to impose the tax was to favor one industry over another.
It is beyond serious question that a
I. TAX: GENERAL PROVISIONS
TIO v. VIDEOGRAM REGULATORY BOARD
FACTS:
Tio is a videogram operator who assailed the constitutionality of PD 1987 entitled “An Act
Creating the Videogram Regulatory Board” with broad powers to regulate and supervise the
videogram industry. A month after the promulgation of the said Presidential Decree, the
amended the National Internal Revenue Code provided that:
"SEC. 134. Video Tapes. — There shall be collected on each processed video-tape
cassette, ready for playback, regardless of length, an annual tax of five pesos; Provided, That
locally manufactured or imported blank video tapes shall be subject to sales tax."
"Section 10. Tax on Sale, Lease or Disposition of Videograms. — Notwithstanding
any provision of law to the contrary, the province shall collect a tax of thirty percent (30%) of
the purchase price or rental rate, as the case may be, for every sale, lease or disposition of a
videogram containing a reproduction of any motion picture or audiovisual program.”
“Fifty percent (50%) of the proceeds of the tax collected shall accrue to the province,
and the other fifty percent (50%) shall accrue to the municipality where the tax is collected;
PROVIDED, That in Metropolitan Manila, the tax shall be shared equally by the City/
Municipality and the Metropolitan Manila Commission.”
The rationale behind the tax provision is to curb the proliferation and unregulated circulation
of videograms including, among others, videotapes, discs, cassettes or any technical
improvement or variation thereof, have greatly prejudiced the operations of movie houses
and theaters. Such unregulated circulation have caused a sharp decline in theatrical
attendance by at least forty percent (40%) and a tremendous drop in the collection of sales,
contractor's specific, amusement and other taxes, thereby resulting in substantial losses
estimated at P450 Million annually in government revenues. Videogram(s) establishments
collectively earn around P600 Million per annum from rentals, sales and disposition of
videograms, and these earnings have not been subjected to tax, thereby depriving the
Government of approximately P180 Million in taxes each year. The unregulated activities of
videogram establishments have also affected the viability of the movie industry.
Petitioner's attack on the constitutionality rests on the following grounds:
1. Section 10 thereof, which imposes a tax of 30% on the gross receipts payable to the local
government is a RIDER and the same is not germane to the subject matter thereof;
2. The tax imposed is harsh, confiscatory, oppressive and/or in unlawful restraint of trade in
violation of the due process clause of the Constitution;
3. There is no factual nor legal basis for the exercise by the President of the vast powers
conferred upon him by Amendment No. 6;
4. There is undue delegation of power and authority;
5. The Decree is an ex-post facto law; and
6. There is over regulation of the video industry as if it were a nuisance, which it is not.
ISSUE: W/N the tax imposed by the DECREE is a valid exercise of police power. (Consti: W/N
it is constitutional.)
HELD:
The public purpose of a tax may legally exist even if the motive which impelled the legislature
1 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
tax does not cease to be valid merely because it regulates, discourages, or even definitely
deters the activities taxed. The power to impose taxes is one so unlimited in force and so
searching in extent, that the courts scarcely venture to declare that it is subject to any
restrictions whatever, except such as those rest in the discretion of the authority which
exercises it. In imposing a tax, the legislature acts upon its constituents. This is, in general, a
sufficient security against erroneous and oppressive taxation. Taxation has been made the
implement of the state's police power. The levy of the 30% tax is for a public purpose. It
was imposed primarily to answer the need for regulating the video industry, particularly
because of the rampant film piracy, the flagrant violation of intellectual property rights, and
the proliferation of pornographic video tapes. And while it was also an objective of the
DECREE to protect the movie industry, the tax remains a valid imposition.
There is no clear violation of the Constitution which would justify us in pronouncing PD No.
1987 as unconstitutional and void. While the underlying objective of the DECREE is to
protect the moribund movie industry, there is no question that public welfare is at bottom of
its enactment, considering "the unfair competition posed by rampant film piracy; the erosion
of the moral fiber of the viewing public brought about by the availability of unclassified and
unreviewed video tapes containing pornographic films and films with brutally violent
sequences; and losses in government revenues due to the drop in theatrical attendance, not
to mention the fact that the activities of video establishments are virtually untaxed since
mere payment of Mayor's permit and municipal license fees are required to engage in
business."
The tax imposed by the DECREE is not only a regulatory but also a revenue measure prompted
by the realization that earnings of videogram establishments of around P600 million per
annum have not been subjected to tax, thereby depriving the Government of an additional
source of revenue. It is an end-user tax, imposed on retailers for every videogram they make
available for public viewing. It is similar to the 30% amusement tax imposed or borne by the
movie industry which the theater-owners pay to the government, but which is passed on to
the entire cost of the admission ticket, thus shifting the tax burden on the buying or the
viewing public. It is a tax that is imposed uniformly on all videogram operators. It is inherent
in the power to tax that a state be free to select the subjects of taxation, and it has been
repeatedly held that "inequities which result from a singling out of one particular class for
taxation or exemption infringe no constitutional limitation". Taxation has been made the
implement of the state's police power. At bottom, the rate of tax is a matter better addressed
to the taxing legislature.
The DECREE is not violative of the ex post facto principle. An ex post facto law is, among other
categories, one which "alters the legal rules of evidence, and authorizes conviction upon less
or different testimony than the law required at the time of the commission of the offense."
Applied to the challenged provision, there is no question that there is a rational connection
between the fact proved, which is non-registration, and the ultimate fact presumed which is
violation of the DECREE, besides the fact that the prima facie presumption of violation of the
DECREE attaches only after a forty-five-day period counted from its effectivity and is,
therefore, neither retrospective in character.
LUTZ v. ARANETA
FACTS:
Due to the threat to industry by the imminent imposition of export taxes upon sugar as
provided in the Tydings-McDuffe Act, and the "eventual loss of its preferential position in the
United States market"; the National Assembly promulgated Commonwealth Act No. 567,
otherwise known as the Sugar Adjustment Act "to obtain a readjustment of the benefits
derived from the sugar industry by the component elements thereof" and "to stabilize the
sugar industry so as to prepare it for the eventuality of the loss of its preferential position in
the United States market and the imposition of the export taxes."
In section 2, Commonwealth Act 567 provides for an increase of the existing tax on the
manufacture of sugar, on a graduated basis, on each picul of sugar manufactured; while
section 3 levies on owners or persons in control of lands devoted to the cultivation of sugar
cane and ceded to others for a consideration, on lease or otherwise — a tax equivalent to the
difference between the money value of the rental or consideration collected and the amount
representing 12 per centum of the assessed value of such land. Plaintiff, Walter Lutz, in his
capacity as Judicial Administrator of the Intestate Estate of Antonio Jayme Ledesma, seeks to
recover from the Collector of Internal Revenue the sum of P14,666.40 paid by the estate as
taxes, under Sec.3 of the Act, alleging that such tax is unconstitutional and void, being levied
for the aid and support of the sugar industry exclusively, which in plaintiff’s opinion is not a
public purpose for which a tax may be constitutionally levied. The action has been dismissed
by the Court of First Instance.
ISSUE: W/N the tax imposed is constitutional.
HELD:
Yes. It is inherent in the power to tax that a state be free to select the subjects of taxation, and
it has been repeatedly held that “inequalities which result from a singling out of one particular
class for taxation or exemption infringe no constitutional limitation.” Taxation may be made
the implement of the state's police power. The funds raised under the Act should be
exclusively spent in aid of the sugar industry, since it is that very enterprise that is being
protected. It may be that other industries are also in need of similar protection; but the
legislature is not required by the Constitution to adhere to a policy of “all or none.”
CIR v. ALGUE
FACTS:
Algue Inc. is a domestic corp engaged in engineering, construction and other allied activities.
The Philippine Sugar Estate Development Company had earlier appointed Algue as its agent,
authorizing it to sell its land, factories and oil manufacturing process. Pursuant to such
authority, Alberto Guevara, Jr., Eduardo Guevara, Isabel Guevara, Edith, O'Farell, and Pablo
Sanchez, worked for the formation of the Vegetable Oil Investment Corporation, inducing
other persons to invest in it. Ultimately, after its incorporation largely through the promotion
of the said persons, this new corporation purchased the PSEDC properties. For this sale, Algue
received as agent a commission of P125, 000.00. From this amount, Algue Inc. paid the five
family members P75,000 as promotional fees. Algue, Inc. declared this P75,000 as a deduction
from its income tax as a legitimate business expense.
On Jan. 14, 1965, the corp received a letter from the CIR regarding its delinquency income
taxes from 1958-1959, amtg to P83,183.85. A letter of protest or reconsideration was filed by
Algue Inc on Jan 18. On March 12, a warrant of distraint and levy was presented to Algue Inc.
thru its counsel, Atty. Guevara, who refused to receive it on the ground of the pending protest.
Since the protest was not found on the records, a file copy from the corp was produced and
given to BIR Agent Reyes, who deferred service of the warrant. On April 7, Atty. Guevara was
informed that the BIR was not taking any action on the protest and it was only then that he
accepted the warrant of distraint and levy earlier sought to be served. On April 23, Algue filed
a petition for review of the decision of the CIR with the Court of Tax Appeals.
CIR contends that the deduction of P75,000.00 was properly disallowed because it was not an
ordinary reasonable or necessary business expense. CIR also claims that payments are
fictitious because most of the payees are members of the same family in control of Algue and
that there is not enough substantiation of such payments. However, the CTA said that the 75K
had been legitimately paid by Algue Inc. for actual services rendered in the form of
2 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
promotional fees. These were collected by the Payees for their work in the creation of the
Vegetable Oil Investment Corporation of the Philippines and its subsequent purchase of the
properties of the Philippine Sugar Estate Development Company.
ISSUE: W/N the P75,000 is tax-deductible as a legitimate business expense of Algue, Inc.
HELD:
Yes, the P75,000 promotional fee is tax-deductible. “Sec. 30: allowed deductions in the net
income – Expenses - All the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business, including a reasonable allowance for
salaries or other compensation for personal services actually rendered xxx”
Sec. 30 of the Tax Code provides that ordinary and necessary expenses incurred during the
taxable year in carrying on any trade or business, including a reasonable allowance for
salaries or other compensation for personal services actually rendered are tax-deductible.
However, the burden in proving the validity of a claimed deduction belongs to the taxpayer. In
this case, the burden has been satisfactorily discharged by the taxpayer Algue, Inc. Algue, Inc.
was able to prove that the promotional fees were not fictitious and were in fact paid
periodically to the five family members. Moreover, the amount of the promotional fees was
reasonable, considering that the five payees actually performed a service for Algue, Inc. by
making the sale of the properties of PSEDC possible. As a result of this sale, Algue, Inc. earned
a net commission of P50,000. The amount of P75,000.00 was 60% of the total commission.
This was a reasonable proportion, considering that it was the payees who did practically
everything, from the formation of the Vegetable Oil Investment Corporation to the actual
purchase by it of the Sugar Estate properties.
Taxes are what we pay for civilized society. Without taxes, the government would be
paralyzed for lack of the motive power to activate and operate it. Hence, despite the natural
reluctance to surrender part of one’s hard-earned income, every person who is able to must
contribute his share in running the government. The government, for its part, is expected to
respond in the form of BENEFITS for general welfare. This symbiotic relationship is the
rationale of taxation and should dispel the erroneous notion that it is an arbitrary exaction by
those in the seat of power. However, it should also be exercised reasonably and in accordance
with the prescribed procedure. If it is not, the taxpayer has a right to complain to the courts.
For all the awesome power of the tax collector, he may still be stopped in his tracks if the
taxpayer can demonstrate, as it has here, that the law has not been observed. Herein, the
claimed deduction (pursuant to Section 30[a] [1] of the Tax Code and Section 70 [1] of
Revenue Regulation 2: as to compensation for personal services) had been legitimately by
Algue Inc.
MACTAN CEBU (MCIAA) v. MARCOS
FACTS:
Petitioner Mactan Cebu International Airport Authority (MCIAA) was created by virtue of
Republic Act No. 6958, mandated to "principally undertake the economical, efficient and
effective control, management and supervision of the Mactan International Airport in the
Province of Cebu and the Lahug Airport in Cebu City, . . . and such other Airports as may be
established in the Province of Cebu . .. . (Sec. 3, RA 6958). Since the time of its creation
petitioner MCIAA enjoyed the privilege of exemption from payment of realty taxes in
accordance with Section 14 of its Charter.
On October 11, 1994, however, Mr. Eustaquio B. Cesa, Officer-in-Charge, Office of the
Treasurer of the City of Cebu, demanded payment for realty taxes on several parcels of land
belonging to the petitioner. Petitioner objected to such demand for payment as baseless and
unjustified, claiming in its favor the aforecited Section 14 of RA 6958 which exempt it from
payment of realty taxes. It was also asserted that it is an instrumentality of the government
performing governmental functions, citing section 133 of the Local Government Code of 1991
which puts limitations on the taxing powers of local government units. Respondent City
refused to cancel and set aside petitioner's realty tax account, insisting that the MCIAA is a
government-controlled corporation whose tax exemption privilege has been withdrawn by
virtue of Sections 193 and 234 of the Local Governmental Code that took effect on January 1,
1992. The trial court dismissed the petitioner ruling that the LGC withdrew the tax exemption
granted the GOCCs.
ISSUE: W/N the City of Cebu has the power to impose taxes on petitioner
HELD:
As a general rule, the power to tax is an incident of sovereignty and is unlimited in its range,
acknowledging in its very nature no limits, so that security against its abuse is to be found
only in the responsibility of the legislature which imposes the tax on the constituency who are
to pay it. Nevertheless, effective limitations thereon may be imposed by the people through
their Constitutions. Our Constitution, for instance, provides that the rule of taxation shall be
uniform and equitable and Congress shall evolve a progressive system of taxation. So potent
indeed is the power that it was once opined that “the power to tax involves the power to
destroy.” Verily, taxation is a destructive power which interferes with the personal and
property for the support of the government. Accordingly, tax statutes must be construed
strictly against the government and liberally in favor of the taxpayer. But since taxes are what
we pay for civilized society, or are the lifeblood of the nation, the law frowns against
exemptions from taxation and statutes granting tax exemptions are thus construed
strictissimi juris against the taxpayers and liberally in favor of the taxing authority. A claim of
exemption from tax payment must be clearly shown and based on language in the law too
plain to be mistaken. Elsewise stated, taxation is the rule, exemption therefrom is the
exception.
However, if the grantee of the exemption is a political subdivision or instrumentality, the rigid
rule of construction does not apply because the practical effect of the exemption is merely to
reduce the amount of money that has to be handled by the government in the course of its
operations. The power to tax is primarily vested in the Congress; however, in our jurisdiction,
it may be exercised by local legislative bodies, no longer merely by virtue of a valid delegation
as before, but pursuant to direct authority conferred by Section 5, Article X of the Constitution.
22 Under the latter, the exercise of the power may be subject to such guidelines and
limitations as the Congress may provide which, however, must be consistent with the basic
policy of local autonomy. There can be no question that under Section 14 of R.A. No. 6958 the
petitioner is exempt from the payment of realty taxes imposed by the National Government or
any of its political subdivisions, agencies, and instrumentalities. Nevertheless, since taxation is
the rule and exemption therefrom the exception, the exemption may thus be withdrawn at the
pleasure of the taxing authority. The only exception to this rule is where the exemption was
granted to private parties based on material consideration of a mutual nature, which then
becomes contractual and is thus covered by the non-impairment clause of the Constitution.
The LGC, enacted pursuant to Section 3, Article X of the constitution provides for the exercise
by local government units of their power to tax, the scope thereof or its limitations, and the
exemption from taxation. Section133 of the LGC prescribes the common limitations on the
taxing powers of LGUs: (o) Taxes, fees or chargeso f any kind on the national government, its
agencies and instrumentalities and LGUs. Among the “taxes” enumerated in the LGC is real
property tax. Section 234 of LGC provides for the exemptions from payment of GOCCs, except
as provided therein. On the other hand, the LGC authorizes LGUs to grant tax exemption
privileges. Reading together Section 133, 232 and 234 of the LGC, we conclude that as a
general rule, as laid down in Secs 133 the taxing powers of LGUs cannot extend to the levy of
inter alia, “taxes, fees, and charges of any kind of the National Government, its agencies and
instrumentalities, and LGUs”; however, pursuant to Sec 232, provinces, cities, municipalities
3 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
in the Metropolitan Manila Area may impose the real property tax except on, inter alia, “real
property owned by the Republic of the Philippines or any of its political subdivisions except
when the beneficial used thereof has been granted to a taxable person.”
As to tax exemptions or incentives granted to or presently enjoyed by natural or juridical
persons, including government-owned and controlled corporations, Section 193 of the LGC
prescribes the general rule, viz., they are withdrawn upon the effectivity of the LGC, except
upon the effectivity of the LGC, except those granted to local water districts, cooperatives duly
registered under R.A. No. 6938, non stock and non-profit hospitals and educational
institutions, and unless otherwise provided in the LGC. The latter proviso could refer to
Section 234, which enumerates the properties exempt from real property tax. But the last
paragraph of Section 234 further qualifies the retention of the exemption in so far as the real
property taxes are concerned by limiting the retention only to those enumerated there-in; all
others not included in the enumeration lost the privilege upon the effectivity of the LGC.
Moreover, even as the real property is owned by the Republic of the Philippines, or any of its
political subdivisions covered by item (a)of the first paragraph of Section 234, the exemption
is withdrawn if the beneficial use of such property has-been granted to taxable person for
consideration or otherwise. Since the last paragraph of Section 234 unequivocally withdrew,
upon the effectivity of the LGC, exemptions from real property taxes granted to natural or
juridical persons, including GOCCs, except as provided in the said section, and the petitioner is,
undoubtedly, a government-owned corporation, it necessarily follows that its exemption from
such tax granted it in Section 14 of its charter, R.A. No. 6958, has been withdrawn. Any claim
to the contrary can only be justified if the petitioner can seek refuge under any of the
exceptions provided in Section 234, but not under Section 133, as it now asserts, since, as
shown above, the said section is qualified by Section 232 and 234. In short, the petitioner can
no longer invoke the general rule in Section 133.It must show that the parcels of land in
question, which are real property, are any one of those enumerated in Section 234, either by
virtue of ownership, character, or use of the property.
If Section 234(a) intended to extend the exception therein to the withdrawal of the exemption
from payment of real property taxes under the last sentence of the said section to the agencies
and instrumentalities of the National Government mentioned in Section 133(o), then it should
have restated the wording of the latter. Yet, it did not Moreover, that Congress did not wish to
expand the scope of the exemption in Section 234(a) to include real property owned by other
instrumentalities or agencies of the government including government-owned and controlled
corporations is further borne out by the fact that the source of this exemption is Section 40(a)
of P.D. No. 646, otherwise known as the Real Property TaxCode. Note that as a reproduced in
Section 234(a), the phrase “and any government-owned or controlled corporation so exempt
by its charter” was excluded. The justification for this restricted exemption in Section 234(a)
seems obvious: to limit further tax exemption privileges, especially in light of the general
provision on withdrawal of exemption from payment of real property taxes in the last
paragraph of property taxes in the last paragraph of Section 234.
The power to tax is the most effective instrument to raise needed revenues to finance and
support myriad activities of local government units for the delivery of basic services essential
to the promotion of the general welfare and the enhancement of peace, progress, and
prosperity of the people. It may also be relevant to recall that the original reasons for the
withdrawal of tax exemption privileges granted to government-owned and controlled
corporations and all other units of government were that such privilege resulted in serious tax
base erosion and distortions in the tax treatment of similarly situated enterprises, and there
was a need for this entities to share in the requirements of the development, fiscal or
otherwise, by paying the taxes and other charges due from them.
Petitioner cannot claim that it was never a “taxable person” under its Charter. It was only
exempted from the payment of real property taxes. The grant of the privilege only in respect
of this tax is conclusive proof of the legislative intent to make it a taxable person subject to all
taxes, except real property tax. Finally, even if the petitioner was originally not a taxable
person for purposes of real property tax, in light of the forgoing disquisitions, it had already
become even if it be conceded to be an “agency” or “instrumentality” of the Government, a
taxable person for such purpose in view of the withdrawal in the last paragraph of Section 234
of exemptions from the payment of real property taxes, which, as earlier adverted to, applies
to the petitioner. Accordingly, the position taken by the petitioner is untenable. Reliance on
Basco vs. Pagcor is unavailing since it was decided before the effectivity of the LGC. Besides,
nothing can prevent Congress from decreeing that even instrumentalities or agencies of the
government performing governmental functions may be subject to tax. Where it is done
precisely to fulfill a constitutional mandate and national policy, no one can doubt its wisdom.
MANILA RAILROAD COMPANY v. INSULAR COLLECTOR OF CUSTOMS
FACTS:
Dust shields are manufactured of wool and hair mixed. The component material of chief value
is the wool. They are used by the Manila Railroad Company on all of its railway wagons. The
purpose of the dust shield is to cover the axle box in order to protect from dust the oil
deposited therein which serves to lubricate the bearings of the wheel. "Dust guard," which is
the same as "dust shield," is defined: "A this piece of wood, leather, felt, asbestos or other
material inserted in the dust guard chamber at the back of a journal box, and fitting closely
around the dust guard bearing of the axle.
Its purpose is to exclude dust and to prevent the escape of oil and waste. Sometimes called
axle packing or box packing." Insular Collector of Customs said that dust shields should be
classified as "manufactures of wool, not otherwise provided for." based on para 141 of tariff
law. Plaintiff argued that it should be classified under 197 w/c grants a lower tax imposition
ISSUE: How should dust shields be classified for the purposes of the tariff, under paragraph
141 or under paragraph 197 of section 8 of the Tariff Law of 1909?
HELD:
PARS: 141. Manufactures of wool not otherwise provided for, forty per centum ad valorem
197. Vehicles for use on railways and tramways, and detached parts thereof, ten per centum
ad valorem.
The burden is upon the importer to overcome the presumption of a legal collection of duties
by proof that their exaction was unlawful. The question to be decided is not whether the
Collector was wrong but whether the importer was right. His Honor, Judge Simplicio del
Rosario, took an opposite view, overruled the decision of the Collector of Customs, and held
that dust shields should be classified as "detached parts" of vehicles for the use on railways. It
is the general rule in the interpretation of statutes levying taxes or duties not to extend their
provisions beyond the clear import of the language used. In every case of doubt, such statutes
are construed most strongly against the Government and in favor of the citizen, because
burdens are not to be imposed, nor presumed to be imposed, beyond what the statutes
expressly and clearly import. There are present two fundamental considerations which guide
the way out of the legal dilemma. The first is by taking into account the purpose of the article
and then acknowledging that it is in reality used as a detached part or railways vehicles. The
second point is that paragraph 141 is a general provision while paragraph 197 is a special
provision. Where there is in the same statute a particular enactment and also a general one
which is embraced in the former, the particular enactment must be operative, and the general
enactment must be taken to effect only such cases within its general language as are not
within the provisions of the particular enactment. Trial judge was correct in classifying dust
shields under paragraph 197 of section 8 of the Tariff Law of 1909, and in refusing to classify
them under paragraph 141 of the same section of the law.
4 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
CIR v. FIREMAN’S FUND INSURANCE
FACTS:
Fireman’s Fund Insurance Company is a resident foreign insurance corporation organized
under the laws of the United States, authorized and duly licensed to do business in the
Philippines. It is a member of the American Foreign Insurance Association, through which its
business is cleared. From January 1952 to December 1958, Fireman’s Fund entered into
various insurance contracts involving casualty, fire and marine risks, for which the
corresponding insurance policies were issued. From January 1952 to 1956, documentary
stamps were bought and affixed to the monthly statements of policies issued; and from 1957
to 1958 documentary stamps were bought and affixed to the corresponding pages of the
policy register, instead of on the insurance policies issued.
On 3 July 1959, the company discovered that its monthly statements of business and policy
register were lost. The loss was reported to the Building Administration of Ayala Building and
the National Bureau of Investigation on 6 July 1959. The Commissioner of Internal Revenue
was also informed of such loss by the company, through the latter’s auditors, Sycip, Gorres
and Velayo, in a letter dated 14 July 1959. After conducting an investigation of said loss, the
company’s examiner’s examiner ascertained that the company failed to affix the required
documentary stamps to the insurance policies issued by it and failed to preserve its
accounting records within the time prescribed by Section 337 of the Revenue Code by using
loose leaf forms as registers of documentary stamps without written authority from the
Commissioner as required by Section 4 of Revenue Regulations V-1.
As a consequence of these findings, the Commissioner, in a letter dated 7 December 1962,
assessed and demanded from petitioner the payment of documentary stamp taxes for the
years 1952 to 1958 in the total amount of P79,806.87 and plus compromise penalties, a total
of P81,406.87. The compromise penalties consisted of the sum of P1,000.00 as penalty for the
alleged failure to affix documentary stamps and the further sum of P600.00 as penalty for an
alleged violation of Revenue Regulations V-1 otherwise known as the Bookkeeping
Regulations. In a letter dated 14 January 1963, the company contested the assessment. After
the Commissioner denied the protest in a decision dated 17 March 1965, the company
appealed to the Court of Tax Appeals on 8 May 1965 (CTA Case 1629). After hearing the court
rendered its decision dated 24 May 1969 reversing the decision of the Commissioner of
Internal Revenue. Hence, the petition filed on 26 June 1969. The Supreme Court resolved to
dismiss the petition and to affirm the assailed decision of the Court of Tax Appeals.
ISSUE: W/N the CIR may impose and require the payment of the subject stamp tax for the
documents in question
HELD:
The affixture of documentary stamps to papers other than those authorized by law is not
tantamount to failure to pay the same. It is true that the mode of affixing the stamps as
prescribed by law was not followed, but the fact remains that the documentary stamps
corresponding to the various insurance policies were purchased and paid by the company.
There is no legal justification for the Commissioner to require the company to pay again the
documentary stamp tax which it had already paid. To sustain the Commissioner’s stand would
require the company to pay the same tax twice. If at all, the company should be proceeded
against for failure to comply with the requirement of affixing the documentary stamps to the
taxable insurance policies and not for failure to pay the tax. (See Sec. 239 and 332, Rev. Code).
With respect to the ‘compromise penalties’ in the total sum of P1,600.00, the penalties cannot
be imposed in the absence of a showing that the company consented thereto. A compromise
implies agreement. If the offer is rejected by the taxpayer, the Commissioner cannot enforce it
except through a criminal action. Section 210 of the National Internal Revenue Code provides
“Upon documents, instruments, and papers, and upon acceptances, assignments, sales, and
transfers of the obligation, right, or property incident thereto, there shall be levied, collected
and paid, for and in respect of the transaction so had or accomplished, the corresponding
documentary stamp taxes prescribed in the following sections of this Title, by the person
making, signing, issuing, accepting, or transferring the same, and at the same time such act is
done or transaction had.”
Section 232 of the National Internal Revenue Code provides “On all policies of insurance or
other instruments by whatever name the same may be called, whereby any insurance shall
be made or renewed upon any life or lives, there shall be collected a documentary stamp tax
of thirty-five centavos on each two hundred pesos or fractional part thereof, of the amount
issued by any such policy. (220) (As amended by PD 1457). Insurance policies issued by a
Philippine company to persons in other countries are not subject to documentary stamp
tax. (Rev. Regs. 26). Medical certificate attached to an insurance policy is not a part of the
said policy. Insurance policy is subject to Section 232 of the Tax Code while medical
certificate is taxable under Section 237 of the same Code. Insurance policies are issued in
the place where delivered to the person insured.”
Section 221 of the National Internal Revenue Code provides “On all policies of insurance or
other instruments by whatever name the same may be called, by which insurance shall be
made or renewed upon property of any description, including rents or profits, against peril by
sea or on inland waters, or by fire or lightning, there shall be collected a documentary stamp
tax of six centavos on each four persons, or fractional part thereof, of the amount of premium
charged.”
Section 237 of the National Internal Revenue Code provides “Documentary stamp taxes shall
be paid by the purchase and affixture of documentary stamps to the document or instrument
taxed or to such other paper as may be indicated by law or regulations as the proper
recepient of the stamp, and by the subsequent cancellation of same, such cancellation to be
accomplished by writing, stamping, or perforating the date of the cancellation across the face
of each stamp in such manner that part of the writing, impression, or perforation shall be on
the stamp itself and part on the paper to which it is attached; Provided, That if the
cancellation is accomplished by writing or stamping the date of cancellation, a hole
sufficiently large to be visible to the naked eye shall be punched, cut or perforated on both
the stamp and the document either by the use of a hand punch, knife, perforating machine,
scissors, or any other cutting instrument but if the cancellation is accomplished by
perforating the date of cancellation, no other hole need be made on the stamp.” (
Section 239 of the National Internal Revenue Code provides “Any person who fails to affix the
correct amount of documentary stamps to any taxable document, instrument, or paper, or to
cancel in the manner prescribed by section 237 any documentary stamp affixed to any
document, instrument, or paper, shall be subject to a fine of not less than twenty pesos or
more than three hundred pesos. (Now Sec. 250.)
Documentary tax is deemed paid by: (a) the purchase of documentary stamps; (b) affixture of
documentary stamps to the document or instrument taxed or to such other paper as may be
indicated by law or regulations; and (c) cancellation of the stamps as required by law.
The over-riding purpose of these provisions of law is the collection of taxes. The three steps
involving documentary stamps are but the means to that end. Thus, the purchase of the
stamps is the form of payment made; the affixture thereof on the document or instrument
taxed is to insure that the corresponding tax has been paid for such document while the
cancellation of the stamps is to obviate the possibility that said stamps will be reused for
similar documents for similar purposes. In the present case, there appears to be no dispute on
the fact that the documentary stamps corresponding to the various policies were purchased
and paid for by the Company. Neither is there any argument that the same were cancelled as
required by law. This conclusion are also the findings of the Commissioner’s examiner
5 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(Amando B. Melgar), and confirmed by the Memorandum of Acting Commissioner of Internal
Revenue Jose B. Lingad, dated 7 November 1962 to the Chief of Business Tax Division. The
purchase of documentary stamps and their being affixed to the monthly statements of
business and policy registers were also admitted by counsel for the Government as could
clearly be gleaned from his Memorandum submitted to the Court of Tax Appeals. Simply said,
the purpose of imposing documentary stamp taxes is to raise revenue and the corresponding
amount has already been paid by the company and has actually become part of the revenue of
the government.
The insurance policies with the corresponding documentary stamps affixed are the best
evidence to prove payment of said documentary stamp tax. This rule however does not
preclude the admissibility of other proofs which are uncontradicted and of considerable weight,
such as: copies of the applications for manager’s checks, copies of the manager’s check
vouchers of the bank showing the purchases of documentary stamps corresponding to the
various insurance policies issued, in the present case, during the years 1952-1958 duly and
properly identified by the witnesses for the company during the hearing and admitted by the
Court of Tax Appeals. It is a general rule in the interpretation of statutes levying taxes or duties,
that in case of doubt, such statutes are to be construed most strongly against the government
and in favor of the subjects or citizens, because burdens are not to be imposed, nor presumed
to be imposed beyond what statutes expressly and clearly import.
The affixture of the stamps on documents not authorized by law is not attended by bad faith
as the practice was adopted from the authority granted to Wise & Company, one of the
company’s general agents. Indeed, the Commissioner argued that such authority was not
given to the company specifically, but under the general principle of agency, where the acts
of the agents bind the principal, the conclusion is inescapable that the justification for the
acts of the agents may also be claimed for the acts of the principal itself. There is no
justification for the government which has already realized the revenue which is the object
of the imposition of subject stamp tax, to require the payment of the same tax for the same
documents. Enshrined in our basic legal principles is the time honored doctrine that no
person shall unjustly enrich himself at the expense of another. It goes without saying that the
government is not exempted from the application of this doctrine.
SEA LAND SERVICES v. CIR
FACTS:
Sea-Land Service Incorporated (SEA-LAND), an American international shipping company
licensed by the Securities and Exchange Commission to do business in the Philippines entered
into a contract with the United States Government to transport military household goods and
effects of U. S. military personnel assigned to the Subic Naval Base. From the aforesaid
contract, SEA-LAND derived an income for the taxable year 1984 amounting to
P58,006,207.54. During the taxable year in question, SEA-LAND filed with the Bureau of
Internal Revenue (BIR) the corresponding corporate Income Tax Return (ITR) and paid the
income tax due thereon of 1.5% as required in Section 25 (a) (2) of the National Internal
Revenue Code (NIRC) in relation to Article 9 of the RP-US Tax Treaty, amounting to
P870,093.12. Claiming that it paid the aforementioned income tax by mistake, a written claim
for refund was filed with the BIR on 15 April 1987. However, before the said claim for refund
could be acted upon by public respondent Commissioner of Internal Revenue, petitioner-
appellant filed a petition for review with the CTA docketed as CTA Case No. 4149, to judicially
pursue its claim for refund and to stop the running of the two-year prescriptive period under
the then Section 243 of the NIRC. On 21 February 1995, CTA rendered its decision denying
SEA-LAND’s claim for refund of the income tax it paid in 1984. Petitioner appealed, CA
affirmed.
ISSUE: W/N the income that petitioner derived from services in transporting the household
goods and effects of U. S. military personnel falls within the tax exemption provided in Article
XII, paragraph 4 of the RP-US Military Bases Agreement.
HELD:
The RP-US Military Bases Agreement provides:
“No national of the United States, or corporation organized under the laws of the United
States, resident in the United States, shall be liable to pay income tax in the Philippines in
respect of any profits derived under a contract made in the United States with the government
of the United States in connection with the construction, maintenance, operation and defense
of the bases, or any tax in the nature of a license in respect of any service or work for the
United States in connection with the construction, maintenance, operation and defense of the
bases.”
“Laws granting exemption from tax are construed strictissimi juris against the taxpayer and
liberally in favor of the taxing power. Taxation is the rule and exemption is the exception.”
The law “does not look with favor on tax exemptions and that he who would seek to be thus
privileged must justify it by words too plain to be mistaken and too categorical to be
misinterpreted.”
Under Article XII (4) of the RP–US Military Bases Agreement, the Philippine Government
agreed to exempt from payment of Philippine income tax nationals of the United States, or
corporations organized under the laws of the United States, residents in the United States in
respect of any profit derived under a contract made in the United States with the Government
of the United States in connection with the construction, maintenance, operation and defense
of the bases. It is obvious that the transport or shipment of household goods and effects of U.
S. military personnel is not included in the term “construction, maintenance, operation and
defense of the bases.” Neither could the performance of this service to the U. S. government be
interpreted as directly related to the defense and security of the Philippine territories. “When
the law speaks in clear and categorical language, there is no reason for interpretation or
construction, but only for application.” Any interpretation that would give it an expansive
construction to encompass petitioner’s exemption from taxation would be unwarranted. The
avowed purpose of tax exemption “is some public benefit or interest, which the lawmaking
body considers sufficient to offset the monetary loss entailed in the grant of the exemption.”
The hauling or transport of household goods and personal effects of U. S. military personnel
would not directly contribute to the defense and security of the Philippines.
MACEDA v. MACARAIG
FACTS:
Commonwealth Act 120 created NAPOCOR as a public corporation to undertake the
development of hydraulic power and the production of power from other sources. RA 358
(1949) granted NAPOCOR tax and duty exemption privileges. RA 6395 (1971) revised the
charter of the NAPOCOR, tasking it to carry out the policy of the national electrification, and
provided in detail NAPOCOR’s tax exceptions. PD 380 (1974) specified that NAPOCOR’s
exemption includes all taxes, etc. imposed “directly or indirectly.” PD 938 integrated the
exemptions in favor of GOCCs including their subsidiaries; however, empowering the
President or the Minister of Finance, upon recommendation of the Fiscal Incentives Review
Board (FIRB) to restore, partially or completely, the exemptions withdrawn or revised.
Since May 27, 1976 (when PD 938 was issued) until June 11, 1984 when PD 1931 was
promulgated (abolishing the tax exemptions of all GOCCs), oil firms never paid excise or specific
and ad valorem taxes for petroleum products sold and delivered to the NPC. This nonpayment
of taxes spanned for 8 years. The oil companies started to pay specific and ad valorem taxes on
their sales of oil products to NPC only after the promulgation of PD 1931 in 1984 w/c withdrew
all exemptions granted in favor of GOCCs and empowering the Fiscal Incentives Review Board
6 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(FIRB) to recommend to the President or to the Minister of Finance the restoration of the
exemptions which were withdrawn. FIRB issued Resolution 10-85 w/c restored the tax
exemption privileges of NPC effective retroactively to June 11, 1984 up to June 30, 1985.
Thus, the NPC applied with the BIR for a refund of Specific Taxes paid on petroleum products
in the total amount of about P58k+. Maceda, Senate member, introduced Resolution 22 w/c
was aimed at conducting an inquiry in aid of legislation in line w/ the reported tax
manipulations and evasions by oil companies (particularly Caltex, Shell and Petrophil) by
availing of their nonexisting exemption of NPC from indirect taxes, w/c resulted in obtaining a
tax refund totaling P1.55 Billion from the Department of Finance. specific and ad valorem
taxes on their sales of oil products to NAPOCOR only in 1984. NAPOCOR claimed for a refund
(P468.58 million). Only portion thereof, corresponding to Caltex, was approved and released
by way of a tax credit memo. The claim for refund of taxes paid by PetroPhil, Shell and Caltex
amounting to P410.58 million was denied. NAPOCOR moved for reconsideration, starting that
all deliveries of petroleum products to NAPOCOR are tax exempt, regardless of the period of
delivery.
The Blue Ribbon Committee conducted a lengthy formal inquiry on the matter and
recommended that the tax refund to NPC be cancelled, and also to cancel the approval of deed
of Assignment by NPC to Caltex, and collect from Caltex its tax liabilities which were
erroneously treated as paid or settled with the use of the tax credit certificate that NPC
assigned to said firm. Maceda contended that the exemption of NPC from INDIRECT TAXATION
was revoked and repealed by the latest amendment to the NPC charter by PD 938, by the
deletion of the phrases “directly or indirectly” and “on all petroleum products used by the
Corporation in the generation, transmission, utilization and sale of electric power” The
exemption of NPC provided in Section of PD 938 regarding the payments of “all forms of taxes,
etc” cannot be interpreted to include indirect tax exception since tax statutes must be strictly
construed against the one claiming the exemption must be strictly construed against the one
claiming the exemption
ISSUE: W/N NPC is liable for indirect tax
HELD:
No, NPC is NOT liable for indirect tax. The NPC is exempted to pay indirect taxes. The court
distinguish direct tax from indirect tax.
a. Direct Tax Ñ that where the person supposed to pay the tax really pays it. WITHOUT
transferring the burden to someone else.
b. Indirect Tax Ñ that where the tax is imposed upon goods BEFORE reaching the consumer
who ultimately pays for it, not as a tax, but as a part of the purchase price.
Indirect taxes are taxes primarily paid by persons who can shift the burden upon someone else.
For example, the excise and ad valorem taxes that oil companies pay to the BIR upon removal of
petroleum products from its refinery can be shifted to its buyer, like the NPC, by adding them to
the “cash” and/or “selling price”. In interpreting a statute, legislative intent must be ascertained
-- the reason for its enactment should be kept in mind and the statute should be construed with
reference to its intended purpose + the evil sought to be remedied. In this case, NPC is a non-
profit public corporation created for the general good and welfare (development of
hydroelectric generation of power and production of electricity from other sources) wholly
owned by the government. From the very beginning of its corporate existence, the NPC enjoyed
preferential tax treatment to enable the Corporation to pay the indebtedness and obligation
and in furtherance and effective implementation of the policy enunciated in Sec 1 of RA 6395.
From the changes made in the NPC charter, the intention to strengthen its preferential tax
treatment is obvious.
In the earlier law, RA 358 the exemptions was worded in general terms, as to cover “all taxes,
duties, fees, imposts, charges, etc” However, the amendment under RA 6395 enumerated the
details covered by the exemption. Subsequently, PD 380, made even more specific the details
of the exemption of NPC to cover, among others, both direct and indirect on all petroleum
products used in its operation. PD 938 amended the tax exemption by simplifying the same
law in general terms. It succinctly exempts NPC from “all forms of taxes, duties, fees, imposts”
as well as costs and service fees including filing fees, appeal bonds, supersede as bonds, in any
court or administrative proceedings.” The use of the phrase “all forms” of taxes demonstrates
the intention of the law to give NPC all the tax exemptions. Provisions granting exemptions
to government agencies may be construed liberally, in favor of non-tax liability of such
agencies. Thus, the rule that tax exemptions should be strictly construed is NOT applicable to
NPC. The practical effect of an exemption is merely to reduce the amount of money that has
to be handled by government in the course of its operations. In the case of property owned
by the state or a city or other public corporations, the express exemption should not be
construed with the same degree of strictness that applies to exemptions contrary to the
policy of the state, since as to such property "exemption is the rule and taxation the
exception."
MACEDA V MACARAIG MR (EXTRA): Unfazed by the Decision that the SC decision, Maceda filed
a motion for reconsideration in the SC. In the process, a hearing was held on July 9, 1992
where all parties presented their respective arguments. However, the MR was denied.
What kind of tax exemption privileges does NPC have? Maceda contended that PD 938
repealed the indirect tax exemption of NPC as the phrase "all forms of taxes etc.," in its section
10, amending Section 13, R.A. No. 6395, as amended by P.D. No. 380, does not expressly
include "indirect taxes." The SC does not agree with this as a chronological review of the NPC
laws will show that it has been the lawmaker's intention that the NPC was to be completely
tax exempt from all forms of taxes Ñ direct and indirect. NPC's tax exemptions at first applied
to the bonds it was authorized to float to finance its operations upon its creation by virtue of
C.A. No. 120. When the NPC was authorized to contract with the IBRD for foreign financing,
any loans obtained were to be completely tax exempt. After the NPC was authorized to borrow
from other sources of funds Ñ aside issuance of bonds Ñ it was again specifically exempted
from all types of taxes "to facilitate payment of its indebtedness." Even when the ceilings for
domestic and foreign borrowings were periodically increased, the tax exemption privileges of
the NPC were maintained. NPC's tax exemption from real estate taxes was, however,
specifically withdrawn by RA 987 but was restored by RA 6396. Moreover, PD 938, which
raised its capital stock and USD borrowing rate, expressly states that the NPC must not only be
able to pay its indebtedness but also to be exempt from ALL forms of taxes if its goal is to be
achieved.
For what periods in time were these privileges being enjoyed? In the case of the tax
exemption restoration of NPC, there is no other comparable entity Ñ not even a single
public or private corporation Ñ whose rights would be violated if NPC's tax exemption
privileges were to be restored. While there might have been a MERALCO before Martial
Law, it is of public knowledge that the MERALCO generating plants were sold to the NPC in
line with the State policy that NPC was to be the State implementing arm for the
electrification of the entire country. Besides, MERALCO was limited to Manila and its
environs. And as of 1984, there was no more MERALCO Ñ as a producer of electricity Ñ
which could have objected to the restoration of NPC's tax exemption privileges. It should be
noted that NPC was not asking to be granted tax exemption privileges for the first time. It
was just asking that its tax exemption privileges be restored. Thus, NPC had its tax
exemption privileges restored from 1984 to the present.
If there are taxes to be paid, who shall pay for these taxes? The oil companies which supply
bunker fuel oil to NPC have to pay the taxes imposed upon said bunker fuel oil sold to NPC. By
7 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the very nature of indirect taxation, the economic burden of such taxation is expected to be
passed on through the channels of commerce to the user or consumer of the goods sold.
HOWEVER, because NPC has been exempted from both direct and indirect taxation, the NPC
must beheld exempted from absorbing the economic burden of indirect taxation. This means,
on the one hand, that the oil companies which wish to sell to NPC absorb all or part of the
economic burden of the taxes previously paid to BIR, which they could shift to NPC if NPC did
not enjoy exemption from indirect taxes. This means also, on the other hand, that the NPC may
refuse to pay the part of the "normal" purchase price of bunker fuel oil which represents all or
part of the taxes previously paid by the oil companies to BIR. If NPC nonetheless purchases
such oil from the oil companies — because to do so may be more convenient and ultimately
less costly for NPC than NPC itself importing and hauling and storing the oil from overseas —
NPC is entitled to be reimbursed by the BIR for that part of the buying price of NPC which
verifiably represents the tax already paid by the oil company-vendor to the BIR.
CIR v. CA
FACTS:
On 22 August 1986, Executive Order No. 41 was promulgated declaring a one-time tax
amnesty on unpaid income taxes, later amended to include estate and donor's taxes and
taxes on business, for the taxable years 1981 to 1985. Respondent R.O.H. Auto Products
Philippines, Inc., availing of the amnesty, filed in October 1986 and November 1986, its Tax
Amnesty Return and Supplemental Tax Amnesty Return No. and paid the corresponding
amnesty taxes due. Prior to this availment, petitioner Commissioner of Internal Revenue, in a
communication received by private respondent on August 13, 1986, assessed the latter
deficiency income and business taxes for its fiscal years 1981 and 1982 in an aggregate
amount of P1,410,157.71. Meanwhile, respondent averred that since it had been able to avail
itself of the tax amnesty, the deficiency tax notice should forthwith be cancelled and
withdrawn. This was denied by the CIR Revenue Memorandum Order No. 4-87,
implementing Executive Order No. 41, had construed the amnesty coverage to include only
assessments issued by the Bureau of Internal Revenue after the promulgation of the
executive order on August 22 1986 and not to assessments theretofore made. On appeal, the
Court of Tax appeal upheld for the respondent, which was further upheld by the Court of
Appeals.
ISSUE: W/N the deficiency assessments were extinguished by reason of respondent’s
availment of the tax amnesty.
HELD:
Yes, as the scope of the amnesty covers the unpaid income taxes for the years 1981 to 1985.
If, as the Commissioner argues, Executive Order No. 41 had not been intended to include
1981-1985 tax liabilities already assessed (administratively) prior to August 22, 1986, the
law could have simply so provided in its exclusionary clauses. It did not. The conclusion is
unavoidable, and it is that the executive order has been designed to be in the nature of a
general grant of tax amnesty subject only to the cases specifically excepted by it. Further, the
law provides that, upon full compliance with the conditions of the tax amnesty and the rules
and regulations issued pursuant to this Executive order, the taxpayer shall be relieved of any
income tax liability on any untaxed income from January 1, 1981 to December 31, 1985,
including increments thereto and penalties on account of the non-payment of the said tax.
Civil, criminal or administrative liability arising from the non-payment of the said tax, which
are actionable under the National Internal Revenue Code, as amended, are likewise deemed
extinguished.
It might not be amiss to recall that the taxable periods covered by the amnesty include the
years immediately preceding the 1986 revolution during which time there had been
persistent calls, all too vivid to be easily forgotten, for civil disobedience, most particularly in
the payment of taxes, to the martial law regime. It should be understandable then that those
who ultimately took over the reign of government following the successful revolution would
promptly provide for abroad, and not a confined, tax amnesty.
CIR v. TODA
FACTS:
Cibeles Insurance Corporation (CIC) authorized Benigno Toda, Jr., President and owner of
99.991% of its issued and outstanding capital stock, to sell the Cibeles Building and the two
parcels of land on which the building stands for an amount of not less than P90M. Toda
purportedly sold the property for P100 million to Rafael Altonaga, who, in turn, sold the same
property on the same day to Royal Match for P200M. For the sale of the property to Royal
Match (RMI), Altonaga paid capital gains tax in the amount of P10M. CIC then filed its
corporate annual income tax return for the year 1989, declaring, among other things, its gain
from the sale of real property in the amount of about P75k+. After crediting withholding taxes
of P254k+, it paid P26k+ for its net taxable income of P75k+
Toda sold his entire shares of stocks in CIC to Choa for P12.5M. Three and a half years later,
Toda died. Subsequently, the BIR sent an assessment notice and demand letter to the CIC for
deficiency income tax for the year 1989 in the amount of about P79k+. The new CIC asked for
a reconsideration, asserting that the assessment should be directed against the old CIC, and
not against the new CIC, which is owned by an entirely different set of stockholders;
moreover, Toda had undertaken to hold the buyer of his stockholdings and the CIC free from
all tax liabilities for the fiscal years 1987-1989. The Estate of Toda received a Notice of
Assessment from the CIR for deficiency income tax for the year 1989 in the amount of P79k+.
The Estate thereafter filed a protest, which the CIR dismissed. The estate filed a Petition for
Review before the CTA alleging, among others, that the CIR erred in holding the estate liable
for income tax deficiency. CTA ruled in favor of the Estate.
ISSUE: W/N Toda intended to evade his taxes.
HELD:
Toda committed fraud so his Estate should pay the P79k+ deficiency income tax for 1989, plus
legal interest until the amount is fully paid. Tax avoidance and tax evasion are the two most
common ways used by taxpayers in escaping from taxation: Tax avoidance is the tax saving
device within the means sanctioned by law. This method should be used by the taxpayer in
good faith and at arms length. Tax evasion, on the other hand, is a scheme used outside of
those lawful means and when availed of, it usually subjects the taxpayer to further or
additional civil or criminal liabilities. It connotes the integration of three factors: (EBU)
1) end to be achieved (payment of < taxes)
2) bad faith / evil state of mind
3) unlawful course of action / failure of action
All these factors are present in the instant case. Prior to the purported sale of the Cibeles
property by CIC to Altonaga, CIC received P40M from from RMI, and NOT Altonaga. The P40M
was debited by RMI and reflected in its trial balance as "other inv. – Cibeles Bldg." Another
₱40M was debited and reflected in RMI’s trial balance as "other inv. – Cibeles Bldg." This shows
that the real buyer of the properties was RMI, and NOT Altonaga. The Estate admitted that the
sale was made to Toda as part of the tax planning scheme of CIC. The scheme resorted to by
CIC in making it appear that there were two sales of the subject properties, i.e., from CIC to
Altonaga, and then from Altonaga to RMI cannot be considered a legitimate tax planning.
Such scheme is tainted with fraud. Fraud pertains to acts and omissions for purposes of
deception, breach of trust or taking advantage is taken of another. In this case, it is obvious
that the objective of the sale to Altonaga was to reduce the amount of tax to be paid
8 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
especially that the transfer from him to RMI would then subject the income to only 5%
individual capital gains tax, and NOT the 35% corporate income tax.
Altonaga’s sole purpose of acquiring and transferring title of the subject properties on the
same day was to create a tax shelter. Altonaga never controlled the property and did not enjoy
the normal benefits and burdens of ownership. The sale to him was merely a tax ploy, a sham,
and without business purpose and economic substance. To allow a taxpayer to deny tax
liability on the ground that the sale was made through another and distinct entity when it is
proved that the latter was merely a conduit is to sanction a circumvention of our tax laws.
Hence, the sale to Altonaga should be disregarded for income tax purposes. The two sale
transactions should be treated as a single direct sale by CIC to RMI.
DELPHER TRADES CORP v. IAC & HYDROPIPES
FACTS:
Pacheco and his sister Pelagia owned a parcel of real estate land identified that was registered
in Bulacan. They then leased the land to Construction Components Inc, and providing that
during the existence or after the term of the lease, the lessor (Pacheco and Pelagia) should he
decide to sell the property leased, shall first offer the same to the lessee (Construction) and
the lessee has the priority to buy under similar conditions. Construction then assigned its
rights and obligations to Hydro Pipes w/ the consent of the Pachecos.
A deed of exchange was executed between the Pachecos and Delpher Trades where Pachecos
conveyed to Delpher the leased property together w/ another parcel of land also located in
Malinta Estate, Valenzuela for 2,500 shares of stock of Delpher w/ a total value of P1.5M. On
the ground that it was not given the first option to buy the leased property pursuant to the
proviso in the lease agreement, Hydro Pipes filed an amended complaint for reconveyance of
the subject lot in its favor under conditions similar to those where Delpher acquired the
property from the Pacheco’s. The CFI of Bulacan ruled in favor of Hydro Pipes who had the
preferential right to acquire the property (right of first refusal), and Pacheco was ordered to
immediately convey the property to Hydro Pipes. The IAC affirmed this decision. Delpher
argued that the “deed of exchange” executed between Pacheco and Delpher was NOT a
contract of sale, so it did not prejudice the right of first refusal in the contract between
Pacheco and Hydro Pipes
ISSUE: W/N the deed of exchange was conducted to avail of certain tax exemptions and
benefits. (Main Issue: W/N there was a contract of sale and a violation of right of first refusal)
HELD:
The deed of exchange was NOT a contract of sale; thus, there was no violation of the right of
first refusal. The "Deed of Exchange" of property between the Pachecos and Delpher Trades
Corporation cannot be considered a contract of sale because there was no transfer of actual
ownership interests by the Pachecos to a third party. The Pacheco family merely changed
their ownership from one form to another. The ownership remained in the same hands.
Hence, Hydro Pipes has no basis for its claim of a light of first refusal under the lease contract.
In order to perpetuate their control over the property through the corporation and to avoid
taxes, the two pieces of real estate w/c had been leased to Hydro Pipes, were transferred to
the corporation by virtue of a deed of exchange of property.
In exchange for these properties, Pelagia and Delfin acquired 2,500 unissued no par value
shares of stock which are equivalent to a 55% majority in the corporation because the other
owners only owned 2,000 shares; they refer to this scheme as "estate planning." By their
ownership of a capital equal to 55% of the shares, the Pachecos have the control of the
petitioner coporation. In effect, the Delpher Trades Corporation is a business conduit or alter
ego of the Pachecos. What they really did was to invest their properties and change the
nature of their ownership from unincorporated to incorporated form by organizing Delpher
Trades Corporation to take control of their properties and at the same time save on
inheritance taxes. Its other advantages are continuous control of the property, tax exemption
benefits, and other inherent benefits in a corporation.
A no-par value share does not purport to represent any stated proportionate interest in the
capital stock measured by value, but only an aliquot part of the whole number of such shares
of the issuing corporation. The holder of no-par shares may see from the certificate itself that
he is only an aliquot sharer in the assets of the corporation. Thus, by removing the par value of
shares, the attention of persons interested in the financial condition of a corporation is
focused upon the value of assets and the amount of its debts. The execution of the deed of
exchange on the properties for no par value shares, the Pacheco’s were able to provide for a
tax-free exchange of property and acquire a corporation.
The execution of the deed of exchange on the properties for no par value shares, the Pachecos
were able to provide for a tax free exchange of property, such that they were able to execute
the deed of exchange free from income tax and acquire a corporation. Sec. 35 of the NIRC
provides that “No gain or loss shall also be recognized if a person exchanges his property for
stock in a corporation of which as a result of such exchange said person alone or together with
others not exceeding four persons gains control of said corporation." The Court believes that
there is nothing wring about the “estate planning” scheme resorted to by the Pachecos. The
legal right of a taxpayer to decrease the amount of what otherwise could be his taxes or
altogether avoid them, by means which the law permits, cannot be doubted.
NOTE: This case is kind of confusing so I searched the internet and found this:
The transfer by a corporation of its fixed assets to another corporation in exchange for shares of
stock of the latter pursuant to a tax-free exchange transaction under section 40(c)(2) of the 1997
tax code is not subject to vat. However, the transfer of inventory is subject to vat.
Example: P Corporation is a domestic corporation engaged in the production and
sale of petroleum products, including liquefied petroleum gas (LPG). S Corporation is a
wholly-owned subsidiary of P Corporation engaged in the business of trading, distributing
and marketing LPG. To streamline operations and achieve optimum efficiency and economy
in the management of the operations of P Corporation’s LPG business, and as part of the
reorganization of the LPG business of P companies worldwide, P Corporation deemed it
necessary to assign its LPG business, including its fixed assets and inventory, to S
Corporation in exchange for shares of stock of the latter pursuant to a tax-free exchange
transaction under Section 40(C)(2) of the 1997 Tax Code.
ISSUE: W/N the transfer of fixed assets and inventory by P Corporation to S Corporation in
exchange for shares of stock of the latter pursuant to a tax-free exchange transaction under
Section 40(C)(2) of the 1997 Tax Code is subject to VAT.
The transfer by P Corporation of the fixed assets of its LPG business to S Corporation in
exchange for the latter’s shares of stock under Section 40(C)(2) of the 1997 Tax Code, and in
accordance with the reorganization of the LPG business of P companies worldwide, does not
constitute a sale or exchange subject to VAT, but rather a mere change inthe form of
ownership. As held by the Supreme Court in Delpher Trades Corporation v. Intermediate
Appellate Court, the transfer of properties to a corporation in exchange for sharesof stock of
the corporation pursuant to Section 35(c)(2) of the NIRC, asamended [now Section
40(C)(2)], where the transferors gain control of the said corporation does not constitute a
sale of properties. The transaction merely involves a change in the nature of the ownership
of properties from unincorporated to incorporated. Ownership over the properties remains
the same. The underlying assumption of tax-free exchange provisions generally is that the
new property received is substantially a continuation of the old investment still
unliquidated. In other words, the said transaction does not constitute a sale or exchange of
9 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
property in the course of trade or business. Hence, the conveyance of assets, property and
equipment used in business but not held for sale in the ordinary course of trade or business
is not subject to VAT. Consequently, the transfer by P Corporation of the fixed assets of its
LPG business to S Corporation is subject to VAT. However, the transfer of inventory which
constitutes stock-in-trade is subject to VAT in accordance with Section 4.106-8(b) of
Revenue Regulations No. 16-2005. BIR Ruling No. 24-2005 dated December 23, 2005.
II. MEANING OF INCOME AND THE REALIZATION PRINCIPLE
SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income means
all income derived from whatever source, including (but not limited to) the following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a
profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional partnership.
REVENUE REGULATIONS NO. 02-40
SECTION 36. Meaning of net income. — The tax imposed by law is upon income. In the
computation of the tax, various classes of income must be considered:
(a) Income, in the broad sense, meaning all wealth which flows into the tax-payer other than
as a mere return of capital. It includes the forms of income specifically described as gains
and profits, including gains derived from the sale or other disposition of capital assets.
Income cannot be determined merely by reckoning cash receipts, for the statute
recognizes as income determining factor other items, among which are inventories,
accounts receivable, property exhaustion, and accounts payable for expenses incurred.
(b) Gross income, meaning income (in the broad sense) less income which is by statutory
provision or otherwise exempt from the tax imposed by law.
(c) Net income, meaning gross income less statutory deductions. The statutory deductions
are, in general, though not exclusively, expenditures other than capital expenditures,
connected with production of income.
(d) In the case of a taxpayer other than a corporation as defined in Section 84 (b) of the Code,
net income means gross income less exemptions. Ordinarily the net income is to be
computed in accordance with the method of accounting regularly employed in keeping
the books of the taxpayer.
A. WHAT IS INCOME (A DEFINITIONAL CONCEPT)?
FISHER v. TRINIDAD (COLLECTOR OF INTERNAL REVENUE)
DOCTRINE:
An income may be defined as the amount or money coming to a person or corporation within
a specified time, whether as payment for services, interest, or profit from investment. A mere
advance in the value of the property of a person or corporation in no sense constitutes the
"income specified in the revenue law. Such advance constitutes and can be treated merely as
an increase of capital.
FACTS:
The Philippine American Drug Company was a corporation duly organized under the laws of
the Philippines, doing business in the City of Manila. Fisher was a stockholder in said
corporation. As result of the business for that year, the corporation declared a stock dividend
and that the proportionate share of said stock dividend of the Fisher was P24,800. The stock
dividend for that amount was issued to the appellant and after a few months, he paid, upon
demand of the Collector, under protest, and voluntarily, the sum of P889.91 as income tax on
said stock dividend. This action is for the recovery of that sum.
Fisher cites and relies on some decisions of the Supreme Court of the United States as well as
the decisions of the Supreme Court of some of the states of the Union based upon similar
statutes, was discussed. In each of said cases an effort was made to collect an "income tax"
upon "stock dividends" and in each case it was held that "stock dividends" were capital and
not an "income" and therefore not subject to the "income tax" law.
ISSUE:
Whether or not stock dividends are income taxable under the provisions of section 25 of Act
No. 2833 (Philippine Income Tax Law)
RULING:
NO. Stock dividends are not income; the same cannot be taxes under that provision of Act No.
2833, which provides for a tax upon income.
When the assets of a corporation have increased so as to justify the issuance of a stock
dividend, the increase of the assets should be taken account of the Government in the ordinary
tax duplicates for the purposes of assessment and collection of an additional tax. The
stockholder who receives a stock dividend has received nothing but a representation of his
increased interest in the capital of the corporation. There has been no separation or
segregation of his interest. All the property or capital of the corporation still belongs to the
corporation. There has been no separation of the interest of the stockholder from the general
capital of the corporation. The stockholder, by virtue of the stock dividend, has no separate or
individual control over the interest represented thereby, further than he had before the stock
dividend was issued. The Legislature would not have intended that a mere increase in the
value of the capital or assets of a corporation, firm, or individual, should be taxed as "income."
Such property can be reached under the ordinary from of taxation.
The Income Tax Law will show that, while it permitted a tax upon income, the same provided
that income shall include gains, profits, and income derived from salaries, wages, or
compensation for personal services, as well as from interest, rent, dividends, securities, etc.
Income received as dividends is taxable as an income but an income from "dividends" is a very
different thing from receipt of a "stock dividend." One is an actual receipt of profits, and the
other is a receipt of a representation of the increased value of the assets of corporation.
EISNER v. MACOMBER
DOCTRINE:
Income means something derived from labor or capital. To be “derived” means something of
exchangeable value separated from the capital.
FACTS:
Mrs. Macomber owned 2,200 shares in Standard Oil. Standard Oil declared a 50% stock
10 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
dividend and she received 1,100 additional shares, of which about $20,000 in par value
represented earnings accumulated by the company—recapitalized rather than distributed—
since the effective date of the original tax law.
The current statute expressly included stock dividends in income, and the government
contended that those certificates should be taxed as income to Mrs. Macomber as though the
corporation had distributed money to her. Mrs. Macomber sued Mr. Mark Eisner, the Collector
of Internal Revenue, for a refund.
ISSUE/S:
Whether or not stock dividends are income
RULING:
No. If a stock dividend is not considered income, it cannot be subject to income tax under the
16th Amendment. In applying the 16th Amendment, it is important to distinguish between
capital and income, as only income is subject to income tax.
A stock dividend reflects the corporation transferring an amount from "surplus" (retained
earnings) to "capital stock." Such a transaction is merely a bookkeeping entry and “affects only
the form, not the essence, of the “liability” acknowledged by the corporation to its own
shareholders ... it does not alter the preexisting proportionate interest of any stockholder or
increases the intrinsic value of his holding or of the aggregate holdings of the other
stockholders as they stood before”.
An increase to the value of capital investment is not income. Nothing of value has been taken
from the corporation and given to the shareholder as is the case with a cash dividend.
In addition, since the shareholder receives no cash, in order to pay any tax on a stock
dividend, he might have to convert the stock into cash - he has no wherewithal to pay from the
nature of the transaction. "Nothing could more clearly show that to tax a stock dividend is to
tax a capital increase, and not income, than this demonstration that in the nature of things it
requires conversion of capital in order to pay the tax".
U.S. v. KIRBY LUMBER CO.
DOCTRINE:
If bonds are purchased and retired at a price less than the issuing price or face value, then the
excess of the issuing price or face value is gain or income for the taxable year.
FACTS:
Kirby Lumber Company issued bonds which had a par value of $12,126,800. Later that same
year, the company repurchased the same bonds in the open market for a sum less than par
value. The difference between the issue price of the bonds and the price at which the company
repurchased them was $137,521.30. The regulations promulgated by the United States
Department of the Treasury stated that such a cost savings to a corporation was to be
considered taxable income.
ISSUE/S:
Whether or not the difference is taxable income
RULING:
Yes. The Supreme Court notes that in this case there was no shrinkage of assets and taxpayer
had a clear gain. Taxpayer gains assets by offsetting the bonds. Kirby Lumber has realized
within the year an accession to income.
HELVERING v. BRUUN
DOCTRINE:
Where, upon termination of a lease, the lessor repossessed the real estate and improvements,
including a new building erected by the lessee, an increase in value attributable to the new
building was taxable under the Revenue Act of 1932 as income of the lessor in the year of
repossession.
FACTS:
Bruun was a landlord. He leased some property to a tenant. When the lease expired, the tenant
left and Bruun took the property back. While the tenant was in possession of the property,
they knocked down an old building and built a new building on the property. When they left,
Bruun got to keep the new building. The new building was assessed to be worth $51k more
than the old one.
The IRS stepped in and said that Bruun's gain of a new building was a capital gain. Bruun
argued that no income had been realized yet because his interest was represented by a deed,
and when the tenant left, he had the exact same deed he had when the tenant arrived. So he
hadn't gained anything. Bruun suggested that the IRS would have to wait until the property
was sold (aka the value was realized).
The construction of the new building increased the value of the land, but there were other
ways the value could change. But until the land was sold, Bruun hadn't received anything. The
IRS argued that until the day the tenant left, Bruun didn't own a new building, as soon as the
lease ended, Bruun did own a new building. He had received a gain and needed to pay taxes on
it immediately.
ISSUE/S:
Whether or not the landlord is liable to pay taxes for the improvements left on his land by the
lessee.
RULING:
Yes. The US Supreme Court found that upon when a lease ended, the landlord repossessed the
real estate and improvements and increase in value attributable to the improvements was
taxable.
The real estate industry felt that this was very unfair to landlords. If the new building was
expensive, the landlord might be forced to sell the land just to be able to afford the tax.
Now, under a new law, gross income generally does not include improvements made by a
tenant.
However, it does not include "improvements other than rent." That clause was added so the
landlord and tenant couldn't conspire to improve the property instead of paying rent. So you
can't say to a tenant, "instead of paying me rent, just build a fancy new building that I can keep
after you leave."
CIR v. GLENSHAW GLASS CO.
DOCTRINE:
“Gross income” includes punitive damages arising out from a litigation and are taxable. They
do not come under any other exemption provided by law. To hold otherwise would do
violence to the plain meaning of the statute.
FACTS:
 Glenshaw Glass Company manufactures glass bottles and containers
 Glenshaw engaged in a litigation with the Hartford-Empire Company – which
manufactured machinery of a character used by Glenshaw
 Glenshaw demanded exemplary damages for fraud and treble damages for injury to its
business because of Hartford’s violation of the federal antitrust law.
11 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 The parties concluded a settlement: Hartford paid Glenshaw $800,000  $320,000++
represented payment of punitive damages for fraud and antitrust violations
 Glenshaw did not report the portion of the settlement as income for the tax year involved
 Commissioner demanded for the deficiency claiming as taxable the entire sum.
ISSUE:
Whether money received as exemplary damages for fraud or as the punitive 2/3 portion of a
treble-damage antitrust recovery must be reported by a taxpayer as a gross income (pursuant
to Section 22 (a) of the Internal Revenue Code of 1939)
RULING: YES
Section 22 – GROSS INCOME
 Gross income includes gains, profits, and income derived from salaries, wages, or
compensation, for personal service… of whatever kind and in whatever form paid, or
from professions, vocations, trades, businesses, commerce, or sales, or dealings in
property, whether real or personal, growing out of the ownership or use of or interest in
such property; also from interest, rent, dividends, securities, or the transaction of any
business carries on for gain or profit, or gains or profits and income derived from any
source whatever…
Respondents contend that punitive damages are not within the scope of the section.
Held:
 However, Congress applied no limitations as to the sources of taxable receipts, nor
restrictive labels as to their nature.
 The Court has given a LIBERAL CONSTRUCTION to the broad phraseology in
recognition of the intention of Congress to tax all gains except those specifically
exempted.
Respondents contend that a narrower reading of Section 22 is required – income to
mean as “the gain derived from capital, from labor, or from both combined”
Held:
 In this case is an undeniable accessions to wealth, clearly realized, and over which the
taxpayers have complete dominion.
 The mere fact that the payments were extracted from the wrongdoers as punishment
for a unlawful conduct cannot detract from their character as taxable income to the
recipients.
 Recoveries are taxable to the extent that they compensate for damages actually
incurred.
 Statutory gross income is “all-inclusive”
 Punitive damages do not come under any exemption provision
JAMES v. U.S.
DOCTRINE:
If a taxpayer receives income – legally or illegally – without consensual recognition of
obligation to repay, that income is taxable.
FACTS:
(Chief Justice Warren) The petitioner, Eugene James, is a union official who, with another
person, embezzled in excess of $738,000 during the years 1951 through 1954. The IRS
(Internal Revenue Service) stepped in and claimed that the $738k should be counted in James'
gross income. Petitioner failed to report these amounts in his gross income and was convicted
for willfully attempting to evade the federal income tax. He was sentenced to a total of three
years' imprisonment. The Court of Appeals affirmed. Eugene claimed in his defense that
embezzled funds did not constitute taxable income. He argued that since a person is legally
obligated to repay money that they steal, they've received no income in the same way as a
person receives no income from taking out a loan – so there should be no tax liability. To back
up his claim, Eugene used a previous USC decision Commissioner v. Wilcox (1946) - a case
whose relevant facts are concededly the same as those in the case. Eugene contends that the
Wilcox rule (stolen money is not part of taxable income) has been in existence since 1946; that
if Congress had intended to change the rule, it would have done so; that there was a general
revision of the income tax laws in 1954 without mention of the rule; that a bill to change it
was introduced in the Eighty-sixth Congress but was not acted upon; that, therefore, the rule
will not be changed now.
ISSUE:
W/N embezzled funds constitutes income taxable to the wrongdoer, even though an
obligation to repay exists? - YES
RULING:
In Wilcox, the Court held that embezzled money does not constitute taxable income to the
embezzler in the year of the embezzlement; BUT 6 yrs later, The Rutkin case laid down that
extorted money does constitutes taxable income to the extortionist, but the USC did not
overrule Wilcox and said that the Rutkin case is an isolated case. The basis for the Wilcox
decision was "that a taxable gain is conditioned upon (1) the presence of a claim of right to the
alleged gain and (2) the absence of a definite unconditional obligation to repay or return that
which would otherwise constitute a gain. Without some bona fide legal or equitable claim,
even though it be contingent or contested in nature, the taxpayer cannot be said to have
received any gain or profit
Since Wilcox embezzled the money, held it 'without any semblance of a bona fide claim of
right,' and therefore 'was at all times under an unqualified duty and obligation to repay the
money to his employer,' the Court found that the money embezzled was not includible within
'gross income.' But, Rutkin's legal claim was no greater than that of Wilcox. It was specifically
found 'that Rutkin had no basis for his claim and that he obtained it by extortion.' Both Wilcox
and Rutkin obtained the money by means of a criminal act; neither had a bona fide claim of
right to the funds. The victim of an extortion, like the victim of an embezzlement, has a right to
restitution. Furthermore, it is inconsequential that an embezzler may lack title to the sums he
appropriates while an extortionist may gain a voidable title. Thus, the fact that Rutkin secured
the money with the consent of his victim is irrelevant. What is important is that the right to
recover exists in both situations. Using this examination, the Court in this case that Rutkin
overruled the decision of Wilcox.
The Court noted that the scope of the Sixteenth Amendment (allows the Congress to levy an
income tax without apportioning it among the states or basing it on the United States Census.
This amendment exempted income taxes from the constitutional requirements regarding
direct taxes, after income taxes on rents, dividends, and interest were ruled to be direct taxes)
was not limited to "lawful" income. It had been a well-established principle that unlawful, as
well as lawful, gains are comprehended within the term "gross income." Section II B of the
Income Tax Act of 1913 provided that "the net income of a taxable person shall include gains,
profits, and income from the transaction of any lawful business carried on for gain or profit, or
gains or profits and income derived from any source whatever." When the statute was
amended in 1916, the one word "lawful" was omitted. The absence of the "lawful" modifier
indicated that the framers of the 16th amendment had intended no safe harbor for illegal
income.
The starting point in all cases dealing with the question of the scope of what is included in
"gross income" begins with the basic premise that the purpose of Congress was "to use the full
12 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
measure of its taxing power." The more simplified language of § 61 (a) of the 1954 Code, "all
income from whatever source derived," have been held to encompass all "accessions to
wealth, clearly realized, and over which the taxpayers have complete dominion." A gain
"constitutes taxable income when its recipient has such control over it that, as a practical
matter, he derives readily realizable economic value from it." Under these broad principles,
USC decided that Eugene’s contention, that all unlawful gains are taxable except those
resulting from embezzlement, should fail.
When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual
recognition, express or implied, of an obligation to repay and without restriction as to their
disposition, "he has received income which he is required to return, even though it may still be
claimed that he is not entitled to retain the money, and even though he may still be adjudged
liable to restore its equivalent."
HOWEVER: What the USC is dealing here with is a felony conviction under statutes which
apply to any person who "willfully" fails to account for his tax or who "willfully" attempts to
evade his obligation. The USC decided that the element of willfulness could not be proven in a
criminal prosecution for failing to include embezzled funds in gross income in the year of
misappropriation so long as the statute contained the gloss placed upon it by Wilcox at the
time the alleged crime was committed. Therefore, Eugene’s criminal conviction will be
dismissed.
DISSENTERS: (3 concurs w/ the dismissal of indictment against Eugene but dissent w/
overruling Wilcox; 3 justices concurred w/ overruling Wilcox but contends that Eugene
should have been given a new trial for his criminal liability)
If the statutory interpretation of "taxable income" in Wilcox is wrong, then James is guilty of
violating the tax evasion statute, for the trial court's judgment establishes that he embezzled
funds and willfully refrained from reporting them as income. They think that Wilcox was right
when it was decided, and is right now. It seems to be implied that one reason for overruling
Wilcox is that a failure to hold embezzled funds taxable would somehow work havoc with the
public revenue or discriminate against "honest" taxpayers and force them to pay more taxes.
It follows that, except for the possible adverse effect on rightful owners, the only substantial
result that one can foresee from this case is that the Federal Government will, under the guise
of a tax evasion charge, prosecute people for a simple embezzlement. But the Constitution
grants power to Congress to get revenue, not to prosecute local crimes. And if there is any
offense which, under our dual system of government, is a purely local one which the States
should handle, it is embezzlement or theft. There are two justifications for barring a
prosecution of this petitioner in the unusual circumstances presented here: (1) that, by reason
of Rutkin having formally left intact the Wilcox doctrine, petitioner did not have due warning
of his possible criminal liability; and (2) that the Court, in making new "law" in Rutkin, should,
like the legislature, not impose criminal liability ex post facto.
Wilcox did not hold that embezzled funds may never constitute taxable income to the
embezzler. To the contrary, it expressly recognized that an embezzler may realize a taxable
gain to the full extent of the amount taken if and when it ever becomes his. The applicable test
of taxable income, i.e., the "presence of a claim of right to the alleged gain," of which Wilcox
spoke, was but a correlative statement of the factor upon which the decision placed its whole
emphasis throughout, namely, the "absence of a definite, unconditional obligation to repay or
return [the money]." why the embezzler had not yet received taxable income: "Sanctioning a
tax under the circumstances before us would serve only to give the United States an
unjustified preference as to part of the money which rightfully and completely belongs to the
taxpayer's employer." However, Wilcox plainly stated that, "if the unconditional indebtedness
is cancelled or retired, taxable income may adhere, under certain circumstances, to the
taxpayer." More specifically, it recognized that, had the embezzler's victim "condoned or
forgiven any part of the [indebtedness], the [embezzler] might have been subject to tax
liability to that extent," in the tax year of such forgiveness. The fact that an embezzler's victim
may have less chance of success than other creditors in seeking repayment from his debtor is
not a valid reason for us further to diminish his prospects by adopting a rule that would allow
the Commissioner of Internal Revenue to assert and enforce a prior federal tax lien against
that which "rightfully and completely belongs" to the victim. When the shortages were
discovered in 1956, the union at once filed civil actions against petitioner to compel
repayment. For reasons which need not be detailed here, petitioner effected a settlement
agreement with the union on July 30, 1958, whereby, in exchange for releases fully
discharging his indebtedness, he repaid to the union the sum of $13,568.50. Accordingly, at
least so far as the present record discloses, petitioner clearly realized a taxable gain in the
year the releases were executed to the extent of the difference between the amount taken and
the sum restored. However, the Government brought the present action against him not for
his failure to report this gain in his 1958 return, but for his failure to report that he had
incurred "income" from -- actually indebtedness to -- the union in each of the years 1951
through 1954. There can be no doubt that, until the releases were executed in 1958, petitioner
and the union stood in an absolute and unconditional debtor-creditor relationship, and, under
all of our relevant decisions, no taxable event could have occurred until the indebtedness was
discharged for less than full repayment.
NOTE:
(If you’re a bit confused, I am too, here is my super short understanding of the case). Eugene
embezzled money in 1951 to 1954. He was caught in 1956 but he and his employer came to an
agreement. In 1958 Eugene thought that the only thing that he did illegally was to embezzle
money so he reported his income tax by reflecting what was agreed by him and his employer,
but IRS (being greedy) hounded him for not reporting his income tax in 1951 to 1954 (the
embezzled money). Eugene disagreed and said that at the time of embezzling, there was no
law that would punish him for tax evasion and there was in fact a case (Wilcox) that ruled that
embezzled money is not taxable during the year it was misappropriated. Eugene avoided
criminal liability using Wilcox. Eugene cannot be prosecuted for tax evasion because it is not
possible to willfully violate laws that were not established at the time of the violation. What
happened here is that the court changed its mind and overruled Wilcox BUT ONLY
PROPECTIVELY… meaning past embezzlers cannot anymore use the Wilcox doctrine to avoid
criminal liability and the gov’t will be trigger happy in going after them for taxes derived from
past embezzled money even though embezzlers would still have to repay them from their
victims. The effect of this ruling is: past embezzlers can be prosecuted for the crime of tax
evasion. There was a discussion in the dissent of that overruling the Wilcox doctrine would
seem to make an ex post facto law and there are some who would think that Eugene must also
be tried criminally.
B. REALIZATION REQUIREMENT
REVENUE REGULATIONS NO. 02-40
SECTION 38. Bases of computation. — Approved standard methods of accounting will be
ordinarily regarded as clearly reflecting income. A method of accounting will not, however, be
regarded as clearly reflecting income unless all items of gross income and all deductions are
treated with reasonable consistency. All items of gross income shall be included in the gross
income for the taxable year in which they are received by the taxpayer and deductions taken
accordingly, unless in order clearly to reflect income such amounts are to be properly
accounted for as of a different period. For instance, in any case in which it is necessary to use
an inventory, no accounting in regard to purchases and sales will correctly reflect income
except an accrual method. A taxpayer is deemed to have received items of gross income which
have been credited to or set apart for him without restriction. On the other hand, appreciation
13 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
in value of property is not even an accrual of income to a taxpayer prior to the realization of
such appreciation through sale or conversion of the property. (For methods of accounting and
determination of accounting period, see Sections 166 to 169 of these regulations.)
HELVERING v. BRUUN (see case above)
HELVERING v. HORST
DOCTRINE:
The power to dispose of income is the equivalent of ownership of it.
FACTS:
Horst owned negotiable bonds with detachable negotiable interest coupons, which were
payable to bearer. In 1934-1935, he detached two of those coupons, worth around $25k each,
and gave them to his son. The interest coupons matured a year after, and his son collected the
payment. Horst didn’t include the income from the interest coupons as part of his gross
income; the collector of internal revenue disagreed. The Board of Tax Appeals found that
Horst, the donor, should pay the income tax on said interest coupons. The circuit court of
appeals reversed the Board’s decision, so petitioners brought this as a certiorari case seeking
to make Horst liable for the income tax.
ISSUE:
Whether or not Horst, as donor, is liable to pay income tax on the interest coupons
HELD:
YES. Horst owned the bonds. Ownership of bonds entails two things: 1) right to be paid the
principal amount, and 2) right to be paid interest in installments. Even if he didn’t receive
direct payment from the interest coupons, it doesn’t mean that he didn’t realize income from
them.
Although the donor here, by the transfer of the coupons, has precluded any possibility of his
collecting them himself he has nevertheless, by his act, procured payment of the interest, as a
valuable gift to a member of his family. Such a use of his economic gain, the right to receive
income, to procure a satisfaction which can be obtained only by the expenditure of money or
property, would seem to be the enjoyment of the income.
The power to dispose of income is the equivalent of ownership of it. The exercise of that
power to procure the payment of income to another is the enjoyment and hence the
realization of the income by him who exercises it. Income is 'realized' by the assignor because
he, who owns or controls the source of the income, also controls the disposition of that which
he could have received himself and diverts the payment from himself to others as the means
of procuring the satisfaction of his wants. The taxpayer has equally enjoyed the fruits of his
labor or investment and obtained the satisfaction of his desires whether he collects and uses
the income to procure those satisfactions, or whether he disposes of his right to collect it as
the means of procuring them.
In a real sense he has enjoyed compensation for money loaned or services rendered and not
any the less so because it is his only reward for them. To say that one who has made a gift thus
derived from interest or earnings paid to his donee has never enjoyed or realized the fruits of
his investment or labor because he has assigned them instead of collecting them himself and
then paying them over to the donee, is to affront common understanding and to deny the facts
of common experience. Common understanding and experience are the touchstones for the
interpretation of the revenue laws. The interest coupons weren’t considered as “gifts” that
were excludable from income because they were merely part of the entire negotiable bond,
which still belonged to Horst. In effect, they derived income from the bond itself, ownership of
which remained with Horst.
COTTAGE SAVINGS ASSOCIATION v. CIR
DOCTRINE:
To constitute a realizable event, from which the gain or loss is taxable or tax deductible in the
year of the event, the properties exchanged in a transaction must be materially different.
FACTS:
Cottage Savings, a savings and loan association which at that time was regulated by the
Federal Home Loan Bank Board (FHLBB), sold "90% participation interests" in 252 mortgages
to four S&L's. It simultaneously purchased "90% participation interests" in 305 mortgages
held by these S&L's. All of the loans involved were secured by single-family homes, most in the
Cincinnati area. The fair market value of the package of participation interests exchanged by
each side was approximately $ 4.5 million. The face value of the participation interests Cottage
Savings relinquished in the transaction was approximately $ 6.9 million. For FHLBB
accounting purposes, the transaction was treated as an exchange of substantially identical
mortgages, which meant that the association's loss on the exchange did not have to be
reported to the FHLBB.
On its 1980 federal income tax return, Cottage Savings claimed a deduction for $ 2,447,091.
As permitted by Memorandum R-49, Cottage Savings did not report these losses to the
FHLBB. After the Commissioner of Internal Revenue disallowed Cottage Savings' claimed
deduction, Cottage Savings sought a redetermination in the Tax Court. The Tax Court held
that the deduction was permissible.
On appeal by the Commissioner, the Court of Appeals reversed. The Court of Appeals agreed
with the Tax Court's determination that Cottage Savings had realized its losses through the
transaction. However, the court held that Cottage Savings was not entitled to a deduction
because its losses were not "actually" sustained during the 1980 tax year.
ISSUE:
WON Cottage Savings could realize tax-deductible losses through its exchange?
RULING:
Cottage Savings realized a tax-deductible loss because the properties it exchanged were
materially different. In order to avoid the cumbersome, abrasive, and unpredictable
administrative task of valuing assets annually to determine whether their value has
appreciated or depreciated, the Code defers the tax consequences of a gain or loss in
property until it is realized through the "sale or disposition of [the] property." This rule
serves administrative convenience because a change in the investment's form or extent
can be easily detected by a taxpayer or an administrative officer.
An exchange of property constitutes a "disposition of property" only if the properties
exchanged are materially different. Properties are materially different if their respective
possessors enjoy legal entitlements that are different in kind or extent. As long as the property
entitlements are not identical, their exchange will allow both the Commissioner and the
transacting taxpayer to fix the appreciated or depreciated values of the property relative to
their tax bases.
Cottage Savings' transactions easily satisfy the material difference test. Since the
participation interests exchanged derived from loans that were made to different obligors
and secured by different homes, the exchanged interests embodied legally distinct
entitlements. Thus, Cottage Savings realized its losses at the point of the exchange, at
which time both it and the Commissioner were in a position to determine the change in
14 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the value of its mortgages relative to their tax bases.
Dissent: Blackmun, J., joined by White, J.,
The association did not realize income-tax-deductible losses from the transaction, because the
mortgage participation partial interests released by the association in the transaction were
not materially different from those received, since (1) the transaction was an exchange of
substantially identical mortgages for FHLBB accounting purposes, and (2) the parties'
handling of the transaction and of the mortgage loans after completion of the transaction
revealed that any differences that might exist were not material.
C. OTHER RELEVANT CONEPTS
1. TAX-FREE IMPUTED INCOME v. TAXABLE BARTER
REVENUE REGULATIONS NO. 02-40
SECTION 41. Compensation paid other than in cash. — Where services are paid for with
something other than money, the fair market value of the thing taken in payment is the
amount to be included as income. If the services were rendered at a stipulated price, in the
absence of evidence to the contrary, such price will be presumed to be the fair value of the
compensation received. Compensation paid an employee of a corporation in its stock is to be
treated as if the corporation sold the stock for its market value and paid the employee in cash.
When living quarters are furnished in addition to cash salary, the rental value of such quarters
should be reported as income.
CIR v. SOL MINZER
DOCTRINE:
Commissions received or retained by a life insurance agent on policies upon his own life are
income to the agent and must be subjected to income tax.
FACTS:
Sol Minzer was an insurance agent or broker. As a representative of the insurance companies
which had issued the policies he became entitled to commissions on the policies to the same
extent as though the insurance had been on the life of someone else. He received the
commissions, or the benefit of them, upon these policies on his own life either by remitting the
premiums, less commissions, to the companies, or by remitting the premiums in their entirety
and receiving back from the companies their checks to him for the amounts of the
commissions. Minzer did not include these commissions as taxable income in his return. The
CIR recomputed the tax by the inclusion of the commissions as income and made a deficiency
determination. The Tax Court held for Minzer.
The Tax Court decided upon the narrow that the Minzer was a broker and not an employee
and hence the transactions were outside the terms of Income Tax Regulations.
ISSUE:
Whether or not the commissions of Minzer must also be subjected to income tax.
HELD:
YES. In both contracts to Western Insurance and Occidental Insurance, Minzer was authorized
to solicit and submit applications for life insurance and in each contract the percentage of
premiums which the taxpayer should receive as commissions was specified. The relationships
created by the contracts were substantially the same. The agent or broker, or by whatever
name he be called, is to receive or retain a percentage of the premiums on policies procured
by him, called commissions, as compensation for his service to the company in obtaining the
particular business for it.
The service rendered to the company, for which it was required to compensate him, was no
different in kind or degree where the taxpayer submitted his own application than where he
submitted the application of another. In each situation there was the same obligation of the
company, the obligation to pay a commission for the production of business measured by a
percentage of the premiums.
The court concludes that the commissions were compensation for services and as such were
income within the meaning of the law. It cannot be said that the insurance had a value less
than the amount of the premiums. It must then be said that a benefit inured to Minzer to the
extent of his commissions. The benefit is neither diminished nor eliminated by referring, as
does the Tax Court, to the word ‘commission’ as a verbal trap.
There was an employer-employee relationship existing. Commissions given are in the nature
of an income. The court's conclusion is that the agent did not receive a bargain purchase and
that the commissions were neither discounts nor rebates.
Hence, the commission received by Minzer must be subjected to income tax.
REV. RUL. 79-24
DOCTRINE:
If services are paid for other than in money, the fair market value of the property or services
taken in payment must be included in income.
FACTS:
SITUATION 1: In return for his legal services, the house painter painted the lawyer’s personal
residence. Both are members of a barter club, an organization that annually furnishes its
members a directory of members and the services they provide. All the members are
professional or trades persons. Members contact other members directly and negotiate the
value of the services to be performed.
SITUATION 2: An individual who owned an apartment building received a work of art created
by a professional artist in return for the rent-free use of an apartment for six months by the
artist.
ISSUE/S:
What is included in the gross income in the above situations?
RULING:
The applicable sections of the Internal Revenue Code of 1954 and the Income Tax Regulations
thereunder are 61(a) and 1.61-2, relating to compensation for services.
Section 1.61-2(d)(1) of the regulations provides that if services are paid for other than in
money, the fair market value of the property or services taken in payment must be included in
income. If the services were rendered at a stipulated price, such price will be presumed to be
the fair market value of the compensation received in the absence of evidence to the contrary.
THUS:
In situation 1, the fair market value of the services received by the lawyer and the
housepainter are includible in their gross incomes under section 61 of the Code.
In situation 2, the fair market value of the work of art and the six months fair rental value of
the apartment are includible in the gross incomes of the apartment-owner and the artist
under section 61 of the Code.
15 TAXATION 1 (ATTY. BELLO)
2. TAX-FREE RETURN OF CAPITAL
REVENUE REGULATIONS NO. 02-40
SECTION 36. Meaning of net income. — The tax imposed by law is upon income. In the
computation of the tax, various classes of income must be considered:
(a) Income, in the broad sense, meaning all wealth which flows into the tax-payer other than
as a mere return of capital. It includes the forms of income specifically described as gains
and profits, including gains derived from the sale or other disposition of capital assets.
Income cannot be determined merely by reckoning cash receipts, for the statute
recognizes as income determining factor other items, among which are inventories,
accounts receivable, property exhaustion, and accounts payable for expenses incurred.
(b) Gross income, meaning income (in the broad sense) less income which is by statutory
provision or otherwise exempt from the tax imposed by law.
(c) Net income, meaning gross income less statutory deductions. The statutory deductions
are, in general, though not exclusively, expenditures other than capital expenditures,
connected with production of income.
(d) In the case of a taxpayer other than a corporation as defined in Section 84 (b) of the Code,
net income means gross income less exemptions. Ordinarily the net income is to be
computed in accordance with the method of accounting regularly employed in keeping the
books of the taxpayer.
CLARK v. CIR
DOCTRINE:
Compensation paid for losses suffered is not income since it is not derived from capital, labor,
or from both combined.
FACTS:
Clark, married and living with his wife, was required by the Revenue Act of 1932 to file a
Federal Income Tax Return of his income for the year 1932. He had two options for filing: he
could file a joint return with his wife, or separate returns.
Clark’s experienced tax counsel prepared a joint return for him and his wife and advised Clark
to file it instead of two separate returns for the year 1934. Clark filed it with the CIR.
The filed tax return was audited and an additional sum of $32,820.14 was assessed against the
petitioner, which he paid. This is an error on the part of the tax counsel because he improperly
deducted from Clark’s income the total amount of losses sustained on the sale of capital assets
held for a period of more than two years instead of applying the statutory limitation required
by Section 101(b) of the Revenue Act (the case didn’t quote the law).
When such error was disclosed to the tax counsel, recomputations showed that Clark and his
wife would have paid $19,941.10 less than what they had paid, if they had filed separate
returns. Admitting his mistake, the tax counsel paid that amount to Clark, who accepted.
Respondent CIR included the $19,941.10 in gross income for the final determination of Clark’s
1934 tax liability.
Respondent CIR theorizes that this amount constituted taxes paid for petitioner by a third
party and that consequently, petitioner was in receipt of income to that extent.
Petitioner Clark contends that this payment constituted compensation for damages or loss
caused by the error of the tax counsel, and that he therefore realized no income from its
receipt in 1934.
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
NOTE: Medyo magulo sya. Basically, the counsel made a mistake in filing the tax returns. He paid
the difference of what Clark lost ($19K). CIR included that amount in Clark’s gross income for
1934 and he is trying to tax it as income. Clark says he can’t since he didn’t earn from that
amount, it is only compensation for the counsel’s error.
ISSUE/S:
Whether petitioner derived income from the amount paid by the tax counsel
RULING:
No. Petitioner received that amount not as payment by a third party for rent, compensation
for services rendered, or otherwise. He paid his own taxes, and in paying that obligation, he
sustained a loss caused by the tax counsel’s negligence.
Recoupment on losses is not income since it is not derived from capital, labor, or from both
combined. The fact that payment of the compensation was voluntary does not change its
exempt status. It was, in fact, compensation for a loss which impaired petitioner’s capital.
BIR RULING NO. 051-00
DOCTRINE:
Section 36 of the Income Tax Regulations provides that income in the broad sense, means
all wealth which flows into the taxpayer other than a mere return of capital.
FACTS
 The Divine Word Educational Association Retirement Plan was established to provide
retirement benefits for qualified employees of school, colleges, universities and Society of
Divine Word (SDV) Education Secretaries office owned and or operated by members of
the SVD and other institutions, congregations or orders which are subsequently accepted
by the Retirement Board.
 The Fund was basically non-contributory however, its members, may, prior to their
retirement elect to contribute an amount equal to at least 2% of their current monthly
salary which shall be subject to the provisions of the Plan and shall not be subject to
withdrawal unless for causes provided therein.
 Due to the prevailing economics crisis, a number of members who have exercised their
option to contribute to the Fund found themselves financially incapable of continuing
their contributions and that they in fact requested the withdrawal of the said
contributions.
receive consisting of their personal contributions, counterpart contribution of the
employer and the income of the Fund to which the employees are entitled and are
distributed to them shall be exempt from income tax.
BIR RULING NO. 184-90
DOCTRINE:
Damages from a breach of contract constitute taxable income to the recipient thereof in the
year received only to the extent that such damages constitute a loss of anticipated profits and
non-taxable to the extent that the same represent a return of capital or investment.
FACTS: (there was no name mentioned for the lessor)
 Intel Phils. Mfg., Inc., entered into a contract of lease with the lessor whereby it was
agreed that the lessee(Intel Phils. Mfg. Inc.) will construct a 3 to 4-storey building on the
land of the lessor.
 The lessee then failed to comply with the said undertaking and that the lessor and the
lessee agreed to a proposed amended contract of lease whereby it was agreed that the
lessor will be paid liquidated damages for actual and compensating damages he suffered
as a result of the aforementioned breach of contract.
ISSUE:
Whether or not liquidated damages to be paid by Intel Philippines Mfg., Inc. for breach of
contract is exempt from income tax.
RULING:
No. The liquidated damages are subject to income tax.
 Since the liquidated damages to be paid to the lessor by Intel Philippines Mfg., Inc. for the
breach of the contract of lease does not represent a return of capital or investment but
constitute a loss of anticipated profits, they are therefore, considered taxable income in
the year received.
REV. RULE. 81-277
DOCTRINE:
The payment by a contractor of a sum of money to a buyer in exchange for a release of the
buyer's claims against the contractor for failure to fulfill the contract for construction of a
plant constitutes a return of capital rather than gross income to the buyer.

