish import quota or to ban imports of
any commodity
o To impose additional duty on all imports, not
exceeding 10% ad valorem
ii. LGUs each LGU has the power to create its own revenue
and levy taxes, fees and charges subject to such guidelines
and limitations as the Congress may provide (Art X, Sec 5,
1987 Constitution)

MACTAN INTL AIRPORT AUTHORITY v. MARCOS, 261 SCRA 667 (1996)
City of Cebu tries to collect from MCIAA claiming that the latter is a GOCC so its tax
exemption was already removed by the LGC. Nevertheless, Court ruled in favor of
MCIAA emphasizing the fact that the power of LGUs to tax is limited and subject to
guidelines.
The power to tax is primarily vested in Congress; however, in our jurisdiction, it
may be exercised by local legislative bodies, no longer by virtue of a valid
delegation as before, but pursuant to direct authority conferred by Sec. 5, Art X of
the Constitution. Under the latter, the exercise of the power may be subject to such
guidelines and limitations as the Congress may provide which, however, must be
consistent with the basic policy of local autonomy.
Currently, Titles I (Local Taxation) and II (RPT) of Book II, LGC of 1991 prescribe the
guidelines and limitations of local taxing power

iii. Administrative Agencies
For the delegation to be valid, the law must be
complete in itself and must set forth the sufficient
standards
Examples: Sec. 244 of the NIRC authorizes the SOF
upon recommendation of the CIR, to promulgate
needful rules and regulations for the effective
enforcement of the NIRC
o Manner n which returns, information and
reports is prepared and reported

d.

c.

d.

e.

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o Manner of paying taxes


o Etc.
o What cannot be delegated:
Selection of property to be taxed
Determination of the purposes for which taxes shall be
levied
Fixing of the rate of taxation
Rules of taxation in general
Territoriality or situs of taxation
o Situs Principle in General place of taxation
o The State where the subject to be taxed has a situs may
rightfully levy and collect the tax.
Exceptions
- Where the tax laws operate outside the territorial
jurisdiction of the taxing state e.g. taxation of
resident citizens on their foreign source income
- Where tax laws do not operate within the territorial
jurisdiction e.g. waiver of taxing jurisdiction via treaty
or international comity
o Situs of income tax
Domiciliary theory based on residence
Nationality theory based on citizenship
Source rule where the activity that produced the
income took place
o Situs of property taxes
Real property lex rei situs or where the property is
located
Personal Property mobilia sequntur personam or
where movable follows owner; movables follow
domicile of the owner
Exemption of the Government from Taxes
o Government cannot tax itself
o Sec.32(B)(7)(b): income derived from any public utility or
from the exercise of any essential government function
accruing to the Government of the Philippines or to any
political subdivision thereof
International comity
o Harmonious and productive relationships among the various
states should be maintained
o Certain representatives of foreign states stationed and
property of such foreign states found within our territory be
exempted from taxation from taxation
o Sec. 159 of LGC: Diplomatic and consular representatives
are exempted from community tax

TAXATION 1 ATTY. BELLO




2.

Constitutional Limitations on Taxing Power


Constitutional Provisions directly affecting taxation
a) Prohibition against imprisonment for non-payment of poll tax
b) Uniformity and equality of taxation
- All taxable articles or kinds of property of the same class shall be taxed at the
same rate
c) Grant by Congress of authority to the President to impose tariff rates
d) Prohibition against taxation of religious, charitable entities, and educational
entities
e) Prohibition against taxation of non-stock, non-profit institutions
f) Majority vote of Congress for grant of tax exemption
g) Prohibition on use of tax levied for special purpose
h) Presidents veto power on appropriations, revenues, tariff bills
i) Non-impairment of jurisdiction of the SC
- The Supreme Court has the right to review, revise, reverse, modify or affirm
on appeal or certiorari final judgments and order of lower courts in all cases
involving the legality of any tax, impost, assessment or toll, or any penalty
imposed in relation thereto
j) Grant of power to the LGUs to create its own source of revenues
k) Flexible tariff clause
l) Exemption from real property taxes
m) No appropriation or use of public money for religious purposes

Constitutional provision indirectly affecting taxation
a) Due process a tax should not be of a confiscatory nature
b) Equal protection - reasonable and natural classifications for the purpose of
taxation
c) Religious freedom
d) Non-impairment of obligations of contracts

VAT RULING No. 7-2006, June 7, 2006
SPEX, SPL, CHEVRON and PNOC-EC are service contractors of the government
trough the DOE Service Contract 38. Through Section 12(a) of PD 87, they are
exempted from all taxes except income tax.
The query delves on the issue WoN pursuant to RA 9337, their sales of natural gas
in whatever form or state from the Malampaya Project have become subject to VAT
BIR in its reply expressed that RA 9337 provides an enumeration of the laws its
enactment has rendered repealed. PD No. 87 was not included in the list.
Moreover, the general repealing clause cannot also be deemed to have affected
the provisions of PD 87 which was a special law.
As regards the non-impairment of contracts, the tax exemption privilege of the

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Service Contract under SC 38 is a contractual tax exemption granted by the


government in exchange for a valid and material consideration obtained by the
government in exchange for granting SC 38 the right to be exempt from all taxes
except income tax. Such contact is protected by the non-impairment clause of the
Constitution.
Tax exemptions granted by government in contracts vs. tax exemptions contained
special franchises: A franchise partake the nature of a grant which is beyond the
purview of the non-impairment clause of the Constitution. Thus, contractual tax
exemptions are subject to the NIC of the Constitution while tax exemptions granted
under legislative franchises are no.



C.

DOUBLE TAXATION

Double Taxation Taxing the same property twice when it should be taxed but once OR
taxing the same person twice by the same jurisdiction over the same thing

No prohibition against double taxation
It is something not favored but nevertheless permissible
Not forbidden by our fundamental law

Requisites of double taxation in the obnoxious sense (hence may be invalidated under
the due process clause)
Same property is taxed twice
Both taxes are imposed on the same property or same subject matter for the
same purpose
Imposed by the same taxing authority
Within the same jurisdiction
During the same period and
Covering the same kind and character of tax

Kinds of Double Taxation
1. Direct Duplicate Taxation
Same property is taxed twice when it should be taxed only once AND both
taxes are imposed on the same property or subject matter for the same
purpose by the same State, Government or taxing authority
2. Indirect Duplicate Taxation
Opposite of direct duplicate taxation
Instances
o TPs businesses as distinct taxable businesses from one another
o License tax on business or occupation v. Property tax on land or
property used in connection therewith

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o
o
o
o
o
o

Both license fee and tax imposed on business or occupation for


selling the same article
Local tax levied on the sale or disposal of an article v. Tax on the
business of selling such product
Tax imposed both on the occupation of fishing and the fishpond itself
Local tax on storage of copra v. Sales tax
Additional 1% tax v. Penalty thereof
Income tax v. Tax on dividends


Means Employed to Avoid Double Taxation
Unilateral: Tax reliefs, tax deductions, tax credits, tax exemption, allowance on
the principle of reciprocity
o Applies also to resident aliens provided that the reciprocity
requirement is satisfied:
Alien invidividual WoN resident in the PH only those
income derived within the Philippines are taxable
Foreign corporation WoN engaged in trade or business in
the Philippines - same
Bilateral: tax treaty
o Treaty override: Sec 34(B)(5)
o Treaty provision mitigates, if not entirely avoids, double taxation
o Purpose of treaty: facilitate international trade and investment by
lowering tax barriers
Income Exclusions: Treaty Override


US
RP


USCo Know-How
PhilCo



Royalties subject to US Income
Tax

Royalties subject to 30% final


withholding tax


International Juridical Double Taxation

Tax Exemptions
Grant of immunity to a particular class or persons from a tax which persons
generally within the same state or taxing district are obliged to pay
It is an immunity or privilege; it is freedom from a financial charge or burden to
which others are subjected

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Exemption allowed only if the law clearly provides for it; not presumed
Not violative of equal protection clause so long as there is a substantial
distinction
Rationale: Among others, to confer a benefit to a particular class which the
legislature feels outweighs the foregone revenue
Grounds for granting exemptions:
o May be based on a contract, e.g. petroleum service contract under
PD 987
o May be based on public policy, e.g. to encourage new industries (e.g.
MCIT exemption for 4 years of operation) or to foster charitable
institutions
o May be based on international reciprocity (e.g. exemption of foreign
vessels from excise tax on petroleum products destined for
consumption outside PH)
Nature:
o Personal to the grantee
o Generally revocable by government (unless exemption founded on a
contractual tax exemption
o Considered a waiver by the government of sovereign right to collect
taxes
o Not necessarily discriminatory (e.g. class legislation) so long as
exemption has reasonable foundation or rational basis
o Non-transferrable
Kinds:
o Express when certain persons, property or transactions are by
express provisions of law, exempted from certain taxes, in while or in
part
o Implied when a tax is levied on certain classes without mentioning
other classes
Misnomer because there is no exemption by implication;
exemption must be expressed in clear and unmistakable
language, what is involved here is the rule on strict
construction of tax imposition in favor of TP
Revocation:
o General Rule: a tax exemption may be revoked by the government
anytime
Since taxation is the rule and exemption therefrom is the
exception, the exemption thus may be withdrawn at the
pleasure of the taxing authority. Mactan Cebu Intl Airport
Authority v. Marcos, 261 SCRA 667 (1996)
o Exception: a contractual tax exemption cannot be revoked anytime
without impairing the obligation of contracts

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The only exception to this is where the exemption was


granted to private parties based on material consideration
of a mutual nature, which then becomes contractual and is
thus covered y the non-impairment clause of the
Constitution.


CONSTRUCTION OF TAX STATUTES

1. Construction of Tax Laws
A tax cannot be imposed without clear and express words for that
purpose so they are not to be implied
MANILA RAILROAD v. COLLECTOR OF CUSTOMS, 52 PHIL. 950 (1929)
Classification of dust shield/dust guard in terms of taxation
In case of doubt, tax statutes are construed most strongly against the Government
and in favor of the TP because burdens are not to be imposed beyond what the
statute expressly and clearly import
COMMISSIONER OF INTERNAL REVENUE v. FIREMENS FUND INS. CO., 148 SCRA 315
(1987)
Firemans Fund Insurance Company erroneously affixed the required doc stamps in
its insurance policies. CIR wants to collect payment for penalties due to such
violation.
Doc stamps were considered paid already giving emphasize to the fact that the real
purpose for such provisions is the collection of taxes. Thus, the purchase of stamps
is the form of payment made that considered just a means to an end that will
insure that the corresponding tax has been paid for such document while
cancellation of the stamps is to obviate the possibility that said stamps will be
reused for similar documents for similar purposes. There appears to be no dispute
on the fact that the documentary stamps have been paid for already by the
company.
In case of doubt, a statute levying a tax should be interpreted in favor of the tax
payer because burdens are not to be imposed, nor presumed to be imposed
beyond what statutes expressly and clearly import.

Tax laws nevertheless are not promulgated in order to encourage tax
evasion or tax avoidance

2. Construction of Tax Exemptions
Strictly Construed against TP
Exemptions are not favored and are construed stictissimi juris against
the TP
He who claims an exemption must be able to justify his claim or right
thereto by a grant express in terms too plain to be mistaken and too
categorical to be misinterpreted
D.

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Deductions, exclusions, condonations and claims for refund are akin


to exemption; hence, strictly construed against TP

SEA-LAND SERVICES, INC. v. COMMISSIONER OF INTERNAL REVENUE, G.R. NO. 122605,
APRIL 30, 2001
SEA-LAND claims that it is exempted from paying income tax under the RP-US
Military Bases Agreement so it is claiming a refund; nevertheless, transport or
shipment of household goods is not within the scope of the exemption.
Laws granting exemption from tax are construed strictissimi juris against the TP and
liberally in favor of the taxing power. He who seeks to be thus privileged must
justify it by words too plain to be mistaken and too categorical to be
misinterpreted.

Exceptions:
o When the law itself provides for a liberal construction
(e.g. laws granting fiscal incentives for foreign
investments)
o In case of exemptions granted to religious, charitable
and education institutions or to the government, its
agencies or to public property because they are
generally exempt from taxation

MACEDA v. MACARAIG, G.R. NO. 882291, MAY 31, 1991
Issue: WON NPC the tax exemption of NPC as to indirect taxes has ceased. Court
riled that it did not.
The rule on strict construction cannot be applied with respect to the interpretation
of laws granting exemptions to NPC. The rule on strict interpretation does not apply
in the case of exemptions granted to political subdivisions or instrumentalities of
the government.

3. Construction and Interpretation of IRRs
Authority of the SOF, in conjunction with CIR, to promulgate rules
and regulations beyond question. Such rules and regulations, as well
as administrative opinions and rulings, ordinarily should deserve
weight and respect by courts
COMMISSIONER OF INTERNAL REVENUE v. CA, 240 SCRA 368 (1995)
ROH product claimed to tax amnesty but BIR collected for tax deficiency positing
that the tax amnesty includes only assessments by the BIR after promulgation of EO
41.
EO 41 is explicit and requires only a simple application of its provisions. If it had not
been intended to include tax liabilities already assessed prior to the EO, the law
could have simply provided in its exclusionary clauses but it did not.
However, IRRs, rulings and other issuances must not override, but must remain

TAXATION 1 ATTY. BELLO



consistent with, the law they seek to apply and implement. They are intended to
carry out, neither to supplant nor to modify, the law.

4. Liberal Construction v. Strict Construction: When Applicable?
COMMISSIONER OF INTERNAL REVENUE v. PILIPINAS SHELL PETROLEUM CORP, G.R.
NO. 192398, SEPT. 29, 2014
Issue: WoN DST should be paid in lieu of a merger as regards transfer of real
property
DST is due on all conveyances, deeds, instruments, or writings whereby any land,
tenement or other realty sold shall be granted, assigned, transferred or otherwise
conveyed to the purchaser or purchasers, or to any other person or persons
designated by such purchaser or purchasers.
In SEA-LAND, there is a law that provides for tax exemption so the case called for a
strict construction. On the other hand, CIR v. PILIPINAS SHELL involves a law that
levies tax, specifically DST, on certain subjects. As a general rule, a tax law should be
strictly construed. A liberal construction then is used in determining WoN a certain
individual/transaction is subject to an exemption while construction should be
against the government in trying to know WoN a certain subject/individual is subject
to such a tax. The latter situation is obviously different from that class that is
exempted since in the first place, the subject in this circumstance is not taxed so
there is no way that it could be exempted to something it is not supposedly subject
to.

E. ESCAPE FROM TAXATION

Shifting
Shifting transfer of tax burden from the person directly liable for the tax to
someone else (e.g., the buyer)
Shifting to tax burden is generally prohibited under the law
What is shifted is the tax burden, not the liability for the tax (i.e., person
directly liable for the tax remains liable WoN the tax burden is shifted)
Only indirect taxes are shifted (e.g. VAT, excise tax, percentage tax)

Impact and Incidence
Impact of taxation is the point on which a tax is originally imposed. From
governments perspective, the statutory taxpayer (i.e. the person directly liable
to pay the tax) is the person who must pay the tax to the government
Incidence of Taxation is the point on which the tax burden finally settles (e.g.,
final consumer in transactions subject to VAT)

Tax Avoidance v. Tax Evasion
Tax avoidance is permissible; tax evasion is illegal

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Tax avoidance occurs when taxpayers take advantage of legally permissible


alternative tax rates or methods of assessing taxable
property/income/transactions in order to avoid or minimize tax liability
Tax Avoidance
Minimization of tax liabilities through legal means
Attempt to minimize taxes does not necessarily constitute fraud. A TP may
diminish his liability by any means which the law permits
E.g. Donation

COMMISSIONER OF INTERNAL REVENUE v. ESTATE OF TODA, 438 SCRA 290 (2004)



CIC
Altonaga
RMI

P200M


Taxpayers Position

P300M


CIC selling price: P100
Land and

Cost: P25
Bldg.

Gain: P75

Tax (35%): P26.25



Altonaga selling price: P200

Cost: P100

Gain: P100

Tax (5%): P5



TOTAL TAX: P31.25

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TAXATION 1 ATTY. BELLO

CIC

Altonaga

RMI

Dummy




Land and
Bldg.

P200M

BIRs Position

CIC selling price: P200
Cost: P25
Gain: P175
Tax (35%): P61.25
BIR v. TP: P61.25 v. P31.25


Factors Considered in disregarding intermediate sale to Altonaga
o Sale to A and Sale to RMI executed on the same day (first sale was
even notarized ahead of the second sale)
o As early as May 1989, CIC received P40M partial payment from RMI
(sale occurred in Aug 1989), indicating that the true buyer was RMI,
not A
o A was a close associate of toda (majority shareholder of CIC)

Tax Evasion
Means used to minimize taxes are fraudulent and illegal
Tax evasion is a term that connotes fraud through the use of pretenses or
forbidden devices to lessen or defeat taxes
Elements
o The end to be achieved, i.e., payment of less than that known by the
TP to be legally due, or paying no tax when it is shown that tax is due
o An accompanying state of mind which is described as being evil, in
bad faith, willful, deliberate, and not accidental
o A course o action (or omission) that is unlawful
SC Findings in CIR v. Estate of Toda
o All elements of tax evasion are present
o First sale: tax ploy, a sham, and without business purpose and
economic substance
o First sale was entered into for no other purpose than to evade taxes

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Scheme was entered into to convert P100M gain from ordinary gain
(subject to 35% tax) to a capital gain (subject to 5% tax)


Examples of tax evasion
o Under-declaration of taxable value
o Mis-declaration of dutiable goods
o Substantial under-declaration of taxable income for consecutive
years coupled with substantial overstatement of deductions
o Simulated sales
o Keeping of two or more books of accounts

Examples of tax avoidance
- Postponing sale of capital asset to take advantage go holding period rule which
reduces capital gain by 50%

DELPHER TRADES CORP. v. IAC, 157 SCRA 349 (1988)
Estate planning scheme resorted to by taxpayers in converting their property to shares
of stock in a corporation which they themselves owned and controlled valid. By virtue of
the deed of exchange, the taxpayers saved on estate tax. The legal right of taxpayers to
decrease the amount of what otherwise could be his taxes or altogether avoid them by
means which the law permits cannot be doubted.

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TAXATION 1 ATTY. BELLO



II.

MEANING OF INCOME AND THE REALIZATION


PRINCIPLE

SECTION 32(A)
SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income
means all income derived from whatever source, including (but not limited to) the
following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a
profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional
partnership.
SEC. 36, REV. REGS. 2
SECTION 36. Meaning of net income. The tax imposed by law is upon income. In the
computation of the tax, various classes of income must be considered: (a) Income, in the
broad sense, meaning all wealth which flows into the tax-payer other than as a mere
return of capital. It includes the forms of income specifically described as gains and
profits, including gains derived from the sale or other disposition of capital assets.
Income cannot be determined merely by reckoning cash receipts, for the statute
recognizes as income determining factor other items, among which are inventories,
accounts receivable, property exhaustion, and accounts payable for expenses incurred.
(b) Gross income, meaning income (in the broad sense) less income which is by
statutory provision or otherwise exempt from the tax imposed by law. (c) Net income,
meaning gross income less statutory deductions. The statutory deductions are, in
general, though not exclusively, expenditures other than capital expenditures,
connected with production of income. (d) In the case of a taxpayer other than a
corporation as defined in Section 84 (b) of the Code, net income means gross income
less exemptions. Ordinarily the net income is to be computed in accordance with the
method of accounting regularly employed in keeping the books of the taxpayer.


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A. WHAT IS INCOME (A DEFINITIONAL CONCEPT)?


Gross Income Inclusions (32(A)) and exclusions (32(B))
xxx
Less: Deductions (34 and 35)
xxx
Equals: Taxable Income (31(
xxx
Multiplied by: Income Tax Rate (e.g. 32%)
xxx
Income Tax Due
xxx

Gross Income starting point to determine income tax liability
32(A), All income derived from whatever source
32(A)(1) to (11), types of gross income
- Section 32 (A): a tautological definition gross income means all income
- in short, definition does not answer whether a particular item is, or is not, income

EISNER v. MACOMBER, 252 U.S. 189 (1920) The Capital-labor formulation
32(A): All income derived from whatever source
Macomber definition of income: Gain derived from capital, from labor, or from
both combined
While TP derived gain from capital, she received noting out of companys assets for
her separate use and benefit


Stock
Mrs. Macomber

dividend

of 1,100
Is this

shares
income?

with par


value of


$1,100

Held: NO

Standard Oil Company

of CA


Gain constituting income must have been derived from capital, from labor, or from
both combined; and
The gain constituting income must have ben severed from capital from the TPs
separate use, benefit and disposal
Practical application of Macomber:
- Acquired in 2005 for P1M, FMV in 2007 of P1.2M
Was there an economic gain? Yes. TP purchased shares at P1M and now it is
P1.2M (on paper)
Was there a gain derived from capital or labor? Yes from capital
Was there a gain severed from from capital for the TPs separate use, benefit
and disposal? No still part of capital

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TAXATION 1 ATTY. BELLO



Is the gain income then? NO applying their case


- Informer collects 2M reward. Income? NO
There was an economic gain
But it was not derived from capital or from labor so it was not a taxable income
- Lucky winner collects brand new Honda Civic. Income? NO. Prize not derived from
capital or from labor
There was an economic gain
But it was not derived from capital or labor

*Macomber test is problematic (too narrow; does not cover items that are clearly
income)
U.S. v. KIRBY LUMBER CO., 284 U.S. 1 (1931)
Buy-back by issuer of bonds at less than par
TPs contention relying on the definition in Eisner v. Macomber, the TP argued that
while the transaction improved its balance sheet, it did not produce any gain that
was severed from its capital
Held: we see nothing to be gained form the discussion of judicial definitions. The TP
has realized within the year an accession to income, if we take words in their plain
popular meaning as they should be taken here
Cancellation of debt is a taxable income since there was en economic gain.
In a balance sheet, it will be labeled as a gain that will go to the net worth.

