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INCOME TAXATION: GENERAL OVERVIEW

Income tax

A tax on all yearly profits arising from property, professions, trades, or offices, or

A tax on a persons income, emoluments, profits and the like

It may succinctly defined as a tax on income, whether gross or net, realized in one taxable
year

TN: Yearly profits because insofar as income taxation is concerned, collection of income tax is
on a year-to-year basis.
Nature of Income Tax
National Tax

Tax imposed by the National Government (specifically the legislative department)

It is the BIR who implements or administers the collection of taxes

You cannot go to the municipal treasurer to pay your income taxes. Even if your payment is
received by the municipal treasurer, it will be as if you have not paid because it is a wrong
jurisdiction.
Excise Tax

It is levied upon the right or the privilege of a person to receive income or profits, of which
not all taxpayers have the privilege to do so
Direct Tax

The tax burden is borne by the income recipient upon whom the tax is imposed. It is tax
demanded from the very person, who it is intended for and who should pay the tax.

In other words, the impact as well as the incidence of taxation falls on the very same person.
Thus, the statutory tax payer will have the burden.

Purposes of Income Tax


Fiscal Purpose
1. To provide large amounts of revenue (general revenue)
Non-Fiscal Purpose
2. To offset regressive sales and consumption taxes
3. To mitigate the evils arising from the inequalities in the distribution of income & wealth
which are considered deterrents to social progress, by a progressive scheme of taxation

Regressive taxation means that as the tax base increases, the tax decreases. A common
example of such is VAT. To offset that, we have the income tax which is progressive in
character. This means that as the income increases, the income tax increases. That is why we
say that Income tax is regarded as the best measure of a persons ability to pay. Meaning to
say, the more you have, the more you will pay.
Historical Background of Philippine Income Taxation
United States Revenue Act of 1913

Extended to the Philippines which was then a territorial possession of the US

Administered and enforced by internal revenue officers of the Phil Govt


Revenue Act of 1916, War Revenue Act of 1917
Act No. 2833

Enacted by the Philippine legislature under authority conferred by 1917 Act


CA No. 466 (National Revenue Code of 1939)

Revised, amended and codified into a single tax code all the internal revenue laws
embodied in the 1939 NIRC and amendatory laws and decrees

When an employer withholds part of the employees salary as payment for the income tax, is it
not a violation of the principle that income tax is a direct tax? Under ER-EE relationship, this
basically represents advance payment of your income tax. There is no violation because it is still
the employee who has the burden to pay the income tax. The role of the employer, in
withholding the income tax, is only for administration or collection purposes so that he merely
withholds and collects the income tax from the employee and subsequently remit it to the BIR.
Insofar as the impact and the incidence of income taxation is concerned, it still falls upon the
employee.

PD 1158 (NIRC OF 1977)

General Tax

Tax with no particular purpose or object for which the revenue is raised, but is simply
raised for whatever need may arise.

Sources of Income Tax Law

Income Tax is source blind. This means that we do not look at the source; so long as
there is income, gain, or profit, you will subjected to tax.

Special tax (tax for a special purpose) goes to a special fund. On the other hand, the general tax
(not being for a special purpose) goes directly to the general fund of the government. The
primary purpose of income tax is to raise revenue for all purposes.

1 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

PD 1994 (NIRC of 1986)

Enacted to simplify and restructure certain provisions of the NIRC

Introduced the concept of VAT; applied the Schedular Net Income Tax System (SNITS)
RA 8424 (Tax Reform Act of 1997)

Took effect on January 1, 1998

RA 8424 as amended and revised by RA 9337 and RA 9504

Definition of Terms
Income all wealth which flows into the taxpayer other than as a mere return of capital;
includes all forms of income specifically described as gains & profits, including gains derived
from the sale or other disposition of capital assets; it means:

accession to wealth

gain

flow of wealth

Return ON Capital vs. Return OF Capital

Return OF Capital return of the amount invested; not subject to income tax

Return ON Capital amount received on top of the amount invested; subject to tax
Examples:
A person invested 1,000 and earned 1,000: return OF capital; not subject to
income tax as it is not considered as income
A person invested 1,000 and sold the thing at 900: no income, in fact, there is a
loss; not subject to income tax
After selling the thing, there is 1,500: return OF capital is 1,000; while, the
return ON capital is 500 (amount received on top of the capital); 500 is subject
to income tax as it is profit, gain, or income
Capital a fund or property existing at one point of time (while income denotes a flow of
wealth during a definite period of time). Capital is wealth, income is the flow of wealth.

Capital is considered as the tree; while, Income/gain is the fruit. What is being subjected to
income tax is the fruit (income) and not the tree (capital)

Different from labor; the latter can also be a source of income which may be subject to
income tax

The example we had earlier (amount of 1,000) is what we refer to as Capital. Say for example
Ms. Alcaraz hired the services of Mr. Fernandez and gave him a payment of 1,000. Is that
amount considered as income? In this case, you have to qualify. If the payment is made purely
under ER-EE relationship, then the entire amount is considered as income and subject to income
tax. However, if Mr. Fernandez received that payment for the practice of his profession (Mr.
Fernandez being a solo practitioner), then you have to deduct the expenses from the amount
received as payment to arrive at the amount of income.

General Principles of Income Taxation


a.

A RESIDENT CITIZEN is taxable on all income derived from sources WITHIN AND
WITHOUT the Philippines.

b.

A NON-RESIDENT CITIZEN is taxable only on incomes derived from sources WITHIN


the Philippines.

c.

An OVERSEAS CONTRACT WORKER is taxable only on income from sources


the Philippines. A seafarer who is a citizen of the Philippines and who
compensation for services rendered abroad as a member of the complement of
engaged exclusively in the international trade shall be treated as an overseas
worker.

d.

An ALIEN INDIVIDUAL whether a resident or no 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.

f.

A FOREIGN CORPORATION whether engaged or not in trade of business in the


Philippines, is taxable only on income derived from sources WITHIN the Philippines

WITHIN
receives
a vessel
contract

TN: Only Resident Citizens and Domestic Corporations are taxed for income derived both
within and without the Philippines.

Resident: domiciled in the Philippines

Citizen: Section 1, Art. 4, 1987 Constitution


those who are citizens of the Philippines at the time of the adoption of the
Constitution
those whose fathers or mothers are citizens of the Philippines
those born before January 17, 1973 (date of adoption of the 1973 Constitution), of
Filipino mothers, who elect Philippine citizenship upon reaching the age of majority
those who are naturalized in accordance with law

Non-Resident Citizen: Sec. 22 (e), NIRC


a citizen of the Philippines who establishes to the satisfaction of the Commissioner the
fact of his physical presence abroad with a definite intention to reside therein
a citizen of the Philippines who leaves the Philippines during the taxable year to reside
abroad, either as an immigrant or for employment on a permanent basis
a citizen of the Philippines who works and derives income from abroad and w hose
employment thereat requires him to be physically present abroad most of the time
during the taxable year
a citizen who has been previously considered as nonresident citizen and who arrives in
the Philippines at any time during the taxable year to reside permanently in the
Philippines shall likewise be treated as a nonresident citizen for the taxable year in
which he arrives in the Philippines with respect to his income derived from sources
abroad until the date of his arrival in the Philippines
the taxpayer shall submit proof to the Commissioner to show his intention of
leaving the Philippines to reside permanently abroad or to return to and reside in
the Philippines as the case may be

Gain transaction resulting in increases of wealth capable of pecuniary estimation

Income vs. Gain: Both terms are synonymous. But in fact, gain is an example of an income.
Income is broader.
Gross Income income (in its broad sense) less income which is by statutory provision or
otherwise excluded from the tax imposed by law. This includes but not limited to the
enumerations under Section 32a.

