FOR THE 12 OCTOBER 2014 BAR EXAMINATION

DOMONDON’S CUT AND PASTE

VER. 2014-A

INCOME TAXATION
During the Pre-Week, from October 6 - 11, 2014, you do not have the luxury of
time to do a leisurely reading of your books and notes. Thus, you should be very
selective in the use of review materials. “Domondon’s CUT AND PASTE” was specially
prepared to help you focus on the areas that are probable sources of questions to be
given during the 2014 Bar Examination in Taxation. The areas were identified by the
author through statistical analysis using data from Bar Examination questions in Taxation
given during the period 1964 up to 2013.

You should note that Domondon’s CUT AND PASTE was prepared using the
2014 coverage of the Bar Exams as the basis. For your guidance doctrines contained in
selected Supreme Court decisions up to March 31, 2014 (if available and applicable),
are also included. For areas without any entries, just try to recall the concepts. If you
could not recall the concepts refer to the books on Taxation authored by Prof.
Domondon.

In order to have a most effective Pre-Week Review, you should read

“Domondon’s CUT AND PASTE” in the following sequence:

1. You should first read and master the areas marked BAR because of the
high statistical probability that 80% to 90% of the 2014 Bar Examination in Taxation may
be sourced from these areas. You could “CUT” the concepts and “PASTE” them as your
answers to the Bar Questions. Of course, there may be a need to adjust the concept
that is “PASTED” to meet the requirements and factual circumstances of the actual Bar
Examination Questions.
To facilitate your understanding of the areas marked BAR, it is suggested that
you should write the notes you take during the “Pre-Week Reviews” directly opposite the
concept that you find difficulty understanding. If you intend to do a self-review during the
Pre-Week then you could annotate the “CUT AND PASTE” by writing your own
comments. Sometimes it is easier to understand the concept if it is in your own
handwriting. There may be no need to highlight the areas marked BAR because all the
areas so marked are equally dangerous.

2. After you have mastered the areas marked BAR you should next do a
selective reading of the areas that are not marked. It is statistically probable that 10% to
20% of the Bar Examination Questions for the 2014 Bar Examination in Taxation may be
sourced from the areas covered by this section. There is likewise a high probability that
“crazy questions” may be sourced from this section.

You could, if you so desire, highlight certain areas that are not marked BAR
which in your own estimation may be probable sources of questions. It is not advisable
to spend a lot of time on the unmarked areas unless you have first mastered the areas
marked BAR.
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Finally, the purpose of “Domondon”s CUT AND PASTE” is not to teach you
Taxation but to provide a guide on the areas you should focus in order to enable you to
pass the Bar Examination and be among the “TOP TEN” Bar passers. Advance
congratulations and see you soon in court as a fellow lawyer.

ABELARDO T. DOMONDON
Magnificus No. _____
July 5, 2014
Leon’s Den, Bigain Ist
San Jose, Batangas

II. National Internal Revenue Code (NIRC) of 1997, as amended

A. Income taxation
1. Income tax systems
a. Global tax system
b. Schedular tax system
c. Semi-schedular or semi-global tax system
Schedular treatment distinguished from global treatment .
1) Under the schedular treatment there are different tax rates WHILE under the global treatment
there is a unitary or single tax rate;
2) Under the schedular treatment there are different categories of taxable income WHILE under
the global treatment there is no need for classification as all taxpayers are subjected to a single rate;
3) The schedular treatment is usually used in the income taxation of individuals WHILE the
global treatment is usually applied to corporations.

2. Features of the Philippine income tax law

a. Direct tax
b. Progressive
c. Comprehensive
d. Semi-schedular or semi-global tax system
3. Criteria in imposing Philippine income tax
a. Citizenship principle
b. Residence principle
The principle of mobilia sequuntur personam in income taxation . This is a principle in income
taxation where the income follows the income earner. The income is thus taxed in the place where the owner (income
earner) is located and not in the place where the income is earned or where the income originated.
This applies to resident citizens on their incomes derived from sources without the Philippines. [NIRC of 1997,
Sec. 23 (A)]
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A resident citizen is given protection by the Philippines no matter where he is found or no matter where he
earns his income. He is therefore obligated to support the Philippines, in exchange for the protection he receives.
It would appear from this concept that the tangible properties of non-resident alien decedents that are
physically located in the Philippines do not form part of their gross estate located in the Philippines. This is so because
the tangible personal property follows the residence of the decedent which is located outside of the Philippines. Thus,
they do not have tangible personal properties located in the Philippines for purposes of estate taxation.

c. Source principle

4. Types of Philippine income tax

5. Taxable period
BAR: a. Calendar period. The taxable period comprising the twelve (12) consecutive months
from January 1 through to December 31. It may be utilized by individuals, estates, trusts or corporation.

BAR: b. Fiscal period. The taxable period comprising any twelve (12) consecutive months,
starting on any day or month and ending twelve (12) months later. It may availed of only by corporations. Individuals,
estates or trusts may not use this tax period.

c. Short period. A taxable period which is less than twelve (12) consecutive months.
Instances when a taxpayer may have a short taxable period.
1) When a corporation is newly organized and commenced operations on any day within the year;
2) when a corporation changes its accounting period;
3) when a corporation is dissolved;
4) when a commissioner of Internal Revenue, by authority, terminates the taxable period of a
taxpayer pursuant to Section 6 (D) of the Tax Code; and
5) in case of final return of the decedent and such period ends at the time of his death. (BIR
Handbook on Audit Procedures and Techniques – Volume I (Revision 2000), Chapter V.B, p. 13, renumbered]

Example of an instance when a corporation may file an income tax return for a short
period.
1) If a taxpayer, other than an individual, changes its accounting period
a) from fiscal year to calendar year,
b) from calendar year to fiscal year, or
c) from one fiscal year to another,
2) the net income shall,
a) with the approval of the Commissioner of Internal Revenue,
b) be computed on the basis of such new accounting period
c) subject to the provisions” for filing of returns for short period resulting from change of
accounting period. (NIRC of 1997, Sec. 46, arrangement, numbering, words in italics and paraphrasing supplied]
NOTES AND COMMENTS: Only a corporation may change its accounting periods but always subject to the
approval of the Commissioner of Internal Revenue and compliance with the requirements for filing returns for short period
resulting from change of accounting period.
An individual taxpayer cannot change his accounting period because he is allowed only one, the calendar year.

Instances when the Commissioner shall declare the tax period of a taxpayer terminated at
any time. When it shall come to the knowledge of the Commissioner that a taxpayer
1) is retiring from business subject to tax, or
2) is intending to leave the Philippines or
3) to remove his property therefrom or to hide or conceal his property, or
4) is performing any act tending to
a) obstruct the proceedings for the collection of the tax for the past or current quarter or
year or
 4

b) to render the same totally or partly ineffective unless such proceedings are begun
immediately, (NIRC of 1997, Sec. 6 (D), arrangement and numbering supplied]

6. Kinds of taxpayers
a. Individual taxpayers
i. Citizens
a) Resident citizens
b) Non-resident citizens
ii. Aliens
a) Resident aliens
b) Non-resident aliens
1) Engaged in trade or business
BAR: The 180-day rule.
1) A non-resident alien individual
2) who shall come to the Philippines
3) and stays therein for an aggregate period of more than 180 days during
any calendar year. [NIRC of 1997, Sec. 25 (A) (1) in relation to Sec. 22 (G)]
4) notwithstanding the definition of a non-resident alien under Sec. 22 (G).
(Ibid.)
5) shall be deemed a nonresident alien doing business in the Philippines.
(Ibid.)

2) Not engaged in trade or business

iii. Special class of individual employees
a) Minimum wage earner. The term “minimum wage earner’ shall refer to a
worker in the private sector paid the statutory minimum wage; to an employee in the public sector with
compensation income of not more than the statutory minimum wage in the non-agricultural sector
where he/she is assigned. [NIRC of 1997, Sec. 22 (HH), as added by Rep. Act No. 9504]

b) Statutory minimum wage, defined. The term ‘statutory minimum wage’ earner
shall refer to rate fixed by the Regional Tripartite Wage and Productivity Board, as defined by the
Bureau of Labor Employment Statistics (BLES) of the Department of Labor and Employment (DOLE).
[NIRC of 1997, Sec. 22 (GG), as added by Rep. Act No. 9504]

b. Corporations. The term ‘corporation’ shall include:

1) partnerships, no matter how created organized,
2) joint stock companies,
3) joint accounts (cuentas en participacion),
4) associations or insurance companies. [NIRC of 1997, Sec. 22 (B), 1st sentence]
NOTES AND COMMENTS: For tax purposes, all the foregoing are considered as corporations,

NOT considered as corporations for income tax purposes.

1) general professional partnerships and
2) a joint venture or consortium formed
3) for purpose of undertaking construction projects
 5

4) or engaging in
a) petroleum,
b) coal,
c) geothermal, and
d) other energy operations, pursuant to
(1) an operation or consortium agreement
(2) under a service contract with the Government. [ NIRC of 1997, Sec. 22 (B), 1st
sentence, arrangement and numbering supplied]

i. Domestic corporations
ii. Foreign corporations
a) Resident foreign corporations
b) Non-resident foreign corporations
iii. Joint venture and consortium
Joint venture, defined. Generally understood to mean an organization formed for some
temporary purpose. (Philex Mining Corporation v. Commissioner of Internal Revenue, G. R. No. 148187, April
16, 2008)
For example: ABC, Inc., and XYZ Corporation, without forming a corporation, a partnership or
other recognizable business organization, agreed to join together to construct a 50 storey building.
After completion of the building then they go their separate ways again. They are said to have entered
into a joint venture agreement (JVA).

General rule, taxable. A joint venture is considered as a partnership. A joint venture is

“hardly distinguishable from the partnership, since their elements are similar – community of interest in
the business, sharing of profits and losses, and a mutual right of control .” (Philex Mining Corporation v.
Commissioner of Internal Revenue, G. R. No. 148187, April 16, 2008)
NOTES AND COMMENTS: Consequently, the joint venture is subject to tax as if it is a corporation.
In this case there would be two levels of taxation. The joint venture would subject to tax as if it is a
corporation. If there are profits distributed they are considered as dividends and taxable as such.

Instances where a joint venture is NOT taxable because it is not considered

as a taxable partnership. A joint venture or consortium formed
1) for purpose of undertaking construction projects
2) or engaging in
a) petroleum,
b) coal,
c) geothermal, and
d) other energy operations, pursuant to
1) an operation or consortium agreement
2) under a service contract with the Government. [NIRC of 1997, Sec. 22
B), 1st sentence, arrangement and numbering supplied]
NOTES AND COMMENTS: The joint venture itself is not considered as if it is a corporation, hence not
taxable as such. However, once there is a distribution of earnings to the members of the joint venture, they shall
be taxable separately on the earnings they receive.

BAR: Requisites that must be present so that a joint venture undertaking

construction projects would not be subject to tax. “A joint venture or consortium formed for
the purpose of undertaking construction projects not considered as corporation under Sec. 22 of the
NIRC of 1997 as amended, should be:
1) for the undertaking of a construction project; and
 6

2) should involve joining or pooling of resources by licensed local contractors; that is,
licensed as general contractor by the Philippine Contractors Accreditation Board (PCAB) of the
Department of Trade and Industry (DTI);
3) these local contractors are engaged in construction business; and
4) the Joint Venture itself must likewise be duly licensed as such by the Philippine
Accreditation Board (PCAB) of the Department of Trade and Industry (DTI).
Joint ventures involving foreign contractors may also be treated as a non-taxable corporation
only if the member foreign contractor is covered by a special license as contractor by the Philippine
Contractors Accreditation Board (PCAB) of the Department of Trade and Industry (DTI); and the
construction project is certified by the appropriate Tendering Agency (government office) that the
project is a foreign financed/international-funded project and that international bidding is allowed under
the Bilateral Agreement entered into by and between the Philippine Government and the
foreign/international financing institution pursuant to the implementing rules and regulations of Republic
Act No. 4566 otherwise known as Contractor’s License Law.
Absent any one of the aforesaid requirements, the joint venture or consortium formed for the
purpose of undertaking construction projects shall be considered as taxable corporations.
In addition, the tax-exempt joint venture or consortium herein defined shall not include
those who are mere suppliers of goods, services or capital to a construction project.
The members to a Joint Venture not taxable as corporation shall each be responsible in
reporting and paying appropriate income taxes on their respective share to the joint venture’s profit.”
(RR No. 10-2012, Section 3)

BAR: c. Partnerships. Taxable partnerships. These are partnerships which are by law
assimilated to be within the context of, and so legally contemplated as, corporations. (Tan v. Del Rosario, Jr., et al., and
companion case, 237 SCRA 324,335)
These are business partnerships or partnerships which are organized for the purpose of engaging in trade or
business. They are subject to income tax as if they are corporations, whether or not registered with the Securities and
Exchange Commission as a partnership. Registration of a business partnership with the SEC is an indication of its
taxable character.

BAR: d. General professional partnerships. A general professional partnership as such

shall not be subject to income taxes. (NIRC of 1997, Sec. 26, 1st sentence)
A general professional partnership is deemed to be no more than a mechanism or flow-through entity in the
generation of income by, and the ultimate distribution of income to, respectively, each of the individual partners. (Tan v.
Del Rosario, Jr. et al., and Companion case, 237 SCRA 324, 335)
NOTES AND COMMENTS: While a general professional partnership as such is not a taxable entity and therefore not
subject to income taxes, the member professionals are to be subject to income taxes on their share in the distributive net income of
such general professional partnerships.
A general professional partnership is not required to file an income tax return because it is not a taxable entity but it is
required to file an information return.

e. Estates and trusts

f. Co-ownerships
BAR: Co-ownerships not deemed unregistered partnerships therefore NOT taxable
like corporations.
1) Article 1769(3) of the Civil Code provides that, “The sharing of gross returns does not
of itself establish a partnership, whether or not the persons sharing them have a joint or common right
or interest in any property from which the returns are derived.”
There must be an unmistakable intention to form a partnership or joint venture . (Obillos, Jr., v.
Commissioner of Internal Revenue, 139 SCRA 436) In co-ownership, the purpose is merely to jointly own
properties, retaining their separate pro-indiviso titles, and not for the purpose of earning a profit.
2) Co-heirs who own inherited properties which produce income should not automatically
be considered as partners of an unregistered partnership or corporation subject to income tax.
REASONS: Sharing of gross returns does not by itself establish a partnership, there must be an
unmistakable intention to form a partnership or joint venture. There is no contribution or investment of
 7

additional capital to increase or expand the inherited properties, merely continuing the dedication of the
property to the use to which it had been put by their forebears. (Obillos, Jr., v. Commissioner of Internal
Revenue, 139 SCRA 436)
3) Persons who contribute property or funds to a common enterprise and agree to share
the gross returns of that enterprise in proportion to their contribution, but who severally retain the title to
their respective contribution, are not thereby rendered partners. They have no common stock capital,
and no community of interest as principal proprietors in the business itself which the proceeds derived.
(Elements of the Law of Partnership by Floyd R. Mechem, 2 nd Ed., section 83, p. 74 cited in Pascual v.
Commissioner of Internal Revenue,166SCRA 560)
4) The common ownership of property does not itself create a partnership between the
owners, though they may use it for purpose of making gains. They may, without becoming partners, are
among themselves co-owners as to the management and use of such property and the application of
the proceeds therefrom. (Spurlock v. Wilson, 142 S.W. 363, 160 No. App. 14. Ibid)
5) A joint purchase of land, by two, does not constitute a co-partnership in respect
thereto, nor does an agreement to share the profits and losses on the sale of land create a partnership;
the parties are only tenants in common. (Clark v. Sideway, 142 U.S. 682, 12 S. Ct. 327, 35 L. Ed., 1157 cited
in Pascual v. Commissioner of Internal Revenue, 166 SCRA 560 )
6) Where plaintiff, his brother, and another agreed to become owners of a single tract of
realty holding as tenants in common, and to divide the profits of disposing of it, the brother and the
other not being entitled to share in plaintiff’s commissions, no partnership existed as between the three
parties, whatever their relation may have been as to third parties. (Magee v. Magee, 123 N.E. 673, 233
Mass. 341, Ibid.)