HELVERING v. BRUUN, 309 U.S. 461 (1940)
TP cancelled a lease and forfeited a leasehold improvement for nonpayment of
rentals, the tenant having erected a building that added about $50,000 to the value
of the property.
Contention of TP: the increase in value (represented by the forfeited leasehold) was
not severed from his investment or received for his separate use, benefit and
disposal (citing Eisner v. Macomber)
There was an economic gain but when will the TP be taxed
Held: while economic gain is not always taxable, realization of gain need not be in
cash derived from sale of an asset. Gain may occur as a result of
Exchange of property
Payment of the TPs indebtedness
Relief from a liability
Other profit realized from the completion of a transaction
TP received back his land with a new building on it, which added an ascertainable
amount to its value. It is not necessary to recognition of taxable gain that he should
be able to sever the improvement begetting the gain from his original capital. If
that were necessary, no income could arise from the exchange of property;
whereas such gain has always been recognized as realizable taxable gain.

ALC D 2017

CIR v. GLENSHAW GLASS CO., 348 U.S. 426 (1955) all realized gains unless specifically
exempted
Glenshaw Glass
Cash payment for damages - $800,000
Punitive (2/3): $475,470
Compensatory (1/3): $324,530

Glenshaw Glass Co.


(Plaintiff)
Manufacturer of glass
bottles and containers

Antitrust lawsuit

Hartford Empire Co.


(Defendant)
Machinery used b y
Glenshaw



TP contention: 2/3 of the damage awards (punitive portion) constituted
punishment on the wrongdoer and, under the gross income definition In
Macomber, this punitive portion of the damages should not be treated as income
derived either from capital or labor; only the 1/3 portion which compensated for
loss of profits could be treated as derived from capital or from labor
Issue: Whether money received as exemplary damages for fraud or as punitive 2/3
portion of a treble damage antitrust recover must be reported by a taxpayer as
gross income
Held: damage awards taxable in their entirety
Court cast aside Macomber definition of income stating that it was not meant to
provide a touchstone to all future gross income questions:
Instead, court stated that Congress had applied not limitations as to the source of
taxable receipts, nor restrictive labels as to their nature
Congress intended to tax all gains, which court described as all accessions to
wealth, clearly realized, and over which the taxpayers have complete dominion
The mere fact that the payments were extracted form the wrong-doers as
punishment for unlawful conduct cannot detract form their character as taxable
income to the recipients
RESTATED: Congress intended to tax all gains, except those specifically exempted
The catch-all provision of IRC 32(A) (from whatever source derived) is
broad/sweeping
Source is irrelevant (income tax is source-blind)
The touchstone to all income questions become simple enrichment
(accessions to wealth) all gains are taxable (at least if clearly realized),

13

TAXATION 1 ATTY. BELLO



whether traceable to labor, to capital, or to mere good fortune



JAMES v. U.S., 366 U.S. 213 (1961)
-What is the income of a government official?
- Supplemental income
-Is a bribe taxable income?

Gross income includes gains from illegal sources. (embezzled money is taxable
income of the embezzler in the year of embezzlement)
Unlawful, as well as lawful, gains are comprehended within the term gross income
A gain constitutes taxable income, when its recipient has control over it that, as a
practical matter, he derives readily realizable economic value from it
When a TP acquires earnings, lawfully or unlawfully, and has actual command over
it, he has received income which he is required to report, even though it may still
be claimed that he is not entitled to retain the money and may be required to
return the same

B. REALIZATION REQUIREMENT

SEC. 38, REV. REGS. 2

SECTION 38. Bases of computation. Approved standard methods of accounting will
be ordinarily regarded as clearly reflecting income. A method of accounting will not,
however, be regarded as clearly reflecting income unless all items of gross income and
all deductions are treated with reasonable consistency. All items of gross income shall
be included in the gross income for the taxable year in which they are received by the
taxpayer and deductions taken accordingly, unless in order clearly to reflect income
such amounts are to be properly accounted for as of a different period. For instance, in
any case in which it is necessary to use an inventory, no accounting in regard to
purchases and sales will correctly reflect income except an accrual method. A taxpayer
is deemed to have received items of gross income which have been credited to or set
apart for him without restriction. On the other hand, appreciation in value of property is
not even an accrual of income to a taxpayer prior to the realization of such appreciation
through sale or conversion of the property. (For methods of accounting and
determination of accounting period, see Sections 166 to 169 of these regulations.)

- A acquired prop. In Jan 2005 for P1M. FMV of prop in Dec. 2005 is P2M: there is an
economic gain only on paper. No realization yet

- B acquired prop in Jan 2005 for P1M. Sold for cash in Dec. 2005 for P2M.
- Already realized the taxable economic gain

ALC D 2017

Glenshaw glass: all accessions to wealth, clearly realized and over which
taxpayers have complete dominion
Why is A not taxable, while B is taxable (Because of the realization
requirement)


HELVERING v. BRUUN, supra
TP cancelled a lease and forfeited a leasehold improvement for nonpayment of
rentals, the tenant having erected a building that added about $50,000 to the value
of the property.
Contention of TP: the increase in value (represented by the forfeited leasehold) was
not severed from his investment or received for his separate use, benefit and
disposal (citing Eisner v. Macomber)
Gain may occur as a result of exchange of property, payment of the taxpayers
indebtedness and relief from all liability, or other profit realized from the
completion of a transaction. The fact that the gain is a portion of the value of
property received by the taxpayer in the transaction does not negative its
realization.
HELVERING v. HORST, 311 U.S. 112 (1940)
Horst, Sr. detached interest coupons and donated same to Horst, JR prior to due
date. Horst, Jr. presented coupons and collected interest payment at maturity.
Issue: Whether gift of coupons to Jr. is realization of taxable income to Sr.
The gift, during the donors taxable year, of interest coupons detached from the
bonds delivered to the done and later in the year paid at maturity is taxable income
in the hands of the donor
The power to dispose of income is equivalent of ownership. The exercise of that
power to procure the payment of income to another is the enjoyment and hence
the realization of the income by him who exercises it
The realization rule, w/c is founded on administrative convenience, GENERALLY
postpones taxability until final enjoyment of the income which is usually receipt
of it by the TP
HOWEVER, the enjoyment of the income may occur when TP has made such use or
disposition of his power to receive or control the income as to procure in its place
other satisfactions which are of economic worth
COTTAGE SAV. ASSN v. CIR, 499 U.S. 554 (1991)
Exchange of mortgages resulted to realized losses
Rationale for realization requirements:
Avoid annual valuation
o To avoid the cumbersome, abrasive, and unpredictable administrative
task of valuing assets annually to determine whether their value has
appreciated or depreciated, 1001(a) of the Code (similar to NIRC 40(a))
defers the tax consequences of a gain or loss in property until it is realized
through the sale or disposition of the property
Serves administrative convenience

14

TAXATION 1 ATTY. BELLO



This rule serves administrative convenience because in contrast a change


in the investments form or extent can be easily detected by a taxpayer or
an administrative officer
Problems that would arise in the absence of the realization requirement:
o Problem of annual property appraisals
o Problem of liquidity
o Forced liquidation
When does realization occur? When the TP has enjoyed the benefit of the
economic gain
When is the TP deemed to have enjoyed the benefit of the economic gain?
B.I.G.; paper profits
Sale, exchange or other disposition
o Benta, puhunan, tubo
o Head or tail?
o Sunog!!!!
o


C.

OTHER RELEVANT CONCEPTS


1. Tax-Free Imputed Income v. Taxable Barter
Imputed income is excludable from gross income, not on the basis of a specific
Code provision, but results from long standing administrative practice
House painting example
Rationale for exemption (administrative convenience, e.g. difficulty of valuing
imputed income)
Differentiate tax-free imputed income from taxable barter
o Ex. Lap dance in exchange for legal services; see Rev Regs 2 41:
where services are paid for with something other than money, the
FMV of the thing taken in payment is the amount to be included as
income
o Endorsement in exchange for cosmetic surgery example
o See e.g., Rev. Rul. 79-24

SEC. 41, REV. REGS 2.

SECTION 41. Compensation paid other than in cash. Where services are paid for with
something other than money, the fair market value of the thing taken in payment is the
amount to be included as income. If the services were rendered at a stipulated price, in
the absence of evidence to the contrary, such price will be presumed to be the fair value
of the compensation received. Compensation paid an employee of a corporation in its
stock is to be treated as if the corporation sold the stock for its market value and paid
the employee in cash. When living quarters are furnished in addition to cash salary, the
rental value of such quarters should be reported as income.

ALC D 2017

CIR v. MINZER, 279 F.2d 338, (5th CIR. 1960)


Commissions derived by an insurance broker on life insurance policies procured on his
own life are taxable income

REV. RUL. 79-24, 1979-1 C.B. 60
Lawyer and housepainter exchanging services; landlord and artist exchanging apartment
usage and a painting

2. Tax-Free Return of Capital
Not all receipts of money are income; to arrive at income, there must be
excluded therefrom an amount representing return of capital (Rev Regs. 2 36:
Income, in the broad sense, means all wealth which flows into the taxpayer
other than as mere return of capital
Basis recovery
Sale or exchange of property is typical example
Examples of return of capital/basis recovery:
Sale or exchange of property
Gradual basis recovery through depreciation
Certain indemnities
Damages under certain instances
Other instances

CLARK v. CIR, 40 B.T.A. 333 (1939)
Reimbursement by tax adviser to client for erroneous tax advice resulting to payment of
taxes client neednt have paid

BIR. RUL. 51-00 (OCT. 30, 2000)
Return to employees of their contributions to a qualified retirement plan
- Should be upon retirement or else such will constitute benefits that shall be taxed
BIR RUL. 184-90 (SEPT. 20, 1990)
Damages in lieu of lost profits damages, however that compensate the taxpayer for
lost profits are includable in gross income. (damages for breach of contract constitute
taxable income to the extent that such damages compensate loss of anticipated profits
and non-taxable to the extent that the same represent a return of capital or investment)
REV. RUL. 81-277, 1981-2 C.B. 14
Payment by a contractor of a sum of money to a buyer in exchange for a release of the
buyers claims against the contractor for failure to fulfill the contract for construction of
a plant constitutes a return of capital rather than gross income to the buyer.




15

TAXATION 1 ATTY. BELLO




3.

Windfall Receipts

SEC. 32(A)(9)
(9) Prizes and winnings;
SEC. 32 (B)(7)(C)
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious,
charitable, scientific, educational, artistic, literary, or civic achievement but only if:

(i) The recipient was selected without any action on his part to enter the contest or
proceeding; and
(ii) The recipient is not required to render substantial future services as a condition
to receiving the prize or award.

Gain without pain is taxable income (effectively settled by Glenshaw Glass)
Examples of windfall receipts
Lost and found property
Unclaimed deposits or uncashed checks
Prizes and winnings

CESARINI v. U.S., 296 F. SUPP. 3 (ND OHIO 1969)
Windfalls, including found monies, are includable in gross income
Finder of treasure trove (i.e., property found by the taxpayer) is in receipt of
taxable income for income tax purposes, to the extent of its value in U.S. currency,
for the taxable year in which it is reduced to undisputed possession
Steinway No.1 example
HORNUNG v. CIR, 47 TC 428 (1967)
Involving a professional football player taxed (1) on value of a Corvette received
from a sports magazine as MVP of the Super Bowl and (2) on the rental value of
two other automobiles made available by a car manufacturer
Tax Court held that use of the cars was an accession to wealth under Glenshaw
Glass and was not a tax-free gift, since the manufacturer had a commercial motive.
Court further held that the award did not fall under the exceptions from for
educational, artistic, scientific, and/or civic achievement (IRC 74(b); similar to NIRC
32(B)(7)(c)) court said that the TPs achievement was purely athletic

4. Tax Benefit Principle Recovery of Deducted Items
Recovery of deducted items includable as taxable income
Rational for Inclusions:
o TP enjoyed underserved tax benefits
o Conversely, if TP derived no tax benefit from the deduction, the
recovery in later years of the deducted item would not be includable
in gross income

ALC D 2017

Examples of recovered deductions:


o Collection of debt previously deducted as worthless (see NIRC
34(E)(1), proviso)
o Refunds of previously deducted taxes
o Reimbursements of previously deducted losses (e.g., payments by a
tortfeasor)
o Business expense paid by check that is never cashed by the payee

SEC. 34(E)(1), proviso
(E) Bad Debts. - (1) In General. - Provided, That 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.

BIR RUL. 102-95 (JULY 7, 1995) on example of tax benefit principle
Contributions made by the employer to employee retirement plans are claimed by
the employer as a deductible business expense
If it turns our later that the company contributed more that it should have, the
excess funds in the retirement plan revert to the employer
Reversion is a recovered deduction because the employer previously benefited
from the business expense deduction

5. Indirect Receipts Cancellation of Indebtedness and Discharge by 3rd
Parties

SEC. 50, REV. REGS. 2

SECTION50. Forgiveness of indebtedness. The cancellation and forgiveness of
indebtedness may amount to a payment of income, to a gift, or to a capital transaction,
dependent upon the circumstances. If, for example, an individual performs services for a
creditor, who, in consideration thereof cancels the debt, income to that amount is
realized by the debtor as compensation for his services. If, however, a creditor merely
desires to benefit a debtor and without any consideration therefor cancels the debt, the
amount of the debt is a gift from the creditor to the debtor and need not be included in
the latter's gross income. If a corporation to which a stockholder is indebted forgives the
debt, the transaction has the effect of the payment of a dividend.
Cancellation of a debt could amount to payment of income, a gift or a capital
transaction
Ex. A Corp. owes B Corp. P5M; due to cash flow problems A was only able to
repay B P3M, with B condoning the balance of P2M
Assuming that the transaction is not otherwise a gift or a capital
transaction, A realizes income to the extent to P2M as its economic
position or net worth improved

16

TAXATION 1 ATTY. BELLO

ALC D 2017


BIR RUL. 76-89 (APRIL 17, 1989)
Waiver of interest by bank generally should have been subject to income tax.
HOWEVER, it was held that the debtor did not realize income from the forgiveness of
indebtedness because even after the condonation it remained insolvent (although the
debtors net worth improved)

OLD COLONY TRUST CO. v. CIR, 279 U.S. 716 (1929) discharge by third parties
Employer pays the income taxes of a keyman; discharge by a third person of
an obligation to him is equivalent to receipt by the person taxed
Such constitutes taxable income since they were paid upon valuable
consideration which is his services derived from his labor.

BIR RUL. 85-95 (JUNE 13, 1995)
Old Colony as applied: 5% final withholding tax on interest assumed by the borrower
constitutes additional income of the nonresident bondholders

17

TAXATION 1 ATTY. BELLO



III.

GROSS INCOME

A. INCLUSIONS
SECTION 32(A)
SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income
means all income derived from whatever source, including (but not limited to) the
following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a
profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional
partnership.

1. Compensation: Special Problems on In-Kind Compensation
Taxability of in-kind benefits (i.e. receipts in a form other than conventional
cash payment)
o Generally includable; 32 embraces cash and non-cash benefits alike
(see e.g. 32(A)(1): compensation for services in whatever form
paid)
o Receipt of in-kind benefits often presents valuation difficulties not
encountered when cash is received
o E.g. legal services in exchange for chicken

SEC 2.78.1(A) AND (1), REV. REGS 2-98 (APRIL 17, 1998)
SECTION 2.78.1. Withholding of Income Tax on Compensation Income.
(A) Compensation Income Defined. In general, the term "compensation" means all
remuneration for services performed by an employee for his employer under an
employer-employee relationship, unless specifically excluded by the Code.
The name by which the remuneration for services is designated is immaterial. Thus,
salaries, wages, emoluments and honoraria, allowances, commissions (e.g.
transportation, representation, entertainment and the like); fees including director's
fees, if the director is, at the same time, an employee of the employer/corporation;
taxable bonuses and fringe benefits except those which are subject to the fringe

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benefits tax under Sec. 33 of the Code; taxable pensions and retirement pay; and other
income of a similar nature constitute compensation income.
The basis upon which the remuneration is paid is immaterial in determining whether the
remuneration constitutes compensation. Thus, it may be paid on the basis of piece-
work, or a percentage of profits; and may be paid hourly, daily, weekly, monthly or
annually.
Remuneration for services constitutes compensation even if the relationship of
employer and employee does not exist any longer at the time when payment is made
between the person in whose employ the services had been performed and the
individual who performed them.
(1) Compensation paid in kind. Compensation may be paid in money or in some
medium other than money, as for example, stocks, bonds or other forms of property.
If services are paid for in a medium other than money, the fair market value of the
thing taken in payment is the amount to be included as compensation subject to
withholding. If the services are rendered at a stipulated price, in the absence of
evidence to the contrary, such price will be presumed to be the fair market value of
the remuneration received. If a corporation transfers to its employees its own stock
as remuneration for services rendered by the employee, the amount of such
remuneration is the fair market value of the stock at the time the services were
rendered.

a. Limited Choice and Restricted Property

U.S. v. DRESCHER, 179 F.2d 863 (2nd Cir. 1950)


An annuity purchased by the employer for the employee is taxable income to the
employee in the year purchase by the employer (and not in the year of pay-out to
the employee) despite the fact that that the policies were non-assignable and were
retained in the possession of the employer
Non-assignability and retention by employer do not effect immediate taxability,
although they may have affect the valuation of the includable income
Amount includable is value greater than zero although less than the premium
cost of $5,000
The stakes: tax now or tax later (time value of money)
A loose end:
o Suppose that B&L had simply given Drescher $5,000 in 1939 as cash bonus and
that Drescher had then purchased the annuity on his own. In that case,
Drescher clearly would have to report as income the $5,000. Should the result
be different if the employer buys the annuity and delivers it to Drescher?
o Note that taxing income in kind is equivalent to treating employees as if he or
she received income in cash and then used the cash to buy an item in question
o Economic benefit: you look forward to something youll received (security at
present)

18

TAXATION 1 ATTY. BELLO



BIR Rul. 9-04 (Sept. 13, 2004)


Under ESAP, all employees were offered Australian registered shares in ANZ
Bank free of charge. These were subject to disposal restriction and forfeiture
clause at the time of the grant so they shall not be taxed until the disposal
restriction is lifted.
Dividends should be recognized on the date payment is approved since when
they are declared, the stockholder already has right thereto
Stock dividends are not income since there is no distribution of the assets of
the corporation. They only create a change in the composition of the
stockholders equity, that is, a transfer from retained earnings to capital stock.

b. Forced Consumption: Convenience of the Employer Rule


SEC. 2.78.1(A)(2), REV. REGS, 2-98 (APRIL 17, 1998)
(2) Living quarters or meals. If a person receives a salary as remuneration for
services rendered, and in addition thereto, living quarters or meals are provided, the
value to such person of the quarters and meals so furnished shall be added to the
remuneration paid for the purpose of determining the amount of compensation
subject to withholding. However, if living quarters or meals are furnished to an
employee for the convenience of the employer, the value thereof need not be
included as part of compensation income.
SEC.2, REV. AUDIT MEM. ORDER 1-87 (APRIL 23, 1987)
2. Housing and Meals

2.1 If an employee receives a remuneration for services salaries and/or allowances
and in addition thereto living quarters and/or meals, the value to such person of the
quarters and meals so furnished shall be added to the remuneration otherwise paid
for the purpose of determining the amount of compensation subject to withholding
tax.

2.2 The value of lodging furnished to an employee by or on behalf of the employer
shall be excluded from the employee's gross income, if the lodging is furnished in the
business premises of the employer; and the employee is required to accept such
lodging as a condition of his employment.

23 The value of meals furnished to an employee by or on behalf of his employer shall
be excluded from the employee's gross income if the meals are furnished on the
business premises of the employer and the meals are furnished for the convenience
of the employer. Meals furnished without charge to an employee as regarded as
furnished for the convenience of the employer where they are furnished to the
employee during his work day to have the employee available for work during his
meal period.

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2.4 Business premises of the employer means the place where the employee
performs a significant portion of his duties or where the employer conducts a
significant portion of his business. In case of doubt, the criteria to be used shall be (a)
time, more than 50% of the employee's work time or (b) value of business, more than
50% of the production of the said employee.

2.5 Notwithstanding the provisions of the preceding paragraphs, if an employee is
provided by his employer with company housing or living quarters outside the
business premises, and such employee, because of his position in the employer-
company, also uses said house or living quarters for the benefit of the latter, like
entertaining and putting up houseguests and guest of the employer-company, then
fifty percent (50%) of such allowance, rental value, or depreciation if the living
quarters are owned by the employer, shall be added to the compensation paid to
such employee and be subject to the withholding tax on wages. The employer may
deduct the said housing expense as a business expense.

2.6 Privileges such as "courtesy discounts" on purchases of company merchandise of a
value not to exceed 1/2 basic month's salary of an employee or an officer shall not be
added to the remuneration of the employee.

2.7 Entertainment of and gifts to company officers and employees shall not be a
deductible expense except for Christmas and major anniversary celebrations (e.g.
25th year of company's establishment), sports tournament, company picnics not to
exceed one a year provided that the value of the gift when it is not a service award for
length of service shall not exceed in value of 1/2 month's of the basic salary of the
employee receiving the gift.

BENAGLIA v. CIR, 36 B.T.A. 838 (1937)
Whether meals and lodging provided to a hotel manager for the proper
performance of his duties because he was on call taxable income
No. Benefits merely incidental; imposed upon TP as a working condition for the
convenience of the employer
Convenience of the employer rule idea behind doctrine is that in-kind benefits
should not be taxed if furnished by the employer to enable the employee to
perform the job satisfactorily (such benefits are known as working conditions)
Other examples of working conditions: spacious office of the successful law firm
partner, tastefully decorated with modern art; trips to France, enjoyed by airline
pilot who works the NY to Paris route; plays attended by theatre critic with tickets
supplied by producers
Kleinwachters conundrum

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TAXATION 1 ATTY. BELLO



De Minimis Benefits
Exempt
Facilities and privileges of relatively small value
Furnished to employees as means of promoting their health, goodwill,
contentment or efficiency

SEC. 2.78.1(A)(3), REV. REGS 2-98 (APRIL 17, 1998)
(3) Facilities and privileges of a relatively small value. Ordinarily, facilities and
privileges (such as entertainment, medical services, or so called "courtesy" discounts on
purchases), furnished or offered by an employer to his employees generally, are not
considered as compensation subject to withholding if such facilities or privileges are of
relatively small value and are offered or furnished by the employer merely as a means of
promoting the health, goodwill, contentment, or efficiency of his employees.