All income less the statutory exclusions as provided under the Tax Code

TN: Exclusions, deductions and exemptions are not the same.


Gross Income Taxation a system of taxation where the income is taxed at gross. The
taxpayers under this system are not entitled to any deductions.
Net Income Taxation system of taxation where the income is taxed at net. The taxpayer
may claim allowable deductions.
Passive Income refers to those items of gross income earned by the taxpayer without his
active/direct participation in the earning process.
Taxable Income (previously, Net Income) pertinent items of income as specified in the
Tax Code less the deductions and/or personal and additional exemptions, if any, authorized for
such types of income by the Code or other special laws. It is the amount of income that is
taxed.

Pertinent items of Gross Income less Allowed Deductions and/or Exemptions


2 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Resident Alien: an individual whose residence is within the Philippines and who is not a
citizen thereof (Sec. 22 (f), NIRC)

Non-Resident Alien: an individual whose residence is not within the Philippines and who
is not a citizen thereof (Sec. 22 (g), NIRC)
Non-Resident Alien engaged in trade or business within the Philippines
Non-Resident Alien not engage in trade or business within the Philippines

Domestic Corporation: a corporation created and organized in the Philippines and under
its laws (Sec. 22 (c), NIRC)

Foreign Corporation: a corporation which is not domestic (Sec. 22 (d), NIRC)

Resident Foreign Corporation: a foreign corporation engaged in trade or business


within the Philippines (Sec. 22 (h), NIRC)

Non-Resident Foreign Corporation: a foreign corporation not engaged in trade or


business within the Philippines (Sec. 22 (i), NIRC)

Dual Citizens: insofar as Philippines is concerned, he/she is a Filipino Citizen

Seafarers who are engaged exclusively in international trade: considered as


overseas contract workers; subject to income tax for income earned within the Philippines

Seafarer engaged in coastwise shipping (vessel operating within the country


inter-island shipping): taxable on all income derived from sources within and without
the Philippines; considered a resident citizen

For example, XYZ Corporation which is organized in the US and registered in the Philippines to
transact trade or business. In this case, that corporation is considered as a Foreign Corporation
because it is organized and incorporated under laws other than the Philippine laws. Take note
that registration is different from organization and incorporation as the former usually refers to
having a permit to conduct business in the Philippines.
If, for example. five Japanese nationals will come here to the Philippines to organize a
corporation in the Philippines, what do you call that corporation? It is a Domestic Corporation
because we do not look at the nationality of the shareholders but on the law under which the
corporation is organized or incorporated. Same thing if you have five Filipinos who goes to
Japan and organizes a corporation under the laws in Japan; that corporation is considered as a
Foreign Corporation insofar as Philippines is concerned.
Systems of Income Taxation
Schedular System of Taxation income tax treatment varies depending on the kind of
taxable income of the taxpayer. It provides for different tax treatment for different types of
income so that a separate return is required to be filed for each type of income and tax is
computed on a per return or per schedule basis. This is usually applicable to individual
taxpayers.

In this type of income taxation, you will have to identify what type of income you have earned
(passive income, business income, compensation income, etc.). The passive income will be
subject to a different tax rate and will be reported in a separate tax return, same with the
business income and compensation income earned.
3 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Global System of Taxation the tax treatment views indifferently the tax base and generally
treats in common all categories of taxable income of the taxpayer. The taxpayer is required to
lump all items of income earned during a taxable period and pay under a single set of income
tax rules. This is applicable to corporate taxpayers.

In this type of income taxation, you will have to add all income regardless of its classification,
report it in one income tax return and it will be subjected to one income tax rule (not necessarily
same rate).
Currently, we adopt a partly Schedular and partly Global System of Income Taxation. It is partly
Schedular because there are certain type of income which are treated differently from other
types of income (e.g., passive income which is subjected to Final Tax and to be declared in a
separate income tax return). For your compensation, business income and other types of
income, we usually use the Global System since we add everything and report it in a single
return.
Formula:
All Income (Global)
Less:
Exclusions
Income subject to Final Tax
Gross Income
Less:
Deductions
Exemptions (personal/additional)
Net Income (Taxable Income)

xx
xx
xx
xx
xx

xx
xx
xx
xx

Exclusions are those specifically enumerated under the Tax Code


Deductions include expenses, losses, interest, and taxes
Exemptions (personal/additional) applies only to individual tax payers, although not all
individual tax payers (applies usually to resident citizens, non-resident citizens, resident
aliens and non-resident aliens engaged in trade or business in the Philippines)

Kinds of Income Tax Methods


1.
2.

Gross Income Taxation - a system of taxation where the income is taxed at gross
Net Income Taxation - system of taxation where the income is taxed at net (gross
income less allowable deductions and/or exemptions)

Features of our Present Income Taxation


1.

Basic Features of Individual Income Taxation


a. Schedular System of Taxation (subject to the graduated income tax rates of 5% up to
32%)
b. Tax rates are progressive in character
c.
Modified gross income taxation as regards pure compensation earner (purely under
ER-EE relationship) no claim for deductions (expenses, losses, interest and taxes);
only exemptions are allowed
d. Net income taxation as regards those individual taxpayers that derive business, trade
or professional income. Allowable deductions under Section 34 may be claimed by
individual taxpayers who derive business, trade and/or professional income
e. Pay-as-you-File System
f.
Under certain cases, Pay-as-you-Earn system, as applicable to income subject to
withholding tax (those subject to final withholding tax such as interest on deposit in
the bank)

2.

3.

Basic Features of Corporate Income Taxation


a. Global Concept of Taxation (subject to a fixed rate of 30%)
b. Corporate taxpayers exception resident foreign corporations are entitled to
deductions. Net Income taxation is applicable to domestic corporations and resident
foreign corporations
c.
Pay-as-you-File system (except in cases of electronic filing system of application)
Criteria Used
a. Residency (Domiciliary Rule)
b. Nationality or Citizenship (Nationality Rule)
c.
Place/Source of Income (Source Rule)

We use the Comprehensive Tax Situs or Comprehensive Tax Source. Why comprehensive?
Because we follow the three principles of tax situs: Residency, Nationality or Citizenship and
Source rules.
Note:

GIT (Graduated Income Tax Rates): applies to individuals - 5% to 32%

FIT (Fixed Income Tax Rate): applies to corporations - 30%


Sources of Income
1.
2.
3.
4.

Capital
Labor
Both Labor and Capital
Sale of Property (real property, personal property or shares of stock)

Criteria to determine if Income is Taxable


1.