7. Income taxation
a. Definition
b. Nature
BAR: c. General principles
Summary of source rule of income taxation as provided in the NRC of 1997. This is also
known as the general principles of income taxation which governs income taxation starting
January 1, 1998.
1) A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines;
2) A nonresident citizen is taxable only on income derived from sources within the Philippines;
3) An individual citizen of the Philippines who is working and deriving income abroad as an
overseas contract worker is taxable only on income from sources within the Philippines: Provided, That a
seaman who is a citizen of the Philippines and 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;
4) An alien individual, whether a resident or not of the Philippines, is taxable only on income
derived from sources within the Philippines;
5) A domestic corporation is taxable on all income derived from sources within and without
the Philippines; and
6) 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. (NIRC of 1997, Sec. 23, emphasis,
arrangement and numbering supplied)

8. Income
a. Definition . Earnings, in the form of money coming to a person or corporation, whether as
payment for services, interest or profit from investment. lawfully or unlawfully acquired, without consensual
recognition, express or implied, of an obligation to repay and without restriction as to their disposition.
 8

Receipts not considered as income:

1) Advance payments or deposits for payments.
2) Property received as compensation but subject to forfeiture.
3) Assessments for additional corporate contributions.
4) Increments resulting from revaluation of property.
5) Parent corporation’s share in the accumulated and current equity on subsidiaries’ net earnings
prior to distribution.
6) Money earmarked for some other persons not included in gross income. (Visayan Cebu Terminal
Co., Inc. v. Commissioner, 13 SCRA 357)
7) Money or property borrowed.
8) Increase in net worth resulting from adjusting entries.

b. Nature
c. When income is taxable
i. Existence of income
ii. Realization of income
a) Tests of realization
b) Actual vis-à-vis constructive receipt
BAR: When income considered received for Philippine income tax
purposes.
1) If actually or physically received by taxpayer; or
2) If constructively received by taxpayer. (RR No. 2, Sec. 52)

Concept of actual receipt of income . Actual receipt may be

1) physical receipt
2) or constructive receipt. (Asia Banking Corporation v. Commissioner of
Internal Revenue, G. R. No. 140857, September 27, 2006

Constructive receipt of income. Constructive receipt occurs when money

consideration or its equivalent is placed at the control of the person who rendered the service
without restriction by the payor. (RR No. 16-2005, Sec. 108-A)

Examples of income constructively received . The following are examples of

constructive receipt:
1) Deposit in banks which are made available to the seller of services without
restrictions.
2) Issuance by the debtor of a notice to offset any debt or obligation and
acceptance thereof by the seller as payment for services rendered.
3) Transfer of the amounts retained by the payor to the account of the contractor.
(RR No. 16-2005, Sec. 4 108-A, renumbered)
4) Interest coupons that have matured and are payable but have not been
cashed.
5) Undistributed share of a partner in the profits of a general partnership.
6) It was once held that there was constructive receipt of income where the
income was applied in payment of debts legally demandable and chargeable to the taxpayer.
(Republic v. dela Rama, et al., 124 Phil. 1493)
7) Dividends set off against valid debts in favor of the corporation, but not if the
debts are not valid or are controversial. (Ibid.)

iii. Recognition of income

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iv. Methods of accounting

a) Cash method vis-à-vis accrual method
Cash method of income recognition . It is also referred to as the “cash receipts
and disbursements method” because both the receipt and disbursements are considered.
Thus, income is recognized only upon actual or constructive receipt of the cash
payment or property but no deductions are allowed from the cash income unless actually
disbursed through an actual or constructive payment in cash or property. [Chapter II.A., BIR
Handbook on Audit Procedures and Techniques – Volume I (Revision 2000), p. 3]

Accrual method of income recognition . This is “a method of accounting for

income in the period it is earned, regardless of whether it has been received or not. In the
same manner, expenses are accounted for in the period they are incurred and not in the period
they are paid. [BIR Handbook on Audit Procedures and Techniques, Chapter II.B, Volume I (Revision
2000), p. 3]

b) Installment payment vis-à-vis deferred payment vis-à-vis

percentage completion (in long-term contracts)
Installment payment method of accounting . This method is considered appropriate
when collections extend over relatively long periods of time and there is a strong possibility that full
collection will not be made. As customers make installment payments, the seller recognizes the gross
profit on sale in proportion to the cash collected. [Handbook on Audit Procedures and Techniques, Chapter II.
E, Accounting Methods, Volume I, (Revision 2000), , pp. 3-4]

BAR: Percentage of completion basis. In the case of long-term contracts involving

building, installation or construction contracts covering a period in excess of one (1) year, persons
whose gross income is derived from such contracts shall report such income upon the basis of
percentage of completion. (NIRC of 1997, Sec. 48)

d. Tests in determining whether income is earned for tax purposes

BAR: i. Realization test. Under the realization principle, revenue is generally
recognized when both of the following conditions are met:
1) The earning process is complete or virtually complete, and
2) an exchange has taken place.
This principle requires that revenues must be earned before it is recorded . (Manila Mandarin
Hotels, Inc. v. The Commissioner of Internal Revenue, CTA Case No. 5046, March 24, 1997)

ii. Claim of right doctrine or doctrine of ownership, command, or control

iii. Economic benefit test, doctrine of proprietary interest
iv. Severance test

BAR: v. All events test. For a taxpayer using the accrual method, the determinative
question is, when do the facts present themselves in such a manner that the taxpayer must recognize income
of expenses ?
The accrual of income and expenses is permitted when the all events test has been met. This test
requires:
1) fixing of a right to income or liability to pay; and
2) the availability of the reasonable accurate determination of such income or liability.
However, the test does not demand that the amount of income or liability be known absolutely, only that
a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy.
The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is
 10

satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year.
The amount of liability does not have to be determined exactly; it must be determined with ‘reasonable
accuracy.’ Accordingly, the term ‘reasonable accuracy’ implies something less than an exact or completely
accurate amount.’ (Commissioner of Internal Revenue v. Isabela Cultural Commission, G. R. No. 172231, February 12
2007)

9. Gross income
a. Definition
b. Concept of income from whatever source derived. Gross income means all income
derived from whatever source. [NIRC of 1997, Sec. 32 (A), paraphrasing supplied]

BAR: Included in income from whatever source.

1) Income from an illegal business is subject to income taxation. So also,
income obtained from criminal activities such as swindling or extortion (Rutkin v. U.S.
343 U.S. 130), embezzlement. (James v. U.S., 366 U.S. 213)
2) Forgiveness of indebtedness in certain instances, or
3) Under the so-called “tax benefit” rule (also known as recapture rules)
where there is recovery of previously written-off debts, or refund of tax payments.

c. Gross income vis-à-vis net income vis-à-vis taxable income

d. Classification of income as to source
i. Gross income and taxable income from sources within the Philippines
ii. Gross income and taxable income from sources without the Philippines
iii. Income partly within or partly without the Philippines
e. Sources of income subject to tax
i. Compensation income
ii. Fringe benefits
a) Special treatment of fringe benefits. A final tax of thirty-two percent (32%)
of the grossed-up monetary value of fringe benefits furnished or granted to the employee (except rank
and file employees) by the employer, whether an individual or a corporation (unless the fringe benefit is
required by the nature of, or necessary to the trade, business or profession of the employee, or when
the fringe benefit is for the convenience or advantage of the employer). [NIRC of 1997, Sec. 33 (A)]

BAR: b) Definition. For purposes of applying fringe benefit taxation, fringe benefit
means “any good, service or other benefit furnished or granted in cash or in kind by an employer to an
individual employee (except rank and file employees), such as but not limited to:
1) Housing.
2) Expense account.
3) Vehicle of any kind.
4) Household personnel, such as maid, driver and others.
5) Interest on loan at less than market rate to the extent of the difference between
the market rate and actual rate granted.
6) Membership fees, dues and other expenses borne by the employer for the
employee in social and athletic clubs or other similar organizations.
7) Expenses for foreign travel.
8) Holiday and vacation expenses.
 11

9) Educational assistance to the employee or his dependents.

10) Life or health insurance and other non-life insurance premiums or similar
amounts in excess of what the law allows. [NIRC of 1997, Sec. 33 (B); RR No. 3-98, Sec. 2.33 (B)]

c) Taxable and non-taxable fringe benefits

Taxable fringe benefits:
1) Housing Privilege subject to the fringe benefits tax may arise under
any of the following:
a) Employer leases residential property for use of the employee.
b) Employer owns a residential property and assigns the same for use by
the employee.
c) Employer purchases a residential property on installment basis and
allows use by the employee.
d) Employer purchases a residential property and transfers ownership to
the employee.
e) The employer provides a monthly fixed amount for the employee to pay
his landlord
2) When expense accounts are treated as taxable fringe benefits, general
rule. “In general, expenses incurred by the employee but which are paid by his employer shall
be treated as taxable fringe benefits, except when the expenditures are duly receipted for and
in the name of the employer and the expenditures do not partake of the nature of a personal
expense attributable to the employee.” [RR No. 3-98, Sec. 2.33 (D) (2) (a)]
a) Reimbursed expenses when taxable. “Expenses paid for by the
employee but reimbursed by his employer shall be treated as taxable benefits except
only when the expenditures are duly receipted for and in the name of the employer and
the expenditures do not partake the nature of a personal expense attributable to the
said employee.” [RR No. 3-98, Sec. 2.33 (D) (2) (b)]
b) Personal expenses taxable benefits. “Personal expenses of the
employee (like purchases of groceries for the personal consumption of the employee
and his family members) paid for or reimbursed by the employer to the employee shall
be treated as taxable fringe benefits of the employee whether or not the same are duly
receipted for in the name of the employer.” [RR. No. 3-98, Sec. 2.33 (D) (2) (c)]
3) Motor vehicles or use of considered as taxable fringe benefits under
the following:
a) Employer purchases vehicle in employee’s name.
b) Employer provides employee cash for vehicle purchase.
c) Employer purchases car on installment in name of employee.
d) Employer shoulders a portion of purchase price.
e) Employer owns and maintains a fleet of motor vehicles for use of
business and employees.
f) Employer leases and maintains a fleet of motor vehicles for the use of
the business and employees.
4) Use of yacht taxable fringe benefit. “The use of yacht whether owned and
maintained or leased by the employer shall be treated as taxable fringe benefit. The value of
the benefit shall be measured based on the depreciation of a yacht at an estimated useful life
of 20 years.” [RR No. 3-98, Sec. 2.33 (D) (3) (h)]
5) Household expenses are taxable fringe benefits. “Expenses of the
employee which are borne by the employer for household personnel, such as salaries of
household help, personal driver of the employee, or other similar personal expenses (like
payment for homeowners association dues, garbage dues, etc.) shall be treated as taxable
fringe benefits.” [RR No. 3-98, Sec. 2.33 (D) (4)]
6) Interest on loan at less than market rate are taxable fringe benefits. “If
the employer lends money to his employee free of interest or at a rate lower than twelve per
cent (12%), such interest foregone by the employer or the difference of the interest assumed
 12

by the employee and the rate of twelve per cent (12%) shall be treated as a taxable fringe
benefit.” [RR No. 3-98, Sec. 2.33 (D) (5) (a)]
7) Membership fees, dues and others are
taxable fringe benefits. Membership fees, dues, and other expenses borne by the employer
for his employee, in social and athletic clubs or other similar organizations shall be treated as
taxable fringe benefits of the employee in
full. [RR. No. 3-98, Sec. 2.33 (D) (6]
8) Expenses for foreign travel treated as taxable fringe benefits. “In the
absence of documentary evidence showing that the employee’s travel abroad was in
connection with business meetings or conventions, the
entire cost of the ticket, including cost of hotel accommodations and other expenses incident
thereto shouldered by the employer, shall be treated as taxable fringe benefits. The business
meetings shall be evidenced by official communications from business associates abroad
indicating the purpose of the meetings. Business conventions shall be evidenced by official
invitations/ communications from the host organization or entity abroad. Otherwise, the entire
cost thereof shouldered by the employer shall be treated as taxable fringe benefits of the
employee.” [RR No. 3-98, Sec. 2.33 (D) (7) (b),]
9) Travelling expenses of family members treated as taxable fringe
benefits. “Travelling expenses which are paid by the employer for the travel of the family
members of the employee shall be treated as taxable fringe benefits of the employee.” [RR No.
3-98; Sec. 2.33 (D) (7) (c)]
10) Holiday and vacation expenses treated as taxable fringe benefits.
“Holiday and vacation expenses of the employee borne by his employer shall be treated as
taxable fringe benefits.” [RR No. 3-98, Sec. 2.33 (D) (8),]
11) Educational assistance to the employee or dependents treated as
taxable fringe benefits. “The cost of the educational assistance to the employee which are
borne by the employer shall, in general, be treated as taxable fringe benefit.” [RR No. 3-98, Sec.
2.33, (D) (9) (a), 1st sentence]
“The cost of educational assistance extended by an employer to the dependents of an
employee shall be treated as taxable fringe benefits of the employee xxx .” [Ibid., Sec. 2.33 (D)
(9) (b), paraphrasing supplied]
12) Life or health insurance treated as taxable fringe benefits. The cost of
life or health insurance and other non-life insurance premiums borne by the employer for his
employee shall be treated as taxable fringe benefit, except the following:
a) Contributions of the employer for the benefit of the employee, pursuant
to the provisions of existing law, such as under the Social Security (SSS) (Rep. Act No.
8282, as amended) or under the Government Service Insurance System (GSIS) (Rep.
Act No. 8291), or similar contributions arising from the provisions of any other existing
law; and
b) The cost of premiums borne by the employer for the group insurance of
his employees. [RR No. 3-98, Sec. 2.33 (D) (10), arrangement supplied]
NOTES AND COMMENTS: If the recipient of the fringe benefit, that is not exempt, is a non-rank and file
employee (managerial or supervisory) it may be subject to the fringe benefit tax to be paid by the employer. If the
recipient is a rank and file employee, the monetary value shall be considered as part of the compensation income
of the employee for which he has to pay the corresponding tax.

Fringe benefits NOT subject to the fringe benefits tax:

1) Housing privileges NOT treated as taxable fringe benefit.
a) “Housing privilege of military officials of the Armed Forces of the
Philippines (AFP) consisting of officials of the Philippine Army, Philippine Navy and
Philippine Air Force shall not be treated as taxable fringe benefit in accordance with the
existing doctrine that the State shall provide its soldiers with necessary quarters which
are within or accessible from the military camp so that they can readily be on call to
meet the exigencies of their military service.” [NIRC of 1997, Sec. 2.33 (D), (1) (f)]
b) “A housing unit which is situated inside or adjacent to the premises of
a business or factory shall not be considered as a taxable fringe benefit. A housing unit
is considered adjacent to the premises of the business if it is located within the
 13

maximum of fifty (50) meters from the perimeter of the business premises.” [RR No. 3-
98, Sec. 2.33 (D) (1) (g)]
2) Use of aircraft not subject to fringe benefits tax. “The use of aircraft
(including helicopters) owned and maintained by the employer shall be treated as business use
and not be subject to the fringe benefits tax.” [RR No. 3-98, Sec. 2.33 (D) (3) (g)]
3) Expenses for foreign travel NOT treated as taxable fringe benefits.
“Reasonable business expenses which are paid for by the employer for the foreign travel of his
employee for the purpose of attending business meetings or conventions shall not be treated
as taxable fringe benefits. In this instance, inland travel expenses (such as expenses for food,
beverages and local transportation) except lodging cost in a hotel (or similar establishments)
amounting to an average of US$300.00 or less per day, shall not be subject to a fringe benefit
tax. The expenses should be supported by documents proving the actual occurrences of the
meetings or conventions.
The cost of economy and business class airplane ticket shall not be subject to a fringe
benefit tax. However, 30 percent of the cost of first class airplane ticket shall be subject to a
fringe benefit tax.” [RR No. 3-98, Sec. 2.33 (D) (7) (a)]
4) Educational assistance to the employee when NOT treated as
taxable fringe benefits. A “scholarship grant to the employee by the employer shall not
be treated as taxable fringe benefit if the education or study involved is directly connected with
the employer’s trade, business or profession, and there is a written contract between them that
the employee is under obligation to remain in the employ of the employer for the period of time
that they have mutually agreed upon. In this case, the expenditure shall be treated as incurred
for the convenience and furtherance of the employer’s trade or business .” [RR No. 3-98, Sec.
2.33 (D) (9) (a), 2nd and 3rd sentences]
5) Other fringe benefits that are NOT subject to the fringe benefits tax:
a) Fringe benefits which are authorized and exempted from tax under the
NIRC of 1997 or special laws;
b) Contributions of the employer for the benefit of the employee to
retirement, insurance and hospitalization benefit plans;
c) Benefits given to the rank and file employees, whether granted
under a collective bargaining agreement or not; and
d) De minimis benefits as defined in the rules and regulations to be
promulgated by the Secretary of Finance upon recommendation of the
Commissioner of Internal Revenue. [ NIRC of 1997 Sec. 32 (C); RR No. 3-98, Sec. 2.33
(C)]

iii. Professional income. These are the gains, returns and revenue derived from the
practice of a profession. Professional income does not include “part of the income which is derived from
engaging in any trade or business.” [NIRC of 1997, Sec. 22 (B), last sentence, emphasis supplied
NOTES AND COMMENTS: There is need to segregate the professional income from income derived from
business in the case of a general professional partnership (GPP). This is so because the professional income earned by
the general professional partnership is not taxable hence the GPP does not file an income tax return but an information
return.
On the other hand, the income from business of a GPP is taxable because the GPP is going to be considered as a
partnership engaged in business taxable as a corporation.

iv. Income from business. These are the gains, returns and revenue derived from a ”trade
or commercial activity regularly engaged in as a means of livelihood or with a view to profit.” (Yamane , etc. v.
BA Lepanto Condominium Corporation, G. R. No. 154993, October 25, 2005)

Association dues, membership fees, and other assessment/charges collected by a

condominium corporation from its members, tenants and other entitles are considered
income subject to tax. “The amounts paid in as dues or fees by members and tenants of a condominium
corporation form part of the gross income of the latter subject to income tax. This is because a condominium
corporation furnishes its members and tenants with benefits, advantages and privileges in exchange for such
payments. For tax purposes, the association dues, membership fees, and other assessments/charges
collected by a condominium corporation constitute income payments or compensation for beneficial services it
 14

provides to its members and tenants. The previous interpretation that the association dues are funds which
are merely held in trust by a condominium corporation lacks legal basis and is hereby abandoned.
Moreover, since a condominium corporation is subject to income tax, income payments made to it are
subject to applicable withholding taxes under existing regulations.” (RMC No. 65-2012, Part I)

v. Income from dealings in property

a) Types of properties
BAR: 1) Ordinary assets. Ordinary assets are all the property that are
held by a taxpayer in connection with his trade or business, and may include:
a) Stock in trade of the taxpayer, or
b) 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
c) Property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business, or
d) Property used in the trade or business, of a character which is subject
to the allowance for depreciation; or real property used in the trade or business of the
taxpayer. [NIRC of 1997, Sec. 39 (A) (1), paraphrasing and numbering supplied]

BAR: 2) Capital assets. The term “capital assets” means property held by
the taxpayer (whether or not connected with his trade or business), BUT DOES NOT
INCLUDE:
a) Stock in trade of the taxpayer, or
b) 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
c) Property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business, or
d) Property used in the trade or business, of a character which is
subject to the allowance for depreciation; or real property used in the trade or business
of the taxpayer. [NIRC of 1997, [Sec. 39 (A) (1), arrangement and numbering supplied]
NOTES AND COMMENTS: For analysis, if the property is used in traded or business, it is an ordinary asset.
If it is NOT used in trade of business it is a capital assert.

b) Types of gains from dealings in property

1) Ordinary income vis-à-vis capital gain
BAR: Ordinary gain, defined. Any gain from the sale or exchange of
property which is NOT a capital asset or property. [NIRC of 1997, Sec. 22 (Z), capitalized
word supplied]

BAR: Capital gain, defined. Any gain from the sale or exchange of
property which IS a capital asset or property.