ISSUE:
Whether or not the said contributions of the employees are subject to income tax or
constitute mere return of capital
RULING:
The contributions of the employees are subject to income tax.
 In order to be exempt from the payment of income tax, the benefits must be paid or
distributed to the officials or employees upon their retirement from the service and not
while they are still in the employ of the company-employer.
 In this case, the earnings/income of the personal contributions of the employees
constitute benefits not upon their retirement but while they are still in the service of the
school colleges, universities and Society of Divine Word (SVD) Education Secretaries
office owned and operated by SVD.
 Pursuant to Section 60(B) of the Tax Code of 1997, any and all amounts actually
distributed to said member-employees over and above their personal contributions shall
be taxable to them in the year in which so paid or distributed, considering that such
distribution has been effected before their retirement from SVD.
 This means that, only upon retirement, the total benefits which the employees shall
16 TAXATION 1 (ATTY. BELLO)
FACTS:
 Corporation M agreed to construct a nuclear generating plant for corporation P at a price
of 250x dollars.
 The construction contract specified that M would provide, at no additional cost to P, any
additional items that later were determined to be necessary to deliver a complete, safe,
licensable, fully operational plant.
 During the construction period, regulatory agencies imposed stricter environmental
safeguards on nuclear generating plants than were in effect at the time the contract was
signed.
 Disputes arose between M and P over M's obligation to provide for stricter safeguards
and to include them as part of the delivered plant at the original contract price.
 The parties eventually settled their dispute by agreeing that both parties must meet the
terms of the 1969 contract.
 They also agreed that M was responsible to deliver a plant that met the stricter
environmental safeguards and that it would cost an additional 40x dollars.
 M then paid P 40x dollars instead, representing the estimated cost to satisfy the stricter
environmental standards rather than completing the plant's construction.
 Both parties then executed general releases to each other and M ceased its construction
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 activities.
 P Then contracted with a third party to finish construction of the nuclear generating
plant.
ISSUE:
Whether or not payment by a contractor of a sum of money to a buyer in exchange for a
release of the buyer's claims against the contractor for failure to fulfill a contract result in
income to the buyer or a return of capital
RULING:
NO. The 40x dollars payment from M to P represents a return of capital and is not income to P.
 The effect of the settlement agreement was that M would compensate P for M's failure to
provide a fully operational and licensable plant for 250x dollars as agreed upon under
the contract.
 The payment from M to P of 40x dollars represents the estimated present damages P has
incurred because of the breach of contract, determined under the settlement agreement
as the estimated additional costs needed to satisfy new regulatory standards that were
necessary to deliver a complete, safe, licensable, fully operational plant as required under
the contract.
 P has received no economic gain as a result of the 40x dollars payment and is merely
being made whole under the contract.
 P is being restored to the position that it would have been in if M had fulfilled the terms
of the contract.
 Payments by the one causing a loss that do not more than restore a taxpayer to the
position he or she was in before the loss was incurred are not included in gross income
because there is no economic gain.
3. WINDFALL RECEIPTS
SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income
means all income derived from whatever source, including (but not limited to) the
following items:
(9) Prizes and winnings;
(B) Exclusions from Gross Income. - The following items shall not be included in gross
income and shall be exempt from taxation under this title:
(7) Miscellaneous Items. -
(a) Income Derived by Foreign Government. - Income derived from investments in
the Philippines in loans, stocks, bonds or other domestic securities, or from
interest on deposits in banks in the Philippines by (i) foreign governments, (ii)
financing institutions owned, controlled, or enjoying refinancing from foreign
governments, and (iii) international or regional financial institutions established
by foreign governments.
(b) Income Derived by the Government or its Political Subdivisions. - Income derived
from any public utility or from the exercise of any essential governmental
function accruing to the Government of the Philippines or to any political
subdivision thereof.
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious,
charitable, scientific, educational, artistic, literary, or civic achievement but only
17 TAXATION 1 (ATTY. BELLO)
if:
(i) The recipient was selected without any action on his part to enter the
contest or proceeding; and
(ii) The recipient is not required to render substantial future services as a
condition to receiving the prize or award.
(d) Prizes and Awards in sports Competition. - All prizes and awards granted to
athletes in local and international sports competitions and tournaments whether
held in the Philippines or abroad and sanctioned by their national sports
associations.
(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and
employees of public and private entities: Provided, however, That the total
exclusion under this subparagraph shall not exceed Thirty thousand pesos
(P30,000) which shall cover:
(i) Benefits received by officials and employees of the national and local
government pursuant to Republic Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential
decree No. 851, as amended by Memorandum Order No. 28, dated August
13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus:
Provided, further, That the ceiling of Thirty thousand pesos (P30,000) may
be increased through rules and regulations issued by the Secretary of
Finance, upon recommendation of the Commissioner, after considering
among others, the effect on the same of the inflation rate at the end of the
taxable year.
(f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of individuals.
(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. -
Gains realized from the same or exchange or retirement of bonds, debentures or
other certificate of indebtedness with a maturity of more than five (5) years.
(h) Gains from Redemption of Shares in Mutual Fund. - Gains realized by the investor
upon redemption of shares of stock in a mutual fund company as defined in
Section 22 (BB) of this Code.
CESARINI v. UNITED STATES
DOCTRINE:
Gross income extends to treasure troves and requires that taxpayers list the income in the
year in which it is reduced to undisputed possession. Many things may constitute gross
income even though they are not explicitly identified in the Tax Code. Taxpayers should
consult all sources, including Treasury Regulations, before making assumptions about what
constitutes income
FACTS:
The plaintiffs were a husband and wife who purchased a used piano at an auction sale in 1957
for approximately $15. In 1964, while cleaning the piano, they discovered $4,467 in old
currency in the piano. Plaintiffs exchanged the old currency for new at a bank and reported
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
$4,467 on their 1964 joint U.S. federal income tax return as ordinary income from other
sources. On October 18, 1965, the couple filed an amended return, eliminating $4,467 from
the gross income computation and requesting a refund of $836.51. On January 18, 1966, the
Internal Revenue Service (IRS) rejected their refund claim, and they later filed a lawsuit. The
taxpayers asserted three arguments: (1) $4,467 is not includable in gross income under
Internal Revenue Code section 61 (26 U.S.C. Sec. 61); (2) Even if the money was gross income,
it was due and owing in the year the piano was purchased, 1957, and by 1964 the statute of
limitations provided by 26 U.S.C. Sec. 6501 had elapsed; and (3) If the money is gross income
in 1964, then plaintiffs are entitled to capital gains treatment under Section 1221 of the
Internal Revenue Code.
ISSUE/S:
Whether the money found in the piano is includable as gross income?
Whether taxes on the money were due in the year the piano was purchased or in the year the
money was found?
Whether plaintiffs are entitled to capital gains treatment?
RULING:
The receipt of the money constituted gross income in 1964, the year in which the funds were
reduced to undisputed possession. Plaintiffs are not entitled to a refund, nor are they entitled
to capital gains treatment.
First, an IRS Revenue Ruling states, “the finder of treasure trove is in receipt of taxable
income, for Federal income tax purposes, to the extent of its value in United States currency,
for the taxable year in which it is reduced to undisputed possession.” Second, numerous
Supreme Court cases recognize the broad sweeping construction of Section 61(a) found in
Treas. Reg. Sec. 1.61-1(a). Third, other courts and commentators have taken the position that
windfalls, including found money, were properly includable in gross income under Section
22(a) of the 1939 Code, which is the predecessor of Section 61(a) in the 1954/1986 Code.
Plaintiffs were unable to point to any inconsistencies between the gross income sections of the
Code, the interpretation of them by the regulations and the courts, and the revenue rulings.
The money was properly included as gross income for the calendar year of 1964. Problems of
when title vests, or when possession is complete, as it relates to federal taxation and in the
absence of definitive federal legislation, is determined by state law. English common-law rule
states that “title belongs to the finder as against all the world except the true owner.”Thus,
Plaintiffs must have actually found the money to have superior title over all but the true
owner. The $4,467 was not “reduced to undisputed possession” until actual discovery in 1964.
Pursuant to Treas. Reg. Sec. 1.61-14, “treasure trove, to the extent of its value in United States
currency, constitutes gross income for the taxable year in which it is reduced to undisputed
possession.” Therefore the United States is not barred by the statute of limitations from
collecting the $836.51 in tax in 1964.
Capital gains treatment is not applicable in this case. At the time relevant to this case, section
1222(3) of the Internal Revenue Code defined long-term capital gains as gains resulting from
the sale or exchange of capital assets held for more than 6 months. Neither the piano nor the
currency were sold or exchanged.
HORNUNG v. COMMISSIONER
DOCTRINE:
All items which constitute gross income are to be included for the taxable year in which
actually or constructively received.
FACTS:
18 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Sport Magazine annually awarded a new Corvette to the outstanding player in the NFL
championship game. Paul Hornung scored a record 19 points, helping the Packers win the
championship. Hornung was awarded a 1962 Corvette. Sport considered the car available to
Hornung as soon as the award was announced, though Sport had not made any arrangements
to have the car ready for Hornung on December 31, and Hornung did not actually receive the
car until January 3, 1962 at an awards luncheon in New York. The fair market value of the
Corvette was $3,331.04. Hornung sold the vehicle and reported this sale on his 1962 Federal
income tax return. However, he did not include the fair market value of the car in his tax
return for 1962. Hornung argued both that the Corvette was a gift and therefore exempt from
federal income tax. The court found that on Sunday, December 31, 1961, there were
substantial limitations on Hornung’s control over the Corvette. Additionally, because
December 31, 1961 was a Sunday, the dealership where the car was kept was closed, and
Hornung could not have accessed it on that date even if he wanted to. After the Court
established that the car has been received in 1962, it turned to a determination of whether it
should be included in gross income for that year. The court held that the Corvette was gross
income to Hornung. The court dismissed Hornung's claims that the championship football
game constitutes an educational achievement.
In July 1962, Hornung asked a friend to arrange for a car to be available for him to drive while
in Green Bay. A local Ford dealership furnished Hornung with a 1962 Thunderbird, later
exchanging the original for a second 1962 Thunderbird. The title to the cars remained with
Ford, though Hornung paid the insurance and all operating costs while driving the
Thunderbirds. Hornung did not recognize or report any income associated with this use. The
value of this use was determined to be $600. Hornung argued that the use of the Thunderbirds
was a gift. The court focused on the dealership's intentions and determined that Hornung had
not proven that the loaned cars were given as a result of a gift. The court then considered
whether the economic benefit to Hornung was gross income.
Hornung's mother received a fur stole in 1961. The stoles were reported by the Packers as
"Other Unallowable Deductions" and were described as "Awards to players' wives, etc." The
stoles were valued at $395 per stole, less an 8-percent bulk discount. Hornung did not report
any gross income with respect to the stole given to his mother. The court dispensed of this
issue easily by noting that the stole was actually received by Hornung's mother in 1961.
ISSUE/S:
Whether the value of a 1962 Chevrolet Corvette won by Paul Hornung should be included in
his gross income for the taxable year 1962
Whether the value of the use of the 1962 Thunderbird automobiles furnished to Hornung
should be included in gross income for the taxable year 1962
Whether Hornung's gross income for 1962 should include the value of a fur stole received by
his mother from his employer.
RULING:
Because the Corvette was received in 1962, the Tax Court held that the value of the car should
have been included in Hornung’s gross income for 1962. The court found that Hornung had
not met the burden of proving his use of the Thunderbirds was a gift. Therefore, the economic
benefit he received was taxable gross income. The stole was not income to Hornung in 1962,
as it was actually received in 1961.
4. TAX BENEFIT PRINCIPLE – RECOVERY OF DEDUCTED ITEMS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation
income arising from personal services rendered under an employer-employee relationship
where no deductions shall be allowed under this Section other than under subsection (M)
hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does
27 (A), (B) and (C); and 28 (A) (1), there shall be allowed the following deductions from gross not give rise to or create taxable income.
income;
FACTS:
(E) Bad Debts. - General Motors Pilipinas, Inc. (GMPI) is a joint venture corporation owned 60% by General
Motors Overseas Distribution Corporation (GM-US) and 40% by Isuzu Motors Limited of Japan
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and (ISUZU). GMPI was engaged in the manufacture of transmissions and components as well as in
charged off within the taxable year except those not connected with profession, trade or the assembly of cars and trucks (largely Isuzu).
business and those sustained in a transaction entered into between parties mentioned
under Section 36 (B) of this Code: Provided, That recovery of bad debts previously September 1985, due to economic recession in the Phil. and the depressed automotive market,
allowed as deduction in the preceding years shall be included as part of the gross income plus the non-availability of foreign exchange for the importation of parts for car and truck
in the year of recovery to the extent of the income tax benefit of said deduction. assemblies, GMPI ceased its operations. GMPI, from that time, was insolvent and has since
remained as such.
December 1985, the SH and the BOD of GMPI recommended its dissolution approved a
BIR RULING 102-95 resolution to shorten GMPI's corporate life to October 1986. Pursuant to the resolution, GMPI
filed with the SEC an application to amend its Articles of Incorporation.
FACTS:
Bacnotan Consolidated Industries, Inc. has a retirement plan for its employees. Because of the Based on the December 31, 1988 unaudited financial statements of GMPI, it has outstanding
spin-off of the Cement and Steel Plants of the Company, a number of its employees transferred liabilities/indebtedness to banks and affiliates in the following amounts:
to other companies. Said employees were given their corresponding separation pay in full.
Only 79 employees are left with the Company and according to its records, despite the release Bank Debt
of the retirement/separation benefits of the employees who left the service of the Company, Non-Trade Related Principal P280,150
the Retirement Plan is overfunded. As of April 30, 1994, the market value of the Fund is
P130,819,682.10. An actuarial valuation showed that the benefits due to the remaining 79 Interest 54,522
employees who are members of the Fund is P31.1 million showing an excess funding of P100
million.
Trade Related Principal 246,942
ISSUE: WON the excess funding may be reverted to the Company?
Interest 48,093
RULING:
Any excess of the Trust Fund, after satisfying all the benefits to which the retiring members Due to Affiliated Companies
are entitled, may revert to the Company. Accordingly, since there is an excess of P100 million
in the Trust Fund after the separated employees had been paid and the reserve fund for the Isuzu Motors Limited P113,240
remaining 79 employee-members is still actuarial sound, such excess may be reverted to the General Motors Corp. (GMC) 19,334 132,574
Company. Thus, the Company should declare as income the said excess of P100 million and
pay the corresponding income tax thereon pursuant to Section 24(a) of the Tax Code, as ———— ————
amended.
TOTAL P762,281
5. INDIRECT RECEIPTS – CANCELLATION OF INDEBTEDNESS AND DISCHARGE BY
=======
3RD PARTIES
Total outstanding liabilities to banks and GMC plus accrued interest = P649,041,000
REV. REGS. 2, SECTION 50. Forgiveness of indebtedness. — The cancellation and forgiveness 1987 GMPI capital deficiency = P664,522,000
of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, 1988 capital deficiency = P739,057,000
dependent upon the circumstances. If, for example, an individual performs services for a Value of property, plant and equipment = P20,450,000
creditor, who, in consideration thereof cancels the debt, income to that amount is realized by
the debtor as compensation for his services. If, however, a creditor merely desires to benefit a Since GM-US has no further interest to continue its ownership in the defunct GMPI, it assigned
debtor and without any consideration therefor cancels the debt, the amount of the debt is a its 60% shares in GMPI to Isuzu. It was agreed that GMPI would "clean-up" its current
gift from the creditor to the debtor and need not be included in the latter's gross income. If a outstanding liabilities except the liability to Isuzu, to be accomplished when the shares are
corporation to which a stockholder is indebted forgives the debt, the transaction has the effect transferred in three steps, as follows:
of the payment of a dividend. (1) By having GMPI's creditor banks waive accrued interest on the non-trade and trade
related debt;
BIR RULING 76-89 (copied from Alimangohan et al digest) (2) By having these banks assign to GM-US, its GMPI non-trade related receivables.
DOCTRINE: At that time GM-US will condone the total GMPI indebtedness due to it amounting to
When a creditor cancels a debt as part of a business transaction, the debtor is enriched or its P299,484,000 including the aforementioned non-trade debt as well as other non-trade
net assets has been increased and, therefore, he realized taxable income. However, a
19 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
liabilities due GMC; taxpayer.
(3) By having the banks grant a participation to GM-US in GMPI trade related receivables, GM- FACTS:
US would then assign these receivables to Isuzu. William Wood was president of the American Woolen Company for the years 1918 through
1920. The company instated a policy for 1919 and 1920 wherein the company would pay the
Later, Isuzu, as the new 100% parent company, considered infusing additional capital to taxes of the president and other company officers. The company paid $681,169.88 for 1918
restore the business into a viable operation and eliminate the capital deficiency so that the and $351,179.27 for 1919 on behalf of Wood. The Board of Tax Appeals held that these
company will resume its "going concern" status. And that as a going concern, its assets amounts paid were income of Wood.
previously adjusted to liquidation values, shall be restored to its valuation prior to liquidation.
As a fringe benefit, the American Woolen Company started paying the income taxes for the
ISSUE: officers of their company, including a guy named Wood. Wood's tax bill amounted to over
WON the bank's waiver (of accrued interest on the non-trade and trade related indebtedness $1M.
of GMPI) and GM-US condonation (of GMPI's non-trade related indebtedness) are subject to
income tax or to gift tax. Woolen paid Wood's taxes for a few years. Then Wood died. When Old Colony stepped in to
execute the will, the IRS assessed a tax penalty. Old Colony appealed. The IRS found that the
HELD: NO! Bank’s waiver and GM-US condonation are NOT subject to income or gift tax. taxes paid by Woolen were gross income for Wood.
RATIO: ISSUE/S:
GM-US’s condonation of GMPI's indebtedness is NOT subject to income tax since before and Were the taxes paid by the company additional income of Wood?
after the condonation GMPI remains insolvent, i.e., in a capital deficiency position. The
condonation is likewise NOT subject to gift tax since there is no donative interest on the part RULING:
of GM-US but solely for business consideration since Isuzu will only acquire the GMPI shares Yes. The US Supreme Court found that the tax payments were themselves taxable as gross
from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to income. The US Supreme Court found that Woolen's payment of Wood's tax bill was the same
Isuzu. as giving him extra income.
Moreover, a return to solvency due to a possible future additional capital infusion by Isuzu Old Colony argued that Woolen never gave the money to Wood, so how could it be considered
and/or subsequent profitability in a different taxable year will not affect the non-taxability of to be Wood's income? However, the Court found that it was immaterial that the money was
the condonation. paid directly to the government, Wood benefited by the payments, so Wood had to pay the tax.
The Court found that the tax payments could not be considered a gift, because they were made
Cancellation and forgiveness of indebtedness may amount to a payment of income / to a gift / in exchange for Wood's work, so it was part of his overall compensation package.
or to a capital transaction, dependent upon the circumstances.
This case said that when a taxpayer reduced a liability, their net worth has increased just as
Examples: surely as it does when they receive a gain. Therefore, that reduction of liability is considered
If an individual performs services for a Then income to that amount is to be gross income for tax purposes.
creditor who, in consideration thereof realized by the debtor as
BIR RULING 85-95 (copied from Alimangohan et al digest)
cancels the debt compensation for his services
FACTS:
If a creditor merely desires to benefit a Then amount of the debt is a gift
Subic Power Corporation (SPC) is registered with the Subic Bay Metropolitan Authority
debtor and without any consideration from the creditor to the debtor and
(SBMA) to engage in the business of generation and sale of electric power. SPC has a contract
therefor cancels the debt need not be included in the latter's
with the National Power Corporation to develop, construct and operate a 108 megawatt
gross income
power station in the Subic Bay Freeport, Olongapo City and the estimated cost of the power
If a corporation to which a stockholder is The waiver of interest by the banks station project is about U.S. $143.0 million
indebted forgives the debt, the on non-trade and trade related
To finance the project, SPC has undertaken a "Rule 144 A" offering in the U.S. and has issued
transaction has the effect of the payment indebtedness of GMPI is not subject
notes under an Indenture Agreement; that the notes are direct obligation of SPC and are
of a dividend to income tax considering that the
floated in the U.S.; that under the Indenture Agreement, SPC will pay interest to the holders
deduction of said interest as
(Sec. 50 Revenue Regulations No. 2) of the notes without any withholding or deduction for any taxes imposed or levied by
expense in prior years did not offset
the Philippine Government; that the said tax assumption is not only in conformity with the
nor reduce the taxable income of
international banking practice on foreign loans, but also primarily as a consideration for
GMPI since it was in a financial loss
the credit and in lieu of additional interest that would have been imposed had SPC not
position even without the
agreed to assume the Philippine withholding tax; that therefore, the Philippine
deduction.
withholding tax on the interest is passed on to SPC and it assumes the payment of the
OLD COLONY TRUST CO. v. CIR tax; that SPC bears the burden of and becomes directly liable to the tax otherwise due
from the noteholders; that the Philippine withholding tax on the interest becomes SPC's
DOCTRINE: additional tax liability, and an addition to its financing charges associated in the
The discharge of a taxpayer’s obligation by a third party is equivalent to direct receipt by the construction of the power plant.

20 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ISSUE:
W/N The withholding tax base for purposes of applying the 5% final withholding tax is the
total amount of income to be remitted without grossing up the 5% final withholding tax due
thereon.
RULING:
YES. The assumption of the tax constitutes an additional income of the non-resident creditor-
bondholders, which in turn should be subject to tax. (Old Colony Trust Co. vs. Commissioner,
279 U.S. 716). Thus, the tax base should be grossed-up by adding to the interest income
payments the amount of tax assumed.
III. GROSS INCOME
A. INCLUSIONS
SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income means
all income derived from whatever source, including (but not limited to) the following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a
profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional partnership.
1. COMPENSATION: SPECIAL PROBLEMS ON “IN-KIND” COMPENSATION
REV. REGS. 2-98, SECTION 2.78.1. Withholding of Income Tax on Compensation Income. —
(A) Compensation Income Defined. — In general, the term "compensation" means all
remuneration for services performed by an employee for his employer under an
employer-employee relationship, unless specifically excluded by the Code.
The name by which the remuneration for services is designated is immaterial. Thus,
salaries, wages, emoluments and honoraria, allowances, commissions (e.g.
transportation, representation, entertainment and the like); fees including director's fees,
if the director is, at the same time, an employee of the employer/corporation; taxable
bonuses and fringe benefits except those which are subject to the fringe benefits tax
under Sec. 33 of the Code; taxable pensions and retirement pay; and other income of a
similar nature constitute compensation income.
The basis upon which the remuneration is paid is immaterial in determining whether the
remuneration constitutes compensation. Thus, it may be paid on the basis of piece-work,
or a percentage of profits; and may be paid hourly, daily, weekly, monthly or annually.
Remuneration for services constitutes compensation even if the relationship of employer
and employee does not exist any longer at the time when payment is made between the
21 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
person in whose employ the services had been performed and the individual who
performed them.
(1) Compensation paid in kind. — Compensation may be paid in money or in some medium
other than money, as for example, stocks, bonds or other forms of property. If services
are paid for in a medium other than money, the fair market value of the thing taken in
payment is the amount to be included as compensation subject to withholding. If the
services are rendered at a stipulated price, in the absence of evidence to the contrary,
such price will be presumed to be the fair market value of the remuneration received. If a
corporation transfers to its employees its own stock as remuneration for services
rendered by the employee, the amount of such remuneration is the fair market value of
the stock at the time the services were rendered.
a. LIMITED CHOICE AND RESTRICTED PROPERTY
U.S. v. DRESCHER
DOCTRINE:
The value of the employer-purchased annuities contract is taxable as part of the taxpayer's
gross income in the year in which the annuities were purchased.
FACTS:
Drescher was an employee of Bausch and Lomb Optical Company (B&L) who was given a
voluntary retirement before he reached 65, He was given a “non-transferrable” annuity in
1939 and 1940 that would begin to pay him when he reached 65 in 1958 or his designated
beneficiary if he died. Each policy was issued by Connecticut General Life Insurance Company
and was delivered to the Optical Company which retained possession of it. B&L will be in
possession of the contract until Mr. Drescher reached 65. The premium paid for each policy
was $5,000. The amount of such payment was deducted by the Company in its tax return for
the year of payment as part of the compensation paid to Mr. Drescher during that year. His
salary as an officer was not reduced because of the purchase of the annuity contract. The
policy had no cash surrender value. It only guaranteed a future stream of income for Mr.
Drescher or his beneficiary. In filing income tax returns Mr. Drescher reported on the cash
basis; the B&L on the accrual basis. Here comes the IRS telling Mr. Drescher that the 5k
annuity contract should be a part of his income for the year 1939 and 1940. IRS argued that
the contracts are taxable to the annuitant (Mr. Drescher) in the year of purchase by the
employer because § 22(a), 26 U.S.C.A., sweeps into gross income "compensation for personal
service, of whatever kind and in whatever form paid, xxx and income derived from any source
whatever." On the other hand, Mr. Drescher cited Treasury rulings to the effect that
retirement annuity contracts purchased for an employee gave rise to taxable income only as
the annuitant received payments under the contract (so meaning Mr. D could only be taxed
once he received the payments); and that the entire amount of each annuity payment was
includible in gross income for the year of its receipt if he had made no contribution toward the
purchase of the annuity, while, if he had made contributions, he was taxable by 3%. Drescher
argues that the annuity is worth nothing to him for the years given by the B&L. The IRS
argues that it is worth $5,000.
ISSUE:
What is the includable income value of the annuity in the tax year 1939 and 1940? Is it the
price of the premium paid by B&L (5K) or is it zero because the annuity gives the taxpayer no
present income?
RULING:
The gov’t won. The value of the annuity contract is equal to the cost to the taxpayer of
acquiring identical rights. The court reasoned that the value should lie somewhere between
the premium price and zero. Even though Mr. Drescher might die before the annuity started
paying, he had some present rights to a future income stream w/ he could designate to a
beneficiary. Furthermore, Mr. Drescher could realize present cash payment from a 3rd party
who he could designate as a trustee to hold the future payments in trust for him. However,
this would probably worth less than the premium paid by the company based on the risk of
Mr. Drescher dying before the annuity began paying and thus the payments going to the
beneficiary – (meaning: B&L retained the annuity and Mr. D would have to go through hoops
to get it early (before retirement). This alone makes it worth less to him than what the B&L
paid for it.) The burden of proof was on Mr. Drescher to show that the present value was less
than 5k. The case was remanded for the determination of tax.
Dissent: Dissenters reasoned that the value of tax was the amount paid by B&L because it
represented the present value of the future payments, and was it was the consideration for the
contract between Mr. D and B&L. The dollar amount of the policy premium represented what
the market expected the present value of the aggregate payments over Mr. D’s life to be, w/c
was greater than 5k.
Note: Annuities are amounts received (other than amounts paid by reason of the death of the
insured and interest payments on such amounts and other than amounts received as
annuities) under a life insurance or endowment contract, but if such amounts (when added to
amounts received before the taxable year under such contract) exceed the aggregate
premiums or consideration paid (whether or not paid during the taxable year) then the excess
shall be included in gross income. In a way, Annuity is some sort of a deferred compensation.
Mr. D insists that he should only be taxed after he receives the payments? His tax rate may be
lower (marginal rate) when he gets to the payment phase (he may have retired) - additionally,
the time value of money. As a result of the gov’t victory, Mr. D would be required to pay taxes
currently on the present value of the policy (5k) plus future taxes on any payments greater
than 5k if he lived long enough. Mr. D would have gotten the same value in present terms if
B&L had given him a cash bonus large enough so that after the payment of taxes, he would be
left with still a 5k bonus.
BIR RULING 9-04
DOCTRINE:
Shares and dividends which are subject to disposal restrictions and/or forfeiture clauses
shall not be taxed until the disposal restriction is lifted.
The main distinction between the two schemes relate to the forfeiture provisions: under the
incentive scheme, the shares and any accumulated DRP shares will be forfeited if the
employee resigns or is dismissed before the end of the three year restriction period; that
however, if the employee retires or is made redundant, the shares will not be forfeited; that
they will be transferred to him following termination of employment. While under the
general scheme, the shares are not forfeitable under any circumstances. When the shares
cease to be restricted shares under both scheme, the Trustee can elect whether to transfer
the shares to the participant or sell the shares and pay the net proceeds of sale to the
participant/employee.
ISSUE:
1. Whether or not the shares granted under the ANZ ESAP Plan and which are
subject to disposal restriction and forfeiture clause at the time of grant shall not
be taxed until the disposal restriction is lifted?
2. Whether or not the dividends from ANZ ESAP shares which are mandatorily
reinvested through the ANZ Dividend Reinvestment Plan (DRP), with the same
disposal restrictions and/or forfeiture clauses as the original shares, shall not
also be taxed until the disposal restriction is lifted.
RULING:
1. "Gross income" includes compensation for services in whatever form paid including, but
not limited to, fees, salaries, wages, commissions, and similar items. Compensation is "all
remuneration for services performed by an employee for his employer under an
employer-employee relationship, unless specifically excluded by the Code". The
regulations further provides that compensation may be paid in money or in some
medium other than money, as for example, stocks, bonds or other forms of property.
The withholding tax on compensation shall apply to compensation actually or
constructively paid. Compensation is constructively paid when it is credited to the
account of or set apart for an employee so that it may be drawn upon by him at any time
although not then actually reduced to possession. If the income is not credited, but it is
set apart, such income must be unqualifiedly subject to the demand of the taxpayer.
Where a corporation contingently credits its employees with a bonus stock, which is
not available to such employees until some future date, the mere crediting on the books
of the corporation does not constitute payment.

FACTS:
ANZ Bank was organized under the laws of Australia; its shares are listed and traded in the
Australian Stock exchange. In order to increase employee motivation and to create a stronger
link between increasing shareholder value and its employee reward system ANZ Bank has
established the ANZ Employee Share Acquisition Plan (ESAP) to provide employees with the
opportunity to participate in the growth of the Bank. All employees, including executive
officers, with at least one year of service with the Bank will be offered Australian registered
shares in ANZ Bank free of charge under either of the two schemes: (1) the general scheme
2.
and (2) the incentive scheme. For both schemes, there is a trading lock preventing employees
from disposing the shares; until the earlier of (a) a period of three years from the date the
shares are awarded, or (b) termination of employment with ANZ in the case of the general
scheme and a period of three years from the date the shares are awarded in the case of the
incentive scheme. During the trading lock, a Trustee will hold the shares on behalf of the
employees. Dividends accruing to the employees during the trading lock are required to be
reinvested in ANZ shares under the compulsory participation requirement of the Dividend
Reinvestment Plan (DRP). As such, employees cannot receive cash dividends; the cash
dividends will be received in the form of additional ANZ shares. The additional shares will be
released from restriction at the same time the participant's plan shares are released.
Thus, the shares granted pursuant to an employer-employee relationship under the ANZ
ESAP Plan which are subject to disposal restriction and forfeiture clause at the time of
grant shall not be taxed until the disposal restriction is lifted, that is, for a period of three
years from the date the shares are awarded or the termination of employment with ANZ
in case of the general scheme and a period of three years from the date the shares are
awarded in the case of the incentive scheme whichever is earlier, as the same will only be
taxable when actually or constructively received.
With respect to dividends, the same, should be recognized on the date of declaration, the
date on which the payment of dividends is approved. The reason is that when dividends
are declared, the stockholder has already the right thereto so much so that if the stocks
are subsequently sold, the sales price normally includes the accrued dividends. Once a
dividend has been declared, a legal liability binding on the corporation is created.
However, stock dividends whether of the same class or different are not income. The
reason is that there is no distribution of the assets of the corporation. The stock
dividends create only a change in the composition of the stockholders' equity, that is, a
transfer from retained earnings to capital stock. Thus, dividends from ANZ ESAP shares
which are mandatorily reinvested through the ANZ Dividend Reinvestment Plan, with the