There is gain or profit

Return ON capital profit must be derived from a completed or closed transaction

It is usually applicable if capital since if your source of income is labor, you do not
necessarily look at the gain or profit.

NB: In determining the profit for sale of property (classified as ordinary property or
ordinary asset), the formula is Amount Received/Realized LESS Cost of
Property = Profit

TN: If that property is classified as a capital property or capital asset, we dont deduct the cost
of the property since the basis in computing the tax is the selling price or fair market value,
whichever is higher.
2.

3.

The gain or profit is realized OR received (either actually or constructively)

You have rendered service but payment for the service was not yet received (income
has been earned or has accrued Accrual Method): INCOME IS REALIZED

You have received payment for service that is yet to be rendered (Cash Method):
INCOME IS RECEIVED

Constructively realized or received under your control or disposition (e.g., interest


on bank deposits, matured interest coupons, dividends, share in a General
Professional Partnership)
Such gain or profit is not exempt under any law or treaty

Stated otherwise, the gain or profit is recognized under the law

4 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Received and Recognized: Taxable


Realized and Recognized: Taxable

Tests (to determine if there is a gain/profit, and ultimately, if taxable):


1.

Flow of Wealth Test

determining factor is that there is a gain

2.

Realization Test/Severance Test/Macomber Test (Eisner vs. Macomber)

Unless an income is deemed realized, there is no taxable income

An income is deemed realized if the earning process is complete or virtually complete


and an exchange has taken place

Issue in the Macomber case: whether or not stock dividends are considered as taxable income.
The US Supreme Court held that it is not a taxable income since there is actually no gain
realized by the shareholders since all of the shareholders interest will increase, in effect they
will have the same shareholder interest. That is the general rule. The exception to that is when
not all stockholders are given the stock dividends since there will be a change in the
stockholders interest; thus, there is gain realized.
What is subject to tax is the difference between the old shareholdings and the new
shareholdings. That is considered as constructive receipt.
3.

Economic-Benefit Principle

more applicable on stock options

The flow of wealth is realized only to the extent that the taxpayer is economically
benefitted.

Lets say, for example, Ms. Curan is into carpentry. If she repairs her house, she does not earn
income as she is not benefitted from it; thus, there is no taxable income. However, if she uses
her carpentry skills and renovates or repairs the house of Ms. Yap, there is income gained from
the repair of the house, the source of which is the labor, which is subject to income tax.
The first scenario pertains to Self-help Income. It is an income that you earn by using your
own effort. There is no need to report this in your income tax return since it is not subjected to
income tax. There is actually no economic benefit on your part since you are using your own
labor. However, if you render your service to another person, you earn income because of the
labor or service rendered; thus, you are economically benefitted. The income earned in that
situation will now be subject to income tax.
A more complex example relates to stock options. This is usually given to employees as
employee benefits wherein the employees are given the option to purchase stocks of the
company at a much lower price. In this case, the employee is benefitted in the form of savings;
thus, under the Economic-Benefit Test, that will be subjected to tax.
4.

Net Effect Test


usually the test applied if it is not clear if there is a gain or income

This was used in the case of Napoles. The BIR looks at the substance of the whole transaction,
regardless of its form. It is also applicable in transfer of shares transactions.
5.

Claim of Right Doctrine/Doctrine of Ownership, Command or Control


does not necessarily mean that you are the owner; embezzled funds are taxable on the
part of the embezzler (not on the part of the victim)

CAPITAL GAINS TAX (CGT)


Kinds of Taxable Income or Gain (applies to individual taxpayers and to coporations)
Capital Gains
Gains or income from the sale or exchange of capital assets, including:
1. Income from dealings in shares of stocks of domestic corporation whether or not
through the stock exchange
2. Income from dealings in real property located in the Philippines
3. Income from dealings in other capital assets other than (a) and (b)
this refers to properties which are not usually sold by the taxpayer (e.g.,
paintings, machineries, etc.)
can still be classified as capital asset; subjected to Capital Gains Tax
this is seldom used

Generally, Capital Gains Tax is an income tax. However, it will have to be filed in a separate tax
return.
1.

Sale of Shares of Stocks


a.

Ordinary Gains
Gains or income from the sale or exchange or property which are not capital assets
1. Business income (graduated tax rate for individuals; fixed rate for corporations)
2. Compensation income (usually applicable to individual under ER-EE relationship)
3. Passive income when the taxpayer does not have to do anything to earn the income
4. Other income derived from whatever source (e.g., income or savings from stock
options, receipt due to mistake, embezzled funds)

TN: The above enumeration, for Ordinary Gains, is not exclusive.


Capital Assets

It is the property held by the taxpayer(whether or not connected with his trade or
business), but does not include stock in trade of the taxpayer or other property of a kind
which would properly be included in the inventory of the taxpayer if on hand at the close of
the taxable year, or property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business, of a character which is subject to the allowance
for depreciation provided in subsection (f) of Section 34; or real property used in trade or
business of the tax payer (Sec. 39 (A)(1), NIRC)

The definition in Section 39 for capital assets is a residual definition. In effect, it actually
enumerates what are considered as ordinary assets.
Ordinary Assets
1. Stock in trade which are included in the inventory of the taxpayer
2. Real property held by the taxpayer primarily for sale to customers
3. Real property used in trade or business that is subject to depreciation
4. Real property used in trade or business of the taxpayer

Anything that does not fall under any of the enumeration above is considered as a Capital Asset.
It is important to classify if it is a capital asset or an ordinary asset because if it is an ordinary
asset, we will be using the graduated tax rate; but if it is a capital asset, we will be using
different rates.

Listed and traded in the local stock exchange (Philippine Stock Exchange)

this means that the buying and selling happens in the PSE

you use stockbrokers and underwriters in the sale

the tax is automatically withheld by the stockbrokers

there is no need to report it as part of the income


Not subject to CGT but is subject to a percentage tax. It is subject to of 1%
(or 0.5% or 0.005) of the Gross Selling Price. This is also referred to as
Stock Transaction s Tax.

Percentage tax is different from CGT because the former is a business tax; while, the
latter is considered as income tax.
The Gross Selling Price refers to the listed price of the share of stock.
b.

Not listed OR traded in the local stock exchange, which covers either two
scenarios:
Not traded at all (e.g., family or closed corporations)
Listed but not traded in the PSE (e.g., when it is done over-the-counter or from
shareholder to shareholder)

subject to CGT: 5% for the first 100K and 10% for the excess based on
the Net Capital Gain (selling price less cost)

Illustration:
Selling Price
Less: Cost
Net Capital Gain
CGT:

100,000 x 5% =
400,000 x 10% =
500,000

1,000,000
500,000
500,000
5,000
40,000
45,000

When the stocks are not listed or traded in the PSE, there is a need to submit a
separate tax return. The BIR considers the selling price, book value based on the
Audited Financial Statements (AFS), appraisal based on the Appraisers Certificate or
zonal value based on the Tax Declaration.
Consideration of the Selling Price is not automatic because the BIR will compare the
Selling Price and the Fair Market Value (FMV) of the shares of stocks. The FMV of the
shares of stocks could be based on the zonal valuation by the BIR, the tax declaration
or the appraisers certificate.
Why is there a need to determine the FMV of the property when in fact you are only
selling shares of stocks? It is because the BIR uses what we call as the Adjusted Net

5 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Asset Method. In this case, the BIR will appraise all the assets and all the liabilities
of the corporation selling the particular shares of stock
2.