Where compensation is paid in property other than money, the employer shall make
necessary arrangements to ensure that the amount of the tax required to be withheld is
available for payment to the Commissioner.
Monetized unused vacation leave credits of employees not exceeding 10 days
during the year and the monetized value of leave credits paid to government
officials and employees
Medical cash allowance to dependents of employees not exceeding {750 per
employee per semester or P125 month;
Rice subsidy of P1,500 or one sack of 50-kg rice per month amounting to not more
than P1,500
Uniform and clothing allowance not exceeding P4,000 per annum
Actual yearly medical benefits not exceeding P10,000 per annum
Laundry allowance not exceeding P300 per month
Employees achievement awards, e.g. length of service or safety achievement,
which must be in the form of tangible personal property other than cash or gift
certificate, with an annual monetary value not exceeding P10,000 received by the
employee under an established written plan which does not discriminate in favor of
higly paid employees
Gifts given during Christmas and major anniversary celebrations not exceeding
P5,000 per employee per annum;
Flowers, fruits, books or similar items given to employees under special
circumstances, e.g., on account of illness, marriage, birth of a baby, etc; and
Daily meal allowance for overtime work not exceeding 25% of the basic minimum
wage

BIR RUL. 23-02 (JUNE 21, 2002)
Sodexho subsidies
Mean and food benefits provided by the client-companies to their employees
through Sodexo mean and food vouchers may be considered tax-exempt

c.

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benefits.
The meal and food allowance, although not for overtime work, is considered
de minimis if it does not exceed 25% of the basic minimum wage.
Rules and regulations on de minimis benefits do not allow aggregation of the
amounts set for each type of benefit.


d.

Travel and Entertainment


RUDOLPH v. US, 370 US 269 (1962)
Whether all-expenses paid trip to attend a convention (spouses included) in NYC
taxable income to the attendees
One morning out of the entire week devoted to business meetings; the rest of
the week devoted to travel, sight-seeing, entertainment, fellowship or free time
Value of trip income to the Rudolphs, the trip being in the nature of a bonus,
reward, and compensation for a job well done
Test to determine whether cost of travel is income: dominant motive and
purpose (whether business or pleasure)

2. Business Income
3. Gains
4. Interests
5. Rents
6. Royalties
7. Dividends
Ordinary dividend (cash or property)
Liquidating dividend
Stock dividend

SEC.73 (NIRC)

SEC. 73. Distribution of dividends or Assets by Corporations. -
(A) Definition of Dividends. - The term 'dividends' when used in this Title means any
distribution made by a corporation to its shareholders out of its earnings or profits and
payable to its shareholders, whether in money or in other property. Where a
corporation distributes all of its assets in complete liquidation or dissolution, the gain
realized or loss sustained by the stockholder, whether individual or corporate, is a
taxable income or a deductible loss, as the case may be.
(B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital
account shall not be subject to tax. However, if a corporation cancels or redeems stock
issued as a dividend at such time and in such manner as to make the distribution and
cancellation or redemption, in whole or in part, essentially equivalent to the distribution
of a taxable dividend, the amount so distributed in redemption or cancellation of the
stock shall be considered as taxable income to the extent that it represents a

20

TAXATION 1 ATTY. BELLO



distribution of earnings or profits.


(C) Dividends Distributed are Deemed Made from Most Recently Accumulated
Profits. - Any distribution made to the shareholders or members of a corporation shall
be deemed to have been made form the most recently accumulated profits or surplus,
and shall constitute a part of the annual income of the distributee for the year in which
received.
(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The
taxable income declared by a partnership for a taxable year which is subject to tax
under Section 27 (A) of this Code, after deducting the corporate income tax imposed
therein, shall be deemed to have been actually or constructively received by the
partners in the same taxable year and shall be taxed to them in their individual capacity,
whether actually distributed or not.
SEC. 250-256, REV. REGS 2
SECTION250. Dividends. Dividends, for the purpose of the law, comprise any
distribution whether in cash or other property, in the ordinary course of business, even
though extraordinary in amount, made by a domestic or resident foreign corporation,
joint-stock company, partnership, joint account (cuentas en participacion), association,
or insurance company to the shareholders or members out of its earnings or profits
accumulated since March 1, 1913.
Although interest on certain Government bonds and other similar obligations is not
taxable when received by a corporation, upon amalgamation with the other funds of the
corporation, such income loses its identity and when distributed to shareholders, is
taxable to the same extent as other dividend.
A taxable distribution made by a corporation to individual stockholders or members
shall be included is the gross income of the distributees when the cash of other property
is unqualifiedly made subject to their demand. Dividends, in cash or other property
received by an individual, are subject to tax in his hands in the same manner another
income.
Dividends, whether in cash or other property, received by a domestic or resident foreign
corporation from a domestic corporation are taxable only to the extent of 25 per cent
thereof in accordance with Section 24 of the Code. Dividends received by a domestic
corporation from a foreign corporation, whether resident or nonresident, are taxable to
the extent that they constitute income from sources within the Philippines, as provided
in Section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a
nonresident foreign corporation are taxable in full. (For definition of the different
classes of corporations, see Section 84 of the Code).

SECTION 251. Dividends paid in property. Dividends paid in securities or other
property (other than its own stock), in which the earnings of a corporation have been
invested, are income to the recipients to the amount of the full market value of such
property when receivable by individual stockholders. When receivable by corporations,
the amount of such dividends includible for purposes of the tax on corporations are
specified in Section 24 of the Code. (See also Section 250 of these regulations). A
dividend paid in stock of another corporation is not a stock dividend, even though the

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stock distributed was acquired through the transfer by the corporation declaring the
dividends of property to the corporation the stock of which is distributed as a dividend.
Where a corporation declares a dividend payable in a stock of another corporation,
setting aside the stock to be so distributed and notifying the stockholders of its action,
the income arising to the recipients of such stock is its market value at the time the
dividend becomes payable. Scrip dividends are subject to tax in the year in which the
warrants are issued.

SECTION 252. Stock dividends. A stock dividend which represents the transfer of
surplus to capital account is not subject to income tax. However a dividend in stock may
constitute taxable income to the recipients thereof notwithstanding the fact that the
officers or directors of the corporation (as defined in Section 84) choose to call such
distribution as a stock dividend. The distinction between a stock dividend which does
not, and one which does, constitute income taxable to the shareholder is the distinction
between a stock dividend which works no change in the corporate entity, the same
interest in the same corporation being represented after the distribution by more
shares of precisely the same character, and a stock dividend where there either has
been a change of corporate identity or a change in the nature of the shares issued as
dividends whereby the proportional interest of the shareholders after the distribution is
essentially different from his former interests. A stock dividend constitutes income if it
gives the shareholder an interest different from that which his former stock holdings
represented. A stock dividend does not constitute income if the new shares confer no
different rights or interests than did the old the new certificates plus the old
representing the same proportionate interest in the net assets of the corporation as did
the old.

SECTION 253. Sale of stock received as dividends. Stock issued by a corporation, as a
dividend, does not constitute taxable income to a stockholder in such corporation, but
gain may be derived or loss sustained by the stockholder, whether individual or
corporate, from the sale of such stock, which gain or loss will be treated as arising from
the sale or exchange of a capital asset. (See Section 34 of the Code.) The amount of gain
derived or loss sustained from the sale of such stock, or from the sale of the stack with
respect to which it is issued, shall be determined in accordance with the following rules:
(a) Where the stock issued as dividend is all or substantially the same character or
preference as the stock upon which the stock dividend is paid, the cost of each share (or
when acquired prior to March 1, 1913, the fair market value as of such date) will be the
quotient of the cost (or such fair market value) of the old shares of stock divided by the
total number of the old and new shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or
preference materially different from the stock upon which the stock dividend is paid,
the cost (and when acquired prior to March 1, 1913, the fair market value as of such
date) of the old shares of stock shall be divided between such old stock and the new
stock, in proportion, as nearly as may be, to the respective value of each class of stock,
old and new, at the time the new shares of stock are issued, and the cost (or when

21

TAXATION 1 ATTY. BELLO



acquired prior to March 1, 1913, the fair market value as of such date) of each share of
stock will be the quotient of the cost (or such fair market value as of March 1, 1913) of
the class to which such share belongs divided by the number of shares in that class.
(c) Where the stock with respect to which a stock dividend is issued was purchased at
different times and at different prices and the identity of the lots can. not be
determined, any sale of the original stock, will be charged to the earliest purchases of
such stock, and any sale of dividend stock issued with respect to such stock will be
presumed to have been made from the stock issued with respect to the earliest
purchased stock, to the amount of the dividend chargeable to such stock.
(d) Where the stock with respect to which a stock dividend is declared was purchased at
different times and at different prices, and the dividend stock issued with respect to
such stock can not be identified as having been issued with respect to any particular lot
of such stock, then any sale of such dividend stock will be presumed to have been made
from the stock issued with respect to the earliest purchased stock, to the amount of the
stock dividend chargeable to such stock.

SECTION 254. Declaration and subsequent redemption of a stock dividend. A true
stock dividend is not subject to tax on its receipt in the hands of the recipient.
Nevertheless, if a corporation, after the distribution of a stock dividend, proceeds to
cancel or redeem its stock at such time and in such manner as to make the
distribution and cancellation or redemption essentially equivalent to the distribution of
a taxable dividend, the amount received in redemption or cancellation of the stocks
shall be treated as a taxable dividend to the extent of the earnings or profits
accumulated by such corporation since March 1, 1913.

SECTION 255. Sources of distribution. For the purpose of income taxation every
distribution made by a corporation is made out of earnings or profits to the extent
thereof and from the most recently accumulated earnings or profits. In determining the
source of a distribution, consideration should be given first, to the earnings or profits of
the taxable year; second, to the earnings or profits accumulated since February 28,
1913, only in the case where, and to the extent that, the distribution made during the
taxable year are not regarded as out of the earnings or profits of the taxable year and all
the earnings or profits accumulated since February 28, 1913, have been distributed;
and, fourth, to sources other than earnings or profits only after the earnings or profits
have been distributed.

SECTION256. Distribution in liquidation. In all cases where a corporation (as defined
in Section 84) distributes all of its property or assets in complete liquidation or
dissolution, the gain realized from the transaction by the stockholder, whether
individual or corporate, is taxable to the extent recognized in Section 34(b) of the Code.
For this purpose, the term "complete liquidation" includes any one of a series of
distributions made by a corporation in complete cancellation or redemption of all of its
stock in accordance with a bona fide plan of liquidation under which the transfer of all
the assets under liquidation is to be complete within a reasonable time from the date of

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the first distribution, usually not to exceed one year from the time of such first
distribution. If the amount received by the stockholder in liquidation is less than the cost
or other basis of the stock, the loss in the transaction is deductible to the extent allowed
in Section 34(c) of the Code.

Wise & Co., Inc. v. Meer (JUNE 30, 1947) ordinary v. liquidating dividend
Determining element is whether the distribution was in the ordinary course of
business and with intent to maintain the business as a going concern, or after
deciding to quit with intent to liquidate
Ordinary dividend: if the distribution is in the nature of a recurring return on stock
Liquidating dividend: if the corporation is really winding up its business or
recapitalizing or narrowing its activities, the distribution is treated as in complete or
partial liquidation and as payt by the corporation to the SH for his stock
What is at stake?
o If ordinary dividend receipt of ordinary dividend then was not subject to
income tax (subject to income tax now at 10%)
o If liquidating dividend amount in excess of the TPs cost basis taxable gain; if
TPs cost basis exceeds the amount distributed, TP realizes a deductible loss
Only the excess is taxable gain (or loss) because a liquidating dividend is
treated as a sale or exchange of stock
Where a corporation distributes all of its assets in complete liquidation in
exchange for the surrender by shareholders of their shares, a transaction
takes place which is no different in essence from a sale of the tame stock
to third persons
CIR v. CA (JAN. 20, 1999)
Illustration of dividend equivalence rules (cancellation or redemption of
previously issued non-taxable stock dividend at such time and in such manner as to
make the distribution and cancellation or redemption essentially equivalent to a
taxable dividend)
Tax-free reclassification of shares
Tax-free exchange of commons for prefs under certain conditions
CIR v. Manning (Aug. 6, 1975)
A stock dividend cannot be declared out of outstanding corporate stock, but only
from retained earnings
A case of constructive distribution of taxable dividends in the guise of a non-taxable
stock dividend distribution
The series of transactions was equivalent to a distribution of E&P to the
stockholders, who turned around and used the proceeds to purchase the
shareholdings of the deceased shareholder

BIR Rul.39-02 (Nov. 11, 2002)
TA is planning to decrease its authorized capital stock. Pursuant to this, shares
shall be surrendered and cancelled in exchange for real and persona, tangible

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TAXATION 1 ATTY. BELLO




8.
9.
10.
11.

and intangible properties.


TA shall not be liable for income tax either on its receipt of the surrendered
shares, or its transfer for Distributed Assets to TMBC as liquidated dividends. A
liquidating corporation does not realize gain or loss in partial or complete
liquidation.
No DST is also due. Transfer of property is not subject to DST on sale or
transfer real property. So is transfer of Loan portfolio.
Only transfer or assignment of any mortgage which stands as security for its
Loan Portfolio shall be subject to DST
It shall be the stockholder who shall realize capital gain or loss when a
corporation distributes its assets as liquidating dividends since they are treated
as payments in exchange for stocks or shares so any gain or profit realized
thereby shall b taxed.
Liquidating gain or loss is in the nature of capital gain or loss, as the case may
be, and therefore treated in the manner stated in Sec. 39 of the NIRC.
Liquidating gain is subject to ordinary income tax rates.

Annuities
Prizes and winnings
Pensions
Share in GPPs Income


SEC. 26. Tax Liability of Members of General Professional Partnerships. - A general
professional partnership as such shall not be subject to the income tax imposed under
this Chapter. Persons engaging in business as partners in a general professional
partnership shall be liable for income tax only in their separate and individual capacities.

For purposes of computing the distributive share of the partners, the net income of the
partnership shall be computed in the same manner as a corporation.
Each partner shall report as gross income his distributive share, actually or
constructively received, in the net income of the partnership.

B. EXCLUSIONS


(B) Exclusions from Gross Income. - The following items shall not be included in gross
income and shall be exempt from taxation under this title:

(1) Life Insurance. - The proceeds of life insurance policies paid to the heirs or
beneficiaries upon the death of the insured, whether in a single sum or otherwise, but if
such amounts are held by the insurer under an agreement to pay interest thereon, the
interest payments shall be included in gross income.

(2) Amount Received by Insured as Return of Premium. - The amount received by the

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insured, as a return of premiums paid by him under life insurance, endowment, or


annuity contracts, either during the term or at the maturity of the term mentioned in
the contract or upon surrender of the contract.

(3) Gifts, Bequests, and Devises. _ The value of property acquired by gift, bequest,
devise, or descent: Provided, however, That income from such property, as well as gift,
bequest, devise or descent of income from any property, in cases of transfers of divided
interest, shall be included in gross income.

(4) Compensation for Injuries or Sickness. - amounts received, through Accident or
Health Insurance or under Workmen's Compensation Acts, as compensation for
personal injuries or sickness, plus the amounts of any damages received, whether by
suit or agreement, on account of such injuries or sickness.

(5) Income Exempt under Treaty. - Income of any kind, to the extent required by any
treaty obligation binding upon the Government of the Philippines.

(6) Retirement Benefits, Pensions, Gratuities, etc.-

(a) Retirement benefits received under Republic Act No. 7641 and those received by
officials and employees of private firms, whether individual or corporate, in
accordance with a reasonable private benefit plan maintained by the employer:
Provided, That the retiring official or employee has been in the service of the same
employer for at least ten (10) years and is not less than fifty (50) years of age at the
time of his retirement: Provided, further, That the benefits granted under this
subparagraph shall be availed of by an official or employee only once. For purposes of
this Subsection, the term 'reasonable private benefit plan' means a pension, gratuity,
stock bonus or profit-sharing plan maintained by an employer for the benefit of some
or all of his officials or employees, wherein contributions are made by such employer
for the officials or employees, or both, for the purpose of distributing to such officials
and employees the earnings and principal of the fund thus accumulated, and wherein
its is provided in said plan that at no time shall any part of the corpus or income of the
fund be used for, or be diverted to, any purpose other than for the exclusive benefit
of the said officials and employees.

(b) Any amount received by an official or employee or by his heirs from the employer
as a consequence of separation of such official or employee from the service of the
employer because of death sickness or other physical disability or for any cause
beyond the control of the said official or employee.

(c) The provisions of any existing law to the contrary notwithstanding, social security
benefits, retirement gratuities, pensions and other similar benefits received by
resident or nonresident citizens of the Philippines or aliens who come to reside
permanently in the Philippines from foreign government agencies and other

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TAXATION 1 ATTY. BELLO



institutions, private or public.



(d) Payments of benefits due or to become due to any person residing in the
Philippines under the laws of the United States administered by the United States
Veterans Administration.

(e) Benefits received from or enjoyed under the Social Security System in accordance
with the provisions of Republic Act No. 8282.

(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement
gratuity received by government officials and employees.

(7) Miscellaneous Items. -

(a) Income Derived by Foreign Government. - Income derived from investments in
the Philippines in loans, stocks, bonds or other domestic securities, or from interest
on deposits in banks in the Philippines by (i) foreign governments, (ii) financing
institutions owned, controlled, or enjoying refinancing from foreign governments, and
(iii) international or regional financial institutions established by foreign governments.

(b) Income Derived by the Government or its Political Subdivisions. - Income derived
from any public utility or from the exercise of any essential governmental function
accruing to the Government of the Philippines or to any political subdivision thereof.

(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious,
charitable, scientific, educational, artistic, literary, or civic achievement but only if:
(i) The recipient was selected without any action on his part to enter the contest
or proceeding; and
(ii) The recipient is not required to render substantial future services as a
condition to receiving the prize or award.

(d) Prizes and Awards in sports Competition. - All prizes and awards granted to
athletes in local and international sports competitions and tournaments whether held
in the Philippines or abroad and sanctioned by their national sports associations.

(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and
employees of public and private entities: Provided, however, That the total exclusion
under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall
cover:
(i) Benefits received by officials and employees of the national and local
government
pursuant
to
Republic
Act
No.
6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential decree

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No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering among others, the effect
on the same of the inflation rate at the end of the taxable year.

(f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of individuals.

(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. -
Gains realized from the same or exchange or retirement of bonds, debentures or
other certificate of indebtedness with a maturity of more than five (5) years.

(h) Gains from Redemption of Shares in Mutual Fund. - Gains realized by the investor
upon redemption of shares of stock in a mutual fund company as defined in Section
22 (BB) of this Code.

1.

2.

Life Insurance
Proceeds of life insurance paid to heirs or beneficiaries of insured exempt
o Interest, however, on the proceeds taxable
o Amounts
Amounts received by insured as return of premium exempt
o Simplest form of estate planning
o Fastest way liquidity
o Estate tax heirs settlement of estate
Gifts, Bequests and Devises


Sec.32 (B)(3) Gifts, Bequests, and Devises. _ The value of property acquired by gift,
bequest, devise, or descent: Provided, however, That income from such property, as
well as gift, bequest, devise or descent of income from any property, in cases of
transfers of divided interest, shall be included in gross income.

CIR v. Duberstein, 363 US 278 (1960)
Illustration of non-taxable gift vs. taxable compensation for services rendered
Court found that the Cadillac was a recompense for Dubersteins past services, or
an inducement for him to be of further service in the future
When is a payment a non-taxable gift and when is a payment taxable compensation
for services rendered?
o Mere absence of a legal or moral obligation to make such a payment does not
mean it is a gift
o If the payment proceeds primarily from the constraining force of any moral or
legal duty, or from the incentive of anticipated benefit of an economic

24

TAXATION 1 ATTY. BELLO



nature, it is not a gift


A gift in the statutory sense, on the other hand, proceeds from a detached
and disinterested generosity, out of affection, respect, admiration, charity or
like impulses
Hornung v. CIR, supra
Corvette received was in exchange of the promotional benefits
Thus, taxable

3. Compensation for Injuries or Sickness

Elements: ( 32(B)(4)):
o (i) damages received;
o (ii) whether by suit or agreement;
o (iii) on account of; and
o (iv) personal injuries or sickness
- e.g. tricycle driver got hit by bus driver, asks for damages
o actual damages- exempt
o moral damages exempt
o exemplary damages not exempted
o lost earnings exempt
PM: personal injuries
o


Sec.32 (B)(4) Compensation for Injuries or Sickness. - amounts received, through
Accident or Health Insurance or under Workmen's Compensation Acts, as compensation
for personal injuries or sickness, plus the amounts of any damages received, whether by
suit or agreement, on account of such injuries or sickness.