BAR: Kinds of capital gains.

1) Capital gains subject to final tax. These are usually imposed
upon the sale, exchange or other disposition of
a) real property
b) and shares of stock that are not listed and trade
through the stock exchange.
2) Capital gains included in gross income and reported in the
income tax return for income tax purposes.

2) Actual gain vis-à-vis presumed gain

 15

Actual capital gain. The amount that remains after taking the receipt from
the disposition of the capital asset and subtracting the acquisition cost or cost basis.
This gain is then the tax base upon which the capital gains tax is imposed.

Presumed capital gain. A fixed value of the capital asset irrespective of

whether there is an actual capital gain or an actual capital loss. The tax base for the
imposition of the capital gains tax is the fixed value as determined by statute.

BAR: Capital gain distinguished from ordinary gain.

1) The source of capital gain is property not used in trade or
business WHILE the source of ordinary gain is property used in trade or
business.
2) Some types of capital gains are adjusted by the holding period,
WHILE the holding period does not find application to ordinary gains.
3) From certain types of capital gains may be deducted ordinary
losses, WHILE only ordinary losses may be deducted from ordinary gains.
4) The concept of net loss carryover applies to capital gains
taxation, WHILE the concept of net operating loss carryover applies to ordinary
gains taxation.
5) Generally no deductions are allowed from capital gains WHILE
deductions are usually allowed for ordinary gains.
6) Generally capital gains are subject to final taxes, WHILE this is
not so with regard to ordinary gains;
7) The income from capital gains are not generally to be included
in the annual income tax return, WHILE ordinary income is to be included in the
annual income tax return.

BAR: 3) Long term capital gain vis-à-vis short-term capital

gain. A long term capital gain is one that is derived from the disposition of a capital asset
that has been held for more than twelve (12) months WHILE a short-term capital gain is that
derived from the disposition of a capital asset that has been held for not more than twelve (12)
months. [NIRC of 1997, Sec. 39 (B)]

4) Net capital gain, net capital loss

BAR: Net capital gain, defined. The excess of the gains from sales or
exchanges of capital assets over the losses from sales or exchanges of such assets.
[NIRC of 1997, Sec. 39 (A) (2)]

BAR: Net capital loss, defined. The excess of the losses from sales
and exchanges of capital assets over the gains from sales or exchanges of such
assets. [NIRC of 1997, Sec. 39 (A) (3)]

5) Computation of the amount of gain or loss

Computation of gain . “The gain from the sale or other disposition of
property shall be the excess of the amount realized therefrom over the basis or
adjusted basis for determining gain.” [NIRC of 1997, Sec. 40 (A), 1st sentence]

Amount realized, defined . “The amount realized from the sale or other
disposition of property shall be the sum of money received plus the fair market value of
the property (other than money) received. [NIRC of 1997, Sec. 40 (A), 2nd sentence]

BAR: Basis for determining gain or loss from sale or disposition

of property.
 16

1) If acquired by purchase: The cost in case of property

acquired on or after March 1, 1913;,
2) If acquired by inheritance: The fair market value or value as of
the date of acquisition.
3) If acquired by gift:
a) the basis shall be the same as if it would be in the
hands of the donor or the last preceding owner by whom it was not
acquired by gift.
b) EXCEPT that if such basis is greater than the fair
market value of the property at the time of the gift, than for the purpose
of determining loss, the basis shall be the fair market value.
4) If the property was acquired for less than an adequate
consideration in money or money’s worth, the basis of such property is the
amount paid by the transferee for the property.

Computation of loss . The “loss shall be the excess of the basis or

adjusted basis for determining loss over the amount realized.” [NIRC of 1997, Sec. 40
(A), 1st
sentence]

6) Income tax treatment of capital loss

Losses not deductible between related partie s. In computing net income, no

deduction shall in any case be allowed in respect of losses from sales or exchanges of property
directly or indirectly between related parties. [NIRC of 1997, Sec. 36 (B)]

BAR: Related parties, defined . The following are included in the concept of
related parties for the purpose of the prohibition.
1) Members of the same family. For purposes of defining related parties,
the family of an individual includes only his brothers and sisters (whether by the whole
or half-blood), spouse, ancestors, and lineal descendants, or
2) An individual and a corporation more than fifty per-cent (50%) in value
of the outstanding stock of which is owned, directly or indirectly, by or for such
individual, or
3) 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
4) The grantor and a fiduciary of any trust, or
5) The fiduciary of a trust and the fiduciary of another trust of the same
person is a grantor with respect to each trust, or
6) A fiduciary of a trust and a beneficiary of such trust. [NIRC of 1997, Sec.
36 (B)]
NOTES AND COMMENTS: Interests paid to related parties are not allowed to be deducted from
gross income.

BAR: (a) Capital loss limitation rule (applicable to both

corporations and individuals)
1) Losses from sales or exchanges of capital assets, are
2) allowed to be deducted only to the extent of the gains from
such sales or exchanges. [NIRC of 1997, Sec. 39 (C), 1 st sentence, arrangement and
numbering supplied]

Instance when the above limitation does not apply.

1) If a bank or trust company incorporated under the laws of the
Philippines,
 17

2) a substantial part of whose business is the receipt of

deposits,
3) sells any bond, debenture, note, or certificate or other evidence
of indebtedness issued by any corporation (including one issued by a
government or political subdivision thereof), with interest coupons or in
registered form,
4) any loss resulting from such sale shall not be subject to the
above limitations and shall not be included in determining the applicability of
such limitation to other losses. [NIRC of 1997, Sec. 39 (C), 2 nd sentence,
arrangement and numbering supplied]

(b) Net loss carry-over rule (applicable only to

individuals)
BAR: The concept of net loss carry-over rule.
1) If any taxpayer, other than a corporation,
2) sustains in any taxable year a net capital loss,
3) such loss (in an amount not in excess of the net income for
such year)
4) shall be treated in the succeeding taxable year as a loss from
the sale or exchange of a capital asset held for not more than twelve months.
[NIRC of 1997, Sec. 39 (D), arrangement and numbering supplied]
NOTES AND COMMENTS: The net capital loss carry-over is allowed only to
individuals, including estates and trusts. It could not be availed of by corporations.
Furthermore, even for individuals the net loss carry-over shall not exceed the
net income for the year sustained, and is deductible only once (for the succeeding year)
from the sale or exchange of a capital asset held for not more than twelve months. The
capital assets must not be real property or stocks listed and traded in the stock
exchanges because these are subject to final taxes.
The reader should note the limitations for the net loss carry-over, specially that
the carry-over is allowed only for the next succeeding taxable year.
Finally, the reader is reminded that all transactions made during the year of
capital assets that are not real property or shares of stocks listed and traded in the stock
exchange should be taken into account in the determination of whether there existed a
loss during the taxable year. Examples of such capital assets are shares of stock that
are not listed and traded in the stock exchange, jewelry, motor vehicles, objects of art,
and other personal property other than shares of stock that are listed and traded in the
stock exchange.
WARNING: The author does not agree with the statement of the BIR that, if
the transferor of the shares is an individual, the rule on holding period and capital loss
carry-over will not apply [RR No. 6-2008, Sec. 7 (c.4, 2 nd sentence)] because an
administrative issuance could not limit an express provision of a statute.

Net loss carry-over DISTINGUISHED FROM net operating loss

carry-over.
1) Net loss carry-over is a concept in capital gains taxation,
WHILE net operating loss carry-over is a concept in ordinary income taxation;
2) Net loss carry-over is enjoyed only by individuals, estates and
trusts and not corporations, WHILE net operating loss carry-over is enjoyed
only by corporations, not individuals, estates or trusts;
3) Net loss carry-over may be availed of only during the
succeeding year, WHILE net operating loss carry-over may be enjoyed over a
period of three (3) years.

7) Dealings in real property situated in the Philippines

BAR: The presumed capital gains tax. A final tax of six percent (6%) based
on the gross selling price or current fair market value (BIR zonal valuation or the assessor’s
 18

value), whichever is higher, is imposed upon capital gains presumed to have been realized
from the sale, exchange, or other disposition of real property located in the Philippines,
classified as capital assets, including pacto de retro sales and other forms of conditional sales,
by individuals, including estates and trusts. [NIRC of 1997, Sec. 24 (D), emphasis supplied)
A final tax of six percent (6%) is hereby imposed on the gain presumed to have been
realized from the sale, exchange or disposition of lands and/or buildings which are not
actually used in the business of a corporation and are treated as capital assets, based on the
gross selling price or fair market value (BIR zonal valuation or the assessor’s value), whichever
is higher, of such lands and/or buildings.” [NIRC of 1997, Sec. 27 (D) (5), emphasis supplied]
NOTES AND COMMENTS: The reader should take note of the differential treatment. For
individuals, estates and trusts the subject may be any “real property” but for corporations the subject is
limited only to “lands and/or buildings.”
Furthermore, the asset disposed of must be a capital asset and the capital asset should be
located in the Philippines. If located outside the Philippines treat it as if it is an ordinary asset.
Likewise, the buyer should not be the government.
Finally, the holding period should not be applied and the tax is applied whether there is a gain or
a loss arising from the transaction. This is so because the tax is imposed on the “presumed capital
gains.”

BAR: The following sellers of real property located in the Philippines

classified as a capital asset subject to the presumed capital gains tax.
1) Individual citizen, whether resident or not, and individual resident alien
of the Philippines. [NIRC of 1997, Sec. 24 (D)]
2) non-resident alien engaged in trade or business within the Philippines.
[Ibid., Sec. 25 (A) (3),in relation to Sec. 24 (D)]
3) non-resident alien not engaged in trade or business within the
Philippines. [Ibid., Sec. 25 (B), 2nd sentence, in relation to Sec. 24 (D)]
4) an estate or trust. [Ibid., Sec. 24 (D)]
5) a domestic corporation. [Ibid., Sec. 27 (D) (5)]

BAR: Tax treatment of sale by individual of real property classified as

a capital asset to the government. The tax imposed on such sale or other dispositions
to the government or any of its political subdivisions or agencies or to government owned or
controlled corporations shall be determined, at the option of the taxpayer, in either of the
following:
1) included as part of gross income to be subject to the allowable
deductions and/or personal and additional exemptions, then subject to the schedular
tax [NIRC of 1997, Sec. 24 (D) (1), in relation to Sec. 24 (A) (1)] or
2) the final tax of six percent (6%) imposed on the presumed capital gain
which is whichever is higher of the gross selling price, or the current fair market value
(BIR zonal valuation or the assessor’s value). [Ibid., Sec. 24 (D) (1) in relation to Sec. 6
(E)]
NOTES AND COMMENTS: The above privilege is not available to a corporation.

Special tax treatment on disposition of real property.

1) Exemption from the presumed capital gains tax and ordinary income
taxes of sales under the Community Mortgage Program.
2) Taxability of owner’s/mortgagor’s failure to redeem foreclosed
auctioned of real property within the applicable statutory redemption period.
3) Exemption from the presumed capital gains tax and ordinary income
taxes of sales under the Special Purpose (SPV) Act of 2002.
4) Real estate transactions under the Real Estate Investment Trust Act of
2009 may be subject to tax if it is a capital asset in the hands of the transferor.
5) Transactions involving ordinary assets are not subject to capital gains
taxation on disposition of real property.
 19

6) Tax exempt transfer of land and the common areas from a real estate
developer to the Condominium Corporation established pursuant to the provisions of
Republic Act No. 4726, otherwise known as the Condominium Act.

8) Dealings in shares of stock of Philippine corporations. Shares of

stock shall include
a) shares of stock of a corporation,
1) warrants and/or
2) options to purchase shares of stock; as well as
b) units of participation in
1) a partnership (except general professional partnerships),
2) joint stock companies,
3) joint accounts,
4) joint ventures taxable as corporations,
5) associations and recreation or amusement clubs (such as golf, polo or
similar clubs), and
6) mutual fund certificates. [NIRC of 1997, Sec. 22 (L); RR No. 6-2008, Sec. 3
(c), numbering and arrangement for both supplied]
NOTES AND COMMENTS: The following tax treatment finds application irrespective of the nature and
character of the taxpayer, whether citizen, alien, resident or non-resident, the location of the shares of stock and
the place where sold. This is so because shares of stock in domestic corporations have obtained a business situs
in the Philippines.

BAR: (a) Shares listed and traded in the stock exchange. There
shall be levied, assessed and collected on every sale, barter or exchange or other disposition
of Shares of Stock Listed and Traded through the Local Stock Exchange other than the sale by
a dealer of securities under the following rules:
1) Tax Rate. - A stock transaction tax at the rate of one-half of one percent
(1/2 of 1%) based on the amount determined in subsection (b) hereunder.
2) Tax Base - Gross selling price or gross value in money of the shares of
stock sold, bartered, exchanged or otherwise disposed of which shall be assumed and
paid by the seller or transferor through the remittance of the stock transaction tax by
the seller or transferor’s broker. [NIRC of 1997 , Sec. 127 (A); RR No. 6-2008, Sec. 5]
NOTES AND COMMENTS: The above tax is not an income tax categorized as a capital
gains tax but a percentage tax in the nature of a transaction tax. Thus, an exemption from
taxation does not include exemption from the payment of this percentage tax.

Mandatory Minimum Public Ownership (MPO). All publicly-listed companies

are required, at all times, to maintain a minimum percentage of listed securities held by the
public (or “public float”) of ten percent (10%) of the publicly-listed companies issued and
outstanding shares, exclusive of any treasury shares or whichever is the higher percentage as
may be prescribed by the Securities and Exchange Commission (SEC) or the Philippine Stock
Exchange (PSE), to be referred to as the MPO. (RR No. 16-2012, Section 1, A, 1st and 2nd pars.)

Tax treatment of sales, barters, exchanges or other disposition of

shares of stock of a publicly-listed company that is non-compliant with the
MPO.
1) Transacted up to December 31, 2012, still subject to the transaction
tax. (RR No. 16-2012, Section 2, A)
2) Transacted after December 31, 2012, subject to tax as if it was not
listed and traded in the stock exchange. (Ibid., Section 2, B)

BAR: (b) Shares not listed and traded in the stock exchange .
Without applying the holding period, a final tax at the rates prescribed below is hereby imposed
upon the net capital gains realized during the taxable year from the sale, barter, exchange or
other disposition of shares of stock in a domestic corporation:
 20

Not over P100,000 ………………………………… 5%

On any amount in excess of P100,000…………... 10% [ NIRC of 1997, Sec. 24 (C); RR
No. 6-2008, Sec. 7 (a), paraphrasing supplied]
NOTES AND COMMENTS: The tax is imposed on the net capital gain which is arrived at by
deducting the cost basis from the realized proceeds of the sale. Sales price less cost basis or acquisition
price = tax base.

Tax treatment of cancellation or redemption of stock dividends.

1) If a corporation cancels or redeems stock issued as a dividend
2) at such time and in such manner as to
3) make the distribution and cancellation or redemption
4) the amount so distributed in redemption or cancellation of the stock
5) shall be considered as taxable income
6) to the extent that it represents a distribution of earnings or profits.
[NIRC of 1997, Sec. 73 (B), 2nd sentence, arrangement and numbering supplied]

Three conflicting tax treatments relative to the taxation of the taxable

income resulting from the cancellation of redemption of stock dividends .
The first tax treatment is that found under Sec. 73 (B), NIRC of 1997, which
posits that the extent of the amounts distributed in redemption or cancellation of the
stock should be considered as taxable income to the extent that it represents a
distribution of earnings or profits. It is clear that the income tax referred to is a tax that
falls under Title II, Tax on Income, of the NIRC of 1997. This may constitute income
reportable as part of the income tax return or subject to final tax on income.
On the other hand, where the shareholder surrenders his shares to the
corporation as a result of cancellation or redemption, that may be considered as “sale,
barter, exchange or other disposition of shares of stock in a domestic corporation”, not
through the stock exchange, subject to the passive income tax which is a final tax
under Secs. 24 (C); 25 (A) (3); 25 (B); 27 (D) (2); Sec. 28 (A) (7) (c); and Sec. 28 (B)
(5) (c), all of the NIRC of 1997. This final tax is considered as a tax on income that
falls under Title II, Tax on Income, of the NIRC of 1997.
The third tax treatment, is that found under Sec. 127 of the Code which
imposes a final tax “on every sale, barter, exchange or other disposition of shares of
stock listed and traded through the local stock exchange other than the sale by a
dealer in securities”. [Sec. 127 (A), NIRC of 1997]
NOTES AND COMMENTS: Considering all the above statements, the author submits
that the tax treatment would be dependent upon the following factors:
1) The nature of the shares of stock being disposed of, whether the shares are
capital assets or ordinary assets;
2) Whether or not the shares of stock are listed and traded and listed in the stock
exchange.
The above tax treatment is recommended because of the phrase “or other disposition”
which could apply to cancellation or redemption.
Refer to the previous discussion on the tax treatment of the disposition of shares of
stock that are capital assets.