Sale of Real Property located in the Philippines

If the real property is classified as Capital Asset, it is subject to CGT of 6% of the


Gross Selling Price (GSP) or Fair Market Value (FMV) of the property at the
time of sale, whichever is higher

What is the situs of taxation when it comes to real property? It is the place where the real
property is located (Principle of Lex Rei Sitae).
If the real property is located in the Philippines and is classified as a capital asset, then it
will be subjected to CGT. But if the real property is located outside the Philippines even if it
is classified as capital asset, it will no longer be subjected to CGT. If the real property is
located outside the Philippines, we will no longer classify it as capital asset or ordinary
asset.
If you were able to sell your property located abroad, it will only be reported as part of
your income here in the Philippines, meaning you will be subjected to graduated income
tax for individuals and fixed 30% tax rate for corporations. But this applies only to Resident
Citizens and Domestic Corporations.
The FMV is based on the zonal valuation by the BIR, FMV based on the tax declaration
(which comes from the assessor of the locality) or based on the appraisal.
Since the CGT is based on the GSP or the FMV, this means that you are not going to
deduct the cost or the accumulated depreciation. This is because the real property is
considered as capital asset. If you are allowed to deduct depreciation, then the property
will be classified as ordinary asset.
Lets say, for example, that Ms. Curan is engaged in real property business (purchasing,
developing and selling of land). Will she be subject to CGT? No, she will be subjected to the
ordinary tax (if individual, subject to graduated income tax rate; if corporation, subject to fixed
rate of 30%). This is because the real property is classified as ordinary asset and not as capital
asset insofar as the type of business she is engaged in.
Take note of the difference between the CGT for the sale of shares of stocks and the CGT for
the sale of real property. In the sale of shares of stock, you base the tax on the Net Capital
Gain, meaning to say you consider the cost; whereas, in the sale of real property classified as
capital asset, you base the tax on the GSP or FMV, meaning you do not consider the cost. This is
because, in the sale of real property classified as capital asset, you are not in the business of
buying and selling real property; thus, what is considered is only the GSP or FMV, whichever is
higher.

Gross Income
Inclusions: CBI2R2DAP3
Compensation income
Business income and professional income
Income from sales or exchange of property
Interests
Rents
Royalties
Dividends
Annuities
Prizes and Winnings
Pensions
Partners distributive share from the net income of the general professional partnership
Sec. 32 (A), NIRC: 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. Partners distributive share from the net income of the general professional partnership.
A.

Compensation Income

Is there a difference between a salary and a wage? In the Labor Code, there is a
difference; however, in the Tax Code, these terms are used synonymously.

All remuneration by an employee for his employer under an ER-EE relationship.

The important factor here is the ER-EE relationship. What if there is no ER-EE
relationship and you received something? Then the relationship is that of a principal
and contractor; thus, you are receiving professional income rather than compensation
income.

6 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

This refers to payment of services in whatever form but not limited to fees, salaries,
wages, commissions, and similar items.

Sec. 78 (A), NIRC: The term wages means all the remuneration (other than fees
paid to a public official) for services performed by an employee for his employer,
including the cash value of all remuneration paid in any medium other than cash,
except that such term shall not include remuneration paid:
1) For agricultural labor paid entirely in products of the farm where the labor is
performed, or
2) For domestic service in a private home, or
3) For casual labor not in the course of the employers trade or business, or

Even if it is the employer who withholds the tax, the burden to pay the tax is still with
the employee. The role of the employer is simply to collect the tax in advance and
remit the tax to the BIR.

4)

For services by a citizen or resident of the Philippines for a foreign government


or an international organization.
If the remuneration paid by an employer to an employee for services performed
during one-half (1/2) or more of any payroll period of not more than thirty-one (31)
consecutive days constitutes wages, all the remuneration paid by such employer to
such employee for such period shall be deemed to be wages; but if the remuneration
paid by an employer to an employee for services performed during more than onehalf (1/2) of any such payroll period does not constitute wages, then none of the
remuneration paid by such employer to such employee for such period shall be
deemed to be wages.

TN: Refer to the REVENUE MEMORANDUM CIRCULAR NO. 31-2013 (separate


pdf file uploaded to the FB group)

Those employed by Foreign Embassies/Diplomatic Missions who are exempted:


Diplomatic agents who are not nationals or permanent residents of the
Philippines
Members of the family of a diplomatic agent forming part of his/her
household who are not Philippine nationals
Members of the administrative and technical staff of the mission together
with members of their families forming part of their respective households
who are not nationals or permanent residents of the Philippines
Members of the service staff of the mission who are not nationals or
permanent residents of the Philippines
Private servants of members of the mission who are not nationals or
permanent residents of the Philippines

Those employed by the United Nations and its Specialized Agencies: of all the
items discussed, this contains a provision wherein a Filipino might be exempted
from income taxation if he/she is an official of the United Nations provided
his/her name is being communicated to the government through the DFA.

Please take note of the exclusions of the term wages. This simply means to say that
there is no need to withhold for the wages or the money that has been received by
those rendering the service.
The compensation includes the cash value of all remuneration paid in any medium
other than cash. Meaning to say, if you are paid in property and not in cash, then the
cash value of it should still be included as part of the income subject to the income
tax. Do you need to include in you r income tax return? Yes, all you need is to include
the cash value of the property received in lieu of cash as your salary.

Types of taxable compensation income: salaries, wages, bonuses, remuneration,


honorarium, benefits and allowances (including representation and transportation
allowances [RATA] or personal emergency relief allowance [PERA]) longevity pay,
subsistence allowance, hazard pay, annuities, pension. Note that the 13th month pay is
included.

(Please read the full text of RMC No. 31-2013 since not everything was included in the
discussion).

TN: bonuses, honorarium, benefits and allowances (including RATA or PERA),


longevity pay, subsistence allowance, hazard pay, annuities, pension usually fall under
the term Other Benefits. As a general rule, they are excluded from compensation
subject to income tax provided that it does not exceed 30K. Thus, if the bonuses, etc.
already exceed the ceiling of 82K, the excess will form part of your compensation
income subject to income tax.
R.A. 10653 increased the total amount of 13th month pay and other benefits, as
one of the exclusions from gross compensation income received by an employee,
from 30K to 82K. As per Revenue Regulation 3-2015, the amount of 82K shall
apply to the 13th month pay and other benefits paid or accrued beginning
January 1, 2015.
In a new BIR Memorandum Order (sometime in June 2014), it was declared that all
benefits received by government officials in whatever form will be subject to tax and
will be subject to withholding tax. This is being petitioned by some government
officials led by the officials of the Sandiganbayan. It is also indicated in such
memorandum order that RATA (and PERA?) is automatically not subject to tax. Note
that the RATA and PERA are only received by those employed by the government.