OGilvie v. US, 519 US 79 (1996) an interpretation of on account of
Whether the gross income exclusion provision applies to punitive damages received
by plaintiff in a tort suit for personal injuries
Held: TPs punitive damages were not received on account of personal injuries;
hence gross-income-exclusion provision does not apply and the damages are
taxable
Exclusionary provision applies only to those personal injury lawsuit damages that
were awarded by reason of, or because of, the personal injuries, and not to
punitive damages that do not compensate injury, but are private fines levied by civil
injuries to punish reprehensible conduct and to deter its future occurrence

Murphy v. US, No. 05-5249 (DC Cir. Aug. 22, 2006) compensation for emotional
distress: non-taxable return of human capital theory
Whether the compensation for emotional distress and injury to professional
reputation is taxable income( note: none of the award was for lost wages or
diminished earning capacity)

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Held: not excludable because damages were not awarded on account of physical
injuries (she received the award of on account of her mental distress and
reputational loss, not her bruxism or other physical symptoms)
However, IRC 104(a)(2) is unconstitutional as applied to Murphys award because
compensation for a non-physical injury is not income under the 16th amendment if
it is unrelated to lost wages or earnings
Application of in lieu of doctrine: in lieu of what were the damages awarded?
Was Murphys award of compensatory damages a substitute for a normally
untaxed personal quality, good or asset?
The damages were awarded to make Murphy emotionally and reputationally
whole and not to compensate her for lost wages or taxable earnings of any kind.
The emotional well-being and good reputation she enjoyed before they were
diminished by her former employer were not taxable as income
Murphy v. US, No. 05-5249 (DC. Cir. July 3, 2007)(on rehearing) involuntary
conversion theory; zero basis in human capital
Award not excludable under IRC 104(a)(2)
Award is not part of gross income as defined by IRC 61 (although Congress
cannot make a thing income which is not so in fact, it can label a thing income and
tax it, so long as it acts within its constitutional authority)
The tax upon the ward is an excise and not a direct tax subject to the
apportionment requirement of Article I, Section 9 of the Constitution. The tax is
uniform throughout the U.S. and therefore passes constitutional muster
Murphys situation seems akin to an involuntary conversion of assets; she was
forced to surrender some part of her mental health and reputation in return for
monetary damages. CF. 26 U.S.C. 1033 (property involuntarily converted into
money is taxed to extend of gain recognized)
AR ($70k) basis (zero) = gain ($70k)

BIR Rul. 57-83 (April 12, 1983)
WoN backwages, allowances and benefits such as cost of living and 13th month pay
should be taxed
General rule: they are forms of compensation
BUT liberal construction was called for to protect the employees who were
deprived of the payment of their wages.


4. Retirement Benefits, Pensions, Gratuities, etc.


Sec.32
(6) Retirement Benefits, Pensions, Gratuities, etc.-

(a) Retirement benefits received under Republic Act No. 7641 and those received by
officials and employees of private firms, whether individual or corporate, in

25

TAXATION 1 ATTY. BELLO



accordance with a reasonable private benefit plan maintained by the employer:


Provided, That the retiring official or employee has been in the service of the same
employer for at least ten (10) years and is not less than fifty (50) years of age at the
time of his retirement: Provided, further, That the benefits granted under this
subparagraph shall be availed of by an official or employee only once. For purposes of
this Subsection, the term 'reasonable private benefit plan' means a pension, gratuity,
stock bonus or profit-sharing plan maintained by an employer for the benefit of some
or all of his officials or employees, wherein contributions are made by such employer
for the officials or employees, or both, for the purpose of distributing to such officials
and employees the earnings and principal of the fund thus accumulated, and wherein
its is provided in said plan that at no time shall any part of the corpus or income of the
fund be used for, or be diverted to, any purpose other than for the exclusive benefit
of the said officials and employees.

(b) Any amount received by an official or employee or by his heirs from the employer
as a consequence of separation of such official or employee from the service of the
employer because of death sickness or other physical disability or for any cause
beyond the control of the said official or employee.

(c) The provisions of any existing law to the contrary notwithstanding, social security
benefits, retirement gratuities, pensions and other similar benefits received by
resident or nonresident citizens of the Philippines or aliens who come to reside
permanently in the Philippines from foreign government agencies and other
institutions, private or public.

(d) Payments of benefits due or to become due to any person residing in the
Philippines under the laws of the United States administered by the United States
Veterans Administration.

(e) Benefits received from or enjoyed under the Social Security System in accordance
with the provisions of Republic Act No. 8282.

(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement
gratuity received by government officials and employees.

(7) Miscellaneous Items. -
(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and
employees of public and private entities: Provided, however, That the total exclusion
under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall
cover:
(i) Benefits received by officials and employees of the national and local
government
pursuant
to
Republic
Act
No.
6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;

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(iii) Benefits received by officials and employees not covered by Presidential decree
No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering among others, the effect
on the same of the inflation rate at the end of the taxable year.

Retirement under the Labor Code (Art. 287) in the absence of a qualified retirement
plan
Retirement upon reaching the retirement age established in the CBA or other
applicable employment contract
Upon reaching 60 years, but not beyond 65 years, which is the compulsory
retirement age
Has served at least 5 years

Retirement benefits from a qualified retirement plan ( 32(B)(6)(a)): conditions for
exemption
There is a reasonable private benefit plan
Retiring official or employee has been in the service of the employer for at
least 10 years
Retiring official or employee is not less than 50 yrs. Old at the time of
retirement
Exemption benefit is availed only once

Separation benefits from involuntary separation ( 32(B)(6)(b)): conditions for
exemption
Official, employee or their heirs receive/s separation pay from employer
Separation is because of death, sickness, other physical disability, or for any
cause beyond the control of the official or employee

Other exempt retirement benefits
Those received by resident and non-resident citizens and aliens who come to
reside in the Philippines from foreign government agencies and other
institutions, private or public
Benefits from the USVA
SSS benefits
GSIS benefits including retirement gratutity received by government officials
and employees

CIR v. CA (March 23, 1992)
Tax exemption for employees trusts was conceived in order to encourage the
formation and establishment of such private Plans for the benefit of laborers.

26

TAXATION 1 ATTY. BELLO



CIR v. CA (Oct. 17, 1991)


Terminal leave pay received by a government official or employee on the occasion
of his compulsory retirement from government service is exempt from income tax
(and consequently withholding tax on compensation)
In the exercise of sound personnel service policy, the Government encourages
unused leaves to be accumulated. The Government recognizes that for most public
servants, retirement pay is always less than generous if not meager and scrimpy. A
modest nest egg which the senior citizen may look forward to is thus avoided.
Terminal leave payments are given not only at the same time but also for the same
policy considerations governing retirement benefits
In Re: Atty. Bernardo Zialcitia, A.M. 90-6-015 (Oct. 18, 1990)
Commutation or money value of accumulated leave credits is covered by exclusion
under 32(B)(6)(b) and (f) (i.e., separation beyond the control and/or retirement
gratuity received by government officials and employees
Compulsory retirement is considered separation beyond the control of the
employee, hence, any amount received by reason of such involuntary separation
(e.g., terminal leave pay) is exempt
IBC v. Amarilla
TPs opted to retire pursuant to 1993 CBA (mandatory retirement age in CBA was 60
years)
Received retirement benefits on a staggered basis (no taxes withheld)
After retirement, retroactive salary differential of employees not given to TPs but
instead was applied against the withholding tax liability of the TPs upon retirement
W/N retirement benefits received under the CBA exempt
No. No showing that CBA presented to the BIR for registration/approval

BIR Rul. 1-95 (Jan 6, 1995)
WoN client correctly withheld taxes from the retirement benefits of employees
given under a voluntary retirement program offered by the company
Exemption is only for those who are involuntarily separated since they are within
the ambit of the phrase for any cause beyond the control of the said official or
employee





RA 4917 (June 17, 1967)

AN ACT PROVIDING THAT RETIREMENT BENEFITS OF EMPLOYEES OF PRIVATE FIRMS
SHALL NOT BE SUBJECT TO ATTACHMENT, LEVY, EXECUTION, OR ANY TAX
WHATSOEVER.

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Section 1. Any provision of law to the contrary notwithstanding, the retirement benefits
received by officials and employees of private firms, whether individual or corporate, in
accordance with a reasonable private benefit plan maintained by the employer shall be
exempt from all taxes and shall not be liable to attachment, garnishment, levy or seizure
by or under any legal or equitable process whatsoever except to pay a debt of the
official or employee concerned to the private benefit plan or that arising from liability
imposed in a criminal action: Provided, That the retiring official or employee has been in
the service of the same employer for at least ten (10) years and is not less than fifty
years of age at the time of his retirement: Provided, further, That the benefits granted
under this Act shall be availed of by an official or employee only once: Provided, finally,
That in case of separation of an official or employee from the service of the employer
due to death, sickness or other physical disability or for any cause beyond the control of
the said official or employee, any amount received by him or by his heirs from the
employer as a consequence of such separation shall likewise be exempt as hereinabove
provided.

As used in this Act, the term "reasonable private benefit plan" means a pension,
gratuity, stock bonus or profit sharing plan maintained by an employer for the benefit of
some or all of his officials and employees, wherein contributions are made by such
employer or officials and employees, or both, for the purpose of distributing to such
officials and employees the earnings and principal of the fund thus accumulated, and
wherein it is provided in said plan that at no time shall any part of the corpus or income
of the fund be used for, or be diverted to, any purpose other than for the exclusive
benefit of the said officials and employees.
RA 7833 (Dec. 8, 1994)

AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO.
6686 AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM
THE COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF
DETERMINING TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE
SECTION 28(B)(8) OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED

Be it enacted by the Senate and House of Representatives of the
Philippines in Congress assembled:

SECTION 1. A new sub-paragraph to be known as subparagraph (F) is hereby inserted at
the end of Section 28(b)(8) of the National Internal Revenue Code, as amended, which
shall read as follows:

"(F) 13th month pay and other benefits.

"(i) Benefits received by officials and employees of the national and local
governments pursuant to Republic Act No. 6686;
"(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as

27

TAXATION 1 ATTY. BELLO



amended by Memorandum Order No. 28, dated August 13, 1986;


"(iii) Benefits received by officials and employees not covered by Presidential
Decree No. 851, as amended; and
"(iv) Other benefits such as productivity incentives and Christmas bonus in an
amount not exceeding Twelve thousand pesos (P12,000) which shall be
integrated in the 13th month pay solely for purposes of this Act.
Rev. Regs. 2-95 (Jan.3, 1995)

Implementing Republic Act No. 7833, An Act to Exclude the Benefits Mandated
Pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as Amended, and
other Benefits from the Computation of Gross Compensation Income for the Purposes
of Determining Taxable Compensation Income, Amending for the Purpose Section 28 (b)
(8) of the National Internal Revenue Code, as Amended.
SECTION 1. Scope Pursuant to Section 245 and 72 of the National Internal Revenue
Code (NIRC), as amended, in relation to Section 3 of Republic Act No. 7833, these
Regulations are hereby promulgated to implement the provisions of Section 28 (b) (9)
(6) of the NIRC, as amended, excluding from the computation of gross compensation
income, for purposes of determining taxable compensation income, the 13th month pay
and other benefits.
SECTION 2. Definition of Terms. For purposes of these Regulations, the following
definitions of words and phrases are hereby adopted:
a) "Act" refers to Republic Act No. 7933.
b) "Exclusions" shall mean the total benefits which are not included in the
computation of gross compensation income for purposes of determining taxable
compensation income and are, therefore, exempt from the withholding tax on wages.
c) "Gross compensation income" means all remunerations for services performed by
an employee for his employer, whether paid in cash or in kind, unless specifically
excluded under Secs. 27 and 28 of the NIRC, as amended.
d) "Immediately succeeding payroll period" refers to the payroll period beginning
January, 1995.

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. f) "Taxable compensation income" means gross compensation income less


personal and additional exemptions provided for under Sec. 29 (l) of the NIRC,
as amended.
. g) "13th month pay" refers to the mandatory one month basic salary of an official
or employee of the National Government, Local Government Units, agencies
and instrumentalities, including government-owned and -controlled
corporations, and of private offices received after the 12th month pay.
. h) "Total benefits" refer to the sum of all the benefits received by an official or
employee for one calendar year in accordance with the provisions of the "Act."

. i) "Which shall be integrated in" shall mean "which shall be added to".
SECTION 3. Benefits Exempted from Income Tax. For purposes of determining the
taxable compensation income, the following benefits shall be excluded from the gross
compensation income, viz:
a) 13th month pay equivalent to the mandatory one (1) month basic salary of officials
and employees of the Government (whether national or local), including government-
owned and -controlled corporations, and of private offices received after the 12th
month pay beginning CY 1994; and
b) Other benefits, such as, Christmas bonus given by, private offices to their officials and
employees, productivity incentives bonus, loyalty award, gifts in cash or in kind and
other benefits of similar nature actually received by officials and employees of both
Government and private offices in an amount not exceeding Twelve Thousand Pesos
(12,000.00) for one (1) calendar year.
The above-stated exclusions [(a) and (b)] shall cover benefits paid or accrued beginning
January 1, 1994 but shall be limited only to an amount not exceeding Twelve Thousand
Pesos (P12,000.00) in the case of the "other benefits" contemplated under paragraph
(b) above, provided, however, that when added to the 13th month pay, the total
amount of tax exempt benefits shall not exceed Thirty Thousand Pesos (P30,000.00).
ILLUSTRATIONS:

. e) "Other benefits" refer to all benefits other than the 13th month pay, such as,
the annual Christmas bonus given by private offices, 14th month pay, mid-year
productivity incentive bonus, gifts in cash or in kind and other similar benefits
received by an official or employee for one calendar year in an amount not
exceeding Twelve Thousand Pesos (P12,000.00) as maximum limit.

CASE NO. 1.
During CY 1994, Mr. "A", and official of a private corporation, received the following
13th month pay and other benefits from his employer, such as:

28

TAXATION 1 ATTY. BELLO



13th month pay P30,000.00


Other benefits:
Christmas bonus P15,000.00
14th month pay 30,000.00

Mid-year productivity bonus 10,000.00 55,000.00
TOTAL BENEFITS RECEIVED
for CY 1994 P 85,000
========
In this illustration, Mr. "A" shall only be exempted on his 13th month pay of P30,000.
His "other benefits" amounting to P55,000 are subject to the withholding tax on wages.

CASE NO. 2.
On the other hand, Mr. "B", a government employee, received the following 13th
month pay and other benefits, such as:
13th month pay P8,000.00
Other benefits:
Productivity incentives bonus P12,000.00
Cash gift 1,000.00 13,0000

TOTAL BENEFITS RECEIVED
for CY 1994 P 21,000
========
Mr. "B" shall only be exempt on a total of P20,000.00, representing 13th month pay of
P8,000.00 plus "other benefits" of P12,000.00 only.
SECTION 4. Computation of Refundable/Creditable Taxes Withheld on the Exempt 13th
Month Pay and Other Benefits. (a) In general. The employer shall compute the
refundable/creditable amount of taxes withheld on the exempt 13th month pay and
other benefits of employees through the annualized computation prescribed in Section
71(8)(2)(b) of Revenue Regulations No. 6-82, as amended by RR No. 4-93, implementing
R.A. No. 7497, otherwise known as the "Final Withholding Tax on Compensation
Income."
(b) Refund/Credit to Employees of Excess Taxes Withheld. Any excess in the taxes
withheld resulting from the annualized computation shall be credited/refunded to the
employees. In return, the employer is entitled to deduct the amount refunded/credited
from the remittable amount of taxes withheld from compensation income in the
current month in which refund/credit was made, and in the succeeding months

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thereafter until the amount refunded/credited by the employer is fully repaid.


ILLUSTRATIONS:
1.The year-end adjustment computation resulted to a REFUND.
(aa)Employee with Only One Employee During the Year.
ABC COMPANY Employee "A" (single)


Salaries

13th month pay

Other Benefits



Gross Compensation
Income

Less: Non-taxable


Benefits:


13th month pay
P12,000
Other benefits
10,000



Less: Personal
Exemption
Taxable
Compensation

P78,000.00
12,000.00
10,000.00

P100,000.00

22,000.00

P 78,000.00
9,000.00

P69,000.00

Tax Due

P7,785.00

Less: Tax Withheld

(13,675.00)


AMOUNT TO BE
REFUNDED by
ABC CO. to Employee
"A"
on or before
JANUARY 25, 1995 OR
TO BE CREDITED
against Taxes
Withheld due from
the Employee for
Succeeding Month/s


(P 5,890.00)
========

29

TAXATION 1 ATTY. BELLO

Beginning following
Sample Computation
No. 1 (cc).

ABC Co.

DEF. Co.

(Previous Employer)

(Present Employer)

Jan.-June, 1994

Nov.-Dec., 1994

Salaries/Allowances

P78,000.00 Salaries

13th Month Pay


Other Benefits

Less: Personal

P20,000.00

10,000.00 Other Benefits




Exemption

12,000.00 13th month pay

P100,000.00
ADD: Income From

8,000.00

3,000.00

P31,000.00

9,000.00 Previous Employer

Net Taxable

Income


LESS:

Non Taxable

TAX DUE

P11,965.00 ABC Co. P12,000

TAX WITHHELD

P11,965.00

91,000.00 Benefits:
13th Month Pay

DEF Co.

*Other Benefits

ABC Co.
P10,000

DEF Co.

3,000

P13,000 10,000

LESS: Personal Exemption

Taxable Compensation Income

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(15,244.66)
(P3,089.66)



(cc) Crediting of Refundable Amounts Against Taxes Withheld Due From


Employees For The Succeeding Month/s.
Amount of refund to be credited against taxes withheld due from Employee
"B" [Based on Sample Computation No. 1 (bb) above) beginning January, 1995 P
3,089.66

Computation of Taxes Withheld for the month of
January, 1995
Salaries/Allowances

100,000.00

TAX DUE
TAX WITHHELD
ABC Co. P11,965.00


DEF Co. P3,279.66
AMOUNT TO BE REFUNDED BY DEF Co. to EMPLOYEE B
on or before JANUARY 25, 1995
OR
TO BE CREDITED against Taxes Withheld due from Employee
for Succeeding Month/s beginning January 1995 (Please see
Sample Computation No. 1 (cc).

(bb) Employee with Successive Employment Within the Year.


Employee "B" (single)

Taxable:


P10,000.00

Tax Required to be Withheld for the


month of January, 1995

(Use Line 2 Col. 8 of the

Withholding Tax Table):

P1,359.66

Less: Refund for CY 1994 due to

8,000 P20,000

30,000.00
P101,000.00
9,000.00
P92,000.00

Non-Taxability of Bonus and


Other Benefits beginning
Jan. 1995 (3,035.66)

Balance to be credited in succeeding month/s (P1,730.00)

February. 1995
Tax Required to be Withheld for the
Month of February P1,359.66
Amount to be credited
for February

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TAXATION 1 ATTY. BELLO



(1,730.00)
Balance of Amount to be Credited for the Month (P370.34)
of March
March. 1995

Tax Required to be Withheld for the Month
of March P1,359.66

Amount to be Credited
for March (370.34)
Amount to be Remitted
for March on or before
April 10, 1995 P989.32
=======
2. The year-end adjustment resulted to a COLLECTIBLE AMOUNT (instead of a refund).
During CY 1994, an employee (single) of a private corporation, received the following
compensation, month pay and other benefits:
Salaries/allowances
P5,000/mo. x 12 mos. P60,000.00
13th Month pay 5,000.00
Gift in kind 5,000.00
Cash gift 10,000.00
Christmas Bonus 5,000.00

Total Gross Compensation Income P85,000.00

Less: 13th Month Pay P5,000
Other Benefits 12,000 17,000.00

Gross Compensation Income After
Deducting Exclusions Under RA 7333 68,000.00
Less: Personal Exemption

9,000.00

Taxable Compensation Income


Tax Due
Tax Withhold

Jan.-Nov., 1994

P393.80/mo. x 11 mos.

P59,000.00
P3,925.00

(4,331.80)

Tax Collectible to be Withheld from December salary

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P1,593.20


=========
Note:
NO REFUND OF WITHHOLDING TAX FOR BONUS AND OTHER BENEFITS WOULD

RESULT DUE TO UNDER WITHOLDING IN PREVIOUS MONTHS OF THE YEAR.
SECTION 5. Refund/Credit of Taxes Withheld from employees Separated from
Employment. a) An employee separate from the service of his previous employer but
is presently employed by another employer shall be refunded/credited the taxes
withheld on his exempt 13th month pay and other benefits by his present employer.
The present employer shall compute the aforesaid excess withholding tax using the
annualized computation set forth in Section 7I (B) (2) (b) of RR No., 6-82, as amended by
RR No. 4-93.
(b) An employee who has been separated from a previous employer but has no present
employment shall claim his refund of excess tax withheld on his 13th month pay and
other benefits by filing with the BIR a refundable income tax return for CY 1994,
provided that the refundable ITR for 1994 reflects the taxes withheld on his 13th month
pay and other benefits.
SECTION6. Concurrent Multiple Employments. An employee is employed by two or
more employers at the same time during the taxable year shall be refunded/credited
the taxes withheld on his 13th month pay and "other benefits" by his main employer,
e.g., the employer paying the highest wage/salary. The said main employer shall
determine the maximum allowable 13th month pay and "other benefits" received from
both main and secondary employer/s in annualizing the taxable compensation income
at year-end adjustment. For this purpose, the secondary employer/s shall furnish the
main employer a certification as to the amount of the 13th month pay and other
benefits received by the employee.
SECTION7. The Employee's Withholding Statement (W-2). The employer shall furnish
each employee with the original and duplicate copies of BIR
Form W-2 showing the name and address of the employer, employer's TIN, name and
address of the employee, taxpayer/employee's TIN, amount of exemptions claimed, the
sum of compensation paid (excluding the total non-taxable benefits), the amount of tax
due and the amount of tax withheld during the calendar year.
The statement must be signed by both the employer or other authorized officer and the
employee and shall contain a written declaration that it is made under the penalties of
perjury.
If the employer is the Government of the Philippines, its political subdivision, agency or
instrumentality or government-owned or controlled corporation, the statement shall be

31

TAXATION 1 ATTY. BELLO



signed by the duly designated officer or employee.


SECTION 8. Annual Return of Income Tax Withheld on Compensation. Every employer
or other person required to deduct and withhold the tax shall, on or before January 31st
of the succeeding year, file with either the Collection Agent or authorized Municipal
Treasurer or Revenue District Officer or Commissioner of Internal Revenue the Annual
Return of Income Tax Withheld on Compensation [BIR 1743-1R (Annex "A")] to be
submitted with an alphabetical list of employees both in duplicate copies.
The Annual Return of Income Tax Withheld on Compensation must show the following:
a)
b)
c)

Withholding agent's registered name, address and taxpayer's identification


number (TIN);
Amount and date of remittance for the 12 months of one calendar year; and
Name of Bank, Bank Code/ROR (if any).


The alphabetical list of employees must show the following:
a) Name and TIN of employees/taxpayers;
b) Gross compensation paid by all present and previous employers for the
calendar year segregating the taxable from the non-taxable compensation
income;
c) Amount of exemptions;
d) Tax required to be withheld computed in accordance with Section 21(a) of the
Tax code;
e) Tax withheld by all present and previous employers for the calendar year; and
f) Adjustment, if any.