22 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 same disposal restrictions and/or forfeiture clauses as the original shares, shall not also
be taxed until the disposal restriction is lifted.
b. FORCED CONSUMPTION: “CONVENIENCE OF THE EMPLOYER” RULE
REV. REGS. 2-98, SECTION 2.78.1. Withholding of Income Tax on Compensation Income. —
(A)(2) Living quarters or meals. — If a person receives a salary as remuneration for services
rendered, and in addition thereto, living quarters or meals are provided, the value to such
person of the quarters and meals so furnished shall be added to the remuneration paid for the
purpose of determining the amount of compensation subject to withholding. However, if living
quarters or meals are furnished to an employee for the convenience of the employer, the value
thereof need not be included as part of compensation income.
REVENUE AUDIT MEMORANDUM ORDER NO. 1-87
2. Housing and Meals
2.1. If an employee receives a remuneration for services salaries and/or allowances and in
addition thereto living quarters and/or meals, the value to such person of the quarters
and meals so furnished shall be added to the remuneration otherwise paid for the
purpose of determining the amount of compensation subject to withholding tax.
2.2. The value of lodging furnished to an employee by or on behalf of the employer shall be
excluded from the employee's gross income, if the lodging is furnished in the business
premises of the employer; and the employee is required to accept such lodging as a
condition of his employment.
2.3. The value of meals furnished to an employee by or on behalf of his employer shall be
excluded from the employee's gross income if the meals are furnished on the business
premises of the employer and the meals are furnished for the convenience of the
employer. Meals furnished without charge to an employee as regarded as furnished for
the convenience of the employer where they are furnished to the employee during his
work day to have the employee available for work during his meal period.
2.4. Business premises of the employer means the place where the employee performs a
significant portion of his duties or where the employer conducts a significant portion of
his business. In case of doubt, the criteria to be used shall be (a) time, more than 50% of
the employee's work time or (b) value of business, more than 50% of the production of
the said employee.
2.5. Notwithstanding the provisions of the preceding paragraphs, if an employee is provided
by his employer with company housing or living quarters outside the business premises,
and such employee, because of his position in the employer-company, also uses said
house or living quarters for the benefit of the latter, like entertaining and putting up
houseguests and guest of the employer-company, then fifty percent (50%) of such
allowance, rental value, or depreciation if the living quarters are owned by the employer,
shall be added to the compensation paid to such employee and be subject to the
withholding tax on wages. The employer may deduct the said housing expense as a
business expense.
2.6. Privileges such as "courtesy discounts" on purchases of company merchandise of a value
not to exceed 1/2 basic month's salary of an employee or an officer shall not be added to
the remuneration of the employee.
2.7. Entertainment of and gifts to company officers and employees shall not be a deductible
expense except for Christmas and major anniversary celebrations (e.g. 25th year of
company's establishment), sports tournament, company picnics not to exceed one a year
23 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
provided that the value of the gift when it is not a service award for length of service shall
not exceed in value of ½ month's of the basic salary of the employee receiving the gift.
BENAGLIA v. COMMISIONER OF INTERNAL REVENUE
DOCTRINE
To a taxpayer employee who, solely for the convenience of his employer and as a necessary
incident of the proper performance of his duty, receives food and lodging from the employer,
the
value thereof is not taxable income.
FACTS
The petitioners are husband and wife, residing in Honolulu, Hawaii, where they filed joint
income tax returns for 1933 and 1934. The petitioner has, since 1926 and including the tax
years in question, been employed as the manager in full charge of the several hotels in
Honolulu owned and operated by Hawaiian hotels, Ltd., a corporation of Hawaii, consisting of
the Royal Hawaiian, the Moana and bungalows, and the Waialae Golf Club. These are large
resort hotels, operating on the American plan.
Petitioner was constantly on duty, and, for the proper performance of his duties and entirely
for the convenience of his employer, he and his wife occupied a suite of rooms in the Royal
Hawaiian Hotel and received their meals at and from the hotel.
Petitioner's salary has varied
in different years, being in one year $25,000. In 1933 it was $9,625, and in 1934 it was
$11,041.67. These amounts were fixed without reference to his meals and lodging, and neither
petitioner nor his employer ever regarded the meals and lodging as part of his compensation
or accounted for them.
The Commissioner determined a deficiency in the petitioners' joint income tax for 1933 of
$856.68, and for 1934 of $1,001.61, and they contest the inclusion in gross income each year
of the alleged fair market value of rooms and meals furnished by the husband's employer.
ISSUE
WON the fair market value of rooms and meals furnished by the husband's employer should
be included in the petitioners’ gross income.
RULING
NO. From the evidence, there remains no room for doubt that the petitioner's residence at the
hotel was not by way of compensation for his services, not for his personal convenience,
comfort or pleasure, but solely because he could not otherwise perform the services required
of him.
The evidence of both the employer and employee shows in detail what petitioner's duties
were and why his residence in the hotel was necessary. His duty was continuous and required
his presence at a moment's call. The demands and requirements of guests are numerous,
various, and unpredictable, and affect the meals, the rooms, the entertainment, and everything
else about the hotel. The manager must be alert to all these things day and night. He would not
consider undertaking the job and the owners of the hotel would not consider employing a
manager unless he lived there. This was implicit throughout his employment, and when his
compensation was changed from time to time no mention was ever made of it. Both took it for
granted. The corporation's books carried no accounting for the petitioner's meals, rooms, or
service.
Under such circumstances, the value of meals and lodging is not income to the employee, even
though it may relieve him of an expense which he would otherwise bear.
ARNOLD, Dissenting Opinion
I disagree with the conclusions of fact that the suite of rooms and meals furnished petitioner
and his wife at the Royal Hawaiian Hotel were entirely for the convenience of the employer
and that the cash salary was fixed without reference thereto and was never regarded as part
of his compensation.
His original employment was in 1925, and in accepting the employment he wrote a letter to
the party representing the employer, with whom he conducted the negotiations for
employment, under date of September 10, 1925, in which he says:
Confirming our meeting here today, it is understood that I will assume the position of general
manager of both the Royal Waikiki Beach Hotel (now under construction) and the Moana
Hotel in Honolulu, at a yearly salary of $10,000.00, payable monthly, together with living
quarters, meals, etc., for myself and wife. In addition I am to receive $20.00 per day while
traveling, this however, not to include any railroad or steamship fares, and I to submit
vouchers monthly covering all such expenses.
This letter, in my opinion, constitutes the basic contract of employment and clearly shows that
the living quarters, meals, etc., furnished petitioner and his wife were understood and
intended to be compensation in addition to the cash salary paid him. Being compensation to
petitioner in addition to the cash salary paid him, it follows that the reasonable value thereof
to petitioner is taxable income.
Conceding that petitioner was required to live at the hotel and that his living there was solely
for the convenience of the employer, it does not follow that he was not benefited thereby to
the extent of what such accommodations were reasonably worth to him. Living quarters and
meals are necessities, which he would otherwise have had to procure at his own expense. His
contract of employment relieved him to that extent. He has been enriched to the extent of
what they are reasonably worth.
 5.
The majority opinion is based on the finding that petitioner's residence at the hotel was solely
for the convenience of the employer and, therefore, not income. While it is no doubt
convenient to have the manager reside in the hotel, I do not think the question here is one of
convenience or of benefit to the employer. What the tax law is concerned with is whether or
not petitioner was financially benefited by having living quarters furnished to himself and
wife. He may have preferred to live elsewhere, but we are dealing with the financial aspect of
petitioner's relation to his employer, not his preference.
c. DE MINIMIS BENEFITS
REV. REGS. 2-98, SECTION 2.78.1. Withholding of Income Tax on Compensation Income. —
(A) (3) Facilities and privileges of a relatively small value. — Ordinarily, facilities and privileges
(such as entertainment, medical services, or so called "courtesy" discounts on purchases),
furnished or offered by an employer to his employees generally, are not considered as
compensation subject to withholding if such facilities or privileges are of relatively small value
and are offered or furnished by the employer merely as a means of promoting the health,
goodwill, contentment, or efficiency of his employees.
Where compensation is paid in property other than money, the employer shall make
necessary arrangements to ensure that the amount of the tax required to be withheld is
available for payment to the Commissioner.
BIR RULING NO. 023-02 (JUNE 21, 2002)
DOCTRINE:
De minimis benefits are facilities or privileges furnished or offered by an employer to his
employees that are relatively small value and offered or furnished by the employer merely as
a means of promoting the health, goodwill, contentment, or efficiency of his employees, and as
such, they are subject to neither compensation income tax nor fringe benefits tax. They are,
24 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
also not subject to withholding tax.
FACTS:
It is represented that Sodexho Pass International, a foreign corporation organized and existing
under the laws of France, is a service company engaged in operating innovative systems (the
issuance of service vouchers) to manage employee benefits given by private companies,
national government agencies, including universities and colleges, government-owned and/or
-controlled corporations, and more generally, any other organization to improve the health,
goodwill, contentment or efficiency of their employees, members or beneficiaries or their
dependents.
In the Philippines, Sodexho proposes to introduce administration of food and rice subsidy
benefits given by Philippine employers to their employees through the following procedures:
1. Client company transfers to Sodexho the amount allotted for its employees' annual or
monthly meal and food allowance and/or rice subsidy with instructions on the amount to
be allotted per employee in conformity with a de minimis threshold that would be
established;
2. Sodexho issues meal and food vouchers (intended for each employee with the value
allotted for the respective employee's benefit per working day) and delivers the same to
the client company. The face value of the vouchers shall be equivalent to the amount
transferred by the client company to Sodexho;
3. Client company distributes the vouchers to its employees;
4. Employee uses these vouchers for meals and/or food at an accredited establishment
(e.g., restaurant/food outlet) of his choice;
Accredited outlet sends back used vouchers to Sodexho for reimbursement;
6. Sodexho reimburses the store/outlet.
ISSUE/S:
1. Whether or not meal and food benefits provided by client companies through Sodexho
meal and food vouchers may be considered tax-exempt benefits
2. Whether or not a meal and food allowance of no more than Php100.00 per day is
considered de minimis benefit
3. Whether or not the de minimis rice allowance of Php1,000 per month given to the
employees may be aggregated with the meal allowance through Sodexho meal and food
vouchers and shall still be exempt from both withholding tax on compensation and fringe
benefit tax.
RULING:
1. The meal and food benefits provided to their employees by client companies through
Sodexho meal and food vouchers may be tax-exempt, subject to the standards set for de
minimis thresholds for fringe benefits and further, to the conditions set for the benefits to be
exempt pursuant to the tests of convenience of the employer and the promotion of health,
goodwill, contentment, or efficiency of the employees.
 Name and basis upon which the benefits are to be given are immaterial in
determining whether such would constitute taxable income.
 The de minimis benefits which are not subject to fringe benefits tax refer to those
same facilities and privileges furnished or offered by an employer to his employees
that are of relatively small value and are being offered or furnished by the employer
merely as a means of promoting the health, goodwill, contentment, or efficiency of
his employee. (The case gave a lot of examples for this) One of the examples given
was:
a. Rice subsidy of PHP 1000 or 1 sack of 50 kg rice per month amounting to not
more than PHP 1000
2. The meal and food allowance, although not for overtime work is considered de minimis if it
 does not exceed 25% of the basic minimum wage.
 Meal and food benefits not exceeding 25% of the daily minimum wage may be
considered de minimis meal benefit and therefore, tax exempt.
 The excess of the meal and food allowance given over the de minimis ceiling shall
still be exempt provided that it, together with the total amount of other benefits,
shall not exceed Php30,000.
3. The rules and regulations on de minimis benefits do not allow aggregation of the amounts
set for each type of benefit.
 The intent of the Regulations is to treat eachitem of de minimis benefits
independently of each other
 There can be no aggregation of de minimis values for rice and meal and food benefits
through Sodexho meal and food vouchers.
 In order to clearly conform with prescribed de minimis standards, therefore,
separate vouchers should be used for the rice allowance and the meal and food
benefit.
d. TRAVEL AND ENTERTAINMENT
RUDOLPH v. US
DOCTRINE:
If the trip was provided by the company primarily for the purpose of affording a pleasure trip
in the nature of a bonus, reward, and compensation for a job well done and that, from the
point of view of petitioners, it was primarily a pleasure trip and that, therefore, the value of
the trip was income and the costs were personal and nondeductible.
FACTS:
Petitioners are husband and wife. The husband worked for Southland Life Insurance
Company. By having sold a predetermined amount of insurance, the husband qualified to
attend the company's convention in New York City and, in line with company policy, to bring
his wife with him. He along with other employees and their spouses went to New York. One
morning was devoted to a "business meeting" and group luncheon, the rest of the time in New
York City to "travel, sight-seeing, entertainment, fellowship or free time." The entire trip
lasted one week.
The company paid all the expenses of the convention-trip which amounted to $80,000;
petitioners' allocable share being $560. When petitioners did not include the latter amount in
their joint income tax return, the Commissioner assessed a deficiency, including he value of
the trip as taxable income, which was sustained by the District Court in a suit for refund. But,
the District Court also held that the value of the trip being "in the nature of a bonus, reward,
and compensation for a job well done," was income to Rudolph, but being "primarily a
pleasure trip in the nature of a vacation," the costs were personal and nondeductible.
ISSUE/S:
1. Whether the value of the trip to the taxpayer-husband is properly includible in gross
income
2. Whether, though income, this outlay for transportation, meals, and lodging was
deductible by petitioners as an “ordinary and necessary” business expense
RULING:
1. YES. Gross income is defined as "all income from whatever source derived," including,
among other items, "compensation for services." In light of the sweeping scope of taxing
"all gains except those specifically exempted," and its purpose to include as taxable
income "any economic or financial benefit conferred on the employee as compensation,
whatever the form or mode by which it is effected," it seems clear that the District Court's
25 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
findings, if sustainable, bring the value of the trip within the reach of the statute (as in the
US taxing law. All of this just means the value of the trip is includible in the gross
income). It is within the Commissioner's competence to consider as "gross income" a
"reward, or a bonus given to . . .employees for excellence in service," which the District
Court found was the employer's primary purpose in arranging this trip.
2. NO. Although includable as gross income, it is not deductible. The Court affirmed the
decision appealed from.
 If a taxpayer who travels to a destination engages in both "business and personal
activities," the traveling expenses are deductible only if the trip is "related
primarily" to the taxpayer's business; if "primarily personal," the traveling expenses
are not deductible even though the taxpayer engages in some business there.
Whether a trip is related primarily to the taxpayer's business or is primarily
personal in nature "depends on the facts and circumstances in each case."
 The deductibility of the expenses of a taxpayer's wife who accompanies her husband
depends, first, on whether his trip is a "business trip." If so, it must further be shown
that the wife's presence on the trip also had a bona fide business purpose.
 In this case, it may be arguable that the trip was both for business and personal
reasons. But…
 The husband places great emphasis on the fact that he is an entrapped "organization
man," required to attend such conventions, and that his future promotions depend
on his presence. Suffice it to say that the District Court did not find any element of
compulsion; to the contrary, it found that the petitioners regarded the convention in
New York City as a pleasure trip in the nature of a vacation.
 The trip not having been primarily a business trip, the wife's expenses are not
deductible. It is not necessary, therefore, to examine whether they would or would
not be deductible if, to the contrary, the husband's trip was related primarily to
business.
2. BUSINESS INCOME
3. GAINS
4. INTERESTS
5. RENTS
6. ROYALTIES
7. DIVIDENDS
SEC. 73. Distribution of dividends or Assets by Corporations. -
(A) Definition of Dividends. - The term 'dividends' when used in this Title means any
distribution made by a corporation to its shareholders out of its earnings or profits and
payable to its shareholders, whether in money or in other property.
Where a corporation distributes all of its assets in complete liquidation or dissolution, the
gain realized or loss sustained by the stockholder, whether individual or corporate, is a
taxable income or a deductible loss, as the case may be.
(B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital account
shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a
dividend at such time and in such manner as to make the distribution and cancellation or
redemption, in whole or in part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent that it represents a distribution of earnings or
profits.
(C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. -
Any distribution made to the shareholders or members of a corporation shall be deemed to
have been made form the most recently accumulated profits or surplus, and shall constitute a
part of the annual income of the distributee for the year in which received.
(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The
taxable income declared by a partnership for a taxable year which is subject to tax under
Section 27 (A) of this Code, after deducting the corporate income tax imposed therein, shall be
deemed to have been actually or constructively received by the partners in the same taxable
year and shall be taxed to them in their individual capacity, whether actually distributed or
not.
REV. REGS. 2, SECTION 250. Dividends. — Dividends, for the purpose of the law, comprise
any distribution whether in cash or other property, in the ordinary course of business, even
though extraordinary in amount, made by a domestic or resident foreign corporation, joint-
stock company, partnership, joint account (cuentas enparticipacion), association, or insurance
company to the shareholders or members out of its earnings or profits accumulated since
March 1, 1913.
Although interest on certain Government bonds and other similar obligations is not taxable
when received by a corporation, upon amalgamation with the other funds of the corporation,
such income loses its identity and when distributed to shareholders, is taxable to the same
extent as other dividend.
A taxable distribution made by a corporation to individual stockholders or members shall be
included is the gross income of the distributees when the cash of other property is
unqualifiedly made subject to their demand. Dividends, in cash or other property received by
an individual, are subject to tax in his hands in the same manner another income.
Dividends, whether in cash or other property, received by a domestic or resident foreign
corporation from a domestic corporation are taxable only to the extent of 25 per cent thereof
in accordance with Section 24 of the Code. Dividends received by a domestic corporation from
a foreign corporation, whether resident or nonresident, are taxable to the extent that they
constitute income from sources within the Philippines, as provided in Section 37 (a) (2) (b) of
the Code. Dividends paid by the domestic corporation to a nonresident foreign corporation
are taxable in full. (For definition of the different classes of corporations, see Section 84 of the
Code).
SECTION 251. Dividends paid in property. — Dividends paid in securities or other property
(other than its own stock), in which the earnings of a corporation have been invested, are
income to the recipients to the amount of the full market value of such property when
receivable by individual stockholders. When receivable by corporations, the amount of such
dividends includible for purposes of the tax on corporations are specified in Section 24 of the
Code. (See also Section 250 of these regulations). A dividend paid in stock of another
corporation is not a stock dividend, even though the stock distributed was acquired through
the transfer by the corporation declaring the dividends of property to the corporation the
stock of which is distributed as a dividend. Where a corporation declares a dividend payable
in a stock of another corporation, setting aside the stock to be so distributed and notifying the
stockholders of its action, the income arising to the recipients of such stock is its market value
at the time the dividend becomes payable. Scrip dividends are subject to tax in the year in
which the warrants are issued.
SECTION 252. Stock dividends. — A stock dividend which represents the transfer of surplus to
capital account is not subject to income tax. However a dividend in stock may constitute
taxable income to the recipients thereof notwithstanding the fact that the officers or directors
of the corporation (as defined in Section 84) choose to call such distribution as a stock
dividend. The distinction between a stock dividend which does not, and one which does,
constitute income taxable to the shareholder is the distinction between a stock dividend
26 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
which works no change in the corporate entity, the same interest in the same corporation
being represented after the distribution by more shares of precisely the same character, and a
stock dividend where there either has been a change of corporate identity or a change in the
nature of the shares issued as dividends whereby the proportional interest of the
shareholders after the distribution is essentially different from his former interests. A stock
dividend constitutes income if it gives the shareholder an interest different from that which
his former stock holdings represented. A stock dividend does not constitute income if the new
shares confer no different rights or interests than did the old — the new certificates plus the
old representing the same proportionate interest in the net assets of the corporation as did
the old.
SECTION 253. Sale of stock received as dividends. — Stock issued by a corporation, as a
dividend, does not constitute taxable income to a stockholder in such corporation, but gain
may be derived or loss sustained by the stockholder, whether individual or corporate, from
the sale of such stock, which gain or loss will be treated as arising from the sale or exchange of
a capital asset. (See Section 34 of the Code.)
The amount of gain derived or loss sustained from the sale of such stock, or from the sale of
the stack with respect to which it is issued, shall be determined in accordance with the
following rules:
(a) Where the stock issued as dividend is all or substantially the same character or
preference as the stock upon which the stock dividend is paid, the cost of each share (or
when acquired prior to March 1, 1913, the fair market value as of such date) will be the
quotient of the cost (or such fair market value) of the old shares of stock divided by the
total number of the old and new shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or preference
materially different from the stock upon which the stock dividend is paid, the cost (and
when acquired prior to March 1, 1913, the fair market value as of such date) of the old
shares of stock shall be divided between such old stock and the new stock, in proportion,
as nearly as may be, to the respective value of each class of stock, old and new, at the time
the new shares of stock are issued, and the cost (or when acquired prior to March 1,
1913, the fair market value as of such date) of each share of stock will be the quotient of
the cost (or such fair market value as of March 1, 1913) of the class to which such share
belongs divided by the number of shares in that class.
(c) Where the stock with respect to which a stock dividend is issued was purchased at
different times and at different prices and the identity of the lots cannot be determined,
any sale of the original stock, will be charged to the earliest purchases of such stock, and
any sale of dividend stock issued with respect to such stock will be presumed to have
been made from the stock issued with respect to the earliest purchased stock, to the
amount of the dividend chargeable to such stock.
(d) Where the stock with respect to which a stock dividend is declared was purchased at
different times and at different prices, and the dividend stock issued with respect to such
stock can not be identified as having been issued with respect to any particular lot of
such stock, then any sale of such dividend stock will be presumed to have been made
from the stock issued with respect to the earliest purchased stock, to the amount of the
stock dividend chargeable to such stock.
SECTION 254. Declaration and subsequent redemption of a stock dividend. — A true stock
dividend is not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a
corporation, after the distribution of a stock dividend, proceeds to cancel or redeem its stock
at such time and in such manner as to make the distribution and cancellation or redemption
essentially equivalent to the distribution of a taxable dividend, the amount received in
redemption or cancellation of the stocks shall be treated as a taxable dividend to the extent of
the earnings or profits accumulated by such corporation since March 1, 1913.
SECTION 255. Sources of distribution. — For the purpose of income taxation every
distribution made by a corporation is made out of earnings or profits to the extent thereof and
from the most recently accumulated earnings or profits. In determining the source of a
distribution, consideration should be given first, to the earnings or profits of the taxable year;
second, to the earnings or profits accumulated since February 28, 1913, only in the case
where, and to the extent that, the distribution made during the taxable year are not regarded
as out of the earnings or profits of the taxable year and all the earnings or profits accumulated
since February 28, 1913, have been distributed; and, fourth, to sources other than earnings or
profits only after the earnings or profits have been distributed.
SECTION 256. Distribution in liquidation. — In all cases where a corporation (as defined in
Section 84) distributes all of its property or assets in complete liquidation or dissolution, the
gain realized from the transaction by the stockholder, whether individual or corporate, is
taxable to the extent recognized in Section 34(b) of the Code. For this purpose, the term
"complete liquidation" includes any one of a series of distributions made by a corporation in
complete cancellation or redemption of all of its stock in accordance with a bona fide plan of
liquidation under which the transfer of all the assets under liquidation is to be complete
within a reasonable time from the date of the first distribution, usually not to exceed one year
from the time of such first distribution. If the amount received by the stockholder in
liquidation is less than the cost or other basis of the stock, the loss in the transaction is
deductible to the extent allowed in Section 34(c) of the Code.
WISE & CO. v. MEER
DOCTRINE:
Income tax law states that where a corporation, partnership, association, joint-account, or
insurance company distributes all of its assets in complete liquidation or dissolution, the gain
realized or loss sustained by the stockholder, whether individual or corporation, is a taxable
income or a deductible loss as the case may be.
FACTS:
Plaintiffs were stockholders of Manila Wine Merchants, Ltd. The Board of Directors of Manila
Wine Merchants, Ltd., (referred to as the Hong Kong Company), recommended to the
stockholders of the company that they adopt the resolutions necessary to enable the company
to sell its business and assets to Manila Wine Merchants, Inc. (referred to as the Manila
Company), for the sum of P400,000 Philippine currency; that this sale was duly authorized by
the stockholders of the Hong Kong Company; that the contract of sale between the two
companies was executed, and that the final resolutions completing the said sale and
transferring the business and assets of the Hong Kong Company to the Manila Company were
adopted on August 3, 1937, on which date the Manila Company paid the Hong Kong company
the P400,000 purchase price.
Pursuant to a resolution by its Board of Directors purporting to declare a dividend, the Hong
Kong Company made a distribution from its earnings for the year 1937 to its stockholders.
The Hong Kong Company has paid Philippine income tax on the entire earnings from which
the said distributions were paid. After deducting the said dividend, the surplus of the Hong
Kong Company resulting from the active conduct of its business was P74,182.12. That as a
result of the sale of its business and assets to the Manila Company, the surplus of the Hong
Kong Company was increased to a total of P270,116.59.
Pursuant to resolutions of its Board of Directors, and of its shareholders, the Hong Kong
Company distributed this surplus to its stockholders. Philippine income tax had been paid by
27 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the Hong Kong Company on the said surplus from which the said distributions were made. At
a special general meeting of the shareholders of the Hong Kong Company, the stockholders by
proper resolution directed that the company be voluntarily liquidated and its capital
distributed among the stockholders; that the stockholders at such meeting appointed a
liquidator duly paid off the remaining debts of the Hong Kong Company and distributed its
capital among the stockholders including plaintiffs; that the liquidator duly filed his
accounting on January 12, 1938, and in accordance with the provisions of Hong Kong Law, the
Hong Kong Company was duly dissolved at the expiration of three months from that date.
Plaintiffs duly filed Philippine income tax returns. Defendant subsequently made deficiency
assessments against plaintiffs. Plaintiffs duly paid the said amounts demanded by defendant
under written protest, which was overruled in due course; that the plaintiffs have since July 1,
1939 requested from defendant a refund of the said amounts which defendant has refused
and still refuses to refund.
ISSUE/S:
Whether the amounts received by plaintiffs and on which the taxes in question were assessed
and collected were ordinary dividends or liquidating dividends?
Whether or not these dividends are taxable income?
RULING:
The distributions under consideration were not ordinary dividends. Therefore, they are
taxable as liquidating dividends. It was stipulated in the deed of sale that the sale and transfer
of the HK Co. shall take effect on June 1, 1937. Distribution took place on June 8. They could
not consistently deem all the business and assets of the corporation sold as of June 1, 1937,
and still say that said corporation, as a going concern, distributed ordinary dividends to them
thereafter.
Appellants received the distributions in question in exchange for the surrender and
relinquishment by them of their stock in the HK Co. which was dissolved and in process of
complete liquidation. That money in the hands of the corporation formed a part of its income
and was properly taxable to it under the Income Tax Law. When the corporation was
dissolved and in process of complete liquidation and its shareholders surrendered their stock
to it and it paid the sums in question to them in exchange, a transaction took place. The
shareholder who received the consideration for the stock earned that much money as income
of his own, which again was properly taxable to him under the Income Tax Law.
The HK Co. was incorporated for the purpose of carrying on in the Philippine Islands the
business of wine, beer, and spirit merchants and the other objects set out in its memorandum
of association. Hence, its earnings, profits, and assets, including those from whose proceeds
the distributions in question were made, the major part of which consisted in the purchase
price of the business, had been earned and acquired in the Philippines. As such, it is clear that
said distributions were income from Philippine sources.
CIR v. CA (Jan 20, 1999)
DOCTRINE:
The three elements in the imposition of income tax are: (1) there must be gain or profit, (2)
that the gain or profit is realized or received, actually or constructively, and (3) it is not
exempted by law or treaty from income tax. Any business purpose as to why or how the
income was earned by the taxpayer is not a requirement.
(In this case, all 3 elements are present in the redemption of stocks, but element 2 is absent in
exchange of stocks)
FACTS:
In 1930s, Don Andres Soriano, a US citizen, formed the corporation "A. Soriano Y Cia",
predecessor of ANSCOR (A. N. Soriano Corp.). Over the years, several transactions involving
the company’s stocks, which include additional subscription, declaration of stock dividends
and transfers to the children of Don Andres happened. On December 30, 1964 Don Andres
died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares
— 50,495 of which are original issues and the balance of 134,659 shares as stock dividend
declarations. Correspondingly, one-half of that shareholdings or 92,577 shares were
transferred to his wife Doñ a Carmen Soriano, as her conjugal share. The other half formed
part of his estate. In the same year (December 1966), stock dividends worth 46,290 and
46,287 shares were respectively received by the Don Andres estate and Doñ a Carmen from
ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864 common
shares each.
In 1968 Doñ a Carmen was able to secure a favorable ruling from US IRS declaring that an
exchange from common to preferred shares is only a recapitalization scheme and not tax
avoidance. As such, she exchanged all her common shares for newly reclassified preferred
shares. The estate also exchanged 11,140 common shares for preferred shares.
Subsequently, In June 1968, ANSCOR redeemed 28,000 common shares of the estate. After a
year, ANSCOR made an additional redemption of 80,000 shares from the estate. As stated in
the Board Resolutions, ANSCOR's business purpose for both redemptions of stocks is to
partially retire said stocks as treasury shares in order to reduce the company's foreign
exchange remittances in case cash dividends are declared.
In 1973, BIR assessed ANSCOR for deficiency withholding tax-at-source, pursuant to Sections
53 and 54 of the 1939 Revenue Code, for the year 1968 and the second quarter of 1969 based
on the transactions of exchange and redemption of stocks. BIR made the assessments despite
the claim of ANSCOR that it availed of the tax amnesty under P.D. 23 which were amended by
P.D.'s 67 and 157. However, petitioner ruled that the invoked decrees do not cover Sections 53
and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was
assessed.
The bone of contention is the interpretation and application of Section 83(b) of the 1939
Revenue Act 38(38) which provides:
"SECTION 83. Distribution of dividends or assets by corporations. —
(b) Stock dividends — A stock dividend representing the transfer of surplus to capital account
shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a
dividend at such time and in such manner as to make the distribution and cancellation
or redemption, in whole or in part, essentially equivalent to the distribution of a
taxable dividend, the amount so distributed in redemption or cancellation of the stock
shall be considered as taxable income to the extent it represents a distribution of
earnings or profits accumulated after March first, nineteen hundred and thirteen."
Petitioner contends that the exchange transaction is tantamount to "cancellation'' under
Section 83(b) making the proceeds thereof taxable. It also argues that the said Section applies
to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner
claims that under the "net effect test," the estate of Don Andres gained from the redemption.
Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two
transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act.
ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres
estate or from Doñ a Carmen based on the two transactions, because the same were done for
legitimate business purposes which are (a) to reduce its foreign exchange remittances in the
event the company would declare cash dividends, and to (b) subsequently "Filipinized"
28 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ownership of ANSCOR, as allegedly envisioned by Don Andres. 41(41) It likewise invoked the
amnesty provisions of P.D. 67.
ISSUE:
W/N ANSCOR's redemption of stocks from its stockholder as well as the exchange of common
with preferred shares can be considered as "essentially equivalent to the distribution of
taxable dividend," making the proceeds thereof taxable
RULING:
The redemption of stocks is TAXABLE but the exchange of common with preferred shares is
NOT TAXABLE.
1) Tax Amnesty
PD 67 (tax amnesty law) condones "the collection of all internal revenue taxes including the
increments or penalties or account of non-payment as well as all civil, criminal or
administrative liabilities arising from or incident to" (voluntary) disclosures under the NIRC
of previously untaxed income and/or wealth "realized here or abroad by any taxpayer, natural
or juridical.
An income taxpayer covers all persons who derive taxable income. ANSCOR was assessed by
petitioner for deficiency withholding tax under Sections 53 and 54 of the 1939 Code. As such,
it is being held liable in its capacity as a withholding agent and not in its personality as a
taxpayer. The withholding agent is merely a tax collector, not a taxpayer. Not being a
taxpayer, a withholding agent, like ANSCOR in this transaction is not protected by the amnesty
under the decree.
2) Stock Dividends and Redemption of Stocks
Most of the redeemed shares of the estate were sourced from stock dividend declaration and
not from the purchase of original shares by Don Andres. The general rule is that stock
dividends are not taxable as held in the Eisner v. Macomber case. However, there is an
exception: if a corporation cancels or redeems stock issued as a dividend at such time and in
such manner as to make the distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the amount so distributed in
redemption or cancellation of the stock shall be considered as taxable income to the extent it
represents a distribution of earnings or profits. The exception was designed to prevent the
issuance and cancellation or redemption of stock dividends, which is fundamentally not
taxable, from being made use of as a device for the actual distribution of cash dividends, which
is taxable. Thus, "the provision had the obvious purpose of preventing a corporation from
avoiding dividend tax treatment by distributing earnings to its shareholders in two
transactions — a pro rata stock dividend followed by a pro rata redemption — that would
have the same economic consequences as a simple dividend."
Although redemption and cancellation are generally considered capital transactions, as such,
they are not subject to tax. However, it does not necessarily mean that a shareholder may not
realize a taxable gain from such transactions. Simply put, depending on the circumstances,
the proceeds of redemption of stock dividends are essentially distribution of cash dividends,
which when paid becomes the absolute property of the stockholder. Those circumstances,
which American courts look at, include the ff.:
1) the presence or absence of real business purpose, 2) the amount of earnings and
profits available for the declaration of a regular dividend and the corporation's past
record with respect to the declaration of dividends, 3) the effect of the distribution
as compared with the declaration of regular dividend, 4) the lapse of time between
issuance and redemption, 5) the presence of a substantial surplus and a generous
 supply of cash which invites suspicion as does a meager policy in relation both to
current earnings and accumulated surplus.
For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is
redemption or cancellation; (b) the transaction involves stock dividends and (c) the "time and
manner" of the transaction makes it "essentially equivalent to a distribution of taxable
dividends."
If the source of the redemption is the original capital subscriptions upon establishment of the
corporation or from initial capital investment in an existing enterprise, its redemption to the
concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939
Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed
shares are from stock dividend declarations other than as initial capital investment, the
proceeds of the redemption is additional wealth, for it is not merely a return of capital but a
gain thereon. It is not the stock dividends but the proceeds of its redemption that may be
deemed as taxable dividends.
The three elements in the imposition of income tax are: (1) there must be gain or profit, (2)
that the gain or profit is realized or received, actually or constructively, and (3) it is not
exempted by law or treaty from income tax. Any business purpose as to why or how the
income was earned by the taxpayer is not a requirement.
In this case, from the total of 108,000 shares redeemed from the estate, the balance of
82,752.5 (108,000 less 25,247.5 – original common shares owned by the estate) came from
stock dividends. The test of taxability under the exempting clause of Section 83(b) is, whether
income was realized through the redemption of stock dividends. The redemption converts
into money the stock dividends, which become a realized profit or gain and consequently, the
stockholder's separate property. Profits derived from the capital invested cannot escape
income tax. As realized income, the proceeds of the redeemed stock dividends can be reached
by income taxation regardless of the existence of any business purpose for the
redemption.
3) Exchange of Common Shares with Preferred Shares
There was no change in their proportional interest after the exchange. There was no cash
flow. Both stocks had the same par value. Under the facts herein, any difference in their
market value would be immaterial at the time of exchange because no income is yet realized
— it was a mere corporate paper transaction. It would have been different, if the exchange
transaction resulted into a flow of wealth, in which case income tax may be imposed.
Reclassification of shares does not always bring any substantial alteration in the subscriber's
proportional interest. But the exchange is different — there would be a shifting of the balance
of stock features, like priority in dividend declarations or absence of voting rights. Yet neither
the reclassification nor exchange per se, yields realized income for tax purposes.
In this case, the exchange of shares, without more, produces no realized income to the
subscriber. There is only a modification of the subscriber's rights and privileges — which is
not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a
subscriber disposes of his entire interest and not when there is still maintenance of
proprietary interest.
CIR v. MANNING
DOCTRINE:
Whenever the company parted with a portion of its earnings "to buy" the corporate
holdings of the deceased stockholders, it was in ultimate effect and result making a
distribution of such earnings to the surviving stockholders. All these amounts are
29 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
consequently subject to income tax as being, in truth and in fact, a flow of cash benefits to
the surviving stockholders.
FACTS:
MANTRASCO had an authorized capital stock of P2,500,000 divided into 25,000 common
shares; 24,700 of these were owned by Julius S. Reese, and the rest, at 100 shares each, by the
three respondents: John Manning, W.D. McDonald, and E.E. Simmons. In view of Reese's
desire that upon his death MANTRASCO and its two subsidiaries, MANTRASCO (Guam),
Inc. and the Port Motors, Inc., would continue under the management of the respondents, a
trust agreement on his and the respondents' interests in MANTRASCO was executed by
and among Reese (as OWNER), MANTRASCO, the law firm of Ross, Selph, Carrascoso and
Janda (as TRUSTEES), and the respondents (as MANAGERS).
The trust agreement provides that Reese and the Managers shall deposit with the trustees
their respective shares in MANTRANSCO. And that upon the Reese’s death, MANTRANSCO
shall purchase Reese’s shares. Reese died. After MANTRASCO made a partial payment of
Reese's shares, the certificate for the 24,700 shares in Reese's name was cancelled and a new
certificate was issued in the name of MANTRASCO. Pending full payment, the new certificate
was endorsed to trustees for and in behalf of MANTRASCO. Subsequently, MANTRASCO’s
stockholders passed a resolution reverting back the 24,700 shares in the Treasury to the
capital account of the company as a stock dividend to be distributed to shareholders of record
at the close of business on December 22, 1958. When the entire purchase price of Reese's
interest in MANTRASCO was finally paid in full by the latter, the trust agreement was
terminated and the trustees delivered to MANTRASCO all the shares which they were holding
in trust.
An examination of MANTRASCO's books was ordered by the Bureau of Internal Revenue.
The examination disclosed that (a) the 24,700 shares declared as dividends had been
proportionately distributed to the respondents, representing a total book value or
acquisition cost of P7,973,660; (b) the respondents failed to declare the said stock
dividends as part of their taxable income for the year 1958. The BIR examiners concluded
that the distribution of Reese's shares as stock dividends was in effect a distribution of the
"asset or property of the corporation as may be gleaned from the payment of cash for the
redemption of said stock and distributing the same as stock dividend." The Commissioner of
Internal Revenue issued notices of assessment for deficiency income taxes to the
respondents for the year 1958 amounting to roughly $2.4M each.
ISSUE:
Whether or not the stock dividends are subject to tax?
RULING:
It is the assumption of both parties that the 24,700 shares declared as stock dividends were
treasury shares. We are however convincedthat the said shares were not, on at anytime
treasury shares. Treasury shares are stocks issued and fully paid for and re-acquired by the
corporation either by purchase, donation, forfeiture or other means. Treasury shares are
therefore issued shares, but being in the treasury they do not have the status of outstanding
shares. Consequently, it cannot participate in dividends, because dividends cannot be
declared by the corporation to itself, nor in the meetings of the corporation as voting stock, for
otherwise equal distribution of voting powers among stockholders will be effectively lost and
the directors will be able to perpetuate their control of the corporation, though it still
represents a paid-for interest in the property of the corporation. The foregoing essential
features of a treasury stock are lacking in the questioned shares.
The manifest intention of the parties to the trust agreement was to treat the 24,700 shares
of Reese as absolutely outstanding shares of Reese's estate until they were fully paid. Such
being the true nature of the 24,700 shares, their declaration as treasury stock dividend in
1958 was a complete nullity and plainly violative of public policy. A stock dividend, being
one payable in capital stock, cannot be declared out of outstanding corporate stock, but
only from retained earnings. "'A stock dividend always involves a transfer of surplus (or
profit) to capital stock.' 'A stock dividend is a conversion of surplus or undivided profits into
capital stock, which is distributed to stockholders in lieu of a cash dividend.'
The respondents, using the trust instrument as a convenient technical device, bestowed unto
themselves the full worth and value of Reese's corporate holdings with the use of the very
earnings of the companies. Such package device, obviously not designed to carry out the usual
stock dividend purpose of corporate expansion reinvestment, e.g. the acquisition of additional
facilities and other capital budget items, but exclusively for expanding the capital base of the
respondents in MANTRASCO, cannot be allowed to deflect the respondents' responsibilities
toward our income tax laws. The conclusion is thus ineluctable that whenever the companies
involved herein parted with a portion of their earnings "to buy" the corporate holdings of
Reese, they were in ultimate effect and result making a distribution of such earnings to the
respondents. All these amounts are consequently subject to income tax as being, in truth and
in fact, a flow of cash benefits to the respondents.
The Commissioner erred in assessing the respondents the total acquisition cost (P7,973,660)
of the alleged treasury stock dividends in one lump sum. The record shows that the earnings
of MANTRASCO over a period of years were used to gradually wipe out the holdings therein
of Reese. Consequently, those earnings, as in effect having been distributed to the
respondents, should be taxed for each of the corresponding years when payments were
made to Reese's estate on account of his 24,700 shares. With regard to payments made with
MANTRASCO earnings in 1958 and the years before, while indeed those earnings were
utilized in those years to gradually pay off the value of Reese's holdings in MANTRASCO,
there is no evidence from which it can be inferred that prior to the passage of the
stockholders' resolution of December 22, 1958 the contributed equity of each of the
respondents rose correspondingly. It was only by virtue of the authority contained in the
said resolution that the respondents actually, albeit illegally, appropriated and partitioned
among themselves the stockholders' equity representing Reese's interests in MANTRASCO.
As those payments accrued in favor of the respondents in 1958 they are and should be liable,
for income tax purposes, to the extent of the aggregate amount paid, from 1955 to 1958, by
MANTRASCO to buy off Reese's shares.
Under the National Internal Revenue Code, income tax is assessed on income received from
any property, activity or service that produces income. The assessment of a fraud penalty and
imposition of interest charges pursuant to the provisions of the Tax Code by the CIR is in
accordance with law.
BIR RULING 39-02
DOCTRINE:
Transfer of assets from liquidating corp. to stockholders is not taxable, but the stockholder
shall be liable for taxes on any gain/loss realized from the transaction.
FACTS:
TA Bank of the Phil is a corporation having total authorized capital P5B divided into 25M
common shares and 25M preferred shares. All of the outstanding shares of TA are wholly
owned by TMBC (thrift bank) and its nominees.
TA plans to decrease its authorized capital stock to 1,129,020 common shares, with a par
value of PhP100.00 per share, and a total value of P112.9M. Under the Plan, all of TA's
outstanding preferred shares, and 5M of its outstanding 6,250,000 common shares shall be
surrendered by TMBC and cancelled immediately upon approval by the TA stockholders, the
SEC and the BSP of the said decrease.
30 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
In exchange for the surrender of the shares by TMBC, TA shall transfer to TMBC both real and
personal, tangible and intangible properties listed hereunder, and referred to hereinafter as
"Distributed Assets."
ISSUES/RULING:
1) W/N TA shall be liable for income tax either for its receipt of the surrendered shares, or its
transfer of the Distributed Assets to TMBC as liquidating dividends.
NO. TA shall not be liable for income tax on its receipt of surrendered shares or transfer of
liquidating dividends. The transfer by the liquidating corporation of its remaining assets to its
stockholders is not considered a sale of these assets. Thus, a liquidating corporation does not
realize gain or loss in partial or complete liquidation.
2) W/N TMBC shall realize capital gain or loss when it surrenders its shares in TA in exchange
for the assets distributed by TA as liquidating dividends; and should such capital gain or loss
shall be subject to final tax under Section 27(D)(2) of the Tax Code
YES, TMBC shall realize capital gain or loss when TA distributes its assets as liquidating
dividends.
The second paragraph of Section 73(A) of the Tax Code of 1997 states: "Where a corporation
distributes all of its assets in complete liquidation or dissolution, the gain realized or loss
sustained by the stockholder, whether individual or corporate, is a taxable income or a
deductible loss, as the case may be."
The tax treatment of liquidating dividends depends on the characterization of the income in
the form of such dividends received by shareholders as a result of the dissolution of the
corporation in which they hold shares.
In the case of Wise & Co., Inc., et al., vs. Meer, the SC held the amounts distributed in the
liquidation of a corporation shall be treated as payments in exchange for stock or shares, and
any gain or profit realized thereby shall be taxed to the distributee as other gains or profits.
In several BIR rulings, it has been held that liquidating gain is to be treated as the gain from
the sale or exchange of shares, consistent with the decision of the Supreme Court in Wise &
Co., Inc., subject, however, not to the 5%/10% final tax rate under Sections 24(C), 25(A)(3) or
(B), 27(D)(2), 28(A)(7)(c) and (B)(5)(c) of the Tax Code of 1997, but to the ordinary income
tax rates provided under Sections 24(A)(1), 25(A)(1) and (B), 27(A) or (E), 28(A)(1) or (2)
and (B)(1) of the Tax Code of 1997, depending on the status of the shareholder/stockholder.
Note: other issues not included in the digest pertain to payment of Documentary Stamp Taxes:
- No documentary stamp tax ("DST") is due on the surrender and cancellation of the TA
shares.
- Transfer by TA to TMBC of real property is not subject to DST on sale or transfer of real
property.
- Transfer by TA of its Loan Portfolio to TMBC is not subject to DST.
- Transfer or Assignment of any mortgage which stands as security for TA's Loan Portfolio
shall be subject to DST.
8. ANNUITIES
9. PRIZES AND WINNINGS
10. PENSIONS
11. SHARE IN GPP’S INCOME
SEC. 26. Tax Liability of Members of General Professional Partnerships. - A general
professional partnership as such shall not be subject to the income tax imposed under this
Chapter. Persons engaging in business as partners in a general professional partnership shall
be liable for income tax only in their separate and individual capacities.
For purposes of computing the distributive share of the partners, the net income of the
partnership shall be computed in the same manner as a corporation.
Each partner shall report as gross income his distributive share, actually or constructively
received, in the net income of the partnership.
B. EXCLUSIONS
SEC. 32. Gross Income. –
(B) Exclusions from Gross Income. - The following items shall not be included in gross
income and shall be exempt from taxation under this title:
(1) Life Insurance. - The proceeds of life insurance policies paid to the heirs or beneficiaries
upon the death of the insured, whether in a single sum or otherwise, but if such amounts are
held by the insurer under an agreement to pay interest thereon, the interest payments shall be
included in gross income.
(2) Amount Received by Insured as Return of Premium. - The amount received by the insured,
as a return of premiums paid by him under life insurance, endowment, or annuity contracts,
either during the term or at the maturity of the term mentioned in the contract or upon
surrender of the contract.
(3) Gifts, Bequests, and Devises. The value of property acquired by gift, bequest, devise, or
descent: Provided, however, That income from such property, as well as gift, bequest, devise
or descent of income from any property, in cases of transfers of divided interest, shall be
included in gross income.
(4) Compensation for Injuries or Sickness. - amounts received, through Accident or Health
Insurance or under Workmen's Compensation Acts, as compensation for personal injuries or
sickness, plus the amounts of any damages received, whether by suit or agreement, on account
of such injuries or sickness.
(5) Income Exempt under Treaty. - Income of any kind, to the extent required by any treaty
obligation binding upon the Government of the Philippines.
(6) Retirement Benefits, Pensions, Gratuities, etc.-
(a) Retirement benefits received under Republic Act No. 7641 and those received by officials
and employees of private firms, whether individual or corporate, in accordance with a
reasonable private benefit plan maintained by the employer: Provided, That the retiring
official or employee has been in the service of the same employer for at least ten (10)
years and is not less than fifty (50) years of age at the time of his retirement: Provided,
further, That the benefits granted under this subparagraph shall be availed of by an
official or employee only once. For purposes of this Subsection, the term 'reasonable
private benefit plan' means a pension, gratuity, stock bonus or profit-sharing plan
maintained by an employer for the benefit of some or all of his officials or employees,
wherein contributions are made by such employer for the officials or employees, or both,
for the purpose of distributing to such officials and employees the earnings and principal
of the fund thus accumulated, and wherein its is provided in said plan that at no time
shall any part of the corpus or income of the fund be used for, or be diverted to, any
purpose other than for the exclusive benefit of the said officials and employees.
(b) Any amount received by an official or employee or by his heirs from the employer as a
consequence of separation of such official or employee from the service of the employer
31 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
because of death sickness or other physical disability or for any cause beyond the control
of the said official or employee.
(c) The provisions of any existing law to the contrary notwithstanding, social security
benefits, retirement gratuities, pensions and other similar benefits received by resident
or nonresident citizens of the Philippines or aliens who come to reside permanently in
the Philippines from foreign government agencies and other institutions, private or
public.
(d) Payments of benefits due or to become due to any person residing in the Philippines
under the laws of the United States administered by the United States Veterans
Administration.
(e) Benefits received from or enjoyed under the Social Security System in accordance with
the provisions of Republic Act No. 8282.
(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement
gratuity received by government officials and employees.
(7) Miscellaneous Items. -
(a) Income Derived by Foreign Government. - Income derived from investments in the
Philippines in loans, stocks, bonds or other domestic securities, or from interest on
deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions
owned, controlled, or enjoying refinancing from foreign governments, and (iii)
international or regional financial institutions established by foreign governments.
(b) Income Derived by the Government or its Political Subdivisions. - Income derived from
any public utility or from the exercise of any essential governmental function accruing to
the Government of the Philippines or to any political subdivision thereof.
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious,
charitable, scientific, educational, artistic, literary, or civic achievement but only if:
(i) The recipient was selected without any action on his part to enter the contest or
proceeding; and
(ii) The recipient is not required to render substantial future services as a condition to
receiving the prize or award.
(d) Prizes and Awards in sports Competition. - All prizes and awards granted to athletes in
local and international sports competitions and tournaments whether held in the
Philippines or abroad and sanctioned by their national sports associations.
(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and employees of
public and private entities: Provided, however, That the total exclusion under this
subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall cover:
(i) Benefits received by officials and employees of the national and local government
pursuant to Republic Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential decree No.
851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering among others, the effect on
the same of the inflation rate at the end of the taxable year.
(f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of individuals.
(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. - Gains
realized from the same or exchange or retirement of bonds, debentures or other
certificate of indebtedness with a maturity of more than five (5) years.
(h) Gains from Redemption of Shares in Mutual Fund. - Gains realized by the investor upon
 redemption of shares of stock in a mutual fund company as defined in Section 22 (BB) of
this Code.
1. GIFTS, BEQUESTS AND DEVISES
SEC 32(B)(3). Gifts, Bequests, and Devises. The value of property acquired by gift, bequest,
devise, or descent: Provided, however, That income from such property, as well as gift,
bequest, devise or descent of income from any property, in cases of transfers of divided
interest, shall be included in gross income.
CIR v. DUBERSTEIN
DOCTRINE:
A voluntary executed transfer of his property by one to another, without any consideration or
compensation is not necessarily a "gift" within the meaning of the statute. The most critical
consideration is the transferor's intention. If the payment proceeds primarily from "the
constraining force of any moral or legal duty," or from "the incentive of anticipated benefit" of
an economic nature, it is NOT a gift.
FACTS:
These two cases concern the provision of the Internal Revenue Code which excludes from the
gross income of an income taxpayer "the value of property acquired by gift."
1st Case: Commissioner v. Duberstein:
Duberstein was president of the Duberstein Iron & Metal Company, a corporation in Ohio. The
company had done business with Mohawk Metal Corp. in New York City. Duberstein and
Berman (president of Mohawk) had generally used the telephone to transact their companies'
business - buying and selling metals. Duberstein also knew Berman 'personally' and had
known him for about seven years. Berman always asks Duberstein whether the latter knew of
potential customers for some of Mohawk's products;. Duberstein provided the names of
potential customers for these items.
In 1951 Berman telephoned Duberstein and said that the information Duberstein had given
him had proved so helpful that he wanted to give him a Cadillac as a gift and that the latter
should send to New York for it. Duberstein testified that he did not think Berman would have
sent him the Cadillac if he had not furnished him with information about the customers. It
appeared that Mohawk later deducted the value of the Cadillac as a business expense on its
corporate income tax return.
Duberstein did not include the value of the Cadillac in gross income for 1951, deeming it a gift.
The Commissioner asserted a deficiency for the car's value against him arguing that the
automobile was intended by the payor to be remuneration for services rendered to it by
Duberstein. CA reversed this decision.
2nd Case: Stanton v. United States:
NOTE: The second case is remanded to the District Court for further proceedings since it made
only the simple and unelaborated finding that the transfer in question was a "gift."
Stanton, upon resigning as comptroller of a church corporation and as president of its wholly
owned subsidiary created to manage its extensive real estate holdings, was given "a gratuity"
of $20,000 "in appreciation of" his past services.
The "gratuity" was duly paid. The Commissioner asserted a deficiency against Stanton after
the latter had failed to include the payments in question in gross income. After payment of the
deficiency and administrative rejection of a refund claim, Stanton sued the United States for a
32 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
refund. The trial judge made the simple finding that the payments were a "gift," and judgment
was entered for Stanton. However, CA reversed this.
ISSUE/S:
W/N a specific transfer to a taxpayer in fact amounted to a "gift" and thus excluded from gross
income
RULING:
(Note: Analogies and inferences drawn from other revenue provisions as to the meaning of
the term “gift”, such as the estate and gift taxes, are dubious. The meaning of the statutory
term has been shaped largely by the decisional law.)
No, the statute does not use the term 'gift' in the common-law sense, but in a more colloquial
sense. A voluntary executed transfer of his property by one to another, without any
consideration or compensation therefor, though a common law gift, is not necessarily a "gift"
within the meaning of the statute. The mere absence of a legal or moral obligation to make
such a payment does not establish that it is a gift. And, importantly, if the payment proceeds
primarily from "the constraining force of any moral or legal duty," or from "the incentive of
anticipated benefit" of an economic nature, it is not a gift. And, conversely, "where the
payment is in return for services rendered, it is irrelevant that the donor derives no economic
benefit from it."
A gift in the statutory sense, on the other hand, proceeds from a "detached and disinterested
generosity, out of affection, respect, admiration, charity or like impulses." And in this regard,
the most critical consideration is the transferor's intention. What controls is the intention with
which payment, however voluntary, has been made.
The "intention" of the transferor cannot mean what the cases on the common law concept of
gift call "donative intent." The donor's characterization of his action is not determinative - that
there must be an objective inquiry as to whether what is called a gift amounts to it in reality.
The proper criterion is one that inquiries what the basic reason for his conduct was in fact -
the dominant reason that explains his action in making the transfer.
Other Notes:
1. Government suggested that the Court promulgate a new "test" to serve as a standard to
be applied by the lower courts and by the Tax Court in dealing with numerous cases
involving the question what is a "gift" excludable from income under the Internal
Revenue Code.
SC: The governing principles are necessarily general and have already been spelled out in the
opinions of this Court. Government’s proposed test depends frankly on a set of "principles" or
"presumptions" derived from the decided cases, and concededly subject to various exceptions;
and it involves various corollaries, which add to its detail.
One proposition is that the concept of a gift is inconsistent with a payment's being a
deductible business expense. However, the taxing statute does not make nondeductibility by
the transferor a condition on the "gift" exclusion. The conclusion whether a transfer amounts
to a "gift" is one that must be reached on consideration of all the factors.
Decision of the issue presented in these cases must be based ultimately on the application of
the fact-finding tribunal's experience with the mainsprings of human conduct to the totality of
the facts of each case.
Accordingly, it cannot be said that the conclusion of the Tax Court was "clearly erroneous."
The Tax Court as trier of the facts was warranted in concluding that despite the
characterization of the transfer of the Cadillac by the parties and the absence of any
obligation, even of a moral nature, to make it, it was at bottom a recompense for
Duberstein's past services, or an inducement for him to be of further service in the
future.
HORNUNG v. CIR (already taken up)
2. COMPENSATION FOR INJURIES OR SICKNESS
SEC 32(B)(4) Compensation for Injuries or Sickness. - amounts received, through Accident or
Health Insurance or under Workmen's Compensation Acts, as compensation for personal
injuries or sickness, plus the amounts of any damages received, whether by suit or agreement,
on account of such injuries or sickness.
O’GILVIE v. US
DOCTRINE:
Compensation for injuries suffered personally is tax exempt. Damages received on account
of “personal injuries of another” are punitive in nature and are not exempt from taxes.
FACTS:
Betty O’Gilvie died of toxic shock syndrome. The petitioners (husband and children of Betty)
received a jury award of $1,525,000 actual damages and $10 million punitive damages in a
tort suit based on Kansas law against the maker of the product that caused decedent's death.
They paid federal income tax insofar as the award's proceeds represented punitive damages,
but immediately sought a refund.
Internal Revenue Code Section(s) 104(a)(2), as it read in 1988, excluded from "gross income,"
the "amount of any damages received (whether by suit or agreement and whether as lump
sums or as periodic payments) on account of personal injuries or sickness."
ISSUE/S:
W/N the above cited provision applies to punitive damages received by a plaintiff in a tort suit
for personal injuries
RULING:
No, the punitive damages received here were not received "on account of" personal injuries.
The provision does not apply and the damages are taxable.
Petitioners received the punitive damages at issue here by an “ordinary suit for personal
injuries." These legal circumstances bring those damages within the gross-income-exclusion
provision, however, only if the petitioners also received those damages on account of personal
injuries.
The Government says that such damages were not "received . . . on account” of the personal
injuries, but rather were awarded on account of a defendant's reprehensible conduct and the
jury's need to punish and to deter it. The Court agrees with the Government's interpretation of
the statute. Punitive damages are not covered because they are an element of damages not
designed to compensate victims; rather they are punitive in nature.
The Government's reading also is more faithful to the statutory provision's history and basic
tax-related purpose of excluding compensatory damages that restore a victim's lost,
nontaxable "capital."
MURPHY V. US
FACTS:
Marrita Murphy brought this suit to recover income taxes she paid on the compensatory
damages. Murphy contends that under § 104(a)(2) of the Internal Revenue Code (IRC), 26
U.S.C. § 104(a)(2), her award should have been excluded from her gross income because it
33 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
was compensation received “on account of personal physical injuries or physical sickness.
In 1994 Marrita Murphy filed a complaint with the Department of Labor alleging that her
former employer, the New York Air National Guard (NYANG), in violation of various whistle-
blower statutes, had “blacklisted” her and provided unfavorable references to potential
employers after shehad complained to state authorities of environmental hazards on a NYANG
airbase. The Secretary of Labor determined the NYANG had unlawfully discriminated and
retaliated against Murphy, ordered that any adverse employment references to the taxpayer
in Office of Personnel Management files be withdrawn, and remanded her case to an
Administrative Law Judge “for findings on compensatory damages.”
On remand Murphy submitted evidence that she had suffered both mental and physical
injuries as a result of the NYANG’s blacklisting her. A physician testified Murphy had
sustained “somatic” and “emotional” injuries. One such injury was “bruxism,” or teeth
grinding often associated with stress, which may cause permanent tooth damage. Upon
finding Murphy had also suffered from other “physical manifestations of stress” including
“anxiety attacks, shortness of breath, and dizziness,” the ALJ recommended compensatory
damages totaling $70,000, of which $45,000 was for “emotional distress or mental anguish,”
and $25,000 was for “injury to professional reputation” from having been blacklisted.
In 1999 the Department of Labor Administrative Review Board affirmed the ALJ’s findings and
recommendations. On her tax return for 2000, Murphy included the $70,000 award in her
“gross income.” Murphy later filed an amended return in which she sought a refund of the
$20,665 based upon § 104(a)(2) of the IRC, which provides that “gross income does not
include ... damages ... received ... on account of personal physical injuries or physical sickness.”
In support of her amended return, Murphy submitted copies of her dental and medical
records. Upon deciding Murphy had failed to demonstrate the compensatory damages were
attributable to “physical injury” or “physical sickness,” the Internal Revenue Service denied
her request for a refund.
ISSUE:
Whether or not compensation for injuries or sickness is considered taxable income
RULING:
Section 104(a), compensation for injuries or sickness, provides that “gross does not include
the amount of any damages received ... on account of personal physical injuries or physical
sickness.” Since 1996 it has further provided that, for purposes of this exclusion, emotional
distress shall not be treated as a physical injury or physical sickness.
Murphy no doubt suffered from certain physical manifestations of emotional distress, but the
record clearly indicates the Board awarded her compensation only “for mental pain and
anguish” and “for injury to professional reputation.” The Board thus having left no room for
doubt about the grounds for her award, we conclude Murphy’s damages were not “awarded
by reason of, or because of, ... [physical] personal injuries” Therefore, § 104(a)(2) does not
permit Murphy to exclude her award from gross income.
Every indication is that damages received solely in compensation for a personal injury are not
income within the meaning of that term in the Sixteenth Amendment. First, as compensation
for the loss of a personal attribute, such as well- being or a good reputation, the damages are
not received in lieu of income. Second, the framers of the Sixteenth Amendment would not
have understood compensation for a personal injury --including a nonphysical injury -- to be
income. Therefore, § 104(a)(2) is unconstitutional insofar as it permits the taxation of an
award of damages for mental distress and loss of reputation.
Murphy’s compensation was not received on account of personal physical injuries excludable
from gross income under § 104(a)(2). The taxpayer, however, is correct in alleging that §
104(a)(2) is unconstitutional as applied to her award because compensation for a non-
physical personal injury is not income under the Sixteenth Amendment if, as here, it is
unrelated to lost wages or earnings.
Murphy’s compensatory award in particular was not received “in lieu of” something normally
taxed as income; nor is it within the meaning of the term “incomes” as used in the Sixteenth
Amendment. Therefore, insofar as § 104(a)(2) permits the taxation of compensation for a
personal injury, which compensation is unrelated to lost wages or earnings, that provision is
unconstitutional. Accordingly, we remand this case to the district court to enter an order and
judgment instructing the Government to refund the taxes Murphy paid on her award plus
applicable interest.
ON REHEARING:
RULING:
Looking at § 61(a) by itself, one sees no indication that it covers Murphy’s award unless the
award is income as defined by Glenshaw Glass and later cases. Damages received for
emotional distress are not listed among the examples of income in § 61 and, as Murphy points
out, an ambiguity in the meaning of a revenue-raising statute should be resolved in favor of
the taxpayer. A statute is to be read as a whole, however, and reading § 61 in combination
with § 104(a)(2) of the Internal Revenue Code presents a very different picture — a picture so
clear that we have no occasion to apply the canon favoring the interpretation of ambiguous
revenue-raising statutes in favor of the taxpayer.
In 1996 the Congress amended § 104(a) to narrow the exclusion to amounts received on
account of “personal physical injuries or physical sickness” from “personal injuries or
sickness,” and explicitly to provide that “emotional distress shall not be treated as a physical
injury or physical sickness,” thus making clear that an award received on account of emotional
distress is not excluded from gross income under § 104(a)(2). As this amendment, which
narrows the exclusion, would have no effect whatsoever if such damages were not included
within the ambit of § 61, and as we must presume that when Congress acts to amend a statute,
it intends its amendment to have real and substantial effect. The 1996 amendment of § 104(a)
strongly suggests § 61 should be read to include an award for damages from nonphysical
harms. Although it is unclear whether § 61 covered such an award before 1996, we need not
address that question here; even if the provision did not do so prior to 1996, the presumption
indicates the Congress implicitly amended § 61 to cover such an award when it amended §
104(a).
For the 1996 amendment of § 104(a) to make sense, gross income in § 61(a) must, and we
therefore hold it does, include an award for non-physical damages such as Murphy received,
regardless whether the award is an accession to wealth.
BIR RULING NO. 057-83
DOCTRINE:
Denial of payment of wages beyond the control of employees entitle them to report the
backwages as income and pay their income taxes by allocating or spreading through the
years such income should have been earned.
FACTS: (basically there are no substantial facts provided for in the case)
The case arose from a labor dispute concerning 12 employees who were dismissed without
just cause brought before the Labor Arbiter who ruled for the reinstatement of said
employees and ordered the payment of back wages, allowances and benefits such as cost of
living and the 13th month pay for the period covering August 10, 1980 to January 15, 1983 to
said employees. The same decision was upheld by the Supreme Court on appeal.
34 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ISSUE:
Whether or not the back wages, allowances and benefits awarded to the reinstated
employees are subject to income and withholding taxes?
RULING:
Section 38 of the Tax Code provides that if the taxpayer is an individual, the income shall be
computed on the basis of the calendar year. All items of income shall be included in gross
income or gross compensation income, as the case may be, for the taxable year in which
received by the taxpayer except those expressly excluded and already subjected to the final
income tax, and exemption as well as deductions taken accordingly pursuant to Sections 21,
28 and 29 in relation to Section 39 all of the Tax Code, as amended. Salaries, commissions,
tips, directors fees, and other forms of compensation are income in the year received, and not
in the year earned. Thus, a taxpayer whose income is from salary or the like is required to file
his income tax return on the cash basis.
However, considering that such back wages, allowances and benefits constitute remunerations
for services that would have been performed by the said employees for the company prior to
the year (1983) when actually received, or during the period of their dismissal from the service
which has been affirmed to be illegal, a liberal construction of the statute is called for in this
particular case if only to protect employees who, in fact, had been deprived of the payment of
their wages and other forms of remunerations, from the payment of a tax heavier than what
should have been imposed if their employer had promptly met its obligation.
Having been denied payment of their wages when they were due because of circumstances
not of their own making and, therefore, beyond their control, the aforenamed employees
come within the scope of the inequity for which this ruling is precisely designed to remedy.
Thus, each of the said employees should report as income and pay their respective income
taxes thereon by allocating or spreading their back wages, allowances and benefits through
the years 1980, 1981 and 1982.
3. RETIREMENT BENEFITS, PENSIONS, GRATUITIES, ETC.
SEC 32(B)(6) Retirement Benefits, Pensions, Gratuities, etc.-
(a) Retirement benefits received under Republic Act No. 7641 and those received by officials
and employees of private firms, whether individual or corporate, in accordance with a
reasonable private benefit plan maintained by the employer: Provided, That the retiring
official or employee has been in the service of the same employer for at least ten (10)
years and is not less than fifty (50) years of age at the time of his retirement: Provided,
further, That the benefits granted under this subparagraph shall be availed of by an
official or employee only once. For purposes of this Subsection, the term 'reasonable
private benefit plan' means a pension, gratuity, stock bonus or profit-sharing plan
maintained by an employer for the benefit of some or all of his officials or employees,
wherein contributions are made by such employer for the officials or employees, or both,
for the purpose of distributing to such officials and employees the earnings and principal
of the fund thus accumulated, and wherein its is provided in said plan that at no time
shall any part of the corpus or income of the fund be used for, or be diverted to, any
purpose other than for the exclusive benefit of the said officials and employees.
(b) Any amount received by an official or employee or by his heirs from the employer as a
consequence of separation of such official or employee from the service of the employer
because of death sickness or other physical disability or for any cause beyond the control
of the said official or employee.
(c) The provisions of any existing law to the contrary notwithstanding, social security
benefits, retirement gratuities, pensions and other similar benefits received by resident
 or nonresident citizens of the Philippines or aliens who come to reside permanently in
the Philippines from foreign government agencies and other institutions, private or
public.
(d) Payments of benefits due or to become due to any person residing in the Philippines
under the laws of the United States administered by the United States Veterans
Administration.
(e) Benefits received from or enjoyed under the Social Security System in accordance with
the provisions of Republic Act No. 8282.
(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement
gratuity received by government officials and employees.
(7) (e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and employees
of public and private entities: Provided, however, That the total exclusion under this
subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall cover:
(i) Benefits received by officials and employees of the national and local government
pursuant to Republic Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential decree No.
851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering among others, the effect on
the same of the inflation rate at the end of the taxable year.
CIR v. CA (MARCH 23, 1992)
DOCTRINE:
Employee's trust is exempted from withholding tax on interest earned on bank deposits.
FACTS:
GCL Retirement Plan (GCL) is an employees' trust maintained by GCL Inc. to provide
retirement, pension, disability and death benefits to its employees. The Plan as submitted
was approved and qualified as exempt from income tax by the Commissioner of Internal
Revenue in accordance with Rep. Act. No. 4917. In 1984, Respondent GCL made investments
and earned therefrom interest income from which was withheld the 15% final withholding tax
imposed by Pres. Decree No. 1959. On 15 January 1985, Respondent GCL filed with Petitioner
a claim for refund for P1,312.66 withheld by Anscor Capital and Investment Corp., and
P2,064.15 by Commercial Bank of Manila. On 12 February 1985, it filed a second claim for
refund of the amount of P7,925.00 withheld by Anscor, stating in both letters that it disagreed
with the collection of the 15% final withholding tax from the interest income as it is an entity
fully exempt from income tax as provided under Rep. Act No 4917 in relation to Section 56 (b)
(3)of the Tax Code. The refund requested having been denied, Respondent GCL elevated the
matter to the CTA. The latter ruled in favor of GCL, holding that employees' trusts are exempt
from the 15% final withholding tax on interest income and ordering a refund of the tax
withheld.
Under Rep. Act No. 1983,, employees' trusts were exempt from income tax. Pres. Decree No.
1156 provided, for the first time, for the withholding from the interest on bank deposits at
the source of a tax of 15% of said interest. However, it also allowed a specific exemption
which recognizes a depositor’s tax-exemption or preferential income tax treatment under
35 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
existing laws upon submission to the Commissioner of Internal Revenue of proof that the
said depositor is a tax-exempt entity or enjoys a preferential income tax treatment.
The exemption from withholding tax on interest on bank deposits carried over by Pres.
Decree No. 1739 if the recipient (individual or corporation) of the interest income is exempt
from income taxation, and the imposition of the preferential tax rates if the recipient of the
income is enjoying preferential income tax treatment, were both abolished by Pres. Decree
No. 1959. Petitioner thus submits that from 15 October 1984 when Pres. Decree No. 1959
was promulgated, employees' trusts ceased to be exempt and thereafter became subject to
the final withholding tax.
GCL contends that the tax exempt status of employees' trusts applies to all kinds of taxes,
including the final withholding tax on interest income. That exemption, according to GCL, is
derived from Section 56(b) and not from Section 21(d) or 24(cc) of the Tax Code, as argued
by Petitioner.
ISSUE:
Whether or not the GCL Plan is exempt from the final withholding tax on interest income
from money placements and purchase of treasury bills?
RULING:
GCL Plan was qualified as exempt from income tax by the Commissioner of Internal Revenue
in accordance with Rep. Act No. 4917. Manifest therefrom is that the tax law has singled out
employees' trusts for tax exemption.
Employees' trusts or benefit plans normally provide economic assistance to employees upon
the occurrence of certain contingencies, particularly, old age retirement, death, sickness, or
disability. It provides security against certain hazards to which members of the Plan may be
exposed. It is an independent and additional source of protection for the working group. What
is more, it is established for their exclusive benefit and for no other purpose.
The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in order to encourage
the formation and establishment of such private Plans for the benefit of laborers and
employee outside of the Social Security Act. It is evident that tax-exemption is likewise to be
enjoyed by the income of the pension trust. Otherwise, taxation of those earnings would result
in a diminution of accumulated income and reduce whatever the trust beneficiaries would
receive out of the trust fund. This would run afoul of the very intendment of the law.
The deletion in Pres. Decree No. 1959 of the provisos regarding tax exemption and
preferential tax rates under the old law, therefore, cannot be deemed to extend to
employees' trusts. Said Decree, being a general law, cannot repeal by implication a specific
provision, A subsequent statute, general in character as to its terms and application, is not
to be construed as repealing a special or specific enactment, unless the legislative purpose
to do so is manifested. This is so even if the provisions of the latter are sufficiently
comprehensive to include what was set forth in the special act.
Since the final tax and the withholding thereof are embraced within the title on "Income Tax."
it follows that said trust must be deemed exempt therefrom. Otherwise, the exception
becomes meaningless. There can be no denying either that the final withholding tax is
collected from income in respect of which employees' trusts are declared exempt. The
application of the withholdings system to interest on bank deposits or yield from deposit
substitute is essentially to maximize and expedite the collection of income taxes by requiring
its payment at the source. If an employees' trust like the GCL enjoys a tax-exempt status from
income, we see no logic in withholding a certain percentage of that income which it is not
supposed to pay in the first place.
CIR v. CA (OCT. 17, 1991)
DOCTRINE:
Terminal leave pay is a retirement benefit and not taxable.
FACTS:
Private respondent Efren P. Castañeda retired from the government service as Revenue
Attaché in the Philippine Embassy in London, England. Upon retirement, he received, among
other benefits, terminal leave pay from which petitioner Commissioner of Internal Revenue
withheld P12,557.13 allegedly representing income tax thereon.
Castañeda filed a formal written claim with petitioner for a refund of the P12,557.13,
contending that the cash equivalent of his terminal leave is exempt from income tax. The
Court of Tax Appeals found for Castañeda and ordered petitioner to refund him the amount.
Petitioner appealed, but the CA affirmed.
The Solicitor General, acting on behalf of the CIR, contends that the terminal leave pay is
income derived from employer-employee relationship, citing in support of his stand Section
28 of the National Internal Revenue Code; that as part of the compensation for services
rendered, terminal leave pay is actually part of gross income of the recipient.
ISSUE/S:
Whether or not terminal leave pay received by a government official or employee on the
occasion of his compulsory retirement from the government service is subject to withholding
(income) tax
RULING:
NO. The Court has already ruled that the terminal leave pay received by a government official
or employee is not subject to withholding (income) tax. In Jesus N. Borromeo vs. The Hon. Civil
Service Commission, et al., the Court explained the rationale behind the employee's entitlement
to an exemption from withholding (income) tax on his terminal leave pay as follows:
" . . . commutation of leave credits, more commonly known as terminal leave, is applied for by
an officer or employee who retires, resigns or is separated from the service through no fault of
his own. In the exercise of sound personnel policy, the Government encourages unused leaves
to be accumulated. The Government recognizes that for most public servants, retirement pay
is always less than generous if not meager and scrimpy. A modest nest egg which the senior
citizen may look forward to is thus avoided. Terminal leave payments are given not only at the
same time but also for the same policy considerations governing retirement benefits."
In fine, not being part of the gross salary or income of a government official or employee but a
retirement benefit, terminal leave pay is not subject to income tax.
IN RE: REQUEST OF ATTY. BERNARDO ZIALCITA FOR RECONSIDERATION OF THE
ACTION OF THE FINANCIAL AND BUDGET OFFICE
DOCTRINE:
 The commutation of leave credits is commonly known as terminal leave. Terminal
leave is applied for by an officer or employee who retires, resigns or is separated
from the service through no fault of his own. Since terminal leave is applied for by
an officer or employee who has already severed his connection with his employer
and who is no longer working, then it follows that the terminal leave pay, which is
the cash value of his accumulated leave credits, is no longer compensation for
services rendered. It cannot be viewed as salary.
FACTS:
 A resolution of the Court En Banc was issued regarding the amounts claimed by Atty.
36 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Bernardo F. Zialcita on the occasion of his retirement. The resolution states, among
others:
 "The terminal leave pay of Atty. Zialcita received by virtue of his compulsory
retirement can never be considered a part of his salary subject to the payment
of income tax but falls under the phrase `other similar benefits received by
retiring employees and workers', within the meaning of Section 1 of PD No. 220
and is thus exempt from the payment of income tax. That the money value of
his accrued leave credits is not a part of his salary is further buttressed by Sec.
3 of PD No. 985, otherwise known as 'The Budgetary Reform Decree on
Compensation and Position Classification of 1976' particularly Sec. 3 (a)
thereof, which makes it clear that the actual service is the period of time for
which pay has been received, excluding the period covered by terminal leave."
 Commissioner of Internal Revenue filed a motion for clarification and/or
reconsideration with the Supreme Court regarding it’s decision ordering the Fiscal
Management and Budget Office to refund Atty. Zialcita the amount of PHP 59,502.33
which was deducted from his terminal leave pay as withholding tax.
ISSUE/S:
Whether or not the money values of the accumulated leave credits of Atty. Zialcita is taxable.
NO
RULING:
Section 28 (b) 7 (b) of the National Internal Revenue Code (NIRC) states:
"Sec. 28 (b) — Exclusions from gross income — The following items shall not be included in
gross income and shall be exempt from taxation under this Title:
(7) Retirement benefits, pensions, gratuities, etc
(b) Any amount received by an official or employee or by his heirs from the employer as a
consequence of separation of such official or employee from the service of the employer due
to death, sickness or other physical disability or for any cause beyond the control of the said
official or employee."
 In the case of Atty. Zialcita, he rendered government service from March 13, 1962 up
to February 15, 1990. The next day, or on February 16, 1990, he reached the
compulsory retirement age of 65 years. Upon his compulsory retirement, he is entitled
to the commutation of his accumulated leave credits to its money value. Within the
purview of the above-mentioned provisions of the NIRC, compulsory retirement may
be considered as a "cause beyond the control of the said official or employee".
 Consequently, the amount that he received by way of commutation of his accumulated
leave credits as a result of his compulsory retirement, or his terminal leave pay, falls
within the enumerated exclusions from gross income and is therefore not subject to
tax.
 The terminal leave pay of Atty. Zialcita may likewise be viewed as a "retirement gratuity
received by government officials and employees" which is also another exclusion from
gross income as provided for in Section 28(b), 7(f) of the NIRC. A gratuity is that paid to
the beneficiary for past services rendered purely out of generosity of the giver or grantor.
 It is a mere bounty given by the government in consideration or in recognition of
meritorious services and springs from the appreciation and graciousness of the
government.
 Section 284 of the Revised Administrative Code grants to a government employee 15
days vacation leave and 15 days sick leave for every year of service. His leave benefits are
already imputed in, and form part of, his salary, which in turn is subjected to withholding
 tax on income. He is taxed on the entirety of his salaries without any deductions for any
leaves not utilized. It follows then that the money values corresponding to these leave
benefits both the used and unused have already been taxed during the year that they
were earned. To tax them again when the retiring employee receives their money value
as a form of government concern and appreciation plainly constitutes an attempt to tax
the employee a second time.
BIR RULING 1-95
DOCTRINE:
Separation benefits from Voluntary Retirement Programs are not tax exempt. Only those
separation benefits that are caused beyond the employees control such as death, sickness, or
other physical disability qualify to the tax exemption.
FACTS:
Due to numerous difficulties, aggravated by the marked downturn in its business, Mantrade
Development Corporation was compelled to take emergency cost-saving measures, one of
which was a voluntary retirement program open to all employees regardless of age and length
of service; and that employees who opted to retire under this program were paid in
accordance with the CBA/company policy on reduction of Company staff.
ISSUE/S:
Whether or not Mantrade correctly withheld taxes
RULING:
Yes. Pursuant to Section 28(b) (7) (B) of the Tax Code, as amended, any amount received by
an official or employee or by his heirs from the employer as a consequence of separation of
such official or employee from the service of the employer due to death, sickness or other
physical disability or for any cause beyond the control of the said official or employee is
exempt from taxes regardless of age or length of service. The phrase "for any cause beyond the
control of the said official or employee" in effect connotes involuntariness on the part of the
official or employee. The separation from the service of the official or employee must not be
asked for or initiated by him. The separation must not be of his own making.
The abovementioned law requires the presence of these two sine qua non conditions in order
that the separation pay of an official or employee may be exempt from taxes, viz:
(1) The official or employee's separation from the service of his employer is due to death,
sickness or other physical disability or for any cause beyond his control; and
(2) The employer pays separation benefits to such official or employee separated from the
service of his employer or to his heirs as a consequence of such involuntary separation.
In this case, the separation of the officials and employees from the service of the company was
of their own making because the Voluntary Retirement Program was availed of by the officials
and employees voluntarily. Such being the case, the separation benefits received by the
employees or officials who availed of the Voluntary Retirement program were subject to
income tax and consequently to the withholding tax. Their separation was voluntary or
initiated by the employees themselves.
Only separation benefits paid to employees by their employer due to their involuntary
separation therefrom as contemplated under Section 28(b) (7) (B) of the Tax Code, as
amended, and as implemented by Rev. Regulations Nos. 1-68 and 6-82, as amended, may be
exempt from income tax.
37 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
REPUBLIC ACT No. 4917
AN ACT PROVIDING THAT RETIREMENT BENEFITS OF EMPLOYEES OF PRIVATE FIRMS
SHALL NOT BE SUBJECT TO ATTACHMENT, LEVY, EXECUTION, OR ANY TAX
WHATSOEVER.
Section 1. Any provision of law to the contrary notwithstanding, the retirement benefits
received by officials and employees of private firms, whether individual or corporate, in
accordance with a reasonable private benefit plan maintained by the employer shall be
exempt from all taxes and shall not be liable to attachment, garnishment, levy or seizure by or
under any legal or equitable process whatsoever except to pay a debt of the official or
employee concerned to the private benefit plan or that arising from liability imposed in a
criminal action: Provided, That the retiring official or employee has been in the service of the
same employer for at least ten (10) years and is not less than fifty years of age at the time of
his retirement: Provided, further, That the benefits granted under this Act shall be availed of by
an official or employee only once: Provided, finally, That in case of separation of an official or
employee from the service of the employer due to death, sickness or other physical disability
or for any cause beyond the control of the said official or employee, any amount received by
him or by his heirs from the employer as a consequence of such separation shall likewise be
exempt as hereinabove provided.
As used in this Act, the term "reasonable private benefit plan" means a pension, gratuity, stock
bonus or profit sharing plan maintained by an employer for the benefit of some or all of his
officials and employees, wherein contributions are made by such employer or officials and
employees, or both, for the purpose of distributing to such officials and employees the
earnings and principal of the fund thus accumulated, and wherein it is provided in said plan
that at no time shall any part of the corpus or income of the fund be used for, or be diverted to,
any purpose other than for the exclusive benefit of the said officials and employees.
Section 2. This Act shall take effect upon its approval. Approved: June 17, 1967
REPUBLIC ACT NO. 7833
AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO.
6686 AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM
THE COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF
DETERMINING TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE Sec.
28(B)(8) OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED
Section 1. A new sub-paragraph to be known as sub-paragraph (F) is hereby inserted at the
end of Sec. 28(b)(8) of the National Internal Revenue Code, as amended, which shall read as
follows:
"(F) 13th month pay and other benefits.
"(i) Benefits received by officials and employees of the national and local governments
pursuant to Republic Act No. 6686;
"(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by
Memorandum Order No. 28, dated August 13, 1986;
"(iii) Benefits received by officials and employees not covered by Presidential Decree No.
851, as amended; and
"(iv) Other benefits such as productivity incentives and Christmas bonus in an amount not
exceeding Twelve thousand pesos (P12,000) which shall be integrated in the 13th month pay
solely for purposes of this Act."
"Provided, however, that the exclusion shall only apply to the first Thirty thousand pesos
(P30,000)."
Sec. 2. The exclusion herein provided shall cover benefits paid or accrued beginning January
1, 1994.
For purposes of reimbursing the officials or employees who may have received the benefits
covered by this Act before its effectivity, the withholding agents are hereby authorized not to
deduct the withholding taxes in the immediately succeeding payroll periods corresponding to
the amount previously withheld from the benefits.
Sec. 3. The Secretary of Finance shall, upon the recommendation of the Commissioner of
Internal Revenue, promulgate the necessary rules and regulations for the effective
implementation of the provision of this Act.
Sec. 4. All laws, decrees, orders, rules and regulations and other issuances inconsistent with
this Act are hereby repealed or amended accordingly.
Sec. 5. This Act shall take effect fifteen (15) days after its complete publication in the Official
Gazette or in any two (2) newspapers of general circulation, whichever comes earlier.
Approved: December 8, 1994
REVENUE REGULATIONS 2-95 (refer to PDF file)
RMC 36-94 (refer to PDF file)
4. INCOME DERIVED BY FOREIGN GOVERNMENT
SEC 32(B)(7)(a) Income Derived by Foreign Government. - Income derived from investments
in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on
deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions
owned, controlled, or enjoying refinancing from foreign governments, and (iii) international
or regional financial institutions established by foreign governments.
CIR v. MITSUBISHI METAL CORP.
DOCTRINE:
Laws granting exemption from tax are construed strictissimi juris against the taxpayer and
liberally in favor of the taxing power. Taxation is the rule and exemption is the exception.
FACTS:
On April 17, 1970, Atlas Consolidated Mining and Development Corporation entered into a
Loan and Sales Contract with Mitsubishi Metal Corporation for purposes of the projected
expansion of the productive capacity of the former's mines in Toledo, Cebu. Under said
contract, Mitsubishi agreed to extend a loan to Atlas 'in the amount of $20,000,000.00 (20m)
for the installation of a new concentrator for copper production. Atlas, in turn undertook to
sell to Mitsubishi all the copper concentrates produced for a period of fifteen (15) years. It
was contemplated that $9m of said loan was to be used for the purchase of the concentrator
machinery from Japan.
Mitsubishi thereafter applied for a loan with the Export-Import Bank of Japan (Eximbank) for
purposes of its obligation under said contract. The records in the Bureau of Internal Revenue
show that the approval of the loan by Eximbank to Mitsubishi was subject to the condition
that Mitsubishi would use the amount as a loan to Atlas and as a consideration for importing
copper concentrates from Atlas, and that Mitsubishi had to pay back the total amount of loan
by September 30, 1981. Pursuant to the contract between Atlas and Mitsubishi, interest
payments were made by the Atlas to the Mitsubishi totaling P13,143,966.79 for the years
38 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
1974 and 1975. The corresponding 15% tax thereon in the amount of P1,971,595.01 was
withheld pursuant to Section 24 (b) (1) and Section 53 (b) (2) of the National Internal
Revenue Code, and duly remitted to the Government.
On March 5, 1976, Mitsubishi filed a claim for tax credit requesting that the sum of
P1,971,595.01 be applied against their existing and future tax liabilities. Parenthetically, it
was later noted by respondent Court of Tax Appeals (CTA) in its decision that on August 27,
1976, Mitsubishi executed a waiver and disclaimer of its interest in the claim for tax credit in
favor of Atlas.
CIR did not act on the tax credit claim so Mitsubishi filed for a review with CTA. Mitsubishi
claims that it is an agent of Eximbank. Eximbank is Japanese-controlled gov’t. Such
governmental status of Eximbank exempts Eximbank (and in extension Mitsubishi) from
paying the tax on the interest payments on the loan. It was further claimed that the interest
payments on the loan from the consortium of Japanese banks were likewise exempt because
said loan supposedly came from or were financed by Eximbank.
The provision of the National Internal Revenue Code relied upon is Section 29 (b) (7) (A)
which excludes from gross income: (A) Income received from their investments in the
Philippines in loans, stocks, bonds or other domestic securities, or from interest on their
deposits in banks in the Philippines by (1) foreign governments, (2) financing institutions
owned, controlled, or enjoying refinancing from them, and (3) international or regional
financing institutions established by governments.
CTA concluded that the ultimate creditor of Atlas was Eximbank with Mitsubishi acting as a
mere "arranger or conduit through which the loans flowed from the creditor Export-Import
Bank of Japan to the debtor Atlas”. While this case was pending appeal, another 15% of tax
was deducted from the years 1977 to 1978 and thus Mitsubishi filed for another tax credit
w/c the CTA granted (so we have two cases here)
ISSUE:
W/N the interest income from the loans extended to Atlas by Mitsubishi is excludible from
groAss income taxation pursuant to Section 29 of the tax code and, therefore, exempt from
withholding tax.
RULING:
No. The loan and sales contract between Mitsubishi and Atlas does not contain any direct or
inferential reference to Eximbank whatsoever. The agreement is strictly between Mitsubishi
as creditor in the contract of loan and Atlas as the seller of the copper concentrates. From the
categorical language used in the document, one prestation was in consideration of the other.
The specific terms and the reciprocal nature of their obligations make it implausible, if not
vacuous to give credit to the cavalier assertion that Mitsubishi was a mere agent in said
transaction. Eximbank had nothing to do with the sale of the copper concentrates since all that
Mitsubishi stated in its loan application with the former was that the amount being procured
would be used as a loan to and in consideration for importing copper concentrates from Atlas.
Such an innocuous statement of purpose could not have been intended for, nor could it legally
constitute, a contract of agency. It became clear to the court that the provision of the law was
used as a cloak to escape the tax imposed, therefore in order to prevent bad precedent in the
future.
The conclusion is indubitable; Mitsubishi, and not Eximbank, is the sole creditor of atlas, the
former being the owner of the $20 million upon completion of its loan contract with Eximbank
of Japan. When Mitsubishi therefore secured such loans, it was in its own independent
capacity as a private entity and not as a conduit of the consortium of Japanese banks or the
Eximbank of Japan. While the loans were secured by Mitsubishi primarily "as a loan to and in
consideration for importing copper concentrates from atlas," the fact remains that it was a
loan by Eximbank of Japan to Mitsubishi and not to atlas. It should also be noted that
Eximbank's loan to Mitsubishi imposes interest at the rate of 75% per annum, while
Mitsubishis contract with Atlas merely states that the "interest on the amount of the loan shall
be the actual cost beginning from and including other dates of releases against loan."
The burden of proof rests upon the party claiming exemption to prove that it is in fact covered
by the exemption so claimed, which the petitioners have failed to discharge. Significantly,
private respondents are not among the entities which, under Section 29 of the tax code, are
entitled to exemption and which should indispensably be the party in interest in this
case. Both Atlas and Mitsubishi were not financing institutions financed by a particular
government, therefore, they are not entitled to tax credit from income derived from interest
earned.
5. GAINS FROM THE SALE OF BONDS, DEBENTURES OR OTHER CERTIFICATES OF
INDEBTEDNESS
SEC 32(B)(7)(g) Gains from the Sale of Bonds, Debentures or other Certificate of
Indebtedness. - Gains realized from the same or exchange or retirement of bonds, debentures
NIPPON LIFE INSURANCE COMPANY v. COMMISIONER OF INTERNAL REVENUE
DOCTRINE:
There is a clear distinction between interest from bonds and gain from the sale of bonds. It is
only the "Gains realized from the sale or exchange or retirement of bonds, debentures or other
certificate of indebtedness with a maturity of more than five (5) years" that is excluded from
gross income and thus exempt from income tax under Section 32(B)(7)(g) of the Tax Code.
Such gains from sale or exchange or retirement of bonds, debentures or other certificate of
indebtedness fall within the general category of "Gains derived from dealings in property", as
distinguished from interest from bonds, debentures or other certificate of indebtedness,
which fall within the general category of "Interests" under Section 32(A) of the Tax Code.
FACTS:
Nippon Life (Petitioner), an insurance company, purchased from Citibank N.A. a 10-year Fixed
Rate Treasury Bond (T-Bond) with a face value of Php20,000,000.00. The Bureau of Treasury
issued the Bond originally to Citibank N.A. with interest income on the bond payable semi-
annually for 10 years. Petitioner purchased the T-Bond from Citibank N.A. at a premium, i.e. at
a price higher than the Bond's face value. Petitioner's total cash outlay to acquire the Bond
amounted to Php20,076,022.89.
Tax Withheld on Income from the Sale
On June 16, 1999, Petitioner sold the Bond to Hongkong and Shanghai Banking Corporation
(HSBC) at a premium for Php27,152,761.15. On this sale, Php890,726.20 was withheld as tax.
Tax Withheld on Income from the Interest
Petitioner held on to the Bond from December 1, 1997 up to June 15, 1999. On three separate
occasions during this period, petitioner collected interest income on the Bond amounting to
Php1,830,000.00 for each income payment, net of Php457,500.00, representing the 20% final
tax withheld. Petitioner received a total of Php5,490,000.00 as interest income on the Bond,
net of Php1,372,500.00 final withholding tax.
In addition, for accrued interest receivable Php 48,291.67 was withheld as tax.
Total Tax Withheld
On the basis of the foregoing transactions, the total amount of taxes withheld from petitioner's
39 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
income on the Bond and remitted by the Bureau of Treasury to the BIR for the years 1998 and
1999 was Php2,223 ,386.82.
Subsequently, the BIR issued BIR Ruling No. 166-99 and BIR Ruling No. 016-00. The rulings
interpreted the tax exemption for gains from the sale of bonds, debentures and other
certificates of indebtedness under Section 32(B)(7)(g) of the 1997 Tax Code as applicable to
interest income.
The rulings provided that the interest income, yield or gain derived from bonds, debentures or
certificates of indebtedness as deposit substitutes, which are ordinarily subject to 20% final
tax under Section 27 (D)(l) of the NIRC, should exclude the interest income, yield or gain from
the gross income if the bonds, debentures or the certificate of indebtedness have maturities of
more than five (5) years.
On the basis of the foregoing rulings, petitioner filed with Revenue District Office No. 50 of the
BIR, an administrative claim for the refund of the amount of Php 2,223,386.82 as taxes
erroneously withheld from its income from investment in Fixed Rate Treasury Bond for the
years 1998 and 1999.
As there was no action on the part of the Respondent, petitioner filed this case.
ISSUE:
W/N petitioner is entitled to the refund of the amount of Php2,223 ,386.82 representing the
total tax withheld.
RULING:
Refund partially granted in the amount of Php 890,726.20 representing 20% final withholding
tax on the gain derived from the sale of the T-bond.
Income from Sale
Under Section 32(B)(7)(g) of the Tax Reform Act of 1997, gains realized from the sale or
exchange or retirement of bonds, debentures or other certificate of indebtedness with a
maturity of more than five (5) years shall not be included in gross income and shall be exempt
from taxation.
Therefore, the sale of the bond was exempt from tax by clear provision of law. The final taxes
withheld by HSBC on the gain from sale realized by petitioner totaling Php 890,726.20
should be refunded to petitioner.
Income from Interest
BIR Ruling No. 166-99 and BIR Ruling No. 016-00 are wrong.
The exemption under Section 32(B)(7)(g) of the Tax Code applies only to gains from the sale
of bonds, debentures and other certificates of indebtedness. It does not apply to gains derived
from interest.
Section 32(B)(7)(g) of the Tax Code particularly refers to "Gains from the Sale of Bonds,
Debentures or other Certificate of Indebtedness " in its title and "Gains realized from the sale or
exchange or retirement of bonds, debentures and other certificate of indebtedness with a
maturity of more than five (5) years" in its body.
In sum, the amounts of Php1,372,500.00 for interest income and Php 48,291.67 for accrued
interest receivable were properly withheld and therefore not refundable.