Backwages, allowances and benefits awarded in labor disputes are subject also to
withholding tax on wages

Primary method of collecting tax from compensation income


GR: Withholding by the employer
EXC: Those employed by Foreign embassies and diplomatic missions

7 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Compensation vis--vis Fringe Benefits (FB)


FB to supervisory and managerial employees subject to income tax (Fringe
Benefit Tax)
FB to rank and file employees if considered a De Minimis Benefit, it is exempt
from income tax; otherwise, it will be subject to income tax

When you say Fringe Benefits, this refers to additional or extra benefits aside from the
compensation given to the employees.
B.

Gross Income derived from the conduct of trade or business or the exercise of a
profession

Please take note that the second enumeration covers two types of income: (1) Business
Income and (2) Professional Income.
1.

Business income
a.

Manufacturing, merchandising, mining business:


Gross Income = total sales cost of goods sold + other income from other
investments/from incidental sources

If you want a detailed discussion on how to compute for the cost of goods sold,
you may refer to the book of Mamalateo. Take note that the total sales is not
really the total sales since in taxation, they call it total sales but in accounting,
it actually refers to the net sales. Why net sales? It should be net already of
the discounts, allowances and sales returns.

2.

If you deduct the operating expenses, losses, interests and tax expenses from
the Gross Income, you will get the amount of Taxable Income.
b.

Real Property
a.

Service Enterprise:
Gross Income = total receipts direct costs and expenses

If you want to know the composition of direct costs and expenses, you may
refer to the Revenue Memorandum Circular No. 4-2003 as amended by Revenue
Memorandum Circular No. 30-2008.
2.
C.

Professional income: refers to the fees received by a profession from the practice
of his profession, provided that there is no ER-EE relationship

Shares of stock of a domestic corporation


a.

Seller is not a real estate dealer, it is considered as a capital asset: subject


to 6% based on SP or FMV, whichever is higher

b.

Located outside the Philippines

Resident Citizen: GIT (Graduated Income Tax Rates): applies to individuals

A corporation who is a dealer in securities is an entity engaged in the buying and


selling of stock.

Domestic Corporation: FIT (Fixed Income Tax Rate): applies to corporations

D.

- 5% to 32%
- 30%

Other Capital Assets

Other Capital Assets are those not held primarily for sale (e.g., motor vehicle not used
in business, short term commercial papers not considered deposit substitutes).

They do not have a special capital gains tax rate. They are subject to the graduated
income tax rate (individuals) or normal corporate tax rate (corporation).

Holding period of other capital assets is material for individual taxpayers ONLY (does
not apply to corporate taxpayers).

HOLDING PERIOD RULE:


50% of the capital gain is taxable if held for more than 12 months long-term
capital gain
100% of the capital gain if held for 12 months or less short-term capital gain

Listed AND traded in the local stock exchange

c.

Seller or transferor is a real estate dealer, it is considered as an ordinary


asset: subject to the normal tax rates [5% to 32% for individuals or 30%
for corporations]

Capital asset if not a dealer in securities

If you are a dealer (i.e., you are engaged in the buying and selling of stock),
then the shares of stock will considered as ordinary asset. But if you are not a
dealer (i.e., you are not engaged in the buying and selling of stocks), then the
shares of stock will be classified as capital asset.
b.

If the real property is sold during involuntary sale (i.e., foreclosure sale), the
taxes thereof shall be counted from the date the right to redeem the property of
the buyer has expired (i.e., one year from the date of registration of the
certificate of sale).

Gains/Income derived from dealings in property


1.

Located in the Philippines

of 1% based on gross selling price (which is basically the listed price)


if there is an excess, then it shall be subject to donors tax

Not listed OR listed but not traded in the local stock exchange

5% for the first 100K and 10% for the excess of the Net Capital Gain

How to determine the FMV?

If listed but not traded in the local stock exchange:


equivalent to the closing rate on the date of the sale or transaction
if the closing rate on the date of the sale or transaction is not
available, then consider the closing rate nearest to the date of sale

If not listed and not traded in the local stock exchange (whichever is
higher):
selling price
book value in the audited financial statement
FMV based on the zonal valuation by the BIR, or as declared in the tax
declaration as determined by the assessors office or based on the
appraisal on appraisers certificate

8 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Example Problem: Mr. X purchased a car for 700K and gave it to his son, Y, on Jan. 1,
2014. Y purchased a new car on July 26, 2014 and traded-in his old car for 800K. The
capital gain is 100K (difference between the selling price and the cost). This is
considered as income on the part of Y. This case relates to a short-term capital gain
because it was held for less than 12months; thus, the entire amount of 100K is
subjected to tax.
TN: Capital losses can be offset only against and to the extent of capital gains; while,
ordinary losses, can be offset only against and to the extent of ordinary gains.

Special Items Treatment:


4.
1.

Interest Income

Forgiveness/Condonation of Debt

2.

If the forgiveness/condonation of debt is out of love or liberality, then it will not be


subject to income tax.
If the forgiveness/condonation of debt because of service rendered or consideration
received, then it will be subject to income tax.

Recovery of amounts previously written off

In other words, if the creditor is a foreign corporation and the debtor is a Filipino citizen
residing here in the Philippines, then the debtor must withhold the amount of tax upon
payment to the creditor.
5.

(Please note that this was not discussed; however, we are advised to read about the Tax
Benefit Rule, as early as now.)

Compensation Income

6.

7.

a.

Merchandising, Farming, Mining: tax situs is the place where the business is
undertaken

b.

Manufacturing:

Goods manufactured and sold within the Philippines: income derived purely
within

Goods manufactured and sold outside the Philippines: income derived purely
outside

Goods manufactured within the Philippines and sold outside the Philippines:
income partly within and partly without

Goods manufactured outside the Philippines and sold within the Philippines:
income partly within and partly without

a.

Received from a domestic corporation: income purely within

b.

Received from foreign corporation outside the income of the foreign corporation in the
Philippines during the last preceding 3 taxable years, the following rules shall apply, to
wit:

The income is purely within if the income derived from the Philippines is more
than 85%

It is purely without if the proportion of its Philippine income to the total income is
less than 50%

There should be an allocation if it is equal to 50% to 85% of the foreign


corporations income is derived within the Philippines (insofar as the dividend is
concerned)

Income from Sale or Exchange of Property


a.

If it involves personal property: the place of the sale

b.

In the case of sale of transport documents (e.g., bill of lading, airway bill, etc.): the
place where the transport document is sold

c.

If it involves real property: the place or location of real property

Annuities

9.

Tax Situs: place where the contract was made

Prizes and winnings


a.

If on the account of services rendered: place where the services where rendered

b.

If not on account of service rendered: place where the same is given

10. Pension

Tax Situs: place where this may be given on account of services rendered

11. Professional Income of professional partners

9 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Tax Situs: place where the intangible is used

Dividend

Business Income

8.

3.

Royalties

For example, if a domestic corporation hires the services of a foreign corporation located in
HK to do some advertisements in HK. Is it subject to withholding tax on income or tax on
advertisement services which are being withheld in HK? No, because the service is
rendered abroad (i.e., in HK), even if the payor is a domestic corporation here in the
Philippines.
2.

Tax Situs: place where the property subject of the contract is located

TN: There is no qualification whether the property subject for lease or rent is a personal
property or a real property.