The alphabetical list of employees shall be prepared indicating separate listings of the
following:
a) Employees as of December 31 of the taxable year;
b) Employees terminated prior to the year-end adjustment computation showing
the month of termination/month of last payment of compensation during the
year of termination;
c) Employees (non-resident citizen) whose services are rendered abroad; and
d) Alien employees subject to final withholding tax.
SECTION9. Transitory Provision. Employers who have already given the 13th month
pay and "other benefits" to their employees and had withheld and remitted the tax due
thereon prior to the approval of R.A. No. 7833 on December 8, 1994 shall, in annualizing
and computing the annual income and the tax due from their employees, exclude the
13th month pay and "other benefits", which shall be limited only to an amount not
exceeding Twelve Thousand Pesos (P12,000.00) in the case of the "other benefits"

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contemplated under Sec. 3, par, (b) of these Regulations and provided, further, that
when the amount of these said "other benefits" is added to the "13th month pay"
contemplated under Sec. 3, par. (a) also of these Regulations, the total amount of tax
exempt benefits shall not exceed Thirty Thousand Pesos (P30,000.00).
SECTION 10. Repealing Clause. All laws, decrees, orders, rules, and regulations and
other issuances inconsistent with the "Act" and these Regulations are hereby amended,
modified or repealed accordingly.
SECTION 11. Effectivity. These Regulations shall take effect fifteen (15) days after its
publication in a newspaper of general circulation.
Footnotes
* The maximum allowable deduction for "Other Benefits" is P12,000.00. However, since
the total 13th month pay and 'other benefits' should not exceed P 30,000, only
P10,000.00 'other benefits" can be added to P 20,000, representing Mr. "B's" total 13th
month pay from his previous and present employers.
RMC 36-94 (Dec. 14, 1994)

Subject : Publishing the full text of Republic Act No. 7833 - an Act excluding the benefits
mandated pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as
amended, and other benefits from the computation of gross compensation income for
purposes of determining taxable compensation income, amending for the purpose
Section 28 (b) (8) of the National Internal Revenue Code, as amended.
To: All Internal Revenue Officers and Others Concerned. For the information and
guidance of all concerned, quoted hereunder is the full text of Republic Act No.
7833: "REPUBLIC ACT NO. 7833
"AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO. 6686
AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM THE
COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF DETERMINING
TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE SECTION 28 (b)(8)
OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED.
"Sec. 1. A new sub-paragraph to be known as sub-paragraph (F) is hereby inserted at
the end of Section 28 (b) (8) of the National Internal Revenue Code, as amended, which
shall read as follows:
"(F) 13thmonthpayandotherbenefits.cdasia

32

TAXATION 1 ATTY. BELLO



"(i) Benefits received by officials and employees of the national and local governments
pursuant to Republic Act No. 6686.
"(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;
"(iii) Benefits received by officials and employees not covered by Presidential Decree
No. 851, as amended; and
"(iv) Other benefits such as productivity incentives and Christmas bonus in an amount
not exceeding Twelve Thousand Pesos (P12,000) which shall be integrated in the 13th
month pay solely for purposes of this Act.
"Provided, however, That the exclusion shall only apply to the first Thirty Thousand
Pesos (P30,000).
"Sec. 2. The exclusion herein provided shall cover benefits paid or accrued beginning
January 1, 1994. cdasia
"For purposes of reimbursing the officials or employees who may have received the
benefits covered by this Act before its effectivity, the withholding agents are hereby
authorized not to deduct the withholding taxes in the immediately succeeding payroll
periods corresponding to the amount previously withheld from the benefits.
"Sec. 3. The Secretary of Finance shall, upon the recommendation of the Commissioner
of Internal Revenue, promulgate the necessary rules and regulations for the effective
implementation of the provision of this Act.
"Sec. 4. All laws, decrees, orders, rules and regulations and other issuances inconsistent
with this Act are hereby repealed or amended accordingly.
"Sec.5. This Act shall take effect fifteen (15) days after its complete publication in the
Official Gazette or in any two (2) newspapers of general circulation, whichever comes
earlier.
SALIENT FEATURES
1.

Before the amendment of Section 28 (b) (8) of the National Internal Revenue Code
(NIRC) by R.A. No. 7833, the following benefits received by officials and employees
of both public (national and local) and private offices, viz:

(F) 13th month pay and other benefits.

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a. Annual Christmas bonus equivalent to one (1) month basic salary and additional cash
gift of One Thousand Pesos (P1,000.00) received by National and Local Government
officials and employees starting CY 1988 in accordance with R.A. No. 6686;
b. Benefits received by employees pursuant to P.D. No. 851 , as amended by
Presidential Memorandum Order No. 28 dated August 13, 1986 requiring all employers
to pay all their rank-and-file employees a 13th month pay not later than December 24
of every year;
c. Benefits received by officials and employees not covered by P.D. No. 851, as
amended; and
d. Other benefits such as productivity incentives and Christmas bonus in an amount not
exceeding Twelve Thousand Pesos (P12,000.00) which shall be integrated in the 13th
month pay solely for purposes of R.A. No. 7833. were taxable compensation income
under Section 21(a) in relation to Section 72, both of the NIRC, as amended, subject to
withholding tax under Revenue Regulations No. 6-82, as amended by Revenue
Regulations No. 4-93.
2. Under sub-paragraph (F) of Section 28 (b) (8) of the NIRC, as amended by R.A. No.
7833, the 13th month pay and other benefits aforestated, received by officials and
employees of the National Government, Local Government Units and agencies,
including government-owned and controlled corporations, as well as by officials and
employees of private corporations and entities, are exempt from income tax, and
consequently from the withholding tax on wages. Provided, that the
exclusions/exemptions from gross compensation income shall cover the 13th month
pay and "other benefits" in the aggregate amount not exceeding P30,000 received by
the officials and employees paid or accrued beginning January 1, 1994. The aforesaid
"other benefits " as contemplated under Section 1 (F) (iv) of R.A. No. 7833 shall not
exceed P12,000, which amount shall be integrated in the 13th month pay. Accordingly,
benefits in excess of P30,000.00 shall be taxable and subject to the withholding tax only
insofar as the amount in excess of P30,000.00.
Illustration:
During CY 1994, Mr. "X", an employee of a private corporation, received the
following 13th month pay and other benefits from his employer, such as:
13th month pay

P15,000.00

Christmas bonus
Other benefits:

10,000.00

Gift in kind

2,000.00

Additional cash gift

1,000.00

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TAXATION 1 ATTY. BELLO



Mid-year productivity

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12,000
---

P33,000.00

TOTAL EXCLUSIONS/EXEMPTION FROM


Under the amendment introduced by R.A. No. 7833 to Section 28(b)(8) of the NIRC, wherein
sub-paragraph (F) has been inserted at the end thereof, the computation of the amount of
the benefits which shall be excluded/exempted from the taxable compensation income
and/or those subject to withholding tax on wages, if any, shall be as follows:

Christmas bonus

Plus: Other benefits:

Gift in kind
Additional cash gift

======

3. For purposes of reimbursing the officials and employees of the income taxes withheld
and already remitted to the BIR, the following guidelines shall be followed:
a. Employers who have already given the 13th month pay and other benefits to their
employees, and had withheld and remitted the tax due thereon prior to the approval of
R.A. No. 7833 (December 8, 1994) shall, in annualizing and computing the annual
income and the tax due from their employees, exclude the 13th month pay and other
benefits. Any excess in the tax withheld shall be refunded by the employer to the
respective employees or credited against the tax required to be withheld from the
compensation of the employees beginning January, 1995. The employer shall then be
allowed to credit and deduct from its subsequent remittances of taxes withheld on
compensation income of their employees for the succeeding months;


P 2,000
1,000

5,000
---

P27,000

P10,000

TAXABLE COMPENSATION INCOME

Computation of whether the full amount of subject "other benefits", as


contemplated under Section 1 (F) (iv) of RA 7833, is exempt from withholding tax
on wages.

incentive bonus

5,000.00

TOTAL

Mid-year productivity

No. I above)

incentive bonus

I.

8,000
---

b. Taxes withheld on the 13th month pay and other benefits given last November, which
should otherwise be remitted by the employer-withholding agent on December 12, 1994,
shall no longer be remitted to the BIR. Said withheld amount should be refunded to the
employees concerned; and

TOTAL

P18,000

Less: P12,000 maximum exemption for
other benefits as contemplated under
c. The exemption/exclusion provided for under R.A. No. 7833 shall cover the 13th month
Sec. 1(F)(iv) of RA 7833 (12,000)
pay
and "other benefits" in the aggregate amount not exceeding P30,000 received by the
officials
and employees paid or accrued beginning January 1, 1994, provided, however,

that
t
he
aforesaid "other benefits" as contemplated under Sec. 1 (F) (iv) of R.A. No. 7833
TAXABLE OTHER BENEFITS SUBJECT TO
shall
n
ot
exceed P12,000 which amount shall be integrated in the 13th month pay.
WITHHOLDING TAX ON WAGES
P6,000

It is desired that this Circular be given as wide a publicity as possible.

II. Computation of total benefits excluded/exempted from withholding tax on wages when
the "other benefits" are integrated in the 13th month pay.
13th month pay

P15,000

Plus: Maximum allowable exemption/


exclusion of P12,000 for

"other benefits" as contemplated

under Sec. 1 (F) (iv) of RA 7833


(please refer to Computation



5.

Income Derived by Foreign Government


Sec.32 (B)(7) Miscellaneous Items. -

(a) Income Derived by Foreign Government. - Income derived from investments in
the Philippines in loans, stocks, bonds or other domestic securities, or from interest
on deposits in banks in the Philippines by (i) foreign governments, (ii) financing

34

TAXATION 1 ATTY. BELLO



institutions owned, controlled, or enjoying refinancing from foreign governments, and


(iii) international or regional financial institutions established by foreign governments.

Enumeration:
Income derived by foreign government
Income derived by the government of its political subdivisions to be exempt,
income must be from:
o Public utility or
o The exercise of any essential government function
Prizes and awards in recognition of religious, charitable, scientific,
educational, artistic, literary or civic achievement, provided
o Selection
o Substantial future services
Prizes and awards in sports competition
o The sports completion or tournament must be sanctioned by the
relevant NSA
13th month pay and other benefits
o Exclusion capped at P30,000
o Excess is taxable
Gains from redemption of shares in mutual fund

CIR v. Mitsubishi Metal Corp. (Jan 22, 1990)
Mitsubishi Metal not an agent/conduit of Eximbank
Loan from Eximbank was made on its own independent capacity
Therefore, exclusion under 32(B)(7)(a) does not apply
- Its from one pocket to another
- Must be from the exercise of PV

6. Gains from the Sale of Bonds, Debentures or Other Certificates of Indebtedness
Sec.32 (B)(7) Miscellaneous Items.

(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness.
Gains realized from the same or exchange or retirement of bonds, debentures or
other certificate of indebtedness with a maturity of more than five (5) years.


Nippon Life Ins. Inc v. CIR, CTA Case No.6142 (Feb.4, 2002)
Gains as the term is used therein in 32(B)(7)(g) does not include interest since it
clearly refers to gains from the sale of bonds, debentures and other certificates of
indebtedness
NB: interest is periodic income derived from the forbearance of money; gain from
the sale of bonds is income derived form the conversion of an asset
NB: interest is income derived from the continuance of the bond investment; gain

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from sale of bonds is income derived from the termination of the bond investment

35

TAXATION 1 ATTY. BELLO



IV. DEDUCTIONS
Individual w/ Gross
Income From Business or
Practice of Profession
OSD
Itemized deductions
PPHHI
Personal exemptions

For corporations

Itemized deductions
OSD


Sec. 36(A)

SEC. 36. Items not Deductible.-

(A) General Rule. - In computing net income, no deduction shall in any case be allowed
in respect to -

(1) Personal, living or family expenses;

(2) Any amount paid out for new buildings or for permanent improvements, or
betterments made to increase the value of any property or estate;

This Subsection shall not apply to intangible drilling and development costs incurred in
petroleum operations which are deductible under Subsection (G) (1) of Section 34 of
this Code.

(3) Any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance is or has been made; or

(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.

The following are not deductible from gross income
o Personal, living or family expenses
o Any amount paid out for new buildings or for permanent
improvements, or betterments, made to increase the value of any
property or estate (CAPEX)
o Any amount expended in restoring property or in making good the
exhaustion thereof for which an allowance is or has been made

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Premium on key-man insurance (36(A))


Ex. PLDT life insurance for keyman MVP
No deduction shall be allowed for:
o Losses from sales or exchanges of property; or
o Interest expense; or
o Bad debts
--- where the transaction is bet. related TPs as follows:
Between members of a family
Between an individual and a corp. more than 50% in value of the
outstanding stock of which is owned by or for such individual
Between grantor and fiduciary of any trust
Between fiduciary of a trust and fiduciary of another trust, if the
same person is grantor with respect to each trust
Between fiduciary of trust and a beneficiary of such trust
Business expenses normally involve the following issues:
o W/N the particular expense was ordinary and necessary
o Whether the expenditure was a current expense or a capital
investment
o Whether the expense was incurred in business or for personal
reasons
Almost all cases of business expenses can be assigned to one or
another of these 3 categories
Expenses
o

Individuals w/Gross
Compensation Income
Only
PPPHHI (Premium
payments on Health
and/or Hospitalization
Insurance)
Personal Exemptions

A.


Sec.34(A)
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation
income arising from personal services rendered under an employer-employee
relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under
Sections 24 (A); 25 (A); 26; 27 (A), (B) and (C); and 28 (A) (1), there shall be allowed the
following deductions from gross income;
(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the ordinary
and necessary expenses paid or incurred during the taxable year in carrying on or which
are directly attributable to, the development, management, operation and/or conduct
of the trade, business or exercise of a profession, including:

36

TAXATION 1 ATTY. BELLO



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(i) A reasonable allowance for salaries, wages, and other forms of compensation for
personal services actually rendered, including the grossed-up monetary value of fringe
benefit furnished or granted by the employer to the employee: Provided, That the final
tax imposed under Section 33 hereof has been paid;

expenditures otherwise considered as capital outlays of depreciable assets incurred


during the taxable year for the expansion of school facilities or (b) to deduct allowance
for depreciation thereof under Subsection (F) hereof.

1. Non-Deductible Personal Expenses v. Deductible Business Expenses

(ii) A reasonable allowance for travel expenses, here and abroad, while away from home
in the pursuit of trade, business or profession;

(iii) A reasonable allowance for rentals and/or other payments which are required as a
condition for the continued use or possession, for purposes of the trade, business or
profession, of property to which the taxpayer has not taken or is not taking title or in
which he has no equity other than that of a lessee, user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation expenses
during the taxable year, that are directly connected to the development, management
and operation of the trade, business or profession of the taxpayer, or that are directly
related to or in furtherance of the conduct of his or its trade, business or exercise of a
profession not to exceed such ceilings as the Secretary of Finance may, by rules and
regulations prescribe, upon recommendation of the Commissioner, taking into account
the needs as well as the special circumstances, nature and character of the industry,
trade, business, or profession of the taxpayer: Provided, That any expense incurred for
entertainment, amusement or recreation that is contrary to law, morals public policy or
public order shall in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed
under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient
evidence, such as official receipts or other adequate records: (i) the amount of the
expense being deducted, and (ii) the direct connection or relation of the expense being
deducted to the development, management, operation and/or conduct of the trade,
business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income
shall be allowed under Subsection (A) hereof for any payment made, directly or
indirectly, to an official or employee of the national government, or to an official or
employee of any local government unit, or to an official or employee of a government-
owned or -controlled corporation, or to an official or employee or representative of a
foreign government, or to a private corporation, general professional partnership, or a
similar entity, if the payment constitutes a bribe or kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses
allowable as deductions under this Chapter, a private educational institution, referred to
under Section 27 (B) of this Code, may at its option elect either: (a) to deduct

Smith v. CIR, 40 B.T.A. 1038 (1939)


TPs argued that since Mrs. Smith would have been unable to leave her child and
take job but for the services of a nursemaid the latters fee should be regarded as
a necessary business expense
If the nursemaids fee allowed because essential to the TPs employment, then by
extension all consumption expenditures food, shelter, clothing, recreation
which enable TPs to carry on the days activities must become deductible as well
Yet these are the very essence of those personal expenses the deductibility of
which is expressly denied
Pevsner v. CIR, 628 F.2d 467 (5th Cir. 1980)
Test for deductibility: cost of clothing is deductible as a business expense only if:
2. the clothing is a type specifically required as a condition of employment
3. it is not adaptable to general usage as ordinary clothing
4. it is not so worn
Rudolph v. US, supra
Deductibility of a combined business-pleasure trip depends on a subjective standard
whether the TPs primary purpose was business or personal
Schultz v. CIR, 16 T.C. 401 (1951)
Entertainment expenses are deductible only if they are in fact ordinary and necessary
expenses for carrying on a trade or business and to the extent that they are primarily
social and personal in nature and bear no direct relation to the operation of a business
such expenditures may not be deducted.

NIRC 34(A)(1)(a)(iv): cap on entertainment expenses; non-deductibility of
entertainment expenses that are contrary to law, public morals, public policy
or public order
NIRC 34(1)(1)(c): non-deductibility of bribes, kickback and other similar
payments

2. Travel Expenses While Away from Home
- Conditions for deductibility of traveling expenses
Reasonable and necessary
Expenses incurred while away from home
Expense must be incurred in pursuit of business; there must be direct
connection between the expense and the carrying on of the trade or
business of the taxpayer or his employer; expense must be necessary or
appropriate to the development and pursuit of the business or trade

37

TAXATION 1 ATTY. BELLO




CIR v. Flowers, 326 U.S. 465 (1946)
Contention of CIR: The word home must be understood to refer to the TPs place
of business (as opposed to TPs actual residence)
Held: although SC did not decide upon the meaning of home sustained the
disallowance on the ground that the expense in question had been incurred by the
TP for his own convenience rather than for business reasons
Appropriate test of deductibility was whether the travel had been motivated by the
exigencies of business or by considerations of personal preference
- Because TP could have chosen to live in Mobile, thereby avoiding the need for
travel, the expenses were found to be self-imposed and personal
What is the bottom line of this case>
o Commuting expenses, while certainly a matter of business exigency, have
never been deductible
o Daily commuting expenses is personal and not deductible
Hantzis v. CIR, 638 F.2d 248 (1st CIR. 1981)
Held: deduction disallowed; Ms. Hantzis had no business home in Boston to be
away from
TP who pursues temporary employment away from location of his usual residence
but has not business connection with that location is not away from home for
purposes of travel expense deduction
While Ms. Hantzis plainly occupied two homes during the summer months, the
home in Boston was maintained as a matter of personal choice rather than business
necessity
It followed that her transportation and added living costs in NYC were not
deductible as travel expense
Hantzis merely confirms the holding in Flowers that long-distance commuting
even combined with meals and lodging expense does not qualify as travel

3. Deductible Current Expenses v. Non-Deductible Capital Expenditures

Statutory basis: non-deductible CAPEX: 36(A)(2)


Expenditures whose benefit extends beyond current taxable year not
deductible
E.g. Land and buildings, machinery and equipment, patents and trademarks
Present payment for future economic benefit should be capitalized rather
than deducted as current expenses
CAPEX recovered by way of depreciation or amortization
Statutory basis: non-deductible CAPEX: 36(A)(2)
Whether deductible current expense or non-deductible CAPEX is a question of
timing: deduct now or spread out
What to use? Depends on the circumstance. It one is at loss already, theres
nose use of going for the deduction anymore since there will no tax to pay.