BAR: 9) Sale of principal residence. Conditional exemption in favor of natural

persons subject to the following requirements:
a) the sellers are natural persons,
b) the sale or disposition is of their principal residence
c) the proceeds of which is fully utilized in acquiring or constructing a new
principal residence
d) within eighteen (18) calendar months from the date of sale or disposition,
e) the historical cost or adjusted basis of the real property sold or disposed shall
be carried over to the new principal residence built or acquired:
 21

f) the BIR Commissioner shall have been duly notified by the taxpayer within
thirty (30) days from the date of sale or disposition through a prescribed return of his intention
to avail of the tax exemption;
g) the said tax exemption can only be availed of once every ten (10) years. [NIRC
of 1997, Sec. 24 (D) (2) , numbering and arrangement supplied]

Conditions for availment of the exemption from payment of capital gains

taxes. The general provisions of the code to the contrary notwithstanding, capital gains presumed to
have been realized from the sale, exchange or disposition by a natural person of his Principal
Residence shall not be imposed with six percent (6%) capital gains tax, subject to compliance with the
following:”
1) Escrow Agreement depositing in escrow the tax appertaining to the proceeds of
the disposition of the principal residence.
2) Capital Gains Tax Return.
3) Post Reporting Requirement showing compliance with the requirements for tax
exemption.
4) Release from the Escrow Agreement.
5) Limitation on Tax Exemption Privilege. [RR No. 13-99, as amended by RR No. 14-
2000, Sec. 3, arrangement and paraphrasing supplied]

Tax treatment if there is no full utilization by the natural person of the

proceeds of disposition. If there is no full utilization of the proceeds of sale, or disposition , the
portion of the gain presumed to have been realized from the sale or disposition shall be subject to
capital gains tax.
For this purpose, the gross selling price or fair market value at the time of sale, whichever is
higher, shall be multiplied by a fraction which the unutilized portion bears to the gross selling price in
order to determine the taxable portion and the presumed capital gains tax. [NIRC of 1997, Sec. 24 (D) (2)
numbering and arrangement supplied]

vi. Passive investment income. This is income from an activity in which the income
earner did not have any substantial material participation. For example interest income earned from bank
deposits and deposit substitutes.

a) Interest income. The compensation which is paid by the borrower of money to

the lender for its use, and generally by a debtor to his creditor in compensation for his detention of the
debt.

BAR: Tax treatment of interest income. Determine the nature of the interest income.
Is it passive income, such as interest earned from bank deposits and deposit substitutes subject to the
final tax OR is it income derived from the business activities of the income earner arising from trade or
business such as interest earned from lending money which should be reported in the income tax
return as ordinary income subject to the global or schedular system of taxation.

BAR: Members’ deposits with cooperative deposits of primary cooperatives

with federations are NOT currency bank deposits nor deposit substitutes. The
interests are not subject to withholding because they are exempt from final taxes. (Dumaguete Cathedral
Credit Cooperative v. Commissioner of Internal Revenue, G.R. No. 182722, January 22, 2010 reiterated in RMC
No. 47-2011)
NOTES AND COMMENTS: Reasons for the above conclusion. The BIR Ruling that cooperatives are
not required to withhold the corresponding ta on the interest from savings and time deposits of their members is an
interpretation of an administrative agency that is given great weight and consideration by the courts.
The aforesaid BIR Ruling is in keeping with the letter and spirit of the Constitution considering
cooperatives as instruments for social justice and economic development, the state policy to promote social justice
which includes the commitment to create economic opportunities based on freedom of initiatives and self reliance.
(Dumaguete, supra)
 22

BAR: Interest income from deposits under the Foreign Currency Deposit
(EFCD) System that are exempt from income tax. Interest earned from foreign currency
deposits of taxpayers that are not subject to tax on their incomes from without are exempt from the final
or other kinds of taxes. (RR No. 10-98) REASON: They are fruits of income from without hence also
incomes from without.
NOTES AND COMMENTS: If the foreign exchange earnings are converted to local currency the interest
income would then be taxable.

BAR: Deposit substitutes, defined. An alternative form of obtaining funds from the
public (the term 'public' means borrowing from twenty (20) or more individual or corporate lenders at
any one time) other than deposits, through the issuance, endorsement, or acceptance of debt
instruments for the borrowers own account, for the purpose of relending or purchasing of receivables
and other obligations, or financing their own needs or the needs of their agent or dealer. [NIRC of 1997,
Sec. 22 (Y), 1st sentence]
NOTES AND COMMENTS: The income are from deposit substitutes are subject to final tax if he income
earner is passive income but if the income is derived from being in the business of lending or relending money
then it is treated as ordinary income subject to regular income taxation.

Examples of deposit substitutes. These instruments may include, but need not be
limited to bankers' acceptances, promissory notes, repurchase agreements, including reverse
repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any
authorized agent bank, certificates of assignment or participation and similar instruments with recourse.
[NIRC of 1997, Sec. 22 (Y), 2nd sentence]
NOTES AND COMMENTS: debt instruments issued for interbank call loans with maturity of not more
than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among
banks and quasi-banks, shall not be considered as deposit substitute debt instruments. [NIRC of 1997, Sec. 22
(Y), 2nd sentence]]

The “19-Lender Rule.” In order for an instrument to qualify as a ‘deposit substitute’ the
borrowing must be made from twenty (20) or more individual or corporate lenders at any one time.
Corollarily, the mere flotation of a debt instrument is not considered to be a ‘public’ borrowing and is not
deemed a ‘deposit substitute’ if there are only nineteen (19) or less individual or corporate lenders at
any one time.
NOTES AND COMMENTS: However, any person holding any interest, whether legal or beneficial, on
a debt instrument or holding thereof either by assignment or participation, with or without recourse, shall be
considered as lender and thus, be counted in applying the 19-lender rule. (RR No. 14-2-12, Section 8)

b) Dividend income
1) Cash dividend
2) Stock dividend
BAR: Tax treatment of stock dividends. Stock dividends are unrealized gain
and cannot be subject to income tax until the gains have been realized. Stock dividends
represent capital and do not constitute income to its recipient. The mere issuance thereof is
not subject to income tax as they are nothing but an “enrichment through increase in value of
capital investment.”
As capital, stock dividends postpone the realization of profits because the “fund
represented by the new stock has been transferred from surplus to capital and no longer
available for actual distribution.”
Before realization, stock dividends are nothing but a representation of an interest in the
corporate properties. As capital, it is not yet subject to income tax. (Commissioner of Internal
Revenue v. Court of Appeals, et al., G.R. No. 108576, January 20, 1999)

3) Property dividend
 23

BAR: Property dividend may be subject to VAT. Distribution or transfer,

of property held for sale and ordinarily subject to VAT, to shareholders or investors as share in
the profits of a VAT- registered person [NIRC of 1997, Sec. 106 (B) (2) (a)] shall be subject to VAT.

4) Liquidating dividend
c) Royalty income. The compensation for the use of a patented invention [Universal
Food Corporation v. Court of Appeals, 33 SCRA 11 (1970)]

BAR: Tax treatment of royalty income for inviduals. A final tax at the rate of twenty
percent (20%) is hereby imposed upon the amount of royalties, except on books, as well as other
literary works and musical compositions, which shall be imposed a final tax of ten percent (10%).
[NIRC of 1997, Sec. 24 (B) (1), paraphrasing supplied]
NOTES AND COMMENTS: For corporations, the tax rate is also 20% without any distinction as to
royalties. [NIRC of 1997, Sec. 27 ((D) (1); Sec. 28 (7) (a)] Thus, even books and other literary works and musical
compositions shall be subject to the 20% tax.
Likewise, prizes, and other winnings (except Philippine Charity Sweepstakes and Lotto winnings) of
corporations are not subject to the final tax but included as part of their ordinary income.

d) Rental income. The amount paid for use of property in which the payor does not
intend to take ownership.

1) Lease of personal property

BAR: Tax treatment of lease payments. Be sure that you are able to
distinguish between a “true lease” and a “conditional sale.” If it is a true lease then the lessee
may deduct the rental payments as expenses and the lessor recognizes income from the lease
payments from which he may deduct depreciation of the leased property.
If it is a conditional sale, then the lessee may not be allowed to deduct the payments as
rental expense because the payments are treated as capital expenditures but he may subject
the property “leased” to depreciation. On the other hand the lessor recognizes the payments
as income but he may deduct the cost of the property sold from his income and not
depreciation.

Compelling persuasive factors for considering a lease as a conditional

sale. A contract or agreement purported to be a lease shall be treated as conditional sales
contract if one or more of the following compelling persuasive factors are present:
1) The lessee is given the option to purchase the asset at any time during the
obligatory period of the lease, notwithstanding that the option price is equivalent to or higher
than the current fair market value of the asset;
2) The lease acquires automatic ownership of the asset upon payment of the
stated amount of “rentals” which under the contract he is required to make;
3) Portions of the periodic rental payments are credited to the purchase price of
the asset;
4) The receipts of payment indicate that the payments made were partial or full
payments of the asset. (RR No. 19-86, Sec. 4.03/2)

Conditions that may indicate intent to consider the lease a conditional

sale even in the absence of compelling persuasive factors. In the absence of the
above compelling persuasive factors or contrary implication, an intent warranting treatment of a
transaction for tax purposes as a purchase and sale rather than as a lease or rental
agreement, may in general be said to exist if, for example, one or more of the following
conditions are present:
1) Portions of the periodic payments are made specifically applicable to an equity
to be acquired by the lessee.
 24

2) The property may be acquired under a purchase option, at a price which is

nominal in relation to the value of the property at the time when the option may be exercised,
as determined at the time of entering into the original agreement, or which is a relatively small
amount when compared with the total payments which are required to be made. (RR No. 19-86,
Sec. 4.03/3, numbering supplied)
2) Lease of real property. Income treated as ordinary income reportable
in the income tax return and not subject to final tax.

3) Tax treatment of
(a) Leasehold improvements by lessee
BAR: Methods for income recognition where ownership of
improvements constructed by the lessees is transferred to the lessor
after the lease period. If improvements are in lieu of rent, the value is income to
the landlord upon completion of the improvements.
If the improvements are not in lieu of rents, the value thereof is income to the
landlord only in the year of termination of the lease. (Bkatt v. U.S., 305 U.S. 267, and
Helvering v. Brunn, 309 U.S. 461)

(b) VAT added to rental/paid by the lessee.

(c) Advance rental/long term lease. Amounts received in
advance are not treated as revenue of the period in which they are received but as
revenue of the future period or periods in which they are earned. These amounts are
carried as unearned revenue, that is liabilities to transfer goods or render services in
the future – until the earning process is complete. (Manila Mandarin Hotels, Inc. v. The
Commissioner of Internal Revenue, CTA Case No. 5046, March 24, 1997)

vii. Annuities, proceeds from life insurance or other types of insurance . Not
subject to final tax considered as ordinary income unless excluded from gross income.

viii. Prizes and awards. Generally considered as income subject to final tax unless it is
among those excluded from gross income or does not exceed P10,000.00 in which case it is included in the
income tax return subject to ordinary income taxation.

ix. Pensions, retirement benefit, or separation pay. If not excluded from gross
income reported in the income tax return subject to ordinary income taxation.

x. Income from any source whatever. All income not expressly excluded or
exempted from the class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in
producing the income. (Gutierrez v. Collector of Internal Revenue, CTA Case No. 65, August 31, 1965)
The source of the income may be legal or illegal. It may likewise include amounts of indebtedness that
are forgiven, recovered accounts previously written-off or taxes previously deducted from gross income but
subsequently refunded.

BAR: a) Forgiveness of indebtedness.

1) When cancellation of debt is income. If an individual performs services for a
creditor, who in consideration thereof, cancels the debt, it is income to the extent of the
amount realized by the debtor as compensation for his services.
2) When the cancellation of debt is a gift. If a creditor merely desires to benefit a
debtor and without any consideration therefore cancels the amount of the debt is a gift from the
creditor to the debtor and need not be included in the latter’s income.
3) When cancellation of debt is a capital transaction. If a corporation to which a
stockholder is indebted forgives the debt, the transaction has the effect of payment of a
dividend. (RR No. 2, Sec. 50)
 25

4) An insolvent debtor does not realize taxable income from the cancellation or
forgiveness. (Commissioner v. Simmons Gin Co., 43 F2d 327 CCA 10th)
5) The insolvent debtor realizes income resulting from the cancellation or
forgiveness of indebtedness when he becomes solvent. [Lakeland Grocery Co. v. Commissioner,
36 BTA (F) 289]

BAR: b) Recovery of accounts previously written-off – when

taxable/when not taxable. Under the “tax benefit rule” bad debts that were previously written
off and deducted from gross income but subsequently paid are “recaptured” and included as part of the
income in the year in which they were subsequently paid. They thus become taxable. This is only
applicable where the debts arose out of trade or business such as trade receivables, or amounts lent.
However, if they were not personal loans that had no relation at all to trade or business, hence
could not be deducted from gross income if not paid, then the subsequent payment does not result to
income.

BAR: c) Receipt of tax refunds or credit. Taxes incurred in connection with

trade or business are generally deductible from gross income to arrive at income subject to tax.
However, under the “tax benefit” or ”recapture” rule, the amount of taxes previously deducted but are
subsequently refunded or allowed as a tax credit to the taxpayer who made the deduction, are then
considered as income in the period refunded or credited.

d) Income from any source whatever

BAR: e) Source rules in determining income from within and
without. As a general rule, the determinative factor for the “source rule” (the place where the income
was earned) is the place where the income earning activity took place. This means that if the income
earning activity took place in the Philippines then it is income derived from sources within the
Philippines. On the other hand if the income earning activity took place outside of the Philippines, then
it is income derived from sources without the Philippines.
The rationale behind the source rule is the symbiotic relationship or the benefit-protection
theory. The place where the income earning activity has the jurisdiction to impose the tax because it is
the one that gives protection to the activity.
The source rule is important because some taxpayers are subject to taxation both on their
incomes from within and without while others are to be taxed only on their incomes from within and
those from without. For detailed discussion refer to general principles of income taxation, page 7,
supra.
1) Interests
2) Dividends
BAR: Dividends considered as gross income from sources WITHIN the
Philippines. The amount received as dividends:
1) from a domestic corporation
2) from a foreign corporation
a) MORE than fifty percent (50%) of the gross income of such foreign
corporation
b) for the three-year period ending with the close of its taxable year
preceding the declaration of such dividends (or for such part of such period as the
corporation has been in existence)
c) was derived from sources within the Philippines as determined under
these provisions
d) but only in an amount which bears the same ratio to such dividends as
the gross income of the corporation for such period derived from sources within the
Philippines
 26

e) bears to its gross income from all sources. [NIRC of 1997, Sec. 42 (A) (2)
(a), (b), numbering and arrangement supplied]
NOTES AND COMMENTS: All dividends other than the above are dividends derived
from sources without the Philippines.
Dividends received by a domestic corporation from another domestic corporation are
not subject to tax.

BAR: 3) Services. Compensation for labor or personal services

performed in the Philippines [NIRC of 1997, Sec. 42 (A) (3)] are considered as income derived
from sources within the Philippines.
This is irrespective of the origin of the money, where the service was performed, the
nationality of the income earner, the nature of the personal service performed, etc.
If the service is performed outside of the Philippines, then the compensation is income
derived from services without the Philippines.

4) Rentals
5) Royalties
6) Sale of real property. Gains, profits and income from the sale of real
property located in the Philippines [NIRC of 1997, Sec. 42 (A) (5) ] are considered from within the
Philippines.
If the real property is located outside of the Philippines, then the proceeds are
considered as derived from sources without the Philippines.

BAR: 7) Sale of personal property. If the contract for the sale of

personal property was consummated in the Philippines, then the proceeds are considered as
income derived from sources within the Philippines. [NIRC of 1997, Sec. 42 (E), 4th pars., in
relation to Sec. 42 (A) (6)]
This is irrespective of the residence and nationality of the buyer and the seller, the
source of the money, where the personal property sold was originally purchased, the place of
delivery and place of payment. (Ibid.)
It follows that if the contract was signed outside of the Philippines, that the income
would from sources derived without the Philippines.

BAR: 8) Shares of stock of domestic corporation. The proceeds

of sales of shares of stock of domestic corporations are always considered as from sources
within the Philippines. [NIRC of 1997, Sec. 42 (E), 4th pars., in relation to Sec. 42 (A) (6)]
This is irrespective of the place where the sale was consummated. residence and
nationality of the buyer and the seller, the source of the money, where the personal property
sold was originally purchased, the place of delivery and place of payment. (Ibid.)
Shares of stock of domestic corporations have obtained a business situs in the
Philippines.

f) Situs of income taxation (see discussion under inherent limitations,

territorial of CUT AND PASTE GENERAL PRINCIPLES and other tax laws)

g) Exclusions from gross income . Exclusions from gross income under the
National Internal Revenue Code of 1997.
1) Life Insurance proceeds.
2) Amount received by insured as return of premium.
3) Gifts, bequest and devises.
4) Compensation for injuries or sickness.
5) Income exempt under treaty.
6) Retirement benefits, pensions; gratuities, etc.
 27

7) Miscellaneous Items:
a) Income derived by foreign government.
b) Income derived by the government or its political subdivisions.
c) Prizes and awards.
d) Prizes and awards in sports competitions.
e) 13th month pay and other benefits.
f) GSIS, SSS, Medicare and other contributions.
g) Gains from the sale of bonds, debentures or other certificate of
indebtedness.
h) Gains from redemption of shares in mutual fund. [NIRC of 1997, Sec. 32
(B)]
1) Rationale for the exclusions. Some receipts are excluded from gross
income because they are not income.
Even if they are by definition income, the exclusions are not subject to tax because of
policy considerations such as to avoid the effects of double taxation, or to provide incentives for
certain socially desirable activities.