Tax Situs: place where the service/s is/are rendered

In the Baer case: the officer is receiving commission abroad but service is rendered here in
the Philippines. SC ruled that the commission of a Non-Resident Alien is subject to the
Philippine Income Tax since he renders services here in the Philippines even if paid by the
payor who is abroad.

Rent Income

Situs of Income
1.

Tax Situs: residence of the debtor/borrower

Tax Situs: place where the exercise of profession is undertaken

Exclusions from Gross Income

Bequest or legacy: personal property subject to Estate Tax

1.

Devise: real property subject to Estate Tax

Proceeds of Life Insurance

TN: Under the Tax Code, the taxpayer can only be subjected to one direct tax. That is why
if it is already subjected to transfer tax, there will be no more income tax and vice versa.
However, it is possible that you can be subjected to many indirect taxes.

Subject to tax if:


Insurer and insured agreed that the amount of the proceeds shall be withheld by
the insurer with the obligation to pay interest in the same: the interest will be
subject to tax
There is transfer of the insurance policy (which entails a consideration)

For example, Ms. Imperial has been with Fast Cargo for 10yrs. For her 10 th year with the
company, she was given an award and 5K for every year of service or a total of 50K. In
this case, the amount is taxable because it is on account of services rendered and not
based on a pure act of liberality (the number of years of service is the consideration).

Of the many types of insurance, what is excluded from income is only the proceeds of a life
insurance policy regardless if it is received in lump sum or in installment. This is because it
is considered more of an indemnity rather than a gain on the part of the recipient of the
proceeds of life insurance. Under our law, life is considered as priceless and beyond
compensation.
TN: The condition here is that the insured should have died. There are instances when the
insured outlives the period of the insurance policy and after the lapse of the period, the
insurance companies will give the insured the face value of the insurance. In this case, that
is still considered as proceeds of life insurance. However, the entire proceeds will not be
excluded. What will be excluded is the equivalent value of the return of the premium; thus,
whatever is received in excess of that will be subject to income taxation. So basically, you
get the difference between the face value of the insurance policy and the total of the
premium. The difference will form part of your gross income.
2.

Amount received as Return of Premium

TN: What is excluded here is the return of premium still related to your life insurance
and not just any other type of insurance

Reason for exclusion: it represents a mere return of capital

Sec. 32 (B)(2), NIRC: The amount received by the 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.

For example, Mr. Zabala took a life insurance of 50K per year.
If after 10years, he died and his heirs received a total amount of 1M. Insofar as the
1M is concerned, it will not be subject to income tax and will not form part of the
gross income of the heirs since this is considered as proceeds of a life insurance.
If after 10years, he outlives the insurance and received the face value of the
insurance policy amounting to 800K. The entire amount of 800K will not be subject to
tax. You need to get the difference between the face value of 800K and the return of
premiums of 500K (10yrs x 50K). In this case, only the 300K (800K less 500K) will be
subject to tax.
3.

Gifts, Bequests, Devises

Reason: they are subject to another type of tax, specifically the transfer tax (Donors
tax or Estate tax)

Must be an act of pure liberality without any consideration

10 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

However, if the company gives Ms. Imperial 50K without any consideration and out of pure
liberality, then the amount received will not be subject to income tax but to transfer tax.
Another example, if you visited a site and you won an IPad, is the cash value of the IPad
taxable? It is not an act of pure liberality because there is an effort from the fact that you
entered into that particular website. It is not considered as a gift; thus, it is taxable.
4.

Compensation or amounts of damage received for personal injuries or sickness

Reason for exclusion: this is just an indemnification for the injuries or damages
suffered (compensatory in nature). The sources are:
The compensation may be paid by virtue of a suit; or
It may be paid by virtue of health insurance, accident insurance or Workmens
Compensation Act.

For example, assume that Mr. Emboy was involved in a car accident and that he was not at
fault. He sued the party at fault and he was awarded the following: 1M for moral damages,
100K for hospitalization expenses, 50K for medication, 150K for Attorneys fees, 300K
representing his lost income for having been hospitalized for 6months and 250K for the
damaged car, although the value of the car at the time of the accident is 150K. What are
considered as compensation to injuries or sickness? What are considered as part of the
gross income?
In this scenario, the following are excluded from the gross income (as they are
compensatory in nature or in the form of reimbursement):

Moral Damages

Hospitalization costs

Medication, Check-ups

Attorneys Fees

Value of the property damaged only to the extent of the value of the car at the time
of the accident
The following will be included as part of your taxable income:

Lost income represents the income that should have been earned had you not met
the accident

Value of property damaged only to the extent of the difference (100K) between the
value of the car at the time of the accident (150K) and the amount awarded (250K)

5.

Income exempt under treaty

Reason for the exclusion: Treaty has the obligatory force of a contract.

Exception: as may be provided in the treaty.

Basis: reciprocity among nations

Private
Benefit Plan

(Please read the full text of RMC No. 31-2013.)


6.

Yrs. of
Service

Age at the time


of Retirement

Taxable or
Not Taxable?

With Plan

11 yrs.

45 yrs. old

Taxable

No Plan

4 yrs.

50 yrs. old

Taxable

With Plan

15 yrs.

60 yrs. old

Not Taxable

Retirement Benefits, Gratuities, Pensions, etc


a.
b.

e.
f.

Retirement benefits under RA 7641 or a reasonable private benefit plan


Separation pay amount received by an official or an employee or by his heirs from
the employer due to separation from service because of death, sickness, or other
physical disability or for any cause beyond the control of the official or employee
Social security benefits, retirement gratuities, pensions and other similar benefits
received by resident or non-resident citizens or resident aliens from foreign
institutions, whether public or private.
US veterans benefit should be given by the United States Veterans Administration
and not just by any other institution
SSS excluded by express provision of the law (RA 8282)
GSIS excluded by express provision of the law (RA 8291)

Recipient: Private employees or official of private firm

Requisites (for the retirement benefit to be excluded from gross income):


1. The private employee or official must be at least 50years of age at the time of
his retirement;
2. He must have rendered at least 10years of service to the employer at the time of
retirement;
3. There must be reasonable private benefit plan;
4. Reasonable private benefit plan may be in the nature of pension plan, profit
sharing plan, stock bonus plan or gratuity;
5. The reasonable private benefit plan must be approved by the BIR;
6. The employer must give contribution and no amount shall inure to the benefit of
a particular employee or officials;
7. This can be availed of once. The subsequent retirement benefits received from
another private employer is no longer exempt but subject to tax. However, if the
second employer is a government entity or institution, still you can avail of the
exemption of the retirement benefit.

c.
d.

TN: The requisites enumerated will only be used when the private employer does not have
a collective bargaining agreement which specifies the retirement requirements of its
employees.

Private
Benefit Plan
With Plan

Yrs. of
Service
9 yrs.

Age at the time


of Retirement
60 yrs. old

Taxable or
Not Taxable?

Reason

Taxable

Falls short of the


required years of
service (i.e.,
10yrs)

11 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Falls short of the


minimum age of
retirement
required (i.e., 50
yrs. old)
There is no
reasonable
private benefit
plan
Complies with
the necessary
requirements

Retirement benefit vs. Separation Pay?