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Mt. Morris Drive-In Theatre Co. v. CIR, 25 T.C. MT. MORRIS v. MIDLAND EMPIRE
272 (1955)
TP constructed an open-air theatre on
A case of replacement or addition
sloping land without including in the
Cost incurred in response to an
construction of any drainage system
event somehow resembling a
TP spent $8,224 to construct a drainage
natural disaster (e.g., oil seepage)
system extending into and over adjacent Need for drainage system
land belonging to another in compromise
forseeable and obvious
of a pending lawsuit against it based
Oil seepage unforseeable
upon allegations that TPs use of its own
property had caused accelerated and
concentrated drainage onto the adjacent
land
Held: the cost of drainage system was
CAPEX and was not deductible either as
an ordinary and necessary business
expense or as a loss
Midland Empire Packing Co v. CIR, 14 T.C. 635
(1950)
Issue was whether the cost of lining
basement walls with concrete to prevent
oil seepage created by a neighboring
refinery should be treated as a deductible
repair or a CAPEX
Held: deductible repair
INDOPCO, Inc. v. CIR, 503 U.S. 79 (1992)
Whether certain professional expenses incurred by a target corporation in the course of
a friendly takeover are deductible by that corporation as ordinary and necessary
business expenses or CAPEX
CIR v. General Foods (Phil.), Inc. (April 24, 2003)
Advertising to stimulate the current sale of merchandise or use of services
deductible current expense
Advertising designed to stimulate the future sale of merchandise or use of services -
CAPEX

4. Ordinary and Necessary
- To be deductible under 34(A) an expenditure must not only be incurred in
carrying on of..[a] trade, business or exercise of profession, but also must
qualify as ordinary and necessary

38

TAXATION 1 ATTY. BELLO



Welch v. Helvering, 290 U.S. 111 (1933)


Payment of anothers debt (restore the TPs credit and to reestablish his reputation
with other firms) is not ordinary, hence, not deductible currently
Efforts to establish reputation are akin to acquisition of capital assets and,
therefore, expenses related thereto are not business expense but CAPEX
Atlas Consolidated Mining & Devt Corp. v. CIR (Jan. 27, 1981)
Fees paid to a P.R. firm to create a favorable image of the co. in order to gain or
maintain the publics and stockholders patronage CAPEX
Recurring stock listing fee paid to the stock exchange (not one-off) ordinary and
necessary
Litigation expenses incurred in defense or protection of title - CAPEX

5. Reasonable Compensation
- 34(A)(1)(a)(i) provides that the TPs business expenses include a
reasonable allowance for salaries, wags and other forms of compensation for
personal services actually rendered
- There s a possibility that BIR might characterize it to something

C.M. Hoskins & Co., Inc. v. CIR (Nov. 28, 1969)
A case of disguised dividends
Reduction of corporate-level tax through deductible excessive compensation
instead of non-deductible dividends
Illustration: BB owns all of the shares of Adult Entertainment Co. and also serves as
its president
The corporation usally earns about P5M a year before BBs salary
But since BB normally takes a reasonable salary of precisely the same amount,
the companys annual taxable income customarily zero and it pays no corporate
income tax whatever
BB of course, pays an individual tax on the salary he receives
Suppose however, that 2005 was a specially good year and the corporations pre-
salary earnings balloon to P15M
BB is eager to get his greedy hands on the entire P15M for his personal use
BB has 2 options: (i) pay himself the customary reasonable salary of P5M, then
declare the after-tax net income as dividends; (ii) pay himself the customary
reasonable salary of P5M, then pay himself an excessive bonus of P10M


Option 1
Option 2
Pre-salary income
15,000,000
15,000,000
Less: regular salary
5,000
5,000
Less: Bonus
-NIL-
10,000,000
Taxable Income
10,000,000
-NIL-


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Tax payments


Corporate income tax (P10M x
3,000,000
-NIL-
30%)
Tax on dividends (P6.5M x 10%)
7,000,000
-NIL-
Tax on regular salary (P5M x
1,600,000

32%)
Tax on bonus paid
-NIL-

Total Taxes paid
5,750,000
4,800,000
BBs take Home (P15M less taxes 9,250,000
10,200,000
Kuenzle & Streiff, Inc v. Collector (Oct. 20, 1959)
Measure of reasonableness: facts and circumstances test

6. Period for Which Deductions and Credits Taken
Year in which deduction taken: paid or incurred during the taxable year
depending also on the method of accounting
If cash method year when expense is paid
Why cant the taxpayer choose when to claim the deduction?
o If you claim a deduction, theres no tax benefit. Therefore, you might
shift it to a year when then there is such
o No accurate matching of financial expenses

Sec. 45

SEC. 45. Period for which Deductions and Credits Taken. - The deductions provided for
in this Title shall be taken for the taxable year in which 'paid or accrued' or 'paid or
incurred', dependent upon the method of accounting the basis of which the net income
is computed, unless in order to clearly reflect the income, the deductions should be
taken as of a different period. In the case of the death of a taxpayer, there shall be
allowed as deductions for the taxable period in which falls the date of his death,
amounts accrued up to the date of his death if not otherwise properly allowable in
respect of such period or a prior period.

CIR v. Isabela Cultural Corp. (Feb. 12, 2007)
TP may not claim as a deduction in 1986 the cost legal and auditing services
rendered in 1984 and 1985, although billed only and paid in 1986
All events test: expense must be claimed as a deduction when liability is (1) fixed
and (2) the amount can be determined with reasonable accuracy





39

TAXATION 1 ATTY. BELLO



B. Interest

Sec.34(B)
(B) Interest.-
(1) In General. - The amount of interest paid or incurred within a taxable year on
indebtedness in connection with the taxpayer's profession, trade or business shall be
allowed as deduction from gross income: Provided, however, That the taxpayer's
otherwise allowable deduction for interest expense shall be reduced by an amount
equal to the following percentages of the interest income subjected to final tax:
Forty-one percent (41%) beginning January 1, 1998;Thirty-nine percent (39%) beginning
January 1, 1999; and Thirty-eight percent (38%) beginning January 1, 2000;
(2) Exceptions. - No deduction shall be allowed in respect of interest under the
succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash basis
incurs an indebtedness on which an interest is paid in advance through discount or
otherwise: Provided, That such interest shall be allowed a a deduction in the year the
indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic
amortizations, the amount of interest which corresponds to the amount of the principal
amortized or paid during the year shall be allowed as deduction in such taxable year;
(b)If both the taxpayer and the person to whom the payment has been made or is to be
made are persons specified under Section 36 (B); or
(c)If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest
incurred to acquire property used in trade business or exercise of a profession may be
allowed as a deduction or treated as a capital expenditure.

Requisites for deductibility
1. Paid or incurred within the taxable year
2. Underlying indebtedness must be in connection with the trade or business or
exercise of profession
3. There must be an indebtedness
4. There should be an interest expense paid or incurred upon such indebtedness;
5. The indebtedness must be that of the TP;

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6.

The indebtedness must be connected with the taxpayers trade, business or


exercise of profession;
7. The interest expense must have been paid or incurred during the taxable year;
8. The interest must have been stipulated in writing;
9. The interest must be legally due;
10. The interest payment arrangement must not be between related parties under
36(B)
11. The interest must not be incurred to finance petroleum operations; and
12. In case of interest incurred to acquire property used in trade, business or exercise
of profession, the same was not treated as a capital expenditure


Paper Ind. Corp. of the Phil. v. CA (Dec. 1, 1995)
The Tax Code does not prohibit the deduction of interest on a loan incurred for
acquiring machinery and equipment. Neither does the Tax Code compel the
capitalization of interest payments on such a loan
NB: 34(B)(3) now gives the TP the option to deduct currently or capitalize interest
incurred to acquire property used in trade, business or exercise of a profession
CIR v. Vda. de Prieto (Sept. 30, 1960)
Although interest payment for delinquent taxes is not deductible as tax under Section
30(c) of the Tax Code [now 34(C) and section 80 of the Income Tax Regulations, the
taxpayer is not precluded thereby from claiming said interest payment as deduction
under section 30(b) of the same Code [now 34(b)]

Rev. Regs. 13-2000 (Nov. 20, 2000)

Subject: Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for
Deductibility of Interest Expense from the Gross Income of a Taxpayer.

To: All Internal Revenue Officers and Others Concerned

SECTION 1.
Scope. Pursuant to the provisions of Section 244 of the Tax Code of 1997, these
Regulations are hereby promulgated to implement the provisions of Section 34(B) of the
same Code on the requirements for deductibility of interest expense from the gross
income of a corporation or an individual engaged in trade, business or in the practice of
profession.

SECTION 2. Definition of Terms. For purposes of these Regulations, the following
words and phrases shall have the following meanings, viz:

(a) Interest shall refer to the payment for the use or forbearance or detention of
money, regardless of the name it is called or denominated. It includes the amount paid

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TAXATION 1 ATTY. BELLO



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.

(b) Taxpayer shall refer to a person, whether natural or juridical, engaged in trade,
business or in the exercise of profession, except one earning compensation income
arising from personal services rendered under an employer-employee relationship.

SECTION3. Requisites for Deductibility of Interest Expense. In general, subject to
certain limitations, the following are the requisites for the deductibility of interest
expense from gross income, viz:

(a) There must be an indebtedness;

(b) There should be an interest expense paid or incurred upon such indebtedness;

(c) The indebtedness must be that of the taxpayer,

(d) The indebtedness must be connected with the taxpayer's trade, business or exercise
of profession;

(e) The interest expense must have been paid or incurred during the taxable year;

(f) The interest must have been stipulated in writing;

(g) The interest must be legally due;

(h) The interest payment arrangement must not be between related taxpayers as
mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997;

(i) The interest must not be incurred to finance petroleum operations; and
(j) In case of interest incurred to acquire property used in trade, business or exercise of
profession, the same was not treated as a capital expenditure.

SECTION 4. Rules on the Deductibility of Interest Expense.

(a) General Rule. In general, the amount of interest expense paid or incurred within a
taxable year on indebtedness in connection with the taxpayer's trade, business or
exercise of profession shall be allowed as a deduction from the taxpayer's gross income.

(b) Limitation. The amount of interest expense paid or incurred by a taxpayer in
connection with his trade, business or exercise of a profession from an existing
indebtedness shall be reduced by an amount equal to the following percentages of the
interest income earned which had been subjected to final withholding tax depending on
the year when the interest income was earned, viz:

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Forty-one percent (41%) beginning January 1, 1998;
Thirty-nine percent (39%) beginning January 1, 1999; and
Thirty-eight percent (38%).beginning January 1, 2000 and thereafter.

This limitation 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. This rule
shall be observed irrespective of the currency the loan was contracted and/or in
whatever currency the investments or deposits were made.

Illustration: Supposing on January 15, 1998, Company A, who has a deposit account with
BCD Bank, obtained a loan from XYZ Financing Corporation in connection with the
operation of its business. Assume that Company A's net income for the year 1998 before
the deduction of the interest expense amounted to P1,000,000. For the year 1998, the
interest income it derived from the said deposit with BCD Bank amounted to P180,000
on which a final tax of P36,000 had been withheld. Its interest expense on the loan
obtained from XYZ Financing Corporation during the same year amounted to P150,000.
Under this illustration, the deductible interest expense, the taxable income and the
income tax due of Company A shall be computed as follows:


1998
Net Income before interest expense

P1,000,000
Less: Interest expense
P150,000

Less: 41% of interest income from
73,800

deposit (41% x P180,000)
Deductible interest expense

76,200
Taxable Income

P 923,800
Income tax due for taxable year 1998

P 314,092
(34%)


(c) Interest on Unpaid Taxes. Provisions of Sec. 4(b) hereof to the contrary
notwithstanding, interest incurred or paid by the taxpayer on all unpaid business-
related taxes shall be fully deductible from gross income and shall not be subject to the
limitation
deduction heretofore mentioned. Thus, such interest expense incurred or paid shall not
be diminished by the percentage of interest income earned which had been subjected
to final withholding tax.

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TAXATION 1 ATTY. BELLO



(d) Other cases where interest expense is not deductible from gross income. No
interest expense shall be allowed as deduction from gross income in any of the
following cases:

(1) If within the taxable year, an individual taxpayer reporting income on the cash basis
incurs an indebtedness on which an interest is paid in advance through discount or
otherwise: Provided, That such interest shall be allowed as a deduction in the year the
indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic
amortization, the amount of interest which corresponds to the amount of the principal
amortized or paid during the year shall be allowed as deduction in such taxable year.

Illustration: Mr. Cruz, a self-employed individual, consistently employs the cash-basis
accounting method in keeping his books of accounts. Assuming that on January 1, 1998,
he contracted a loan of P1,000,000 from XYZ Bank for use in his business operations.
Terms:

Payable in two (2) years at 15% interest per annum, payable in advance. On January 1,
1998, he received from the bank the proceeds of his loan in the sum of P700,000, net of
interest paid in advance in the amount of P300,000.

In general, the interest expense shall be taken for the taxable year in which "paid or
incurred" or "paid or accrued" depending upon the method of accounting upon the
basis of which the net income is computed, unless in order to clearly reflect the income,
the deduction should be taken as of a different period. Thus, a self-employed individual
is allowed to deduct from his gross income the entire amount of interest expense
actually paid during the taxable year. However, if the interest expense is paid in advance
and the accounting method used by the self-employed individual is the cash-basis
accounting method, such interest expense paid in advance shall only be allowed as
deduction in the year when he has fully paid his liability. So that if the said debtor has
fully paid his loan as of the end of the taxable year 1999, his interest expense paid in
advance on January 1, 1998 in the amount of P300,000 shall only be allowed as
deduction from his gross income in the taxable year 1999.

On the other hand, even if the interest expense is paid in advance but the indebtedness
is payable in periodic amortization, the amount of interest expense which corresponds
to the amount of the principal amortized or paid during the respective years 1998 and
1999 shall be allowed as deduction in such respective taxable years.

(2) If both the taxpayer and the person to whom the payment has been made or is to be
made are persons specified under Sec. 36(B) of the Tax Code of 1997, viz:

(i) Between members of a family. For purposes of this paragraph, the family of an
individual shall include only his brothers and sisters (whether by the whole or half-
blood), spouse, ancestors and lineal descendants; or

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(ii) Between an individual and a corporation more than fifty percent (50%) in value of
the outstanding stock of which is owned, directly and indirectly, by or for such
individual; or

(iii) Between two corporations more than fifty percent (50%) in value of the outstanding
stock of each of which is owned, directly or indirectly, by or for the same individual; or

(iv)Between the grantor and a fiduciary of any trust; or

(v)Between the fiduciary of a trust and the fiduciary of another trust if the same person
is a grantor with respect to each trust; or

(vi) Between a fiduciary of a trust and a beneficiary of such trust.

(3) If the indebtedness on which the interest expense is paid is incurred to finance
petroleum exploration in the Philippines. The non-deductible interest expense 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 by P.D. No. 87, otherwise known as "The Oil Exploration
and Development Act of 1972."

(e) Optional treatment of interest expense on capital expenditure. At the option of
the taxpayer, interest expense on a capital expenditure incurred to acquire property
used in trade, business or exercise of a profession may be allowed as a deduction in full
in the year when incurred, the provisions of Sec. 36 (A)(2) and (3) of the Tax Code of
1997 to the contrary notwithstanding, or may be treated as a capital expenditure for
which the taxpayer may claim only as a deduction the periodic amortization of such
expenditure.

SECTION5. Repealing Clause. The provisions of any revenue regulations or any
revenue issuance or ruling inconsistent with these Regulations are hereby repealed,
amended, or modified accordingly.

SECTION 6. Effectivity Clause. These Regulations shall take effect immediately.


- Interest Arbitrage
Anti-tax arbitrage provision: interest otherwise deductible reduce by 33% of
interest income subject to final tax
o Back-to-back loans: TP takes out loan; uses proceeds to purchase
government securities; interest income from government securities

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TAXATION 1 ATTY. BELLO



subject to 20% FWT; interest expense on loan deductible from gross


income (tax benefit is 32%/35%); tax advantage is 15%
o Tax arbitrage avoided by imposing limit on deductible business
expense
Rationale: 1997, banks and financial advisers used to take advantage over this.
They acquire loan and use the proceeds for buying securities. So you have an
interest expense on one hand and an interest income on the other.

BIR Rul. No. 006-00 (Jan.5, 2000)
Limitation applies regardless of whether or not a tax arbitrage scheme was entered into
by TP or regardless of the date of 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

Illustration:
1. Interest income from time deposit in BPI in 2007: P100,000 (subjected to 20%
FWT)
o Interest expense form business loan: P120,000
o Formula: interest expense 38% of interest income subjected to final
tax = allowable interest expense
o P120,000 P38,000 = P82,000
2. TP took out a loan for P1m; interest at 10% p/a
o Uses P1M loan proceeds to purchase T-bills paying interest at 10%
p/a, subject to 20% final tax
o For every P1.00 of interest income earned from T-bills, TP pays tax of
P0.20
o For every P1.00 of interest expense claimed as a deduction, income
tax liability is reduced by P0.30
o P0.30 tax benefit vs. P0.20 tax paid = P0.10 tax advantage/revenue
leak
3. With anti-tax arbitrage provision in palce, TP can deduct only P0.62 (P1.000
interest expense less 38% of P1.00 interest income)
o Tax benefit of P0.62 interest expense is P0.186
o Tax paid on P1.00 interest income is P0.20
o Tax loop hole is plugged by anti-arbitrage provision

Non-deductible interest
Prepaid/advance interest of cash-basis individual
TP and recipient of interest are related parties under section 36(B)
Interest to finance petroleum exploration (capitalized under special rules)

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Related Party transactions:


Between members of a family
Between an individual and a corp. more than 50% in value of the
outstanding stock of which is owned by or for such individual
Between grantor and fiduciary of any trust
Between fiduciary of a trust and fiduciary of another trust, if the
same person is grantor with respect to each trust
Between fiduciary of trust and a beneficiary of such trust

C. Taxes


Sec. 34(C)
(C) Taxes. -
(1) In General. - Taxes paid or incurred within the taxable year in connection with the
taxpayer's profession, trade or business, shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction shall
be allowed in the case of a taxpayer who does not signify in his return his desire to have
to any extent the benefits of paragraph (3) of this subsection (relating to credits for
taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of the
property assessed.
Provided, That taxes allowed under this Subsection, when refunded or credited, shall be
included as part of gross income in the year of receipt to the extent of the income tax
benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in
trade or business in the Philippines and a resident foreign corporation, the deductions
for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to
the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his
return his desire to have the benefits of this paragraph, the tax imposed by this Title

43

TAXATION 1 ATTY. BELLO



shall be credited with:


(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a
domestic corporation, the amount of income taxes paid or incurred during the taxable
year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of a
general professional partnership or a beneficiary of an estate or trust, his proportionate
share of such taxes of the general professional partnership or the estate or trust paid or
incurred during the taxable year to a foreign country, if his distributive share of the
income of such partnership or trust is reported for taxation under this Title.

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Section may, at the option of the taxpayer and irrespective of the method of accounting
employed in keeping his books, be taken in the year which the taxes of the foreign
country were incurred, subject, however, to the conditions prescribed in Subsection
(C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the
taxes of the foreign country accrued, the credits for all subsequent years shall be taken
upon the same basis and no portion of any such taxes shall be allowed as a deduction in
the same or any succeeding year.
(7)Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed
only if the taxpayer establishes to the satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;

An alien individual and a foreign corporation shall not be allowed the credits against the
tax for the taxes of foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be
subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country shall
not exceed the same proportion of the tax against which such credit is taken, which the
taxpayer's taxable income from sources within such country under this Title bears to his
entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax
against which such credit is taken, which the taxpayer's taxable income from sources
without the Philippines taxable under this Title bears to his entire taxable income for
the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from
the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole
or in part, the taxpayer shall notify the Commissioner; who shall redetermine the
amount of the tax for the year or years affected, and the amount of tax due upon such
redetermination, if any, shall be paid by the taxpayer upon notice and demand by the
Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to
the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a
condition precedent to the allowance of this credit may require the taxpayer to give a
bond with sureties satisfactory to and to be approved by the Commissioner in such sum
as he may require, conditioned upon the payment by the taxpayer of any amount of tax
found due upon any such redetermination. The bond herein prescribed shall contain
such further conditions as the Commissioner may require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this

(b) The amount of income derived from each country, the tax paid or incurred to which
is claimed as a credit under said paragraph, such amount to be determined under rules
and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such credits.

In General
Taxes paid or incurred in connection with the TPs trade, business or
profession are deductible
Exception: the following taxes are not deductible
o Income tax
o Foreign taxes, if TP elects FTC
o Donors and estate tax
o Special assessments imposed by an LGU over an adjoining
landowner who is benefitted. This seldom happens
Examples: Local business taxes
Why would a taxpayer choose a tax credit over a deduction?
o Tax benefit has an effective rate
o Deduction: Tax benefit is the entire P1

Foreign Tax Credits
Granted when there is foreign source income + tax foreign and domestic
Resident citizens and domestic corporations are taxed on income from within
and without the Philippines (23(A) & (E))
If a resident citizen or a domestic corporation derive both Philippine source
and foreign source income, it is possible that they may be subject to tax in
more than one country
o The right of a foreign country to tax income derived from any activity
of a TP within its territorial boundary may coincide with the

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TAXATION 1 ATTY. BELLO



Philippines right to tax the same TP on the basis of citizenship or


residency
Ex. fight purse of Manny Pacquiao earned in a boxing match in the
U.S.

Result:
o International double taxation exists when a single item of income is
subject to income tax by more than one country
Remedies to eliminate or mitigate effects of double taxation:
o Granting a credit for foreign taxes paid (unilateral mechanism) -
34(C)(3), subject to the limitation set forth in subsection (C)(4)
o Allowing foreign taxes paid as a deduction against income (unilateral
mechanism) - 34(C)(1)(b)
o Income tax treaties (bilateral mechanism) - 32(B)(5)
Foreign tax credit available only to resident citizens and domestic corporation
(not available to non-resident citizens, aliens and foreign corporation because
they are not taxable on foreign source income)
FTC applies only if there is foreign source income and income tax on the
foreign source income is paid to another jurisdiction

* YOU MUST INVOKE THE TAX CREDIT

CIR v. Lednicky (July 31, 1964)
An alien resident who derives income wholly from sources within the Philippines
may not deduct form gross income the income taxes he paid to his home country
for the taxable year
An alien residents right to deduct from gross income the income taxes he paid to a
foreign government is given only as an alternative to his right to claim a tax credit
for such foreign income taxes; so that unless he has a right to claim such tax credit
if he chooses, he is precluded from said deduction
An alien resident is not entitled to tax credit for foreign income taxes paid when his
income is derived wholly from sources within the Philippines
What they should have done: they should have just claimed foreign tax credit in the
US for their income in the Philippines.