IV. DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation
income arising from personal services rendered under an employer-employee relationship
where no deductions shall be allowed under this Section other than under subsection (M)
hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26;
27 (A), (B) and (C); and 28 (A) (1), there shall be allowed the following deductions from gross
income;
(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the
ordinary and necessary expenses paid or incurred during the taxable year in
carrying on or which are directly attributable to, the development, management,
operation and/or conduct of the trade, business or exercise of a profession,
including:
(i) A reasonable allowance for salaries, wages, and other forms of
compensation for personal services actually rendered, including the grossed-
up monetary value of fringe benefit furnished or granted by the employer to
the employee: Provided, That the final tax imposed under Section 33 hereof has
been paid;
(ii) A reasonable allowance for travel expenses, here and abroad, while away
from home in the pursuit of trade, business or profession;
(iii) A reasonable allowance for rentals and/or other payments which are
required as a condition for the continued use or possession, for purposes of the
trade, business or profession, of property to which the taxpayer has not taken
or is not taking title or in which he has no equity other than that of a lessee,
user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation
expenses during the taxable year, that are directly connected to the
development, management and operation of the trade, business or profession
of the taxpayer, or that are directly related to or in furtherance of the conduct
of his or its trade, business or exercise of a profession not to exceed such
ceilings as the Secretary of Finance may, by rules and regulations prescribe,
upon recommendation of the Commissioner, taking into account the needs as
well as the special circumstances, nature and character of the industry, trade,
business, or profession of the taxpayer: Provided, That any expense incurred
for entertainment, amusement or recreation that is contrary to law, morals
public policy or public order shall in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be
allowed under Subsection (A) hereof unless the taxpayer shall substantiate with
sufficient evidence, such as official receipts or other adequate records: (i) the
amount of the expense being deducted, and (ii) the direct connection or relation of
the expense being deducted to the development, management, operation and/or
conduct of the trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross
income shall be allowed under Subsection (A) hereof for any payment made,
directly or indirectly, to an official or employee of the national government, or to an
40 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
official or employee of any local government unit, or to an official or employee of a
government-owned or -controlled corporation, or to an official or employee or
representative of a foreign government, or to a private corporation, general
professional partnership, or a similar entity, if the payment constitutes a bribe or
kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the
expenses allowable as deductions under this Chapter, a private educational institution,
referred to under Section 27 (B) of this Code, may at its option elect either: (a) to deduct
expenditures otherwise considered as capital outlays of depreciable assets incurred
during the taxable year for the expansion of school facilities or (b) to deduct allowance
for depreciation thereof under Subsection (F) hereof.
(B) Interest.-
(1) In General. - The amount of interest paid or incurred within a taxable year on
indebtedness in connection with the taxpayer's profession, trade or business shall be
allowed as deduction from gross income: Provided, however, That the taxpayer's
otherwise allowable deduction for interest expense shall be reduced forty-two percent
(42%) of the interest income subjected to final tax: Provided, That effective January 1,
2009, the percentage shall be thirty-three percent (33%).
(2) Exceptions. - No deduction shall be allowed in respect of interest under the
succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash
basis incurs an indebtedness on which an interest is paid in advance through
discount or otherwise: Provided, That such interest shall be allowed a a deduction in
the year the indebtedness is paid: Provided, further, That if the indebtedness is
payable in periodic amortizations, the amount of interest which corresponds to the
amount of the principal amortized or paid during the year shall be allowed as
deduction in such taxable year;
(b)If both the taxpayer and the person to whom the payment has been made or is to
be made are persons specified under Section 36 (B); or
(c)If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest
incurred to acquire property used in trade business or exercise of a profession may be
allowed as a deduction or treated as a capital expenditure.
(C) Taxes.-
(1) In General. - Taxes paid or incurred within the taxable year in connection with the
taxpayer's profession, trade or business, shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction
shall be allowed in the case of a taxpayer who does not signify in his return his
desire to have to any extent the benefits of paragraph (3) of this subsection (relating
to credits for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed.
 Provided, That taxes allowed under this Subsection, when refunded or credited,
shall be included as part of gross income in the year of receipt to the extent of the
income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged
in trade or business in the Philippines and a resident foreign corporation, the deductions
for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to
the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his
return his desire to have the benefits of this paragraph, the tax imposed by this Title shall
be credited with:
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and
of a domestic corporation, the amount of income taxes paid or incurred during the
taxable year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of
a general professional partnership or a beneficiary of an estate or trust, his
proportionate share of such taxes of the general professional partnership or the
estate or trust paid or incurred during the taxable year to a foreign country, if his
distributive share of the income of such partnership or trust is reported for taxation
under this Title.
An alien individual and a foreign corporation shall not be allowed the credits against
the tax for the taxes of foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be
subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country
shall not exceed the same proportion of the tax against which such credit is taken,
which the taxpayer's taxable income from sources within such country under this
Title bears to his entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax
against which such credit is taken, which the taxpayer's taxable income from
sources without the Philippines taxable under this Title bears to his entire taxable
income for the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ
from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in
whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine the
amount of the tax for the year or years affected, and the amount of tax due upon such
redetermination, if any, shall be paid by the taxpayer upon notice and demand by the
Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the
taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition
precedent to the allowance of this credit may require the taxpayer to give a bond with
sureties satisfactory to and to be approved by the Commissioner in such sum as he may
require, conditioned upon the payment by the taxpayer of any amount of tax found due
upon any such redetermination. The bond herein prescribed shall contain such further
conditions as the Commissioner may require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this
Section may, at the option of the taxpayer and irrespective of the method of accounting
employed in keeping his books, be taken in the year which the taxes of the foreign
country were incurred, subject, however, to the conditions prescribed in Subsection
41 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the
taxes of the foreign country accrued, the credits for all subsequent years shall be taken
upon the same basis and no portion of any such taxes shall be allowed as a deduction in
the same or any succeeding year.
(7)Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed
only if the taxpayer establishes to the satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;
(b) The amount of income derived from each country, the tax paid or incurred to
which is claimed as a credit under said paragraph, such amount to be determined
under rules and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such
credits.
(D) Losses. -
(1) In General.- Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or profession, if the loss arises
from fires, storms, shipwreck, or other casualties, or from robbery, theft or
embezzlement.
The Secretary of Finance, upon recommendation of the Commissioner, is hereby
authorized to promulgate rules and regulations prescribing, among other things, the
time and manner by which the taxpayer shall submit a declaration of loss sustained
from casualty or from robbery, theft or embezzlement during the taxable year:
Provided, however, That the time limit to be so prescribed in the rules and
regulations shall not be less than thirty (30) days nor more than ninety (90) days
from the date of discovery of the casualty or robbery, theft or embezzlement giving
rise to the loss.
(c) No loss shall be allowed as a deduction under this Subsection if at the time of the
filing of the return, such loss has been claimed as a deduction for estate tax purposes
in the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation,
the losses deductible shall be those actually sustained during the year incurred in
business, trade or exercise of a profession conducted within the Philippines, when such
losses are not compensated for by insurance or other forms of indemnity. The secretary
of Finance, upon recommendation of the Commissioner, is hereby authorized to
promulgate rules and regulations prescribing, among other things, the time and manner
by which the taxpayer shall submit a declaration of loss sustained from casualty or from
robbery, theft or embezzlement during the taxable year: Provided, That the time to be so
prescribed in the rules and regulations shall not be less than thirty (30) days nor more
than ninety (90) days from the date of discovery of the casualty or robbery, theft or
embezzlement giving rise to the loss; and
(3) Net Operating Loss Carry-Over. - The net operating loss of the business or
enterprise for any taxable year immediately preceding the current taxable year, which
had not been previously offset as deduction from gross income shall be carried over as a
deduction from gross income for the next three (3) consecutive taxable years
immediately following the year of such loss: Provided, however, That any net loss
incurred in a taxable year during which the taxpayer was exempt from income tax shall
not be allowed as a deduction under this Subsection: Provided, further, That a net
operating loss carry-over shall be allowed only if there has been no substantial change in
the ownership of the business or enterprise in that -
(i) Not less than seventy-five percent (75%) in nominal value of outstanding issued
shares., if the business is in the name of a corporation, is held by or on behalf of the
same persons; or
(ii) Not less than seventy-five percent (75%) of the paid up capital of the
corporation, if the business is in the name of a corporation, is held by or on behalf of
the same persons.
"For purposes of this subsection, the term 'not operating loss' shall mean the excess
of allowable deduction over gross income of the business in a taxable year.
Provided, That for mines other than oil and gas wells, a net operating loss without
the benefit of incentives provided for under Executive Order No. 226, as amended,
otherwise known as the Omnibus Investments Code of 1987, incurred in any of the
first ten (10) years of operation may be carried over as a deduction from taxable
income for the next five (5) years immediately following the year of such loss. The
entire amount of the loss shall be carried over to the first of the five (5) taxable
years following the loss, and any portion of such loss which exceeds, the taxable
income of such first year shall be deducted in like manner form the taxable income
of the next remaining four (4) years.
(4) Capital Losses. -
(a) Limitation. - Loss from sales or Exchanges of capital assets shall be allowed only
to the extent provided in Section 39.
(b) Securities Becoming worthless. - If securities as defined in Section 22 (T)
become worthless during the taxable year and are capital assets, the loss resulting
therefrom shall, for purposes of this Title, be considered as a loss from the sale or
exchange, on the last day of such taxable year, of capital assets.
(5) Losses From Wash Sales of Stock or Securities. - Losses from 'wash sales' of stock
or securities as provided in Section 38.
(6) Wagering Losses. - Losses from wagering transactions shall b allowed only to the
extent of the gains from such transactions.
(7) Abandonment Losses. -
(a) In the event a contract area where petroleum operations are undertaken is
partially or wholly abandoned, all accumulated exploration and development
expenditures pertaining thereto shall be allowed as a deduction: Provided, That
accumulated expenditures incurred in that area prior to January 1, 1979 shall be
allowed as a deduction only from any income derived from the same contract area.
In all cases, notices of abandonment shall be filed with the Commissioner.
(b) In case a producing well is subsequently abandoned, the unamortized costs
thereof, as well as the undepreciated costs of equipment directly used therein , shall
be allowed as a deduction in the year such well, equipment or facility is abandoned
by the contractor: Provided, That if such abandoned well is reentered and
production is resumed, or if such equipment or facility is restored into service, the
said costs shall be included as part of gross income in the year of resumption or
42 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
restoration and shall be amortized or depreciated, as the case may be.
(E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and
charged off within the taxable year except those not connected with profession, trade or
business and those sustained in a transaction entered into between parties mentioned
under Section 36 (B) of this Code: Provided, That recovery of bad debts previously
allowed as deduction in the preceding years shall be included as part of the gross income
in the year of recovery to the extent of the income tax benefit of said deduction.
(2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are
ascertained to be worthless and charged off within the taxable year and are capital
assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank or
trust company incorporated under the laws of the Philippines a substantial part of whose
business is the receipt of deposits, for the purpose of this Title, be considered as a loss
from the sale or exchange, on the last day of such taxable year, of capital assets.
(F) Depreciation. -
(1) General Rule. - There shall be allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including reasonable allowance for
obsolescence) of property used in the trade or business. In the case of property held by
one person for life with remainder to another person, the deduction shall be computed as
if the life tenant were the absolute owner of the property and shall be allowed to the life
tenant. In the case of property held in trust, the allowable deduction shall be apportioned
between the income beneficiaries and the trustees in accordance with the pertinent
provisions of the instrument creating the trust, or in the absence of such provisions, on
the basis of the trust income allowable to each.
(2) Use of Certain Methods and Rates. - The term 'reasonable allowance' as used in the
preceding paragraph shall include, but not limited to, an allowance computed in
accordance with rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method;
(b) Declining-balance method, using a rate not exceeding twice the rate which
would have been used had the annual allowance been computed under the method
described in Subsection (F) (1);
(c) The sum-of-the-years-digit method; and
(d) any other method which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner.
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. - Where under
rules and regulations prescribed by the Secretary of Finance upon recommendation of
the Commissioner, the taxpayer and the Commissioner have entered into an agreement
in writing specifically dealing with the useful life and rate of depreciation of any
property, the rate so agreed upon shall be binding on both the taxpayer and the national
Government in the absence of facts and circumstances not taken into consideration
during the adoption of such agreement. The responsibility of establishing the existence of
such facts and circumstances shall rest with the party initiating the modification. Any
change in the agreed rate and useful life of the depreciable property as specified in the
agreement shall not be effective for taxable years prior to the taxable year in which
notice in writing by certified mail or registered mail is served by the party initiating such
 change to the other party to the agreement:
Provided, however, that where the taxpayer has adopted such useful life and
depreciation rate for any depreciable and claimed the depreciation expenses as
deduction from his gross income, without any written objection on the part of the
Commissioner or his duly authorized representatives, the aforesaid useful life and
depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be
considered binding for purposes of this Subsection.
(4) Depreciation of Properties Used in Petroleum Operations. - An allowance for
depreciation in respect of all properties directly related to production of petroleum
initially placed in service in a taxable year shall be allowed under the straight-line or
declining-balance method of depreciation at the option of the service contractor.
However, if the service contractor initially elects the declining-balance method, it may at
any subsequent date, shift to the straight-line method.
The useful life of properties used in or related to production of petroleum shall be ten
(10) years of such shorter life as may be permitted by the Commissioner.
Properties not used directly in the production of petroleum shall be depreciated under
the straight-line method on the basis of an estimated useful life of five (5) years.
(5) Depreciation of Properties Used in Mining Operations. - an allowance for
depreciation in respect of all properties used in mining operations other than petroleum
operations, shall be computed as follows:
(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or
(b) Depreciated over any number of years between five (5) years and the expected
life if the latter is more than ten (10) years, and the depreciation thereon allowed as
deduction from taxable income: Provided, That the contractor notifies the
Commissioner at the beginning of the depreciation period which depreciation rate
allowed by this Section will be used.
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business
or Resident Foreign Corporations. - In the case of a nonresident alien individual
engaged in trade or business or resident foreign corporation, a reasonable allowance for
the deterioration of Property arising out of its use or employment or its non-use in the
business trade or profession shall be permitted only when such property is located in the
Philippines.
(G) Depletion of Oil and Gas Wells and Mines. -
(1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for
depletion or amortization computed in accordance with the cost-depletion method shall
be granted under rules and regulations to be prescribed by the Secretary of finance, upon
recommendation of the Commissioner. Provided, That when the allowance for depletion
shall equal the capital invested no further allowance shall be granted: Provided, further,
That after production in commercial quantities has commenced, certain intangible
exploration and development drilling costs: (a) shall be deductible in the year incurred if
such expenditures are incurred for non-producing wells and/or mines, or (b) shall be
deductible in full in the year paid or incurred or at the election of the taxpayer, may be
capitalized and amortized if such expenditures incurred are for producing wells and/or
mines in the same contract area.
'Intangible costs in petroleum operations' refers to any cost incurred in petroleum
operations which in itself has no salvage value and which is incidental to and necessary
43 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
for the drilling of wells and preparation of wells for the production of petroleum:
Provided, That said costs shall not pertain to the acquisition or improvement of property
of a character subject to the allowance for depreciation except that the allowances for
depreciation on such property shall be deductible under this Subsection.
Any intangible exploration, drilling and development expenses allowed as a deduction in
computing taxable income during the year shall not be taken into consideration in
computing the adjusted cost basis for the purpose of computing allowable cost depletion.
(2) Election to Deduct Exploration and Development Expenditures. - In computing
taxable income from mining operations, the taxpayer may at his option, deduct
exploration and development expenditures accumulated as cost or adjusted basis for cost
depletion as of date of prospecting, as well as exploration and development expenditures
paid or incurred during the taxable year: Provided, That the amount deductible for
exploration and development expenditures shall not exceed twenty-five percent (25%)
of the net income from mining operations computed without the benefit of any tax
incentives under existing laws. The actual exploration and development expenditures
minus twenty-five percent (25%) of the net income from mining shall be carried forward
to the succeeding years until fully deducted.
The election by the taxpayer to deduct the exploration and development expenditures is
irrevocable and shall be binding in succeeding taxable years.
'Net income from mining operations', as used in this Subsection, shall mean gross income
from operations less 'allowable deductions' which are necessary or related to mining
operations. 'Allowable deductions' shall include mining, milling and marketing expenses,
and depreciation of properties directly used in the mining operations. This paragraph
shall not apply to expenditures for the acquisition or improvement of property of a
character which is subject to the allowance for depreciation.
In no case shall this paragraph apply with respect to amounts paid or incurred for the
exploration and development of oil and gas.
The term 'exploration expenditures' means expenditures paid or incurred for the
purpose of ascertaining the existence, location, extent or quality of any deposit of
ore or other mineral, and paid or incurred before the beginning of the development
stage of the mine or deposit.
The term 'development expenditures' means expenditures paid or incurred during the
development stage of the mine or other natural deposits. The development stage of a
mine or other natural deposit shall begin at the time when deposits of ore or other
minerals are shown to exist in sufficient commercial quantity and quality and shall end
upon commencement of actual commercial extraction.
(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien
individual or Foreign Corporation. - In the case of a nonresident alien individual
engaged in trade or business in the Philippines or a resident foreign corporation,
allowance for depletion of oil and gas wells or mines under paragraph (1) of this
Subsection shall be authorized only in respect to oil and gas wells or mines located
within the Philippines.
(H) Charitable and Other Contributions. -
(1) In General. - Contributions or gifts actually paid or made within the taxable year to,
or for the use of the Government of the Philippines or any of its agencies or any political
subdivision thereof exclusively for public purposes, or to accredited domestic
corporation or associations organized and operated exclusively for religious, charitable,
scientific, youth and sports development, cultural or educational purposes or for the
rehabilitation of veterans, or to social welfare institutions, or to non-government
organizations, in accordance with rules and regulations promulgated by the Secretary of
finance, upon recommendation of the Commissioner, no part of the net income of which
inures to the benefit of any private stockholder or individual in an amount not in excess
of ten percent (10%) in the case of an individual, and five percent (%) in the case of a
corporation, of the taxpayer's taxable income derived from trade, business or profession
as computed without the benefit of this and the following subparagraphs.
(2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding
subparagraph, donations to the following institutions or entities shall be deductible in
full;
(a) Donations to the Government. - Donations to the Government of the Philippines
or to any of its agencies or political subdivisions, including fully-owned government
corporations, exclusively to finance, to provide for, or to be used in undertaking
priority activities in education, health, youth and sports development, human
settlements, science and culture, and in economic development according to a
National Priority Plan determined by the National Economic and Development
Authority (NEDA), In consultation with appropriate government agencies, including
its regional development councils and private philantrophic persons and
institutions: Provided, That any donation which is made to the Government or to
any of its agencies or political subdivisions not in accordance with the said annual
priority plan shall be subject to the limitations prescribed in paragraph (1) of this
Subsection;
(b) Donations to Certain Foreign Institutions or International Organizations. -
donations to foreign institutions or international organizations which are fully
deductible in pursuance of or in compliance with agreements, treaties, or
commitments entered into by the Government of the Philippines and the foreign
institutions or international organizations or in pursuance of special laws;
(c) Donations to Accredited Nongovernment Organizations. - the term
'nongovernment organization' means a non profit domestic corporation:
(1) Organized and operated exclusively for scientific, research, educational,
character-building and youth and sports development, health, social welfare,
cultural or charitable purposes, or a combination thereof, no part of the net
income of which inures to the benefit of any private individual;
(2) Which, not later than the 15th day of the third month after the close of the
accredited nongovernment organizations taxable year in which contributions
are received, makes utilization directly for the active conduct of the activities
constituting the purpose or function for which it is organized and operated,
unless an extended period is granted by the Secretary of Finance in accordance
with the rules and regulations to be promulgated, upon recommendation of the
Commissioner;
(3) The level of administrative expense of which shall, on an annual basis,
conform with the rules and regulations to be prescribed by the Secretary of
Finance, upon recommendation of the Commissioner, but in no case to exceed
thirty percent (30%) of the total expenses; and
(4) The assets of which, in the even of dissolution, would be distributed to
another nonprofit domestic corporation organized for similar purpose or
purposes, or to the state for public purpose, or would be distributed by a court
44 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
to another organization to be used in such manner as in the judgment of said
court shall best accomplish the general purpose for which the dissolved
organization was organized.
Subject to such terms and conditions as may be prescribed by the Secretary of
Finance, the term 'utilization' means:
(i) Any amount in cash or in kind (including administrative expenses) paid
or utilized to accomplish one or more purposes for which the accredited
nongovernment organization was created or organized.
(ii) Any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more purposes for which the accredited
nongovernment organization was created or organized.
An amount set aside for a specific project which comes within one or more
purposes of the accredited nongovernment organization may be treated as a
utilization, but only if at the time such amount is set aside, the accredited
nongovernment organization has established to the satisfaction of the
Commissioner that the amount will be paid for the specific project within a
period to be prescribed in rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the Commissioner, but not to
exceed five (5) years, and the project is one which can be better accomplished
by setting aside such amount than by immediate payment of funds.
(3) Valuation. - The amount of any charitable contribution of property other than money
shall be based on the acquisition cost of said property.
(4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if
verified under the rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner.
(I) Research and Development.-
(1) In General. - a taxpayer may treat research or development expenditures which are
paid or incurred by him during the taxable year in connection with his trade, business or
profession as ordinary and necessary expenses which are not chargeable to capital
account. The expenditures so treated shall be allowed as deduction during the taxable
year when paid or incurred.
(2) Amortization of Certain Research and Development Expenditures. - At the
election of the taxpayer and in accordance with the rules and regulations to be
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the
following research and development expenditures may be treated as deferred expenses:
(a) Paid or incurred by the taxpayer in connection with his trade, business or
profession;
(b) Not treated as expenses under paragraph 91) hereof; and
(c) Chargeable to capital account but not chargeable to property of a character
which is subject to depreciation or depletion.
In computing taxable income, such deferred expenses shall be allowed as deduction
ratably distributed over a period of not less than sixty (60) months as may be elected by
the taxpayer (beginning with the month in which the taxpayer first realizes benefits from
such expenditures).
The election provided by paragraph (2) hereof may be made for any taxable year
 beginning after the effectivity of this Code, but only if made not later than the time
prescribed by law for filing the return for such taxable year. The method so elected, and
the period selected by the taxpayer, shall be adhered to in computing taxable income for
the taxable year for which the election is made and for all subsequent taxable years
unless with the approval of the Commissioner, a change to a different method is
authorized with respect to a part or all of such expenditures. The election shall not apply
to any expenditure paid or incurred during any taxable year for which the taxpayer
makes the election.
(3) Limitations on deduction. - This Subsection shall not apply to:
(a) Any expenditure for the acquisition or improvement of land, or for the
improvement of property to be used in connection with research and development
of a character which is subject to depreciation and depletion; and
(b) Any expenditure paid or incurred for the purpose of ascertaining the existence,
location, extent, or quality of any deposit of ore or other mineral, including oil or
gas.
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide for
the payment of reasonable pensions to his employees shall be allowed as a deduction (in
addition to the contributions to such trust during the taxable year to cover the pension
liability accruing during the year, allowed as a deduction under Subsection (A) (1) of this
Section ) a reasonable amount transferred or paid into such trust during the taxable year in
excess of such contributions, but only if such amount (1)has not theretofore been allowed as a
deduction, and (2) is apportioned in equal parts over a period of ten (10) consecutive years
beginning with the year in which the transfer or payment is made.
(K) Additional Requirements for Deductibility of Certain Payments. - Any amount paid or
payable which is otherwise deductible from, or taken into account in computing gross income
or for which depreciation or amortization may be allowed under this Section, shall be allowed
as a deduction only if it is shown that the tax required to be deducted and withheld therefrom
has been paid to the Bureau of Internal Revenue in accordance with this Section 58 and 81 of
this Code.
(L) Optional Standard Deduction. – In lieu of the deductions allowed under the preceding
Subsections, an individual subject to tax under Section 24, other than a nonresident alien, may
elect a standard deduction in an amount not exceeding forty percent (40%) of his gross sales
or gross receipts, as the case maybe. In the case of a corporation subject to tax under Sections
27(A) and 28(A)(1), it may elect a standard deduction in an amount not exceeding forty
percent (40%) of its gross income as defined in Section 32 of this Code. Unless the taxpayer
signifies in his return his intention to elect the optional standard deduction, he shall be
considered as having availed himself of the deductions allowed in the preceding Subsections.
Such election when made in the return shall be irrevocable for the taxable year for which the
return is made: Provided, That an individual who is entitled to and claimed for the optional
standard deduction shall not be required to submit with his tax return such financial
statements otherwise required under this Code: Provided, further, That except when the
Commissioner otherwise permits, the said individual shall keep such records pertaining to his
gross income during the taxable year, as may be required by the rules and regulations
promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
(M) Premium Payments on Health and/or Hospitalization Insurance of an Individual
Taxpayer. - the amount of premiums not to exceed Two thousand four hundred pesos
(P2,400) per family or Two hundred pesos (P200) a month paid during the taxable year for
health and/or hospitalization insurance taken by the taxpayer for himself, including his
family, shall be allowed as a deduction from his gross income: Provided, That said family has a
45 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
gross income of not more than Two hundred fifty thousand pesos (P250,000) for the taxable
year: Provided, finally, That in the case of married taxpayers, only the spouse claiming the
additional exemption for dependents shall be entitled to this deduction.
Notwithstanding the provision of the preceding Subsections, The Secretary of Finance, upon
recommendation of the Commissioner, after a public hearing shall have been held for this
purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized
deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of
determining such ceilings or limitations, the Secretary of Finance shall consider the following
factors: (1) adequacy of the prescribed limits on the actual expenditure requirements of each
particular industry; and (2)effects of inflation on expenditure levels: Provided, further, That
no ceilings shall further be imposed on items of expense already subject to ceilings under
present law.
SEC. 36. Items not Deductible.-
(A) General Rule. - In computing net income, no deduction shall in any case be allowed in
respect to -
(1) Personal, living or family expenses;
(2) Any amount paid out for new buildings or for permanent improvements, or
betterments made to increase the value of any property or estate;
This Subsection shall not apply to intangible drilling and development costs incurred in
petroleum operations which are deductible under Subsection (G) (1) of Section 34 of this
Code.
(3) Any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance is or has been made; or
(4) Premiums paid on any life insurance policy covering the life of any officer or
employee, or of any person financially interested in any trade or business carried on by
the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a
beneficiary under such policy.
REVENUE REGULATIONS NO. 2
SECTION 119. Personal, living, and family expenses. — Personal, living, and family expenses
are not deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a
personal expense and not deductible. Premiums paid for life insurance by the insured are not
deductible. In the case of a professional man who rents a property for residential purposes,
but incidentally receives his clients, patients, or callers in connection with his professional
work (his place of business being elsewhere), no part of the rent is deductible as a business
expense. If however, he uses part of the house for his office, such portion of the rent as is
properly attributable to such office is deductible. Where the father is legally entitled to the
services of his minor children, any allowances which he gives them, whether said to be in
consideration of services or otherwise, are not allowable deductions in his return of income.
Alimony, and an allowance paid under a separation agreement are not deductible from gross
income.
SECTION 120. Capital expenditures. — No deduction from gross income may be made for
any amounts paid out for new buildings or for permanent improvements or betterments made
to increase the value of the taxpayer's property, or for any amount expended in restoring
property or in making good the exhaustion thereof for which an allowance for depreciation or
depletion or other allowance is or has been made. Amounts expended for securing a copyright
and plates, which remain the property of the person making the payments, are investments of
capital. The cost of defending or perfecting title to property constitutes a part of the cost of the
property and is not a deductible expense. The amount expended for architect's services is part
of the cost of the building. Commissions paid in purchasing securities are a part of the cost of
such securities. Commissions paid in selling securities are an offset against the selling price.
Expenses of the administration of an estate, such as court costs, attorney's fees, and executor's
commissions, are chargeable against the "corpus" of the estate and are not allowable
deductions. Amounts to be assessed and paid under an agreement between bondholders or
shareholders of a corporation, to be used in a reorganization of the corporation, are
investments of capital and not deductible for any purpose in return of income. In the case of a
corporation, expenses for organization, such as incorporation fees, attorney's fees and
accountants' charges, are ordinarily capital expenditures; but where such expenditures are
limited to purely incidental expenses, a taxpayer may charge such items against income in the
year in which they are incurred. A holding company which guarantees dividends at a specified
rate on the stock of a subsidiary corporation for the purpose of securing new capital for the
subsidiary and increasing the value of its stockholdings in the subsidiary may not deduct
amounts paid in carrying out this guaranty in computing its net income, but such payments
may be added to the cost of its stock in the subsidiary.
A. EXPENSES
Sec 34 (A) Expenses
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the
ordinary and necessary expenses paid or incurred during the taxable year in
carrying on or which are directly attributable to, the development, management,
operation and/or conduct of the trade, business or exercise of a profession,
including:
(i) A reasonable allowance for salaries, wages, and other forms of compensation
for personal services actually rendered, including the grossed-up monetary
value of fringe benefit furnished or granted by the employer to the
employee: Provided, That the final tax imposed under Section 33 hereof has
been paid;
(ii) A reasonable allowance for travel expenses, here and abroad, while away
from home in the pursuit of trade, business or profession;
(iii) A reasonable allowance for rentals and/or other payments which are
required as a condition for the continued use or possession, for purposes of
the trade, business or profession, of property to which the taxpayer has not
taken or is not taking title or in which he has no equity other than that of a
lessee, user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation
expenses during the taxable year, that are directly connected to the
development, management and operation of the trade, business or
profession of the taxpayer, or that are directly related to or in furtherance of
the conduct of his or its trade, business or exercise of a profession not to
exceed such ceilings as the Secretary of Finance may, by rules and
regulations prescribe, upon recommendation of the Commissioner, taking
into account the needs as well as the special circumstances, nature and
character of the industry, trade, business, or profession of the taxpayer:
Provided, That any expense incurred for entertainment, amusement or
46 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
recreation that is contrary to law, morals public policy or public order shall
in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed
under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient
evidence, such as official receipts or other adequate records: (i) the amount of the
expense being deducted, and (ii) the direct connection or relation of the expense
being deducted to the development, management, operation and/or conduct of
the trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income
shall be allowed under Subsection (A) hereof for any payment made, directly or
indirectly, to an official or employee of the national government, or to an official
or employee of any local government unit, or to an official or employee of a
government-owned or -controlled corporation, or to an official or employee or
representative of a foreign government, or to a private corporation, general
professional partnership, or a similar entity, if the payment constitutes a bribe or
kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the
expenses allowable as deductions under this Chapter, a private educational institution,
referred to under Section 27 (B) of this Code, may at its option elect either: (a) to
deduct expenditures otherwise considered as capital outlays of depreciable assets
incurred during the taxable year for the expansion of school facilities or (b) to deduct
allowance for depreciation thereof under Subsection (F) hereof.
1. NON-DEDUCTIBLE PERSONAL EXPENSES v. DEDUCTIBLE BUSINESS EXPENSE
SMITH v. CIR
DOCTRINE:
Cost of hiring nursemaids to care for the infant child of a couple, both of whom are employed,
held not deductible as an ordinary and necessary business expense of the wife.
FACTS:
CIR determined a deficiency of $23.62 in Spouse Smith's 1937 income tax. This was due to
the disallowance of a deduction claimed for sums spent by the wife in employing nursemaids
to care for their child, and themselves. They want this to be considered the business expense
of the wife
The Smith’s propose that the wife could not leave her child but because of the maids, she can
now work. Without the maids, there would be no income and no tax.
ISSUE:
Whether or not the salary of the nursemaids are tax deductible as business expense
RULING:
The Court is not prepared to say that the care of children, like similar aspects of family and
household life, is other than a personal concern. The wife's services as custodian of the home
and protector of its children are ordinarily rendered without monetary compensation. There
results no taxable income from the performance of this service and the correlative
expenditure is personal and not susceptible of deduction.
Here the wife has chosen to employ others to discharge her domestic function and the
services she performs are rendered outside the home. They are a source of actual income and
taxable as such. But that does not deprive the same work performed by others of its personal
character nor furnish a reason why its cost should be treated as an offset in the guise of a
deductible item.
The line is not always an easy one to draw nor the test simple to apply. It may for practical
purposes be said to constitute a distinction between those activities which, as a matter of
common acceptance and universal experience, are ‘ordinary‘ or usual as the direct
accompaniment of business pursuits, on the one hand; and those which, though they may in
some indirect and tenuous degree relate to the circumstances of a profitable occupation, are
nevertheless personal in their nature, of a character applicable to human beings generally,
and which exist on that plane regardless of the occupation, though not necessarily of the
station in life, of the individuals concerned.
The Court states that payments made to servants or others occupied in looking to the
personal wants of their employers are taxable.
PEVSNER v CIR
DOCTRINES:
Many expenses which are helpful or essential to one's business activities, such as commuting
expenses and the cost of meals while at work, are considered inherently personal and thus are
not deductible.
Cost of clothing is deductible as a business expense only if the clothing is of a type specifically
required as a condition of employment, is not adaptable to general use as ordinary clothing,
and is not so worn.
When a taxpayer is prohibited from wearing the clothing away from work, deduction as a
business expense is normally allowed for the cost of the clothing.
Cost of expensive designer clothing which manager of boutique was required to wear was not
deductible, even though she did not wear the clothes during off-work hours because they
were too expensive for simple, everyday life-style where the employer did not preclude her
from wearing the clothing away from work.
Under the objective test for determining deductibility of the cost of clothing, no reference is
made to the individual taxpayer's life-style or personal taste; adaptability for personal or
general use depends on what is generally accepted for ordinary streetwear.
FACTS:
Sandra J. Pevsner, taxpayer, has been employed as the manager of the Sakowitz Yves St.
Laurent Rive Gauche Boutique located in Dallas, Texas. The boutique sells only women's
clothes and accessories designed by Yves St. Laurent (YSL), one of the leading designers of
women's apparel. Although the clothing is ready to wear, it is highly fashionable and
expensively priced.
As manager of the boutique, the taxpayer is expected by her employer to wear YSL clothes
while at work. In addition to wearing YSL apparel while at the boutique, she wears them while
commuting to and from work, to fashion shows sponsored by the boutique, and to business
luncheons at which she represents the boutique. During 1975, the taxpayer bought, at an
employee's discount, several items amounting to $1,381.91. In addition, the sum of $240 was
expended for maintenance of these items. This amount was later claimed as a deduction in
taxpayer’s joint income tax return.
Although the clothing and accessories purchased by the taxpayer were the type used for
general purposes by the regular customers of the boutique, the taxpayer is not a normal
purchaser of these clothes.
Although taxpayer's employer has no objection to her wearing the apparel away from work,
taxpayer stated that she did not wear the clothes during off-work hours because she felt that
47 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
they were too expensive for her simple everyday lifestyle. Another reason why she did not
wear the YSL clothes apart from work was to make them last longer.
ISSUE/S:
Whether the taxpayer is entitled to deduct as an ordinary and necessary business expense the
cost of purchasing and maintaining the YSL clothes and accessories worn by the taxpayer in
her employment as the manager of the boutique.
RULING:
NO. Taxpayer is not allowed to deduct the amount of her purchase of YSL clothing.
Consequently, the maintenance costs for the clothing is not also deductible.
Although many expenses are helpful or essential to one's business activities - such as
commuting expenses and the cost of meals while at work – these expenditures are considered
inherently personal and are disallowed under Section 262 of the Internal Revenue Code.
The generally accepted rule governing the deductibility of clothing expenses is that the cost of
clothing is deductible as a business expense only if:
(1) the clothing is of a type specifically required as a condition of employment,
(2) it is not adaptable to general usage as ordinary clothing, and
(3) it is not so worn.
When the taxpayer is prohibited from wearing the clothing away from work a deduction is
normally allowed. However, in the present case no such restriction was placed upon the
taxpayer's use of the clothing.
The Commissioner maintained, however, that a deduction should be denied because the YSL
clothes and accessories purchased by the taxpayer were adaptable for general usage as
ordinary clothing and she was not prohibited from using them as such. The tax court, in
rejecting the Commissioner's argument for the application of an objective test, recognized that
the test for deductibility was whether the clothing was “suitable for general or personal wear”
but determined that the matter of suitability was to be judged subjectively, in light of the
taxpayer's lifestyle.
In reaching its decision, the tax court relied heavily upon Yeomans v. Commissioner. In
Yeomans, the tax court allowed a deduction for the cost of the items that were not suitable for
Yeomans’ personal wear. Although the basis for the decision in Yeomans is not clearly stated,
the tax court in the case sub judice determined that a careful reading of Yeomans shows that,
without a doubt, the Court based its decision on a determination of Ms. Yeomans' lifestyle and
that the clothes were not suitable for her use in such lifestyle. Thus, Yeomans clearly decides
the issue before us in favor of the petitioner.
Notwithstanding the tax court's decision in Yeomans, the Circuits that have addressed the
issue have taken an objective, rather than subjective, approach.
Under an objective test, no reference is made to the individual taxpayer's lifestyle or personal
taste. Instead, adaptability for personal or general use depends upon what is generally
accepted for ordinary street wear.
The principal argument in support of an objective test is, of course, administrative necessity.
An objective test, although not perfect, provides a practical administrative approach that
allows a taxpayer or revenue agent to look only to objective facts in determining whether
clothing required as a condition of employment is adaptable to general use as ordinary
streetwear.
Conversely, the tax court's reliance on subjective factors provides no concrete guidelines in
determining the deductibility of clothing purchased as a condition of employment.
In addition to achieving a practical administrative result, an objective test also tends to
promote substantial fairness among the greatest number of taxpayers.
RUDOLPH v. US
SCHULZT v. CIR
DOCTRINE:
Entertainment expenses are deductible only if they are in fact ordinary and necessary
expenses for carrying on a trade or business. To the extent that they are primarily social and
personal in nature and bear no direct relation to the operation of a business, such
expenditures may not be deducted. There is no serious dispute as to whether either of these
sums was spent; the issue is whether they are deductible.
FACTS:
Petitioner is engaged in the business of manufacturing and importing fine watches and
jewelry. He conducts his business in a loft factory in NY. During the year 1945, petitioner had a
shortage in supply of merchandise. Because of this shortage, the buyers came to New York
City more frequently than usual.
In 1945 petitioner entertained customers to maintain or promote good will, not to ‘drum up‘
business. Petitioner elaborately entertained buyers and others connected with the jewelry
business, personally spending about $7,000. In addition thereto approximately $2,000 was
expended by his wife and employees on luncheons, drinks, weekend visits, conventions,
suppers, theaters, and nightclubs and evening entertainment. They bear little semblance to
the usual gatherings of business people at restaurants or other places of entertainment which
serve primarily as congenial meeting places for the discussion or negotiation of business
matters.
Petitioner claimed entertainment and traveling expenses in 1943 in the amount of $4,490.24,
and entertainment expenses in 1944 in the amount of $8,256.64. The respondent has
determined a deficiency in petitioner's 1945 income tax in the amount of $8,928.05. The
deficiency results from the disallowance of deductions in the sums of $9,304.40 and $400
claimed by petitioner as entertainment and advertising expenses, respectively, incurred in
that year.
ISSUE/S:
Whether or not the expenditure was an ordinary and necessary business advertising expense.
RULING:
NO. Entertainment expenses are deductible only if they are in fact ordinary and necessary
expenses for carrying on a trade or business. To the extent that they are primarily social and
personal in nature and bear no direct relation to the operation of a business, such
expenditures may not be deducted. There is no serious dispute as to whether either of these
sums was spent; the issue is whether they are deductible.
The requirements that the expense must be both ordinary and necessary must be strictly
complied with, and whether contested expenditures are ordinary and necessary is primarily a
question of fact. Proof is required that the purpose of the expenditure was primarily business
rather than social or personal, and that the business in which taxpayer is engaged benefited or
was intended to be benefited thereby.
These gatherings may have been desirable and helpful to the present and future success of
petitioner's business, but this is usually true of all entertaining done by business or
professional people for the purpose of acquiring or retaining the favor of patrons and clients.
Such expenditures are nonetheless nondeductible absent a showing that they were ordinary
and necessary to the taxpayer's business.
48 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
2. TRAVEL EXPENSES WHILE AWAY FROM HOME
CIR v. FLOWERS
FACTS:
The taxpayer has resided with his family in Jackson, Mississippi. He paid taxes, voted,
schooled his children, and established social and religious connections. - Taxpayer was
employed by Gulf, Mobile, and Ohio Railroad. He was elected as the General Solicitor, general
counsel, and Vice President. - The main office of the company was in Mobile, Alabama. The
company and the taxpayer made an arrangement whereby he may continue to reside in
Jackson provided he pays his traveling expenses between Mobile and Jackson and pay his
living expenses in both places. - The railroad company provided the taxpayer with an office in
Mobile but not in Jackson. While he was in Jackson, his participation was merely advisory.
1939- 203 days in Jackson, 66 in Mobile (33 trips) 1940 - 168 days in Jackson, 102 in Mobile
(40 trips)
- The company paid his trips when he went to places other than Jackson and Mobile, paid
none of his expenses in traveling between the 2 points.
- Taxpayer deducted $900 (1939) and $1620 (1940) from his ITR as traveling expenses
incurred in making trips from Jackson to Mobile. - The Commissioner disallowed the the
deductions - sustained by the Tax Court - reversed by the CA
ISSUE: Whether or not the taxpayer is entitled to the deduction as contemplated by law
HELD: NO
RULING:
The provision in 23(a)(1)(A) of the Internal Revenue Code allows the deduction of "traveling
expenses (including meals and lodging) while away from home in the pursuit of a trade or
business".
--- This provision is to be contrasted from 24(a)(1) which disallows any deductions for
personal, living, or family expenses.
--- 3 conditions must be satisfied before a traveling expense deduction may be made under
23(a)(1)(A): 1) The expense must be a reasonable and necessary traveling expense- includes
transportation, fares, food, and lodging expenses 2) Expense must be incurred "while away
from home" 3) Expense must be incurred in pursuit of business- there must be a direct
connection between the expenditure and the carrying of the trade or business of the taxpayer
or his employer. Such an expenditure must be necessary in the pursuit of the business or
trade.
--- Tax Court disallowed the deduction because: A) it contemplates a situation where the
taxpayer is employed in one place and resides in another. the expenses represent living
expenses (not in the pursuit of business)
--- CA allowed the deduction because: A) Tax Court misconstrued the word "home" in
condition no. 2 as "principal or post or place of business" "home" is to be construed in its
ordinary meaning = the place where one resides C) the situation can be considered as one
falling under condition 2 = expenses incurred while away from home
--- Tax courts and other rulings construe the word "home" as the taxpayer's place of business.
While others thought it as "the place of residence". However, the Court contends that the Tax
Court, in disallowing such deduction, relied on the absence of direct connection between the
expenditure and the pursuit of business, not on what the word "home" really means.
--- In this case, the facts undeniably show that the expenditures were not incurred in the
pursuit of the company's business: A) expenses incurred solely as a result of the taxpayer's
desire to maintain a home in Jackson while working in Mobile - a factor irrelevant to the
company's business but only for the taxpayer's personal convenience All the taxpayer's work
in jackson could have been performed in Mobile. C) company gained nothing from this
arrangement except the personal satisfaction of the taxpayer D) it could have been deductible
if the company forced the taxpayer to travel and to live temporarily at some place
DISSENTING: - home should be taken in its ordinary meaning - taxpayer incurred expenses
away from home - conceding that "home" means business headquarters, then the bulk of the
taxpayer's work was in Jackson - if Congress had meant "business headquarters" and not
"home", then it could have simply stated so in the law
(In short: Deductible kasi yung traveling expenses in pursuit of business. Kaya lang hindi
pinayagan kasi walang koneksyon yung pag travel niya sa dalawang lugar. Hindi nirequire ng
company na mag maintain siya ng 2 lugar. In short, parang nakatira ako sa Novaliches tapos
sa Fort ako nagwowork. Hindi ko pwedeng ipa-shoulder or ideduct yung pamasahe ko from
home to work kasi part yun ng living expenses ko as an employee and as a natural person.
Deductible lang unless part ng trabaho ko ang mag stay sa Novaliches. Yown lang powhz.)
HANTZIS v. COMMISSIONER
DOCTRINE:
Place of a taxpayer's principal business or employment. In general, the tax home is a
taxpayer's main place of business or post of duty, without regard to the place of the taxpayer's
family home. A taxpayer's tax home is the entire city or general area in which the taxpayer's
main place of work or business is located, regardless of where the taxpayer maintains his
family home.
Which of two residents will be your tax home? Look at:
a. Which is more demanding job, where you spend more of your time.
b. Where you make the most money.
FACTS:
Catharine Hantzis (taxpayer) entered Harvard Law School in Cambridge, Massachusetts, as a
full- time student. During her second year of law school she sought unsuccessfully to obtain
employment for the summer of 1975 with a Boston law firm. She did, however, find a job as a
legal assistant with a law firm in New York City, where she worked for ten weeks beginning in
June 1975. Her husband, then a member of the faculty of Northeastern University with a
teaching schedule for that summer, remained in Boston and lived at the couple's home there.
At the time of the Tax Court's decision in this case, Mr. and Mrs. Hantzis still resided in Boston.
On their joint income tax return for 1975, Mr. and Mrs. Hantzis reported the earnings from
taxpayer's summer employment ($3,750) and deducted the cost of transportation between
Boston and New York, the cost of a small apartment rented by Mrs. Hantzis in New York and
the cost of her meals in New York ($3,204). The deductions were taken under § 162(a)(2)
ISSUE: W/N the deductions were to be allowed?
RULING:
The SC did not agree w/ the Commissioner contention but still denied the deduction, on the
basis that the expenses were not incurred "while away from home." The Commissioner has
directed his argument at the meaning of "in pursuit of a trade or business." He interprets this
phrase as requiring that a deductible traveling expense be incurred under the demands of a
trade or business which predates the expense, i. e., an "already existing" trade or business.
Under this theory, section 162(a)(2) would invalidate the deduction taken by the taxpayer
because she was a full-time student before commencing her summer work at a New York law
firm in 1975 and so was not continuing in a trade or business when she incurred the expenses
of traveling to New York and living there while her job lasted.
The First Circuit held that the allowance of a deduction under 26 USCA § 162(a)(2) depends
on the reason for the taxpayer's maintenance of two homes. If the reason is personal, the tax
"home" will be the place of employment and the deduction will be denied; if business
exigencies require the taxpayer to maintain two homes, the tax home will be held to be the
taxpayer's residence and the deduction will be allowed. The court further held that the
temporary employment doctrine does not eliminate the requirement that continued
maintenance of a first home have a business justification, and thus it concluded that a
taxpayer who pursues temporary employment away from the location of his usual residence,
but who has no business connection with the location of his usual residence, is not "away from
home" for purposes of 26 USCA § 162(a)(2).
The court announces a sound principle that, in dual residence cases, deductibility of traveling
expenses depends upon a showing that both residences were maintained for business
reasons. If that principle is understood to be derived from the language of section 162(a)(2)
taken as a whole, "home" retains operative significance for determining which of the
business-related residences is the one the expense of which can be treated as deductible. In
this context, "home" should be given its ordinary meaning to allow a deduction only for
expenses relating to an abode that is not the taxpayer's principal place of residence. On the
undisputed facts in this case, the Tax Court found that Boston was the taxpayer's "home" in
the everyday sense, i. e., her principal place of residence. Because the taxpayer had no
business reason for maintaining both residences, her deduction for expenses associated with
maintaining a second residence closer than her principal residence to her place of
employment must be disallowed without regard to which of her two residences was her
"home" under section 162(a)(2).
The taxpayer's home may be the tax home if, (1) The taxpayer incurs duplicate living expenses
while traveling and maintaining the home; (2) the taxpayer has personal and historical
connections to the home; and (3) the taxpayer has a business justification for maintaining the
home,” The court concluded that because the taxpayer's jobs were temporary, she had no
principal place of work, the taxpayer incurred duplicated expenses, and her home historically
had been around the city of her residence.