A retirement benefit is based on age and length of service. On the other hand, the
separation pay is not based on age and length of service but due to sickness, physical
disability, death or any cause beyond the control of the employee (i.e., authorized causes).
TN: If you receive a separation pay not due to a reason beyond your control as an
employee (i.e., just causes), then that will not anymore be excluded from your gross
income.
TN: The requirement as to age and number of service applies only to retirement benefits
and not to separation pay.
7.

Miscellaneous Items
a.

Prizes and awards given in recognition of Religious, Charitable, Scientific,


Educational, Artistic, Literary, or Civic achievements.

Conditions:
The recipient was selected without any action on his part to enter the
contest or proceeding, and
The recipient is not required to render substantial future services as a
condition to receiving the prize or award

If the selection of the award recipient was done randomly and you are not required to
render future services to the organization granting you that award, then the prize or
award is not subject to tax. However, if it is complied with through application by the
recipient, it is subject to tax.
b.

Prizes and awards in sports competitions

Examples:

Reason

Requisites:
Competition and tournament must be sanctioned or approved by the
National Sports Association (e.g., CVRAA, Palarong Pambansa, etc.); and
The competition and tournament must also be approved by the Philippine
Olympic Committee, whether local or international, whether held in the
Philippines or outside.

c.

Income derived by the Government or its political subdivisions from the


exercise of any essential governmental function or from any public utility.

It is impractical if we subject this item to taxation because it will be just like


transferring your own money from one pocket to the other.
d.

Income derived from investments in the Philippines by Foreign Government


or Financing Institutions

Requisites:
Recipient must be a

Foreign government;

Financing institution owned, enjoying refinancing or controlled by


foreign government; OR

Regional financing institution, international financing institution


established by foreign government
It must be an income received from investment in the Philippines

TN: The source of the income is the Philippines.


Example: Financing institution being refinanced by the Government of Japan. The
financing institution made an investment here in the Philippines and earned profit. Is
the income earned by the financing institution, which is refinanced by the Government
of Japan, be excluded or exempted from income taxation here in the Philippines? Yes.
Thus, financing institutions owned, financed, controlled or enjoying refinancing by a
foreign government their income derived here in the Philippines will be excluded or
exempted from income taxation.
e.

j.

The employee is not subject to income tax as long as he/she is not a mixed earner
(i.e., he/she does not have any other source of income).
Allowable Deductions

Similarities between exemption, exclusion and deductions: they cause a reduction in your
taxable income; therefore, your tax payable is decreased.
Exemption refers to inflow of cash or wealth but by virtue of the Constitution, law or treaty,
it has to be exempted or the state waives its right to collect thereon
Exclusion does not necessarily mean and inflow or income; refers to items that are not
taxable as an income because: (1) they are merely a return of capital or (2) it is subject to
another direct tax, (3) or the law or treaty provides that it is excluded from gross income
Deductions refers to expenses or outflows which causes a reduction in your gross income
1.

For SSS and GSIS, you are not allowed to increase your contributions since it will
always be based on your monthly salary.

h.

Double Nexus Rule:

The taxpayer seeking deduction must point to some specific provisions of the
statute authorizing the deduction, and

He must be able to prove that he is entitled to the deduction authorized or


allowed

b.

When there is doubt, deductions are strictly construed against the taxpayer and
liberally construed in favor of the government.

c.

The taxpayer is allowed to deduct if you are able to follow statutory requirements
(e.g., act of withholding).

2.

Kinds of allowable deductions

These are not taxable provided they do not exceed 30K.

b.

Personal and additional deductions/exemptions (Sec. 35, NIRC)

This pertains to individual taxpayers only and not to corporate taxpayers

Personal exemption: 50K for each individual taxpayer regardless the civil status

Additional exemption: 25K for each dependent child not exceeding four (4)
Itemized deductions (Sec. 34(A) to (K) and Sec. 34(M), NIRC)

a.

Gains derived from the sale, exchange, or retirement of bond debentures or


other certificate of indebtedness with a maturity of more the five (5) years.

c.

Optional Standard Deduction (OSD) of 40% of the Gross Sales/Receipts

Benefits in the form of 13th month pay and other benefits

The maturity should be more than 5yrs for it to be excluded from gross income.
i.

a.

For example: For rent expense, the law requires the lessee to automatically withhold 5%
from the amount of rental payment. If your monthly rental is 50K, you have to withhold
5% of the monthly rental or 2.5K. Thus, the amount that you will remit to the lessor is only
47.5K (50K less the 5% withholding tax). If you did not withhold the amount of tax
required, you cannot claim the deduction for rent expense.

Contributions to GSIS, SSS, PAG-Ibig and Union Dues

As to PAG-Ibig contributions, it only pertains to the minimum contribution of 100. So if


you increased your PAG-Ibig contributions to 500, the excess of 400 will be taxable.

g.

Basic Principles governing deductions

Gains derived from redemption of shares of stock issued by a Mutual Fund


Company

When we say Mutual Fund, there is pooling of funds in order to make use of larger
investments. Whatever gains you derive from there is considered excluded. When you
redeem your shares of stocks, it is like a return OF capital.
f.

Pure minimum wage earner

Income of qualified senior citizens not exceeding the poverty level as


determined by NEDA

12 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

It is actually a choice between the Itemized Deductions and the OSD. When we talk of
OSD, all you have to do is just to compute 40% of your Gross Income. Therefore, the 60%
of your Gross Income will be considered as your taxable income. The Itemized Deductions
and OSD options are given to both corporate and individual taxpayers provided that the

individual taxpayer is earning business income. Thus, it does not apply to individual
taxpayers who are earning purely compensation income.
Non-deductible Items
1.

2.

Reason: the law already provides for personal and additional exemptions which is already
considered as the total family or personal living expense

d.
e.

Amount paid for new buildings or permanent improvements, or betterment to


increase the value of any property or estate

f.

Exception: in the case of non-stock, non-profit educational institutions since they are not
subject to tax whatsoever, they are allowed to make outright deductions such as capital
expenses.
Any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance is or has been made

TN: This is more or less related to the second item but this item (third item) actually refers
to major repairs and not minor repairs. When we say major repairs, it extends the life of an
asset or of the property being repaired.
Example: repair on the roof is considered as a minor repair; thus, you are allowed to make
an outright deduction for the expenses incurred and you are not required to capitalize it.
Another example: retrofitting of the building, which increases the useful life of the building,
is considered as a major repair; thus, you cannot make an outright deduction for the
expenses incurred.
4.

c.

Personal living and family expenses

Reason: as a rule, our Tax Code requires you to capitalize it and to report it as an asset;
then, you provide for an allowance for depreciation every year.

3.

b.

Premium 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

TN: For the first three enumerations (a to c), these transactions are considered nondeductible because these transactions are considered transactions between related parties.
If it is a transaction between related parties, our Tax Code makes a presumption that it is
not an honest transaction or a transaction not in arms length.
When can you say that a transaction is an honest transaction or a transaction at arms
length? If it is a sale and the seller is not compelled to sell and the buyer is not compelled
to buy.
When we talk of related parties, usually, there is an under-the-table agreement.
TN: There is only one exception which is during liquidations.
TN: For the last three items (d to f), the loss is not deductible because it is just considered
as a temporary transfer.
Example: Sale of a vehicle with a selling price of 1M, cost of 2M and loss of 1M.