D. Losses


NIRC uses the term loss in three distinct ways;
a) Casualty - TP parting of something of value (money or property) as a result of
an identifiable event e.g., abandonment of property ( 34(D)(7), expenditure
of funds or a casualty ( 34(D)(1)), obsolescence loss (medicines not sold but
about to expire already)


b)

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Excess of deductions over items of income e.g., NOL under 34(D)(3); such
loss could be composed of hundreds or even thousand of distinct items of
income and deduction
Sale exchange or other disposition of property Gain/loss = AR-AB ( 40)

c)


Types of deductible losses under section 34(D):
Losses incurred in trade, business or profession ( 34(D)(1))
Casualty losses and losses from robbery, theft & embezzlement ( 34(D)(3))
NOL- law allows carry-over of NOLs under certain conditions ( 34(D)(3)
Capital losses governed by 39
Losses from wash sales - 38
Wagering losses deductible only to the extent of wagering gains
Abandonment losses covered by special laws (e.g. PD 87)

1. Casualty Losses


Sec. 34(D)

(D) Losses. -
(1) In General. - Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or profession, if the loss arises from
fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.
The Secretary of Finance, upon recommendation of the Commissioner, is hereby
authorized to promulgate rules and regulations prescribing, among other things, the
time and manner by which the taxpayer shall submit a declaration of loss sustained
from casualty or from robbery, theft or embezzlement during the taxable year:
Provided, however, That the time limit to be so prescribed in the rules and regulations
shall not be less than thirty (30) days nor more than ninety (90) days from the date of
discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.
(c) No loss shall be allowed as a deduction under this Subsection if at the time of the
filing of the return, such loss has been claimed as a deduction for estate tax purposes in
the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation,

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TAXATION 1 ATTY. BELLO



the losses deductible shall be those actually sustained during the year incurred in
business, trade or exercise of a profession conducted within the Philippines, when such
losses are not compensated for by insurance or other forms of indemnity. The secretary
of Finance, upon recommendation of the Commissioner, is hereby authorized to
promulgate rules and regulations prescribing, among other things, the time and manner
by which the taxpayer shall submit a declaration of loss sustained from casualty or from
robbery, theft or embezzlement during the taxable year: Provided, That the time to be
so prescribed in the rules and regulations shall not be less than thirty (30) days nor more
than ninety (90) days from the date of discovery of the casualty or robbery, theft or
embezzlement giving rise to the loss; and

Losses under 34(D)(1): conditions for deductibility
Actually sustained in the year claimed
Not compensated for insurance or other forms of indemnity
Property is connected with a trade, business or profession and loss arises from
fire, storm
Property is connected with a trade, business or profession and loss arises from
the fire, storm, shipwreck, or other casualty or from theft
Sworn declaration of loss filed within 45 days (Rev. Regs. 12-77); failure to file
results in disallowance
o Must substantiate loss through adequate records
o There needs to be basis for the BIR to verify if there was really a loss

2. NOLCO
- More allowable deductions than gross income: Net operating loss
- Started in 1997 TP can carry over NOL to 3 succeeding years
- NOL will be an additional deduction
- Provided that there should be no substantial change in the ownership
(3) Net Operating Loss Carry-Over. - The net operating loss of the business or enterprise
for any taxable year immediately preceding the current taxable year, which had not
been previously offset as deduction from gross income 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: Provided, however, That 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 this Subsection: Provided, further, That a net
operating loss carry-over shall be allowed only if there has been no substantial change in
the ownership of the business or enterprise in that -
(i) Not less than seventy-five percent (75%) in nominal value of outstanding issued
shares, if the business is in the name of a corporation, is held by or on behalf of the
same persons; or(ii) Not less than seventy-five percent (75%) of the paid up capital of
the corporation, if the business is in the name of a corporation, is held by or on behalf of

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the same persons.


"For purposes of this subsection, the term 'not operating loss' shall mean the excess of
allowable deduction over gross income of the business in a taxable year.
Provided, That for mines other than oil and gas wells, a net operating loss without the
benefit of incentives provided for under Executive Order No. 226, as amended,
otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first
ten (10) years of operation may be carried over as a deduction from taxable income for
the next five (5) years immediately following the year of such loss. The entire amount of
the loss shall be carried over to the first of the five (5) taxable years following the loss,
and any portion of such loss which exceeds, the taxable income of such first year shall
be deducted in like manner form the taxable income of the next remaining four (4)
years.

Net operating loss (NOL): excess of allowable deductions over gross income of
the business in a taxable year
NOLs may be carried over as a deduction from gross income for the next three
consecutive taxable years immediately following the year of loss
Provided, there has been no substantial change in ownership of the business
enterprise
o Change in shareholders: corporation will still benefit
o Merger and consolidation: there is a transfer from one entity to
another


















46

TAXATION 1 ATTY. BELLO

PICOP v. CA

R S/H

PICOP claimed P44M of


RPPMs NOL as a deduction
against its 1977 gross
income

To grant PICOPs claimed


deduction would be to
permit PICOP to purchase a
tax deduction and RPPM to
peddle its accumulated
operating loss

PICOP established the rule


that NOLCO is available
only to the TP which

P S/H

PICOP

NOL



Important rules (PICOP codified)
NOL is always available as a deduction in the hands of the TP who sustained
and accumulated the NOL, regardless of the change in ownership (Rev Regs.
14-01 2.2)
NOL is retained also if the TP who sustained and accumulated the NOL is
involved in a merger and the same TP is the surviving entity
If NOL transfers from the TP who sustained and accumulated the same to
another TP via merger, consolidation, or business combination, and there is no
substantial change in ownership (75% rule), NOL deductible in the hands of the
transferee

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If NOL transfers from TP who sustained and accumulated the same to another
TP via merger, consolidation, or business combination, and there is substantial
change in ownership, NOL is lost
NOLCO allowed only if there has been no substantial change in the ownership
of the business enterprise
Illustration of substantial change in ownership rule (see NOLCO charts)

3. Realized v. Unrealized losses



BIR Rul. No. 206-90 (Oct.30, 1990)
Conversion of dollar denominated loans to pesos at the prevailing exchange rate
Not taxable income because such increase has not yet been realized. The increase
in value can only be realized when there is severance of the gain already.
It is also the same to obtaining losses. Annual decline in value of a property is not
normally allowed as a deduction.
The loss is only deductible for the year it was actually sustained and that is during
the year in which the loss occurs as evidenced by a complete transaction. There has
to be a taxation even that should happen.
BIR Rul. No. 144-85 (Aug. 26, 1985)
Losses that arose from matured but unremitted principal repayments of loans
affected by debt restructuring program in the Philippines
The increase in value, i.e., the gain, could only be taxed when a disposition of the
property occurred which was of such a nature as to constitute a realization of such
gain, that is, a severance of the gain from the original capital invested in the
property. The same conclusion obtains as to losses. The annual decrease in the
value of property is not normally allowable as a loss. Hence, to be allowable the
loss must be realized.

4. Losses from sales or exchanges (to be taken-up in XV below)

E.

Bad Debts


Sec. 34(E)
(E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and
charged off within the taxable year except those not connected with profession, trade
or business and those sustained in a transaction entered into between parties
mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts
previously allowed as deduction in the preceding years shall be included as part of the

47

TAXATION 1 ATTY. BELLO



gross income in the year of recovery to the extent of the income tax benefit of said
deduction.
(2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are
ascertained to be worthless and charged off within the taxable year and are capital
assets, the loss resulting therefrom shall, in the case of a 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, for the purpose of this Title, be considered as
a loss from the sale or exchange, on the last day of such taxable year, of capital assets.

Requisites for deductibility
There must be an existing indebtedness due to the taxpayer which must be
valid and legally demandable
The same must be connected with the taxpayers trade, business or practice of
profession;
The same must not be sustained in a transaction entered into between related
parties enumerated under NIRC 36(B)
The same must be actually charged off the books of accounts of the taxpayer
as of the end of the taxable year; and
The same must be actually ascertained to be worthless and uncollectible as of
the end of the taxable year

When is an indebtedness actually ascertained to be worthless?
No hard and fast rule; facts and circumstances
Debt no worthless simply because it is doubtful value or difficult to
collect
Deduction may not be postponed on the basis of a mere hope of
ultimate collection

Rev. Regs. 5-99 (March 10, 1999)

SUBJECT : Implementing Section 34(E) of the Tax Code of 1997 on the Requirements
for Deductibility of Bad Debts from Gross Income

TO : REVENUE REGULATIONS NO. 05-99
All Internal Revenue Officers and Others Concerned

SECTION 1.
Scope. Pursuant to the provisions of Section 244 of the Tax Code of 1997, these
regulations are hereby promulgated to implement the provisions of Section 34(E) of the
same Code on the requirements for deductibility of bad debts from the gross income of
a corporation or an individual engaged in trade or business or a professional engaged in
the practice of his profession.

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SECTION 2. Definition of Terms. For purposes of these regulations, the following
words and phrases shall have the following meaning, viz:

a. "Bad debts" shall refer to those 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.

b. "Securities" shall mean shares of stock in a corporation and rights to subscribe for
or to receive such shares. The term includes bonds, debentures, notes or certificates, or
other evidence of indebtedness, issued by any corporation, including those issued by a
government or political subdivision thereof, with interest coupons or in registered form.

c. "Actually ascertained to be worthless" In general, a debt is not worthless simply
because it is of doubtful value or difficult to collect. Worthlessness is not determined by
an inflexible formula or slide rule calculation but upon the exercise of sound business
judgment. The determination of worthlessness in a given case must depend upon the
particular facts and the circumstances of the case.

A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of
ultimate collection or because of a continuance of attempts to collect notes which have
long become overdue, and where there is no showing that the surrounding
circumstances differ from those relating to other notes which were charged off in a
prior year. While a mere hope probably will not justify postponement of the deduction,
a reasonable possibility of recovery will permit the account to be carried along
notwithstanding that the probabilities are that the debt may not be collected at all. The
creditor may offer evidence to show some expectation that the debt would have been
paid in the intervening years, and that subsequently, the hope was shattered or
appeared to have been unfounded. If, for example, the creditor could show that during
the years he attempted to collect the debt, the debtor had property the title of which
was in dispute but which would enable him to pay his debts when the title was cleared,
the creditor would be entitled to defer the deduction on the ground that there was no
genuine ascertainment of worthlessness.
Thus, accounts receivable, the amount whereof is insignificant and the collection of
which through court action may be more costly to the taxpayer, may be written-off as
bad debts even without conclusive evidence that the taxpayer's receivable from a
debtor has definitely become worthless.

Good faith does not require that the taxpayer be an "incorrigible optimist" but on the
other hand, he may not be unduly pessimistic. Creditors do not have to wait until some
turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may
strike a middle course between pessimism and optimism and determine debts to be
worthless in the exercise of sound business judgment based upon as complete

48

TAXATION 1 ATTY. BELLO



information as is reasonably ascertainable. The taxpayer need not have perfect


discernment.

d. "Actually charged off from the taxpayers books of accounts" This phrase means
that the amount of money lent by the taxpayer (in the course of his business, trade or
profession) to his debtor had been recorded in his books of account as a receivable has
actually become worthless as of the end of the taxable year, that the said
receivable has been cancelled and written-off from the said taxpayer's books of account.
A mere recording in the taxpayer's books of account of estimated uncollectible accounts
does not constitute a write-off of the said receivable, hence, shall not be a valid basis for
its deduction as a bad debt expense. In no case may any bad debt deduction be allowed
unless the facts pertaining to the money or property lent and its cancellation or write-
off from the taxpayer's accounting records, after having been determined that the same
has actually become worthless, have been complied with by the taxpayer.

SECTION 3. Requisites for Valid Deduction of Bad Debts From Gross income. General
Rule. In general, the requisites for deductibility of bad debts are:

(1) There must be an existing indebtedness due to the taxpayer which must be valid and
legally demandable;

(2) The same must be connected with the taxpayer's trade, business or practice of
profession;

(3) The same must not be sustained in a transaction entered into between related
parties enumerated under Sec. 36(B) of the Tax Code of 1997;

(4) The same must be actually charged off the books of accounts of the taxpayer as of
the end of the taxable year; and

(5) The same must be actually ascertained to be worthless and uncollectible as of the
end of the taxable year.

Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to
demonstrate with reasonable degree of certainty the uncollectibility of the debt. The
Commissioner of Internal Revenue will consider all pertinent evidence, including the
value of the collateral, if any, securing the debt and the financial condition of the debtor
in determining whether a debt is worthless, or the assigning of the case for collection to
an independent collection lawyer who is not under the employ of the taxpayer and who
shall report on the legal obstacle and the virtual impossibility of collecting the same
from the debtor and who shall issue a statement under oath showing the propriety of
the deductions thereon made for alleged bad debts. Thus, where the surrounding
circumstances indicate that a debt is and uncollectible and that legal action to enforce
payment would in all probability not result in the satisfaction of execution on a

ALC D 2017

judgment, a showing of those facts will be sufficient evidence of the worthlessness of


the debt for the purpose of deduction.

Exception: In the case of banks, however, in lieu of requisite No. 5 above, the Bangko
Sentral ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and
uncollectibility of the bad debts and it shall approve the writing off of the said
indebtedness from the banks' books of accounts at the end of the taxable year. The
bank though should still comply with requisites Nos. 1-4 as enumerated above before it
can avail of the benefit of deduction.

Also, in no case may a receivable from an insurance or surety company be written-off
from the taxpayer's books and claimed as bad debts deduction unless such company has
been declared closed due to insolvency or for any such similar reason by the Insurance
Commissioner. cda

SECTION 4. Tax Benefit Rule. The recovery of bad debts previously allowed as
deduction in the preceding year or years shall be included as part of the taxpayer's gross
income in the year of such recovery to the extent of the income tax benefit of said
deduction.

Example: If in the year the taxpayer claimed deduction of bad debts written-off, he
realized a reduction of the income tax due from him on account of the said deduction,
his subsequent recovery thereof from his debtor shall be treated as a receipt of realized
taxable income. Conversely, if the said taxpayer did not benefit from the deduction of
the said bad debt written-off because it did not result to any reduction of his income tax
in the year of such deduction (i.e. where the result of his business operation was a net
loss even without deduction of the bad debts written-off), then his subsequent recovery
thereof shall be treated as a mere recovery or a return of capital, hence, not treated as
receipt of realized taxable income.

SECTION 5. Securities Becoming Worthless. If securities, as defined under Sec. 2(b)
hereof, held as capital asset, are ascertained to be worthless and charged off within the
taxable year, the loss resulting therefrom shall be considered as a loss from the sale or
exchange of capital asset made on the last day of such taxable year. The taxpayer,
however, has to prove through clear and convincing evidence that the securities are in
fact worthless.
This rule, however, is not true in the case of banks or trust companies incorporated
under the laws of the Philippines, a substantial part of whose business is the receipt of
deposits.

SECTION6. Repealing Clause. The provision of any revenue regulations, revenue
memorandum order, revenue memorandum circular or any other revenue issuances
inconsistent with these Regulations are hereby repealed, amended, or modified
accordingly.

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TAXATION 1 ATTY. BELLO




SECTION 7. Effectivity Clause. These Regulations shall take effect fifteen (15) days
after publication in any newspaper of general circulation.

Phil. Refining Co. v. CA (May 8, 1996)
Mere testimony of the accountant of the TP explaining the worthlessness of the
debts is self-serving; worthlessness of debts sought to be deducted must be
substantiated
Mere allegations cannot prove the worthlessness of debts sought to be deducted;
no documentary evidence presented (e.g., collection letters, field reports, referral
of letter to lawyers, police report that owners bankrupt due to fire that engulfed
store or that the owner was murdered, etc.)
Steps to be undertaken generally by the TP to prove that he exerted diligent efforts
to collect the debts
- sending of statement of accounts
- sending of collection letters
- giving the account to a lawyer for collection
- filing a collection case in court
Fernandez Hermanos, Inc. v. CIR (Sept. 30, 1969)
No bad debt could arise where there is no valid and subsisting debt
There was no due date
Case involved advances made by one company to an affiliate
Lender-TP did not expect to be repaid
In consideration for the advances, TP entitled to 15% of net profits
Thus, if there were no profits, there was no obligation to repay the advances

F. Depreciation

Sec. 34(F)
(F) Depreciation.
(1) General Rule. There shall be allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including reasonable allowance for
obsolescence) of property used in the trade or business. In the case of property held by
one person for life with remainder to another person, the deduction shall be computed
as if the life tenant were the absolute owner of the property and shall be allowed to the
life tenant. In the case of property held in trust, the allowable deduction shall be
apportioned between the income beneficiaries and the trustees in accordance with the
pertinent provisions of the instrument creating the trust, or in the absence of such
provisions, on the basis of the trust income allowable to each.

ALC D 2017

(2) Use of Certain Methods and Rates. The term reasonable allowance as used in the
preceding paragraph shall include, but not limited to, an allowance computed in
accordance with rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method;(b) Declining-balance method, using a rate not exceeding
twice the rate which would have been used had the annual allowance been computed
under the method described in Subsection (F) (1);(c) The sum-of-the-years-digit method;
and(d) any other method which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner.
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. Where under
rules and regulations prescribed by the Secretary of Finance upon recommendation of
the Commissioner, the taxpayer and the Commissioner have entered into an agreement
in writing specifically dealing with the useful life and rate of depreciation of any
property, the rate so agreed upon shall be binding on both the taxpayer and the
national Government in the absence of facts and circumstances not taken into
consideration during the adoption of such agreement. The responsibility of establishing
the existence of such facts and circumstances shall rest with the party initiating the
modification. Any change in the agreed rate and useful life of the depreciable property
as specified in the agreement shall not be effective for taxable years prior to the taxable
year in which notice in writing by certified mail or registered mail is served by the party
initiating such change to the other party to the agreement:
Provided, however, that where the taxpayer has adopted such useful life and
depreciation rate for any depreciable and claimed the depreciation expenses as
deduction from his gross income, without any written objection on the part of the
Commissioner or his duly authorized representatives, the aforesaid useful life and
depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall
be considered binding for purposes of this Subsection.
(4) Depreciation of Properties Used in Petroleum Operations. An allowance for
depreciation in respect of all properties directly related to production of petroleum
initially placed in service in a taxable year shall be allowed under the straight-line or
declining-balance method of depreciation at the option of the service contractor.
However, if the service contractor initially elects the declining-balance method, it may at
any subsequent date, shift to the straight-line method.
The useful life of properties used in or related to production of petroleum shall be ten
(10) years of such shorter life as may be permitted by the Commissioner.

50

TAXATION 1 ATTY. BELLO



Properties not used directly in the production of petroleum shall be depreciated under
the straight-line method on the basis of an estimated useful life of five (5) years.

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(5) Depreciation of Properties Used in Mining Operations. an allowance for


depreciation in respect of all properties used in mining operations other than petroleum
operations, shall be computed as follows:

Limpan Investment Corp. v. CIR (July 26, 1966)


Depreciation is a question of fact (e.g., appropriate useful life to adopt)
Bulletin F of the IRS has persuasive effect in Philippines jurisdiction
- The BIR has adopted Bulletin F under a revenue issuance

G. Depletion

(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or

Sec. 34(G)

(b) Depreciated over any number of years between five (5) years and the expected life if
the latter is more than ten (10) years, and the depreciation thereon allowed as
deduction from taxable income: Provided, That the contractor notifies the
Commissioner at the beginning of the depreciation period which depreciation rate
allowed by this Section will be used.

(G) Depletion of Oil and Gas Wells and Mines. -

(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or


Resident Foreign Corporations. In the case of a nonresident alien individual engaged in
trade or business or resident foreign corporation, a reasonable allowance for the
deterioration of Property arising out of its use or employment or its non-use in the
business trade or profession shall be permitted only when such property is located in
the Philippines.

From a valuation standpoint: decrease in value of assets through the passage
of time, wear and tear of obsolescence
From financial reporting/tax standpoint: allocation of the cost of an asset to
periods in which the asset expected to be used

Basilan Estates, Inc. v. CIR (Sept. 5, 1967)
Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949
on the basis of their acquisition cost
As of 1/1/50 it changed the depreciable value of said assets by increasing it to
conform with the increase in cost for their replacement
Accordingly, from 1950 to 1953 it deducted from gross income the value of
depreciation computed on the reappraised value
Issue: Whether depreciation shall be determined on the acquisition cost or on the
re-appraised value of the assets
Held: Income ax law does not authorize the depreciation of an asset beyond its
acquisition cost
Rationale: The recovery, free of income tax of an amount more than the invested
capital in an asset will transgress the underlying purpose of a depreciation
allowance. For then what the TP would recover will be not only the acquisition cost,
but also some profit.

(1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for
depletion or amortization computed in accordance with the cost-depletion method shall
be granted under rules and regulations to be prescribed by the Secretary of finance,
upon recommendation of the Commissioner. Provided, That when the allowance for
depletion shall equal the capital invested no further allowance shall be granted:
Provided, further, That after production in commercial quantities has commenced,
certain intangible exploration and development drilling costs: (a) shall be deductible in
the year incurred if such expenditures are incurred for non-producing wells and/or
mines, or (b) shall be deductible in full in the year paid or incurred or at the election of
the taxpayer, may be capitalized and amortized if such expenditures incurred are for
producing wells and/or mines in the same contract area.
'Intangible costs in petroleum operations' refers to 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:
Provided, That said costs shall not pertain to the acquisition or improvement of property
of a character subject to the allowance for depreciation except that the allowances for
depreciation on such property shall be deductible under this Subsection.
Any intangible exploration, drilling and development expenses allowed as a deduction in
computing taxable income during the year shall not be taken into consideration in
computing the adjusted cost basis for the purpose of computing allowable cost
depletion.
(2) Election to Deduct Exploration and Development Expenditures. - In computing
taxable income from mining operations, the taxpayer may at his option, deduct
exploration and development expenditures accumulated as cost or adjusted basis for
cost depletion as of date of prospecting, as well as exploration and development
expenditures paid or incurred during the taxable year: Provided, That the amount
deductible for exploration and development expenditures shall not exceed twenty-five
percent (25%) of the net income from mining operations computed without the benefit

51

TAXATION 1 ATTY. BELLO



of any tax incentives under existing laws. The actual exploration and development
expenditures minus twenty-five percent (25%) of the net income from mining shall be
carried forward to the succeeding years until fully deducted.

The election by the taxpayer to deduct the exploration and development expenditures is
irrevocable and shall be binding in succeeding taxable years.
'Net income from mining operations', as used in this Subsection, shall mean gross
income from operations less 'allowable deductions' which are necessary or related to
mining operations. 'Allowable deductions' shall include mining, milling and marketing
expenses, and depreciation of properties directly used in the mining operations. This
paragraph shall not apply to expenditures for the acquisition or improvement of
property of a character which is subject to the allowance for depreciation.

ALC D 2017

property constituting the basis of the deduction. 24(24) This burden-of-proof rule
has been frequently applied and a value claimed has been disallowed for lack of
evidence.
It had burden of establishing the components of the amount of P1,738,974.57:
what were the particular expenses made and the corresponding amount of each, so
that it may be determined whether the expenses were actually made and whether
the items are properly part of cost of mine development, or are actually
depreciable items.


H.