2) Taxpayers who may avail of the exclusions

3) Exclusions distinguished from deductions and tax credit
a) Exclusions are amounts that are not included in gross income;
deductions are amounts subtracted from pertinent items of gross income in order to
arrive at taxable income upon which the tax rate is applied, tax credits are amounts
subtracted from the computed tax in order to arrive at taxes payable.
b) Exclusions are not income; deductions are part of income; tax
credits are taxes that are not collected.

4) Under the Constitution

(a) Income derived by the government or its political
subdivisions from the exercise of any essential governmental
function
5) Under the Tax Code
(a) Proceeds of life insurance policies
BAR: Conditions for exclusion from gross income of life
insurance proceeds.
1) The proceeds of life insurance policies
2) paid to the heirs or beneficiaries
3) upon the death of the insured,
4) whether in a single sum or otherwise. [NIRC of 1997, Sec. 32 (B)
(1) paraphrasing, arrangement and numbering supplied]
NOTES AND COMMENTS: The reader should note that the revocability or irrevocability
of the designation of the beneficiary is not among the conditions. Whether the beneficiary is
designated in a revocable or irrevocable capacity does not matter. The life insurance proceeds
are still excluded from gross estate.

Reasons for the exclusion:

1) Proceeds of life insurance are excluded from gross income
because they partake more of indemnity or compensation rather than gain to
the recipient. (RR No. 2, Sec. 62)
2) Life insurance proceeds serve the same purpose as
nontaxable inheritance.
 28

(b) Return of premium paid

Conditions for amounts received by insured as return of
premiums to be excluded from gross income.
1) The amount received by the insured,
2) as a return of premiums paid by him
3) under life insurance, endowment or annuity contracts,
4) either
a) during the term, or
b) at maturity of the term mentioned in the contract, or
c) upon surrender of the contract. [NIRC of 1997, Sec. 32
(B) (2), arrangement and numbering supplied]

Reason for the exclusion . The amount returned are not income but return
of capital. They represent earnings which were previously taxed.
NOTES AND COMMENTS: The premiums are excluded but the amounts received
exceeding the premiums paid are subject to tax being a return from the use of money (the
premiums paid).

(c) Amounts received under life insurance, endowment

or annuity contracts
(d) Value of property acquired by gift, bequest, devise or
descent
BAR: (e) Amount received through accident or health
insurance. Excluded from gross income are
1) Amounts received, through
a) Accident or Health Insurance or
b) Workmen’s Compensation Acts,
2) as compensation for personal injuries or sickness,
3) plus the amounts of any damages received,
a) by suit or
b) agreement,
4) on account of such injuries or sickness. [NIRC of 1997, Sec. 32
(B) (4), arrangement and numbering supplied)]

Reason for exclusion of damages. They are mere compensation for

injuries or sickness suffered and not income.
The legal theory of personal injury damages is that the amount received is
intended “to make the plaintiff (the injured party) whole as before the injury.” [C.A.
Hawkins, 6 B.T.A. 1023 (1923)]
There is need to exclude the compensation so as to restore the injured party
whole as before the injury. To include the compensation for injuries or sickness
suffered in gross income would be reducing the restoration of “the plaintiff (the injured
party) whole as before the injury,”

(f) Income exempt under tax treaty

(g) Retirement benefits, pensions, gratuities, etc.
Retirement benefits, gratuities, pensions, etc, that are excluded from gross income are
the following:
1) Retirement benefits received under Republic Act No. 7641,
provided the age and years of service requirements are met.
 29

2) Retirement received from reasonable private benefit plan after

compliance with certain conditions such as the age and years of service
requirements.
3) Amounts received for beyond control separation which does
not require any age and years of service requirements.
4) Foreign social security, retirement gratuities, pensions, etc,,
which do not require any minimum age and years of service.
5) USVA benefits which do not require compliance with any
minimum age and years of service.
6) SSS benefits which require only compliance with the requisites
for retirement under the enabling law.
7) GSIS benefits which require only compliance with the
requisites for retirement under the enabling law. [NIRC of 1997, Sec. 32 (B) (6),
numbering supplied]

BAR: Summary of requirements for exclusion of retirement

benefits, pensions, gratuities, etc. to be excluded from gross income
The following requirements must all be complied with in order to avail of the exclusion
from gross income:
1) Qualified employee. The retiree must
a) have rendered at least ten (10) years service with the employer
from which he is retiring;
b) not less than fifty (50) years at the time of the retirement;
2) Qualified funding source. The retirement must be in accordance with a
reasonable private retirement plan maintained by the employer OR the retirement is in
accordance with Rep. Act No. 7641, which provides for the optional and mandatory
retirement to employees in the private sector.
3) The retiree must have never enjoyed the benefit of exclusion of any
retirement payment received in the past.
NOTES AND COMMENTS: It does not matter whether the retirement is voluntary as
long as the requirements are met, the retirement proceeds are excluded from gross income.
If the retirement is compulsory, there is no need to comply with the above requirements
before the retirement benefits would be excluded because the same would be excluded under
the concept of amounts received as a result of separation beyond control.

Separation pay excluded from gross income.

1) Any amount received by an official, employee or by his heirs;
2) from the employer
3) as a consequence of separation of such official or employee from the
service of the employer:
a) because of death, sickness or other physical disability; or
b) for any cause beyond the control of the said official or
employee [NIRC of 1997, Sec. 32 (B) (6) (b), arrangement and numbering supplied],
such as
(1) retrenchment,
(2) redundancy and
(3) cessation of business. [RR 2-98, Sec. 2(b) (2),
arrangement and numbering supplied]
NOTES AND COMMENTS: The separation of the official or employee must be
compelled. In short, he did not voluntarily seek his separation.
There is no requirement to comply with the age and term of service
requirement nor of the funding source.

The money value of the accumulated leave credits/terminal leaves

given to a retiring government official or employee is not subject to tax.
Reasons :
 30

1) Terminal leave pay is applied for by an employee who is no longer

working, it is no longer compensation for services rendered, hence, not subject to
income tax;
2) Terminal leave pay is applied for by an employee who retires, resigns
or is separated from the service through “no fault of his own;”
3) Compulsory retirement may be considered as a “cause beyond the
control of the retiring employee,” which falls within the enumerated exclusions;
4) Terminal leave pay may likewise be viewed as a “retirement gratuity
received by government employees” which falls within the enumerated exclusions .
(Borromeo v. Civil Service Commission, 199 SCRA 911; Commissioner of Internal Revenue v.
Court of Appeals, et al., 203 SCRA 72)

Pensions, and gratuities from foreign sources that are excluded from
gross income.
1) The provisions of any existing law to the contrary notwithstanding,
social security benefits, retirement gratuities, pensions and other similar benefits
a) received by resident or non-resident citizens of the
Philippines or aliens
b) who come to reside permanently in the Philippines
c) from foreign government agencies and other institutions,
private or public. [NIRC of 1997, Sec. 32 (B) (6) (c), arrangement and numbering
supplied]
2) Payments of benefits due or to become due to
a) any person residing in the Philippines
b) under the laws of the United States administered by the United
States Veterans Administration. [Ibid., Sec. 32 (B) (6) (c))
NOTES AND COMMENTS: It would appear from the above that there is no need to
comply with the ten (10) year length of service, the age requirement of not less than fifty (50)
years at the time of retirement and not having previously enjoyed the exclusion of retirement
benefits.

(h) Winnings, prizes, and awards, including those in

sports competition
Requisites to be met before prizes and awards are excluded from
gross income. Prizes and awards made primarily in recognition of religious, charitable,
scientific, educational, artistic, literary, or civic achievement but only if:
1) the recipient was selected without any action on his part to enter the
contest or proceeding.
2) The recipient is not required to render substantial future services as a
condition to receiving the prize or award. [NIRC of 1997, Sec. 32 (B) (7) (c), arrangement
and numbering supplied]

Requisites for the exclusion from gross income of prizes and awards in
sports competition: All prizes and awards
1) granted to athletes
2) in local and international sports tournaments and competitions
3) whether held in the Philippines or abroad, and
4) sanctioned by their national sports associations. [NIRC of 1997, Sec.
32 (B) (7) (d), arrangement and numbering supplied]

6) Under special laws

(a) Personal Equity and Retirement Account
 31

Income tax exemption of the PERA Investment Income .

Investment income of the contributor consisting of all income earned from the
investments and reinvestments of his PERA assets in the maximum amount allowed
herein shall be exempt from the following taxes as may be applicable:
1) The final withholding tax on interest from any currency bank
deposit, yield or any other monetary benefit from deposit substitutes and from
trust funds and similar arrangements, including a depository bank under the
expanded foreign currency deposit system;
2) The capital gains tax on the sale, exchange, retirement or
maturity of bonds, debentures or other certificates of indebtedness;
3) The 10% tax on cash and/or property dividends actually or
constructively received from a domestic corporation, including a mutual fund
company;
4) The capital gains tax on the sale, barter, exchange or other
disposition of shares of stock in a domestic corporation;
5) Regular income tax.
Provided, that each specific investment products must be approved by
the concerned Regulatory Authority in accordance with the provisions of PERA
before its income or distribution can be granted tax incentives and privileges
herein provided. (RR No. 17-2011, Sec. 9)

No exemption from non-income taxes. Non-income taxes, if

applicable, relating to the above investment income of the PERA Account of a
contributor, shall remain imposable, including the following:
1) Percentage taxes on persons exempt from value-added tax,
domestic carriers and keepers of garages, international carriers, franchise
holders, overseas dispatch, message or conversation originating from the
Philippines, banks and non-bank financial intermediaries performing quasi-
banking functions, other non-bank finance intermediaries, life insurance
premiums, agents of foreign insurance companies, amusement, and winnings;
2) Value-added tax;
3) Stock transaction tax on the sale, barter, or exchange of shares
of stock listed and traded through the local stock exchange or through initial
public offerings; and
4) Documentary stamp tax. (RR No. 17-2011, Sec. 9)

h) Deductions from gross income

Deductions allowed under the National Internal Revenue Code, in general.
1) Optional standard deduction. [NIRC of 1997, as amended by Rep. Act No.
9504, Sec. 34 (L)]
2) Itemized deductions. [Ibid., Sec. 34 (A) to (K) and (M)]
3) Personal and additional exemptions. ( Ibid., Sec. 35, as amended by Rep. Act No.
9504)
4) Extraordinary deductions
a) Those allowed to insurance companies. (Ibid., Sec. 37)
b) Deductions allowed to estates and trusts availing of itemized
deductions of income currently distributed to beneficiaries. (Ibid., Sec. 61)
c) Losses from wash sales of stocks or securities. (Ibid., Sec. 38)
d) Certain capital losses but only from capital gains. (Ibid., Sec. 39)
e) Deductions allowed to private educational institutions. [Ibid., Sec. 34 (A)
(2)]

1) General rules
BAR: Requisites before deductions are allowed.
 32

1) There must be a specific provision of law allowing the deductions,

since deductions do not exist by implication. (Atlas Consolidated Mining and Development
Corporation v. Commissioner of Internal Revenue, L-26911, January 27, 1981 and
Commissioner of Internal Revenue v. Atlas Consolidated Mining and Development Corporation,
et al., 102 SCRA 246);
2) The requirements of deductibility for each specific deduction must be
met;
3) There must be proof of entitlement to the deductions (Atlas
Consolidated, supra; Paper Industries Corporation of the Philippines v. Court of Appeals, et al .,
250 SCRA 434);
4) The deductions must not have been waived (RR No. 2, Sec. 76);
5) The withholding and payment of the tax required must be shown [NIRC
of 1997, Sec. 34 (K), Secs. 58 and 81].

(a) Deductions must be paid or incurred in connection

with the taxpayer’s trade, business or profession
BAR: Matching concept for deductibility . The matching concept for
deductibility posits that the deductions must, as a general rule, “match” the income, i.e. helped
earn the income.
Thus, the requisite that the ordinary and necessary expense that is being deducted
must have been paid or accrued or paid or incurred during the taxable year. Consequently, a
taxpayer who is authorized to deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the next year. (Commissioner of
Internal Revenue v. Isabela Cultural Corporation, G. R. No. 172231, February 12, 2007)

BAR: (b) Deductions must be supported by adequate

receipts or invoices (except standard deduction). This is known as
the substantiation rule or substantiation requirement. The taxpayer shall substantiate
the expense being deducted with sufficient evidence, such as official receipts or other
adequate records by showing:
1) The amount of the expense being deducted; and
2) 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. [NIRC of 1997, Sec. 34 (A) {1} (b),
arrangement and numbering supplied]
Unless provided, substantiation, i.e.
1) Receipts or adequate records;
2) amount of expense;
3) date and place of expense;
4) purpose of expense.
5) Professional or business relationship of expense
a) must support each claimed business or professional
expense;
b) otherwise it shall be disallowed. (RAMO No. 1-87, No. 1,
last sentence, arrangement and numbering supplied)

(c) Additional requirement relating to withholding

BAR: Where no withholding made but still deductible. A deduction
will also be allowed in the following cases where no withholding tax was made:
1) The payee reported the income and pays the income due
thereon and the withholding agent pays the tax including the interest incident to
the failure to withhold the tax, and surcharges, if applicable, at the time of the
audit investigation or reinvestigation/reconsideration.
 33

2) The recipient/payee failed to report the income on the due date

thereof, but the withholding agent/taxpayer pays the tax, including the interest
incident to the failure to withhold the tax, and surcharges, if applicable, at the
time of the audit/investigation or reinvestigation/reconsideration.
3) The withholding agent erroneously underwithheld the tax, but
pays the difference between the correct amount and the amount of tax
withheld, including the interest, incident to such error, and surcharges, if
applicable at the time of the audit/investigation or reinvestigation/
reconsideration. (RR No. 2-98, Sec. 2.58.5, 2nd par., as amended by RR. No. 14-
2002, numbering supplied)

2) Return of capital (cost of sales or services)

(a) Sale of inventory of goods by manufacturers and
dealers of properties
(b) Sale of stock in trade by a real estate dealer and
dealer in securities
(c) Sale of services

3) Itemized deductions
(a) Expenses. There shall be allowed as deduction from gross
income
(1) all the ordinary and necessary expenses
2) paid or incurred during the taxable year
3) in carrying on or which are directly attributable to, the
a) development,
b) management,
c) operation and/or
d) conduct
(1) of the trade, business or exercise of a
profession. [NIRC of 1997, Sec. 34 (A) (1) (a)]

(1) Requisites for deductibility

BAR: Requisites for deductibility of business expense.
1) It must be paid or incurred within the taxable year;
2) The expense must be ordinary and necessary;
3) It must meet the business test rule and be paid or
incurred in carrying on a trade or business;
4) The substantiation rule must be complied through
substantially proving by evidence or records the deductions claimed
under the law. Otherwise, the same will be disallowed. The mere
allegation of the taxpayer that an item of expense is ordinary and
necessary does not justify its deduction . (Atlas Consolidated Mining and
Development Corporation, v. Commissioner of Internal Revenue, 102 SCRA
246; Esso Standard Eastern, Inc. v. Commissioner of Internal Revenue, 175
SCRA 149)
5) The business expense must not be an illegal
expenditure, such as bribes, kickbacks, for immoral purposes , etc.
NOTES AND COMMENTS: The above are more familiarly known as
the conditions for deductibility of business expense. The reader should note
that aside from the above, the business expense must still comply with the
requisites for deductibility in general.
 34

(a) Nature: ordinary and necessary

BAR: Ordinary expenses . These are the expenses
which are common to incur in the trade or business of the taxpayer as
distinguished from capital expenditures. These are usually incurred
during taxable year and benefits such taxable year.
The term ”ordinary expenses” as used in income taxation is
taken in its common significance and it has the connotation of being
normal, usual or customary (Deputy v. Du Pont, 308 U.S. 488) expenses in
earning the income that is subject to the tax.

BAR: Necessary expense for tax purposes,

defined . Expenses which are appropriate or helpful to development of
the taxpayer’s business. (Atlas Consolidated Mining and Development
Corporation v. Commissioner of Internal Revenue, 102 SCRA 246; Alhambra
Cigar & Cigarette Manufacturing Co., v. Collector of Internal Revenue, 105 Phil.
1337)
An expense is necessary if the taxpayer subjectively believes it
may lead to an economic benefit. (Welch v. Helvering, 290 U.S. 111)

(b) Paid and incurred during taxable year

(2) Salaries, wages and other forms of
compensation for personal services actually rendered,
including the grossed-up monetary value of the fringe
benefit subjected to fringe benefit tax which tax should
have been paid
Requisites for deductibility of salaries and wages and
other forms of compensation: A reasonable allowance for salaries,
wages and other forms of compensation for personal services actually
rendered,
1) Including the grossed-up monetary value of fringe
benefit furnished or granted by the employer to the employee;
2) Provided, That the final tax imposed on such
grossed-up monetary value of the fringe benefit has been paid. [NIRC
of 1997, Sec. 34 (A) (1) (a) (I), in relation to Sec. 33]

BAR: Requisites for bonus to employees to be

deductible by the employer as business expense.
1) The payment of the bonus is made in good faith for
additional compensation.
2) It must be for personal services actually rendered.
3) The bonus when added to salaries is “reasonable when
measured by the amount and quality of the services performed with
relation to the business of the particular taxpayer ,” (Kuenzle & Streiff, Inc.
v. Collector, 106 Phil. 355; C.M. Hoskins & Co., Inc. v. Commissioner, 30
SCRA 434) and when added to the stipulated salaries do not exceed a
reasonable compensation for services rendered .
NOTES AND COMMENTS: In C.M. Hoskins, & Co., Inc., Hoskins
owned 99.6% of the stock, he being the chairman when the resolution
authorizing the bonus was passed. The Supreme Court held, “Having chosen
to use the corporate form with its advantages of a separate corporate
personality as distinguished from his individual personality, the corporation so
erected, i.e. petitioner, is bound to comport itself in accordance with its
 35

corporate obligations. Specifically, it is bound to pay the income tax imposed

by law on corporations and may not be legally permitted, by way of corporate
resolution authorizing payment of inordinately large allowances and fees to its
controlling stockholder, to dilute and diminish its corresponding corporate tax
liability .”