If Mr. X sold the vehicle to Mr. Y and the parties are not related: DEDUCTIBLE

If Mr. X, who is the brother of Mr. Y, sold the vehicle to the latter: NOT DEDUCTIBLE
(sale between family members)

If Mr. X (seller) sold the vehicle to Corporation A (buyer): DEDUCTIBLE (there was no
qualification that Mr. X owns more than 50% of Corporation A)

If Mr. X (seller) sold the vehicle to Corporation A (buyer) and the latter is owned by
shareholders V, W, X, Y, Z
If X owns 10% of Corporation A: DEDUCTIBLE (Mr. X owns less than 50%)
If X owns 60% of Corporation A: NOT DEDUCTIBLE (Mr. X owns more than
50%)

If Company S (seller) sold the vehicle to Company B (buyer): DEDUCTIBLE (there was
no qualification)

If Company S (owned by C 10%, D 10%, E 10%, F 10%, G 60%) sold the vehicle to
Company B (owned by G 10%, H 10%, I 10%, J 10%, K 60%): DEDUCTIBLE (the
share of G in the second company is merely 10%; thus, he has no control)
- in this case, there is an interlocking shareholder, G, who is a shareholder of both
corporations

TN: If the taxpayer, who took the life insurance, is not the beneficiary of the policy, then
you can deduct it. But if the taxpayer is the beneficiary, then it is not deductible. This is
because it is just like transferring the money from the taxpayer to the insurance company
and then returning it back to the taxpayer.
Example: Company X insured the life of its president, Mr. Y, paying a premium of 100K. If
the beneficiary is Company X, then the amount of premium cannot be deducted by
Company X as he is the direct beneficiary of the insurance policy. In this case, there is no
outflow. However, if the beneficiary of the insurance policy is the estate of Mr. Y, then
Company X can claim for a deduction for 100K since he is not the direct or indirect
beneficiary of the insurance policy. In this case, there is an outflow.
5.

Losses from sales or exchanges of property directly or indirectly


a. Between members of a family (brother, sister of half or full blood, spouse,
ascendants, lineal descendants).

13 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015

Except in case of distributions in liquidations between an individual and a corporation


more than 50% in value of the outstanding stock of which is owned, directly by or for
such and individual
Except in case of distributions in liquidation, between two corporations more than
50% in value of the outstanding stock of which is owned, directly or indirectly, by or
for same individual, if either one of such corporation is a personal holding company or
a foreign personal holding company; or
Between the grantor and a fiduciary of any trust; or
Between fiduciary of a trust and the fiduciary of another trust, if the same person is a
grantor with respect to each trust; or
Between a fiduciary of a trust and a beneficiary of such trust.

If Company S (owned by C 10%, D 10%, E 10%, F 10%, G 60%) sold the vehicle to
Company B (owned by G 60%, H 10%, I 10%, J 10%, K 10%): NOT DEDUCTIBLE
(the same shareholder controls both corporations)

Company S is owned by C 10%, D 10%, E 10%, F 10%, G 60%


Company B is owned by shareholder G 10%, H 10%, I 10%, J 10% and Corporation
XYZ 60%
Shareholders of Corporation XYZ are G 60%, K 10%, L 10%, M 10%, N 10%
In this case, insofar as G is concerned on Company B, he has a direct shareholding of
10% and an indirect shareholding through Corporation XYZ:
Direct ownership
10%
Indirect ownership (60% x 60%)
36%
Total Ownership or shareholding
46%
In this case, the loss is DEDUCTIBLE since ownership, direct and indirect, is not more
than 50%.
Grandfather rule: You dont just look at the corporate shareholder but you also look at
the individual shareholders of the corporate shareholder to its extent of ownership

Company S is owned by C 10%, D 10%, E 10%, F 10%, G 60%


Company B is owned by shareholder G 10%, H 10%, I 10%, J 10% and Corporation
XYZ 60%
Shareholders of Corporation XYZ are G 99%, K 0.25%, L 0.25%, M 0.25%, N 0.25%
In this case, insofar as G is concerned on Company B, he has a direct shareholding of
10% and an indirect shareholding through Corporation XYZ:
Direct ownership
10.00%
Indirect ownership (99% x 60%)
59.40%
Total Ownership or shareholding
69.40%
In this case, the loss is NOT DEDUCTIBLE since ownership, direct and indirect, is more
than 50%.

Revenue Regulations (RRs) are issuances signed by the Secretary of Finance, upon
recommendation of the Commissioner of the Internal Revenue that specify, prescribe or define
rules and regulations for the effective enforcement of the provisions of the National Internal
Revenue Code (NIRC) and related statutes.
Revenue Memorandum Circulars (RMCs) are issuances that publish pertinent and
applicable portions, as well as amplifications, of laws, rules, regulations and precedents issued
by the BIR and other agencies/offices

-this is issued interrelated to other agencies of the government. Example is the issuance of a
resolution by the HULRB which increases the amount of ceiling for the socialized housing. This
has effect on the BIR so far as Value Added Tax (VAT) is concern. BIR will not issue RMO since
the resolution did not come the BIR itself but instead the RMC and it will mention there pursuant
to bla bla.
Revenue Bulletins - refer to preiodic issuances, notices and official announcements of the
Commissioner that consolidate the BIRs position on certain specific issues of law or
administration in relation to the provisions of the Tax Code, relevant to tax laws and other
issuances for the guidance of the public. These are found in the website (i.e., reminders re:
deadlines of the tax returns)
Revenue Memorandum Order (RMOs) - are issuances that provide directives or
instructions; prescribe guidelines; and outline processes, operations, activities, workflows,
methods and procedures necessary in the implementation of stated policies, goals, objectives,
plans and programs of the Bureau in all areas of operations, except auditing.

-this is issued by the Commissioner of the BIR in relation to a resolution issued by the BIR itself.
Revenue Memorandum Rulings (RMRs) - are rulings, opinions and interpretations of the
Commissioner of Internal Revenue with respect to the provisions of the Tax Code and other tax
laws, as applied to a specific set of facts, with or without established precedents, and which the
Commissioner may issue from time to time for the purpose of providing taxpayers guidance on
tax consequences in specific situations. BIR Rulings, therefore, cannot contravene duly issued
RMRs; otherwise, the Rulings are void ab initio.

-this is broader than the BIR Ruling because this is applicable to all taxpayers.
BIR Rulings - are official position of the Bureau to queries raised by taxpayers and other
stakeholders relative to clarification and interpretation of tax laws.

-if you are a taxpayer and you try to ask for a ruling, whatever is the ruling of the CIR is, is only
applicable to you even though other taxpayers have the same facts as yours. It does not mean
that applicable na sad na sya sa iyaha.

14 | TAXATION 1 NOTES (Based on Atty. Aranas Syllabus and Lecture) EH403 S.Y. 2014-2015