The Commissioner disallowed the deduction on the ground that taxpayer's home for purposes
of section 162(a)(2) was her place of employment and the cost of traveling to and living in
New York was therefore not "incurred ... while away from home." The Commissioner also
argued that the expenses were not incurred "in the pursuit of a trade or business." Both
positions were rejected by the Tax Court, which found that Boston was Mrs. Hantzis' home
because her employment in New York was only temporary and that her expenses in New York
were "necessitated" by her employment there. The court thus held the expenses to be
deductible under section 162(a)(2). The Commissioner has contended that the expenses were
not incurred "in the pursuit of a trade or business." The taxpayer has not argued that being a
law student constitutes a trade or business
49 TAXATION 1 (ATTY. BELLO)
NOTE: (BUSINESS REASON RULE) In Peurifoy, the SC recognized an exception to the principal
place of business rule when a taxpayer's employment is “temporary,” because it is
unreasonable to expect a taxpayer to uproot his family for a job that is neither permanent nor
long-term. In Peurifoy, the SC recognized an exception to the principal place of business rule
when a taxpayer's employment is “temporary,” because it is unreasonable to expect a
taxpayer to uproot his family for a job that is neither permanent nor long-term. However, the
majority of married couples cannot take advantage of this exception because of the “business
reason” rule created by the First Circuit in Hantzis and the one-year limitation imposed by the
statute.
In Hantzis, the First Circuit limited the temporary exception to situations where the taxpayer
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
had a business reason for maintaining his place of residence away from his place of business.
In Hantzis, the taxpayer resided in Boston, Massachusetts, with her husband. She attended
Harvard Law School, and her husband was employed as a faculty member at Northeastern
University. During her second year of law school, she unsuccessfully tried to obtain
employment in Boston for the following summer. Instead, she worked for ten weeks as a legal
assistant in New York City, while her husband taught summer classes in Boston and remained
in their family residence. She returned to their shared home in Boston after only ten weeks.
After acknowledging the temporary exception, the court found her “tax home” was New York
City because she had no business reason to maintain her residence in Boston, and therefore
disallowed the deduction. Although a majority of courts have adopted the First Circuit's
reasoning, the Hantzis decision is unrealistic for married couples. A spouse, like the taxpayer
in Hantzis, will generally first search for job opportunities close to home before considering to
work farther away. Regardless of how temporary the position might be, if a taxpayer is forced
to work away from home, he will not be able to deduct expenses if he lacks a “business
connection” to his place of residence. While a taxpayer's willingness to be geographically
mobile gives him more job flexibility and reduces his potential for unemployment, a taxpayer
should not have to move his family each time a new opportunity arises just to save duplicative
living expenses.
3. DEDUCTIBLE CURRENT EXPENSES v. NON-DEDUCTIBLE CAPITAL
EXPENDITURES
MT. MORRIS DRIVE-IN THEATRE COMPANY V. COMMISSIONER OF INTERNAL REVENUE
DOCTRINE:
It is a capital improvement of there is substantial evidence that it added to the value of the
petitioner's land for the use to which it had been put; that it is immaterial that that increase
in value was not by evidence measured in dollars, and that the inferences of the Tax Court
could be and were drawn from the physical configuration of the land and what it had been
necessary to do to establish thereon the Drive-In Theatre which the petitioner erected
thereon.
The Tax Court held that a drive-in theater’s drainage system was a capital expenditure, even
though the business only built it after a neighbor sued for nuisance. The court reasoned that
it didn’t matter why the drive-in company built the drainage system. What counted was that
the property was improved, and so it fell under § 263(a). This rule avoids a taxpayer
intentionally doing something half-assed—like installing substandard tanks at a gas station—
and then treating the “repair” as a present expense.
FACTS:
Petitioner purchased 13 acres of farm land on the outskirts of Flint, Michigan. He built a
drive-in theater on the land which was adjacent to David and Mary D. Nickola's farm land and
trailer park. By removing the covering vegetation, slightly changing the land's grade and
building gravel-covered ramps and aisles the petitioner caused excessive rain water to drain
onto the Nickolas' property, causing damage to their crops and roadways.
After repeatedly complaining, the Nickolas filed a lawsuit against the petitioner, asking for an
award for damages done to their property, and for an injunction forcing the petitioner to
correct the drainage problem. The suit was settled. The petitioner agreed to install a mutually
agreed-upon drainage system which was completed. The project cost the petitioner $8,224.
The petitioner claimed that the entire cost of the drainage system was deductible in 1950 as
an ordinary and necessary business expense incurred in the settlement of a lawsuit. In the
alternative, the petitioner claimed the cost was a loss, to be deducted from claimed profits for
the year.
50 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ISSUE:
Whether or not the drainage system is a capital expenditure or an expense.
HELD:
The majority found that the character of the transaction was that of a capital expenditure,
and thus not deductible as an expense.
When the Mt. Morris Drive-in Theatre Co. purchased the land in 1947, it was to convert it into
a drive-in theatre. The company should have foreseen that the construction would cause
drainage problems that would affect the adjacent properties. It should have included proper
drainage in its original construction plan, which certainly would have been considered a
Capital Expenditure for tax purposes.
Instead, under threat of litigation, the petitioner corrected the problem a year later, and
sought to deduct the cost as an ordinary and necessary business expense, or a loss. Focusing
on the fact that there was no sudden, unforeseeable or catastrophic factor that caused the
construction, the court held that this was not an ordinary business expense or a deductible
loss. Additionally, the court reasoned that until the drainage system installed, the
construction of the theatre incomplete, and thus the petitioners capital investment
incomplete.
Contrast this decision with Midland Empire Packing Company v. Commissioner, in which the
Tax Court held that an expenditure to line basement walls with cement to prevent further oil
leakage constituted a repair and was thus deductible as an ordinary and necessary business
expense. Although it appears that the Tax Court set forth conflicting opinions, the two
decisions are easily reconcilable. The installation of the drainage system in this case was an
acquisition and construction of a new capital asset that did not previously exist. Nothing was
replaced nor repaired when the drainage system was installed. On the other hand, the new
basement lining in Midland Empire Packing Company v. Commissioner repaired basement
walls that had been in existence for over 25 years. The repairs to the basement were
necessary to continue the property’s operation for the duration of its expected life. Thus the
two cases are distinguishable.
Dissent
The dissent found that the construction of drainage system was an ordinary and necessary
business expense that did not increase the value of the property. Thus they found no Capital
Expenditure.
MIDLAND EMPIRE PACKING COMPANY v. COMMISSIONER OF INTERNAL REVENUE
DOCTRINE:
In determining whether an expenditure is a capital one or is chargeable against operating
income, it is necessary to bear in mind that purpose for which the expenditure was made.
The cost of incidental repairs which neither materially add to the value of the property nor
appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be
deducted as expense, provided the plant or property account is not increased by the amount
of such expenditures.
FACTS:
Midland Empire Packing Co. is the owner of a meat-packing plant. The basement rooms of
petitioner's plant were used by it since 1917 (year plant was constructed) in its business
for the curing of hams and bacon and for the storage of meat and hides. The original walls and
floors, which were of concrete, were not sealed against water. There had been seepage for
many years and this condition became worse around 1943.
The Yale Oil Corporation was the owner of an oil-refining plant and storage area located
some 300 yards from petitioner's meat-packing plant. Yale expanded its plant and storage
from year to year and oil escaping from the plant and storage facilities was carried to the
ground surrounding the plant of Midland. In 1943 petitioner found that oil was seeping into
its water wells and into water which came through the concrete walls of the basement of its
packing plant. The water would soon drain out through the sump, leaving a thick scum of oil
on the basement floor. Such oil gave off a strong odor, which permeated the air of the entire
plant. The oil in the basement and fumes therefrom created a fire hazard. The Federal meat
inspectors advised petitioner to oilproof the basement and discontinue the use of the water
wells or shut down the plant.
Midland informed Yale that they intended to hold it liable for all damage caused by the oil.
Frank Jacoby, a construction contractor, talked with the officers of Yale about the nature of the
oil-sealing work to be done on petitioner's plant in order to insure that the work was done to
the satisfaction of Yale, inasmuch as petitioner was looking for reimbursement for that
amount from Yale. For the purpose of preventing oil from entering its basement, petitioner
added concrete lining to the walls from the floor to a height of about four feet, and also
added concrete to the floor of the basement. Since the walls and floor had been thickened,
petitioner now had less space in which to operate. Petitioner had this work done by
independent contractors, supervised by Jacoby, in the fiscal year ended November 30, 1943,
at a cost of $4,868.81. Petitioner paid for this work during that year.
The oilproofing work was effective in sealing out the oil. After the oilproofing was completed
and prior to the close of the petitioner's taxable year ended November 30, 1943, negotiations
for settlement were again conducted, at which time Yale offered to pay petitioner in cash the
$7,500 in satisfaction of all claims asserted, provided Midland would execute a general release
to Yale. Because Midland was unwilling and refused to give such release for the payment
offered, no amount was in fact paid in that year.
The petitioner thereafter filed suit against Yale to recover damages for the nuisance created
by the oil seepage, and joined as a defendant in such action Yale's successor, the Carter Oil Co.,
which had acquired the properties of Yale Oil Corporation. Petitioner subsequently settled its
cause of action against Yale for $11,659.49 and gave Yale a complete release of all liability.
This release was dated October 23, 1946. The recovery of the cost of the waterproofing only
was reported in its excess profits and income tax returns for the year ended November 30,
1946. Midland charted the $4,868.81 to repair expense on its regular books and deducted that
amount on its tax returns as an ordinary and necessary business expense for the fiscal year
1943. The Commissioner, in his notice of deficiency, determined that the cost of oilproofing
was not deductible, either as an ordinary and necessary expense or as a loss in 1943.
ISSUE:
Whether the expenditure is deductible as an ordinary and necessary expense?
RULING:
In determining whether an expenditure is a capital one or is chargeable against operating
income, it is necessary to bear in mind that purpose for which the expenditure was made. To
repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A
repair is an expenditure for the purpose of keeping the property in an ordinarily efficient
operating condition. It does not add to the value of the property nor does it appreciably
prolong its life. It merely keeps the property in an operating condition over its probable useful
life for the uses for which it was acquired. Expenditures for that purpose are distinguishable
from those for replacements, alterations, improvements, or additions which prolong the life of
the property, increase its value, or make it adaptable to a different use. The one is a
maintenance charge, while the others are additions to capital investment which should not be
applied against current earnings.
Petitioner during the taxable year undertook steps to oilproof the basement. It is the cost of
51 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
this work which it seeks to deduct as a repair. The basement was not enlarged by this work,
nor did the oilproofing serve to make it more desirable for the purpose for which it had been
used through the years prior to the time that the oil nuisance had occurred. The expenditure
did not add to the value or prolong the expected life of the property over what they were
before the event occurred which made the repairs necessary. It is true that after the work was
done the seepage of water, as well as oil, was stopped, but the presence of the water had never
been found objectionable. The repairs merely served to keep the property in an operating
condition over its probable useful life for the purpose for which it was used.
The expense is an ordinary one because we know from experience that payments for such a
purpose, whether the amount is large or small, are the common and accepted means of
defense against attack. Steps to protect a business building from the seepage of oil from a
nearby refinery, which had been erected long subsequent to the time petitioner started to
operate its plant, would seem to us to be a normal thing to do, and in certain sections of the
country it must be a common experience to protect one's property from the seepage of oil.
Expenditures to accomplish this result are likewise normal.
The petitioner here made the repairs in question in order that it might continue to operate its
plant. Not only was there danger of fire from the oil and fumes, but the presence of the oil led
the Federal meat inspectors to declare the basement an unsuitable place for the purpose for
which it had been used for a quarter of a century. After the expenditures were made, the plant
did not operate on a changed or larger scale, nor was it thereafter suitable for new or
additional uses. The expenditure served only to permit petitioner to continue the use of the
plant, and particularly the basement for its normal operations. Thus, the expenditure of
$4,868.81 for lining the basement walls and floor was essentially a repair and, as such, it is
deductible as an ordinary and necessary business expense.
NOTE: SEC. 29.23(a)-4. REPAIRS.- The cost of incidental repairs which neither materially add
to the value of the property nor appreciably prolong its life, but keep it in an ordinarily
efficient operating condition, may be deducted as expense, provided the plant or property
account is not increased by the amount of such expenditures. Repairs in the nature of
replacements, to the extent that they arrest deterioration and appreciably prolong the life of
the property, should be charged against the depreciation reserve if such account is kept.
INDOPCO v. CIR
DOCTRINE:
The expenses incurred in a friendly takeover do not qualify for tax deduction as “ordinary and
necessary” expenses.
FACTS:
In 1977, Unilever expressed interest in acquiring INDOPCO (formerly named National Starch
and Chemical Corporation). In order to adequately prepare for being bought out, National
Starch hired Morgan Stanley to be its investment banker on this transaction. The fees charged
by Morgan Stanley amounted to $2,200,000, in addition to $7,586 for out-of-pocket expenses
and $18,000 in legal fees. National Starch tried to claim all of these fees as deductions. The
Commissioner of the Internal Revenue Service disallowed the claimed deduction. The Tax
Court and the Court of Appeals for the Third Circuit affirmed the Commissioner’s decision. The
courts held that the amount spent towards Morgan Stanley added to the long-term betterment
of National Starch.
ISSUE/S:
Whether or not professional expenses incurred by a target corporation in the course of a
friendly takeover are deductible by that corporation as "ordinary and necessary" business
expenses under § 162(a) of the Internal Revenue Code?
RULING:
The key here is that National Starch did not demonstrate that the investment banking, legal,
and other costs it incurred in connection with Unilever’s acquisition of its shares are
deductible as ordinary and necessary business expenses under §162(a). In addition to the
analysis provided by the two previous courts, the Supreme Court cited the fact that there is a
long history of finding that the purpose of changing the corporate structure for the benefit of
future operations is not an ordinary and necessary business expense.
Treasury Regulation 1.263(a)-4(b) requires the taxpayer to capitalize listed intangible assets.
Specifically, the taxpayer must capitalize
1. Amounts paid to acquire or create intangible assets.
2. Amounts paid to create or enhance separate and distinct intangible assets – i.e.
property interests with ascertainable value protected under state, federal, and
foreign law, that are capable of being sold, transferred, or pledged, and are separate
from a trade or business. Amounts to create computer software or package design
are not included.
3. Amounts paid to create or enhance future benefits identified as intangibles
requiring capitalization under the Federal Register or Internal Revenue Bulletin.
4. Amounts facilitating the acquisition or creation of intangible assets.
To simplify application, Treasury Regulation 1.263-4(f)(1) enacts a “12-month rule” allowing
the taxpayer a current deduction for amounts paid to create rights or benefits that last beyond
one year of the taxpayer realizing the right or benefit if that benefit doesn’t last beyond the
taxable year following the tax year the initial payment is made.
The transaction provided significant benefits to Taxpayer beyond the tax year. The
transaction changed the corporate structure for the benefit of future operations which is not
an ordinary and necessary expense. The acquisition related expenses are more like capital
expenditures.
CIR v. GENERAL FOODS
DOCTRINE:
Tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in
favor of the taxing authority; and he who claims an exemption must be able to justify his claim
by the clearest grant of organic or statute law.
Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be strictly construed.
The Court extends due consideration to the CTA’s opinion unless there is an abuse or
improvident exercise of authority.
Capital outlay to create “goodwill” for a product and/or business is a capital expenditure to be
spread out over a reasonable time; otherwise, it is akin to the acquisition of capital assets and
is not to be considered as business expenses but as capital expenditures, hence non-
deductible.
FACTS:
Respondent corporation filed its income tax return for the fiscal year ending February 28,
1985. In said tax return, respondent corporation claimed as deduction, among other business
expenses, the amount of P9,461,246 for media advertising for “Tang.”
The Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent
52 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
corporation. Consequently, respondent corporation was assessed deficiency income taxes in
the amount of P2,635,141.42.
CTA dismissed respondent’s appeal saying that it is not convinced that such amount is
reasonable “to stimulate the current sale of merchandise” regardless of respondent’s
explanation that such expense “does not connote unreasonableness considering the grave
economic situation taking place after the Aquino assassination characterized by capital fight,
strong deterioration of the purchasing power of the Philippine peso and the slacking demand
for consumer products”. It said that such expenditure was probably incurred “to create or
maintain some form of good will for the taxpayer’s trade or business or for the industry or
profession of which the taxpayer is a member.” Efforts to establish reputation are akin to
acquisition of capital assets and, therefore, expenses related thereto are not business
expenses but capital expenditures.
However, the CA reversed the CTA, since it has not been sufficiently established that the
expenses were excessive, hence, its deduction should be allowed.
ISSUE/S:
Whether or not the media advertising expense for “Tang” incurred by respondent was an
ordinary and necessary expense fully deductible under the NIRC
RULING:
NO, IT IS NOT DEDUCTIBLE.
It is a governing principle in taxation that tax exemptions must be construed in strictissimi
juris against the taxpayer and liberally in favor of the taxing authority; and he who claims an
exemption must be able to justify his claim by the clearest grant of organic or statute law. An
exemption from the common burden cannot be permitted to exist upon vague implications.
Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be strictly construed.
The parties are in agreement that the subject advertising expense was paid within the
corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was
necessary. However, their views conflict as to whether or not it was ordinary. To be
deductible, an advertising expense should not only be necessary but also ordinary. These two
requirements must be met.
The Commissioner maintains that the subject advertising expense was not ordinary on the
ground that it failed the two conditions set by U.S. jurisprudence: first, “reasonableness” of the
amount incurred and second, the amount incurred must not be a capital outlay to create
“goodwill” for the product and/or private respondent’s business. Otherwise, the expense
must be considered a capital expenditure to be spread out over a reasonable time.
The right to a deduction depends on a number of factors such as: the type and size of business;
the volume and amount of its net earnings; the nature of the expenditure itself; the intention
of the taxpayer and the general economic conditions. It is the interplay of these that will yield
a proper evaluation.
In the case at bar, the Court found that the subject expense for the advertisement of a single
product to be inordinately large. Therefore, even if it is necessary, it cannot be considered an
ordinary expense deductible under the NIRC.
Advertising is generally of two kinds: (1) advertising to stimulate the current sale of
merchandise or use of services and (2) advertising designed to stimulate the future sale of
merchandise or use of services. The second type involves expenditures incurred, in whole or
in part, to create or maintain some form of goodwill for the taxpayer’s trade or business or for
the industry or profession of which the taxpayer is a member. If the expenditures are for the
advertising of the first kind, then, except as to the question of the reasonableness of amount,
there is no doubt such expenditures are deductible as business expenses. If, however, the
expenditures are for advertising of the second kind, then normally they should be spread out
over a reasonable period of time. The subject advertising expense was of the second kind. Not
only was the amount staggering; the respondent corporation itself also admitted that the
subject media expense was incurred in order to protect respondent’s brand franchise.
The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s
property. This is a capital expenditure which should be spread out over a reasonable period
of time.
Respondent’s venture to protect its brand franchise was tantamount to efforts to establish a
reputation. This was akin to the acquisition of capital assets and therefore expenses related
thereto were not to be considered as business expenses but as capital expenditures.
It is the taxpayer’s prerogative to determine the amount of advertising expenses it will incur
and where to apply them. But that is subject to certain considerations. The first relates to the
extent to which the expenditures are actually capital outlays. The second relates to whether
the expenditures are ordinary and necessary. Concomitantly, for an expense to be considered
ordinary, it must be reasonable in amount. Respondent failed to meet the two foregoing
limitations.
Respondent incurred the subject advertising expense in order to protect its brand
franchise. This as a capital outlay since it created goodwill for its business and/or
product. The P9,461,246 media advertising expense for the promotion of a single product,
almost one-half of respondent’s entire claim for marketing expenses for that year under
review, inclusive of other advertising and promotion expenses of P2,678,328 andP1,548,614
for consumer promotion, is doubtlessly unreasonable.
It has been a long standing policy and practice of the Court to respect the conclusions of quasi-
judicial agencies such as the Court of Tax Appeals, a highly specialized body specifically
created for the purpose of reviewing tax cases. The Court extends due consideration to its
opinion unless there is an abuse or improvident exercise of authority.
4. ORDINARY AND NECESSARY
WELCH vs. HELVERING, Commissioner of Internal Revenue
DOCTRINE:
 What is ordinary, though there must always be a strain of constancy within it, is
nonetheless a variable affected by time and place and circumstance. Ordinary in this
context does not mean that the payments must be habitual or normal in the sense
that the same taxpayer will have to make them often.
FACTS:
 Petitioner was the secretary of the E. L. Welch Company, a Minnesota corporation,
engaged in the grain business. The company was adjudged an involuntary bankrupt, and
had a discharge from its debts. Thereafter the petitioner made a contract with the
Kellogg Company to purchase grain for it on a commission.
 In order to re-establish his relations with customers whom he had known when acting
for the Welch Company and to solidify his credit and standing, he decided to pay the
debts of the Welch business so far as he was able.
 In fulfillment of that resolve, he made payments of substantial amounts during five
successive years:
o 1924, the commissions $18,028.20, the payments $3,975.97
o 1925, the commissions $31,377. 07, the payments $11,968.20;
53 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
o 1926, the commissions $20,925.25, the payments $12,815.72;
o 1927, the commissions $22,119.61, the payments $7, 379.72;
o 1928, the commissions $26,177.56, the payments $11,068.25.
 The Commissioner ruled that these payments were not deductible from income as
ordinary and necessary expenses, but were rather in the nature of capital expenditures,
an outlay for the development of reputation and good will.
ISSUE/S:
Whether payments by a taxpayer, who is in business as a commission agent, are allowable
deductions in the computation of his income if made to the creditors of a bankrupt
corporation in an endeavor to strengthen his own standing and credit. NO
RULING:
 In computing net income there shall be allowed as deductions all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on any trade or
business.
 We may assume that the payments to creditors of the Welch Company were necessary
for the development of the petitioner's business, at least in the sense that they were
appropriate and helpful.
 Many necessary payments are charges upon capital. There is need to determine
whether they are both necessary and ordinary.
 Now, what is ordinary, though there must always be a strain of constancy within it, is
nonetheless a variable affected by time and place and circumstance. Ordinary in this
context does not mean that the payments must be habitual or normal in the sense that
the same taxpayer will have to make them often.
 A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel
fees may be so heavy that repetition is unlikely. Nonetheless, the expense is an ordinary
one because we know from experience that payments for such a purpose, whether the
amount is large or small, are the common and accepted means of defense against attack.
 Men do at times pay the debts of others without legal obligation or the lighter obligation
imposed by the usages of trade or by neighborly amendities, but they do not do so
ordinarily, not even though the result might be to heighten their reputation for
generosity and opulence. Payment in such circumstances, instead of being ordinary is in
a high degree extraordinary.
 The Commissioner of Internal Revenue resorted to that standard in assessing the
petitioner's income, and found that the payments in controversy came closer to capital
outlays than to ordinary and necessary expenses in the operation of a business. His
ruling has the support of a presumption of correctness, and the petitioner has the
burden of proving it to be wrong.
 Reputation and learning are akin to capital assets, like the good will of an old
partnership. For many, they are the only tools with which to hew a pathway to success.
The money spent in acquiring them is well and wisely spent. It is not an ordinary
expense of the operation of a business.
NOTE: (examples of ordinary and not ordinary expenses provided in the case)
Ordinary expenses:
o Expenses incurred in the defense of a criminal charge growing out of the business of
the taxpayer;
o Contributions to a civic improvement fund by a corporation employing half of the
wage earning population of the city, the payments being made, not for charity, but to
add to the skill and productivity of the workmen
o Donations to a hospital by a corporation whose employees with their dependents
made up two-thirds of the population of the city
o Payments of debts discharged in bankruptcy, but subject to be revived by force of a
 new promise.
o Where additional compensation, reasonable in amount, was allowed to the officers
of a corporation for services previously rendered.
Not ordinary expenses
o Payments by the taxpayer for the repair of fire damage, such payments being
distinguished from those for wear and tear
o Counsel fees incurred by the taxpayer, the president of a corporation, in prosecuting
a slander suit to protect his reputation and that of his business;
o Gratuitous payments to stockholders in settlement of disputes between them, or to
assume the expense of a lawsuit in which they had been made defendants;
o Payments in settlement of a lawsuit against a member of a partnership, the effect
being to enable him to devote his undivided efforts to the partnership business and
also to protect its credit.
ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION vs. COMMISSIONER OF
INTERNAL REVENUE
FACTS:
 Atlas is a corporation engaged in the mining industry registered under the laws of the
Philippines. In 1962, the CIR assessed Atlas for deficiency income tax for the years 1957
and 1958.
 For the year 1957, it was the opinion of the Commissioner that Atlas is not entitled to
exemption from the income tax under Section 4 of Republic Act 909 because the same
covers only gold mines.
 For the year 1958, the assessment of deficiency income tax covers the disallowance of
items claimed by Atlas as deductible from gross income.
 The Secretary of Finance ruled that the exemption provided in Republic Act 909
embraces all new mines and old mines whether gold or other minerals. Accordingly, the
Commissioner recomputed Atlas deficiency income tax liabilities in the light of the ruling
of the Secretary of Finance.
 The assessment for 1957 was eliminated, while the 1958 assessment was reduced and
the following items claimed as deductible were disallowed:
Transfer agent's fee - P59,477.42
Stockholders relation service fee (paid to P.K. Macker & Co.) - 25,523.14
U.S. stock listing expenses - 8,326.70
Suit expenses - 6,666.65
Provision for contingencies - 60,000.00
Total - P159,993.9
 Atlas appealed to the Court of Tax Appeals. The CTA rendered a decision allowing the
above mentioned disallowed items, except the stockholders relation service fee and suit
expenses.
ISSUES:
1. W/N the stockholders relation service fee is an ordinary expense hence deductible from
gross income; and
2. W/N the transfer agent's fee, stock listing fee, and suit expense should be allowed as
deductions from gross income
RULING:
54 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
1. NO. The stockholders relation service fee is NOT an ordinary expense, hence NOT
deductible from Atlas’ gross income in 1958, because it was an expense relating to
recapitalization and reorganization of the corporation.
To be deductible as a business expense, three conditions are imposed, namely: (1) the
expense must be ordinary and necessary, (2) it must be paid or incurred within the
taxable year, and (3) it must be paid or incurred in carrying in a trade or business. In
addition, not only must the taxpayer meet the business test, he must substantially
prove 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. An expense will be considered
"necessary" where the expenditure is appropriate and helpful in the development of the
taxpayer's business. It is "ordinary" when it connotes a payment which is normal in
relation to the business of the taxpayer and the surrounding circumstances. The term
"ordinary" does not require that the payments be habitual or normal in the sense that the
same taxpayer will have to make them often; the payment may be unique or non-
recurring to the particular taxpayer affected. The intention of the taxpayer often may be
the controlling fact in making the determination. A business expense must be determined
from the nature of the expenditure itself, which in turn depends on the extent and
permanency of the work accomplished by the expenditure.
The expense in question was incurred to create a favorable image of the corporation in
order to gain or maintain the public's and its stockholders' patronage. It was in effect
spent for the acquisition of additional capital. Efforts to establish reputation are akin to
acquisition of capital assets and, therefore, expenses related thereto are not business
expense but capital expenditures.
2. YES. The transfer agent's fee, stock listing fee are ordinary and necessary business
expense. NO. Suit expenses are not deductible as ordinary expenses.
The stock exchange fee in dispute, which is an annually recurring cost for the
maintenance of the listing, was paid annually to a stock exchange for the privilege of
having its stock listed. It must be noted that the Court of Tax Appeal rejected the Dome
Mines case, relied upon by CIR, because it involves a payment made only once, hence, it
was held therein that the single payment made to the stock exchange was a capital
expenditure, as distinguished from the instant case, where payments were made
annually. For this reason, we hold that said listing fee is an ordinary and necessary
business expense. This is also in accord with the ruling in a similar case, Chesapeake v.
CIR.
As for the suit expenses, the litigation expenses under consideration were incurred in
defense of Atlas title to mining properties. It is well established in jurisprudence that
litigation expense incurred in defense or protection of title are capital in nature and not
deductible and that such expense constitute a part of the cost of the property.
5. REASONABLE COMPENSATION
C.M. HOSKINS & CO., INC. v. CIR
DOCTRINE:
The conditions precedent to the deduction of bonuses to employees are: (1) the payment of
the bonuses is in fact compensation; (2) it must be for personal services actually rendered;
and (3) the bonuses, when added to the salaries, are 'reasonable . . . when measured by the
amount and quality of the services performed with relation to the business of the particular
taxpayer'
FACTS:
We uphold in this taxpayer's appeal the Tax Court's ruling that payment by the taxpayer to its
controlling stockholder of 50% of its supervision fees or the amount of P99,977.91 is not a
deductible ordinary and necessary expense and should be treated as a distribution of earnings
and profits of the taxpayer.
Petitioner, a domestic corporation engaged in the real estate business as brokers, managing
agents and administrators, filed its income tax return for its fiscal year ending September 30,
1957 showing a net income of P92,540.25 and a tax liability due thereon of P18,508.00, which
it paid in due course.
Upon verification of its return, respondent Commissioner of Internal Revenue, disallowed four
items of deduction in petitioner's tax returns and assessed against it an income tax deficiency
in the amount of P28,054.00 plus interests. The Court of Tax Appeals upon reviewing the
assessment at the taxpayer's petition, upheld respondent's disallowance of the principal item
of petitioner's having paid to Mr. C. M. Hoskins, its founder and controlling stockholder the
amount of P99,977.91 representing 50% of supervision fees earned by it and set aside
respondent's disallowance of three other minor items.
The Tax Court therefore determined petitioner's tax deficiency to be in the amount of
P27,145.00 and on November 8, 1964 rendered judgment against it.
ISSUE:
Whether or not the deductions of the supervision fees CM Hoskins earned is deductible as
business expense.
RULING:
No. Considering that in addition to being Chairman of the board of directors of petitioner
corporation, which bears his name, Hoskins, who owned 99.6% of its total authorized capital
stock while the four other officers-stockholders of the firm owned a total of four-tenths of 1%,
or one-tenth of 1% each, with their respective nominal shareholdings of one share each was
also salesman-broker for his company, receiving a 50% share of the sales commissions earned
by petitioner, besides his monthly salary of P3,750.00 amounting to an annual compensation
of P45,000.00 and an annual salary bonus of P40,000.00, plus free use of the company car and
receipt of other similar allowances and benefits, the Tax Court correctly ruled that the
payment by petitioner to Hoskins of the additional sum of P99,977.91 as his equal or 50%
share of the 8% supervision fees received by petitioner as managing agents of the real estate,
subdivision projects of Paradise Farms, Inc. and Realty Investments, Inc. was inordinately
large and could not be accorded the treatment of ordinary and necessary expenses allowed as
deductible items within the purview of Section 30 (a) (i) of the Tax Code.
If such payment of P99,977.91 were to be allowed as a deductible item, then Hoskins would
receive on these three items alone (salary, bonus and supervision fee) a total of P184,977.91,
which would be double the petitioner's reported net income for the year of P92,540.25.
It will be readily seen therefrom that when the petitioner's commission covers general
supervision, it is provided that the 1/2 rule of equal sharing of the sales commissions does not
apply and that the salesman's share is stipulated in the case of each subdivision. Furthermore,
what is involved here is not Hoskins' salesman's share in the petitioner's 12% sales
commission, which he presumably collected also from petitioner without respondent's
questioning it, but a 50% share besides in petitioner's planning and supervision fee of 8% of
the gross sales, as mentioned above. 'In determining whether the particular salary or
compensation payment is reasonable, the situation must be considered as whole. Ordinarily,
no single factor is decisive. . . . it is important to keep in mind that it seldom happens that the
application of one test can give satisfactory answer, and that ordinarily it is the interplay of
several factors, properly weighted for the particular case, which must furnish the final
answer."
55 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Petitioner's case fails to pass the test. On the right of the employer as against respondent
Commissioner to fix the compensation of its officers and employees, we there held further that
while the employer's right may be conceded, the question of the allowance or disallowance
thereof as deductible expenses for income tax purposes is subject to determination by
respondent Commissioner of Internal Revenue. Thus: "As far as petitioner's contention that as
employer it has the right to fix the compensation of its officers and employees and that it was
in the exercise of such right that it deemed proper to pay the bonuses in question, all that We
need say is this: that right may be conceded, but for income tax purposes the employer cannot
legally claim such bonuses as deductible expenses unless they are shown to be reasonable. To
hold otherwise would open the gate of rampant tax evasion.
It should be noted that we have here a case practically of a sole proprietorship of C. M.
Hoskins, who however chose to incorporate his business with himself holding virtually
absolute control thereof with 99.6% of its stock with four other nominal shareholders holding
one share each. Having chosen to use the corporate form with its legal advantages of a
separate corporate personality as distinguished from his individual personality, the
corporation so created, i.e., petitioner, is bound to comport itself in accordance with corporate
norms and comply with its corporate obligations. Specifically, it is bound to pay the income
tax imposed by law on corporations and may not legally be permitted, by way of corporate
resolutions authorizing payment of inordinately large commissions and fees to its controlling
stockholder, to dilute and diminish its corresponding corporate tax liability.
KUENZLE & STREIFF, INC. v. CIR
DOCTRINE:
Bonuses to employees made in good faith and as additional compensation for the services
actually rendered by the employees are deductible, provided such payments, when added to
the stipulated salaries, do not exceed a reasonable compensation for the services rendered".
The condition precedents to the deduction of bonuses to employees are: (1) the payment of
the bonuses is in fact compensation; (2) it must be for personal services actually rendered;
and (3) the bonuses, when added to the salaries, are reasonable when measured by the
amount and quality of the services performed with relation to the business of the particular
taxpayer"
FACTS:
Petitioner is engaged in the importation of textiles, hardware, sundries, chemicals,
pharmaceuticals, lumbers, groceries, wines and liquor; in insurance and lumber; and in some
exports. In the income tax returns for the years 1950, 1951 and 1952 it filed with respondent,
petitioner deducted from its gross income certain items representing salaries, directors' fees
and bonuses of its non-resident president and vice-president; bonuses of its resident officers
and employees; and interests on earned but unpaid salaries and bonuses of its officers and
employees. The income tax computed in accordance with these returns was duly paid by
petitioner. In 1953, CIR disallowed these 3 deductions made by petitioner, and assessed and
demanded from petitioner the payment of deficiency income taxes in the sums of P26,370.00,
P53,865.00 and P44,112.00 for the years 1950, 1951 and 1952, respectively. Petitioner
requested for the re-examination of this assessment, and respondent modified the same by
allowing as deductible all items comprising directors' fees and salaries of the non-resident
president and vice-president, but disallowing the bonuses insofar as they exceed the salaries
of the recipients, as well as the interests on earned but unpaid salaries and bonuses. Hence, for
the years 1950, 1951 and 1952, respondent made a new assessment and demanded from
petitioner as deficiency income taxes the amounts of P10,147.00, P26,783.00 and P20,481.00,
respectively. Petitioner having taken the case on appeal to the Court of Tax Appeals, the latter
modified the assessment of respondent to a total of P33,187.00 as deficiency income tax due
for the years 1950, 1951 and 1952.
Both parties appealed, petitioner from that portion which holds that the measure of the
reasonableness of the bonuses paid to its non-resident president and vice-president should be
applied to the bonuses given to resident officers and employees in determining their
deductibility and so only so much of said bonuses as applied to the latter should be allowed as
deduction, and respondent from that portion of the decision which allows the deduction of so
much of the bonuses which is in excess of the yearly salaries paid to the respective recipients
thereof.
ISSUE: Whether or not the deductions made by petitioner were reasonable?
RULING:
SEC. 30. Deductions from gross income. — In computing net income there shall be allowed as
deductions —
a. Expenses:
(1) In general. — All the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business, including a reasonable allowance for salaries or
other compensation for personal services actually rendered;
b. Interest:
(1) In general. — The amount of interest paid within the taxable year on indebtedness, except
on indebtedness incurred or continued to purchase or carry obligations the interest upon
which is exempt from taxation as income under this Title.
The bonuses paid to the officers and employees of petitioner, whether resident or non-
resident, were paid to them as additional compensation for personal services actually
rendered and as such can be considered as ordinary and necessary expenses incurred in the
business within the meaning of the law, the only question in dispute being how much of said
bonuses may be considered reasonable in order that it may be allowed as deduction.
Petitioner gave to its non-resident president and vice president for the years 1950 and 1951
bonuses equal to 133-1/2% of their annual salaries and bonuses equal to 125-2/3% for the
year 1952, whereas with regard to its resident officers and employees it gave them much
more on the alleged reason that they deserved them because of their valuable contribution to
the business of the corporation which has made it possible for it to realize huge profits during
the aforesaid years. And the Court of Tax Appeals ruled that while the bonuses given to the
non-resident officers are reasonable considering their yearly salaries and the services actually
rendered by them, the bonuses given to the resident officers and employees are, however,
quite excessive, the court saying on this point that "there is no special reason for granting
greater bonuses to such lower ranking officers than those given to Messrs. Kuenzle and
Streiff."
While it may be admitted that the resident officers and employees had performed their duty
well and rendered efficient service and for that reason were given greater amount of
additional compensation in the form of bonuses than what was given to the non-resident
officers. The reason for this is that, in the opinion of the management itself of the corporation,
said non-resident officers had rendered the same amount of efficient personal service and
contribution to deserve equal treatment in compensation and other emoluments with the
particularity that their liberation yearly salaries had been much smaller.
The contention of respondent that the trial court erred also in allowing the deduction bonuses
in excess of the yearly salaries of their respective recipients predicated upon his own decision
that the deductible amount of said bonuses should be only equal to their respective yearly
salaries cannot also be sustained. This claim cannot be justified considering the factors we
have already mentioned that play in the determination of the reasonableness of the bonuses
56 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
or additional compensation that may be given to an officer or an employee which, if properly
considered, warrant the payment of the bonuses in question to the extent allowed by the trial
court. This is specially so considering the post-war policy of the corporation in giving salaries
at low levels because of the unsettled conditions resulting from war and the imposition of
government controls on imports and exports and on the use of foreign exchange which
resulted in the diminution of the amount of business and the consequent loss of profits on the
part of the corporation. The payment of bonuses in amounts a little more than the yearly
salaries received considering the prevailing circumstances is in our opinion reasonable.
6. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN
SEC. 45. Period for which Deductions and Credits Taken. - The deductions provided for in
this Title shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred',
dependent upon the method of accounting the basis of which the net income is computed,
unless in order to clearly reflect the income, the deductions should be taken as of a different
period. In the case of the death of a taxpayer, there shall be allowed as deductions for the
taxable period in which falls the date of his death, amounts accrued up to the date of his death
if not otherwise properly allowable in respect of such period or a prior period.
CIR v. ISABELA CULTURAL CORP.
DOCTRINE:
 Under the accrual method of accounting, expenses not being claimed as deductions by a
taxpayer in the current year when they are incurred cannot be claimed as deduction from
income for the succeeding year.
 For a taxpayer using the accrual method, the determinative question is, when do the facts
present themselves in such a manner that the taxpayer must recognize income or
expense? The accrual of income and expense is permitted when the all-events test has
been met. This test requires:
1. Fixing of a right to income or liability to pay; and
2. The availability of the reasonable accurate determination of such income or
liability.
 The amount of liability does not have to be determined exactly; it must be
determined with “reasonable accuracy.” Accordingly, the term “reasonable
accuracy” implies something less than an exact or completely accurate amount.
 The propriety of an accrual must be judged by the facts that a taxpayer knew, or
could reasonably be expected to have known, at the closing of its books for the
taxable year. Accrual method of accounting presents largely a question of fact; such
that the taxpayer bears the burden of proof of establishing the accrual of an item of
income or deduction.
FACTS:
 ICC received from the BIR 2 Assessment Notices, both for the taxable year 1986: One of
which is for deficiency income tax in the amount of P333,196.86 arising from the BIR’s
disallowance of ICC’s claimed expense deductions for professional and security services
billed to and paid by ICC in 1986, to wit:
1. Expenses for the auditing services of SGV & Co., for the year ending December 31,
1985;
2. Expenses for the legal services of the law firm Bengzon Zarraga Narciso Cudala
Pecson Azcuna & Bengson for the years 1984 and 1985.
3. Expense for security services of El Tigre Security & Investigation Agency for the
months of April and May 1986.
 ICC sought a reconsideration of the subject assessments. However, it received a final
notice before seizure demanding payment of the amounts stated in the said
notices. Hence, it brought the case to the CTA.
 CTA rendered a decision canceling and setting aside the assessment notices issued
against ICC. CA affirmed the CTA decision. Hence, CIR filed the instant petition.
 CIR’s contention: Since ICC is using the accrual method of accounting, the expenses for
the professional services that accrued in 1984 and 1985, should have been declared as
deductions from income during the said years and the failure of ICC to do so bars it from
claiming said expenses as deduction for the taxable year 1986.
ISSUE/S: W/N ICC can claim the deduction of the expenses for professional and security
services from ICC’s gross income
RULING:
1. The expenses for professional fees consisting of expenses for legal and auditing
services CANNOT be validly deducted from its gross income for the said year and were
therefore properly disallowed by the BIR.
2. The expenses for security services were incurred by ICC in 1986 and could therefore be
properly claimed as deductions for the said year.
The requisites for the deductibility of ordinary and necessary trade, business, or professional
expenses, like expenses paid for legal and auditing services, are:
1. The expense must be ordinary and necessary;
2. It must have been paid or incurred during the taxable year;
3. It must have been paid or incurred in carrying on the trade or business of the
taxpayer; and
4. It must be supported by receipts, records or other pertinent papers.
 The requisite that it must have been paid or incurred during the taxable year is further
qualified by Section 45 of the National Internal Revenue Code (NIRC) which states that:
“the deduction provided for in this Title shall be taken for the taxable year in which ‘paid
or accrued’ or ‘paid or incurred’, dependent upon the method of accounting upon the
basis of which the net income is computed x x x”.
 Accounting methods for tax purposes comprise a set of rules for determining when and
how to report income and deductions. In the instant case, the accounting method used by
ICC is the accrual method.
 Under the accrual method of accounting, expenses not being claimed as deductions by a
taxpayer in the current year when they are incurred cannot be claimed as deduction from
income for the succeeding year. Thus, 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.
 For a taxpayer using the accrual method, the determinative question is, when do the facts
present themselves in such a manner that the taxpayer must recognize income or
expense? The accrual of income and expense is permitted when the all-events test has
been met. This test requires:
3. Fixing of a right to income or liability to pay; and
4. The availability of the reasonable accurate determination of such income or
liability.
 The amount of liability does not have to be determined exactly; it must be
determined with “reasonable accuracy.” Accordingly, the term “reasonable
accuracy” implies something less than an exact or completely accurate amount.
 The propriety of an accrual must be judged by the facts that a taxpayer knew, or
could reasonably be expected to have known, at the closing of its books for the
taxable year. Accrual method of accounting presents largely a question of fact; such
57 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
that the taxpayer bears the burden of proof of establishing the accrual of an item of
income or deduction.
 Corollarily, it is a governing principle in taxation that tax exemptions must be construed
in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and
one who claims an exemption must be able to justify the same by the clearest grant of
organic or statute law. An exemption from the common burden cannot be permitted to
exist upon vague implications. And since a deduction for income tax purposes partakes
of the nature of a tax exemption, then it must also be strictly construed.
 In the instant case, ICC failed to discharge the burden of proving that the claimed expense
deductions for the professional services were allowable deductions for the taxable year
1986.
o The expenses for legal services pertain to the 1984 and 1985 legal and retainer
fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson,
and for reimbursement of the expenses of said firm in connection with ICC’s tax
problems for the year 1984. As testified by the Treasurer of ICC, the firm has
been its counsel since the 1960’s. From the nature of the claimed deductions
and the span of time during which the firm was retained, ICC can be expected
to have reasonably known the retainer fees charged by the firm as well as the
compensation for its legal services. ICC, in the exercise of due diligence could
have inquired into the amount of their obligation to the firm. Also, it could have
reasonably determined the amount of legal and retainer fees owing to its
familiarity with the rates charged by their long time legal consultant.
o In the same vein, the professional fees of SGV & Co. for auditing the financial
statements of ICC for the year 1985 cannot be validly claimed as expense
deductions in 1986. ICC failed to present evidence showing that even with only
“reasonable accuracy,” as the standard to ascertain its liability to SGV & Co. in
the year 1985, it cannot determine the professional fees which said company
would charge for its services.
B. INTEREST
SEC. 34. (B) Interest.-
(1) In General. - The amount of interest paid or incurred within a taxable year on
indebtedness in connection with the taxpayer's profession, trade or business shall be
allowed as deduction from gross income: Provided, however, That the taxpayer's
otherwise allowable deduction for interest expense shall be reduced forty-two percent
(42%) of the interest income subjected to final tax: Provided, That effective January 1,
2009, the percentage shall be thirty-three percent (33%).
(2) Exceptions. - No deduction shall be allowed in respect of interest under the
succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash
basis incurs an indebtedness on which an interest is paid in advance through
discount or otherwise: Provided, That such interest shall be allowed a a deduction in
the year the indebtedness is paid: Provided, further, That if the indebtedness is
payable in periodic amortizations, the amount of interest which corresponds to the
amount of the principal amortized or paid during the year shall be allowed as
deduction in such taxable year;
(b)If both the taxpayer and the person to whom the payment has been made or is to
be made are persons specified under Section 36 (B); or
(c)If the indebtedness is incurred to finance petroleum exploration.
 (3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest
incurred to acquire property used in trade business or exercise of a profession may be
allowed as a deduction or treated as a capital expenditure.
PAPER IND. CORP. OF THE PHIL. v. CA
DOCTRINE:
Our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring
machinery and equipment. Neither does our 1977 NIRC compel the capitalization of interest
payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one
or the other tax treatment of such interest payments. Accordingly, the general rule that
interest payments on a legally demandable loan are deductible from gross income must be
applied.
FACTS:
Paper Industries Corporation of the Philippines (PICOP) is a business engaged in operation of
a pulp and paper mill. PICOP obtained loans from foreign creditors in order to finance the
purchase of machinery and equipment needed for its operations. In its 1977 Income Tax
Return, PICOP claimed interest payments made in 1977, amounting to P42,840,131.00, on
these loans as a deduction from its 1977 gross income.
The CIR disallowed this deduction upon the ground that, because the loans had been incurred
for the purchase of machinery and equipment, the interest payments on those loans should
have been capitalized instead and claimed as a depreciation deduction taking into account the
adjusted basis of the machinery and equipment (original acquisition cost plus interest
charges) over the useful life of such assets.
ISSUE/S:
Whether PICOP is entitled to deductions against income of interest payments on loans for the
purchase of machinery and equipment
RULING:
YES. The general rule is that interest expenses are deductible against gross income and this
certainly includes interest paid under loans incurred in connection with the carrying on of the
business of the taxpayer. In the instant case, the CIR does not dispute that the interest
payments were made by PICOP on loans incurred in connection with the carrying on of the
registered operations of PICOP, i.e., the financing of the purchase of machinery and equipment
actually used in the registered operations of PICOP. Neither does the CIR deny that such
interest payments were legally due and demandable under the terms of such loans, and in fact
paid by PICOP during the tax year 1977.
The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows:
Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other purposes
on account of capital or surplus invested in the business, which does not represent a
charge arising under an interest-bearing obligation, is not allowable deduction from
gross income. (Emphases supplied)
We read the above provision of Revenue Regulations No. 2 as referring to so called
"theoretical interest," that is to say, interest "calculated" or computed (and not incurred or
paid) for the purpose of determining the "opportunity cost" of investing funds in a given
business. Such "theoretical" or imputed interest does not arise from a legally demandable
interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g.,
whether he would have been better off by lending out his funds and earning interest rather
than investing such funds in his business. One thing that Section 79 quoted above makes clear
is that interest which does constitute a charge arising under an interest-bearing obligation is
58 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
an allowable deduction from gross income.
CIR v. VDA DE PRIETO
FACTS:
Respondent conveyed by way of gifts to her 4 children a real property with a total amount
value of P892,497. The CIR appraised the real property for gift tax purposes at P1.2M and
assessed the total sum of P117,706 as the donor's gift tax and interest. Of the total P117k, the
sum of P55,978 represents the total interest on account of delinquency. The P55k was claimed
by the respondent as deductible. CIR disallowed such deduction and imposed P21,000 as
deficiency income tax on the P55k including interest and surcharge for the late payment.
The law provides that for an interest to be deductible, it must be shown that: 1) there was a
debt 2) that there was interest upon that debt 3) what is claimed as an interest deduction
have been paid and accrued within the year
ISSUE: Whether or not the interest claimed as deductible was paid upon an indebtedness
within the contemplation of Section 30(b)(1) of the Tax Code? YES, the interest paid by
respondent for the late payment of her donor's tax is deductible from gross income
RULING:
Section 30(b)(1): Interest- the amount of interest paid within the taxable year or
indebtedness, except on indebtedness incurred or continued to purchase or carry obligations
the interest upon which is exempt from taxation as income under this Title.
1) "indebtedness" - unconditional and legally enforceable obligation for the payment of money
2) Santiago Sambrano case - although taxes already due does not have the same concept as
debts, they are, however, obligations that may be considered as such. The term "debt" may
also mean whatever one is bound to render to another, either for contract or the requirement
of law.
3) interest on taxes is interest on indebtedness and is deductible
4) the CIR relies heavily on Section 80of the Revenue Regulation no 2 which provides that
"taxes" means taxes proper and no deduction should be allowed for amounts representing
interest, surcharge or penalties incident to delinquency.
However, Section 80 has been a part of thr development of the law on deduction of taxes in
the US. :: Interest on deficiency taxes ARE DEDUCTIBLE, NOT AS TAXES, BUT AS INTEREST.
REVENUE REGULATIONS NO. 13-00
Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for Deductibility of
Interest Expense from the Gross Income of a Taxpayer.
SECTION 3. Requisites for Deductibility of Interest Expense. — In general, subject to certain
limitations, the following are the requisites for the deductibility of interest expense from gross
income, viz:
(a) There must be an indebtedness;
(b) There should be an interest expense paid or incurred upon such indebtedness;
(c) The indebtedness must be that of the taxpayer,
(d) The indebtedness must be connected with the taxpayer's trade, business or exercise of
profession;
 (e) The interest expense must have been paid or incurred during the taxable year;
(f) The interest must have been stipulated in writing;
(g) The interest must be legally due;
(h) The interest payment arrangement must not be between related taxpayers as mandated
in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997 ;
(i) The interest must not be incurred to finance petroleum operations; and
(j) In case of interest incurred to acquire property used in trade, business or exercise of
profession, the same was not treated as a capital expenditure.
SECTION 4. Rules on the Deductibility of Interest Expense. —
(a) General Rule. — In general, the amount of interest expense paid or incurred within a
taxable year on indebtedness in connection with the taxpayer's trade, business or exercise of
profession shall be allowed as a deduction from the taxpayer's gross income.
(b) Limitation. — The amount of interest expense paid or incurred by a taxpayer in
connection with his trade, business or exercise of a profession from an existing indebtedness
shall be reduced by an amount equal to the following percentages of the interest income
earned which had been subjected to final withholding tax depending on the year when the
interest income was earned, viz:
Forty-one percent (41%) beginning January 1, 1998;
Thirty-nine percent (39%) beginning January 1, 1999; and
Thirty-eight percent (38%).beginning January 1, 2000 and thereafter.
This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered
into by the taxpayer or regardless of the date when the interest bearing loan and the date
when the investment was made for as long as, during the taxable year, there is an interest
expense incurred on one side and an interest income earned on the other side, which interest
income had been subjected to final withholding tax. This rule shall be observed irrespective of
the currency the loan was contracted and/or in whatever currency the investments or
deposits were made.
1. INTEREST ARBITRAGE
BIR RULING 006-00
PNB requested for a ruling that interest income derived by it from the treasury bonds be
excluded in the determination of the interest expense not allowable as deduction from gross
income.
Under the SEC 34(B) of the Tax Reform Act of 1997, states that interest expense used in the
trade or business will be consider as a deductible expense, except when the money where use
to generate interest income. Under the tax reform act of 1997, the interest expense allowed to
be deductible is equivalent to 41% of the interest income in 1998.
The request is to consider the interest income earned from the treasury bonds not
included in the computation of the limit of the deductible interest expense. The Court
denied the request and held that the interest income earned from the treasury bonds is not
the main purpose of the company and secondly the treasury bonds which I believe is the
Philippine Government issue note is subject to 20% withholding tax. Therefore the interest
income generated from the treasury bonds must include in the computation of the 42%
59 TAXATION 1 (ATTY. BELLO)
limit on the deductible interest expense.
PNB claims its an direct income but CTA held that it is indirect income, which is not the
income earned in relation to trade, profession etc.
C. TAXES
SEC. 34. (C) Taxes.-
(1) In General. - Taxes paid or incurred within the taxable year in connection with the
taxpayer's profession, trade or business, shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction
shall be allowed in the case of a taxpayer who does not signify in his return his
desire to have to any extent the benefits of paragraph (3) of this subsection (relating
to credits for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of
the property assessed.
Provided, That taxes allowed under this Subsection, when refunded or credited,
shall be included as part of gross income in the year of receipt to the extent of the
income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged
in trade or business in the Philippines and a resident foreign corporation, the deductions
for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to
the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his
return his desire to have the benefits of this paragraph, the tax imposed by this Title shall
be credited with:
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and
of a domestic corporation, the amount of income taxes paid or incurred during the
taxable year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of
a general professional partnership or a beneficiary of an estate or trust, his
proportionate share of such taxes of the general professional partnership or the
estate or trust paid or incurred during the taxable year to a foreign country, if his
distributive share of the income of such partnership or trust is reported for taxation
under this Title.
An alien individual and a foreign corporation shall not be allowed the credits against
the tax for the taxes of foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be
subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country
shall not exceed the same proportion of the tax against which such credit is taken,
which the taxpayer's taxable income from sources within such country under this
Title bears to his entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 against which such credit is taken, which the taxpayer's taxable income from
sources without the Philippines taxable under this Title bears to his entire taxable
income for the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ
from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in
whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine the
amount of the tax for the year or years affected, and the amount of tax due upon such
redetermination, if any, shall be paid by the taxpayer upon notice and demand by the
Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the
taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition
precedent to the allowance of this credit may require the taxpayer to give a bond with
sureties satisfactory to and to be approved by the Commissioner in such sum as he may
require, conditioned upon the payment by the taxpayer of any amount of tax found due
upon any such redetermination. The bond herein prescribed shall contain such further
conditions as the Commissioner may require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this
Section may, at the option of the taxpayer and irrespective of the method of accounting
employed in keeping his books, be taken in the year which the taxes of the foreign
country were incurred, subject, however, to the conditions prescribed in Subsection
(C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the
taxes of the foreign country accrued, the credits for all subsequent years shall be taken
upon the same basis and no portion of any such taxes shall be allowed as a deduction in
the same or any succeeding year.
(7)Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed
only if the taxpayer establishes to the satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;
(b) The amount of income derived from each country, the tax paid or incurred to
which is claimed as a credit under said paragraph, such amount to be determined
under rules and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such
credits.
CIR v. LEDNICKY
FACTS:
Spouses V.E. Lednicky and Maria Valero Lednicky are American Citizens residing in the
Philippines and derived their income from Philippines. This case involves three separate cases
that deals with the same issue:
1. ITR for 1956: In 1957, Sps filed their ITR for 1956 reporting a gross income
P1,017,287.65 and a net income of P733,809.44 on which P317,395.40 was assessed
after deducting P4,805.59 as withholding tax. Sps paid then 326,247.41 on April
1957. On March 1959 – Sps filed an amended ITR for 1956. They claimed a
deduction of P205,939.24 paid in 1956 to US gov’t. Now, Sps are now requesting a
refund of 112,437.90. CIR failed to answer the claim for refund, so Sps filed their
petition with the Tax Court.
2. ITR for 1955: In Feb 1956 Sps filed ITR for 1955 = gross income of P1,7771,124.63
and net income of P1,052,550.67. The following year, Sps filed an amended ITR
because apparently Sps filed with the US Internal Revenue Agent in Manila their
60 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
federal ITR for the years 1947,1951-54 on income from Phil sources on a cash basis
and thus, the amended ITR includes the deductions of US Federal income taxes,
interest accrued up to May 15, 1955, and exchange and bank charges. Sps. filed w/
the CTA is also a claim for refund in the amount of P150,269.00 as alleged overpaid
income tax for 1955
3. ITR for 1957: again, they claim deductions representing taxes paid to US Gov’t. They
claim the refund as overpayment.
CTA held that the taxes may be deducted because the Sps “did not signify” in their ITR a desire
to avail themselves of the benefits of paragraph 3(B) of Sec. 30:
Par. (c) (3) Credits against tax for taxes of foreign countries. — If the taxpayer signifies in his
return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be
credited with
(B) Alien resident of the Philippines. — In the case of an alien resident of the Philippines, the
amount of any such taxes paid or accrued during the taxable year to any foreign country, if the
foreign country of which such alien resident is a citizen or subject, in imposing such taxes,
allows a similar credit to citizens of the Philippines residing in such country.
ISSUE: WON a citizen of the US residing in Phils who derives income wholly from sources
within the Phils may deduct from his gross income the income taxes he has paid to US gov’t for
the taxable year?
RULING:
SC favors the view of CIR rather than CTA. CIR was correct that the construction and wording
of Sec. 30c(1)B of the Internal Revenue Act shows the law’s intent that the right to deduct
income taxes paid to foreign government from the taxpayer’s gross income is given only as an
alternative or substitute to his right to claim a tax credit for such foreign income taxes
(B) – Income, war-profits, and excess profits taxes imposed by the authority of any
foreign country; but this deduction shall be allowed in the case of a taxpayer who
does not signify in his return his desire to have any extent the benefits of paragraph
(3) of this subsection (relating to credit for foreign countries)
So that unless the alien resident has a right to claim such tax credit if he so chooses, he is
precluded from deducting the foreign income taxes from his gross income. For it is obvious
that in prescribing that such deduction shall be allowed in the case of a taxpayer who does not
signify in his return his desire to have any extent benefits of paragraph 3, the statute assumes
that the taxpayer in question may signify his desire to claim a tax credit and waive the
deduction; otherwise, the foreign taxes would always be deductible and their mention in the
list on non-deductible items in Sec. 30c might as well have been omitted or at least expressly
limited to taxes on income from sources outside the Philippines. Had the law intended that
foreign income taxes could be deducted from gross income in any event, regardless of the
taxpayer’s right to claim a tax credit, it is the latter right that should be conditioned upon the
taxpayer’s waiving the deduction
Sps admit in their brief that the purpose of the law is to prevent the taxpayer from claiming
twice the benefits of his payment of foreign taxes, by deduction from gross income (subs. c-1)
and by tax credit (subs. c-3). This danger of double credit certainly cannot exist if the taxpayer
cannot claim benefit under either of these headings at his option, so that he must be entitled to
a tax credit (Sps taxpayers admittedly are not so entitled because all their income is derived
from Philippine sources), or the option to deduct from gross income disappears altogether.
Much stress is laid on the thesis that if the respondent taxpayers are not allowed to deduct the
income taxes they are required to pay to the government of the United States in their return
for Philippine income tax, they would be subjected to double taxation. Double taxation
becomes obnoxious only where the taxpayer is taxed twice for the benefit of the same
governmental entity. The Philippine government only receives the proceeds of one tax. Justice
and equity demand that the tax on the income should accrue to the benefit of the Philippines.
Any relief from the alleged double taxation should come from the US since the former’s right
to burden the taxpayer is solely predicated in is citizenship, without contributing to the
production of wealth that is being taxed. To allow an alien resident to deduct from his gross
income whatever taxes he pays to his own government amounts to conferring on the latter the
power to reduce the tax income of the Philippine government simply by increasing the tax
rates on the alien resident.
D. LOSSES
1. CASUALTY LOSSES
SEC 34. (D) Losses. -
(1) In General.- Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or profession, if the loss arises
from fires, storms, shipwreck, or other casualties, or from robbery, theft or
embezzlement.
The Secretary of Finance, upon recommendation of the Commissioner, is hereby
authorized to promulgate rules and regulations prescribing, among other things, the
time and manner by which the taxpayer shall submit a declaration of loss sustained
from casualty or from robbery, theft or embezzlement during the taxable year:
Provided, however, That the time limit to be so prescribed in the rules and
regulations shall not be less than thirty (30) days nor more than ninety (90) days
from the date of discovery of the casualty or robbery, theft or embezzlement giving
rise to the loss.
(c) No loss shall be allowed as a deduction under this Subsection if at the time of the
filing of the return, such loss has been claimed as a deduction for estate tax purposes
in the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the
losses deductible shall be those actually sustained during the year incurred in business, trade
or exercise of a profession conducted within the Philippines, when such losses are not
compensated for by insurance or other forms of indemnity. The secretary of Finance, upon
recommendation of the Commissioner, is hereby authorized to promulgate rules and
regulations prescribing, among other things, the time and manner by which the taxpayer shall
submit a declaration of loss sustained from casualty or from robbery, theft or embezzlement
during the taxable year: Provided, That the time to be so prescribed in the rules and
regulations shall not be less than thirty (30) days nor more than ninety (90) days from the
date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss; and
2. NOLCO
SEC 34. (D) (3) Net Operating Loss Carry-Over. - The net operating loss of the business or
enterprise for any taxable year immediately preceding the current taxable year, which had not
been previously offset as deduction from gross income shall be carried over as a deduction
from gross income for the next three (3) consecutive taxable years immediately following the
year of such loss: Provided, however, That any net loss incurred in a taxable year during
61 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
which the taxpayer was exempt from income tax shall not be allowed as a deduction under
this Subsection: Provided, further, That a net operating loss carry-over shall be allowed only if
there has been no substantial change in the ownership of the business or enterprise in that -
(i) Not less than seventy-five percent (75%) in nominal value of outstanding issued
shares., if the business is in the name of a corporation, is held by or on behalf of the same
persons; or
(ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation, if
the business is in the name of a corporation, is held by or on behalf of the same persons.
"For purposes of this subsection, the term 'not operating loss' shall mean the excess of
allowable deduction over gross income of the business in a taxable year.
Provided, That for mines other than oil and gas wells, a net operating loss without the benefit
of incentives provided for under Executive Order No. 226, as amended, otherwise known as
the Omnibus Investments Code of 1987, incurred in any of the first ten (10) years of operation
may be carried over as a deduction from taxable income for the next five (5) years
immediately following the year of such loss. The entire amount of the loss shall be carried
over to the first of the five (5) taxable years following the loss, and any portion of such loss
which exceeds, the taxable income of such first year shall be deducted in like manner form the
taxable income of the next remaining four (4) years.
PAPER INDUSTRIES CORP. OF THE PHLS. v. CA
REVENUE REGULATIONS 14-01
Implementing Section 34(D)(3) of the National Internal Revenue Code of 1997 Relative to the
Allowance of Net Operating Loss Carry-Over (NOLCO) as a Deduction from Gross Income.
SECTION 2. General Principles anal Policies. —
2.1 For purposes of these Regulations, the allowance for deduction of NOLCO shall be limited
only to net operating losses accumulated beginning January 1, 1998.
2.2 In general, NOLCO shall be allowed as a deduction from the gross income of the same
taxpayer who sustained and accumulated the net operating losses regardless of the change in
its ownership. This rule shall also apply in the case of a merger where the taxpayer is the
surviving entity.
2.3 Unless otherwise provided in these Regulations, NOLCO of the taxpayer shall not be
transferred or assigned to another person, whether directly or indirectly, such as, but not
limited to, the transfer or assignment thereof through a merger, consolidation or any form of
business combination of such taxpayer with another person.
2.4 NOLCO shall also be allowed if there has been no substantial change in the ownership of
the business or enterprise in that not less than 75% in nominal value of outstanding issued
shares or not less than 75% of the paid up capital of the corporation, if the business is in the
name of the corporation, is held by or on behalf of the same persons.
The 75% equity, ownership or interest rule prescribed in these Regulations shall only apply to
a transfer or assignment of the taxpayer's net operating losses as a result of or arising from
the said taxpayer's merger or consolidation or business combination with another person. In
case the transfer or assignment of the taxpayer's net operating losses arises from the said
taxpayer's merger, consolidation or combination with another person, the transferee or
assignee shall not be entitled to claim the same as deduction from gross income unless, as a
result of the said merger, consolidation or combination, the shareholders of the
transferor/assignor, or the transferor (in case of other business combinations) gains control
of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of
the transferee/assignee (in case the transferee/assignee is a corporation) or 75% or more
interest in the business of the transferee/assignee (in case the transferee/assignee is other
than a corporation).
2.5 Unless otherwise provided in these Regulations, an individual (including estate or trust)
engaged in trade or business or in the exercise of profession, or a domestic or resident foreign
corporation may be allowed to claim deduction of his/its corresponding NOLCO: Provided,
however, that an individual who claims the 10% optional standard deduction shall not
simultaneously claim deduction of the NOLCO:
Provided, further, that the three-year reglementary period shall continue to run
notwithstanding the fact that the aforesaid individual availed of the 10% optional standard
deduction during the said period.
2.6 The three-year reglementary period on the carry-over of NOLCO shall continue to run
notwithstanding the fact that the corporation paid its income tax under the "Minimum
Corporate Income Tax" computation.
2.7 NOLCO shall be availed of on a "first-in, first-out" basis.
2.8 The net operating loss incurred by a taxpayer in the year in which a substantial change in
ownership in such taxpayer occurs shall not be affected by such change in ownership,
notwithstanding subsections 2.3 and 2.4.
SECTION 4. Taxpayers Entitled to Deduct NOLCO from Gross Income.
— Any individual (including estates and trusts) engaged in trade or business or in the exercise
of his profession, and domestic and resident 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) on their
taxable income as defined in Section 3 of these Regulations shall be entitled to deduct from
his/its gross income for the current year his/its accumulated net operating losses for the
immediately preceding three (3) consecutive taxable years: Provided, however, that net
operating losses incurred or sustained prior to January 1, 1998 shall not qualify for purposes
of the NOLCO. Provided, further, that any provision of these Regulations notwithstanding, the
following shall not be entitled to claim deduction of NOLCO:
4.1 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);
4.2 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;
4.3 An enterprise registered with the Philippine Economic Zone Authority (PEZA), pursuant to
R.A. No. 7916, as 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;
4.4 An enterprise registered under R.A. 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;
4.5 Foreign corporations engaged in international shipping or air carriage business in the
62 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Philippines; and
4.6 In general, any person, natural or juridical, enjoying exemption from income tax, pursuant
to the provisions of the 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.
SECTION 5. Determination of Substantial Change in the Ownership of the Business.
5.1 Time of Determination of Substantial Change in the Ownership of the Business; Determined
as of the End of the Taxable Year — The substantial change in the ownership of the business or
enterprise shall be determined as of the end of the taxable year when NOLCO is to be claimed
as deduction. Whether or not substantial change in ownership occurred shall be determined
on the basis of any change in the ownership of interest in the said business or enterprise
arising from or incident to its merger, or consolidation, or combination with another person
(e.g., in the case of merger or consolidation of two or more corporations, such change shall be
determined based on the ownership of the outstanding shares of stock issued or based on
paid-up capital as of the end of the taxable year, and as a result of or arising from the said
merger or consolidation).
5.2 When Change Occurs — A change in the ownership of the business occurs when the person
who sustained net operating losses enters into a merger, or consolidation or combination with
another person, thereby resulting to the transfer or conveyance of the said net operating
losses, to another person, in the course of the said merger or consolidation or combination.
(a) When No Substantial Change Occurs — No substantial change in ownership of the business
occurs if, as a result of the said merger or consolidation or combination, the stockholders of
the transferor, or the transferor, in case of other business combinations, gains control of at
least 75% or more in nominal value of the outstanding issued shares or paid-up capital of the
transferee-assignee (in case the transferee-assignee is a corporation) or 75% or more interest
in the business of the transferee-assignee (in case the transferee-assignee is other than a
corporation).
(b) When Substantial Change Occurs — A substantial change in ownership of the business
occurs if, as a result of the transaction referred to in subsection 5.2 (a) hereof, the
stockholders of the transferor or the transferor, in case of other business combinations, gains
control of the aforesaid transferee-assignee only to the extent of less than 75%.
SECTION 6. Entitlement to Net Operating Loss Carry-Over.—
6.1 In General — In general, only net operating losses incurred by a qualified taxpayer for the
period beginning January 1, 1998 may be carried over to the next three (3) immediately
succeeding taxable years following the year of such loss for purposes of the NOLCO deduction.
Provided, however, that for mines other than oil and gas wells, a net operating loss without
the benefit of incentives provided for under Executive Order No. 226, otherwise known as the
Omnibus Investments Code of 1987, as amended, incurred in any of the first ten (10) years of
operation may be carried over as a deduction from taxable income for the next five (5) years
immediately following the year of such loss. Provided, further, that the entire amount of the
loss shall be carried over to the first of the five (5) taxable years following the loss, and any
portion of such loss which exceeds the taxable income of such first year shall be deducted in
like manner from the taxable income of the next remaining (4) four years.
6.2 Transitory Apportionment of NOLCO, in Case of Corporation Using the Fiscal Year Accounting
Period — In general, only net operating losses incurred beginning January 1, 1998 may be
claimed as a NOLCO deduction. In the case of a corporation using a fiscal year accounting
period as of the said dates whose result of operations for the fiscal year 1997-1998 shows a
net operating loss, the allowable NOLCO for the succeeding fiscal years shall be determined, as
follows:
NOLCO for the entire fiscal year (1997-1998) xxx
Multiplied by the ratio of: No. of months in 1998
———————————
12 mos. covering FY 97-98 xxx
NOLCO to be carried over to FYs 1998-1999, 1999-2000,
and/or 2000-2001 xxx
6.3 Where Taxpayer is Exempt, or Partly Exempt from Income Tax, or Enjoying Preferential Tax
Treatment Under Special Laws — Net operating loss or losses incurred by any person who is
exempt from income tax, or enjoying preferential tax treatment pursuant to the provisions of
special laws, shall not be allowed a NOLCO deduction (e.g., any BOI-registered enterprise
enjoying income tax holiday pursuant to E.O. No. 226, as amended, otherwise known as the
Omnibus Investments Code of 1987; or any PEZA-registered enterprise enjoying preferential
tax treatment or income tax holiday pursuant to R.A. No. 7916, as amended; any person
enjoying preferential tax treatment pursuant to R.A. No. 7227, otherwise known as the Bases
Conversion and Development Act of 1992. See Section 4 of these Regulations for further
discussion).
In case any of the aforementioned persons is engaged in both registered and unregistered
business activities under any of the aforesaid laws (e.g., a corporation with a BOI-registered
activity enjoying income tax holiday; and other unregistered business activities not enjoying
any BOI incentive) the net operating loss or losses sustained or incurred by the said BOI-
enterprise from its registered activities shall not be allowed as NOLCO deduction from its
gross income derived from the unregistered business activities.
6.4 Quarterly and Annual Availment of NOLCO — NOLCO shall be allowed as deduction in
computing the taxpayer's income taxes per quarter and annual final adjustment income tax
returns: Provided, however, that if per the taxpayer's final annual adjustment income tax
return, the entire operations for the year resulted to a net operating loss, such net operating
loss may be claimed as NOLCO deduction in the immediately succeeding taxable year:
Provided, further, that NOLCO may be claimed as deduction only within a period of three (3)
consecutive taxable years immediately following the year the net operating loss was sustained
or incurred. In order that compliance with this three-year statutory requisite may be
effectively monitored, the taxpayer shall, at all times, show its NOLCO deduction, in its income
tax return, as a separate item of deduction. In no case may NOLCO be claimed, as a part of the
taxpayer's other itemized deductions, like under deduction of "losses," in general.
6.5 NOLCO in Relation to the Minimum Corporate Income Tax (MCIT) — In general, domestic
and resident foreign corporations subject to the normal income tax rate are liable to the 2%
MCIT, if applicable, computed based on gross income, whenever the amount of the MCIT is
greater than the normal income tax due (computed with the benefit of NOLCO, if any),
pursuant to Sections 27 or 28 of the Code. Thus, such corporation cannot enjoy the benefit of
NOLCO for as long as it is subject to MCIT in any taxable year. Provided, however, that the
running of the three-year period for the expiry of NOLCO is not interrupted by the fact that
such corporation is subject to MCIT in any taxable year during such three-year period.
SECTION 7. Presentation of NOLCO in Tax Return and Unused NOLCO in the Income Statement.
— The NOLCO shall be separately shown in the taxpayer's income tax return (also shown in
the Reconciliation Section of the Tax Return) while the Unused NOLCO shall be presented in
the Notes to the Financial Statements showing, in detail, the taxable year in which the net
operating loss was sustained or incurred, and any amount thereof claimed as NOLCO
deduction within three (3) consecutive years immediately following the year of such loss.
63 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Failure to comply with this requirement will disqualify the taxpayer from claiming the NOLCO.
BIR RULING NO. 030-00
FACTS:
Republic Cement Corp. and Fortune Cement Corp. are engaged in the manufacture,
development, exploitation and sale of cement, marble and other kinds and classes of building,
materials. Blue Circle Philippines, Inc. (BCPI), a wholly owned subsidiary of Blue Circle Home
Products B.V. (BCHP-BV), partnered with the Montinola Group, the SM Group, the CG&E
Holdings Group, and the PICOP/Guoco Group in the latter's existing cement businesses in the
Philippines, by making investments in the form of equity and debt, in the following
companies: Republic, Fortune, Zeus Holdings, Inc. which owns 99.63% of Mindanao Portland
Cement Corporation (MPCC), and Iligan Cement Corp (Group Companies); that all the Group
Companies are in a net loss position, and of the Group Companies, Republic, Fortune and
Zeus are listed on the PSE; that in addition to the investments in equity, BCPI and the SM
Group (through SMIC) extended loans to Fortune for a total of P4,011,194,109 and MPCC for
P404,341,397; that BCPI also extended a loan to Alsons Cement Corporation of
US$41,976,489 at 6% per annum payable in arrears; that the loan can be settled either by the
payment of the principal amount and the interest accruing thereon, or by its exchange into
the Iligan shares held by Alsons (Alsons Note).
The boards of directors of Republic, Fortune, Zeus and Iligan approved a proposal to integrate
their cement business operations and activities; that the integration will consolidate the
operations of the Group Companies under a single management structure that will make the
Group the second largest cement group in the Philippines; that subject to certain conditions,
the proposed integration consists of the consolidation in Republic of the Investments in shares
in Fortune, Zeus and Iligan of BCPI, SWCV, RRI, Montinola Group, SM Group and CG&E
Holdings Group, and of the Fortune CLN held by the SM Group through SMIC by exchanging
such investments with new shares of Republic, based on the Share Swap Ratios approved by
the Boards of Republic, Fortunes, Zeus and Iligan; that as a publicly-listed company, Republic
will make a tender offer to the Minority Stockholders of each of Fortune, Zeus and Iligan, in
accordance with the Share Swap Ratios; that the Share Swap Ratios are 1,000 Republic shares
for 1,575 Fortune shares, 14,411 Zeus shares, and 206 Iligan shares.
In effecting the above Share Swap, BCPI, RRI, SMIC, Sysmart Corporation and CG&E Holdings
will transfer their respective Fortune, Zeus and Iligan shares to Republic in exchange for
Republic shares, as a result of which they will together own 63.618% of the total subscribed
common voting stock of Republic. The 6th to the last shareholder participating in the
proposed integration will transfer their Fortune and Zeus shares to Republic, in exchange for
new Republic shares, through the facilities of the PSE; that the transfer of the Iligan shares will
not be through the facilities of the PSE because Iligan is not a listed company; that BCPI,
SWCV, RRI, the SM Group, the CG&E Holdings Group and the Minorities of Fortune, Zeus and
Iligan participate in the proposed integration, Republic will own 100% of each of Fortune and
Zeus, and 30.367% of Iligan; that Republic will in turn, continue to be owned by the following
persons: BCPI (27.74%), SWCV (11.077%), RRI (12.356%), Sm Group (23.354%), CG&E
Holdings (5.453%), Montinola Group (8.662%), and other minorities (11.358%).
ISSUE: Whether or not the net operating losses of each of Republic, Fortune, MPCC and Iligan
may be carried over and claimed as a deduction from their respective gross income? YES.
RULING:
Section 34(D)(3) of the Tax Code provides:
Net Operating Loss Carry-Over — The net operating loss of the business or any enterprise for
any taxable year immediately preceding the current taxable year, which had not been
previously offset as deduction from gross income shall be carried over as a deduction from
gross income for the next three (3) consecutive taxable years immediately following the year
of such loss: Provided, however, That any net loss incurred in a taxable year during which the
taxpayer was exempt from income tax shall not be allowed as a deduction under this
Subsection: Provided, further, That a net operating loss carry-over shall be allowed only if
there has been no substantial change in the ownership of the business or the enterprise in that
— PMI has an existing US dollar loans from Noritake Company, Limited and Toyota Tsusho
(i) Not less than 75% in nominal value of outstanding issued shares, if the business is
in the name of a corporation, is held by or on behalf of the same persons; or
(ii) 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.
For purposes of this subsection, the term 'net operating loss' shall mean the excess of
allowable deduction over gross income of the business in the taxable year: xxx
Considering that the consolidation of the operations of the Group Companies under a single
management structure is for a bonafide business purpose, and there is no substantial change
of ownership, the net operating loss carry-over of Republic, Fortune, MPCC and Iligan are
preserved and may be carried over and claimed as a deduction from their respective gross
income for purposes of computing the income tax using the normal income tax rate and
without prejudice to the applicability of the rule on the Minimum Corporate Income Tax
(MCIT). (NOTE: The succeeding paragraphs are the basis for the conclusion)
corporation.
3. REALIZED vs. UNREALIZED LOSSES
BIR RULING No. 206-90
FACTS:
Corporation in the aggregate amounts of US $7,636,679.17 and US $3,054,671.27,
respectively, that in 1989, the parties agreed to convert the said dollar denominated loans
into pesos at the exchange rate prevailing on June 30, 1989; that in December 1989, both
agreements were approved by the Central Bank subject to the submission of a copy each of
the signed agreements incorporating the conversion; that thereafter, drafts of the amended
agreements were submitted to the Central Bank for pre-approval; that on January 29, 1990,
the Central Bank considered and incorporated the drafts in the final amended agreements;
that in June 1990, the parties submitted to the Central Bank the signed agreements; that in
the case of PMI, the resultant loss on conversion of US dollar denominated loans to peso is
more than a shrinkage in value of money; that the approval by the Central Bank and the
signing by the parties of the agreements covering the said conversion established the loss,
after which, the loss became final and irrevocable, so that recoupment is reasonably
impossible; and that having been fixed and determinable, the loss is no longer susceptible to
change, hence, it could fairly be stated that such has been sustained in a closed and
completed transaction.