BAR: Alternative factors to be considered in the

determination of deductibility of bonus as business expense.
1) Payment must be in good faith;
2) the character of the taxpayer’s business;
a) the volume and amount of net earnings;
b) its locality;
c) the type and extent of the services
rendered;
d) the taxpayer’s salary policy;
3) the size of the particular business;
4) the employee’s qualifications and contributions to the
business venture; and
5) General economic conditions.
Ordinarily, it is the interplay of several factors, properly weighted for the
particular case which would determine the deductibility of the bonus. (Kuenzle &
Streiff, Inc. v. Collector, 106 Phil. 355, citing Mertens)

(3) Travelling/transportation expenses

Requisites for deductibility of travelling expenses as
ordinary and necessary expenses.
1) A reasonable and necessary allowance for traveling
expenses,
2) for traveling expenses here and abroad,
a 3) while away from home,
4) in the pursuit of trade, business or profession [NIRC of
1997, Sec. 24 (A) (1) (a) (ii), arrangement and numbering supplied]

(4) Cost of materials

Cost of materials deductible as expense. Taxpayers
carrying materials and supplies on hand
1) should include in expenses the charges for materials
and supplies
2) only to the extent that
a) they are actually consumed and used in
operations
b) during the year
c) for which the return is made
3) provided that the cost of such materials and supplies
a) have not been deducted in determining the net
income for any previous year. (RR No. 2, Sec. 68, arrangement
and numbering supplied)

(5) Rentals and/or other payments for use or

possession of property. Refer to page 23, supra.
(6) Repairs and maintenance
 36

Incidental or ordinary repairs deductible as expense,

defined.
1) The cost of incidental repairs which
a) neither materially add to the value of the
property
b) nor appreciably prolong its life, but keep it in an
ordinary efficient operating condition
2) may be deducted as expenses,
3) provided the plant or property account
a) is not increased by the amount of such
expenditures
Repairs
1) in the nature of replacements,
2) to the extent that they arrest deterioration and
appreciably prolong the life of the property
3) should be charged against the depreciation reserve if
such account is kept. (RR No. 2, Sec. 68, arrangement and numbering
supplied)

(7) Expenses under lease agreements. Refer to page

23, supra.

(8) Expenses for professionals. Requisites for the

deductibility of ordinary and necessary trade, business, or professional expenses,
like expenses paid for legal and auditing services.
a. The expense must be ordinary and necessary.
b. It must have been paid or incurred during the taxable
year dependent upon the method of accounting upon the basis of which
the net income is computed.
c. It must be supported by receipts, records or other
pertinent papers. (Commissioner of Internal Revenue v, Isabela Cultural
Corporation, G. R. No. 172231, February 12, 2007)

(9) Entertainment/Representation expenses

Summary outline of deductible entertainment expenses. A
reasonable allowance for entertainment, amusement and recreation expenses,
1) during the taxable year,
2) that are directly connected to the development,
management and operation of the trade, business or profession of the
taxpayer, or
3) that are directly related to or in furtherance of the
conduct of his or its trade, business or profession,
4) not to exceed such ceilings as the Secretary of Finance
may, by rules and regulations prescribe, upon recommendation of the
Commissioner of Internal Revenue,
5) taking into account the needs as well as the special
circumstances, nature and character of the industry, trade, business or
profession of the taxpayer;
6) 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. [NIRC of 1997,
Sec. 34 (A) (1) (a) (iv), arrangement and numbering supplied)
 37

Requisites of deductibility of “Entertainment, Amusement

and Recreation Expenses.”
1) It must be paid or incurred during the taxable year.
2) It must be
a) directly connected to the development,
management and operation of the trade, business or
profession of the taxpayer, or
b) directly related to or in furtherance of the
conduct of its trade, business or exercise of a profession.
3) It must not be contrary to law, morals, good customs,
public policy or public order.
4) It must not have been paid, directly or indirectly, to an
official or employee of the national government, or any local
government unit, or of any government-owned or controlled corporation
(GOCC), or of a foreign government, or to a private individual, or
corporation, or general professional partnership (GPP), or a similar
entity, if it constitutes a bribe, kickback or other similar payment.
5) It must be duly substantiated by adequate proof. The
official receipts, or invoices, or bills or statements of accounts should
be in the name of the taxpayer claiming the deduction.
6) The appropriate amount of withholding tax, if
applicable, should have withheld therefrom and paid to the Bureau of
Internal Revenue. (RR No. 10-2002, Sec. 4)
7) It must not exceed the ceilings provided for by the
Secretary of Finance upon recommendation of the Commissioner.

BAR: Three (3) kinds of advertising and their

deductibility.
1) Advertising to stimulate the current sale of
merchandise or use of services.
Except as to questions of reasonableness of amount, these
are deductible as business expenses. (General Foods,(Philippines), Inc. v..
Commissioner of Internal Revenue, CTA Case No. 4386, February 8, 1994,
emphasis supplied)
2) Advertising designed to stimulate the future sale of
merchandise or use of services. This involves expenditures incurred,
in whole or in part, to create or maintain some form of goodwill for the
taxpayer’s trade or business of which the taxpayer is a member.
These expenditures are not deductible as expense but instead
to be spread over a reasonable period of time, irrespective of whether
the taxpayer is on the cash or accrual basis. REASON: A capital asset
which has a determinable life has been acquired and, therefore, the
expenditure should be spread over the life of the asset. (Ibid., citing
Mertens, emphasis supplied)
3) Advertising to promote the sales of shares of stock or
to create a favorable corporate image are not deductible.

Rules for deductibility of advertising and promotional

expenses. As a general rule, the company or business concerned shall
decide the kind and size of advertising and/or promotional expense that has to
be expended to promote its product or image subject to the following special
requirements if the taxpayer intends to deduct said expenses as a tax
deductible expense:
1) The rules on substantiation must be followed.
 38

2) All payments for the purchase of promotional

giveaways, contest prizes, or similar material must be properly
receipted.
3) All payments for services such as radio and TV time,
print ads, talent fees, advertising expertise or know-how must be
subject to withholding tax. Otherwise, the same cannot be claimed as
a deductible expense. (RAMO No. 1-87, No. 4)

(10) Political campaign expenses

(11) Training expenses
(b) Interest
Summary outline of deductible interest expense, in general.
1) The amount of interest paid or incurred
2) within a taxable year
3) on indebtedness
4) in connection with the taxpayer’s profession, trade or business;
5) shall be allowed as deduction from gross income . [NIRC of
1997, Sec. 34 (B) (1), arrangement and numbering supplied]

(1) Requisites for deductibility

Requisites for deductibility of interes t. In general, subject to
certain limitations, the following are the requisites for the deductibility of interest
expense from gross income, viz:
1) There must be an indebtedness.
2) There should be an interest expense paid or incurred
upon such indebtedness.
3) The indebtedness must be that of the taxpayer.
4) The indebtedness must be connected with the
taxpayer’s trade, business or exercise of profession.
5) The interest expense must have been paid or incurred
during the taxable year.
6) The interest must have been stipulated in writing.
7) The interest must be legally due.
8) The interest payment arrangement must not be
between related taxpayers xxx.
9) The interest must not be incurred to finance petroleum
operations.
10) 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.” (RR 13-2000, Sec. 3, paraphrasing supplied)
11) The amount deducted must be within the limits
provided by law.

Examples of interest deductible as ordinary and

necessary expense.
1) Interest paid to finance purchase of inventory, or
otherwise finance operations.
2) Interest paid on delinquent business taxes.
3) Interest paid, by banks, loan or trust companies,
within the year on deposits or on savings received for investment and
 39

secured by interest-bearing certificates of indebtedness issued by such

bank or company. (RR No. 2, Sec. 78, par. 1)

(2) Non-deductible interest expense

a. Interest expense equal to 33% of the interest income
subject to final tax. [NIRC of 1997, Sec. 34 (B) (1), as amended by Rep. Act
No. 9337]
b. 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:
1) Provided, That such interest shall be allowed
as a deduction in the year the indebtedness is paid, and
2) Provided further, That if the indebtedness is
payable in periodic amortizations, the amount of the principal
amortized or paid during the year shall be allowed as deduction
in such taxable year.
c. If both the taxpayer and the person to whom the
payment has been made or is to be made are considered as related
parties.
d. If the indebtedness is incurred to finance petroleum
exploration. [NIRC of 1997, Sec. 34 (B) (2)]
e. Interest in the form of dividends paid to preferred
shareholders. (RR No. 2, Sec. 78, par. 3, RMC No. 17-71)
f. Interest paid on earned and unclaimed salary . (Kuenzle
& Streiff, Inc. v. Collector, 106 Phil. 355)
g. Interest paid on indebtedness used to purchase
securities by one who is not a dealer in securities. This is so because
such interest is part of the acquisition of a capital asset .

BAR: Interest in the form of dividends paid to preferred

shareholders not deductible interest. Preferred shares are considered
capital regardless of the conditions under which such shares are issued and
dividends or “interests” paid thereon are not allowed as deductions from the
gross income of Corporations. (RR No. 2, Sec. 78, par.3;; Rev. Memo. Circ. No. 17-
71)
NOTES AND COMMENTS: The above doctrine applies only with respect to
dividends not being considered as interest. It does not apply where the corporation
issues script dividends, in which case the dividends themselves are not considered
interest, but the interest paid by a corporation on the script dividend is deductible
interest. (RR No. 2, Sec. 78, 1st par.)
A script dividend is a dividend in the form of a promissory note.

(3) Interest subject to special rules

(a) Interest paid in advance. No deduction shall
be allowed in respect of interest 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. [NIRC of 1997, Sec. 34 (B) (2) (a) paraphrasing
supplied]
NOTES AND COMMENTS: The above is an example of an exception
to the cash method. The interest expense is not recognized at the time it is
paid, but at the time when the indebtedness is paid.

(b) Interest periodically amortized

 40

(c) Interest expense incurred to acquire

property for use in trade/business/profession
BAR: Summary outline of optional treatment interest
expense .
1) At the option of the taxpayer,
2) interest incurred to acquire property used in trade,
business or exercise of a profession,
3) may be allowed as a deduction or treated as a capital
expenditure. [NIRC of 1997, Sec. 34 (B) (3), numbering and arrangement
supplied]

(d) Reduction of interest expense/interest

arbitrage
(c) Taxes
(1) Requisites for deductibility
a. Taxes paid or incurred,
b. within the taxable year,
c. in connection with the taxpayer’s profession, trade or
business. [NIRC of 1997, Sec. 34 (C) (1)]
NOTES AND COMMENTS: The basic rationale for allowing the
deduction of taxes paid or incurred in connection with the taxpayer’s
profession, trade or business (as with other deductions), is the accounting
concept of matching revenues with expenditures. If the expenditure helped
earn the income, then it should be allowed as a deduction. Conversely, if the
expenditure did not help earn the income, then it should not be deducted.

BAR: (2) Non-deductible taxes

a. The income tax provided for under the NIRC;
b. Income taxes imposed by authority of any foreign
country
1) 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 credits for taxes paid to
foreign countries;
c. Estate and donor’s taxes;
d. Taxes assessed against local benefits of a kind
tending to increase the value of the property assessed. [NIRC of 1997,
Sec. 34 (C) (1), arrangement and numbering supplied]
e. Taxes on sale, barter or exchange of shares of stock
listed and traded through the local stock exchange or through initial
public offering. [Ibid., Sec. 127 (D)]
f. Final income taxes, such as the presumed capital gains
tax on the disposition of real property, and the capital gains tax on the
disposition of shares of stock not listed and traded in the stock
exchange.

(3) Treatment of surcharges/interests/fines for

delinquency. 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 on deductions 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. [RR No. 13-2000, Sec. 4(c)]
 41

Interest on delinquent taxes are deductible as they are considered as

interest on indebtedness and not as taxes. (Commissioner of Internal Revenue v.
Prieto, 109 Phil. 592; Commissioner of Internal Revenue v. Palanca, Jr. 18 SCRA 496)
NOTES AND COMMENTS: The unpaid delinquent taxes referred to are only
business taxes and not income taxes.

(4) Treatment of special assessment. Taxes assessed

against local benefits of a kind tending to increase the value of the property
assessed are not deductible from gross income. [NIRC of 1997, Sec. 34 (C) (1)]

(5) Tax credit vis-à-vis deduction

a. A tax credit reduces the taxpayer's liability dollar for
dollar, COMPARED to a deduction which reduces taxable income upon
which the tax liability is calculated.
b. A tax credit differs from deduction to the extent that the
former is subtracted from the tax, WHILE the latter is subtracted from
the income before the tax is computed. (M.E. Holding Corporation v.
Commissioner of Internal Revenue, CTA Case No. 5314, August 17, 1998
citing Black's Law Dictionary, 6th ed.)

(d) Losses
(1) Requisites for deductibility
BAR: General requisites for deductibility of losses. There
must be compliance with the general requisites for deductibility as applied to
losses:
1) There must be a specific provision of law allowing the
deductions, since deductions do not exist by implication . (Atlas
Consolidated Mining and Development Corporation v. Commissioner of
Internal Revenue, L-26911, January 27, 1981 and Commissioner of Internal
Revenue v. Atlas Consolidated Mining and Development Corporation, et al.,
102 SCRA 246).
2) There must be proof of entitlement to the deduction s.
(Atlas Consolidated, supra; Paper Industries Corporation of the Philippines v.
Court of Appeals, et al., 250 SCRA 434)
3) The deductions must not have been waived. (RR No. 2,
Sec. 76)
4) The withholding and payment of the tax required must
be shown. [NIRC of 1997, Secs. 34 (K), 58 and 81]

BAR: Specific requisites for deductibility of losses. The

specific requirements of deductibility of losses must be met:
1) They must be ordinary losses that are incurred by a
taxable entity as a result of its day to day operations conducted for
profit or otherwise, or casualty losses.
2) They must have been losses that are actually
sustained during the taxable year.
3) Must not have been compensated for by insurance or
other forms of indemnity.
4) If they are casualty losses, they are of property
connected with trade, business, or profession and the lose arises from
fires, storms, shipwreck, or other casualties, or from robbery, theft or
embezzlement.
5) Must not have been claimed as a deduction for estate
tax purposes in the estate tax return. [NIRC of 1997, Sec. 34 (D) (1)]
 42

(2) Other types of losses

(a) Capital losses . These arise only from the
disposition of capital assets and may be deductible only from capital
gains.

(b) Securities becoming worthless. These may

be deductible only from the ordinary income of a dealer in securities.
For one who is not a dealer in securities, these losses may be
deducted only from capital gains.

(c) Losses on wash sales of stocks or

securities. These may be deducted only from the ordinary income
of a dealer in securities.
For one who is not a dealer in securities, these losses may be
deducted only from capital gains.

(d) Wagering losses . These may be deducted only

from wagering gains. Gambling losses may be deducted only from
gabling winnings.

(e) Net Operating Loss Carry-Over (NOLCO)

BAR: Requisites for deductibility of NOLCO.
1) The net operating loss of the business or
enterprise,
2) for any taxable year immediately preceding the
current taxable year,
3) which has not been previously offset as
deduction from gross income,
4) shall be carried over as a deduction from gross
income,
5) for the next three (3) consecutive taxable
years immediately following the year of such loss:
6) 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 xxx,
7) Provided, further, That a net operating loss
carry-over shall be allowed only
8) if there has been no substantial change in
the ownership of the business or enterprise. [NIRC of 1997,
Sec. 34 (D) (3), numbering, arrangement and paraphrasing supplied]

Elements of substantial change in ownership:

1) Not less than 75% in nominal value of
outstanding issued shares, if the business is in the name of a
corporation, is held by or on behalf of the same persons; or
2) Not less than 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 the same persons. [NIRC of 1997, Sec.
34 (D) {3}, paraphrasing supplied]

Taxpayers entitled to deduct NOLCO from

gross income .
1) Any individual (including estates and trusts) engaged in
trade or business or in the exercise of his profession.
 43

2) Domestic and foreign corporations subject to the

normal income tax (e.g., manufacturers and traders) or preferential tax
rates under the Code (e.g. private educational institutions, hospitals,
and regional operating headquarters ). (RR No. 14-2001;, Sec. 2.5, Sec.
4, 1st par., numbering and arrangement supplied)

Taxpayers NOT entitled to claim deduction of NOLCO.