Charitable and Other Contributions


Sec. 34(H)
(H) Charitable and Other Contributions. -

In no case shall this paragraph apply with respect to amounts paid or incurred for the
exploration and development of oil and gas.
The term 'exploration expenditures' means expenditures paid or incurred for the
purpose of ascertaining the existence, location, extent or quality of any deposit of ore or
other mineral, and paid or incurred before the beginning of the development stage of
the mine or deposit.
The term 'development expenditures' means expenditures paid or incurred during the
development stage of the mine or other natural deposits. The development stage of a
mine or other natural deposit shall begin at the time when deposits of ore or other
minerals are shown to exist in sufficient commercial quantity and quality and shall end
upon commencement of actual commercial extraction.
(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien
individual or Foreign Corporation. - In the case of a nonresident alien individual
engaged in trade or business in the Philippines or a resident foreign corporation,
allowance for depletion of oil and gas wells or mines under paragraph (1) of this
Subsection shall be authorized only in respect to oil and gas wells or mines located
within the Philippines.

Consolidated Mines Inc v. CTA (Aug. 29, 1974)
As an income tax concept, depletion is wholly a creation of the statute 21(21)
"solely a matter of legislative grace." 22(22) Hence, the taxpayer has the burden of
justifying the allowance of any deduction claimed. 23(23) As in connection with all
other tax controversies, the burden of proof to show that a disallowance of
depletion by the Commissioner is incorrect or that an allowance made is
inadequate is upon the taxpayer, and this is true with respect to the value of the

(1) In General. - Contributions or gifts actually paid or made within the taxable year to,
or for the use of the Government of the Philippines or any of its agencies or any political
subdivision thereof exclusively for public purposes, or to accredited domestic
corporation or associations organized and operated exclusively for religious, charitable,
scientific, youth and sports development, cultural or educational purposes or for the
rehabilitation of veterans, or to social welfare institutions, or to non-government
organizations, in accordance with rules and regulations promulgated by the Secretary of
finance, upon recommendation of the Commissioner, no part of the net income of
which inures to the benefit of any private stockholder or individual in an amount not in
excess of ten percent (10%) in the case of an individual, and five percent (%) in the case
of a corporation, of the taxpayer's taxable income derived from trade, business or
profession as computed without the benefit of this and the following subparagraphs.
(2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding
subparagraph, donations to the following institutions or entities shall be deductible in
full;
(a) Donations to the Government. - Donations to the Government of the Philippines or
to any of its agencies or political subdivisions, including fully-owned government
corporations, exclusively to finance, to provide for, or to be used in undertaking priority
activities in education, health, youth and sports development, human settlements,
science and culture, and in economic development according to a National Priority Plan
determined by the National Economic and Development Authority (NEDA), In
consultation with appropriate government agencies, including its regional development
councils and private philantrophic persons and institutions: Provided, That any donation
which is made to the Government or to any of its agencies or political subdivisions not in
accordance with the said annual priority plan shall be subject to the limitations

52

TAXATION 1 ATTY. BELLO



ALC D 2017

prescribed in paragraph (1) of this Subsection;

nongovernment organization was created or organized.

(b) Donations to Certain Foreign Institutions or International Organizations. - donations


to foreign institutions or international organizations which are fully deductible in
pursuance of or in compliance with agreements, treaties, or commitments entered into
by the Government of the Philippines and the foreign institutions or international
organizations or in pursuance of special laws;

An amount set aside for a specific project which comes within one or more purposes of
the accredited nongovernment organization may be treated as a utilization, but only if
at the time such amount is set aside, the accredited nongovernment organization has
established to the satisfaction of the Commissioner that the amount will be paid for the
specific project within a period to be prescribed in rules and regulations to be
promulgated by the Secretary of Finance, upon recommendation of the Commissioner,
but not to exceed five (5) years, and the project is one which can be better
accomplished by setting aside such amount than by immediate payment of funds.

(c) Donations to Accredited Nongovernment Organizations. - the term 'nongovernment


organization' means a non profit domestic corporation:
(1) Organized and operated exclusively for scientific, research, educational, character-
building and youth and sports development, health, social welfare, cultural or charitable
purposes, or a combination thereof, no part of the net income of which inures to the
benefit of any private individual;
(2) Which, not later than the 15th day of the third month after the close of the
accredited nongovernment organizations taxable year in which contributions are
received, makes utilization directly for the active conduct of the activities constituting
the purpose or function for which it is organized and operated, unless an extended
period is granted by the Secretary of Finance in accordance with the rules and
regulations to be promulgated, upon recommendation of the Commissioner;
(3) The level of administrative expense of which shall, on an annual basis, conform with
the rules and regulations to be prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, but in no case to exceed thirty percent (30%) of
the total expenses; and
(4) The assets of which, in the even of dissolution, would be distributed to another
nonprofit domestic corporation 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.
Subject to such terms and conditions as may be prescribed by the Secretary of Finance,
the term 'utilization' means:
(i) Any amount in cash or in kind (including administrative expenses) paid or utilized to
accomplish one or more purposes for which the accredited nongovernment
organization was created or organized.(ii) Any amount paid to acquire an asset used (or
held for use) directly in carrying out one or more purposes for which the accredited

(3) Valuation. - The amount of any charitable contribution of property other than
money shall be based on the acquisition cost of said property.
(4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if
verified under the rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner.

When are charitable and other contributions deductible in full?
Donations to the National Government, its agencies or political subdivisions
and fully-owned government corporations

PARTIAL
FULL
Donation exclusively for public purpose
Donation for exclusive use in undertaking
priority activities in:
(i) education
(ii) health
(iii) youth and sports devt
(iv) human setlements
(v) science and culture and
(vi) economit devt

In accordance with NPP of NEDA

o If not compliant with 2 reqts for full deductibility, still deductible but
with limitation (10%/5% cap)






53

TAXATION 1 ATTY. BELLO



Donations to certain domestic corporations or associations, social welfare


institutions, NGO

PARTIAL
FULL
Donations to
Donation to accredited NGOs organized
(1) accredited domestic
and operated exclusively for
corporations or associations
(i) scientific
organized and operated and
(ii) research
exclusively for
(iii) educational
(i) religious
(iv) character-building and youth and
(ii) charitable
sports development
(iii) scientific
(v) health
(iv) youth and sports devt
(vi) social welfare
(v) cultural or educational
(vii) cultural or charitable purposes, or a
purposes, or
combination thereof, no part of the net
(vi) rehabilitation of veterans
income of which inures to the benefit of
(2) social welfare institutions
any private individual
(3) NGOs

Direct utilization of the donation on or
before the 15th day of the 3rd month
following the close of the taxable year

Annual administrative expense must not
exceed 30%

Distibution of assets in case of dissolution
to a similar institution, to the state for
public purposes, and by the court for
another org. to be used in manner that
would best accomplish the general
purpose of the dissolved org

Donations foreign institutions or international organizations which fully
deductible in compliance with existing treaties or special law











Donor-
taxpayer

Govt

Certain Foreign
Institutions

Accredited
NGOs/Donee
Institutions

Others

ALC D 2017
Deductible
In full


Deductible
In full


Deductible
In full





Not
deductible





Donations to the National Government, etc. conditions for full deductibility:
Must be exclusive use in undertaking priority activities in
o Education
o Health
o Youth and sports development
o Human settlements
o Science and culture
o Economic development
AND, in accordance with the NPP of the NEDA
o If not compliant with the 2 reqts above, still deductible but with
limitation (10%/5% of taxable income without the benefit of the
charitable contribution)

Donations to accredited NGOs/done institutions: conditions for full deductibility
Organized and operated exclusively for scientific, research, educational,
character-building and youth and sports development, health, social welfare,
cultural or charitable purposes, or a combination thereof, no part of the net
income of which inures to the benefit of any private individual
Direct utilization of the donation on or before the 15th day of the third month
following the close of the taxable year of the done institution
Annual administrative expense must not exceed 30%

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TAXATION 1 ATTY. BELLO



Distribution of assets in case of dissolution to a similar institution, to the state


for public purposes, and by a court of law to another organization to be used in
manner that would best accomplish the general purposes of the dissolved org.



BIR Rul. 19-01 (May 10, 2001)
Whether or not international organizations with home offices based abroad are
qualified to be granted donee institution status
A non-stock, non-profit corporation or organization must be created or organized
under Philippine Laws and that an NGO must be a non-profit domestic corporation,
this Office is of the opinion that a foreign corporation, like Conservation
International, whether resident or non-resident, cannot be accredited as donee
institution.

I. Research and Development

Sec. 34(I)
(I) Research and Development. -
(1) In General. - a taxpayer may treat research or development expenditures which are
paid or incurred by him during the taxable year in connection with his trade, business or
profession as ordinary and necessary expenses which are not chargeable to capital
account. The expenditures so treated shall be allowed as deduction during the taxable
year when paid or incurred.
(2) Amortization of Certain Research and Development Expenditures. - At the election
of the taxpayer and in accordance with the rules and regulations to be prescribed by the
Secretary of Finance, upon recommendation of the Commissioner, the following
research and development expenditures may be treated as deferred expenses:
(a) Paid or incurred by the taxpayer in connection with his trade, business or
profession;(b) Not treated as expenses under paragraph 91) hereof; and(c) Chargeable
to capital account but not chargeable to property of a character which is subject to
depreciation or depletion.
In computing taxable income, such deferred expenses shall be allowed as deduction
ratably distributed over a period of not less than sixty (60) months as may be elected by
the taxpayer (beginning with the month in which the taxpayer first realizes benefits
from such expenditures).
The election provided by paragraph (2) hereof may be made for any taxable year

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beginning after the effectivity of this Code, but only if made not later than the time
prescribed by law for filing the return for such taxable year. The method so elected, and
the period selected by the taxpayer, shall be adhered to in computing taxable income
for the taxable year for which the election is made and for all subsequent taxable years
unless with the approval of the Commissioner, a change to a different method is
authorized with respect to a part or all of such expenditures. The election shall not apply
to any expenditure paid or incurred during any taxable year for which the taxpayer
makes the election.
(3) Limitations on deduction. - This Subsection shall not apply to:
(a) Any expenditure for the acquisition or improvement of land, or for the improvement
of property to be used in connection with research and development of a character
which is subject to depreciation and depletion; and
(b) Any 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.

In general deductible as ordinary and necessary expenses during the year
when R&D expenses paid, or incurred, provided:
o In connection with the trade, business or profession
o Not chargeable to a capital account
Election to defer deduction TP may defer outright deduction and elect to
spread out deduction over a period not less than 60 months (beginning with
the month in which TP first realizes benefits from such expenditures)
o In connection with trade, business or profession
o Chargeable to a capital account, but not to property of a character
which is subject to depreciation or depletion
o Not treated as outright expense
34(I) and election to defer not applicable to the ff:
o Expenditure for acquisition or improvement of land (expense is
capitalized as part of the cost of the land)
o Improvement of property to be used in connection with R&D of a
character subject to depreciation or depletion
o Expenditure for exploration activities (minerals, oil & gas, etc.)


3M Phil., Inc. v. CIR (Sept. 26, 1988)
Although the Tax Code allows payments of royalty to be deducted from gross income as
business expenses, it is CB Circular No. 393 that defines what royalty payments are
proper. Hence, improper payments of royalty are not deductible as legitimate business
expenses.

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Pension Trusts
Reasonable private benefit plan
o Defined benefit plan
Benefits to be received by retiring employees are defined or
fixed upon retirement (e.g., 2 months salary for every year of
service)
Employer bears investment risk, but will benefit from surpluses
o Defined contribution plan
Employers annual contribution to the pension plan is fixed
Individual accounts are set up for participants and
retirement benefits consist of aggregate contributions
credited to individual accounts plus investment earnings
Employee bears investment risk and rewards
Normal cost annual employer contributions to the plan (whether defined
benefit or defined contribution) deductible as ordinary and necessary
business expenses under 34(A)(1)
Past service cost deduction is spread out over a 10-year period

Sec. 34(J)

J.

(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide


for the payment of reasonable pensions to his employees shall be allowed as a
deduction (in addition to the contributions to such trust during the taxable year to cover
the pension liability accruing during the year, allowed as a deduction under Subsection
(A) (1) of this Section ) a reasonable amount transferred or paid into such trust during
the taxable year in excess of such contributions, but only if such amount (1)has not
theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a
period of ten (10) consecutive years beginning with the year in which the transfer or
payment is made.

K. Additional Requirements for Deductibility

Sec. 34(K)

(K) Additional Requirements for Deductibility of Certain Payments. - Any amount paid
or payable which is otherwise deductible from, or taken into account in computing gross
income or for which depreciation or amortization may be allowed under this Section,
shall be allowed as a deduction only if it is shown that the tax required to be deducted
and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance
with this Section 58 and 81 of this Code.

L.

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34(A)(1)(b) ordinary and necessary business expenses must be substantiated


by sufficient evidence (e.g., O/Rs and other adequate business records);
amount of expense and connection with trade, business or profession
34(K) deduction will be disallowed if TP fails to withhold taxes, as may be
required by law or regulations, and remit such withheld taxes to the BIR

Optional Standard Deduction


Sec. 34(L)
(L) Optional Standard Deduction. - In lieu of the deductions allowed under the
preceding Subsections, an individual subject to tax under Section 24, other than a
nonresident alien, may elect a standard deduction in an amount not exceeding ten
percent (10%) of his gross income. Unless the taxpayer signifies in his return his
intention to elect the optional standard deduction, he shall be considered as having
availed himself of the deductions allowed in the preceding Subsections. Such election
when made in the return shall be irrevocable for the taxable year for which the return is
made: Provided, That an individual who is entitled to and claimed for the optional
standard deduction shall not be required to submit with his tax return such financial
statements otherwise required under this Code: Provided, further, That except when
the Commissioner otherwise permits, the said individual shall keep such records
pertaining to his gross income during the taxable year, as may be required by the rules
and regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner.
Amendment by RA 9504:
(L) Optional Standard Deduction. - In lieu of the deductions allowed under the preceding
Subsections, an individual subject to tax under Section 24, other than a nonresident
alien, may elect a standard deduction in an amount not exceeding forty percent (40%)
of his gross sales or gross receipts, as the case may be. 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 of
this Code. Unless the taxpayer signifies in his return his intention to elect the optional
standard deduction, he shall be considered as having availed himself of the deductions
allowed in the preceding Subsections. Such election when made in the return shall be
irrevocable for the taxable year for which the return is made: Provided, That an
individual who is entitled to and claimed for the optional standard shall not be required
to submit with his tax return such financial statements otherwise required under this
Code: Provided, further, That except when the Commissioner otherwise permits, the
said individual shall keep such records pertaining to his gross sales or gross receipts, or
the said corporation shall keep such records pertaining to his gross income as defined in
Section 32 of this Code during the taxable year, as may be required by the rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner.

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In lieu of itemized deductions under 34, an individual subject to tax under
24 (except a nonresident alien) may elect a standard deduction of 40% of gross
sales/receipts
In the case of a domestic corporation subject to tax under 24(A) and a
resident foreign corporation subject to tax under 28(A)(1), it may elect a
standard deduction of 40% of gross income
Intention to elect OSD must be made in the return (otherwise TP will be
considered to have elected to claim itemized deductions

M. Premium Payments


Sec. 34(M)
(M) Premium Payments on Health and/or Hospitalization Insurance of an Individual
Taxpayer. - the amount of premiums not to exceed Two thousand four hundred pesos
(P2,400) per family or Two hundred pesos (P200) a month paid during the taxable year
for health and/or hospitalization insurance taken by the taxpayer for himself, including
his family, shall be allowed as a deduction from his gross income: Provided, That said
family has a gross income of not more than Two hundred fifty thousand pesos
(P250,000) for the taxable year: Provided, finally, That in the case of married taxpayers,
only the spouse claiming the additional exemption for dependents shall be entitled to
this deduction.
Notwithstanding the provision of the preceding Subsections, The Secretary of Finance,
upon recommendation of the Commissioner, after a public hearing shall have been held
for this purpose, may prescribe by rules and regulations, limitations or ceilings for any of
the itemized deductions under Subsections (A) to (J) of this Section: Provided, That for
purposes of determining such ceilings or limitations, the Secretary of Finance shall
consider the following factors: (1) adequacy of the prescribed limits on the actual
expenditure requirements of each particular industry; and (2)effects of inflation on
expenditure levels: Provided, further, That no ceilings shall further be imposed on items
of expense already subject to ceilings under present law.

P2,400 per family, per year (or {200/month) for health and hospitalization
insurance
PPHHI may be claimed as a deduction, provided gross income of family does
not exceed P250,000 for the taxable year

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V.

TAXABLE INCOME

SEC. 31. Taxable Income Defined. - The term taxable income means the pertinent items
of gross income specified in this Code, less the deductions and/or personal and
additional exemptions, if any, authorized for such types of income by this Code or other
special laws.

Gross Income ( 32(A))
P xxx
Less: Deductions (34; itemized or OSD) and/or Addl and
(xxx)
Personal Exemptions ( 35)
Equals: Taxable Income ( 31)
P xxx

Individuals earning compensation income under an employer-employee
relationship:

Gross compensation income ( 32(A)(1))
Less: PPHI ( 34(M))
Less: Personal and addl exemptiosn ( 35)
Equals: Taxable Income ( 31)

Resident citizens, residents aliens and nonresidents citizens ETB or exercising a
profession

Gross income ( 32)
Less: Personal and addl exemptions ( 35)
Less: Itemized deductions or optional dtf. Deduction ( 34)
Equals: Taxable income ( 31)

Domestic corporations; in general

Gross income ( 32)
Less: itemized deductions or OSD ( 34)
Equals: Taxable income ( 31)

Resident foreign corporations; in general:

Gross income ( 32)
Less: itemized deductions or OSD ( 34)
Equals: Taxable income ( 31)

Nonresident aliens not ETB and NRFCs generally subject to 25/30% flat tax on
Philippine source gros income

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Resident citizen taxable on a net basis (with the benefit of deductions and/or
personal and addl exemptions)
Resident alien taxable on a net basis (with the benefit of deductions and/or
personal and addl exemptions)
Nonresident citizen taxable on a net basis basis (with the benefit of
deductions and/or personal and addl exemptions)
Nonresident alien engaged in trade or business in the Philippines taxable on
a net basis (with the benefit of deductions and/or personal and addl
exemptions)
Nonresident alien not ETB subject to flat tax of 25% of Philippines gross
income basis (without the benefit of deductions and/or personal and addl
exemptions)
Aliens employed by RQHQs, OBUs, petroleum service contractors subject to
flat tax of 15% on Philippien gross income (without the benefit of deductions
and/or personal and addl exemptions)

Domestic corporation generally taxable on a net basis (with the benefit of
deductions)
Resident foreign corporations generally taxable on a net basis (with the
benefit of deductions)
Nonresident foreign corporations generally subject to 35% flat tax on
Philippine gross income (without the benefit of deductions)

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VI.

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GENERAL PRINCIPLES OF INCOME TAXATION


SEC. 23. General Principles of Income Taxation in the Philippines. - Except when
otherwise provided in this Code:
(A) A citizen of the Philippines residing therein is taxable on all income derived from
sources within and without the Philippines;
(B) A nonresident citizen is taxable only on income derived from sources within the
Philippines;
(C) An individual citizen of the Philippines who is working and deriving income from
abroad as an overseas contract worker is taxable only on income derived from sources
within the Philippines: Provided, That a seaman who is a citizen of the Philippines and
who receives compensation for services rendered abroad as a member of the
complement of a vessel engaged exclusively in international trade shall be treated as an
overseas contract worker;
(D) An alien individual, whether a resident or not of the Philippines, is taxable only on
income derived from sources within the Philippines;
(E) A domestic corporation is taxable on all income derived from sources within and
without the Philippines; and
(F) 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.

Resident citizens taxable on income derived from sources within and without
the Philippines
Nonresident citizens taxable only on Philippine source income
OCWs/OFWs taxable only on Philippine source income
Aliens (whether residents or nonresidents) taxable only on Philippine source
income
Domestic corporations taxable on income derived from sources within and
without the Philippines
Foreign corporations (whether residents or nonresidents) taxable only on
Philippine source income

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VII.

INCOME TAX ON INDIVIDUALS

A.

DEFINITIONS
1. Resident Citizens and Resident Aliens
Resident Citizen a Filipino individual whose residence is in the
Philippines
Resident alien an individual whose residence is in the Philippines
but who is not a citizen thereof ( 22(f))
2. Non-Resident Citizens ( 22(E))
Physically present abroad with intention to reside therein
Leaves the Philippines to reside abroad as immigrant or permanent
employee
Works and derives income abroad as immigrant or permanent
employee
Works and derives income abroad; physically present abroad most
of the time (i.e., at least 183 days in a taxable year)
Arriving and departing nonresident citizens
o OCWs ( 23(C)) a special class

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3.

Non-Resident Aliens Engaged/not Engaged in Trade or Business in the


Philippines
Ramnani v. CIR
TP won a money judgment in the amount of P65M
CIR sought to impose a 30% flat tax on the money judgment on the ground that TP
was a nonresident alien not ETB
Held: TP is a resident alien (citing Rev. Regs. 25)
The establishment of a home even temporarily here in the Philippines for the
accomplishment of a purpose even if he has the intention to return to his domicile
abroad categorizes on individual as a resident
TP is an American citizen who frequently comes to the Philippines for the most part
of the year to oversee his various investments as shown by his passport entries
The BI even approved the change of his status of admission from temporary visitor
to immigrant/resident alien under sec. 13(e) of the Philippine Immigration Act
TP has paid his Community Residence Certificates from 1987-1994

4. Dependent
5. Minimum Wage Earner


BIR Rul. 33-00
Distinguished between a nonresident citizen and an OCW for purposes of
applying the most of the time rule
For the exemption on foreign source income to apply, an individual to be
considered a nonresident citizen must be physically abroad for at least 183
days
As regards OCWs, the time spent abroad is not material for tax exemption
purpose; all that is required is for the contract to be registered with the POEA

Garrison v. CA
TPs were born in the Philippines, repatriated temporarily to the U.S., returned to
the Philippines and presently residing herein by virtue of their employment in the
US Naval Base in Subic
Some have married Philippine citizens, have children, and have purchased income
producing properties in the Philippines
TPs are resident aliens, not nonresident aliens
The fact that all the TPs were born here, repatriated to the US and to come back, in
the latest in 1967, and to stay in the Philippines up to the present time, makes the
TPs resident aliens not merely transients or sojourners
The TPs intention to return to their domicile abroad is immaterial because they
have resided in the Philippines for quite a long time

60