In the case of Republic, since BCPI, SWCV, RRI, SM Group and Montinola Group already
owned Republic 87.079% before the proposed integration plan, and they continue to own
Republic 83.189% after the proposed integration plan, the issuance by Republic of new shares
from the unsubscribed portion of the authorized capital stock or from an increase in
authorized capital stock to BCPI, SWCV, RRI, and the SM Group will neither result in a
substantial nor in an effective change in the ownership of Republic. Consequently, more than
75% of the paid-up capital of Republic continues to be held by or on behalf of BCPI, SWCV,
RRI, Montinola Group and SM Group after the proposed integration. In the case of MPCC,
MPCC continues to be owned 99.63% by Zeus.
In the case of Fortune, BCPI, SWCV, RRI, Montinola Group, SM Group and CG&E Holdings
Group already owned Fortune 94.141% before the proposed share swap, and they continue to
own Fortune through Republic 88.642% after the proposed share swap, and more than 75%
of the paid-up capital of Fortune continues after the share swap to be held by Republic on
behalf of BCPI, SWCV, RRI, SM Group and CG&E Holdings Group.
In the case of Iligan, while Republic may end up owning 30.367% of the capital stock of
Iligan, BCPI was, even before the proposed share swap, already a 25% shareholder in Iligan.
After the proposed share swap and with the original issuance of new Republic shares to
BCPI, it continues to own 28.538% of Republic. Consequently, even if SWCV, RRI, the
Montinola Group, the SM Group, the CG&E Holdings Group, and the Minorities of Fortune
and Zeus who are, after the proposed share swap, shareholders in Republic but were not
original shareholders in Iligan, their combined percentage ownership in Iligan through
Republic after the proposed integration is only 21.943%. Even after the proposed
integration, more than 75% of the paid-up capital of Iligan continues to be held by or on
behalf of BCPI and the Alsons and Alsons-related shareholders.
As explicitly provided for in Section 34(D)(3) of the Tax Code, there will be a substantial
change in the ownership of the business only if there has been a change of ownership
greater than 25% of either the nominal value of the outstanding issued shares (in the case of
no par value shares) or of the paid-up capital (in the case of par value shares) of the
64 TAXATION 1 (ATTY. BELLO)
ISSUE: W/N the foreign exchange loss incurred by PMI is a deductible loss in 1990?
RULING:
The annual increase in value of an asset is not taxable income because such increase has not
yet been realized. The increase in value i.e., the gain, could only be taxed when a disposition
of the property occurred which was of such a nature as to constitute a realization of such
gain, that is, a severance of the gain from the original capital invested in the property. The
same conclusion obtains as to losses. The annual decline in the value of property is not
normally allowable as a deduction. Hence, to be allowable the loss must be realized.
When foreign currency acquired in connection with a transaction in the regular course of
business is disposed ordinary gain or loss results from the fluctuations. The loss is deductible
only for the year it is actually sustained. It is sustained during the year in which the loss
occurs as evidenced by the completed transaction and as fixed by identifiable occurring in that
year. A closed transaction is a taxable event which has been consummated. No taxation event
has as yet been consummated prior to the remittance of the scheduled amortization.
Accordingly, your request for confirmation of your aforesaid opinion is hereby denied
considering that foreign exchange losses sustained as a result of conversion or devaluation of
the peso vis-a-vis the foreign currency or US dollar and vice versa but which remittance of
scheduled amortization consisting of principal and interests payment on a foreign loan has
not actually been made are not deductible from gross income for income tax purposes.
BIR RULING No. 144-85
FACTS: (The only fact presented in the case)
The losses arose from matured but unremitted principal repayments on loans affected by the
debt restructuring program in the Philippines.
ISSUE: Whether foreign exchange losses which have accrued by reason of devaluation are
deductible for income tax purposes?
RULING:
Annual increase in value of an asset is not taxable income because such increase has not yet
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
been realized. The increase in value, i.e., the gain, could only be taxed when a disposition of
the property occurred which was of such a nature as to constitute a realization of such gain,
that is, a severance of the gain from the original capital invested in the property. The same
conclusion obtains as to losses. The annual decrease in the value of property is not normally
allowable as a loss. Hence, to be allowable the loss must be realized.
When foreign currency acquired in connection with a transaction in the regular course of
business is disposed of ordinary gain or loss results from the fluctuations. The loss is
deductible only for the year it is actually sustained. It is sustained during the year in which the
loss occurs as evidenced by closed and completed transaction and as fixed by identifiable
events occurring in that year. A closed transaction is a taxable event which has been
consummated. No taxable event has as yet been consummated prior to the remittance of the
scheduled amortization. Accordingly, foreign exchange losses sustained as a result of
devaluation of the peso vis-a-vis the foreign currency e.g., US dollar, but which remittance of
scheduled amortization consisting of principal and interests payments on a foreign loan has
not actually been made are not deductible from gross income for income tax purposes.
4. LOSSES FROM SALES OR EXCHANGES (TO BE TAKEN UP IN XV BELOW)
E. BAD DEBTS
SEC 34. (E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and
charged off within the taxable year except those not connected with profession, trade or
business and those sustained in a transaction entered into between parties mentioned
under Section 36 (B) of this Code: Provided, That recovery of bad debts previously
allowed as deduction in the preceding years shall be included as part of the gross income
in the year of recovery to the extent of the income tax benefit of said deduction.
(2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are
ascertained to be worthless and charged off within the taxable year and are capital assets, the
loss resulting therefrom shall, in the case of a taxpayer other than a bank or trust company
incorporated under the laws of the Philippines a substantial part of whose business is the
receipt of deposits, for the purpose of this Title, be considered as a loss from the sale or
exchange, on the last day of such taxable year, of capital assets.
REVENUE REGULATIONS NO. 05-99
Implementing Section 34(E) of the Tax Code of 1997 on the Requirements for Deductibility of
Bad Debts from Gross Income
SECTION 3. Requisites for Valid Deduction of Bad Debts From Gross income. — General Rule. —
In general, the requisites for deductibility of bad debts are:
(1) There must be an existing indebtedness due to the taxpayer which must be valid and
legally demandable;
(2) The same must be connected with the taxpayer's trade, business or practice of profession;
(3) The same must not be sustained in a transaction entered into between related parties
enumerated under Sec. 36(B) of the Tax Code of 1997;
(4) The same must be actually charged off the books of accounts of the taxpayer as of the end
of the taxable year; and
(5) The same must be actually ascertained to be worthless and uncollectible as of the end of
65 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the taxable year.
Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to
demonstrate with reasonable degree of certainty the uncollectibility of the debt. The
Commissioner of Internal Revenue will consider all pertinent evidence, including the value of
the collateral, if any, securing the debt and the financial condition of the debtor in determining
whether a debt is worthless, or the assigning of the case for collection to an independent
collection lawyer who is not under the employ of the taxpayer and who shall report on the
legal obstacle and the virtual impossibility of collecting the same from the debtor and who
shall issue a statement under oath showing the propriety of the deductions thereon made for
alleged bad debts. Thus, where the surrounding circumstances indicate that a debt is
worthless and uncollectible and that legal action to enforce payment would in all probability
not result in the satisfaction of execution on a judgment, a showing of those facts will be
sufficient evidence of the worthlessness of the debt for the purpose of deduction.
Exception: In the case of banks, however, in lieu of requisite No. 5 above, the Bangko Sentral
ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and
uncollectibility of the bad debts and it shall approve the writing off of the said indebtedness
from the banks' books of accounts at the end of the taxable year. The bank though should still
comply with requisites Nos. 1-4 as enumerated above before it can avail of the benefit of
deduction.
Also, in no case may a receivable from an insurance or surety company be written-off from the
taxpayer's books and claimed as bad debts deduction unless such company has been declared
closed due to insolvency or for any such similar reason by the Insurance Commissioner.
SECTION 4. Tax Benefit Rule. — The recovery of bad debts previously allowed as deduction in
the preceding year or years shall be included as part of the taxpayer's gross income in the year
of such recovery to the extent of the income tax benefit of said deduction. Example: If in the
year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the
income tax due from him on account of the said deduction, his subsequent recovery thereof
from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said
taxpayer did not benefit from the deduction of the said bad debt written-off because it did not
result to any reduction of his income tax in the year of such deduction (i.e. where the result of
his business operation was a net loss even without deduction of the bad debts written-off),
then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital,
hence, not treated as receipt of realized taxable income.
SECTION 5. Securities Becoming Worthless. — If securities, as defined under Sec. 2(b) hereof,
held as capital asset, are ascertained to be worthless and charged off within the taxable year,
the loss resulting therefrom shall be considered as a loss from the sale or exchange of capital
asset made on the last day of such taxable year. The taxpayer, however, has to prove through
clear and convincing evidence that the securities are in fact worthless.
This rule, however, is not true in the case of banks or trust companies incorporated under the
laws of the Philippines, a substantial part of whose business is the receipt of deposits.
PHILIPPINE REFINING COMPANY V. COURT OF APPEALS
DOCTRINE:
For debts to be considered as "worthless," and thereby qualify as "bad debts" making them
deductible, the taxpayer should show that
(1) there is a valid and subsisting debt;
(2) the debt must be actually ascertained to be worthless and uncollectible during the taxable
year;
(3) the debt must be charged off during the taxable year; and
(4) the debt must arise from the business or trade of the taxpayer.
Additionally, before a debt can be considered worthless, the taxpayer must also show that it is
indeed uncollectible even in the future.
ALSO The applicant must submit a supporting documentary evidence for the claim of bad debt
FACTS:
Philippine Refining Company (also known as UNILEVER CO.) claimed deductions of Bad
Debts in the amount of Php 713,070.93 and Interest Expenses in the amount of Php
2,666,545.49. Respondent Commissioner of Internal Revenue disallowed the deductions and
assessed Philippine Refining Company to pay a deficiency tax in the amount of Php
1,892,54.00.
Upon appeal, CTA modified the findings of the Commissioner by reducing the deficiency
income tax assessment to Php 237,381.26. The CTA allowed the deduction of interest
expenses but disallowed the supposed bad debts of thirteen (13) debtors in the total sum of
Php 395,324.97. Petitioner appealed to the CA. The CA denied, hence, this appeal.
ISSUE:
W/N the alleged bad debts of thirteen (13) debtors of Philippine Refining Company are
allowable deductions;
HELD:
No. The thirteen accounts did not satisfy the requirements of “worthlessness” of a debt.
Due Diligence to collect the debts
Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he
exerted diligent efforts to collect the debts, viz.:
(1) sending of statement of accounts;
(2) sending of collection letters;
(3) giving the account to a lawyer for collection; and
(4) filing a collection case in court.
Failure to prove the worthlessness of the thirteen accounts
Petitioner did not satisfy the requirements of "worthlessness of a debt" as to the thirteen (13)
accounts disallowed as deductions.
The only evidentiary support given by PRC for its aforesaid claimed deductions was the
explanation or justification posited by its financial adviser or accountant, Guia D. Masagana.
Her allegations were not supported by any documentary evidence.
Specific explanations by petitioner about some of the debtors
The following are the transactions that Phil Refining are claiming as bad debts:
a. Remoblas Store and CM Store
Petitioner: The stores burned down.
Court: No proof presented. (e.g. police report)
66 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
b. Tomas Store
Petitioner: The owner was murdered.
Court: No proof that owner was indeed killed or that diligent efforts were exerted to
collect from the owner.
c. Aboitiz Shipping and J. Ruiz Trucking
Petitioner: The cargo was hijacked and petitioner had to give 30% rebates.
Court: No proof presented. (e.g. copy of policy regulation that PRC gives rebates)
d. C. Itoh, Crocklaan B.V. and Craig, Mostyn Pty. Ltd.
Petitioner: Debtors are foreign corporations and could not be sued in the
Philippines.
Court: Petitioner was unable to show proof of its efforts to collect the debts, even by
a single demand letter. While it is not required to file suit, it is at least expected by
the law to produce reasonable proof that the debts are uncollectible although
diligent efforts were exerted to collect the same.
e. AFPCES
Petitioner: Debtor is a government agency and could not be sued.
Court: The mere fact that AFPCES is a government agency does not preclude PRC
from filing suit since said agency, while discharging proprietary functions, does not
enjoy immunity from suit.
FERNANDEZ HERMANOS vs. CIR
DOCTRINE:
Expenses, taxes, bad debts, depreciation, and depletion of oil and gas wells and mines are
some examples of deductions from gross income, and these losses may be allowable or
disallowable, depending on the facts of the case.
FACTS:
The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal
purpose of engaging in business. Upon verification of the taxpayer's income tax returns for the
period in question, the Commissioner of Internal Revenue assessed against the taxpayer the
sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and P14,451.00 as alleged deficiency
income taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said assessments
were the result of alleged discrepancies found upon the examination and verification of the
taxpayer's income tax returns for the said years. It therefore modified the deficiency
assessments accordingly, found the total deficiency income taxes due from the taxpayer for
the years under review to amount to P123,436.00 instead of P166,063.00 as originally
assessed. Both parties have appealed from the respective adverse rulings against them in the
Tax Court's decision.
In 1957, upon examination of its corresponding income tax return, the Commissioner
assessed it for deficiency income tax in the amount of P38,918.76. The Tax Court overruled
the Commissioner's disallowance of the taxpayer's losses in the operation of its Hacienda
Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62,
which allegedly represented 1/5 of the cost of the "contractual right" over the mines of its
subsidiary, Palawan Manganese Mines, Inc. which the taxpayer had acquired. It found the
taxpayer liable for deficiency income tax for the year 1957 in the amount of P9,696.00, instead
of P32,982.00 as originally assessed. Both parties again appealed from the respective adverse
rulings against them in the Tax Court's decision.
ISSUE/S:
W/N the Tax Court's rulings with respect to the disputed items of disallowances enumerated
in the Tax Court's summary are correct
W/N the government's right to collect the deficiency income taxes in question has already
prescribed.
RULING:
1. Re allowances/disallowances of losses.
(a) Allowance of losses in Mati Lumber Co. (1950). — The CIR questions the Tax Court's
allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of
P8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the
taxpayer, on the ground that the worthlessness of said stock in the year 1950 had not been
clearly established. The Commissioner contends that although the said Company was no
longer in operation in 1950, it still had its sawmill and equipment which must be of
considerable value. The Court found that "the company ceased operations in 1949 when its
owner left for Spain ,where he subsequently died. This information reached (the taxpayer) in
1950," when it properly claimed the loss as a deduction in its 1950 tax return. There was
adequate basis for the writing off of the stock as worthless securities. Assuming that the
Company would later somehow realize some proceeds from its sawmill and equipment, the
amount so received by the taxpayer would then properly be reportable as income of the
taxpayer in the year it is received.
(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). — The
taxpayer appeals from the Tax Court's disallowance of its writing off in 1951 as a loss or bad
debt the sum of P353,134.25, which it had advanced or loaned to Palawan Manganese Mines,
Inc. Despite these advances, Palawan Manganese Mines, Inc. continued to suffer losses. By
1951, petitioner became convinced that those advances could no longer be recovered. While it
continued to give advances, it decided to write off as worthless the sum of P353,134.25.
Petitioner decided to maintain the advances given in 1950 and 1951 in the hope that it might
be able to recover the same, as in fact it continued to give advances up to 1952. From these
facts, Palawan Manganese Mines, Inc., was still in operation when the advances corresponding
to the years 1945 to 1949 were written off the books of petitioner. It will be noted that in
giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid. In
other words, if there were no earnings or profits, there was no obligation to repay those
advances. It has been held that the voluntary advances made without expectation of
repayment do not result in deductible losses. No bad debt could arise where there is no valid
and subsisting debt. It has been held that if the debtor corporation, although losing money or
insolvent, was still operating at the end of the taxable year, the debt is not considered
worthless and therefore not deductible.
(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The Court sustains the
Tax Court's disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for
the operation of its Balamban coal mines in Cebu in 1950 and 1951, respectively, and claimed
as losses in the taxpayer's returns for said years. The Tax Court correctly held that the losses
"are deductible in 1952, when the mines were abandoned, and not in 1950 and 1951, when
they were still in operation." 9 The taxpayer's claim that these expeditions should be allowed
as losses for the corresponding years that they were incurred, because it made no sales of coal
during said years, since the promised road or outlet through which the coal could be
transported from the mines to the provincial road was not constructed, cannot be sustained.
The Tax Court held that the losses were properly deductible in 1952, but the appealed
judgment does not show that the taxpayer was credited therefor in the determination of its
tax liability for said year. This additional deduction of P36,722.42 from the taxpayer's taxable
67 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
income in 1952 would result in the elimination of the deficiency tax liability for said year in
the sum of P3,600.00 as determined by the Tax Court in the appealed judgment.
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-
1952). —Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of
P17,418.95 in 1950, P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and
P42,938.56 in 1954. These deductions were disallowed by respondent on the ground that the
farm was operated solely for pleasure or as a hobby and not for profit. This conclusion is
based on the fact that the farm was operated continuously at a loss. From the evidence, we are
convinced that the Hacienda Dalupiri was operated by petitioner for business and not
pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not
appear that the farm was used by petitioner for entertainment, social activities, or other non-
business purposes. Therefore, it is entitled to deduct expenses and losses in connection with
the operation of said farm. Section 100 of Revenue Regulations No. 2, otherwise known as the
Income Tax Regulations, authorizes farmers to determine their gross income on the basis of
inventories. Evidently, petitioner determined its income or losses in the operation of said farm
on the basis of inventories. As the Hacienda Dalupiri was operated by petitioner for business
and since it sustained losses in its operation, it was error for respondent to have disallowed
the deduction of said losses. The same is true with respect to loss sustained in the operation of
the Hacienda Samal for the years 1951 and 1952.
2. Disallowance of excessive depreciation of buildings (1950-1954). — During the years 1950 to
1954, the taxpayer claimed a depreciation allowance for its buildings at the annual rate of
10%. The Commissioner claimed that the reasonable depreciation rate is only 3% per annum,
and, hence, disallowed. We sustain the Tax Court's finding that the taxpayer did not submit
adequate proof of the correctness that the depreciable assets or buildings in question had a
useful life only of 10 years so as to justify its 10% depreciation per annum claim.
3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the Commissioner's
treatment as taxable income of certain increases in the taxpayer's net worth. It appears that
certain items (all amounting to P1,382.85) remained in petitioner's books as outstanding
liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in
prior years, so that the necessary adjustments were made to correct the errors. If there was an
increase in net worth of the petitioner, the increase in net worth was not the result of receipt
by petitioner of taxable income." 13 The Commissioner advances no valid grounds in his brief
for contesting the Tax Court's findings. Certainly, these increases in the taxpayer's net worth
were not taxable increases in net worth, as they were not the result of the receipt by it of
unreported or unexplained taxable income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its indebtednesses to certain
creditors, which had been erroneously overstated or listed as outstanding when they had in
fact been duly paid. The Tax Court's action must be affirmed.
4. Gain realized from sale of real property (1950). — We likewise sustain as being in
accordance with the evidence the Tax Court's reversal of the Commissioner's assessment on
all alleged unreported gain in the sum of P11,147.26 in the sale of a certain real property of
the taxpayer in 1950. As found by the Tax Court, the evidence shows that this property was
acquired in 1926 for P11,852.74, and was sold in 1950 for P60,000.00, apparently, resulting in
a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a
discrepancy of P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after
acquiring the property, the taxpayer had made improvements totalling P11,147.26, 16
accounting for the apparent discrepancy in the reported gain. On the second issue of
prescription, the government's right to collect the taxes due has clearly not prescribed, as the
taxpayer's appeal or petition for review was filed with the Tax Court on May 4, 1960, with the
Commissioner filing on May 20, 1960 his Answer with a prayer for payment of the taxes due,
long before the expiration of the five-year period to effect collection by judicial action counted
from the date of assessment.
5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited its previous decision
overruling the Commissioner's disallowance of losses suffered by the taxpayer in the
operation of its Hacienda Dalupiri, since it was convinced that the hacienda was operated for
business and not for pleasure. A taxpayer may not, ordinarily, combine the cash and accrual
bases. The 1954 Code provisions permit, however, the use of a hybrid method of accounting,
combining a cash and accrual method, under circumstances and requirements to be set out in
Regulations to be issued. Also, if a taxpayer is engaged in more than one trade or business he
may use a different method of accounting for each trade or business. And a taxpayer may
report income from a business on accrual basis and his personal income on the cash basis.
6. Disallowance of amortization of alleged "contractual rights." —It appears that the Palawan
Manganese Mines, Inc., during a special meeting of its Board of Directors on January 19, 1956,
approved a resolution. On March 29, 1956, petitioner's corporation accepted the above offer
of transfer. Petitioner determined the cost of the mines at P242,408.10 by adding the value of
the contractual rights (P100,000.00) and the value of its mining claims (P142,408.10).
Respondent disallowed the deduction on the following grounds: (1) that the Palawan
Manganese Mines, Inc. could not transfer P242,408.10 worth of assets to petitioner because
the balance sheet of the said corporation for 1955 shows that it had only current as worth
P97,636.96; and (2) that the alleged amortization of "contractual rights" is not allowed by the
Revenue Code. The sole basis of petitioner in claiming the amount of P48,481.62 as a
deduction was the memorandum of its mining engineer who stated that the ore reserves of
the Busuange Mines would be exhausted in five (5) years, hence, the claim for P48,481.62 or
one-fifth (1/5) of the alleged cost of the mines corresponding to the year 1957 and every year
thereafter for a period of 5 years. The said memorandum merely showed the estimated ore
reserves of the mines and it probable selling price. No evidence whatsoever was presented to
show the produced mine and for how much they were sold during the year for which the
return and computation were made. This is necessary in order to determine the amount of
depletion that can be legally deducted from petitioner's gross income. The method employed
by petitioner in making an outright deduction of 1/5 of the cost of the mines is not authorized
under Section 30(g) (1) (B) of the Revenue Code. Respondent's disallowance of the alleged
"contractual rights" amounting to P48,481.62 must therefore be sustained.
F. DEPRECIATION
SEC 34. (F) Depreciation. -
(1) General Rule. - There shall be allowed as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear (including reasonable allowance for
obsolescence) of property used in the trade or business. In the case of property held by
one person for life with remainder to another person, the deduction shall be computed as
if the life tenant were the absolute owner of the property and shall be allowed to the life
tenant. In the case of property held in trust, the allowable deduction shall be apportioned
between the income beneficiaries and the trustees in accordance with the pertinent
provisions of the instrument creating the trust, or in the absence of such provisions, on
the basis of the trust income allowable to each.
(2) Use of Certain Methods and Rates. - The term 'reasonable allowance' as used in the
preceding paragraph shall include, but not limited to, an allowance computed in
accordance with rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method;
(b) Declining-balance method, using a rate not exceeding twice the rate which
68 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
would have been used had the annual allowance been computed under the method
described in Subsection (F) (1);
(c) The sum-of-the-years-digit method; and
(d) any other method which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner.
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. - Where under
rules and regulations prescribed by the Secretary of Finance upon recommendation of
the Commissioner, the taxpayer and the Commissioner have entered into an agreement
in writing specifically dealing with the useful life and rate of depreciation of any
property, the rate so agreed upon shall be binding on both the taxpayer and the national
Government in the absence of facts and circumstances not taken into consideration
during the adoption of such agreement. The responsibility of establishing the existence of
such facts and circumstances shall rest with the party initiating the modification. Any
change in the agreed rate and useful life of the depreciable property as specified in the
agreement shall not be effective for taxable years prior to the taxable year in which
notice in writing by certified mail or registered mail is served by the party initiating such
change to the other party to the agreement:
Provided, however, that where the taxpayer has adopted such useful life and
depreciation rate for any depreciable and claimed the depreciation expenses as
deduction from his gross income, without any written objection on the part of the
Commissioner or his duly authorized representatives, the aforesaid useful life and
depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be
considered binding for purposes of this Subsection.
(4) Depreciation of Properties Used in Petroleum Operations. - An allowance for
depreciation in respect of all properties directly related to production of petroleum
initially placed in service in a taxable year shall be allowed under the straight-line or
declining-balance method of depreciation at the option of the service contractor.
However, if the service contractor initially elects the declining-balance method, it may at
any subsequent date, shift to the straight-line method.
The useful life of properties used in or related to production of petroleum shall be ten
(10) years of such shorter life as may be permitted by the Commissioner.
Properties not used directly in the production of petroleum shall be depreciated under
the straight-line method on the basis of an estimated useful life of five (5) years.
(5) Depreciation of Properties Used in Mining Operations. - an allowance for
depreciation in respect of all properties used in mining operations other than petroleum
operations, shall be computed as follows:
(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or
(b) Depreciated over any number of years between five (5) years and the expected
life if the latter is more than ten (10) years, and the depreciation thereon allowed as
deduction from taxable income: Provided, That the contractor notifies the
Commissioner at the beginning of the depreciation period which depreciation rate
allowed by this Section will be used.
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business
or Resident Foreign Corporations. - In the case of a nonresident alien individual
engaged in trade or business or resident foreign corporation, a reasonable allowance for
the deterioration of Property arising out of its use or employment or its non-use in the
 business trade or profession shall be permitted only when such property is located in the
Philippines.
BASILAN ESTATES v. CIR
DOCTRINE:
Depreciation is the gradual diminution in the useful value of tangible property resulting from
wear and tear and normal obsolescense. Depreciation commences with the acquisition of the
property and its owner is not bound to see his property gradually waste, without making
provision out of earnings for its replacement. It is entitled to see that from earnings the value
of the property invested is kept unimpaired, so that at the end of any given term of years, the
original investment remains as it was in the beginning.
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost.
Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is
that deductions from gross income are privileges, not matters of right. They are not created by
implication but upon clear expression in the law.
FACTS:
A Philippine corporation engaged in the coconut industry, Basilan Estates, Inc. filed its income
tax returns for 1953 and paid an income tax of P8,028. The Commissioner of Internal Revenue
assessed Basilan Estates, Inc., a deficiency income tax of P3,912 for 1953 and P86,876.85 as
25% surtax on unreasonably accumulated profits as of 1953 pursuant to Section 25 of the Tax
Code.
Basilan Estates, Inc. filed before the Court of Tax Appeals a petition for review of the
Commissioner's assessment, alleging prescription of the period for assessment and collection;
error in disallowing claimed depreciations, travelling and miscellaneous expenses; and error
in finding the existence of unreasonably accumulated profits and the imposition of 25% surtax
thereon. The Court of Tax Appeals found that there was no prescription and affirmed the
deficiency assessment in toto.
ISSUE/S:
(there are a lot, but since this falls under depreciation according to the outline, yun nalang
nilagay ko)
Whether depreciation shall be determined on the acquisition cost or on the reappraised value
of the assets
RULING:
ACQUISITION COST!
Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 on the
basis of their acquisition cost. As of January 1, 1950 it changed the depreciable value of said
assets by increasing it to conform to the increase in cost for their replacement. Accordingly,
from 1950 to 1953 it deducted from gross income the value of depreciation computed on the
reappraised value.
In 1953, the year involved in this case, taxpayer claimed the following depreciation deduction:
Reappraised assets P47,342.53
New assets consisting of hospital building and 3,910.45
equipment
69 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Total depreciation P51,252.98
Upon investigation and examination of taxpayer's books and papers, the Commissioner of
Internal Revenue found that the reappraised assets depreciated in 1953 were the same ones
upon which depreciation was claimed in 1952. And for the year 1952, the Commissioner had
already determined, with taxpayer's concurrence, the depreciation allowable on said assets to
be P36,842.04, computed on their acquisition cost at rates fixed by the taxpayer. Hence, the
Commissioner pegged the deductible depreciation for 1953 on the same old assets at
P36,842.04 and disallowed the excess thereof in the amount of P10,500.49.
Depreciation is the gradual diminution in the useful value of tangible property resulting from
wear and tear and normal obsolescense. The term is also applied to amortization of the value
of intangible assets, the use of which in the trade or business is definitely limited in
duration. Depreciation commences with the acquisition of the property and its owner is not
bound to see his property gradually waste, without making provision out of earnings for its
replacement. It is entitled to see that from earnings the value of the property invested is kept
unimpaired, so that at the end of any given term of years, the original investment remains as it
was in the beginning. It is not only the right of a company to make such a provision, but it is its
duty to its bond and stockholders, and, in the case of a public service corporation, at least, its
plain duty to the public. Accordingly, the law permits the taxpayer to recover gradually his
capital investment in wasting assets free from income tax. Precisely, Section 30 (f) (1) which
states:
(1) In general. — A reasonable allowance for deterioration of property arising out of its
use or employment in the business or trade, or out of its not being used: Provided,
That when the allowance authorized under this subsection shall equal the capital
invested by the taxpayer . . . no further allowance shall be made. . . .
allows a deduction from gross income for depreciation but limits the recovery to the
capital invested in the asset being depreciated.
The income tax law does not authorize the depreciation of an asset beyond its acquisition cost.
Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is
that deductions from gross income are privileges, not matters of right. They are not created by
implication but upon clear expression in the law.
Moreover, the recovery, free of income tax, of an amount more than the invested capital in an
asset will transgress the underlying purpose of a depreciation allowance. For then what the
taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery in
due time thru depreciation of investment made is the philosophy behind depreciation
allowance; the idea of profit on the investment made has never been the underlying reason for
the allowance of a deduction for depreciation.
Accordingly, the claim for depreciation beyond P36,842.04 or in the amount of P10,500.49 has
no justification in the law. The determination, therefore, of the Commissioner of Internal
Revenue disallowing said amount, affirmed by the Court of Tax Appeals, is sustained.
LIMPAN INVESTMENT CORPORATION v. CIR
DOCTRINE:
 Depreciation is a question of fact and is not measured by theoretical yardstick, but
should be determined by a consideration of actual facts", and the findings of the Tax
Court in this respect should not be disturbed when not shown to be arbitrary or in
abuse of discretion
FACTS:
 Petitioner, a domestic corporation is engaged in the business of leasing real
 properties.
 Its principal stockholders are the spouses Isabelo P. Lim and Purificacion Ceñiza de
Lim, who own and control ninety-nine per cent (99%) of its total paid-up capital. Its
president and chairman of the board is the same Isabelo P. Lim.
 Its real properties consist of several lots and buildings, mostly situated in Manila
and in Pasay City, all of which were acquired from said Isabelo P. Lim and his
mother, Vicente Pantangco Vda. de Lim.
 Petitioner corporation duly filed its 1956 and 1957 income tax returns, reporting
therein net incomes of P3,287.81 and P11,098.36, respectively, for which it paid the
corresponding taxes therefor in the sums of P657.00 and P2,220.00.
 Sometime in 1958 and 1959, the examiners of the Bureau of Internal Revenue
conducted an investigation of petitioner's 1956 and 1957 income tax returns and, in
the course thereof, they discovered and ascertained that petitioner had under
declared its rental incomes by P20,199.00 and P81,690.00 during these taxable
years and had claimed excessive depreciation of its buildings in the sums of
P4,260.00 and P16,336.00 covering the same period.
 On the basis of these findings, respondent Commissioner of Internal Revenue issued
its letter-assessment and demand for payment of deficiency income tax and
surcharge against petitioner corporation, computed as follows: (SEE ATTACHED
TABLE)
 Petitioner corporation requested respondent Commissioner of Internal Revenue to
reconsider the above assessment but the latter denied said request
 Hence, the corporation filed its petition for review before the Tax Appeals court,
questioning the correctness and validity of the above assessment of respondent.
 Petitioner alleged in its petition that the rates of depreciation applied by
respondent Commissioner of its buildings in the above assessment are unfair
and inaccurate.
 Sole witness for petitioner corporation in the Tax Court was its Secretary-Treasurer,
Vicente G. Solis, who admitted that it had omitted to report the sum of P12,100.00 as
rental income in its 1956 tax return and also the sum of P29,350.00 as rental income
in its 1957 tax return.
 With regard to the depreciation, which respondent disallowed and deducted
from the returns filed by petitioner, the same witness tried to establish that
some of its buildings are old and out of style; hence, they are entitled to higher
rates of depreciation than those adopted by respondent in his assessment.
 Isabelo P. Lim was not presented as witness to corroborate the above testimony of
Vicente G. Solis.
 One of the BIR examiners who personally conducted the investigation of the 1956
and 1957 income tax returns of petitioner corporation, testified for the respondent
that he personally interviewed the tenants of petitioner and found that these
tenants had been regularly paying their rentals to the collectors of either petitioner
or its president, Isabelo P. Lim, but these payments were not declared in the
corresponding returns; and that in applying rates of depreciation to petitioner's
buildings, he adopted Bulletin "F" of the U.S. Federal Internal Revenue Service.
 On the basis of the evidence, the Tax Court upheld respondent Commissioner's
assessment and demand for deficiency income tax.
ISSUE/S:
1. W/N respondent Court erred in holding that the petitioner had an unreported rental
income of P20,199.00 for the year 1956. NO
2. W/N respondent Court erred in holding that the petitioner had an unreported rental
income of P81,690.00 for the year 1957. NO
3. W/N respondent Court erred in holding that the depreciation in the amount of
70 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
P20,598.00 claimed by petitioner for the years 1956 and 1957 was excessive.
NO (relevant for this topic)
RULING:
1. With respect to the balance, which petitioner denied having unreported in the
disputed tax returns, the excuse that Isabelo P. Lim and Vicenta Pantangco Vda. de
Lim retained ownership of the lands and only later transferred or disposed of the
ownership of the buildings existing thereon to petitioner corporation, so as to justify
the alleged verbal agreement whereby they would turn over to petitioner
corporation six percent (6%) of the value of its properties to be applied to the
rentals of the land and in exchange for whatever rentals they may collect from the
tenants who refused to recognize the new owner or vendee of the buildings, is not
only unusual but uncorroborated by the alleged transferors, or by any document or
unbiased evidence. Hence, the first assigned error is without merit.
2. As to the second assigned error, petitioner's denial and explanation of the non-
receipt of the remaining unreported income for 1957 is not substantiated by
satisfactory corroboration. As above noted, Isabelo P. Lim was not presented as
witness to confirm accountant Solis nor was his 1957 personal income tax return
submitted in court to establish that the rental income, which he allegedly collected
and received in 1957, were reported therein.
3. This Court has already held that "depreciation is a question of fact and is not
measured by theoretical yardstick, but should be determined by a consideration of
actual facts", and the findings of the Tax Court in this respect should not be
disturbed when not shown to be arbitrary or in abuse of discretion and petitioner
has not shown any arbitrariness or abuse of discretion in the part of the Tax Court in
finding that petitioner claimed excessive depreciation in its returns. It appearing
that the Tax Court applied rates of depreciation in accordance with Bulletin "F" of
the U.S. Federal Internal Revenue Service, which this Court pronounced as having
strong persuasive effect in this jurisdiction, for having been the result of scientific
studies and observation for a long period in the United States, after whose Income
Tax Law ours is the foregoing error is devoid of merit.
G. DEPLETION
SEC 34. (G) Depletion of Oil and Gas Wells and Mines. -
(1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for
depletion or amortization computed in accordance with the cost-depletion method shall
be granted under rules and regulations to be prescribed by the Secretary of finance, upon
recommendation of the Commissioner. Provided, That when the allowance for depletion
shall equal the capital invested no further allowance shall be granted: Provided, further,
That after production in commercial quantities has commenced, certain intangible
exploration and development drilling costs: (a) shall be deductible in the year incurred if
such expenditures are incurred for non-producing wells and/or mines, or (b) shall be
deductible in full in the year paid or incurred or at the election of the taxpayer, may be
capitalized and amortized if such expenditures incurred are for producing wells and/or
mines in the same contract area.
'Intangible costs in petroleum operations' refers to any cost incurred in petroleum
operations which in itself has no salvage value and which is incidental to and necessary
for the drilling of wells and preparation of wells for the production of petroleum:
Provided, That said costs shall not pertain to the acquisition or improvement of property
 of a character subject to the allowance for depreciation except that the allowances for
depreciation on such property shall be deductible under this Subsection.
Any intangible exploration, drilling and development expenses allowed as a deduction in
computing taxable income during the year shall not be taken into consideration in
computing the adjusted cost basis for the purpose of computing allowable cost depletion.
(2) Election to Deduct Exploration and Development Expenditures. - In computing
taxable income from mining operations, the taxpayer may at his option, deduct
exploration and development expenditures accumulated as cost or adjusted basis for cost
depletion as of date of prospecting, as well as exploration and development expenditures
paid or incurred during the taxable year: Provided, That the amount deductible for
exploration and development expenditures shall not exceed twenty-five percent (25%)
of the net income from mining operations computed without the benefit of any tax
incentives under existing laws. The actual exploration and development expenditures
minus twenty-five percent (25%) of the net income from mining shall be carried forward
to the succeeding years until fully deducted.
The election by the taxpayer to deduct the exploration and development expenditures is
irrevocable and shall be binding in succeeding taxable years.
'Net income from mining operations', as used in this Subsection, shall mean gross income
from operations less 'allowable deductions' which are necessary or related to mining
operations. 'Allowable deductions' shall include mining, milling and marketing expenses,
and depreciation of properties directly used in the mining operations. This paragraph
shall not apply to expenditures for the acquisition or improvement of property of a
character which is subject to the allowance for depreciation.
In no case shall this paragraph apply with respect to amounts paid or incurred for the
exploration and development of oil and gas.
The term 'exploration expenditures' means expenditures paid or incurred for the
purpose of ascertaining the existence, location, extent or quality of any deposit of
ore or other mineral, and paid or incurred before the beginning of the development
stage of the mine or deposit.
The term 'development expenditures' means expenditures paid or incurred during the
development stage of the mine or other natural deposits. The development stage of a
mine or other natural deposit shall begin at the time when deposits of ore or other
minerals are shown to exist in sufficient commercial quantity and quality and shall end
upon commencement of actual commercial extraction.
(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien
individual or Foreign Corporation. - In the case of a nonresident alien individual engaged in
trade or business in the Philippines or a resident foreign corporation, allowance for depletion
of oil and gas wells or mines under paragraph (1) of this Subsection shall be authorized only
in respect to oil and gas wells or mines located within the Philippines.
CONSOLIDATED MINES, INC. V. CTA (Aug. 29, 1974)
DOCTRINE:
As an income tax concept, depletion is wholly a creation of the statute — "solely a matter of
legislative grace." Hence, the taxpayer has the burden of justifying the allowance of any
deduction claimed.
FACTS:
Petitioner Consolidated Mines, Inc. is a domestic corporation engaged in mining. It filed its
71 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
income tax returns for 1951, 1952, 1953 and 1956. In 1957 examiners of the Bureau of
Internal Revenue investigated the income tax returns filed by Petitioner because its auditor,
Felipe Ollada, claimed the refund of the sum of P107,472.00 representing alleged
overpayments of income taxes for the year 1951.
After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the
Company had not accrued as an expense the share in the company profits of Benguet
Consolidated Mines as operator of the Company's mines, although for income tax purposes the
Company had reported income and expenses on the accrual basis; (2) depletion and
depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and
miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B)
for the year 1956 (1) Petitioner had overstated its claim for depletion; and (2) certain claims
for miscellaneous expenses were not duly supported by evidence.
The Commissioner of Internal Revenue sent Petitioner a letter of demand requiring it to pay
certain deficiency income taxes for the years 1951 to 1954, inclusive, and for the year 1956.
The assessments were challenged by the Petitioner before the CTA. The Tax Court rendered
judgment ordering the Company to pay the amounts of P79,812.93, P51,528.24 and
P71,382.82 for the years 1953, 1954 and 1956, respectively.
Petitioner appealed to the Supreme Court. Petitioner questions the rate of mine depletion
adopted by the Court of Tax Appeals (other issues are not related to the topic).
ISSUE: (relevant issue)
W/N the rate of mine depletion used by the CTA was correct.
RULING:
NO, the rate of depletion per ton of the ore deposit mined and sold by the Company is P0.6196
per ton, not P0.59189 as contended by the Commissioner nor P1.0197 as claimed by the
Company.
The petitioner claimed depletion expense as P1,738,974.56, while the Commissioner (and
CTA) says it is only P131,878.44.
The difference is based on the depletion rate as calculated below:
CIR/CTA Company SC decision
Cost of Mine Property (a) 2,646,878.44 4,238,974.57 2,646,878.44
Estimated Ore Deposit (b) 4,471,892 4,156,888 4,271,892
Rate of Depletion Per Unit of
product Mined and sold (a/b) 0.59189 1.01975 0.61960
The Tax Code provides that in computing net income there shall be allowed as deduction, in
the case of mines, a reasonable allowance for depletion thereof not to exceed the market value
in the mine of the product thereof which has been mined and sold during the year for which
the return is made.
Burden of Proof
As an income tax concept, depletion is wholly a creation of the statute — "solely a matter of
legislative grace." Hence, the taxpayer has the burden of justifying the allowance of any
deduction claimed. As in connection with all other tax controversies, the burden of proof to
show that a disallowance of depletion by the Commissioner is incorrect or that an allowance
made is inadequate is upon the taxpayer, and this is true with respect to the value of the
property constituting the basis of the deduction. P13,966.62; and diamond drilling, P22,335.07. As there is no contention as to the mine cost of
2,500,000, it
On the Cost of Mine Property
On the estimated ore deposit
The "cost of the mine property" consists of (1) mine cost; and (2) expenses of development
before production. The geological report relied by the Company was used by the Court as the basis as the report
was clear enough. However, the Court added 115,004 tons, which the geologist estimated to
There is no contention on the mine cost (P2,500,000) , but the discrepancy is on the expenses be recoverable from the milling dumps.
of development.
Evidence of petitioner
H. CHARITABLE AND OTHER CONTRIBUTIONS

The petitioner presented to the court Exhibit I. This was the Company's report to its SEC 34. (H) Charitable and Other Contributions. -
stockholders for the year 1947. It contained the Company's balance sheet as of December 31,
(1) In General. - Contributions or gifts actually paid or made within the taxable year to,
1946 (Exhibit I-1). Among the assets listed is "Mines, Improvement & Dev." in the amount of
or for the use of the Government of the Philippines or any of its agencies or any political
P4,238,974.57, which, according to petitioner, consisted of P2,500,000, purchase price of the
subdivision thereof exclusively for public purposes, or to accredited domestic
mine, and P1,738,974.56, cost of developing it.
corporation or associations organized and operated exclusively for religious, charitable,
Court’s assessment of petitioner’s evidence scientific, youth and sports development, cultural or educational purposes or for the
rehabilitation of veterans, or to social welfare institutions, or to non-government
The presentation of the balance sheet would only prove that the figure P4,238,974.57 appears organizations, in accordance with rules and regulations promulgated by the Secretary of
therein as corresponding to mine cost. But the petitioner would still need to present proof to finance, upon recommendation of the Commissioner, no part of the net income of which
justify its adoption of that figure. It had burden of establishing the components of the amount inures to the benefit of any private stockholder or individual in an amount not in excess
of P1,738,974.57: what were the particular expenses made and the corresponding amount of of ten percent (10%) in the case of an individual, and five percent (%) in the case of a
each, so that it may be determined whether the expenses were actually made and whether the corporation, of the taxpayer's taxable income derived from trade, business or profession
items are properly part of cost of mine development, or are actually depreciable items. as computed without the benefit of this and the following subparagraphs.
Exhibit 31 (2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding
Assets subject to: subparagraph, donations to the following institutions or entities shall be deductible in
full;
1941
(a) Donations to the Government. - Donations to the Government of the Philippines
1. Depletion P2,646,878.44 or to any of its agencies or political subdivisions, including fully-owned government
corporations, exclusively to finance, to provide for, or to be used in undertaking
2. 10 years depreciation 1,188,987.76
priority activities in education, health, youth and sports development, human
3. 3 years depreciation 8,283.75 settlements, science and culture, and in economic development according to a
National Priority Plan determined by the National Economic and Development
4. 20 years depreciation 9,143.63 Authority (NEDA), In consultation with appropriate government agencies, including
5. 10% amortization 171,985.00 its regional development councils and private philantrophic persons and
institutions: Provided, That any donation which is made to the Government or to
Less: Cost Chromite Field P4,085,277.58 any of its agencies or political subdivisions not in accordance with the said annual
priority plan shall be subject to the limitations prescribed in paragraph (1) of this
Expenses by operator 2,515,000.00
Subsection;
P 1,570,277.58
(b) Donations to Certain Foreign Institutions or International Organizations. -
A large part of the amount spent by the operator may not be allowed for purposes of depletion donations to foreign institutions or international organizations which are fully
deduction, depletion being different from depreciation. The Company's balance sheet for deductible in pursuance of or in compliance with agreements, treaties, or
December 31, 1947 lists the "mine cost" of P2,500,000 as "development cost" and the commitments entered into by the Government of the Philippines and the foreign
amount of P1,738,974.37 as "suspense account (mining properties subject to war losses)." The institutions or international organizations or in pursuance of special laws;
Company claims that its accountant, Mr. Calpo, made these errors, because he was then new at
(c) Donations to Accredited Nongovernment Organizations. - the term
the job.
'nongovernment organization' means a non profit domestic corporation:
Granting that was what had happened, it does not affect the fact that the evidence on hand is
(1) Organized and operated exclusively for scientific, research, educational,
insufficient to prove the cost of development alleged by the petitioner.
character-building and youth and sports development, health, social welfare,
In light of Petitioner’s failure to discharge the burden of proof, greater weight may be cultural or charitable purposes, or a combination thereof, no part of the net
given to Commissioner's assertion that the “development cost" was P131,878.44, income of which inures to the benefit of any private individual;
broken down as follows: assessment, P34,092.12; development, P61,484.63; exploration,
72 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 (2) Which, not later than the 15th day of the third month after the close of the
accredited nongovernment organizations taxable year in which contributions
are received, makes utilization directly for the active conduct of the activities
constituting the purpose or function for which it is organized and operated,
unless an extended period is granted by the Secretary of Finance in accordance
with the rules and regulations to be promulgated, upon recommendation of the
Commissioner;
(3) The level of administrative expense of which shall, on an annual basis,
conform with the rules and regulations to be prescribed by the Secretary of
Finance, upon recommendation of the Commissioner, but in no case to exceed
thirty percent (30%) of the total expenses; and
(4) The assets of which, in the even of dissolution, would be distributed to
another nonprofit domestic corporation organized for similar purpose or
purposes, or to the state for public purpose, or would be distributed by a court
to another organization to be used in such manner as in the judgment of said
court shall best accomplish the general purpose for which the dissolved
organization was organized.
Subject to such terms and conditions as may be prescribed by the Secretary of
Finance, the term 'utilization' means:
(i) Any amount in cash or in kind (including administrative expenses) paid
or utilized to accomplish one or more purposes for which the accredited
nongovernment organization was created or organized.
(ii) Any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more purposes for which the accredited
nongovernment organization was created or organized.
An amount set aside for a specific project which comes within one or more
purposes of the accredited nongovernment organization may be treated as a
utilization, but only if at the time such amount is set aside, the accredited
nongovernment organization has established to the satisfaction of the
Commissioner that the amount will be paid for the specific project within a
period to be prescribed in rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the Commissioner, but not to
exceed five (5) years, and the project is one which can be better accomplished
by setting aside such amount than by immediate payment of funds.
(3) Valuation. - The amount of any charitable contribution of property other than money
shall be based on the acquisition cost of said property.
(4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if
verified under the rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner.
BIR RULING NO. 019-01 (ACCREDITATION OF A FOREIGN CORPORATION AS DONEE
INSTITUTION)
DOCTRINE: A Foreign Corporation, whether resident or non-resident, cannot be accredited as
donee institution.
FACTS:
Conservation International applied for certification for done institution status w/ PCNC (Phil.
Council for NGO Cert.), but its board members are based overseas.
73 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ISSUE: W/N int’l orgs with home offices based abroad are qualified to be granted donee
institution status.
RULING:
Sec. 34 (H) of the Tax Code provides:
"(H) Charitable and Other Contributions-
"(l) In General. — Contributions or gifts actually paid or made within the taxable year to, or for
the use of the Government of the Philippines or any of its agencies or any political subdivision
thereof exclusively for public purposes, or to accredited domestic corporations or associations
organized and operated exclusively for religious, charitable, scientific, youth and sports
development, cultural or educational purposes or for the rehabilitation of veterans, or to social
welfare institutions or to non-government organizations, in accordance with rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner, no part of the net income of which inures to the benefit of any private stockholder
or individual in an amount not in excess of ten percent (10%) in the case of an individual, and
five percent (5%) in the case of a corporation of the taxpayer's taxable income derived from
trade, business or profession as computed without the benefit of this and the following
subparagraphs".
Sec. 34(H)(l) of the Tax Code of 1997 specifically mentions "accredited domestic corporation
or associations" and "non-government organizations". On the other hand, subparagraph (2)(c)
of the same Section of the Tax Code definesa "non-government organization" to mean a non-
profit domestic corporation.
On the other hand, Rev. Regs. No. 13-98 was issued to implement Sec. 34(H)(I):
a) "Non-stock, non-profit corporation or organization" — shall refer to a corporation or
association/organization referred to under Section 30 (E) and
(G) of the Tax Code
b) "Non-government Organization (NGO)" — shall refer to a non-stock, non-profit domestic
corporation or organization as defined under Section 34(H)(2)(c) of the Tax Code organized
and operated exclusively . . ."
As donee corporation, considering the requirements of the Tax Code of 1997 and RR No. 13-
98 that a non-stock, non-profit corporation or organization must be created or organized
under Philippine laws, and that an NGO must be a non-profit domestic corporation, a foreign
corporation like Conservation International, whether resident or non-resident, cannot be
accredited as donee institution.
I. RESEARCH AND DEVELOPMENT
SEC 34. (I) Research and Development.-
(1) In General. - a taxpayer may treat research or development expenditures which are
paid or incurred by him during the taxable year in connection with his trade, business or
profession as ordinary and necessary expenses which are not chargeable to capital
account. The expenditures so treated shall be allowed as deduction during the taxable
year when paid or incurred.
(2) Amortization of Certain Research and Development Expenditures. - At the
election of the taxpayer and in accordance with the rules and regulations to be
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the
following research and development expenditures may be treated as deferred expenses:
 (a) Paid or incurred by the taxpayer in connection with his trade, business or
profession;
(b) Not treated as expenses under paragraph 91) hereof; and
(c) Chargeable to capital account but not chargeable to property of a character
which is subject to depreciation or depletion.
In computing taxable income, such deferred expenses shall be allowed as deduction
ratably distributed over a period of not less than sixty (60) months as may be elected by
the taxpayer (beginning with the month in which the taxpayer first realizes benefits from
such expenditures).
The election provided by paragraph (2) hereof may be made for any taxable year
beginning after the effectivity of this Code, but only if made not later than the time
prescribed by law for filing the return for such taxable year. The method so elected, and
the period selected by the taxpayer, shall be adhered to in computing taxable income for
the taxable year for which the election is made and for all subsequent taxable years
unless with the approval of the Commissioner, a change to a different method is
authorized with respect to a part or all of such expenditures. The election shall not apply
to any expenditure paid or incurred during any taxable year for which the taxpayer
makes the election.
(3) Limitations on deduction. - This Subsection shall not apply to:
(a) Any expenditure for the acquisition or improvement of land, or for the
improvement of property to be used in connection with research and development
of a character which is subject to depreciation and depletion; and
(b) Any expenditure paid or incurred for the purpose of ascertaining the existence,
location, extent, or quality of any deposit of ore or other mineral, including oil or
gas.
3M PHIL. INC v. CIR
DOCTRINE: Although the Tax Code allows payments of royalty to be deducted from gross
income as business expenses, it is CB Circular No. 393 that defines what royalty payments are
proper. Hence, improper payments of royalty are not deductible as legitimate business
expenses.
FACTS:
3M Phils is a subsidiary of 3M St Paul (Minnesota USA). 3M Phils is the exclusive importer,
manufacturer, and distributor in the Philippines of all 3M St Paul products. - Petitioner
entered into a "Service Information and Technical Assistance Agreement" and a "Patent and
Trademark License Agreement" with 3M-St. Paul. Petitioner agreed to pay to 3M-St. Paul a
technical service fee of 3% and a royalty of 2% of its net sales. - In petitioner's ITR for year
1974, it claime deductions for royalties and technical services fees of P3M as business
expenses and pre-operational cost of tape coater of P97k. - The CIR allowed a deduction of
P797k only as technical service fee and royalty for LOCALLY manufactured products and
disallowed the rest (P2.3M). The alleged deduction was treated by respondent as a disguised
dividend or income. - Petitioner protested the assessment but the CIR issued warrants of
distraint and levy.
ISSUE: w/n the petitioner is entitled to the deductions is claims? NO.
RULING:
The salient provisions of law involved are:
74 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
1) CB Circular No. which was promulgated by the Central Bank as an exchange control
regulation to conserve foreign exchange and avoid unnecessary drain on the country's
international reserves. Section 3-C of the circular provides that royalties shall be paid only on
commodities manufactured by the licensee under the royalty agreement. No royalty is payable
on the wholesale price of finished products imported by the licensee from the licensor.
2) Section 29(a)(1) of the Tax Code which provides: "(a) Expenses. — (1) Business expenses.
— (A) In general. — All ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business, including a reasonable allowance for salaries or
other compensation for personal services actually rendered; travelling expenses while away
from home in the pursuit of a trade, profession or business, rentals or other payments
required to be made as a condition to the continued use or possession, for the purpose of the
trade, professio n or business, for property to which the taxpayer has not taken or is not
taking title or in which he has no equity."
-----> Petitioner points out that the Central bank has no say in the assessment and collection of
internal revenue taxes as such power is lodged in the Bureau of Internal Revenue. The Tax
Code never mentions Circular 393 and there is no law or regulation governing deduction of
business expenses that refers to said circular.
J. PENSION TRUSTS
SEC 34. (J) Pension Trusts. - An employer establishing or maintaining a pension trust to
provide for the payment of reasonable pensions to his employees shall be allowed as a
deduction (in addition to the contributions to such trust during the taxable year to cover the
pension liability accruing during the year, allowed as a deduction under Subsection (A) (1) of
this Section ) a reasonable amount transferred or paid into such trust during the taxable year
in excess of such contributions, but only if such amount (1)has not theretofore been allowed
as a deduction, and (2) is apportioned in equal parts over a period of ten (10) consecutive
years beginning with the year in which the transfer or payment is made.
K. ADDITIONAL REQUIREMENTS FOR DEDUCTIBILITY
SEC 34. (K) Additional Requirements for Deductibility of Certain Payments. - Any
amount paid or payable which is otherwise deductible from, or taken into account in
computing gross income or for which depreciation or amortization may be allowed under this
Section, shall be allowed as a deduction only if it is shown that the tax required to be deducted
and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with
this Section 58 and 81 of this Code.
L. OPTIONAL STANDARD DEDUCTION
SEC 34. (L) Optional Standard Deduction. - In lieu of the deductions allowed under the
preceding Subsections, an individual subject to tax under Section 24, other than a nonresident
alien, may elect a standard deduction in an amount not exceeding forty percent (40%) of his
gross sales or gross receipts, as the case maybe. In the case of a corporation subject to tax
under Sections 27(A) and 28(A)(1), it may elect a standard deduction in an amount not
exceeding forty percent (40%) of its gross income as defined in Section 32 of this Code. Unless
the taxpayer signifies in his return his intention to elect the optional standard deduction, he
shall be considered as having availed himself of the deductions allowed in the preceding
Subsections. Such election when made in the return shall be irrevocable for the taxable year
for which the return is made: Provided, That an individual who is entitled to and claimed for
the optional standard deduction shall not be required to submit with his tax return such
financial statements otherwise required under this Code: Provided, further, That except when
the Commissioner otherwise permits, the said individual shall keep such records pertaining to
his gross income during the taxable year, as may be required by the rules and regulations
promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
M. PREMIUM PAYMENTS
SEC 34. (M) Premium Payments on Health and/or Hospitalization Insurance of an
Individual Taxpayer. - the amount of premiums not to exceed Two thousand four hundred
pesos (P2,400) per family or Two hundred pesos (P200) a month paid during the taxable year
for health and/or hospitalization insurance taken by the taxpayer for himself, including his
family, shall be allowed as a deduction from his gross income: Provided, That said family has a
gross income of not more than Two hundred fifty thousand pesos (P250,000) for the taxable
year: Provided, finally, That in the case of married taxpayers, only the spouse claiming the
additional exemption for dependents shall be entitled to this deduction.
Notwithstanding the provision of the preceding Subsections, The Secretary of Finance, upon
recommendation of the Commissioner, after a public hearing shall have been held for this
purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized
deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of
determining such ceilings or limitations, the Secretary of Finance shall consider the following
factors: (1) adequacy of the prescribed limits on the actual expenditure requirements of each
particular industry; and (2)effects of inflation on expenditure levels: Provided, further, That
no ceilings shall further be imposed on items of expense already subject to ceilings under
present law.
V. TAXABLE INCOME
SEC. 31. Taxable Income Defined. - The term taxable income means the pertinent items of
gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.
VI. GENERAL PRINCIPLES OF INCOME TAXATION
SEC. 23. General Principles of Income Taxation in the Philippines. - Except when
otherwise provided in this Code:
(A) A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines;
(B) A nonresident citizen is taxable only on income derived from sources within the
Philippines;
(C) An individual citizen of the Philippines who is working and deriving income from abroad
as an overseas contract worker is taxable only on income derived from sources within the
Philippines: Provided, That a seaman who is a citizen of the Philippines and who receives
compensation for services rendered abroad as a member of the complement of a vessel
engaged exclusively in international trade shall be treated as an overseas contract worker;
(D) An alien individual, whether a resident or not of the Philippines, is taxable only on income
derived from sources within the Philippines;
(E) A domestic corporation is taxable on all income derived from sources within and without
the Philippines; and
75 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is
taxable only on income derived from sources within the Philippines.
VII. INCOME TAX ON INDIVIDUALS
A. DEFINITIONS
1. RESIDENT CITIZENS AND RESIDENT ALIENS
Sec. 22. Definitions. – When used in this Title:
(F) The term ‘resident alien’ means an individual whose residence is within the Philippines
and who is not a citizen thereof
SEC. 5, REV. REGS. 2. Definition. — A "non-resident alien individual" means an individual —
(a) Whose residence is not within the Philippines; and
(b) Who is not a citizen of the Philippines.
An alien actually present in the Philippines who is not a mere transient or sojourner is a
resident of the Philippines for purposes of the income tax. Whether he is a transient or not is
determined by his intentions with regard to the length and nature of his stay. A mere floating
intention indefinite as to time, to return to another country is not sufficient to constitute him a
transient. If he lives in the Philippines and has no definite intention as to his stay, he is a
resident. One who comes to the Philippines for a definite purpose which in its nature may be
promptly accomplished is a transient. But if his purpose is of such a nature that an extended
stay may be necessary for its accomplishment, and to that end the alien makes his home
temporarily in the Philippines, he becomes a resident, though it may be his intention at all
times to return to his domicile abroad when the purpose for which he came has been
consummated or abandoned.
GARRISON v. CA
FACTS:
JOHN L. GARRISON "was born in the Philippines and lived in this country since birth up to
1945, when he was repatriated and returned to the United States. He stayed in the United
States for the following twenty years until May 5, 1965, when he entered the Philippines
through the Clark Air Base. The said accused lived in the Philippines since his return on May 6,
1965. He lives with his Filipino wife and their children in Olongapo City, and they own the
house and lot on which they are presently residing.
JAMES W. ROBERTSON "was born on December 22, 1915 in Olongapo and he grew up in this
country. He and his family were repatriated to the United States in 1945. His next arrival in
the Philippines was in 1958 and he stayed in this country from that time up to the present. He
is presently residing at Olongapo City.
FRANK W. ROBERTSON "was born in the Philippines and he lived in this country up to 1945,
when he was repatriated to the United States along with his brother, his co-accused James W.
Robertson. In 1962, he returned once more to the Philippines and he has been residing here
ever since. He is married to a Filipino citizen named Generosa Juico and they live in Olongapo
City.
ROBERT H. CATHEY was born in Tennessee, United States, on April 8, 1917; his first arrival in
the Philippines, as a member of the liberation forces of the United States, was in 1944. He
stayed in the Philippines until April, 1950, when he returned to the United States, and he came
back to the Philippines in 1951. He stayed in the Philippines since 1951 up to the present.
FELICITAS DE GUZMAN "was born in the Philippines in 1935 and her father was a naturalized
American citizen. While she was studying at the University of Sto. Tomas, Manila, she was
recruited to work in the United States Naval Base, Subic Bay, Philippines. Afterwards, she left
the Philippines to work in the United States Naval Base, Honolulu, Hawaii, and she returned to
the Philippines on or about April 21, 1967. She is married to Jose de Guzman, a Filipino citizen,
and they and their children live at Olongapo City.
EDWARD McGURK "came to the Philippines on July 11, 1967 and he stayed in this country
continuously up to the present time."
Petitioners are United States citizens, entered this country under Section 9 (a) of the
Philippine Immigration Act of 1940 and presently employed in the United States Naval Base,
Olongapo City.
They received separate notices informing them that they had not filed their respective income
tax returns for the year 1969, as required by Section 45 of the National Internal Revenue Code,
and directing them to file the said returns within ten days from receipt of the notice. But the
accused refused to file their income tax returns, claiming that they are not resident aliens but
only special temporary visitors, having entered this country under Section 9 (a) of the
Philippine Immigration Act of 1940.
ISSUE:
Whether or not the petitioners may not under the law be deemed resident aliens required to
file income tax returns.
RULING:
The Bases Agreement very plainly identifies the persons NOT "liable to pay income tax in the
Philippines except in regard to income derived from Philippine sources or sources other than
the US sources."
They are the persons that concur the following requisites, to wit:
1) nationals of the United States serving in or employed in the Philippines;
2) their service or employment is "in connection with construction, maintenance, operation or
defense of the bases;
3) they reside in the Philippines by reason only of such employment; and 4) their income is
derived exclusively from "U.S. sources."
(1) that the petitioners are U.S. nationals serving or employed in the (2) that their
employment is "in connection with construction, maintenance, operation or defense" of a
base, Subic Bay Naval Base; (3) they reside in the Philippines by reason only of such
employment since, as is undisputed, they all intend to depart from the country on
termination of their employment
(4) they earn no income from Philippine sources or sources other than the U.S. sources.
Therefore, by the explicit terms of the Bases Agreement, none of them "shall be liable to pay
income tax in the Philippines.
Each of the petitioners does indeed fall within the letter of the codal precept that an "alien
residing in the Philippines" is obliged "to file an income tax return." None of them may be
considered a non-resident alien, "a mere transient or sojourner," who is not under any legal
duty to file an income tax return under the Philippine Tax Code.
The Taxpayer’s intention to return to their domicile abroad is immaterial because they have
76 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
resided in the Philippines for quite a long time.
The situation is no different from that of Filipino and other resident income-earners in the
Philippines who, by reason of the personal exemptions and permissible deductions under the
Tax Code, may not be liable to pay income tax year for any particular year; that they are not
liable to pay income tax, no matter how plain or irrefutable such a proposition might be, does
not exempt them from the duty to file an income tax return.
RAMNANI v. CIR
DOCTRINE:
 Sec. 20(f) of the NIRC defines a resident alien as an “individual whose residence is within
the Philippines and who is not a citizen thereof”.
 An alien actually present in the Philippines who is not a mere transient or sojourner is a
resident of the Philippines for purposes of the income tax. Whether he is a transient or
not is determined by his intentions with regard to the length and nature of his stay. A
mere floating intention indefinite as to time, to return to another country is not sufficient
to constitute him a transient. If he lives in the Philippines and has no definite Intention as
to stay, he is a resident. One who comes to the Philippines for a definite purpose which in
its nature may be promptly accomplished is a transient. But if his purpose Is of such a
nature that an extended stay may be necessary for its accomplishment, and to that end
the alien makes his home temporarily in the Philippines, he becomes a resident though it
may be his intention at all times to return to his domicile abroad when the purpose for
which he came has been consummated or abandoned.
 The establishment of a home even temporarily here in the Philippines for the
accomplishment of a purpose even if he has the intention to return to his domicile abroad
categorizes an individual as a resident.
FACTS:
 In a certain case involving parcels of land, improvements, and rentals and where
petitioner spouses where also parties, the SC decided a favorable judgment in favor of
herein petitioners.
 Pursuant to this SC case, a tripartite agreement was entered into by the parties to finally
settle the award for money judgment at P65 Million.
 The counsel of Harish Jethmal Ramnani and Choithram Jethmal Ramnani, as payors of
the said money judgment, requested the CIR for a clarificatory ruling with regard to the
tax implications of such an agreement.
 BIR issued a letter declaring the petitioners as non-resident aliens not doing business in
the Philippines and subjecting the money judgment, excluding the award for damages, to
the income tax.
 Petitioners disagree with the said letter maintaining that they are resident aliens and
that the money judgment rendered in their favor is in the nature of a mere return of
capital/investment and hence must not be subject to the income tax.
ISSUE/S:
1. WON petitioners are resident aliens
2. WON the money judgment issued in their favor are subject to income tax
RULING:
1. YES. Petitioner is considered a resident alien taxable in the same manner as a resident
citizen under Section 21(f) of the NIRC.
 Sec. 20(f) of the NIRC defines a resident alien as an “individual whose residence is within
the Philippines and who is not a citizen thereof”. Evidence adduced during the trial
convinced this Court that petitioner Ishwar Ramnani's stay in the Philippines can no longer
be considered as transient.
Section 5 of Revenue Regulations No. 2 delineates the distinction between a person who can
be considered a resident and one who is not:
"SEC. 5. Definition. — A 'non-resident alien individual' means an individual —
(a) Whose residence is not within the Philippines; and
(b) Who is not a citizen of the Philippines.
An alien actually present in the Philippines who is not a mere transient or sojourner is a
resident of the Philippines for purposes of the income tax. Whether he is a transient or not
is determined by his intentions with regard to the length and nature of his stay. A mere
floating intention indefinite as to time, to return to another country is not sufficient to
constitute him a transient. If he lives in the Philippines and has no definite Intention as to
stay, he is a resident. One who comes to the Philippines for a definite purpose which in its
nature may be promptly accomplished is a transient. But if his purpose Is of such a nature
2. NON-RESIDENT CITIZENS
that an extended stay may be necessary for its accomplishment, and to that end the alien
makes his home temporarily in the Philippines, he becomes a resident though it may be his Sec. 22. Definitions. – When used in this Title:
intention at all times to return to his domicile abroad when the purpose for which he came (E) The term ‘nonresident citizen’ means:
has been consummated or abandoned.
(1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact
The establishment of a home even temporarily here in the Philippines for the of his physical presence abroad with a definite intention to reside therein.
accomplishment of a purpose even if he has the intention to return to his domicile abroad
categorizes an individual as a resident. There is no doubt that petitioner Ishwar Ramnani is (2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside
an American citizen who frequently comes to the Philippines for the most part of the year to abroad, either as an immigrant or for employment on a permanent basis.
oversee his various investments as shown by his passport entries. The then Commissioner (3) A citizen of the Philippines who works and derives income from abroad and whose
of Immigration even approved the change of his status of admission from temporary visitor employment thereat requires him to be physically present abroad most of the time during
to immigrant/resident alien; Petitioner has paid his Community Residence Certificates the taxable year.
1987-1994
(4) A citizen who has been previously considered as nonresident citizen and who arrives in
2. The rental income of P24,879,265.00 is subject to 5% withholding tax, which is the Philippines at any time during the taxable year to reside permanently in the
P1,243,963.25. The withholding tax shall be creditable from the income tax due and payable Philippines shall likewise be treated as a nonresident citizen for the taxable year in which
by petitioners in the year said income was received. he arrives in the Philippines with respect to his income derived from sources abroad until
The capital investment should not form part of the taxable base for income tax purpose the date of his arrival in the Philippines.
since this is not income but a mere return of the capital. (5) The taxpayer shall submit proof to the Commissioner to show his intention of leaving the
The moral and exemplary damages as well as the attorney’s fees are not subject to income Philippines to reside permanently abroad or to return to and reside in the Philippines as
tax. the case may be for purposes of this Section.