1) Offshore Banking Unit (OBU) of a foreign banking
corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic
or foreign banking corporation, duly authorized as such by the Bangko
Sentral ng Pilipinas (BSP).
2) An enterprise registered with the Board of Investments
(BOI) with respect to its BOI-registered activity enjoying the Income Tax
Holiday incentive. Its accumulated net operating losses incurred or
sustained during the period of such Income Tax Holiday shall not
qualify for purposes of the NOLCO.
3) An enterprise registered with the Philippine
Economic Zone Authority (PEZA) pursuant to Rep. Act No. 7916,
amended, with respect to its PEZA-registered business activity. Its
accumulated net operating losses incurred or sustained during the
period of its PEZA registration shall not qualify for purposes of the
NOLCO.
4) An enterprise registered under Rep. Act No. 7227,
otherwise known as the Bases Conversion and Development Act of
1992, e.g. SBMA-registered enterprises, with respect to its registered
business activity. Its accumulated net operating losses incurred or
sustained during the period of its said registered operation shall not
qualify for purposes of the NOLCO.
5) Foreign corporations engaged in international shipping
or air carriage business in the Philippines.
6) In general, any person, natural or juridical, enjoying
exemption from income tax, pursuant to the provisions of the Tax Code
or any special law, with respect to its operation during the period for
which the aforesaid exemption is applicable. Its accumulated net
operating losses incurred or sustained during the said period shall not
qualify for purposes of the NOLCO." (RR No. 14-2001, Sec. 4.1 to 4.6)
7) An individual who claims the 40% optional standard
deduction shall not simultaneously claim deduction of the NOLCO,
provided that the three-year reglementary period shall continue to run
notwithstanding the fact that the aforesaid individual availed of the 40%
optional standard deduction during the said period . [Ibid., Sec. 2.5, NIRC
of 1997, Sec. 34 (L), as amended by Rep. Act No. 9504]

(e) Bad debts

BAR: (1) Requisites for deductibility
a. There must be an existing indebtedness due to the
taxpayer which must be valid and legally demandable.
b. The same must be connected with the taxpayer’s
trade, business or practice of profession.
c. The same must not be sustained in a transaction
entered into between related parties.
d. The same must be actually charged off the books of
accounts of the taxpayer as of the end of the taxable year.
e. The debt must be actually ascertained to be
worthless and uncollectible during the taxable year.
 44

f. The debts are uncollectible despite diligent effort

exerted by the taxpayer. [NIRC of 1997, Sec. 34 (E) (1); RR No. 5-99, Sec.
3, reiterated in RR No. 25-2002; Philippine Refining Corporation v. Court of
Appeals, et al., 256 SCRA 667]

Criteria to determine whether advances are contributions

or loans .
a. Name given to the certificate evidencing the alleged debt.
b. A fixed maturity date for the alleged debt.
c. The sources of the debtor corporation's repayment of the
alleged loan.
d. The creditor’s right to enforce repayment of the alleged loans.
e. The increase of the individual taxpayer's control over the
debtor corporation as a result of the advances.
f. The creditor subordination to the general creditors of the debtor
corporation.
g. The intention of the parties to the alleged loan.
h. Sufficient capitalization of the debtor corporation.
i. The proportion of the advances made in relation to the
shareholder's interest in the alleged debtor corporation;
j. If a true lender, the creditor’s concern with collecting interest on
the advances.
k. Ability of the debtor corporation to obtain loans from outside
lending institutions.
l. Use of advances to purchase capital assets.
m. Failure of the debtor corporation to pay the alleged debt on the
due date. [Philex Mining Corporation v. Commissioner of Internal Revenue, CTA Case
No. 5200, August 21, 1998 citing Estate of Nixon v. U.S., 464 F2d 394 (CA5, 1972);
Fernandez Hermanos, Inc. v. Commissioner of Internal Revenue, 29 SCRA 552,
affirmed in Philex Mining Corporation v. Commissioner of Internal Revenue,G. R. No.
148187, April 16, 2008]

(2) Effect of recovery of bad debts. Refer to page 24,

supra.

(f) Depreciation
BAR: (1) Requisites for deductibility
a. The property subject to depreciation must be property
with life of more than one taxable year.
b. The property depreciated must be used in trade,
business or exercise of a profession.
c. The depreciation method used must be reasonable and
consistent.
d. The depreciation must have been charged during the
taxable year. (RR No. 2, Sec. 113)
e. A depreciation schedule should be attached to the
income tax return. (Ibid., Sec. 115)

Depreciation of goodwill . Goodwill may or may not be

subject to depreciation. If cost is paid or incurred in the acquisition,
then it may be subject to depreciation.
On the other hand, goodwill that is internally generated may or
may not be subject to depreciation depending on certain
considerations.
 45

(2) Methods of computing depreciation allowance

(a) Straight-line method. The annual depreciation
charge is calculated by allocating the amount to be depreciated equally
over the number of years of the estimated useful life of a tangible.
“Straight-line depreciation results in a constant charge over the useful
life.” (IAS/PAS par.. 62, 3rd sentence, effective January 1, 2005)
Annual depreciation expense is computed by deducting the
estimated scrap value (also called residual value or salvage value) if
any, from the cost of the asset and dividing the remaining depreciable
cost by the years of estimated life.

(b) Declining-balance method. It is an

accelerated method of depreciation which writes off a relatively larger
amount of the asset’s cost nearer the start of its useful life than does
the straight line. “The diminishing balance method results in a
decreasing charge over the useful life.” (IAS/PAS 16, par. 62, 4th sentence,
effective January 1, 2005)

(c) Sum-of-the-years-digit method. An

accelerated method of depreciation that provides higher depreciation
expense in the earlier years and lower charges in the later years.

Other reasonable methods for computing

depreciation. The following methods if approved by the
Commissioner of Internal Revenue may also be used:
1) Apportionment to units of production
2) Units of production method
3) Hours of use method
4) Revaluation method
5) Sinking fund method

(g) Charitable and other contributions

(1) Requisites for deductibility
Summary outline of requisites for deductibility, in general,
of charitable and other contributions:
1) Contributions or gifts actually paid or made within the
taxable year
2) to, or for the use of
a) the Government of the Philippines or any of its
agencies or any political subdivision thereof
(1) exclusively for public purposes,
b) or to accredited domestic corporation or
associations organized and operated exclusively
(1) for religious, charitable, scientific, youth
and sports development, cultural or educational
purposes or for the rehabilitation of veterans,
c) or to social welfare institutions, or to non-
government organizations,
 46

3) in accordance with rules and regulations promulgated

by the Secretary of Finance, upon recommendation of the
Commissioner,
4) no part of the net income of which inures to the benefit
of any private stockholder or individual
5) in an amount not in excess of
a) ten percent (10%) in the case of an individual,
b) and five percent (5%) in the case of a
corporation, of the taxpayer's taxable income
(1) derived from trade, business or
profession as computed
(2) without the benefit of this and the
following subparagraphs [NIRC of 1997, Sec. 34 (H)]
arrangement and numbering supplied]
6) after compliance with the substantiation requirements

Kinds of charitable and other contributions allowed as

deductions from gross income.
1) Partial deductions:
a) Contributions or gifts to the government or
accredited NGOs.
2) Deducted in full:
a) Donations to the government, under certain conditions.
b) Donations to certain foreign institutions or international
organizations.
c) Donations to accredited nongovernment organizations,
under certain conditions.
d) Donations of prizes to athletes.
3) Donations that are deductible up to the extent of 150%.
a) Donations under the adopt-a-school program
b) Donations for accredited manpower training
NOTES AND COMMENTS: Not all donations to the government are fully
deductible. Furthermore, not all donations that are exempt from donor’s taxes are
allowed as deductions from gross income. Political contributions made by individuals,
that are reported to the Commission on Elections (COMELEC) are exempt from donor’s
taxes but not allowed as deductions from gross income.

(2) Amount that may be deducted

(h) Contributions to pension trusts
(1) Requisites for deductibility
a. An employer establishing or maintaining a pension
trust,
b. to provide for the payment of reasonable pensions to
his employees,
c. 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 for ordinary
and necessary trade, business or professional expenses),
 47

d. a reasonable amount transferred or paid into such

trust during the taxable year in excess of such contributions,
e. but only if such amount
1) has not theretofore been allowable 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.” [NIRC of 1997, Sec. 34 (J),
arrangement, numbering, paraphrasing and words in italics supplied]

(i) Deductions under special laws

4) Optional standard deduction. A fixed percentage deduction which is allowed
certain taxpayers without regard to any actual expenditures.
Under the NIRC, the standard optional deduction is an amount
a. not exceeding forty percent (40%) of the gross sales or gross receipts of
the qualified individual taxpayer sales or gross receipts of the qualified individual taxpayer or
b. in the case of qualified corporations not exceeding forty percent (40%) of their
gross income. [NIRC of 1997, Sec. 34 (L), as amended by Rep. Act No. 9504, Sec. 3, emphasis,
arrangement and numbering supplied]

(a) Individuals, except non-resident aliens. The OSD

allowed to individual taxpayers shall be a maximum of forty percent (40%) of gross
sales or gross sales during the taxable year (RR No. 16-2008, Sec. 3, 1st par., 1st
sentence, emphasis supplied) which shall be determined depending upon the method of
accounting used for recognizing income and deductions:
1) Accrual basis of accounting
2) Cash basis
3) Percentage of completion basis, etc.

Determination of the optional standard deduction (OSD) allowed

for individuals who use the accrual basis for recognition of income and
deductions. If the individual is on the accrual basis of accounting for his income and
deductions, the OSD shall be based on the gross sales during the taxable year. (RR
No. 16-2008, Sec. 3, 1st par., 2nd sentence)
NOTES AND COMMENTS: The “gross sales” is the total sales that are recognized,
whether collected or not. Cost of sales or cost of services are not allowed as deductions.

Determination of the optional standard deduction (OSD) allowed

for individuals who use the cash basis for recognition of income and
deductions. If the individual employs the cash basis of accounting for his income
and deductions, the OSD shall be based on the gross receipts during the taxable year.
(RR No. 16-2008, Sec. 3, 1st par., last sentence)
NOTES AND COMMENTS: The “gross receipts” refer to the total payments received for
the sales without deducting the cost of sales or cost of services.

“Gross sales” DISTINGUISHED FROM “gross receipts.”

1) Gross sales are those recognized whether paid or not WHILE
gross receipts refer to those that are actually paid;
2) Allowance for bad debts are recognized as a deductibility from
gross sales WHILE no such recognition is allowed from gross receipts.

(b) Corporations, except non-resident foreign

corporations. In case of qualified corporate taxpayers (domestic and resident
 48

foreign corporations) the OSD allowed shall be in an amount not exceeding forty
percent (40%) of their gross income. (RR No. 16-2008, Sec. 4, 1st par.)

Optional standard deduction for individuals DISTINGUISHED

FROM optional standard deduction for corporations:
1) The OSD for individuals is dependent upon the method of
accounting used (such as cash basis or accrual) WHILE the OSD for
corporations does not consider the method of accounting.
2) The basis of the OSD for individuals is either gross sales or
gross receipts WHILE that for corporations is the gross income.
3) Since the basis of the OSD for individuals is either the gross
sales or gross receipts, no deduction is allowed for cost of sales or cost of
services WHILE since that for the corporation is gross income, it is allowed to
deduct cost of sales or cost of services.
4) An individual who avails of the OSD need not submit his
financial statements with his tax returns WHILE a corporation is still required to
submit its financial statements when it files its annual income tax returns .

(c) Partnerships. A GPP may claim the optional standard

deduction. Sec. 26 of the Code provides that – “ For purposes of computing the
distributive share of the partners, the net income of the GPP shall be computed in the
same manner as a corporation.” As such, a GPP may claim either the itemized
deductions allowed under Section 34 of the Code or in lieu thereof, it can opt to avail
of the OSD allowed to corporations in claiming the deductions in an amount not
exceeding forty percent (40%) of its gross income. (RR No. 2-2010 reiterating RR No. 16-
2008, Sec. , 2nd par. in relation to the NIRC of 1997, Sec. 26)

The individual partner in a GPP may claim either the OSD or

itemized deduction. However, if the GPP availed of itemized deductions, the
partners are not allowed to claim the OSD from their share in the net income because
the OSD is a proxy for all the items of deductions allowed in arriving at taxable income.
If the GPP avails of OSD in computing its net income, the partners comprising
it can no longer claim further deduction from their share in the said net income. (RR No.
2-2010, Sec. 2 reiterating and amending RR No. 16-2008, Sec. 6)

Other implications of the Optional Standard Deduction . The

taxpayer must choose OSD by ticking the box on the return, if he (it) does not so it is
deemed to chosen the itemized deduction.
The taxpayer could not change from OSD to itemized deduction once chosen
for a particular year. (RR No. 2-2010, Sec. 3 amending RR No. 16-2008, Sec. 7, 1 st to 3rd
pars.)

5) Personal and additional exemption (R.A. No. 9504,

Minimum Wage Earner Law)
BAR: (a) Basic personal exemption. There shall be
allowed a basic personal exemption amounting to Fifty thousand pesos
(P50,000) for each individual taxpayer.
In the case of married individuals where only one of the spouse is
deriving gross income, only such spouse shall be allowed the personal
exemption. [NIRC of 1997, Sec. 35 (A), as amended by Rep. Act No. 9504; RR No. 2-
98, Sec. 2.79 (I) (1) (a), as amended by RR No. 10-2008]
NOTES AND COMMENTS: There is a substantial change in concept
occasioned by Rep. Act No. 9504 which removed the distinctions between the concepts
 49

of single, married and head of the family for purpose of availing of the basic personal
exemption.

(b) Additional exemptions for taxpayer with dependents.

These are the exemptions in addition to the basic personal exemptions that are
granted to certain individuals who have dependents that qualify them for this
exemption.

Additional exemptions for taxpayers with dependents. An

individual,
1) whether single or married,
2) shall be allowed an additional exemption of Twenty-Five
Thousand Pesos (P25,000.00)
3) for each qualified dependent child,
4) provided that the total number of dependents for which
additional exemptions may be claimed
a) shall not exceed four (4) dependents. [NIRC of 1997,
Sec. 35 (B), as amended by Rep. Act No. 9504; RR No. 2-98, Sec. 2.79 (I) (1)
(b), 1st par., as amended by RR No. 10-2008, arrangement and numbering
supplied]
NOTES AND COMMENTS: It is clear that under the amendment, that single
individuals may now claim for the additional exemptions. Furthermore, the concept of
head of a family does not find application anymore.

Additional dependents other than qualified dependent children:

1) Senior citizens shall be treated as dependents provided for in
the National Internal Revenue Code, as amended, and as such, individual
taxpayers caring for them, be they relatives or not shall be accorded the
privileges granted by the Code insofar as having dependents are concerned.
[Rep. Act No. 7432, as amended by Rep. Act 9257, “The Expanded Senior Citizens Act
of 2003”, Sec. 5 (a), last par.]
2) Additional exemptions for dependent foster child under
Republic Act No. 10165, the Foster Care Act of 2012. The term “dependent”
under Section 35 (B) of the NIRC of 1997 was amended to include a “Foster
Child.”
A Foster Parent shall be allowed an additional exemption of Twenty
Five Thousand Pesos (P25,000.00) for each qualified dependent, Provided
however, that the total number of dependents for which additional exemptions
may be claimed shall not exceed four (4) as provided for by Republic Act No.
9504.
The Twenty Five Thousand Pesos (P25,000.00) additional exemption
for a Foster Child shall be allowed only if the period of foster care is at least a
continuous period of one (1) taxable year.

(c) Status-at-the-end-of-the-year rule. If the taxpayer marries

or should have additional dependent(s) during the taxable year, the taxpayer may
claim the corresponding additional exemptions, as the case may be, in full for such
year. [NIRC of 1997, Sec. 35 (C), 1st par.]
1) If the employee should have additional dependent (s), as
defined above,
2) during the taxable year,
3) he may claim the corresponding additional exemption, as the
case may be,
 50

a) in full for such year. [RR 2-98, Sec. 2.79 (I) (1) (b), 4th par.,
2nd sentence, as amended by RR No. 10-2008, arrangement and numbering
supplied]

(d) Exemptions claimed by non-resident aliens

Requirements to qualify a non-resident alien individual for the
availment of personal exemptions, which includes both the “basic
personal exemption” and the “additional exemption for dependents:
1) Must be engaged in trade, business, or in the exercise of a
profession in the Philippines.
2) The country of which he is a subject or citizen should grant
exemptions to citizens of the Philippines not residing in such country (the
concept of reciprocity).
3) The amount of the personal exemption to which the
nonresident alien individual is entitled is in the amount equal to the exemptions
allowed in the income tax law in the country of which he is a subject or citizen,
to citizens of the Philippines not residing in such country.
4) The amount of the personal exemption should not exceed the
amount fixed under the Tax Code as the exemption for citizens or residents of
the Philippines.
5) He files in the Philippines a true and accurate return of the total
income received by him from all sources in the Philippines . [NIRC of 1997, Sec.
35 (D), arrangement and numbering supplied]
6) Items not deductible
(a) General rules
(b) Personal, living or family expenses
(c) Amount paid for new buildings or for permanent
improvements (capital expenditures)
(d) Amount expended in restoring property (major repairs)
BAR: (e) Premiums paid on life insurance policy covering life
or any other officer or employee financially interested. Not deductible are
premiums paid on any life insurance policy
1) 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,
2) when the taxpayer is directly or indirectly a beneficiary under
such policy. [NIRC of 1997, Sec. 36 (A)]
NOTES AND COMMENTS: The premiums may be deductible as an ordinary and
necessary expense if the insurance was taken as part of the employee’s compensation package
and the designated beneficiary is not the employer.

(f) Interest expense, bad debts, and losses from sales of

property between related parties.
Not related parties are relatives by affinity and collateral relatives,
other than brothers and sisters. Thus, interest payments made to parents-in-law,
brothers or sisters-in law, as well as made to all kinds of cousins, uncles and aunts may be
deductible from gross income.
 51

(g) Losses from sales or exchange or property. If a loss results from

the exchange, the loss is not allowed to be deducted from gross income because the loss is
not yet realized.
If a loss results, from the disposition of the property received as a result of the
exchange, the loss maybe deductible if the taxpayer is a corporation but not if he is an
individual.