The rest of the income earned by way of money judgment per agreement of the parties
constitutes taxable income to petitioner subject to the income tax under Section 21(f) in the
same manner as citizens of the Philippines
As a resident alien, petitioner is also entitled to deductions and personal and additional
exemptions. Furthermore, as a resident alien, petitioner is required to file his income tax
return declaring therein the income awarded to him by the Court's judgment, amounting to
P57,200,000.00 in the year he received such income.
77 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
REV. REGS. 1-79
Section 2. Who are considered as non-resident citizens. The term "non-resident citizen"
means one who establishes to the satisfaction of the Commissioner of Internal Revenue the
fact of his physical presence abroad with the definite intention to reside therein and shall
include any Filipino who leaves the country during the taxable year as:
(a) Immigrant — one who leaves the Philippines to reside abroad as an immigrant for
which a foreign visa as such has been secured.
(b) Permanent employee – one who leaves the Philippines to reside abroad for employment
on a more or less permanent basis.
(c) Contract worker — one who leaves the Philippines on account of a contract of
 employment which is renewed from time to time within or during the taxable year
under such circumstances as to require him to be physically present abroad most of the
time during the taxable year. To be considered physically present abroad most of the
time during the taxable year, a contract worker must have been outside the Philippines
for not less than 183 days during such taxable year.
Any such Filipino shall be considered a non-resident citizen for such taxable year with respect
to the income he derived from foreign sources from the date he actually departed from the
Philippines.
A Filipino citizen who has been previously considered as a non-resident citizen and who
arrives in the Philippines at any time during the taxable year to reside therein permanently
shall also be considered a non-resident citizen for the taxable year in which he arrived in the
Philippines with respect to his income derived from sources abroad until the date of his
arrival.
Section 3. Proof of intention. — A Filipino citizen who leaves the Philippines to reside abroad
either as an immigrant or for permanent employment or a contract worker, shall submit to the
Commissioner of Internal Revenue proof of his intention of leaving the Philippines to reside
permanently abroad. A returning non-resident citizen, on the other hand, must present proof
of his intention to return to and reside permanently in the Philippines. Such proof of intention
shall be attached to his income tax return (BIR Form No. 1701C) and may consist of the
following:
(a) In the case of an immigrant, photostat or xerox copy of his foreign visa.
(b) In the case of one leaving for permanent employment abroad, a certificate from his
employer showing the nature and duration of his employment.
(c) In the case of a contract worker —
(1) Certificate of the employer; or
(2) Copy of the contract of employment; or
(3) Other documentary evidence.
(d) In the case of a returning non-resident citizen -
(1) Xerox copy of his passport bearing the stamp of Philippine immigration
authorities showing that he is a returning resident, as distinguished from a mere
Balikbayan.
(2) Other documentary evidence.
Section 4. Manner of filing returns. — Every non-resident citizen must file an income tax
return covering all his income earned abroad on BIR Form No. 1701C. When husband and
wife are both non-resident citizens, only one return containing their consolidated income is
required to be filed on BIR Form No. 1701C.
If aside from the foreign income, the non-resident citizen also derives income from Philippine
sources, two separate returns should be filed, one on BIR Form No. 1701C covering the
income derived from foreign sources and the other on BIR Form No. 1701 or 1701A, as the
case may be, covering the income from sources within the Philippines. However, if the
Philippine income is derived solely, from salaries, wages, remunerations or other similar
compensation for services rendered and such gross income does not exceed P2,000, if the
taxpayer is single, or P3,333.33, if married or a head of the family, the non-resident citizen is
exempt from filing an income tax return with respect to such income.
78 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
The income tax return of a non-resident citizen covering his taxable income earned abroad
shall be accompanied by a copy of the income tax return filed with the national government
of the foreign country of his residence as well as the evidences of tax payment.
(1) What to include as gross income. — The gross income of a nonresident citizen derived
from sources outside the Philippines includes all income enumerated under Section 29
of the National Internal Revenue Code, whether or not such income is exempted from
income tax in the foreign country where it was derived.
If the income is in foreign currency other than US dollars, it shall first be converted into
US dollars at the average annual rate of exchange of the foreign currency and the US
dollar for the year in which the income was earned.
3. Computation of Adjusted Gross Income. — The adjusted gross income is arrived at by
deducting from the gross income the following:
a. Personal exemption
b. The total amount of the national income tax actually paid to the national
government of the foreign country of his residence.
B. On income derived from sources within the Philippines.
The tax due on income derived by a non-resident citizen from sources within the
Philippines shall be computed in the same manner as the income tax payable by resident
citizens and resident aliens.
Section 5. Computation of income and tax. —
a. On income derived from all sources outside the Philippines. —
b. The total amount of the national income tax actually paid to the national government of
the foreign country of his residence.
4. Head of family. — The term "head of family" is defined as "an unmarried man or woman
with one or both parents, or one or more brothers or sisters, or one or more legitimate,
recognized natural, or adopted children living with and dependent upon him or her for
their chief support where such brothers, sisters, or children are not more than twenty-
one years of age, unmarried and not gainfully employed or where such children are
incapable of self-support because they are mentally or physically defective.
If the return is filed and payment of the tax made in the Philippines by or for the non-resident
citizen, the tax may be paid in Philippine currency, the dollar amount of the tax to be
converted into pesos at the rate of exchange prescribed by Revenue Memorandum Circular
No. 21-78 for internal revenue tax purposes.
When the tax due is in excess of two hundred dollars (U.S. $200.00), the non-resident citizen
may elect to pay the tax in two equal installments in which case, the first installment shall be
paid at the time the return is filed and the second installment, on or before the fifteenth day of
July following the close of the calendar year. If any installment is not paid on or before the
date fixed for its payment, the whole amount of the tax unpaid becomes due and payable
together with the delinquency penalties.
Section 6. When and where to file. — The return must be filed, and the tax due, if any, must
be paid on or before April 15 following the year for which the return is being filed with the
Philippine Embassy or Office of the Consulate General nearest to the taxpayer's place of
residence or direct to the Commissioner of Internal Revenue, BIR Bldg.. Diliman, Quezon City,
Philippines.
If the return and payment, if any, are sent by mail, the same should be mailed on such a date as
to reach the Philippine Embassy, Philippine Consulate General or the Commissioner of
Internal Revenue on or before April 15. The payment should be made in the form of an
international money order, bank draft or manager's check payable to the Commissioner .of
Internal Revenue.
REV. REGS. 5-01
Revoking the Requirement for Non-Resident Citizens, Overseas Contract Workers (OCWs) and
Seamen to File Information Returns on Income Derived from Sources Outside the Philippines.
SECTION 2. FILING OF INFORMATION RETURNS (BIR FORM 1701C OR BIR FORM 1703) NO
LONGER REQUIRED. — Non-resident citizens who are exempt from tax with respect to income
derived from sources outside the Philippines in accordance with Section 23(B) and (C), in
relation to Section 22 (E) and Section 51 (A)(2)(d) and (A)(3) of the Tax Code of 1997, but
who are nevertheless mandated to file information returns (BIR Form 1701C or the new
computerized BIR Form 1703) pursuant to RMO 30-99 and RR 9-99, shall no longer be
required to file the same on their income derived from sources outside the Philippines
beginning taxable year 2001.
BIR RUL. NO. 33-00
DOCTRINE:
A non-resident citizen is one who works and derives income from abroad and whose
employment thereat requires him to be physically present abroad for at least 183 days during
the taxable year. Thus, exempt from income tax for sources outside the Philippines.
FACTS:
Technoserve International Co., Inc. (TIC), is a domestic foreign corporation engaged in
rendering specialty and technical services for overseas or domestic projects in the areas of
engineering, procurement service and construction management and other related fields. The
bulk of its revenue comes from work order contracts for design and engineering works for
overseas projects being awarded by its parent company, JGC Corporation, having its principal
office at Yokohama, Japan. The design works are being done at the Alabang office but there are
also cases wherein TIC is required to send their qualified staff to Japan and other site office for
design and engineering works, thus the Secondment Agreement with JGC. The employee shall
be stationed at JGC offices for a certain period of time and shall perform his duties according
to client's instruction and without losing the status of employment with TIC. Usually, Intra-
company Transference Visas are being secured by JGC and the work contracts pass thru POEA.
JGC will provide for the accommodation, transportation, meal and site allowances and other
necessities while on overseas assignment. The salaries, which are stated in US dollar, are
being paid here in the Philippines by TIC converted to pesos using the prevailing exchange
rate at the time of payment.
The manhour spent by the overseas' assignees are billed to JGC at an agreed manhour billing
rate based on their position level and salaries. JGC then remits the payment and TIC converts
the same to pesos through the Philippine Banking System. In effect, JGC Corporation is actually
the one paying the salaries of overseas' assignees through TIC. For income tax purposes, all
TIC’s employees who are assigned overseas for at least 183 days in a taxable year were
classified as non-residents since the situs of income whether within or without was
determined by the place where the service was rendered. The income thus earned, even if
paid locally, were taxed based on the preferential rates of 1-2-3% before the taxable year
1998. With the implementation of the Comprehensive Tax Reform Program as of January 1,
1998, TIC now seek clarifications as the proper tax treatment of its employees assigned
abroad.
79 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
ISSUE: Whether or not the employees assigned abroad are considered non-resident citizens?
YES.
RULING:
Section 23(C) of the Tax Code of 1997 provides: "(C) An individual citizen of the Philippines
who is working and deriving income from abroad as an overseas contract workers is taxable
only on income from sources within the Philippines. . .” Corollary thereto, Section 22(E)(3) of
the same Code provides one of the definitions of the term 'non-resident citizen' of the
Philippines: "(3) A citizen of the Philippines who works and derives income from abroad and
whose employment thereat requires him to be physically present abroad most of the time
during the taxable year."
Thus, for purposes of exemption from income tax, a citizen must be deriving foreign-sources
income for being a non-resident citizen or for being an overseas contract worker (OCW). All of
TIC’s employees whose services are rendered abroad for being seconded or assigned overseas
for at least 183 days may fall under the first category and are therefore exempt from payment
of Philippine income tax. In this connection, the phrase "most of the time" which is used in
determining when a citizen's physical presence abroad will qualify him as non-resident, shall
mean that the said citizen shall have stayed abroad for at least 183 days in a taxable year. The
same exemption applies to an overseas contract worker but as such worker, the time spent
abroad is not material for tax exemption purposes. All that is required is for the worker's
employment contract to pass through and be registered with the POEA.
3. NON-RESIDENT ALIENS ENGAGED/NOT ENGAGED IN TRADE OR BUSINESS IN
THE PHILIPPINES
Sec. 22. Definitions. – When used in this Title:
(G) The term ‘nonresident alien’ means an individual whose residence is not within the
Philippines and who is not a citizen thereof.
REV. REGS. 2 - SECTION 5. Definition. — A "non-resident alien individual" means an
individual —
(a) Whose residence is not within the Philippines; and
(b) Who is not a citizen of the Philippines.
An alien actually present in the Philippines who is not a mere transient or sojourner is a
resident of the Philippines for purposes of the income tax. Whether he is a transient or not is
determined by his intentions with regard to the length and nature of his stay. A mere floating
intention indefinite as to time, to return to another country is not sufficient to constitute him a
transient. If he lives in the Philippines and has no definite intention as to his stay, he is a
resident. One who comes to the Philippines for a definite purpose which in its nature may be
promptly accomplished is a transient. But if his purpose is of such a nature that an extended
stay may be necessary for its accomplishment, and to that end the alien makes his home
temporarily in the Philippines, he becomes a resident, though it may be his intention at all
times to return to his domicile abroad when the purpose for which he came has been
consummated or abandoned.
SECTION 6. Loss of residence by alien. — An alien who has acquired residence in the
Philippines retains his status as a resident until he abandons the same and actually departs
from the Philippines. An intention to change his residence does not change his status as a
resident alien to that of a nonresident alien. Thus an alien who has acquired a residence in the
Philippines is taxable as a resident for the remainder of his stay in the Philippines.
4. DEPENDENT
SEC 35. Allowance of Personal Exemption for Individual Taxpayer –
(B) Additional Exemption for Dependents. – There shall be allowed an additional exemption of
Twenty-five Thousand pesos (P25,000) for each dependent not exceeding four (4).
The additional exemption for dependents shall be claimed by only one of the spouses in the
case of married individuals.
In the case of legally separated spouses, additional exemptions may be claimed only by the
spouse who has custody of the child or children: Provided, That the total amount of additional
exemptions that may be claimed by both shall not exceed the maximum additional exemptions
herein allowed.
For purposes of this Subsection, a ‘dependent’ means a legitimate, illegitimate, or legally
adopted child chiefly dependent upon and living with the taxpayer if such dependent is not
more than twenty-one (21) years of age, unmarried and not gainfully employed or if such
dependent, regardless of age, is incapable of self-support because of mental or physical defect.
5. MINIMUM WAGE EARNER
Sec. 22. Definitions. – When used in this Title:
(HH) The term ‘minimum wage earner’ shall refer to a worker in the private sector paid the
statutory minimum wage, or 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.
B. INCOME TAX ON CITIZENS AND RESIDENT ALIENS
1. INCOME TAX RATE AND BASE, IN GENERAL
SEC. 24. Income Tax Rates. —
(A) Rates of Income Tax on Individual Citizen and Individual Resident Alien of the
Philippines. —
a. An income tax is hereby imposed:
i. On the taxable income defined in Section 31 of this Code, other than income subject to
tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year
from all sources within and without the Philippines by every individual citizen of the
Philippines residing therein;
ii. On the taxable income defined in Section 31 of this Code, other than income subject to
tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year
from all sources within the Philippines by an individual citizen of the Philippines who
is residing outside of the Philippines including overseas contract workers referred to
in Subsection (C) of Section 23 hereof; and
iii. On the taxable income defined in Section 31 of this Code, other than income subject to
tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year
from all sources within the Philippines by an individual alien who is a resident of the
Philippines.
b. Rates of Tax on Taxable Income of Individuals. — The tax shall be computed in accordance
with and at the rates established in the following schedule:
80 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Not over P10,000 5%
Over P10,000 but not over P30,000 P500 + 10% of the excess over P10,000
Over P30,000 but not over P70,000 P2,500 + 15% of the excess over P30,000
Over P70,000 but not over P140,000 P8,500 + 20% of the excess over P70,000
Over P140,000 but not over P250,000 P22,500 + 25% of the excess over P140,000
Over P250,000 but not over P500,000 P50,000 + 30% of the excess over P250,000
Over P500,000 P250,000 + 32% of the excess over P500,000
Sec. 31. Taxable Income, Defined. – The term ‘taxable income’ means the pertinent items of
gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.
2. SPECIAL EXEMPTION OF MINIMUM WAGE EARNERS
Section 24(A), proviso
3. INCOME TAX RATE AND BASE ON CERTAIN TYPES OF INCOME
a. FINAL INCOME TAX ON INTERESTS, ROYALTIES, PRIZES, AND OTHER WINNINGS
SEC. 24. Income Tax Rates. —
(B) Rate of Tax on Certain Passive Income: –
(1) Interests, Royalties, Prizes, and Other Winnings. – A final tax at the rate of twenty
percent (20%) is hereby imposed upon the amount of interest from any currency bank
deposit and yield or any other monetary benefit from deposit substitutes and from trust funds
and similar arrangements; royalties, except on books, as well as other literary works and
musical compositions, which shall be imposed a final tax of ten percent (10%); prizes (except
prizes amounting to Ten thousand pesos (P10,000) or less which shall be subject to tax under
Subsection (A) of Section 24; and other winnings (except Philippine Charity Sweepstakes and
Lotto winnings), derived from sources within the Philippines: Provided, however, That interest
income received by an individual taxpayer (except a nonresident individual) from a
depository bank under the expanded foreign currency deposit system shall be subject to a
final income tax at the rate of seven and one-half percent (7 1/2%) of such interest income:
Provided, further, That interest income from long-term deposit or investment in the form of
savings, common or individual trust funds, deposit substitutes, investment management
accounts and other investments evidenced by certificates in such form prescribed by the
Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed under this
Subsection: Provided, finally, That should the holder of the certificate pre-terminate the
deposit or investment before the fifth (5th) year, a final tax shall be imposed on the entire
income and shall be deducted and withheld by the depository bank from the proceeds of the
long-term deposit or investment certificate based on the remaining maturity thereof:
Four (4) years to less than five (5) years — 5%;
Three (3) years to less than four (4) years — 12%; and
Less than three (3) years — 20%
Sec. 22. Definitions. – When used in this Title:
(Y) The term 'deposit substitutes' shall mean 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 borrower's own account, for the purpose of re-lending
or purchasing of receivables and other obligations, or financing their own needs or the needs
of their agent or dealer. 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: Provided, however, That debt instruments issued for inter-bank 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.
Sec. 22. Definitions. – When used in this Title:
(FF) The term 'long-term deposit or investment certificate' shall refer to certificate of time
deposit or investment in the form of savings, common or individual trust funds, deposit
substitutes, investment management accounts and other investments with a maturity period
of not less than five (5) years, the form of which shall be prescribed by the Bangko Sentral ng
Pilipinas (BSP) and issued by banks only (not by non-bank financial intermediaries and
finance companies) to individuals in denominations of Ten thousand pesos (P10,000) and
other denominations as may be prescribed by the BSP.
REV. REGS. 10-98
Sec. 2.24. Income Tax Rate of Interest Income from Foreign Currency Deposit. —
(A) Individual Income Tax on Interest Income from a Depository Bank under the Foreign
Currency Deposit System
(1) Interest income which is actually or constructively received by a resident citizen of the
Philippines or by a resident alien individual from a foreign currency bank deposit shall be
subject to a final withholding tax of seven and one-half percent (7.5%). The depository bank
shall withhold and remit the tax pursuant to Sections 57 and 58 (withholding tax at source) of
the Code.
(2) If a bank account is jointly in the name of a non-resident citizen such as an overseas
contract worker, or a Filipino seaman, and his spouse or dependent who is a resident in the
Philippines, fifty percent (50%) of the interest income from such bank deposit shall be treated
as exempt while the other fifty percent (50%) shall be subject to a final withholding tax of
seven and one-half percent (7.5%).
(B) Compliance and Administrative Procedures for Non-Resident Citizen and Non-Resident Alien.
The tax on interest income from foreign currency deposit shall be imposed unless the
depositor who is a non-resident citizen or a non-resident alien can present documentary
evidence that he is not a resident of the Philippines. Such evidence shall consist of the original
or certified copy of any of the following:
(1) an immigration visa issued by the foreign government in the country where he is a
resident of; or
(2) a certificate of residency which is issued by the Philippine Embassy or Consulate in the
foreign country of his residence; or
(3) a certificate of the contract of employment of an overseas contract worker which is duly
registered with the Philippine Overseas Employment Agency (POEA); or a Seaman's
Certificate, in the case of a Filipino seaman; or
(4) a certification from the Bureau of Immigration of the Philippines that a non-resident
81 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
alien is not a resident of the Philippines; or
(5) a certification from the Department of Foreign Affairs (DFA) of the Philippines that the
individual is a regular member of the diplomatic corps of a foreign government and is
entitled to income tax exemption under an international agreement to which the
Philippines is a signatory.
(C) Name of the Foreign Currency Bank Account — To be entitled to an exemption from the tax
on interest income on foreign currency deposit, the Foreign Currency Bank Account shall be in
the name of the non-resident individual or non-resident corporation. Otherwise, the interest
income therefrom shall be considered as subject to the tax imposed herein.
Sec. 2.27 and Sec. 2.28 — Corporate Income Tax on Interest Income from a Depository Bank
under the Foreign Currency Deposit System.
(A) Interest income which is actually or constructively received by a domestic corporation or
a resident foreign corporation from a foreign currency bank deposit shall be subject to a final
withholding tax at the rate of seven and one-half percent (7.5%) based on the gross amount of
such interest income. The depository bank shall withhold and remit the tax pursuant to the
provisions of Sections 57 and 58 (withholding tax at source) of the Code.
(B) Compliance and Administrative Procedures for a Non-resident Corporation. The tax on
interest income from foreign currency deposit shall be imposed unless the depositor, which is
a non-resident corporation, can present documentary evidence that it is not a resident of the
Philippines. Such evidence shall consist of the original or certified copy of all the following
requirements:
A) Certificate of registration of the corporation abroad; and
B) Certification from the Securities and Exchange Commission (SEC) that the non-resident
corporation is not licensed to do business in the Philippines.
(C) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions. In general,
income derived by an FCDU or an OBU from foreign currency transactions with residents of
the Philippines, including local commercial banks, local branches of foreign banks, and other
depository banks under the foreign currency deposit system, shall be subject to a final
withholding tax of ten percent (10%) based on gross income pursuant to Sec. 27(D)(3) and
Sec. 28(A)(4) of the Code. Income from foreign currency transactions shall include interest
income from lending operations, including bank charges, commissions, service fees, and net
foreign exchange transaction gains.
Income from foreign currency transactions with non-residents of the Philippines shall not be
subject to income tax.
The person making the income payment shall withhold and remit the tax withheld pursuant to
the provisions of Sections 57 and 58 of the Code. Thus, in the case of interest payment by a
resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the
withholding agent shall be the said resident.
(D) Taxation of Other Incomes of an FCDU or an OBU . Income derived by an FCDU or an OBU
from activities other than foreign currency transactions shall be subject to the pertinent
income tax/taxes prescribed under Section 27 or Section 28 of the Code. To illustrate: Income
derived by an FCDU from consultancy services and rentals shall be subject to an income tax
based on net income at the tax rates prescribed under Section 27(A) of the Code. Capital gains
derived from the sale, barter, exchange or disposition of shares of stocks in a domestic
corporation shall be subject to tax prescribed under Section 27(D) of the Code.
The aforesaid depository bank shall file its corporate income tax return for income referred to
in the preceding paragraph in accordance with the provisions of Section 52 of the Code. It
shall also declare thereunder all other incomes derived during the taxable period which are
subject to the final withholding taxes, the fact that such final withholding taxes have been
withheld therefrom by the payor notwithstanding, indicating the following information:
(a) Name of the withholding agent;
(b) His/its address;
(c) His/its Taxpayer Identification Number (TIN);
(d) Period covered;
(e) Gross Income;
(f) R ate of final withholding tax applied; and
(g) Amount of final withholding tax withheld.
The submission of the foregoing information shall not be required with respect to its interest
income derived from bank deposits.
Sec. 2.58. Information Requirement for Depositors/Taxpayers Exempt from Withholding Tax on
Interest Income from Foreign Currency Deposits. —
The Depository Bank shall submit with its quarterly withholding tax remittance prescribed
under Sec. 58(A) of the Code a list of all persons and corporations who were given exemption
from the tax on interest income on foreign currency deposits.
To avail of the exemption from the tax on interest income from foreign currency deposit, the
depositor is required to execute a written permission allowing its depository bank to inform
the Commissioner of Internal Revenue that as a non-resident, the depositor is exempt from
the tax. A depositor who fails to comply with this requirement, which constitutes a limited
waiver of the confidentiality of foreign currency deposits, shall not be entitled to the
exemption privilege.
b. FINAL INCOME TAX ON CASH AND/OR PROPERTY DIVIDENDS
SEC. 24. Income Tax Rates. —
(B) Rate of Tax on Certain Passive Income: –
(2) Cash and/or Property Dividends. — A final tax at the following rates shall be imposed upon
the cash and/or property dividends actually or constructively received by an individual from a
domestic corporation or from a joint stock company, insurance or mutual fund companies
(sic)" and a regional operating headquarters of a multinational company, or on the share of an
individual in the distributable net income after tax of a partnership (except a general
professional partnership) of which he is a partner, or on the share of an individual in the net
income after tax of an association, a joint account, or a joint venture or consortium taxable as a
corporation of which he is a member or co-venturer.
Six percent (6%) beginning January 1, 1998;
Eight percent (8%) beginning January 1, 1999;
Ten percent (10%) beginning January 1, 2000.
Provided, however, That the tax on dividends shall apply only on income earned on or after
January 1, 1998. Income forming part of retained earnings as of December 31, 1997 shall not,
82 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
even if declared or distributed on or after January 1, 1998, be subject to this tax.
SEC. 73. Distribution of dividends or Assets by Corporations. -
(A) Definition of Dividends. - The term 'dividends' when used in this Title means any
distribution made by a corporation to its shareholders out of its earnings or profits and
payable to its shareholders, whether in money or in other property.
Where a corporation distributes all of its assets in complete liquidation or dissolution, the
gain realized or loss sustained by the stockholder, whether individual or corporate, is a
taxable income or a deductible loss, as the case may be.
(B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital account
shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a
dividend at such time and in such manner as to make the distribution and cancellation or
redemption, in whole or in part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent that it represents a distribution of earnings or
profits.
(C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. -
Any distribution made to the shareholders or members of a corporation shall be deemed to
have been made form the most recently accumulated profits or surplus, and shall constitute a
part of the annual income of the distributee for the year in which received.
(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The
taxable income declared by a partnership for a taxable year which is subject to tax under
Section 27 (A) of this Code, after deducting the corporate income tax imposed therein, shall be
deemed to have been actually or constructively received by the partners in the same taxable
year and shall be taxed to them in their individual capacity, whether actually distributed or
not.
c. CAPITAL GAINS TAX ON SALE OF SHARES
SEC. 24. Income Tax Rates. —
(C) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange. — The
provisions of Section 39(B) notwithstanding, 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 n domestic corporation, except
shares sold, or disposed of through the stock exchange.
Not over P100,000 5%
On any amount in excess of P100,000 10%
Sec. 127. Tax on Sale, Barter or Exchange of Shares of Stock Listed and Traded through
the Local Stock Exchange or through Initial Public Offering. –
(A) Tax on Sale, Barter or Exchange of Shares of Stock Listed and Traded through the Local
Stock Exchange. – There shall be levied, assessed and collected 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, a tax at the rate of one-half of one
percent (1/2 of 1%) of the gross selling price or gross value in money of the shares of
stock sold, bartered, exchanged or otherwise disposed which shall be paid by the seller or
transferor.
Sec. 22. Definitions. – When used in this Title: Less: CPG due: 3.01 Million

(L) The term 'shares of stock' shall include shares of stock of a corporation, warrants and/or Refund claimed 3 Million
options to purchase shares of stock, as well as units of participation in a partnership BIR averred that:
(except general professional partnerships), joint stock companies, joint accounts, joint
ventures taxable as corporations, associations and recreation or amusement clubs (such a. the burden of proof rests upon petitioner to show that the taxes were paid erroneously
as golf, polo or similar clubs), and mutual fund certificates. or collected illegally;
b. claims for refund are construed strictly against the claimants since they are in the nature
Sec. 22. Definitions. – When used in this Title: of an exemption from taxation; and
(U) The term 'dealer in securities' means a merchant of stocks or securities, whether an c. taxes are presumed to have been paid and collected in accordance with law.
individual, partnership or corporation, with an established place of business, regularly
engaged in the purchase of securities and the resale thereof to customers; that is, one who, ISSUE/S:
as a merchant, buys securities and re-sells them to customers with a view to the gains and WON petitioner is entitled to the refund or issuance of a tax credit certificate in the amount of
profits that may be derived therefrom. P3 Million Pesos allegedly representing its overpaid CGT-on-ST.
RULING:
BENGUET CORP. v. CIR
Yes! Benguet Corp is entitled to refund the amount of its overpaid Capital Gains Tax on Stock
DOCTRINE: Transactions OR to be issued a Tax Credit Certificate.
Tax payers are allowed to claim refunds for overpayments made in Capital Gains Tax Return
It appears that:
on Stock Transactions.
1. Benguet Corp. has complied with the statutory requirement mentioned in Sections 204
FACTS:
and 230 of the Tax Code by having filed a written claim for refund within the two-year
Benguet Corp is engaged in the mining business. It sold 2 sets of shares on different dates in
period from date of payment of the tax;
favor of 2 separate buyers:
2. BIR has NOT disputed the correctness of the Capital Gains Tax Returns and the payment
1. Shares in Itogon-Suyoc Mines
of the petitioner of its capital gains tax on stock transactions amounting to 6 Million
Sale price: 25 Million Pesos; and
Cost of shares: 40 Million 3. BIR manifested to the Court several times that the whole amount of petitioner's claim for
refund or tax credit was favorably recommended by the investigating examiner.
Net Capital Loss -15 Million
d. CAPITAL GAINS TAX ON SALE OF REALTY
2. Shares in Monte de Piedad and Savings Bank
Sale price: 75 Million SEC. 24. Income Tax Rates. —

Cost of shares: 45 Million (D) Capital Gains from Sale of Real Property. –

Net Capital Gain 30 Million (1) In General. — The provisions of Section 39(B) notwithstanding, a final tax of six percent
(6%) based on the gross selling price or current fair market value as determined in
Benguet realized a profit of 15 Million by subtracting the Net Capital Loss from the Net accordance with Section 6(E) of this Code, whichever is higher, is hereby imposed upon
Capital Gain, and from this, the company paid a total of 6 Million in Capital Gains Tax. capital gains presumed to have been realized from the sale, exchange, or other
Benguet filed with BIR a written claim for refund or tax credit worth 3 Million Pesos for over disposition of real property located in the Philippines, classified as capital assets,
overpayments made based on the following computation: including pacto de retro sales and other forms of conditional sales, by individuals,
Including estates and trusts: Provided, That the tax liability, if any, on gains from sales or
Total Profit(basis of CPG): 15 Million
other dispositions of real property to the government or any of its political subdivisions
Total Capital Gains Tax: or agencies or to government-owned or -controlled corporations shall be determined
either under Section 24(A) or under this Subsection, at the option of the taxpayer;
Not over 100K x 10% 10K
(2) Exception. — The provisions of paragraph (1) of this Subsection to the contrary
Over 100K x 20% 3 Million notwithstanding, capital gains presumed to have been realized from the sale or
Total Capital Gains Tax 3.01 Million disposition of their principal residence by natural persons, the proceeds of which is fully
utilized In acquiring or constructing a new principal residence within eighteen (18)
calendar months from the date of sale or disposition, shall be exempt from the capital
gains tax imposed under this Subsection: Provided, That the historical cost or adjusted
Total CPG paid: 6 Million
basis of the real property sold or disposed shall be carried over to the new principal

83 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 residence built or acquired: Provided, further, That the 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 herein
mentioned: Provided, still further, That the said tax exemption can only be availed of once
every ten (10) years: Provided, finally, That 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 d imposition 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 amount bears to the gross selling price in order to
determine the taxable portion and the tax prescribed under paragraph (1) of this
Subsection shall be imposed thereon.
REV. REGS. 8-98 – Revenue Regulations Amending Pertinent Portions of Revenue Regulations
Nos. 11-96 and 2-98 Relative to the Tax Treatment on the Sale, Transfer or Exchange of Real
Property and for this Purpose Revising the Time and Place of Payment of the Capital Gains Tax
Due Thereon
SECTION 1. Scope. — Pursuant to Section 244 of the Tax Code of 1997, in relation to Sections
24(D)(1) and 27(D)(5) of the same Code, these Regulations are hereby promulgated amending
pertinent portions of Revenue Regulations Nos. 11-96 and 2-98 and other relevant regulations
and issuances regarding the tax treatment on the sale, transfer or exchange of real property
and amending for this purpose the date and venue for the filing of capital gains tax returns
and payment of taxes due on transactions involving real properties classified as capital assets
and likewise amending the venue for the filing and payment of creditable withholding tax due
on transactions involving real properties classified as ordinary assets.
SECTION 2. Final Tax on Sales, Exchanges or Transfers of Real Properties Classified as Capital
Assets. — The rate of six percent (6%) shall be imposed on capital gains presumed to have
been realized by the seller from the sale, exchange or other disposition of real properties
located in the Philippines, classified as capital assets, including pacto de retro sales and other
forms of conditional sales based on the gross selling price or fair market value as determined
in accordance with Section 6(E) of the Code (i.e., the authority of the Commissioner to
prescribe the real property values), whichever is higher.
In case of disposition of real property made by individuals to the government or to any of its
political subdivisions or agencies or to government-owned or -controlled-corporations, the
tax to be imposed shall be determined either under the normal income tax rate imposed in
Section 24(A) or under a final capital gains tax of six percent (6%) imposed under Section
24(D)(1), both of the Tax Code of 1997, at the option of the taxpayer.
SECTION 3. Time and Place of Payment of Capital Gains Tax. — Within thirty (30) days
following each sale or disposition, the Capital Gains Tax Return shall be filed by the seller and
payment made to an Authorized Agent Bank (AAB) located within the Revenue District Office
(RDO) having jurisdiction over the place where the property being transferred is located.
SECTION 4. Creditable Withholding Tax on the Sale, Transfer or Exchange of Real Property
Classified as Ordinary Asset. — A creditable withholding tax based on the gross selling
price/total amount of consideration or the fair market value determined in accordance with
Section 6(E) of the Code, whichever is higher, paid to the seller/owner for the sale, transfer or
exchange of real property, other than capital asset, shall be imposed upon the withholding
agent/buyer, in accordance with the following schedule:
A. Upon the following values of real property, where
the seller/transferor is habitually engaged in the
real estate business as per proof of registration
84 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
with the HLURB or HUDCC:
With a selling price of P500,000 or less 1.5%
With a selling price of more than P500,000 but
not more than P2,000,000 3.0%
With a selling price of more than P2,000,000 5.0%
B. Where the seller/transferor is not habitually
engaged in the real estate business 7.5%
C. Where the seller/transferor is exempt from
creditable withholding tax in accordance with
Section 2.57.5 of Revenue Regulations No. 2-98 Exempt
SECTION 5. Time and Place of Payment of Creditable Withholding Tax. — Creditable
withholding taxes deducted and withheld by the withholding agent/buyer on the sale, transfer
or exchange of real property classified as ordinary asset, shall be paid by the withholding
agent/buyer upon filing of the return with the Authorized Agent Bank (AAB) located within
the Revenue District Office (RDO) having jurisdiction over the place where the property being
transferred is located within ten (10) days following the end of the month in which the
transaction occurred. Provided, however, that taxes withheld in December shall be filed on or
before January 25 of the following year.
SECTION 6. Tax Clearance Certificate. — Upon presentation of the Capital Gains Tax Return or
Creditable Withholding Tax Return with a bank validation evidencing full payment of the
capital gains tax or the creditable withholding tax due on the sale, transfer, barter, exchange
or other disposition of real property classified as capital or ordinary asset, as the case may be,
the Revenue District Officer (RDO) of the revenue district where the property being
transferred is located shall issue the corresponding Tax Clearance (TCL) or Certificate
Authorizing Registration (CAR) for the registration of the real property in favor of the
transferee.
REV. REGS. 13-99 – Exemption of Certain Individuals from the Capital Gains Tax on the Sale,
Exchange or Disposition of a Principal Residence under Certain Conditions
SECTION 3. Conditions of Exemption. — 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 income
tax, including the six percent (6%) capital gains tax, subject to the following conditions:
(3) Sworn Declaration Requirement. — He shall submit a Sworn Declaration (ANNEX A
hereof) of his intent to avail of the tax exemption herein provided which shall be filed
with the aforementioned Revenue District Office (RDO) having jurisdiction over the
location of the principal residence within thirty (30) days from the date of its sale,
exchange or disposition, inclusive of the following:
(a) Duly Accomplished Capital Gains Tax Return (BIR Form No. 1706);
(b) P roof of payment of documentary stamp tax on conveyance of real property;
(c) A sworn statement from the Barangay Chairman that his principal residence is
located within the jurisdiction of that Barangay and has been his residence as of the
date of sale, exchange or disposition thereof;
(d) A duplicate original copy of the Deed of Conveyance of his Principal Residence;
 (e) Photocopy of the Transfer Certificate of Title (TCT) or Condominium Certificate of
Title (CCT), in case of a condominium unit (covering the principal residence sold,
exchanged or disposed); and
(f) Latest Tax Declaration of the said principal residence (land and improvement).
(4) Post Reporting Requirement. — The proceeds from the sale, exchange or disposition of his
principal residence must be fully utilized in acquiring or constructing his new principal
residence within eighteen (18) calendar months from date of its sale, exchange or
disposition. In order to show proof that positive action was undertaken to utilize the
proceeds for the acquisition or construction of his new principal residence within the 18-
month reglementary period, he shall submit to the RDO concerned, within thirty (30)
days from the lapse of the said period, the following documents:
(a) A sworn statement that the total proceeds from the sale of his old principal
residence has been actually utilized in the acquisition or construction of his new
principal residence or, if the construction of his new principal residence is still in
progress, a sworn statement that such amount shall be fully utilized to procure the
necessary materials and pay for the cost of labor and other expenses for the
construction thereof;
(b) A certified statement from his architect or engineer, or both, showing the cost of
materials and labor for the construction of his new principal residence;
(c) A certified copy of the Building Permit issued by the Office of the Building Official of
the City or Municipality where his new principal residence shall be constructed, as
well as photocopies of documents (e.g. building specification plan, construction
plans, construction cost estimates) submitted with his application for said permit;
(d) In case his new principal residence is acquired by purchase, a duplicate original
copy of the Deed of Absolute Sale covering the purchase of his new principal
residence.
(5) The tax exemption herein granted may be availed of only once every ten (10) years;
(6) The historical cost or adjusted basis of his old principal residence sold, exchanged or
disposed shall be carried over to the cost basis of his new principal residence; and
(7) If there is no full utilization of the proceeds of sale, exchange or disposition of his old
principal residence for the acquisition or construction of his new principal residence, he
shall be liable for deficiency capital gains tax which shall be computed in accordance with
Sec. (4) hereof. Accordingly, only a fractional part (which the utilized amount bears to the
gross selling price) of the historical cost of the old principal residence sold shall be
carried over to the cost basis of the new principal residence.
SECTION 4. Determination of Capital Gains Tax Due if the Proceeds of Sale, Exchange or
Disposition of his Principal Residence has not Been Fully Utilized. — In a case where the entire
proceeds of sale is not utilized for the purchase or construction of a new principal residence,
the capital gains tax shall attach. In computing the capital gains tax due on the sale of the
principal residence, we follow the following steps:
(1) Determine the percentage (%) of non-utilization applying the formula:
Unutilized Portion of GSP
----------------------------------- = Percentage (%) of Non-Utilization
GSP
(2) Multiply the % of non-utilization by the GSP or FMV, whichever is higher.
85 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(3) Multiply the product in item (2) above by the rate of six percent (6%).
If the seller fails to utilize the proceeds of sale or disposition in full or in part within the 18-
month reglementary period, his right of exemption from the capital gains tax did not arise to
the extent of the unutilized amount, in which event, the tax due thereon shall immediately
become due and demandable on the 31st day after the date of the sale, exchange or
disposition of principal residence. As such, he shall file his capital gains tax return covering the
sale, exchange or disposition of his principal residence and pay the deficiency capital gains tax
inclusive of the twenty five percent (25%) surcharge for late payment of the tax plus twenty
percent (20%) delinquency interest per annum incident to such late payment computed on
the basis of the basic tax assessed. The interest shall be imposed from the thirty-first (31st)
day after the date of the sale of principal residence until the date of payment, provided, that
the date of sale shall mean the date of notarization of the document of sale, exchange, or
disposition of principal residence.
SECTION 5. Disposition of the Principal Residence in Exchange for Property Other than Cash. —
(1) If the individual taxpayer's principal residence is disposed in exchange for a condominium
unit, the disposition of the taxpayer's principal residence shall not be subjected to the capital
gains tax herein prescribed, provided that the said condominium unit received in the
exchange shall be used by the taxpayer-transferor as his new principal residence. In this
particular case, the exempt provision of Sec. 24(D)(2) of the 1997 Tax Code shall only apply to
the transferor of the principal residence and not to the transferee who shall be subject to the
capital gains tax in case his/its condominium unit is treated as capital asset or to the income
tax which shall be withheld in accordance with Sec. 2.57.2(J) of Revenue Regulations No. 2-98,
as amended, in case the condominium unit is treated as an ordinary asset. However, if the
condominium unit is similarly treated by an individual owner as his principal residence, then
the same shall also be covered by the exempt provision under Sec. 24(D)(2) of the same Code.
(2) If the said taxpayer's principal residence is disposed of in exchange for a parcel of land and
such land received in the exchange shall be used for the construction of his new principal
residence, no income tax or capital gains tax shall be imposed upon the owner of the principal
residence. However, the owner of the land shall be subject to capital gains tax or to income
tax, as the case may be.
(3) If in the acquisition of his new principal residence, the taxpayer exchanged his old
principal residence plus cash or other property, the unutilized portion subject to capital gains
tax shall be determined by the difference between the total consideration made on the
conveyance of old principal residence transferred (FMV of old principal residence + cash or
FMV of other property) and the total consideration received (FMV of new principal residence)
for such exchange.
In order to avail of the tax exemption from capital gains tax with respect to such exchanges,
the aforesaid taxpayer is nevertheless required to acquire his new principal residence within
the eighteen (18) month reglementary period, otherwise, he shall be liable to pay the capital
gains tax on the disposition of his principal residence.
In all cases of exchange of principal residence for another real property, the liability of
documentary stamp tax provided under Sec. 196 of the 1997 Code shall accrue to both parties
involved in the exchange.
SECTION 6. Issuance of Certificate Authorizing Registration (CAR) or Tax Clearance Certificate
(TCL). — The taxpayer's filing of the Sworn Declaration of Intent to avail of the capital gains
tax exemption in the manner prescribed under Sec. (3) hereof shall be a sufficient basis of the
RDO to approve and issue the CAR or TCL of the principal residence sold, exchanged or
disposed by the aforesaid taxpayer.
Said CAR or TCL shall state that on the sale, exchange or disposition of the taxpayer's principal
residence is exempt from capital gains tax pursuant to Sec. 24(D)(2) of the Code.
REV. REGS. 14-2000 - Sections 2(2), 3 and 6 of Revenue Regulations No. 13-99 vis-a-vis sale,
exchange or disposition, by a natural person, of his "Principal Residence"
(b) Where ownership of the land and the dwelling house thereon belongs to different persons,
e.g., where the land is leased to the dwelling house owner, only the dwelling house shall be
treated as Principal Residence of the dwelling house owner. Thus, if the said land and the
dwelling house thereon be jointly sold or disposed by the said owners, only the-sale or
disposition of the dwelling house shall be entitled to the benefit of exemption from the capital
gains tax herein prescribed: Provided, however, that where both the owner of the land and
owner of the dwelling house actually reside in the said dwelling house, then both the said land
and dwelling house shall be treated as their Principal Residence (e.g., owner of the land is the
parent while owner of the house is his child, or vice versa).
"(c) Where the land and the dwelling house thereon be owned by several co-owners, e.g.,
inherited by two or more heirs through hereditary succession, and where the said property is
actually used as Principal Residence by one or more of the said co-owners, including the
members of his/their family, the said property shall be treated as the Principal Residence of
the co-owner/s actually occupying and using the same as his/their Principal Residence but to
the extent of his/their proportionate share in the value of the principal residence. Conversely,
the capital gains tax exemption benefit herein prescribed shall not apply in respect of the
other co-owners who do not actually use and occupy the same as their Principal Residence.
"(d) The residential address shown in the latest income tax return filed by the
vendor/transferor immediately preceding the date of sale of the said real property shall be
treated, for purposes of these Regulations, as a conclusive presumption about his true
residential address, the certification of the Barangay Chairman, or Building Administrator (in
case of a condominium unit), to the contrary notwithstanding, in accordance with the doctrine
of admission against interest or the principle of estoppel (e.g., if the property was sold on May 1,
2000, the vendor's annual income tax return for the year 1999, which he filed on or before
April 15, 2000, showing his residential address, shall be treated as a conclusive presumption
that his true residential address is that which is shown in his aforesaid income tax return). If
the vendor is exempt from filing any tax return, in which case, he has no tax record
immediately prior to the sale of his property, then the aforementioned certification from the
Barangay Chairman or Building Administrator, as the case may be, shall suffice."
SEC. 3. Conditions for Exemption. — 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. — The six percent (6%) capital gains tax otherwise due on the
presumed capital gains derived from the sale, exchange or disposition of his Principal
Residence shall be deposited in cash or manager's check in interest-bearing account with an
Authorized Agent Bank (AAB) under an Escrow Agreement (ANNEX A hereof) between the
concerned Revenue District Officer, the Seller/Transferor and the AAB to the effect that the
amount so deposited, including its interest yield, shall only be released to such
Seller/Transferor upon certification by the said RDO that the proceeds of sale or disposition
thereof has, in fact, been utilized in the acquisition or construction of the Seller/Transferor's
new Principal Residence within eighteen (18) calendar months from date of the said sale or
disposition. The date of sale or disposition of a property refers to the date of notarization of
the document evidencing the transfer of said property. In general, the term "Escrow" means "A
scroll, writing or deed, delivered by the grantor, promisor or obligor into the hands of a third
86 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
person, to be held by the latter until the happening of a contingency or performance of a
condition, and then by him delivered to the grantee, promisee or obligee."
"(2) Capital Gains Tax Return. — The Seller/Transferor shall file, in duplicate, his Capital Gains
Tax Return (BIR FORM No. 1706) covering the sale or disposition of his Principal Residence
with the concerned .Revenue District Office within thirty (30) days from date of its sale or
disposition: Provided, however, that the Seller/Transferor shall not be required to pay any
capital gains tax during the 18-month period on the sale of his principal residence duly
established as such. Provided, further, that for purposes of the capital gains tax otherwise due
on the sale, exchange or disposition of the said Principal Residence, the execution of the Escrow
Agreement referred to in the immediately preceding Section 3 (1) hereof shall be considered
sufficient.
"The following shall be submitted with the Capital Gains Tax Return herein required to be
filed:
(a) Proof of payment of the documentary stamp tax imposed under Sec. 196 of the Tax Code of
1997 on the deed of sale or conveyance of the said "Principal Residence;"
(b) A sworn statement from the Barangay Chairman that the taxpayer's Principal Residence is
located within the jurisdiction of that Barangay and that the same has been his residence
immediately prior to the date of its sale or disposition: Provided, however, that if the
taxpayer's Principal Residence sold or disposed is a condominium unit, in lieu of the said
Barangay Chairman, the certification shall be issued by the Building Administrator of the
Condominium building.
(c) A duplicate original copy of the Deed of Conveyance of his Principal Residence;
(d) A certified xerox copy of the Transfer Certificate of Title (TCT) or Condominium
Certificate of Title (CCT), in case of a condominium unit, covering the Principal Residence sold
or disposed;
(e) A certified xerox copy of the latest Tax Declaration covering the said Principal Residence
(land and improvement); and
(f) If the building or improvement thereon has been constructed on or after the year 1990, the
Building Permit or Occupancy Permit issued by the concerned city or municipality, showing
the amount of the construction cost thereof.
"(3) Post Reporting Requirement. — The proceeds from the sale, exchange or disposition of his
old Principal Residence must be fully utilized in acquiring or constructing his new Principal
Residence within eighteen (18) calendar months from date of its sale, exchange or disposition.
in order to show proof that positive action was undertaken to utilize the proceeds for the
acquisition or construction of his new Principal Residence within the 18-month reglementary
period, he shall submit to the RDO concerned, within thirty (30) days from the lapse of the
said period, the following documents:
(a) A sworn statement that the total proceeds from the sale or disposition of his old Principal
Residence has been actually utilized in the acquisition or construction of his new Principal
Residence or, if the construction of his new Principal Residence is still in progress, a sworn
statement that such amount shall be fully utilized to procure the necessary materials and pay
for the cost of labor and other expenses for the construction thereof;
(b) A certified statement from his architect or engineer, or both, showing the cost of materials
and labor for the construction of his new Principal Residence;
(c) A certified copy of the Building Permit issued by the Office of the Building Official of the
City or Municipality where his new Principal Residence shall be constructed as well as xerox
copies of documents (e.g., building specification plan, construction plans, or construction cost
estimates) submitted with his application for the said Building Permit on which computation
of the amount of the building license fee has been based;
(d) In case his new Principal Residence is acquired by purchase, a duplicate original copy of the
Deed of Absolute Sale covering the purchase of his new Principal Residence.
"(4) Release from the Escrow Agreement. — Upon a showing, based on the foregoing
documents, that the proceeds of sale, exchange or disposition of his old Principal Residence
have already been fully utilized in the acquisition or construction of his new Principal
Residence, the concerned Revenue District Officer shall, within fifteen (15) days from date of
submission by the Seller/Transferor of the foregoing documents, release the Escrow on the
aforesaid bank deposit in favor of the Seller/Transferor (ANNEX B hereof).
"(5) Limitation on Tax Exemption Privilege. — The tax exemption herein granted may be
availed of only once every ten (10) years;
"(6) Cost Basis of the New "Principal Residence". — The historical cost or adjusted cost basis of
his old Principal Residence sold, exchanged or disposed shall be carried over to the cost basis
of his new Principal Residence; and
"(7) Assessment for Deficiency Capital Gains Tax; Application of the Escrowed Bank Deposit
Against the Deficiency Tax. — If the Seller/Transferor fails to submit documentary evidence
within thirty (30) days after the lapse of the aforesaid 18-month period, showing that he has
utilized the proceeds of sale, exchange or disposition of his old Principal Residence to acquire
or construct his new Principal Residence, it shall be presumed that he did not, in fact, utilize
the aforesaid proceeds of sale for the construction or acquisition of his new Principal
Residence, in which case, he shall be treated deficient in the payment of his capital gains tax
from the sale or disposition of his aforesaid Principal Residence, and shall be accordingly be
assessed for deficiency capital gains tax, inclusive of the 20% interest per annum, pursuant to
the provisions of Section 228 of the Code, as implemented by Revenue Regulations No. 12-99,
in relation to Section 249 of the said Code.
Pursuant to the provisions of Revenue Regulations No. 12-99, the taxpayer shall be issued
with the required Post Reporting Notice informing him, in writing, of the aforementioned facts,
in order that he may present his side of the case through informal conference, and the
required Preliminary Assessment Notice, before issuance of the Formal Assessment Notice. If, at
this point in time, the escrowed tax money is still in the custody of the Depository Bank, the
full amount thereof, including its interest earnings, shall be applied in computing for the
taxpayer's deficiency capital gains tax. Upon the time that the said deficiency tax assessment
has become final and executory, the deposit in escrow, inclusive of its interest earnings, shall
be forfeited and applied against the taxpayer's deficiency capital gains tax liability. The
depository Bank shall forthwith be informed of this action, and shall, upon demand in writing,
by the Commissioner or his duly authorized representative (ANNEX C hereof), turn over the
money for application in payment of the taxpayer's deficiency tax liability. If the same is
insufficient to cover the entire amount assessed, the seller/transferor shall remain liable for
the remaining balance of the assessment. On the other hand, the excess of the deposit in
escrow, if any, shall forthwith be returned to the Seller/Transferor, by the Bank, upon written
authorization from the Commissioner or his duly authorized representative.
"(8) Partial Utilization of the Proceeds of Sales Exchange or Disposition. — If there is no full
utilization of the proceeds of sale, exchange or disposition of his old Principal Residence for the
acquisition or construction of his new Principal Residence, he shall be liable for deficiency
capital gains tax, inclusive of 20% interest per annum, computed from the 31st day after the
date of sale or disposition of the said old Principal Residence."
87 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
2.3. Section 6 of Revenue Regulations No. 13-99 is hereby amended, to read as follows:
"SEC 6. Issuance of Certificate Authorizing Registration (CAR) or Tax Clearance Certificate
(TCL). — The seller/transferor's compliance with the preliminary conditions for exemption
under Sec. 3(1) and (2) of these Regulations shall be sufficient basis for the RDO to approve
and issue the CAR or TCL of the principal residence sold, exchanged or disposed by the
aforesaid taxpayer. Said CAR or TCL shall state that the said sale; exchange or disposition of
the taxpayer's principal residence is exempt from capital gains tax pursuant to Sec. 24 (D)(2)
of the Code but subject to compliance with the post-reporting requirements imposed under Sec.
3(3) of these Regulations.
SECTION 3. Penalty Clause. — (1) Any Barangay Chairman, or Building Administrator, as the
case may be, who shall falsely certify that the property sold or disposed is the
vendor/transferor's Principal Residence when, in truth and in fact, it is not, shall be punished
under the penalty of perjury, at the discretion of the Court.
(2) Any other violation of the provisions of these Regulations shall, upon conviction for each
act or omission, be punishable under Section 275 of the Code by a fine of not more than One
Thousand Pesos (P1,000.00) or imprisonment of not more than six (6) months, or both, at the
discretion of the Court.
REV. REGS. 4-99 – Payment of Capital Gains Tax and Documentary Stamp Tax on Extra-
Judicial Foreclosure Sale of Capital Assets Initiated by Banks, Finance and Insurance Companies
SECTION 3. Capital Gains Tax. —
(1) In case the mortgagor exercises his right of redemption within one year from the issuance
of the certificate of sale, no capital gains tax shall be imposed because no capital gains has
been derived by the mortgagor and no sale or transfer of real property was realized. A
certification to that effect or the deed of redemption shall be filed with the Revenue District
Office having jurisdiction over the place where the property is located which certification or
deed shall likewise be filed with the Register of Deeds and a brief memorandum thereof shall
be made by the Register of Deeds on the Certificate of Title of the mortgagor.
(2) In case of non-redemption, the capital gains tax on the foreclosure sale imposed under
Secs. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price
of the highest bidder but only upon the expiration of the one-year period of redemption
provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid
within thirty (30) days from the expiration of the said one-year redemption period.
SECTION 4. Documentary Stamp Tax. —
(1) In case the mortgagor exercises his right of redemption, the transaction shall only be
subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997
because no land or realty was sold or transferred for a consideration.
(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied,
collected and paid by the person making, signing, issuing, accepting, or transferring the real
property wherever the document is made, signed, issued, accepted or transferred where the
property is situated in the Philippines; Provided, That whenever one party to the taxable
document enjoys exemption from the tax, the other party thereto who is not exempt shall be
the one directly liable for the tax. The tax return prescribed under the Code shall be filed
within ten (10) days after the close of the month following the lapse of the one-year
redemption period, and the tax due under Sec. 196 of the Tax Code of 1997 shall be paid based
on the bid price at the same time the aforesaid return is filed.
SECTION 5. Tax Clearance Certificate/Certificate Authorizing Registration. — In case of non-
redemption, a tax clearance certificate (TCC) or Certificate Authorizing Registration (CAR) in
favor of the purchaser/highest bidder shall only be issued upon presentation of the capital
gains and documentary stamp taxes returns duly validated by an authorized agent bank (AAB)
evidencing full payment of the capital gains and documentary stamp taxes due imposed under
Secs. 3 and 4 of these Regulations on the sale of the property classified as capital asset. The
AAB must be located at the Revenue District Office having jurisdiction over the place where
the property is located.
4. PERSONAL AND ADDITIONAL EXEMPTIONS
SEC 35. Allowance of Personal Exemption for Individual Taxpayer –
(B) In General. – For purposes of determining the tax provided in Section 24(A) of this Title,
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 spouses is deriving gross income,
only such spouse shall be allowed the personal exemption.
(C) Additional Exemption for Dependents. – There shall be allowed an additional exemption of
Twenty-five Thousand pesos (P25,000) for each dependent not exceeding four (4).
The additional exemption for dependents shall be claimed by only one of the spouses in
the case of married individuals.
In the case of legally separated spouses, additional exemptions may be claimed only by the
spouse who has custody of the child or children: Provided, That the total amount of
additional exemptions that may be claimed by both shall not exceed the maximum
additional exemptions herein allowed.
For purposes of this Subsection, a ‘dependent’ means a legitimate, illegitimate, or legally
adopted child chiefly dependent upon and living with the taxpayer if such dependent is not
more than twenty-one (21) years of age, unmarried and not gainfully employed or if such
dependent, regardless of age, is incapable of self-support because of mental or physical
defect.
5. CHANGE OF STATUS
SEC 35. Allowance of Personal Exemption for Individual Taxpayer –
(D) Change of Status. – if the taxpayer marries or should have additional dependent(s) as
defined above during the taxable year, the taxpayer may claim the corresponding
additional exemption, as the case may be, in full for such year.
If the taxpayer dies during the taxable year, his estate may still claim the personal and
additional exemptions for himself and his dependent(s) as if he died at the close of such
year.
If the spouse or any of the dependents dies or if any of such dependents marries, becomes
twenty-one (21) years old or becomes gainfully employed during the taxable year, the
taxpayer may still claim the same exemptions as if the spouse or any of the dependents
died, or as if such dependents married, became twenty-one (21) years old or became
gainfully employed at the close of such year.
88 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
6. OPTIONAL STANDARD DEDUCTION
SEC 34. (L) Optional Standard Deduction. - In lieu of the deductions allowed under the
preceding Subsections, an individual subject to tax under Section 24, other than a nonresident
alien, may elect a standard deduction in an amount not exceeding forty percent (40%) of his
gross sales or gross receipts, as the case maybe. In the case of a corporation subject to tax
under Sections 27(A) and 28(A)(1), it may elect a standard deduction in an amount not
exceeding forty percent (40%) of its gross income as defined in Section 32 of this Code. Unless
the taxpayer signifies in his return his intention to elect the optional standard deduction, he
shall be considered as having availed himself of the deductions allowed in the preceding
Subsections. Such election when made in the return shall be irrevocable for the taxable year
for which the return is made: Provided, That an individual who is entitled to and claimed for
the optional standard deduction shall not be required to submit with his tax return such
financial statements otherwise required under this Code: Provided, further, That except when
the Commissioner otherwise permits, the said individual shall keep such records pertaining to
his gross income during the taxable year, as may be required by the rules and regulations
promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
7. PREMIUM PAYMENTS ON HEALTH AND/OR HOSPITALIZATION INSURANCE
SEC 34. (M) Premium Payments on Health and/or Hospitalization Insurance of an
Individual Taxpayer. - the amount of premiums not to exceed Two thousand four hundred
pesos (P2,400) per family or Two hundred pesos (P200) a month paid during the taxable year
for health and/or hospitalization insurance taken by the taxpayer for himself, including his
family, shall be allowed as a deduction from his gross income: Provided, That said family has a
gross income of not more than Two hundred fifty thousand pesos (P250,000) for the taxable
year: Provided, finally, That in the case of married taxpayers, only the spouse claiming the
additional exemption for dependents shall be entitled to this deduction.
Notwithstanding the provision of the preceding Subsections, The Secretary of Finance, upon
recommendation of the Commissioner, after a public hearing shall have been held for this
purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized
deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of
determining such ceilings or limitations, the Secretary of Finance shall consider the following
factors: (1) adequacy of the prescribed limits on the actual expenditure requirements of each
particular industry; and (2)effects of inflation on expenditure levels: Provided, further, That
no ceilings shall further be imposed on items of expense already subject to ceilings under
present law.
C. INCOME TAX ON NONRESIDENT ALIENS ENGAGED IN TRADE OR
BUSINESS IN THE PHILIPPINES
1. MEANING OF “ENGAGED IN TRADE OR BUSINESS”
REV. REGS. 2 - SECTION 8. Taxation of non-resident aliens; classification. — Non-resident
alien individuals are divided into two classes: (1) Those engaged in trade or business within
the Philippines, and (2) those not engaged in trade or business within the Philippines. Non-
resident aliens falling within the first class are subject to the graduated rates established in
Section 21 with respect to their net income from sources within the Philippines. Non-resident
aliens falling within the second class are subject to a flat rate of 20 per cent on their total
income from sources within the Philippines, if such total income does not exceed P23,800,
otherwise, the graduated rates established in Section 21 will apply to the total income if it
exceeds P23,800. (Conforms with amendments by R.A. 2343, effective June 20, 1959.)
The phrase "engaged in trade or business within the Philippines" includes the performance of
personal services within the Philippines. Whether a non-resident alien has an "office or place
of business," however, implies a place for the regular transaction of business and does not
include a place where casual or incidental transactions might be, or are, effected. Neither the
beneficiary nor the grantor of a trust, whether revocable or irrevocable, is deemed to be
engaged in trade or business in the Philippines or to have an office or place of business
therein, merely because the trustee is engaged in trade or business in the Philippines or has an
office or place of business therein. (Test of "office or place of business" was deleted by R.A.
2343.)
SEC. 25. Tax on Nonresident Alien Individual. —
(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. —
(1) In General. — A nonresident alien individual engaged in trade or business in the
Philippines shall be subject to an income tax in the same manner as an individual citizen
and a resident alien individual, on taxable income received from all sources within the
Philippines. A nonresident alien individual who shall come to the Philippines and stay
therein for an aggregate period of more than one hundred eighty (180) days during any
calendar year shall be deemed a 'nonresident alien doing business in the Philippines,'
Section 22(G) of this Code notwithstanding.
HIGGINS v. CIR
DOCTRINE:
Mere investment, including the active management of one’s own investment, however
intensive, does not constitute a trade or business.
FACTS:
Petitioner, the taxpayer, with extensive investments in real estate, bonds and stocks, devoted
a considerable portion of his time to the oversight of his interests and hired others to assist
him in offices rented for that purpose. For the tax years 1932 and 1933, he claimed the
salaries and expenses incident to looking after his properties were deductible under Section
23(a) of the Revenue Act of 1932. The Commissioner refused the deductions. The
Commissioner conceded before the Board of Tax Appeals that the real estate activities of the
petitioner in renting buildings constituted a business. The Board allowed such portions of the
claimed deductions as were fairly allocable to the handling of the real estate. The same offices
and staffs handled both real estate and security matters. After this adjustment there remained
for the year 1932 over $20,000 and for the year 1933 over $16,000 expended for managing
the stocks and bonds.
Petitioner's financial affairs were conducted through his New York office pursuant to his
personal detailed instructions. His residence was in Paris, France, where he had a second
office. By cable, telephone and mail, petitioner kept a watchful eye over his securities. The
offices kept records, received securities, interest and dividend checks, made deposits,
forwarded weekly and annual reports and undertook generally the care of the investments as
instructed by the owner. Purchases were made by a financial institution. Petitioner did not
participate directly or indirectly in the management of the corporations in which he held stock
or bonds. The method of handling his affairs under examination had been employed by
petitioner for more than 30 years. No objection to the deductions had previously been made
by the Government. The Board of Tax Appeals held that these activities did not constitute
carrying on a business and that the expenses were capable of apportionment between the real
estate and the investments. The Circuit Court of Appeals affirmed.
ISSUE: Whether or not taxpayer is entitled to the deduction? NO.
89 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
RULING:
Petitioner urges that the 'elements of continuity, constant repetition, regularity and extent'
differentiate his activities from the occasional like actions of the small investor. His activity is
and the occasional action is not 'carrying on business.' On the other hand, the respondent
urges that 'mere personal investment activities never constitute carrying on a trade or
business, no matter how much of one's time or of one's employees' time they may occupy.'
The Revenue Act of 1913 allowed as a deduction 'the necessary expenses actually paid in
carrying on any business.' No regulation has ever been promulgated which interprets the
meaning of 'carrying on a business,' nor any rulings approved by the Secretary of the
Treasury. To determine whether the activities of a taxpayer are 'carrying on a business'
requires an examination of the facts in each case. As the Circuit Court of Appeals observed, all
expenses of every business transaction are not deductible. Only those are deductible which
relate to carrying on a business. The Bureau of Internal Revenue has this duty of determining
what is carrying on a business, subject to re-examination of the facts by the Board of Tax
Appeals and ultimately to review on the law by the courts on which jurisdiction is conferred.
The Commissioner and the Board appraised the evidence here as insufficient to establish
petitioner's activities as those of carrying on a business. The petitioner merely kept records
and collected interest and dividends from his securities, through managerial attention for his
investments. No matter how large the estate or how continuous or extended the work
required may be, such facts are not sufficient as a matter of law to permit the courts to reverse
the decision of the Board.
The petitioner makes the point that his activities in managing his estate, both realty and
personalty, were a unified business. Since it was admittedly a business in so far as the realty is
concerned, he urges, there is no statutory authority to sever expenses allocable to the
securities. But we see no reason why expenses not attributable, as we have just held these are
not, to carrying on business cannot be apportioned. It is not unusual to allocate expenses paid
for services partly personal and partly business.
WELINER v. CIR
DOCTRINE:
The following requisites must concur before the income tax imposed therein shall apply:
1. There is a non-resident alien engaged in trade/business w/in the Phil
2. Income must have been received from sources w/in the Philippines
As long as the income is derived from the sources coming w/in the Philippines, it will be
considered as gross income regardless of “place of payment”
FACTS:
Roger, an Aussie, works as an Area Manager for Southeast Asia and Middle East, in Envirotech
Corp – a US Corp w/ headquarters in CA, represented by BB. Fisher & Co, a Philippine Corp.
His salary is paid in his Bank – Bank of America in Belmont, CA. During his employment, he
made various trips across the Southeast and Middle East. All expenses were paid by
Envirotech. In 1975, Roger went to the Philippines to visit BB Fisher & Co (involved in
supplying equipments for mining sugar, environmental and general processing industries thru
Envirotech). CIR classified Roger as non-resident alien engaged in trade w/in the Phil under
Sec. 22(a) of NIRC. Thus, on the last week of Feb. 1980, Roger was taxed for 18424 w/ interest
of 7738.08 = 26162.08. Roger protested the tax assessment and requested for it to be set
aside, but the CIR denied the request. Roger requested for reconsideration but it was again
denied, hence he appealed to CTA.
ISSUE: W/N Roger is a non-resident alien engaged in trade or business w/in the Philippines in
1975 in accordance w/ Sec. 22(a)
HELD:
The case deals with the following provisions:
NIRC Sec. 22. Tax on non-resident alien individuals - (a) non-resident alien engaged in trade
or business within the Philippines. There shall be levied, collected and paid for each taxable
year upon the entire net income received from all source within the Philippines by every non-
resident alien individual engaged in trade or business within the Philippines the tax imposed
by Section twenty-one: Provided, That for purposes of this title, a non-resident alien
individual who shall come to the Philippines and stay therein for an aggregate period of more
than one hundred eighty days during any calendar year shall be deemed a non-resident alien,
doing business in the Philippines….
NIRC Sec. 37. – simply treats services (compensation for services rendered as part of gross
income
Revenue Reg. 2 (Sec. 8): The phrase "engaged in trade or business within the Philippines"
includes the performance of personal services within the Philippines…
(Sec.155): Compensation for labor or personal services. - Gross income from sources within
the Philippines includes compensation for labor or personal services performed within the
Philippines regardless of the residence of the payor, or the place in which the contract for
service was made, or of the place of payment.
From the provisions above, it could be seen that Roger is a non-resident alien engaged in trade
w/in the Phil. To summarize, the following requisites must concur before the income tax
imposed therein shall apply:
1. There is a non-resident alien engaged in trade/business w/in the Phil
2. Income must have been received from sources w/in the Philippines
These 2 reqs. are present in this case.
Roger’s contention that his income is not sourced within the Philippines is without merit.
Roger stayed in the Phil for 191 days in behalf of Envirotech, represented in the Phil by BB
Fisher. During these days, he received income from sources w/in the Phil although payment of
his salary was made by Envirotech directly to his bank in CA. Rev. Reg. 2 Secs 8 and 155
clearly states that gross income from sources w/in the Philippines includes compensation for
service performed w/in the Phil regardless of the residence of the payor, or the place in w/c
the contract for service was made, or the place of payment. Thus, Roger, who having rendered
personal service to Envirotech w/c is represented by BB Fisher in the Phil is rightfully
considered as a non-resident alien engaged in trade/business and as such subject to income
tax on income earned for personal services performed in the Phil in 1975.
2. INCOME TAX RATE AND TAX BASE, IN GENERAL
SEC. 25. Tax on Nonresident Alien Individual. —
(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. —
(2) In General. — A nonresident alien individual engaged in trade or business in the
Philippines shall be subject to an income tax in the same manner as an individual citizen
and a resident alien individual, on taxable income received from all sources within the
Philippines. A nonresident alien individual who shall come to the Philippines and stay
therein for an aggregate period of more than one hundred eighty (180) days during any
calendar year shall be deemed a 'nonresident alien doing business in the Philippines,'
Section 22(G) of this Code notwithstanding.
90 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Sec. 31. Taxable Income, Defined. – The term ‘taxable income’ means the pertinent items of
gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.
3. INCOME TAX RATE AND BASE ON CERTAIN TYPES OF INCOME
a. CASH AND/OR PROPERTY DIVIDENDS FROM A DOMESTIC CORPORATION OR
JOINT STOCK COMPANY, OR INSURANCE OR MUTUAL FUND CO., OR ROHQ, OR
SHARE IN THE DISTRIBUTABLE NET INCOME OF A TAXABLE PARTNERSHIP,
INTERESTS, ROYALTIES, PRIZES, AND OTHER WINNINGS
SEC. 25. Tax on Nonresident Alien Individual. —
(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. —
(2) Cash and/or Property Dividends from a Domestic Corporation or Joint Stock Company, or
Insurance or Mutual Fund Company or Regional Operating Headquarters of Multinational
Company, or Share in the Distributable Net Income of a Partnership (Except a General
Professional Partnership), Joint Account, Joint Venture Taxable as a Corporation or
Association, Interests, Royalties, Prizes, and Other Winnings. — Cash and/or property
dividends from a domestic corporation, or from a joint stock company, or from an
insurance or mutual fund company or from a regional operating headquarters of
multinational company, or the share of a nonresident alien individual in the distributable
net income after tax of a partnership (except a general professional partnership) of which
he is a partner, or the share of a nonresident alien individual in the net income after tax of
an association, a joint account, or a joint venture taxable as a corporation of which he is a
member or a co-venturer; interests; royalties (in any form); and prizes (except prizes
amounting to Ten thousand pesos [P10,000] or less which shall be subject to tax under
Subsection (B)(1)(sic)12 of Section 24); and other winnings (except Philippine Charity
Sweepstakes and Lotto winnings), shall be subject to an income tax of twenty percent
(20%) on the total amount thereof: Provided, however, That royalties on books as well as
other literary works, and royalties on musical compositions shall be subject to a final tax
of ten percent (10%) on the total amount thereof: Provided, further, That
cinematographic films and similar works shall be subject to the tax provided under
Section 28 of this Code: Provided, furthermore, That interest income from long-term
deposit or investment in the form of savings, common or individual trust funds, deposit
substitutes, investment management accounts and other investments evidenced by
certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) shall ho
exempt from the tax imposed under this Subsection: Provided, finally, That should the
holder of the certificate pre-terminate the deposit or investment before the fifth (5th)
year, a final tax shall be Imposed on the entire income and shall be deducted and
withheld by the depository bank from the proceeds of the long-term deposit or
investment certificate based on the remaining maturity thereof:
Four (4) years to less than five (5) years — 5%:
Three (3) years to less than four (4) years — 12%: and
Less than three (3) years — 20%.
b. CAPITAL GAINS ON THE SALE OF SHARES AND REALTY
SEC. 25. Tax on Nonresident Alien Individual. —
(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. —
(3) Capital Gains. — Capital gains realized from sale, barter or exchange of shares of stock in
domestic corporations not traded through the local stock exchange, and real properties
shall be subject to the tax prescribed under Subsections (C) and (D) of Section 24.
4. PERSONAL EXEMPTION ALLOWABLE TO NONRESIDENT ALIEN INDIVIDUALS
ENGAGED IN TRADE OR BUSINESS IN THE PHILIPPINES
SEC 35. Allowance of Personal Exemption for Individual Taxpayer –
(E) Personal Exemption Allowable to Nonresident Alien Individual. – A nonresident alien
individual engaged in trade, business or in the exercise of a profession in the Philippines
shall be entitled to a personal exemption 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, not to exceed the amount fixed in this Section as
exemption for citizens or residents of the Philippines: Provided, That said nonresident
alien should file a true and accurate return of the total income received by him from all
sources in the Philippines, as required by this Title.
D. NONRESIDENT ALIENS NOT ENGAGED IN TRADE OR BUSINESS IN THE
PHILIPPINES
SEC. 25. Tax on Nonresident Alien Individual. —
(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the
Philippines. — There shall be levied, collected and paid for each taxable year upon the
entire income received from all sources within the Philippines by every nonresident alien
individual not engaged in trade or business within the Philippines as interest, cash
and/or property dividends, rents, salaries, wages, premiums, annuities, compensation,
remuneration, emoluments, or other fixed or determinable annual or periodic or casual
gains, profits, and income, and capital gains, a tax equal to twenty-five percent (25%) of
such income. Capital gains realized by a nonresident alien individual not engaged in trade
or business in the Philippines from the sale of shares of stock in any domestic
corporation and real property shall be subject to the income tax prescribed under
Subsections (C) and (D) of Section 24.
CIR v. WODEHOUSE
DOCTRINE:
Sums received by a nonresident alien author not engaged in trade or business within the
United States and not having an office or place of business therein are included in his gross
income for federal tax purposes.
FACTS:
Pelham Wodehouse was a British subject residing in France. He was a nonresident alien of the
United States not engaged in trade or business within the United States and not having an
office or place of business therein during either the taxable year 1938 or 1941. He was a
writer of serials, plays, short stories, and other literary works published in the United States in
the Saturday Evening Post, Cosmopolitan Magazine, and other periodicals.
In 1938, the Curtis Publishing Company paid Reynolds Agency, Pelman’s literary agent,
$40,000 under an agreement reserving to Curtis the American serial rights of respondent's
unpublished novel "The Silver Cow, including in such rights those in the United States, Canada,
and South America. Also in 1938, the respondent received $5,000 from Doubleday, Doran &
Company for the book rights in this story. The story was published serially in 1939.
91 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Respondent received $40,000 from Curtis in 1938, for serial rights in and to his story "Uncle
Fred in the Springtime." In 1941, Hearst's International Cosmopolitan Magazine paid the
respondent $2,000 for "all American and Canadian serial rights to the respondent's article
entitled "My Years Behind Barbed Wire." In 1941, Curtis, through the same agent, paid the
respondent $40,000 for the "North American serial rights" to respondent's novel "Money in
the Bank." After each story's serial publication, Curtis reassigned to the respondent, on the
latter's demand, all rights in and to the story excepting those rights which the respondent
expressly had agreed that Curtis was to retain. The respective sums were thus paid to the
respondent, in advance and in full, for the serial or book rights which he had made available.
For United States income tax purposes, the respondent's literary agent, or some other
withholding agent, withheld from the respondent, or from his wife as his assignee, a part of
each payment.
In 1944, the Commissioner of Internal Revenue gave the respondent notice of tax deficiencies
assessed against him for the taxable years 1923, 1924, 1938, 1940 and 1941. The
Commissioner claimed deficiencies in the respondent's income tax payments based upon his
receipts. The respondent, in a petition to the Tax Court for a redetermination of such
deficiencies, not only contested the additional taxes assessed against him, but he asked also
for the refund to him of the amounts which had been withheld, for income tax purposes, from
each such payment. The Tax Court entered judgment against him for additional taxes for 1938,
1940, and 1941 in the respective amounts of $11,806.71, $8,080,83 and $1,854,85.
PETITIONER’’S CONTENTION: Receipts of the type long have been recognized as rentals or
royalties paid for the use of or for the privilege of using in the United States, patents,
copyrights, and other like property. Before 1936, such receipts were expressly subject to
withholding as part of the taxable income of nonresident alien individuals, and that those
receipts remained taxable and subject to withholding in 1938 and 1941, after the standards
for taxation of such aliens had been made expressly coterminous with the standards for
subjecting this part of their income to withholding procedures.
RESPONDENT’s CONTENTION: Each sum he received was a payment made to him in return for
his sale of a property interest in a copyright, and not a payment to him of a royalty for rights
granted by him under the protection of his copyright. Being the proceeds of a sale by him of
such a property interest, those proceeds were not required to be included in his taxable gross
income because the controlling Revenue Acts did not attempt to tax nonresident alien
individuals like himself upon income from sales of property. Even if his receipts were to be
treated as royalties, yet each was received in a single lump sum, and not "annually" or
"periodically," and that therefore they did not come within his taxable gross income.
ISSUE: Whether certain sums received in 1938 and 1941 by the respondent, as a nonresident
alien author not engaged in trade or business within the United States were to be included in
his gross income for federal tax purposes? YES.
RULING: (This is a matter of statutory construction)
Under the income tax laws of the United States, sums received by a nonresident alien author
not engaged in trade or business within the United States and not having an office or place of
business therein long have been required to be included in his gross income for our federal
tax purposes. Such receipts have been an appropriate and readily collectible subject of
taxation. Since the early days of our income tax levies, rentals and royalties paid for the use of
or for the privilege of using in the United States, patents, copyrights, and other like property
have been taxed to nonresident aliens, and for many years, at least, a part of the tax has been
withheld at the source of the income. To exempt this type of income from taxation in 1938 or
1941, in the face of this long record of its taxation, would require clearness and positiveness of
legislative determination to change the established procedure that is entirely absent here.
A. These receipts unquestionably would have been taxed to a nonresident alien individual if
received by him under the Revenue Act of 1934.
The Act of 1934 thus sought to include as taxable gross income any income which a
nonresident alien individual received as royalties for the privilege of using any copyrights in
the United States, and also sought to tax his income from the sale of any personal property
which he had produced (in whole or in part) outside the United States but had sold within the
United States.
B. The Revenue Act of 1936 preserved the taxability of the several kinds of income of nonresident
alien individuals which had been the subject of withholding at their respective sources, including
receipts in the nature of royalties for the use of copyrights in the United States.
It had been difficult for United States tax officials to ascertain the taxable income which had
been derived from sales of property at a profit by nonresident alien individuals, or by foreign
corporations, when the respective taxpayers were not engaged in trade or business within the
United States and did not have an office or place of business therein. It was the purpose of
Congress to limit future taxes on nonresident alien individuals to those readily collectible. To
have exempted these nonresident aliens from these readily collectible taxes derived from
sources within the United States would have discriminated in their favor against resident
citizens of the United States who would be required to pay their regular income tax on such
income, if treated as royalties within the meaning of the gross income provisions, or at least to
pay a tax upon them as capital gains, if treated as income from sales of capital within the
meaning of the capital gains provisions. No such purpose to discriminate can be implied. None
of the provisions of the 1936 Act here involved were changed by the 1938 Act or the Internal
Revenue Code, except as to the rates of tax, and the principal changes even in the rates were to
provide higher taxes in the higher brackets, rather than to reduce the taxes on nonresident
aliens.
The receipt of the respective amounts by the respondent in single lump sums as payments in
full, in advance, for certain rights under the respective copyrights did not exempt those
receipts from taxation. Once it has been determined that the receipts of the respondent would
have been required to be included in his gross income for federal income tax purposes if they
had been received in annual payments or from time to time during the life of the respective
copyrights, it is clear that the receipt of those same sums by him in single lump sums as
payments in full, in advance, for the same rights to be enjoyed throughout the entire life of the
respective copyrights cannot, solely by reason of the consolidation of the payment into one
sum, render it tax exempt. The words "annual" and "periodical", do not require a different
result from that here reached.
Dissenting Opinion: Frankfurter, Murphy and Jackson
Congress has chosen not to tax the alien author for such larger income than is received from
the sale merely of serial rights, although the native author is so taxed. It is for Congress to
make differentiations between alien and American authors, and we should respect the
differentiations Congress has made for the sale both of serial and total rights as between alien
and American authors. The need for revenue is no justification for warping the provisions of
the 1936 legislation to deny immunity from taxation to a nonresident alien author for the
entire transfer of some of the property interests explicitly conferred by § 1, particularly in
view of the fact that Congress knowingly chose to leave untouched the more sizeable source of
revenue available where the nonresident alien sells all the rights conferred by § 1. Wodehouse
made an absolute transfer of some of those rights. He did not receive royalties, but, instead,
gave up that chance in return for a lump sum, just as the seller of a house gives up the right to
receive rent in return for the purchase price. That transaction can only be regarded as a sale.
As the revenue laws now stand, it was nontaxable.
92 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
E. SPECIAL ALIENS
SEC. 25. Tax on Nonresident Alien Individual. —
(C) Alien Individual Employed by Regional or Area Headquarters and Regional
Operating Headquarters of Multinational Companies. — There shall be levied,
collected and paid for each taxable year upon the gross income received by every alien
individual employed by regional or area headquarters and regional operating
headquarters established in the Philippines by multinational companies as salaries,
wages, annuities, compensation, remuneration and other emoluments, such as honoraria
and allowances, from such regional or area headquarters and regional operating
headquarters, a tax equal to fifteen percent (15%) of such gross income: Provided,
however, That the same tax treatment shall apply to Filipinos employed and occupying
the same position as those of aliens employed by these multinational companies. For
purposes of this Chapter, the term 'multinational company' means a foreign firm or entity
engaged in international trade with affiliates or subsidiaries or branch offices in the Asia-
Pacific Region and other foreign markets.
(D) Alien Individual Employed by Offshore Banking Units. - There shall be levied, collected
and paid for each taxable year upon the gross income received by every alien individual
employed by offshore banking units established in the Philippines as salaries, wages,
annuities, compensation, remuneration and other emoluments, such as honoraria and
allowances, from such offshore banking units, a tax equal to fifteen percent (15%) of such
gross income: Provided, however, That the same tax treatment shall apply to Filipinos
employed and occupying the same position as those of aliens employed by these offshore
banking units.
(E) Alien Individual Employed by Petroleum Service Contractor and Subcontractor. — An
alien individual who is a permanent resident of a foreign country but who is employed
and assigned in the Philippines by a foreign service contractor or by a foreign service
subcontractor engaged in petroleum operations in the Philippines shall be liable to a tax
of fifteen percent (15%) of the salaries, wages, annuities, compensation, remuneration
and other emoluments, such as honoraria and allowances, received from such contractor
or subcontractor: Provided, however, That the same tax treatment shall apply to a Filipino
employed and occupying the same position as an alien employed by petroleum service
contractor and subcontractor.
Any income earned from all other sources within the Philippines by the alien employees
referred to under Subsections (C), (D) and (E) hereof shall be subject to the pertinent
income tax, as the case may be, imposed under this Code.
VIII. INCOME TAX ON DOMESTIC CORPORATIONS
A. DEFINITION OF DOMESTIC CORPORATION
Sec. 22. Definitions. – When used in this Title:
(B) The term 'corporation' shall include partnerships, no matter how created or organized,
joint-stock companies, joint accounts (cuentas en participacion), associations, or insurance
companies, but does not include general professional partnerships and a joint venture or
consortium formed for the purpose of undertaking construction projects or engaging in
petroleum, coal, geothermal and other energy operations pursuant to an operating or
consortium agreement under a service contract with the Government. 'General
professional partnerships' are partnerships formed by persons for the sole purpose of
 exercising their common profession, no part of the income of which is derived from
engaging in any trade or business.
(C) The term 'domestic,' when applied to a corporation, means created or organized in the
Philippines or under its laws.
AFISCO INSURANCE CORP. v. CA
FACTS:
The petitioners are 41 local insurance firms which entered into Reinsurance Treaties with
Munchener Ruckversicherungs-Gesselschaft or simply known as Munich, a non-resident
foreign insurance corporation. The reinsurance treaties required them to form an “insurance
pool” or “clearing house” in order to facilitate the handling of the business they contracted
with Munich. The CIR assessed the insurance pool deficiency corporate taxes and withholding
taxes on dividends paid on Munich and to the petitioners respectively. The assessments were
protested by the petitioners.
The CA ruled that the insurance pool was a partnership taxable as a corporation and that the
latter’s collection of premiums on behalf of its members was taxable income.
The petitioners belie the existence of a partnership because, according to them, the reinsurers
did not share the same risk or solidary liability, there was no common fund, the executive
board of the pool did not exercise control and management of its funds and the pool was not
engaged in business of reinsurance from which it could have derived income for itself.
ISSUES:
Whether or not the insurance pool be deemed a partnership or an association that is taxable
as a corporation.
Wheteher or not the pool’s remittances to member companies and to Munich be taxable as
dividends.
HELD:
The pool is taxable as a corporation.
In the present case, the ceding companies entered into a Pool Agreement or an association
that would handle all the insurance businesses covered under their quota-sharing reinsurance
treaty and surplus reinsurance treaty with Munich. There are unmistakable indicators that
it is a partnership or an association covered by NIRC.
a. The pool has a common fund, consisting of money and other valuables that are deposited
in the name and credit of the pool.
b. The pool functions through an executive board which resembles the BOD of a
corporation.
c. Though the pool itself is not a reinsurer, its work is indispensable, beneficial and
economically useful to the business of the ceding companies and Munich because
without it they would not have received their premiums. Profit motive or business is
therefore the primordial reason for the pool’s formation.
The fact that the pool does not retain any profit or income does not obliterate an antecedent
fact that of the pool is being used in the transaction of business for profit. It is apparent, and
petitioners admit that their association or co-action was indispensable to the transaction of
the business. If together they have conducted business, profit must have been the object as
indeed, profit was earned. Though the profit was apportioned among the members, this is one
a matter of consequence as it implies that profit actually resulted.
93 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Petitioners' reliance on Pascual v. Commissioner is misplaced, because the facts obtaining
therein are not on all fours with the present case. In Pascual, there was no unregistered
partnership, but merely a co-ownership which took up only 2 isolated transactions. The CA
did not err in applying Evangelista, which held that Section 24 covered these unregistered
partnerships and even associations or joint accounts, which had no legal personalities apart
from their individual members also which involved a partnership that engaged in a series of
transactions spanning more than 10 years, as in the case before us.
PASCUAL v. CIR
DOCTRINE:
The fact that those who agree to form a co-ownership share or do not share any profits made
by the use of the property held in common does not convert their venture into a partnership.
The sharing of the gross returns does not of itself establish a partnership whether or not the
persons sharing therein have a joint or common right or interest in the property. This only
means that, aside from the circumstance of profit, the presence of other elements constituting
partnership is necessary, such as the clear intent to form a partnership, the existence of a
juridical personality different from that of the individual partners, and the freedom to transfer
or assign any interest in the property by one with the consent of the others.
FACTS:
Petitioners bought two (2) parcels of land from Santiago Bernardino, et al. and on May 28,
1966, they bought another three (3) parcels of land from Juan Roque. The first two parcels of
land were sold by petitioners in 1968 to Marenir Development Corporation, while the three
parcels of land were sold by petitioners to Erlinda Reyes and Maria Samson on March
19,1970. Petitioners realized a net profit in the sale made in 1968 in the amount of
P165,224.70, while they realized a net profit of P60,000.00 in the sale made in 1970. The
corresponding capital gains taxes were paid by petitioners in 1973 and 1974 by availing of the
tax amnesties granted in the said years.
However, in a letter dated March 31, 1979 of then Acting BIR Commissioner Efren I. Plana,
petitioners were assessed and required to pay a total amount of P107,101.70 as alleged
deficiency corporate income taxes for the years 1968 and 1970. Petitioners protested the said
assessment in a letter of June 26, 1979 asserting that they had availed of tax amnesties way
back in 1974. In a reply of August 22, 1979, respondent Commissioner informed petitioners
that in the years 1968 and 1970, petitioners as co-owners in the real estate transactions
formed an unregistered partnership or joint venture taxable as a corporation under Section
20(b) and its income was subject to the taxes prescribed under Section 24, both of the
National Internal Revenue Code 1 that the unregistered partnership was subject to corporate
income tax as distinguished from profits derived from the partnership by them which is
subject to individual income tax; and that the availment of tax amnesty under P.D. No. 23, as
amended, by petitioners relieved petitioners of their individual income tax liabilities but did
not relieve them from the tax liability of the unregistered partnership. Hence, the petitioners
were required to pay the deficiency income tax assessed.
Petitioners filed a petition for review with the respondent Court of Tax Appeals, the
respondent court affirmed the decision and action taken by respondent commissioner with
costs against petitioners. It ruled that an unregistered partnership was in fact formed by
petitioners, which like a corporation, was subject to corporate income tax distinct from that
imposed on the partners. In a separate dissenting opinion, Associate Judge Constante Roaquin
stated that considering the circumstances of this case, although there might in fact be a co-
ownership between the petitioners, there was no adequate basis for the conclusion that they
thereby formed an unregistered partnership which made "them liable for corporate income
tax under the Tax Code.
ISSUE/S:
W/N there is a distinction between co-ownership and an unregistered partnership or joint
venture for income tax purposes?
W/N petitioners are liable to pay taxes?
RULING:
The petition is meritorious. The essential elements of a partnership are two, namely: (a) an
agreement to contribute money, property or industry to a common fund; and (b) intent to
divide the profits among the contracting parties. In the present case, there is no evidence that
petitioners entered into an agreement to contribute money, property or industry to a common
fund, and that they intended to divide the profits among themselves. Respondent
commissioner and/ or his representative just assumed these conditions to be present on the
basis of the fact that petitioners purchased certain parcels of land and became co-owners
thereof. In the instant case, petitioners bought two (2) parcels of land in 1965. They did not
sell the same nor make any improvements thereon. In 1966, they bought another three (3)
parcels of land from one seller. It was only 1968 when they sold the two (2) parcels of land
after which they did not make any additional or new purchase. The remaining three (3)
parcels were sold by them in 1970. The transactions were isolated. The character of
habituality peculiar to business transactions for the purpose of gain was not present.
In Evangelista, petitioners borrowed a sum of money from their father which together with
their own personal funds they used in buying several real properties. They appointed their
brother to manage their properties with full power to lease, collect, rent, issue receipts, etc.
They had the real properties rented or leased to various tenants for several years and they
gained net profits from the rental income. Such condition existed for over fifteen (15) years.
Thus, the Collector of Internal Revenue demanded the payment of income tax on a
corporation, among others, from them.
Compared to Evangelista, none of the circumstances are present in the case at bar. The co-
ownership started only in 1965 and ended in 1970. The sharing of returns does not in itself
establish a partnership whether or not the persons sharing therein have a joint or common
right or interest in the property. There must be a clear intent to form a partnership, the
existence of a juridical personality different from the individual partners, and the freedom of
each party to transfer or assign the whole property.
In the present case, there is clear evidence of co-ownership between the petitioners. There is
no adequate basis to support the proposition that they thereby formed an unregistered
partnership. The two isolated transactions whereby they purchased properties and sold the
same a few years thereafter did not thereby make them partners. They shared in the gross
profits as co- owners and paid their capital gains taxes on their net profits and availed of the
tax amnesty thereby. Under the circumstances, they cannot be considered to have formed an
unregistered partnership which is thereby liable for corporate income tax, as the respondent
commissioner proposes. And even assuming for the sake of argument that such unregistered
partnership appears to have been formed, since there is no such existing unregistered
partnership with a distinct personality nor with assets that can be held liable for said
deficiency corporate income tax, then petitioners can be held individually liable as partners
for this unpaid obligation of the partnership p. 7 However, as petitioners have availed of the
benefits of tax amnesty as individual taxpayers in these transactions, they are thereby relieved
of any further tax liability arising therefrom. WHEREFROM, the petition is hereby GRANTED.
OBILLOS v. CIR
DOCTRINE:
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
94 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
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.
FACTS:
Jose Obillos, Sr. bought two lots from Ortigas Co. located at Greenhills, San Juan, Rizal. The
next day he transferred his rights to his four children, the petitioners, to enable them to build
their residences. The company sold the two lots to petitioners for P178,708.12. Presumably,
the Torrens titles issued to them would show that they were co-owners of the two lots.
After having held the two lots for more than a year, the petitioners resold them to the Walled
City Securities Corporation and Olga Cruz Canda for the total sum of P313,050. They derived
from the sale a total profit of P134,341.88 or P33,584 for each of them.
They treated the profit as a capital gain and paid an income tax on one-half thereof or of
P16,792.
A day before the expiration of the five-year prescriptive period, the Commissioner of Internal
Revenue required the four petitioners to pay corporate income tax on the total profit of
P134,336 in addition to individual income tax on their shares thereof He assessed P37,018 as
corporate income tax, P18,509 as 50% fraud surcharge and P15,547.56 as42% accumulated
interest, or a total of P71,074.56.
He also considered the share of the profits of each petitioner in the sum of P33,584 as a
“taxable in full” (not a mere capital gain of which ½ is taxable) and required them to pay
deficiency income taxes aggregating P56,707.20 including the 50% fraud surcharge and the
accumulated interest.
Thus, the petitioners are being held liable for deficiency income taxes and penalties totalling
P127,781.76 on their profit of P134,336, in addition to the tax on capital gains already paid by
them.
The Commissioner acted on the theory that the four petitioners had formed an unregistered
partnership or joint venture within the meaning of sections 24(a) and 84(b) of the Tax Code.
ISSUE/S:
Whether the petitioners should be considered as forming an unregistered partnership or joint
venture
RULING:
NO. It is error to consider the petitioners as having formed a partnership simply because they
allegedly contributed P178,708.12 to buy the two lots, resold the same and divided the profit
among themselves.
As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure and
simple. To consider them as partners would obliterate the distinction between a co-ownership
and a partnership. The petitioners were not engaged in any joint venture by reason of that
isolated transaction.
Their original purpose was to divide the lots for res-identical purposes. If later on they found
it not feasible to build their residences on the lots because of the high cost of construction,
then they had no choice but to resell the same to dissolve the co-ownership. The division of
the profit was merely incidental to the dissolution of the co-ownership which was in the
nature of things a temporary state.
It had to be terminated sooner or later. 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.
Co-ownership distinguished from partnership.—The case at bar is fundamentally similar to De
Leon vs. CIR. Thus, like the De Leon heirs, the Longa heirs inherited the 'hacienda' in question
pro-indiviso from their deceased parents; they did not contribute or invest additional ' capital
to increase or expand the inherited properties; they merely continued dedicating the property
to the use to which it had been put by their forebears; they individually reported in their tax
returns their corresponding shares in the income and expenses of the 'hacienda', and they
continued for many years the status of co-ownership in order, as conceded by respondent, 'to
preserve its (the 'hacienda') value and to continue the existing contractual relations with the
Central Azucarera de Bais for milling purposes.
All co-ownerships are not deemed unregistered partnership.—Co-Ownership who own
properties which produce income should not automatically be considered partners of an
unregistered partnership, or a corporation, within the purview of the income tax law. To hold
otherwise, would be to subject the income of all co-ownerships of inherited properties to the
tax on corporations, inasmuch as if a property does not produce an income at all, it is not
subject to any kind of income tax, whether the income tax on individuals or the income tax on
corporation.
What the Commissioner should have investigated was whether the father donated the two lots
to the petitioners and whether he paid the donor's tax (See Art. 1448, Civil Code).
ONA v. CIR
DOCTRINE:
 For tax purposes, the co-ownership of inherited properties is automatically converted
into an unregistered partnership the moment the said common properties and/or the
incomes derived therefrom are used as a common fund with intent to produce profits for
the heirs in proportion to their respective shares in the inheritance as determined in a
project partition either duly executed in an extrajudicial settlement or approved by the
court in the corresponding testate or intestate proceeding.
 The income derived from inherited properties may be considered as individual income of
the respective heirs only so long as the inheritance or estate is not distributed or, at least,
partitioned, but the moment their respective known shares are used as part of the
common assets of the heirs to be used in making profits, it is but proper that the income
of such shares should be considered as the part of the taxable income of an unregistered
partnership
FACTS:
 Julia Buñales died on March 23, 1944, leaving as heirs her surviving spouse, Lorenzo T.
Oña and her five children.
 Later, Lorenzo T. Oña the surviving spouse was appointed administrator of the estate of
said deceased.
 On April 14, 1949, the administrator submitted the project of partition, which was
approved by the Court on May 16, 1949.
 Because three of the heirs, namely Luz, Virginia and Lorenzo, Jr., all surnamed Oña, were
still minors when the project of partition was approved, Lorenzo T. Oña, their father and
administrator of the estate, filed a petition for appointment as guardian of said minors.
 The project of partition shows that the heirs have undivided one-half (1/2) interest in
ten parcels of land with a total assessed value of P87,860.00, six houses with a total
assessed value of P17,590.00 and an undetermined amount to be collected from the War
Damage Commission. Later, they received from said Commission the amount of
P50,000.00, more or less. This amount was not divided among them but was used in the
95 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
rehabilitation of properties owned by them in common.
 The project of partition also shows that the estate shares equally with Lorenzo T. Oña,
the administrator thereof, in the obligation of P94,973.00, consisting of loans contracted
by the latter with the approval of the Court.
 Although the project of partition was approved by the Court on May 16, 1949, no attempt
was made to divide the properties therein listed. Instead, the properties remained under
the management of Lorenzo T. Oña who used said properties in business by leasing or
selling them and investing the income derived therefrom and the proceeds from the sales
thereof in real properties and securities.
 As a result, petitioners' properties and investments gradually increased from
P105,450.00 in 1949 to P480,005.20 in 1956
 From said investments and properties petitioners derived such incomes as profits from
installment sales of subdivided lots, profits from sales of stocks, dividends, rentals and
interests.
 The income was always left in the hands of Lorenzo T. Oña who invested them in real
properties and securities.
 On the basis of the foregoing facts, the Commissioner of Internal Revenue decided that
petitioners formed an unregistered partnership and therefore, subject to corporate
income tax, pursuant to Section 24, in relation to Section 84(b), of the NIRC
 Accordingly, he assessed against the petitioners the amounts of P8,092.00 and
P13,899.00 as corporate income taxes for 1955 and 1956, respectively.
 Petitioners protested against the assessment and asked for reconsideration of the ruling
of respondent that they have formed an unregistered partnership.
 Finding no merit in petitioners' request, respondent denied it.
ISSUE/S:
3. Whether or not petitioners be considered as co-owners of the properties inherited
by them from the deceased Julia Buñales and the profits derived from transactions
involving the same, or, must they be deemed to have formed an unregistered
partnership subject to tax under Sections 24 and 84(b) of the NIRC (relevant for this
topic) THEY FORMED AN UNREGISTERED PARTNERSHIP
4. Whether or not as far as their respective shares in the inheritance are concerned, the total
income thereof should be considered as that of co-owners and not of the unregistered
partnership, assuming that an unregistered partnership was formed
5. Assuming again that they are taxable as an unregistered partnership, should not the
various amounts already paid by them for the same years 1955 and 1956 as individual
income taxes on their respective shares of the profits accruing from the properties they
owned in common be deducted from the deficiency corporate taxes, herein involved,
assessed against such unregistered partnership by the respondent Commissioner?
RULING:
3. The Tax Court found that instead of actually distributing the estate of the deceased among
themselves pursuant to the project of partition approved in 1949, "the properties
remained under the management of Lorenzo T. Oña who used said properties in business
by leasing or selling them and investing the income derived therefrom and the proceed
from the sales thereof in real properties and securities," as a result of which said
properties and investments steadily increased yearly from P87,860.00 in "land account"
and P17,590.00 in "building account" in 1949 to P175,028.68 in "investment account,"
P135.714.68 in "land account" and P169,262.52 in "building account" in 1956. And all
these became possible because, admittedly, petitioners never actually received any share
of the income or profits from Lorenzo T. Oña and instead, they allowed him to continue
using said shares as part of the common fund for their ventures, even as they paid the
corresponding income taxes on the basis of their respective shares of the profits of their
common business as reported by the said Lorenzo T. Oña.
It is thus incontrovertible that petitioners did not, contrary to their contention, merely
limit themselves to holding the properties inherited by them. Indeed, it is admitted that
during the material years herein involved, some of the said properties were sold at
considerable profit, and that with said profit, petitioners engaged, thru Lorenzo T. Oña, in
the purchase and sale of corporate securities. It is likewise admitted that all the profits
from these ventures were divided among petitioners proportionately in accordance with
their respective shares in the inheritance. In these circumstances, it is Our considered
view that from the moment petitioners allowed not only the incomes from their respective
shares of the inheritance but even the inherited properties themselves to be used by
Lorenzo T. Oña as a common fund in undertaking several transactions or in business, with
the intention of deriving profit to be shared by them proportionally, such act was
tantamount to actually contributing such incomes to a common fund and, in effect, they
thereby formed an unregistered partnership within the purview of the above-mentioned
provisions of the Tax Code.
Before the partition and distribution of the estate of the deceased, all the income thereof
does belong commonly to all the heirs, obviously, without them becoming thereby
unregistered co-partners, but it does not necessarily follow that such status as co-owners
continues until the inheritance is actually and physically distributed among the heirs, for it
is easily conceivable that after knowing their respective shares in the partition, they might
decide to continue holding said shares under the common management of the
administrator or executor or of anyone chosen by them and engage in business on that
basis.
From the moment of such partition, the heirs are entitled already to their respective
definite shares of the estate and the incomes thereof, for each of them to manage and
dispose of as exclusively his own without the intervention of the other heirs, and,
accordingly he becomes liable individually for all taxes in connection therewith. If after
such partition, he allows his share to be held in common with his co-heirs under a single
management to be used with the intent of making profit thereby in proportion to his
share, there can be no doubt that, even if no document or instrument were executed for
the purpose, for tax purposes, at least, an unregistered partnership is formed. This is
exactly what happened to petitioners in this case.
To begin with, the tax in question is one imposed upon "corporations", which, strictly
speaking, are distinct and different from "partnerships". When our Internal Revenue Code
includes "partnerships" among the entities subject to the tax on "corporations", said Code
must allude, therefore, to organizations that are not necessarily "partnerships", in the
technical sense of the term. Thus, for instance, section 24 of said Code exempts from the
aforementioned tax "duly registered general partnerships," which constitute precisely one
of the most typical forms of partnerships in this jurisdiction. Likewise, as defined in
section 84(b) of said Code, "the term corporation includes partnerships, no matter how
created or organized." This qualifying expression clearly indicates that a joint venture need
not be undertaken in any of the standard forms, or in confirmity with the usual
requirements of the law on partnerships, in order that one could be deemed constituted
for purposes of the tax on corporation
96 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
For purposes of the tax on corporations, our National Internal Revenue Code includes
these partnerships — with the exception only of duly registered general co-
partnerships — within the purview of the term "corporation." It is, therefore, clear to
our mind that petitioners herein constitute a partnership, insofar as said Code is
concerned, and are subject to the income tax for corporations.
4. In connection with the second ground, it is alleged that, if there was an unregistered
partnership, the holding should be limited to the business engaged in apart from the
properties inherited by petitioners. In other words, the taxable income of the partnership
should be limited to the income derived from the acquisition and sale of real properties
and corporate securities and should not include the income derived from the inherited
properties. It is admitted that the inherited properties and the income derived therefrom
were used in the business of buying and selling other real properties and corporate
securities. Accordingly, the partnership income must include not only the income derived
from the purchase and sale of other properties but also the income of the inherited
properties.
5. In other words, it is the position of petitioners that the taxable income of the partnership
must be reduced by the amounts of income tax paid by each petitioner on his share of
partnership profits. This is not correct; rather, it should be the other way around. The
partnership profits distributable to the partners (petitioners herein) should be reduced by
the amounts of income tax assessed against the partnership. Consequently, each of the
petitioners in his individual capacity overpaid his income tax for the years in question, but
the income tax due from the partnership has been correctly assessed. Since the individual
income tax liabilities of petitioners are not in issue in this proceeding, it is not proper for
the Court to pass upon the same.
BIR RUL. NO. 317-92
DOCTRINE:
A joint venture will create, a joint venture subject to tax under Section 24(a) of the Tax Code,
as amended, separate and distinct from the companies creating them. Furthermre, the
distribution by the joint venture of its net income to participating companies are in the nature
of dividends which are not subject to tax under Section 24(e)(4) of the Tax Code
FACTS:
Ayala Land, Inc. (ALI) and Appleyard Properties, Inc. (API) entered into a Memorandum of
Agreement (MOA) for the construction of an office building on that lot owned by ALI located
along Ayala Avenue, Makati, to be known as 6750 Ayala Office Tower (Building). Pursuant to
the terms of the MOA, ALI and API each contributed equal amounts to the construction costs
of the office tower and 351 parking stalls, in consideration of each of them acquiring the
ownership of such numbers of specifically designated whole floors in the proportion of 60%
(ALI) and 40% (API) respectively, of the net leasable floor area of 22,335 square meters of the
office tower, and the right to use the parking stalls and storage spaces in the same proportion
of 60%/40%; that while there would be separate ownership of specifically designated whole
floors, common areas expenses, maintenance and insurance costs, real estate taxes,
commercial center dues and expenses would be shared by ALI and the API in the same
proportion; that upon the expiration of the 48 year term of the MOA in year 2038, the
ownership of all the floors or portions of the building allocated to API shall automatically be
transferred to ALI; that the principal objective of both ALI and API is to lease out to third party
tenants the specific floors separately owned by them.
To carry out their common objectives, ALI and API now propose to enter into another
agreement, a Joint Venture Agreement (JVA); that under the JVA, ALI and API will contribute
money to a common fund for the initial and, if necessary, additional working capital of the
joint venture; that ALI will be appointed as manager of the joint venture and subject to the
mutual control of ALI and API, shall be responsible, among others, for the leasing of the
Building floors or portions thereof owned by ALI and API; that irrespective of who owns the
floor or floors, or portions of the Building that are leased out, the JV will hold the rental
receipts in a common pool and the net balance every quarter, after deducting all expenses
chargeable thereto, such as salaries of JV personnel and maintenance expenses, shall be
distributed to ALI and API in same proportion of 60%/40% as dividends; that the JV will have
a life of three years; and that upon its dissolution, each party will receive the rentals for the
floors owned by it and shoulder its own expenses, independently of the other.
ISSUE:
1. Whether or not the Memorandum of Agreement entered into by and between ALI and API
in 1990 providing for the construction of the office tower has, by itself, created a
separately taxable joint venture;
2. Whether or not the joint venture to be subsequently entered into by and between ALI and
API, for the leasing of the Building floors or portions thereof separately owned by them
will be considered as a corporation taxable as such, separate and distinct from ALI and
API;
3. Whether or not the rentals to be paid by the tenants of the Building to the joint venture
during the term of the JVA are to be treated as income of the joint venture;
4. Whether or not the distributions by the joint venture of the net income from its operations
to ALI and API will be considered as dividend distributions taxable to ALI and API
RULING:
To constitute a joint venture:
1. each party to the venture must make a contribution, not necessarily of capital, but by way
of services, skill, knowledge, material or money;
2. profits must be shared among the parties;
3. there must be a joint proprietary interest and right of mutual control over the subject
matter of the enterprise;
4. usually, there is single business transaction rather than a general or continuous
transaction
Likewise, a joint venture was created when two corporations while registered and operating
separately were placed under one sole management which operated the business affairs of
said companies as though constituted a single entity thereby obtaining substantial economy
and profits in the operation. The Memorandum of Agreement entered into by and between
ALI and API in 1990 providing for the construction of the aforementioned office tower has not
by itself created a taxable joint venture. However, the joint venture to be subsequently
entered into by and between ALI and API, for the leasing of the Building floors or portions
thereof separately owned by them will create, a joint venture subject to tax under Section
24(a) of the Tax Code, as amended, separate and distinct from ALI and API. Moreover, the
rentals to be received by the joint venture from the tenants in the Building are income to the
joint venture. Furthermore, the distribution by the joint venture of its net income to ALI and
API are in the nature of dividends which are not subject to tax under Section 24(e)(4) of the
Tax Code, as amended.
B. INCOME TAX RATE AND TAX BASE, IN GENERAL
SEC. 27. Rates of Income Tax on Domestic Corporations. —
(A) In General. — Except as otherwise provided in this Code, an income tax of thirty-five
97 TAXATION 1 (ATTY. BELLO)
percent (35%) is hereby imposed upon the taxable income derived during each
taxable year from all sources within and without the Philippines by every
corporation, as defined in Section 22(B) of this Code and taxable under this Title as a
corporation, organized in, or existing under the laws of the Philippines: Provided,
That effective January 1, 2009, the rate of income tax shall be thirty percent (30%).
In the case of corporations adopting the fiscal-year accounting period, the taxable
income shall be computed without regard to the specific date when specific sales,
purchases and other transactions occur. Their income and expenses for the fiscal
year shall be deemed to have been earned and spent equally for each month of the
period.
The corporate income tax rate shall be applied on the amount computed by
multiplying the number of months covered by the new rate within the fiscal year by
the taxable income of the corporation for the period, divided by twelve."
Provided, further, That the President, upon the recommendation of the Secretary of
Finance, may, effective January 1, 2000, allow corporations the option to be taxed at
fifteen percent (15%) of gross income as defined herein, after the following
conditions have been satisfied:
a. A tax effort ratio of twenty percent (20%) of Gross National Product (GNP);
b. A ratio of forty percent (40%) of income tax collection to total tax revenues;
c. A VAT tax effort of four percent (4%) of GNP; and
d. A 0.9 percent (0.9%) ratio of the Consolidated Public Sector Financial
Position (CPSFP) to GNP.
The option to be taxed based on gross income shall be available only to firms whose
ratio of cost of sales to gross sales or receipts from all sources does not exceed fifty-five
percent (55%).
The election of the gross income tax option by the corporation shall be irrevocable for
three (3) consecutive taxable years during which the corporation is qualified under the
scheme.
For purposes of this Section, the term 'gross income' derived from business shall be
equivalent to gross sales less sales returns, discounts and allowances and cost of goods
sold. 'Cost of goods sold' shall include all business expenses directly incurred to produce
the merchandise to bring them to their present location and use.
For a trading or merchandising concern, 'cost of goods sold' shall include the invoice
cost of the goods sold, plus import duties, freight in transporting the goods to the
place where the goods are actually sold, including insurance while the goods are in
transit.
For a manufacturing concern, 'cost of goods manufactured and sold' shall include all
costs of production of finished goods, such as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance premiums and other costs incurred to
bring the raw materials to the factory or warehouse.
In the case of taxpayers engaged in the sale of service, 'gross income' means gross
receipts less sales returns, allowances and discounts.
Sec. 31. Taxable Income, Defined. – The term ‘taxable income’ means the pertinent items of
gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
C. PROPRIETARY EDUCATIONAL INSTITUTIONS AND HOSPITALS
SEC. 27. Rates of Income Tax on Domestic Corporations. —
(B) Proprietary Educational Institutions and Hospitals. — Proprietary educational
institutions and hospitals which are nonprofit shall pay a tax of ten percent (10%)
on their taxable income except those covered by Subsection (D) hereof: Provided,
That if the gross income from unrelated trade, business or other activity exceeds
fifty percent (50%) of the total gross income derived by such educational
institutions or hospitals from all sources, the tax prescribed in Subsection (A) hereof
shall be imposed on the entire taxable income. For purposes of this Subsection, the
term 'unrelated trade, business or other activity' means any trade, business or other
activity, the conduct of which is not substantially related to the exercise or
performance by such educational institution or hospital of its primary purpose or
function. A 'proprietary educational institution' is any private school maintained and
administered by private individuals or groups with an issued permit to operate
from the Department of Education, Culture and Sports (DECS) or the Commission on
Higher Education (CHED), or the Technical Education and Skills Development
Authority (TESDA), as the case may be, in accordance with existing laws and
regulations.
DOF ORDER 137-87
Rules and Regulations Implementing Section 4(3), Article XIV of the New Constitution —
Pursuant to Section 79(b) of the Revised Administrative Code, the following rules and
regulations are hereby promulgated for the effective implementation of the provisions of the
New Constitution, to wit:
"Section 4(3), Article XIV — All revenues and assets of non-stock, non-profit educational
institution used actually, directly and exclusively for educational purposes, shall be exempt
from taxes and duties . . ."
SECTION 1. Scope — This set of guidelines shall govern the availment of exemption from the
payment of internal revenue taxes and customs duties provided for under the National
Internal Revenue Code, and the Tariff and Customs Code, both as amended.
1.1. Educational institution — means a non-stock, non-profit corporation/association duly
registered under Philippine law, and operated exclusively for educational purposes,
maintained and administered by private individuals or groups, and offering formal
education, issued a permit, to operate by the Department of Education, Culture and
Sports (DECS) in accordance with existing laws and regulations.
1.2. Educational Activity Includes —
1.2.1. Instructing or training of individuals either through formal education.
Formal education refers to the institutionalized, chronologically graded and
hierarchically structured educational system at all levels of education.
1.3. Utilization by Educational Institution — means
1.3.1. Any amount in cash or in kind (including administrative expenses) paid or
utilized to accomplish one or more purposes for which it was created or
organized, including grant of scholarship to deserving students and
professorial chairs for the enhancement of professional course.
1.3.2. Any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more purposes for which the educational institution was
98 TAXATION 1 (ATTY. BELLO)
created or organized, including the upgrading of existing facilities to support
the conduct of the above activities.
1.3.3. Any amount in cash or in kind invested in an activity related to the
educational purposes for which it was created or organized.
1.3.4. Any amount set aside for a specific project subject/ prior to approval of the
Commissioner of Internal Revenue in writing. Application thereof must
contain the following:
(i) the nature and purpose of the specific project and the amount
programmed therefor;
(ii) a detailed description of the project, including estimated costs, sources
of any future funds expected to be used for completion of the project,
and the location or locations (general or specific) of any physical
facilities to be acquired or constructed as part of the project; and
(iii) a statement by an authorized official of the corporation or association
that the amount to be set aside will actually be disbursed for the
specific project within two (2) years from the date of approval by the
Commissioner of Internal Revenue, unless the nature of the project is
such that the two (2) year period is impracticable.
1.3.5. Any amount set aside shall be evidenced by book entries and documents
showing evidence of deposits or investments, including investment of the
funds so set aside, or other documents that the Commissioner may require.
1.4. Non-Profit — means no part of the income inures directly or indirectly to any
individual or member.
1.5. Operated exclusively — means primarily engaged in activities which accomplish the
educational purposes. To meet the operational test, an organization must be engaged
in activities furthering "public purposes" rather than private interests. It must not be
operated for the benefit of designated individuals or the persons who created it.
1.6. Actually, Directly and Exclusively Used. — shall refer to the purpose for which the
property is principally utilized for educational purposes.
1.7. Revenues — refer to income derived in pursuance of its purpose as an educational
institution.
1.8. Assets — Any owned physical object (tangible) or right (intangible) having a money
value; an item or source of wealth, expressed in terms of its cost, depreciated cost, or
less frequently, some other value; hence, any cost benefiting a future period.
SECTION 2. Coverage of Exemption Under Section 4(3), Article XIV of the New Constitution —
The exemption herein contemplated refers to internal revenue taxes and customs duties, in
appropriate cases, imposed by the national government on all revenues and assets of non-
stock, non-profit educational institutions used actually, directly and exclusively for
educational purposes.
2.1. Non-stock, non-profit educational institutions are exempt from tax on all revenues
derived in pursuance of its purpose as an educational institution and used actually,
directly, and exclusively for educational purposes. They shall, however, be subject to
internal revenue taxes on income from trade, business or other activity the conduct of
which is not related to the exercise of performance by such educational institution of
its educational purpose or function.
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
2.2. Revenues derived from and assets used in the operations of cafeterias/canteens,
dormitories, bookstores are exempt from taxation provided they are owned and
operated by the educational institution as ancillary activities and the same are located
within the school premises.
2.3. Revenues derived from and assets used in the operations of hospitals are exempt from
taxation provided they are owned and operated by the educational institution as an
indispensable requirement in the operation and maintenance of its medical
school/college/institute.
SECTION 3. Non-Exemption from the Withholding Taxes. — Non stock educational institutions
are constituted as withholding agents of the government to insure that the withholding tax
liability of their employees, and other taxpayers to whom income payments are made, are
complied with.
SECTION 4. Filing of Return — Educational institutions shall file information return annually
on or before the 15th day of the 4th month following the end of the taxable year.
DOF ORDER 149-95
Amending Department Order No. 137-87 as Amended by Department Order No. 92-88
Implementing Section 4(3), Article XIV of the New Constitution
SECTION 1. Section 2(2.1) of Department Order No. 137-87 as amended Order No. 92-88 is
hereby amended to read as follows:
"2.1. NON-STOCK, NON-PROFIT EDUCATIONAL INSTITUTIONS ARE EXEMPT FROM TAXES
ON ALL THEIR REVENUES AND ASSETS USED ACTUALLY, DIRECTLY, AND EXCLUSIVELY FOR
EDUCATIONAL PURPOSES. They shall, however, be subject to internal revenue taxes on
income from trade, business or other activity the conduct of which is not related to the
exercise or performance by such educational institution of its educational purpose or
function."
"2.1.1 To ensure that the exempt interest income from Philippine currency deposits and
yield from deposit substitute instruments are used actually, directly, and exclusively for
educational purposes, the said educational institutions shall, on annual basis submit to the
Revenue District Officer, together with the annual information return and duly audited
financial statement, the following:
a) Certification from their depository banks as to the amount of interest income
earned from passive investments not subject to the 20% final withholding tax
imposed by Section 24(e) of the Tax Code, as amended;
b) Certification of actual utilization of the said income; and
c) Board Resolution by the school administration on proposed projects. (i.e.
construction and/or improvement of school building and facilities; acquisition of
equipments, books and the like) to be funded out of money deposited in banks or
placed in money markets.
The RDO shall conduct an audit of the annual information return filed to determined
compliance with the conditions set forth in the Certificate of exemption and the tax liabilities,
if any.
D. GOCCs
SEC. 27. Rates of Income Tax on Domestic Corporations. —
99 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(C) Government-owned or -controlled Corporations, Agencies or Instrumentalities. — The
provisions of existing special or general laws to the contrary notwithstanding, all
corporations, agencies, or instrumentalities owned or controlled by the
Government, except the Government. Service and Insurance System (GSIS), the
Social Security System (SSS), the Philippine Health Insurance Corporation (PHIC),
the local water districts (LWDs), and the Philippine Charity Sweepstakes Office
(PCSO), shall pay such rate of tax upon their taxable income as are imposed by this
Section upon corporations or associations engaged in a similar business, industry, or
activity.
E. PASSIVE INCOME
SEC. 27. Rates of Income Tax on Domestic Corporations. —
(D) Rates of Tax on Certain Passive Incomes. –
(1) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes and from Trust Funds and Similar Arrangements, and Royalties. — A final
tax at the rate of twenty percent (20%) is hereby imposed upon the amount of
interest on currency bank deposit and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements received by
domestic corporations, and royalties, derived from sources within the Philippines:
Provided, however, That interest income derived by a domestic corporation from a
depository bank under the expanded foreign currency deposit system shall be
subject to a final income tax at the rate of seven and one-half percent (7 1/2%) of
such interest income.
(2) Capital Gains from the Sale of Shares of Stock Not Traded in the Stock Exchange. — A
final tax at the rates prescribed below shall be imposed on net capital gains realized
during the taxable year from the sale, exchange or other disposition of shares of
stock in a domestic corporation except shares sold or disposed of through the stock
exchange:
Not over P100,000 5%
Amount in excess of P100,000 10%
(3) Tax on Income Derived under the Expanded Foreign Currency Deposit System. —
Income derived by a depository bank under the expanded foreign currency deposit
system from foreign currency transactions with nonresidents, offshore banking
units in the Philippines, local commercial banks, including branches of foreign banks
that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact
business with foreign currency deposit system units and other depository banks
under the expanded foreign currency deposit system shall be exempt from all taxes.
except net income from such transactions as may be specified by the Secretary of
Finance, upon recommendation by the Monetary Board to be subject to the regular
income tax payable by banks: Provided, however, That interest income from foreign
currency loans granted by such depository banks under said expanded system to
residents other than offshore banking units in the Philippines or other depository
banks under the expanded system, shall be subject to a final tax at the rate of ten
percent (10%).
Any income of nonresidents, whether individuals or corporations, from transactions
with depository banks under the expanded system shall be exempt from income tax.
(4) Intercorporate Dividends. — Dividends received by a domestic corporation from
 another domestic corporation shall not be subject to tax.
(5) Capital Gains Realized from the Sale, Exchange or Disposition of Lands
and/or Buildings. — A final tax of six percent (6%) is hereby imposed on the gain
presumed to have been realized on 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 as
determined in accordance with Section 6(E) of this Code, whichever is higher, of
such lands and/or buildings.
1. INTEREST, DEPOSIT SUBSTITUTES, ROYALTIES
Sec. 22. Definitions. – When used in this Title:
(Y) The term 'deposit substitutes' shall mean 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 borrower's own account, for the purpose of re-lending
or purchasing of receivables and other obligations, or financing their own needs or the needs
of their agent or dealer. 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: Provided, however, That debt instruments issued for inter-bank 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.
BIR RUL. NO. 57-00
DOCTRINE:
To be subject to the 20% final withholding tax, the royalties must be in the nature of passive
income.
FACTS:
Midas-Kapiti International Inc. (Philippines) ["MKI-Phils"] is a BOI-registered (non-pioneer)
domestic company primarily engaged in the licensing, implementation and maintenance of
computer software in the domestic and foreign markets; that it is licensed by Midas
Kapiti International in the United Kingdom ("MKI-UK"); that MKI-Phils pays royalties to MKI-
UK net of the 15% final withholding tax prescribed by Article 11(2)(a)(i) of the RP-UK Tax
Treaty, that as its principal and main activity, MKI-Phils distributes the Licensed Systems by
entering with Philippine bank-clients into Licensing Agreements (LA) as well as Consultancy,
Supplementary License and Services Agreement; that MKI-Phils receives fees in consideration
for the rights granted and the support services provided.
ISSUE/S:
Whether the income derived by MKI-Phils. from its bank-clients in the distribution of
computer systems software and rendition of maintenance services is in the nature of ordinary
business income subject to the 33% (for 1999) regular corporate income tax and not the 20%
final tax on gross royalty payments under Section 27(D)(1) of the Tax Code of 1997
RULING:
ORDINARY BUSINESS INCOME. Section 27(D)(1) of the Tax Code of 1997 provides as follows:
"(D) Rates of tax on certain passive incomes. —
100 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(1) Interest from deposits and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements, and
royalties. — A final tax at the rate of twenty percent (20%) is hereby
imposed upon the amount of interest on currency bank deposit and yield
or any other monetary benefit from deposit substitutes and from trust
funds and similar arrangements received by domestic corporations, and
royalties, derived from sources within the Philippines; provided, however,
that interest income derived by a domestic or a resident foreign
corporation from a depository bank under the expanded foreign currency
deposit system shall be subject to a final tax at the rate of seven and one-
half percent (7½%) of such interest income…"
As expressly denoted in the caption, to be subject to the 20% final withholding tax, the
royalties must be in the nature of passive income.
On the other hand, since the income derived by MKI-Phils. from the distribution of the
Licensed Computer Systems to Philippine banks and the performance of support services is
income generated in the active pursuit and performance of its primary purpose, the same is
clearly NOT passive income subject to the 20% final tax. Such being the case, the payments
received by MKI-Phils. from the active conduct of trade or business is considered ordinary
business income subject to the 33% (for 1999) regular corporate income tax.
2. SALE OF SHARES
REV. REGS. 2-82
Taxation of Sales of Shares of Stock Classified as Capital Assets.
SECTION 1. Scope. — These regulations shall define the manner of taxation of sales of shares
of stock classified as capital assets.
SECTION 2. Definition of Terms. — For the purpose of these regulations, the following
definitions of terms are hereby adopted:
(a) "Stock classified as capital assets" shall mean all stocks and securities held by taxpayers
other than dealers in securities.
(b) " Dealer in securities" includes all persons who for their own account are engaged in the
sale of stock, bonds, exchange, bullion, coined money, bank notes, promissory notes, or other
securities as licensed by the Securities and Exchange Commission.
Notwithstanding the foregoing, nothing in these regulations shall preclude the Commissioner
of Internal Revenue from treating other taxpayers engaged in similar activities but not
licensed by the Securities and Exchange Commission as a dealer in securities.
(c) "Gross selling price" is the total amount of money or its equivalent which the purchaser
pays the vendor to receive or get the goods.
SECTION 3. Persons Liable to the Tax. — The following persons are liable to the tax provided
for in Section 5 of these Regulations:
(a) individual taxpayer, citizens or alien;
(b) c orporate taxpayer, domestic or foreign;
(c) other taxpayers not falling under (a) or (b), such as estate, trust, trust funds and
pension funds among others.
SECTION 4. Persons Not Liable to the Tax. — The taxes imposed herein shall not apply to the
following: from the date of incorporation
a. gains derived by dealers in securities; B) The economic outlook in general and the business condition and
outcome of the specific industry in particular
b. gains on sale of shares of stock to the extent invested in new shares of stock in banks,
non-bank financial intermediaries and corporations organized primarily to hold C) The financial condition of the business
equities in banks, in accordance with Presidential Decree No. 1739; and
D) The earning capacity of the company
c. all other gains which are specifically exempt from income tax under existing investment
incentives and other special law. E) The dividend paying capacity