(h) Non-deductible interest

(i) Non–deductible taxes
(j) Non-deductible losses
(k) Losses from wash sales of stock or securities
7) Exempt corporations
(a) Propriety educational institutions and hospitals

(b) Government-owned or controlled corporations

(c) Others

10. Taxation of resident citizens, non-resident citizens, and resident aliens

a. General rule that resident citizens are taxable on income from all sources
within and without the Philippines

i. Non-resident citizens

b. Taxation on compensation income

i. Inclusions

a) Monetary compensation

(1) Regular salary/wage

(2) Separation pay/retirement benefit not otherwise exempt

(3) Bonuses, 13th month pay, and other benefits not exempt

(4) Director’s fees. Director’s fees are considered as included as part of

compensation income, and taxable as such, “if the director is at the same time, an employee of
the employer/corporation.” [RR No. 2-98, Sec. 2.78.1 (A), 2nd par. (6)]

BAR: b) Non-monetary compensation. Compensation may be paid in money,

or in some medium other than money, as for example, stocks, bonds or other forms of property. [RR
No. 2-98, Sec. 2.787.1 (A) (1), 1st sentence]
Thus, they are subject to tax unless there is a specific provision of law that exempts them.
 52

(1) Fringe benefit not subject to tax

ii. Exclusions
a) Fringe benefit subject to tax
b) De minim is benefits. The term ‘de minimis’ benefits which are exempt from the
fringe benefits tax shall, in general, be limited to facilities or privileges furnished or offered by an
employer to his employees that 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 such as the following:
1) Monetized unused vacation leave credits of private employees not exceeding
ten (10) days during the year and the monetized value of leave credits paid to government
officials and employees;
2) Medical cash allowance to dependents of employees not exceeding P750.00
per employee per semester or P125 per month;
3) Rice subsidy of P1,500.00 or one (1) sack of 50-kg. rice per month amounting
to not more than P1,500.00;
4) Uniforms and clothing allowance not exceeding P5,000.00 per annum;
5) Actual yearly medical benefits not exceeding P10,000.00 per annum;
6) Laundry allowance not exceeding P300 per month;
7) Employees achievement awards, e.g. for length of service or safety
achievement, which must be in the form of a tangible personal property other than cash or gift
certificate, with an annual monetary value not exceeding P10,000.00 received by an employee
under an established written plan which does not discriminate in favor of highly paid
employees;
8) Gifts given during Christmas and major anniversary celebrations not exceeding
P5,000 per employee per annum;
9) 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
10) Daily meal allowance for overtime work not exceeding twenty five percent
(25%) of the basic minimum wage. [RR 3-98, Sec. 2.33 (C), last par., as amended by RR. No. 10-
2000, RR No. 5-2008; RR No. 5-2011; RR No. and RR No. 8-2012)

c) 13th month pay and other benefits, and payments specifically

excluded from taxable compensation income. Gross benefits received by officials and
employees of public and private entities: Provided, however, That the total exclusion shall not exceed
Thirty thousand pesos (P30,000) which shall cover:
1) Benefits received by officials and employees of the national and local
government pursuant to Republic Act No. 6686;
2) Benefits received by employees pursuant to Presidential Decree No.
851, as amended by Memorandum Order No. 28, dated August 13, 1986;
3) 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
4) Other benefits such as productivity incentives and Christmas bonus:
Provided, further, That the ceiling of Thirty Thousand Pesos (P30,000.00) may be
increased through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner of Internal Revenue, after considering among
others, the effect on the same of the inflation rate at the end of the taxable year. [NIRC
of 1997, Sec. 32 (B) (7) (e)]

iii. Deductions
a) Personal exemptions and additional exemptions
 53

b) Health and hospitalization insurance. 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. [NIRC of 1997, Sec. 34 (M)]

c) Taxation of compensation income of a minimum wage earner

(1) Definition of statutory minimum wage
(2) Definition of minimum wage earner
(3) Income also subject to tax exemption: holiday pay,
overtime pay, night-shift differential, and hazard pay
c. Taxation of business income/income from practice of profession
d. Taxation of passive income
i. Passive income subject to final tax
a) Interest income
1) Treatment of income from long-term deposits
b) Royalties

c) Dividends from domestic corporations

d) Prizes and other winnings

ii. Passive income not subject to final tax

e. Taxation of capital gains

i. Income from sale of shares of stock of a Philippine corporation

a) Shares traded and listed in the stock exchange

b) Shares not listed and traded in the stock exchange

ii. Income from the sale of real property situated in the Philippines

iii. Income from the sale, exchange, or other disposition of other capital
assets

11. Taxation of non-resident aliens engaged in trade or business

a. General rules
 54

b. Cash and/or property dividends

c. Capital gains

Exclude: non-resident aliens not engaged in trade or business

12. Individual taxpayers exempt from income tax

a. Senior citizens

b. Minimum wage earners

c. Exemptions granted under international agreements

13. Taxation of domestic corporations

a. Tax payable

i. Regular tax
ii. Minimum Corporate Income Tax (MCIT)
a) Imposition of MCIT
b) Carry forward of excess minimum tax
c) Relief from the MCIT under certain conditions
d) Corporations exempt from the MCIT
e) Applicability of the MCIT where a corporation is governed both
under the regular tax system and a special income tax system
b. Allowable deductions
i. Itemized deductions
ii. Optional standard deduction
c. Taxation of passive income
i. Passive income subject to tax
a) Interest from deposits and yield, or any other monetary benefit
from deposit substitutes and from trust funds and similar arrangements and
royalties
b) Capital gains from the sale of shares of stock not traded in the
stock exchange
c) Income derived under the expanded foreign currency deposit
system
 55

d) Inter-corporate dividends
e) Capital gains realized from the sale, exchange, or disposition of
lands and/or buildings
ii. Passive income not subject to tax
d. Taxation of capital gains

i. Income from sale of shares of stock

ii. Income from the sale of real property situated in the Philippines

iii. Income from the sale, exchange, or other disposition of other capital
assets
General rule. The entire amount of gain or loss upon the sale or exchange of property shall be recognized.
[NIRC of 1997, Sec. 40 (c) (1)]
NOTES AND COMMENTS: If gains are recognized, the gains shall be taxable. If gains are not recognized they are not
going to be taxed.
If losses are recognized they shall be allowed as deductions from gross income. If the losses are not recognized, they are
not allowed to be deducted from gross income.

Exceptions to the general rule:

1) Gains recognized but loss not recognized in transactions between related parties. [NIRC of
1997, Sec. 36 (B)]
2) No gain or loss recognized where there is an exchange solely in kind
a) if in pursuance of a plan of merger or consolidation
b) or where the one exchanging together with others not exceeding four (4) are able to
obtain control of the corporation. [Ibid.,, Sec. 40 (C) (2)]
3) Gain recognized but loss not recognized where the exchange is not solely in kind. [Ibid., Sec. 40
(C) (3)
NOTES AND COMMENTS: An exchange solely in kind is an exchange of property for property. For example
shares of stock are exchanged for a parcel of land. No money is involved.
An exchange not solely in kind is one where the properties exchanged includes money. For example, shares of
stock plus money are exchanged for a parcel of land.]

Tax-exempt exchanges of property or instances where no gain or loss is recognized. Also

called exchanges of property solely in kind. No gain or loss shall be recognized if in pursuance of a plan of
merger or consolidation;
1) A corporation which is a party to a merger or consolidation exchanges property solely for
stock in a corporation which is a party to the merger or consolidation; or
2) A shareholder exchanges stock in a corporation which is a party to the merger or
consolidation solely for the stock of another corporation, also a party to the merger or consolidation;
3) A security holder of a corporation which is a party to the merger or consolidation exchanges his
securities in such corporation solely for stock or securities in another corporation, a party to the merger or
consolidation; or
4) No gain or loss shall also be recognized if property is transferred to a corporation by a person
in exchange for stock or unit of participation in such a corporation of which as a result of such exchange said
person, alone or together with others, not exceeding four (4) persons gain control of said corporation: Provided,
That, stocks issued for services shall not be considered as issued in return for property.” [NIRC of 1997, Sec. 40
(C)]
NOTES AND COMMENTS: Stock issued for services are known as ”disguised dividends”. They are not dividends in the
true sense of the word because they do not represent return on investments. This is the reason for the proviso clause “That, stocks
issued for services shall not be considered as issued in return for property.” [NIRC of 1997, Sec. 40 (C)]
 56

Example of a tax-free exchange. A single proprietor transfers all his interest in the business including
its goodwill at their fair market value to a corporation which shall be organized in exchange for the shares of stock of
equivalent value of the latter. There would be a tax-free exchange if it will result to the proprietor owning entirely the
capital stock of the corporation, except perhaps the qualifying shares of the other incorporators. REASON: The
exchange will not give rise to any gain for purposes of income tax. (BIR Ruling February 29, 1960)
NOTES AND COMMENTS: A precondition for the tax-free exchange is that it should result to corporate control. The author
submits that If there was already corporate control prior to the exchange, then the tax-free exchange does not apply.

Technically there is no tax exemption even if the exchange is solely in kind . It is correct to
state that no taxable gain or loss is recognized under certain circumstances where there is an exchange solely in kind.
However, the exemption refers only to the initial exchange. Where the parties to the exchange dispose of the property
they received as a result of the exchange, then a gain or loss would be recognized.
Thus, there is merely a deferral of the income tax.

e. Tax on proprietary educational institutions and hospitals

f. Tax on government-owned or controlled corporations, agencies or
instrumentalities
14. Taxation of resident foreign corporations
a. General rule
b. With respect to their income from sources within the Philippines

c. Minimum Corporate Income Tax

d. Tax on certain income

i. Interest from deposits and yield, or any other monetary benefit from
deposit substitutes, trust funds and similar arrangements and royalties
ii. Income derived under the expanded foreign currency deposit system
iii. Capital gains from sale of shares of stock not traded in the stock
exchange
iv. Inter-corporate dividends
Exclude:
i. International carrier
ii. Offshore banking units
iii. Branch profits remittances
iv) Regional or area headquarters and regional operating headquarters of
multinational companies
15. Taxation of non-resident foreign corporations
a. General rule
b. Tax on certain income
i. Interest on foreign loans
 57

ii. Inter-corporate dividends

(iii) Capital gains from sale of shares of stock not traded in the stock
exchange
Exclude:
i. Non-resident cinematographic film-owner, lessor or distributor
ii) Non-resident owner or lessor of vessels chartered by Philippine nationals
(iii) Non-resident owner or lessor of aircraft machineries and other equipment
16. Improperly accumulated earnings of corporations
17. Exemption from tax on corporations
18. Taxation of partnerships
19. Taxation of general professional partnerships
20. Withholding tax
a. Concept. This practice which is also known as “taxation at source”, refers to the requirement that
taxes imposed or prescribed by the NIRC are to be deducted and withheld by the payor-corporations and/or persons
from payments made to payees-corporations and/or persons for the former to pay the same directly to the BIR. Thus,
the taxes are collected practically at the time the transaction is made or when the taxable act occurs.

Rationale for the withholding tax system .

1) To provide the taxpayer a convenient manner to meet his probable income tax liability.
2) To ensure the collection of the income tax which could otherwise be lost or substantially
reduced through failure to file the corresponding returns.
3) To improve the government’s cash flow. (Citibank, N.A. v. Court of Appeals, et al., G.R. No. 107434,
October 10, 1997)
4) To minimize tax evasion, thus resulting in a more efficient tax collection system

Liabilities for failure of withholding agent to collect and remit taxes. Any person required
to withhold, account for, and remit any tax imposed by the NIRC of 1997, or who willfully fails to withhold such tax, or
account for and remit such tax, or aids or abets in any manner to evade any such tax, or the payment thereof,
1) shall in addition to the criminal penalties of fine and imprisonment provided for under Sec. 255
of the NIRC of 1997,
2) be liable upon conviction to a penalty equal to the total amount of the tax not withheld, or not
accounted for and remitted. (NIRC of 1997, Sec. 251)

Liability for failure of withholding agent to refund excess withholding tax.

1) Criminal penalties of fine and imprisonment under Sec. 255 of the NIRC of 1997.
2) A penalty equal to the total amount of refunds which was not returned to the employee
resulting from any excess of the amount withheld over the tax actually due on their return. (NIRC of 1997, Sec.
252)

Criminal penalties for failure to withhold, remit or refund . Any person required under this Code or
by rules and regulations promulgated thereunder to withhold or remit taxes withheld, or refund excess taxes withheld
on compensation, at the time or times required y law or rules and regulations shall, in addition to other penalties
provided by law, upon conviction thereof, be punished by a fine of not less than Ten thousand pesos (P10,000.00) and
suffer imprisonment of not less than one (1) year but ore more than ten (10) years. (NIRC of 1997, Sec. 255, paraphrasing
supplied)
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Liability of withholding agent is personal. The withholding agent is explicitly made personally liable
under the NIRC of 1997 for the payment of the tax required to be withheld.
REASON: The law sets no condition for the personal liability of the withholding agent to attach. This is in order
to compel the withholding agent to withhold the tax under any and all circumstances. In effect, the responsibility for the
collection of the tax as well as the payment thereof is concentrated upon the person over whom the Government has
jurisdiction.
Thus, the withholding agent is the constituted agent both of the government and the taxpayer. With respect to
the collection and/or withholding of the tax, he is the Government’s agent. In regard to the filing of the necessary
income tax return and the payment to the Government, he is the agent of the taxpayer. The withholding agent,
therefore, is no ordinary government agent especially because under the Tax Code he is personally liable for the tax he
is duty bound to withhold; whereas, the Commissioner of Internal Revenue and his deputies are not made liable under
the law. (Filipinas Synthetic Fiber Corporation v. Court of Appeals, et al., G.R. Nos. 118498 & 124377, October 12, 1999)

Liability if the withholding agent is the Government . If the withholding agent is the
Government or any of its agencies, political subdivisions or instrumentalities, or a government-owned or controlled
corporation, the employee thereof responsible for the withholding and remittance of the tax shall be personally liable for
the deficiency taxes. [NIRC of 1997, Sec. 247 (b)]

Penal liability of corporations. Any corporation, association or general co-partnership liable for any of
the acts or omissions penalized under this Code, in addition to the penalties imposed herein upon the responsible
corporate officers, partners, or employees shall, upon conviction for each act or omission, be punished by a fine of not
less than Fifty thousand pesos (P50,000) but not more than One hundred thousand pesos (P100,000). (NIRC of 1997,
Sec. 256)

b. Kinds
i. Withholding of final tax on certain incomes. Under the final withholding tax
system the amount of income tax withheld by the withholding agent is constituted as a full and final payment of
the income due from the payee on the said income. The liability for payment of the tax rests primarily on the
payor as the withholding agent. Thus, in case of his failure to withhold the tax or in case of under withholding,
the deficiency tax shall be collected from the payor/withholding agent. The payee is not required to file an
income tax return for the particular income. [RR No. 2-98, Sec. 2.57 (A), 1st par.]

ii. Withholding of creditable tax at source.

1) The Secretary of Finance upon the recommendation of the Commissioner of Internal
Revenue,
2) may require the withholding of a tax on the items of income payable to natural or
juridical persons, residing in the Philippines,
3) by payor-corporations/persons as provided by law,
4) at the rate of not less than one percent (1%) but not more than thirty-two percent (32%)
thereof,
5) which shall be credited against the income tax liability of the taxpayer for the taxable
year. [NIRC of 1997, Sec. 57 (B)]
NOTES AND COMMENTS: A withholding tax certificate is provided by the payor-corporation/person to
the recipient of the income. This should be attached to the income tax return. The amount withheld shall be
allowed as a reduction of the income tax liability of the recipient of the income.

c. Withholding of VAT. The Government or any of its political subdivisions, instrumentalities or

agencies, including government-owned or -controlled corporations (GOCCs) shall, before making payment on account
of each purchase of goods from sellers and services rendered by contractors which are subject to the value- added
tax imposed in this Code, deduct and withhold the value-added tax due. [NIRC, Sec. 114 (C)]

d. Filing of return and payment of taxes withheld

i. Return and payment in case of government employees. The government
officials/employees should ensure that the Annual Information Return of Income Taxes Withheld on
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Compensation and Final Withholding Taxes (BIR Form No. 1604-CF) and the required Alphabetical Lists of
Employees/Payees and Annual Information Return of Creditable Income Taxes Withheld (Expanded)/Income
Payments Exempt from Withholding Tax (BIR Form No. 1604-E) and the required Alphabetical List of Payees
are filed with their respective RDOs on or before January 31 and March 1 of the following year respectively.
(Note: No annual return for withholding tax on GVAT and GPT). (RMC No. 23-2012, B, paraphrasing and
note supplied

ii. Statements and returns

e. Final withholding tax at source
f. Creditable withholding tax
i. Expanded withholding tax. Refer to creditable withholding tax at source, supra.
ii. Withholding tax on compensation. Except in the case of a minimum wage earner
every employer making payment of wages shall deduct and withhold upon such wages a tax determined in
accordance with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation
of the Commissioner. [NIRC of 1997, Sec. 79 (A), as amended by R. A. No. 9504, paraphrasing supplied]
The employer shall be liable for the withholding and remittance of the correct amount of tax required to
be deducted and withheld. [Ibid., Sec. 80 (A), 1st sentence]

g. Timing of withholding. The obligation of the payor to deduct and withhold the tax arises at the
time an income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset,
whichever is applicable in the payor’s books, whichever comes first. The term ‘payable’ refers to the date the
obligation becomes due, demandable and legally enforceable.
Provided, however, that where income is not yet paid or payable but the same has been recorded as an
expense or asset, whichever is applicable, in the payor’s books, the obligation to withhold shall arise in the last month
of the return period in which the same is claimed as an expense or amortized for tax purposes. (RR No. 2-98, Sec.
2.57.4, as amended by RR No. 12-2001, paraphrasing supplied)

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