SECTION 5. Imposition of the Tax. — F) Goodwill

1. Sales of shares of stock listed and traded through a local stock exchange. — A tax of 1/4 of G) Sales of stocks and size of the block of stock to be valued
1% shall be imposed on the gross selling price of the shares of stock sold, exchanged or H) Market price of stocks of corporations engaged inthe same or similar
transferred through the facilities of a stock exchange registered with the Securities and line of business to be valued
Exchange Commission.
I) Existence of corporate debts in favor of the family of the principal
2. Shares of stock not traded through a local stock exchange. — Net capital gains derived shareholder
during the taxable year from sales, exchanges, transfers or similar transaction shall be
taxed as follows: J) Restrictive agreements impairing the alienability of the stock

Not over P100,000 10% K) Investments in business or property maintained at a deficit

Over P100,000 20% L) Dividend arrearages

SECTION 6. Determination of Tax Base. — In determining the tax base, the following rules
shall apply:
(a) Determination of selling price. — The selling price of the shares of stocks shall be the fair
market value of the shares of stocks transferred or exchanged and not the fair market
value of the property received in exchange. If the total consideration of the sale or
disposition consists partly in cash or money and partly in kind, the selling price shall be
the fair market value of the shares disposed.
(1) In the case of shares traded through the stock exchange, "fair market value" shall
consist of the actual selling price as shown in the sales confirmation issued by the
member of the stock exchange through whom the sale was effected.
(2) In the case of shares not traded through the stock exchange, but listed in one or
more stock exchanges, the highest closing price on the day when the shares are sold,
transferred or exchanged, shall be the "fair market value."
When no sale is made in any stock exchange, the highest closing price on the day
nearest to the day of sale, transfer or exchange of the shares shall be the fair market
value.
(3) In the case of sale, transfer or exchange of shares not listed in the stock exchange,
the following rules shall be observed:
(i) In general, the unlisted shares shall be valued at their book value nearest the
valuation date. The book value of these unlisted shares of stock shall be prima
facie considered as their fair market value.
(ii) In case the shares are valued on a basis lower than their book values, a
justification for the deviation from the book value, together with the evidences
in support thereof, should be submitted. The following factors are considered
relevant in the valuation of shares of stock of closed corporations.
A) The nature of the business and the financial history of the enterprise,
M) Voting rights of stockholders
N) Difficulty in liquidating the assets
If such lower fair market valuation is not clearly established and documented,
the book value of the unlisted shares of stock shall be adopted. If there have
been previous sales/exchanges of the unlisted shares of stock, the price at
which these shares exchanged hands should be taken/considered as its fair
market value/s.
(b) Determination of cost. — The cost basis for determining the capital gains or losses shall
be the basis as determined in accordance with the provisions of Section 35 of the
National Internal Revenue Code, as amended, and its implementing regulations applied in
the following manner:
(1) If the stocks can be identified, then the cost shall be the actual purchase price plus
all costs of acquisition such as commission, documentary tax, transfer fees, etc.
(2) If the stocks cannot be properly identified, then the cost to be assigned shall be
computed on the basis of the first-in, first-out (FIFO) method. However -
(3) If books of accounts are maintained by the seller where every transaction of a
particular stocks are recorded, then the moving average method shall be applied
rather than the first-in, first-out, (FIFO) method.
(4) In all cases, stock dividend received must be assigned a corresponding cost by
allocating the original cost of acquisition to the total number of shares composed of
the original shareholdings plus the number of shares of stocks received as stock
dividend.
(c) In determining the deductibility of capital losses, the following rules shall apply:
(1) The provisions of Section 33 of the National Internal Revenue Code, as amended,
and its implementing regulations on the non-deductibility of losses on wash sales.

101 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 (2) The net capital losses sustained during the taxable year shall be allowed as a capital
loss deductible in the same taxable year only.
(3) The entire amount of capital gains and capital loss shall be considered without
taking into account the period or duration during which the stocks were held by the
seller up to disposition for purposes of computing net capital gains.
(d) Installment sales of shares of stock not listed and traded through any local stock exchange.
— In cases of gains arising from installment sales of shares of stocks, the provisions of
Section 43 of the National Internal Revenue Code, as amended, and its implementing
regulations shall apply.
SECTION 8. Effect of Non-payment of Tax. — No sale, exchange, transfer or similar transaction
intended to convey ownership of, or title to any share of stock shall be registered in the books
of the corporation unless the receipt of payment of the tax herein imposed is filed with and
recorded by the stock transfer agent or secretary of the corporation. It shall be duty of the
aforesaid persons to inform the Bureau of Internal Revenue in case of non-payment of tax.
Any stock transfer agent or secretary of the corporation who caused the registration in
violation of the aforementioned requirement shall be punished by a fine of not more than
P2,000.00 or by imprisonment for not more than six months, or both.
3. FCDU
REV. REGS. 10-98
Sec. 2.24. Income Tax Rate of Interest Income from Foreign Currency Deposit. —
(A) Individual Income Tax on Interest Income from a Depository Bank under the Foreign
Currency Deposit System
(1) Interest income which is actually or constructively received by a resident citizen of the
Philippines or by a resident alien individual from a foreign currency bank deposit shall be
subject to a final withholding tax of seven and one-half percent (7.5%). The depository bank
shall withhold and remit the tax pursuant to Sections 57 and 58 (withholding tax at source) of
the Code.
(2) If a bank account is jointly in the name of a non-resident citizen such as an overseas
contract worker, or a Filipino seaman, and his spouse or dependent who is a resident in the
Philippines, fifty percent (50%) of the interest income from such bank deposit shall be treated
as exempt while the other fifty percent (50%) shall be subject to a final withholding tax of
seven and one-half percent (7.5%).
(B) Compliance and Administrative Procedures for Non-Resident Citizen and Non-Resident Alien.
The tax on interest income from foreign currency deposit shall be imposed unless the
depositor who is a non-resident citizen or a non-resident alien can present documentary
evidence that he is not a resident of the Philippines. Such evidence shall consist of the original
or certified copy of any of the following:
(1) an immigration visa issued by the foreign government in the country where he is a
resident of; or
(2) a certificate of residency which is issued by the Philippine Embassy or Consulate in the
foreign country of his residence; or
(3) a certificate of the contract of employment of an overseas contract worker which is
duly registered with the Philippine Overseas Employment Agency (POEA); or a
102 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Seaman's Certificate, in the case of a Filipino seaman; or
(4) a certification from the Bureau of Immigration of the Philippines that a non-resident
alien is not a resident of the Philippines; or
(5) a certification from the Department of Foreign Affairs (DFA) of the Philippines that the
individual is a regular member of the diplomatic corps of a foreign government and is
entitled to income tax exemption under an international agreement to which the
Philippines is a signatory.
(C) Name of the Foreign Currency Bank Account — To be entitled to an exemption from the tax
on interest income on foreign currency deposit, the Foreign Currency Bank Account shall be in
the name of the non-resident individual or non-resident corporation. Otherwise, the interest
income therefrom shall be considered as subject to the tax imposed herein.
Sec. 2.27 and Sec. 2.28 — Corporate Income Tax on Interest Income from a Depository Bank
under the Foreign Currency Deposit System.
(A) Interest income which is actually or constructively received by a domestic corporation or
a resident foreign corporation from a foreign currency bank deposit shall be subject to a final
withholding tax at the rate of seven and one-half percent (7.5%) based on the gross amount of
such interest income. The depository bank shall withhold and remit the tax pursuant to the
provisions of Sections 57 and 58 (withholding tax at source) of the Code.
(B) Compliance and Administrative Procedures for a Non-resident Corporation. The tax on
interest income from foreign currency deposit shall be imposed unless the depositor, which is
a non-resident corporation, can present documentary evidence that it is not a resident of the
Philippines. Such evidence shall consist of the original or certified copy of all the following
requirements:
A) Certificate of registration of the corporation abroad; and
B) Certification from the Securities and Exchange Commission (SEC) that the non-
resident corporation is not licensed to do business in the Philippines.
(C) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions. In general,
income derived by an FCDU or an OBU from foreign currency transactions with residents of
the Philippines, including local commercial banks, local branches of foreign banks, and other
depository banks under the foreign currency deposit system, shall be subject to a final
withholding tax of ten percent (10%) based on gross income pursuant to Sec. 27(D)(3) and
Sec. 28(A)(4) of the Code. Income from foreign currency transactions shall include interest
income from lending operations, including bank charges, commissions, service fees, and net
foreign exchange transaction gains.
Income from foreign currency transactions with non-residents of the Philippines shall not be
subject to income tax.
The person making the income payment shall withhold and remit the tax withheld pursuant to
the provisions of Sections 57 and 58 of the Code. Thus, in the case of interest payment by a
resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the
withholding agent shall be the said resident.
(D) Taxation of Other Incomes of an FCDU or an OBU . Income derived by an FCDU or an OBU
from activities other than foreign currency transactions shall be subject to the pertinent
income tax/taxes prescribed under Section 27 or Section 28 of the Code. To illustrate: Income
derived by an FCDU from consultancy services and rentals shall be subject to an income tax
based on net income at the tax rates prescribed under Section 27(A) of the Code. Capital gains
derived from the sale, barter, exchange or disposition of shares of stocks in a domestic
corporation shall be subject to tax prescribed under Section 27(D) of the Code.
The aforesaid depository bank shall file its corporate income tax return for income referred to
in the preceding paragraph in accordance with the provisions of Section 52 of the Code. It
shall also declare thereunder all other incomes derived during the taxable period which are
subject to the final withholding taxes, the fact that such final withholding taxes have been
withheld therefrom by the payor notwithstanding, indicating the following information:
a. Name of the withholding agent;
b. His/its address;
c. His/its Taxpayer Identification Number (TIN);
d. Period covered;
e. Gross Income;
f. R ate of final withholding tax applied; and
g. Amount of final withholding tax withheld.
The submission of the foregoing information shall not be required with respect to its interest
income derived from bank deposits.
4. INTERCORPORATE DIVIDENDS
CIR v. MANNING
DOCTRINE:
Whenever the company parted with a portion of its earnings "to buy" the corporate
holdings of the deceased stockholders, it was in ultimate effect and result making a
distribution of such earnings to the surviving stockholders. All these amounts are
consequently subject to income tax as being, in truth and in fact, a flow of cash benefits to
the surviving stockholders.
FACTS:
MANTRASCO had an authorized capital stock of P2,500,000 divided into 25,000 common
shares; 24,700 of these were owned by Julius S. Reese, and the rest, at 100 shares each, by the
three respondents: John Manning, W.D. McDonald, and E.E. Simmons. In view of Reese's
desire that upon his death MANTRASCO and its two subsidiaries, MANTRASCO (Guam),
Inc. and the Port Motors, Inc., would continue under the management of the respondents, a
trust agreement on his and the respondents' interests in MANTRASCO was executed by
and among Reese (as OWNER), MANTRASCO, the law firm of Ross, Selph, Carrascoso and
Janda (as TRUSTEES), and the respondents (as MANAGERS).
The trust agreement provides that Reese and the Managers shall deposit with the trustees
their respective shares in MANTRANSCO. And that upon the Reese’s death, MANTRANSCO
shall purchase Reese’s shares. Reese died. After MANTRASCO made a partial payment of
Reese's shares, the certificate for the 24,700 shares in Reese's name was cancelled and a new
certificate was issued in the name of MANTRASCO. Pending full payment, the new certificate
was endorsed to trustees for and in behalf of MANTRASCO. Subsequently, MANTRASCO’s
stockholders passed a resolution reverting back the 24,700 shares in the Treasury to the
capital account of the company as a stock dividend to be distributed to shareholders of record
at the close of business on December 22, 1958. When the entire purchase price of Reese's
interest in MANTRASCO was finally paid in full by the latter, the trust agreement was
terminated and the trustees delivered to MANTRASCO all the shares which they were holding
in trust.
103 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
An examination of MANTRASCO's books was ordered by the Bureau of Internal Revenue.
The examination disclosed that (a) the 24,700 shares declared as dividends had been
proportionately distributed to the respondents, representing a total book value or
acquisition cost of P7,973,660; (b) the respondents failed to declare the said stock
dividends as part of their taxable income for the year 1958. The BIR examiners concluded
that the distribution of Reese's shares as stock dividends was in effect a distribution of the
"asset or property of the corporation as may be gleaned from the payment of cash for the
redemption of said stock and distributing the same as stock dividend." The Commissioner of
Internal Revenue issued notices of assessment for deficiency income taxes to the
respondents for the year 1958 amounting to roughly $2.4M each.
ISSUE: Whether or not the stock dividends are subject to tax? Yes.
RULING:
The manifest intention of the parties to the trust agreement was to treat the 24,700 shares
of Reese as absolutely outstanding shares of Reese's estate until they were fully paid. Their
declaration as treasury stock dividend in 1958 was a complete nullity and plainly violative
of public policy. A stock dividend, being one payable in capital stock, cannot be declared out
of outstanding corporate stock, but only from retained earnings. "'A stock dividend always
involves a transfer of surplus (or profit) to capital stock.' 'A stock dividend is a conversion of
surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a
cash dividend.'
The respondents, using the trust instrument as a convenient technical device, bestowed unto
themselves the full worth and value of Reese's corporate holdings with the use of the very
earnings of the companies. Such package device, obviously not designed to carry out the usual
stock dividend purpose of corporate expansion reinvestment, but exclusively for expanding
the capital base of the respondents in MANTRASCO, cannot be allowed to deflect the
respondents' responsibilities toward our income tax laws. The conclusion is that whenever
the companies involved herein parted with a portion of their earnings "to buy" the corporate
holdings of Reese, they were in ultimate effect and result making a distribution of such
earnings to the respondents. All these amounts are consequently subject to income tax as
being, in truth and in fact, a flow of cash benefits to the respondents.
The Commissioner erred in assessing the respondents the total acquisition cost (P7,973,660)
of the alleged treasury stock dividends in one lump sum. The record shows that the earnings
of MANTRASCO over a period of years were used to gradually wipe out the holdings therein
of Reese. Consequently, those earnings, as in effect having been distributed to the
respondents, should be taxed for each of the corresponding years when payments were
made to Reese's estate on account of his 24,700 shares. As those payments accrued in favor
of the respondents in 1958 they are and should be liable, for income tax purposes, to the
extent of the aggregate amount paid, from 1955 to 1958, by MANTRASCO to buy off Reese's
shares.
Under the National Internal Revenue Code, income tax is assessed on income received from
any property, activity or service that produces income. The assessment of a fraud penalty and
imposition of interest charges pursuant to the provisions of the Tax Code by the CIR is in
accordance with law.
5. SALE OF REALTY
REV. REGS. 8-98 – Revenue Regulations Amending Pertinent Portions of Revenue Regulations
Nos. 11-96 and 2-98 Relative to the Tax Treatment on the Sale, Transfer or Exchange of Real
Property and for this Purpose Revising the Time and Place of Payment of the Capital Gains Tax
Due Thereon
SECTION 1. Scope. — Pursuant to Section 244 of the Tax Code of 1997, in relation to Sections
24(D)(1) and 27(D)(5) of the same Code, these Regulations are hereby promulgated amending
pertinent portions of Revenue Regulations Nos. 11-96 and 2-98 and other relevant regulations
and issuances regarding the tax treatment on the sale, transfer or exchange of real property
and amending for this purpose the date and venue for the filing of capital gains tax returns
and payment of taxes due on transactions involving real properties classified as capital assets
and likewise amending the venue for the filing and payment of creditable withholding tax due
on transactions involving real properties classified as ordinary assets.
SECTION 2. Final Tax on Sales, Exchanges or Transfers of Real Properties Classified as Capital
Assets. — The rate of six percent (6%) shall be imposed on capital gains presumed to have
been realized by the seller from the sale, exchange or other disposition of real properties
located in the Philippines, classified as capital assets, including pacto de retro sales and other
forms of conditional sales based on the gross selling price or fair market value as determined
in accordance with Section 6(E) of the Code (i.e., the authority of the Commissioner to
prescribe the real property values), whichever is higher.
In case of disposition of real property made by individuals to the government or to any of its
political subdivisions or agencies or to government-owned or -controlled-corporations, the
tax to be imposed shall be determined either under the normal income tax rate imposed in
Section 24(A) or under a final capital gains tax of six percent (6%) imposed under Section
24(D)(1), both of the Tax Code of 1997, at the option of the taxpayer.
SECTION 3. Time and Place of Payment of Capital Gains Tax. — Within thirty (30) days
following each sale or disposition, the Capital Gains Tax Return shall be filed by the seller and
payment made to an Authorized Agent Bank (AAB) located within the Revenue District Office
(RDO) having jurisdiction over the place where the property being transferred is located.
REV. REGS. 4-99 – Payment of Capital Gains Tax and Documentary Stamp Tax on Extra-
Judicial Foreclosure Sale of Capital Assets Initiated by Banks, Finance and Insurance Companies
SECTION 3. Capital Gains Tax. —
(1) In case the mortgagor exercises his right of redemption within one year from the issuance
of the certificate of sale, no capital gains tax shall be imposed because no capital gains has
been derived by the mortgagor and no sale or transfer of real property was realized. A
certification to that effect or the deed of redemption shall be filed with the Revenue District
Office having jurisdiction over the place where the property is located which certification or
deed shall likewise be filed with the Register of Deeds and a brief memorandum thereof shall
be made by the Register of Deeds on the Certificate of Title of the mortgagor.
(2) In case of non-redemption, the capital gains tax on the foreclosure sale imposed under
Secs. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price
of the highest bidder but only upon the expiration of the one-year period of redemption
provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid
within thirty (30) days from the expiration of the said one-year redemption period.
SECTION 4. Documentary Stamp Tax. —
(1) In case the mortgagor exercises his right of redemption, the transaction shall only be
subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997
because no land or realty was sold or transferred for a consideration.
(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied,
collected and paid by the person making, signing, issuing, accepting, or transferring the real
property wherever the document is made, signed, issued, accepted or transferred where the
property is situated in the Philippines; Provided, That whenever one party to the taxable
104 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
document enjoys exemption from the tax, the other party thereto who is not exempt shall be
the one directly liable for the tax. The tax return prescribed under the Code shall be filed
within ten (10) days after the close of the month following the lapse of the one-year
redemption period, and the tax due under Sec. 196 of the Tax Code of 1997 shall be paid based
on the bid price at the same time the aforesaid return is filed.
SECTION 5. Tax Clearance Certificate/Certificate Authorizing Registration. — In case of non-
redemption, a tax clearance certificate (TCC) or Certificate Authorizing Registration (CAR) in
favor of the purchaser/highest bidder shall only be issued upon presentation of the capital
gains and documentary stamp taxes returns duly validated by an authorized agent bank (AAB)
evidencing full payment of the capital gains and documentary stamp taxes due imposed under
Secs. 3 and 4 of these Regulations on the sale of the property classified as capital asset. The
AAB must be located at the Revenue District Office having jurisdiction over the place where
the property is located.
F. MINIMUM CORPORATE INCOME TAX (MCIT)
SEC. 27. Rates of Income Tax on Domestic Corporations. —
(E) Minimum Corporate Income Tax on Domestic Corporations. —
(1) Imposition of Tax. — A minimum corporate income tax of two percent (2%) of the
gross income as of the end of the taxable year, as defined herein, is hereby imposed
on a corporation taxable under this Title, beginning on the fourth taxable year
immediately following the year in which such corporation commenced its business
operations, when the minimum income tax is greater than the tax computed under
Subsection (A) of this Section for the taxable year.
(2) Carry Forward of Excess Minimum Tax. — Any excess of the minimum corporate
income tax over the normal income tax as computed under Subsection (A) of this
Section shall be carried forward and credited against the normal income tax for the
three (3) immediately succeeding taxable years.
(3) Relief from the Minimum Corporate Income Tax Under Certain Conditions. — The
Secretary of Finance is hereby authorized to suspend the imposition of the
minimum corporate income tax on any corporation which suffers losses on account
of prolonged labor dispute, or because of force majeure, or because of legitimate
business reverses.
The Secretary of Finance is hereby authorized to promulgate, upon
recommendation of the Commissioner, the necessary rules and regulations that
shall define the terms and conditions under which he may suspend the imposition
of the minimum corporate income tax in a meritorious case.
(4) Gross Income, Defined. — For purposes of applying the minimum corporate income
tax provided under Subsection (E) hereof, the term 'gross income' shall mean gross
sales less sales returns, discounts and allowances and cost of goods sold. 'Cost of
goods sold' shall include all business expenses directly incurred to produce the
merchandise to bring them to their present location and use.
For a trading or merchandising concern, 'cost of goods sold' shall include the invoice
cost of the goods sold, plus import duties, freight in transporting the goods to the
place where the goods are actually sold including insurance while the goods are in
transit.
For a manufacturing concern, 'cost of goods manufactured and sold' shall include all
 costs of production of finished goods, such as raw materials used, direct labor and
manufacturing overhead freight cost, insurance premiums and other costs incurred
Computation of Net Amount of Tax Payable in 2000:
to bring the raw materials to the factory or warehouse.
Amount of Tax Payable P100,000
In the case of taxpayers engaged in the sale of service, 'gross income' means gross
receipts less sales returns, allowances, discounts and cost of services. 'Cost of Less:
services' shall mean all direct costs and expenses necessarily incurred to provide
the services required by the customers and clients including (A) salaries and 1998 excess MCIT (25,000)
employee benefits of personnel, consultants and specialists directly rendering the 1999 excess MCIT (40,000) P65,000
service and (B) cost of facilities directly utilized in providing the service such as
depreciation or rental of equipment used and cost of supplies: Provided, however, Net amount of Tax Payable P35,000
That in the case of banks, 'cost of services' shall include interest expense.

The taxpayer shall pay the MCIT whenever it is greater than the regular or normal corporate
REV. REGS. 9-98 income tax which is imposed under Sec. 27(A) of the Code. The comparison between the
Sec. 2.27(E) MINIMUM CORPORATE INCOME TAX (MCIT) ON DOMESTIC CORPORATIONS — normal income tax payable by the corporation and the MCIT shall be made at the end of the
taxable year.
(1) Imposition of the Tax — A minimum corporate income tax (MCIT) of two percent (2%) of
the gross income as of the end of the taxable year (whether calendar or fiscal year, depending The excess MCIT is creditable against the normal income tax within the next three (3) years
on the accounting period employed) is hereby imposed upon any domestic corporation from payment thereof.
beginning the fourth (4th) taxable year immediately following the taxable year in which such (3) Relief from the Minimum Corporate Income Tax under Certain Conditions — The Secretary
corporation commenced its business operations. The MCIT shall be imposed whenever such of Finance, upon recommendation of the Commissioner, may suspend imposition of the MCIT
corporation has zero or negative taxable income or whenever the amount of minimum- upon submission of proof by the applicant-corporation, duly verified by the Commissioner's
corporate income tax is greater than the normal income tax due from such corporation. authorized representative, that the corporation sustained substantial losses on account of a
For purposes of these Regulations, the term, "normal income tax" means the income tax rates prolonged labor dispute or because of "force majeure" or because of legitimate business
prescribed under Sec. 27(A) and Sec. 28(A)(1) of the Code at 34% on January 1, 1998; 33% reverses.
effective January 1, 1999; and at 32% effective January 1, 2000 and thereafter. (4) Definition of Terms —
In the case of a domestic corporation whose operations or activities are partly covered by the (a) "Gross Income" defined — For purposes of the minimum corporate income tax prescribed
regular income tax system and partly covered under a special income tax system, the MCIT under this Subsection, the term "gross income" means gross sales less sales returns, discounts
shall apply on operations covered by the regular income tax system. For example, if a BOI- and allowances and cost of goods sold. "Gross sales" shall include only sales contributory to
registered enterprise has a "registered" and an "unregistered" activity, the MCIT shall apply to income taxable under Sec. 27(A) of the Code. "Cost of goods sold" shall include all business
the unregistered activity. expenses directly incurred to produce the merchandise to bring them to their present location
(2) Carry forward of excess minimum corporate income tax — Any excess of the minimum and use.
corporate income tax (MCIT) over the normal income tax as computed under Sec. 27(A) of the Passive incomes which have been subject to a final tax at source shall not form part of gross
Code shall be carried forward on an annual basis and credited against the normal income tax income for purposes of the minimum corporate income tax.
for the three (3) immediately succeeding taxable years.
For a trading or merchandising concern, "cost of goods sold" means the invoice cost of the
Illustration on how to carry forward excess minimum corporate income tax — goods sold, plus import duties, freight in transporting the goods to the place where the goods
Excess of MCIT are actually sold, including insurance while the goods are in transit.
NORMAL Over the Normal For a manufacturing concern, "cost of goods manufactured and sold" means all costs of
YEAR INCOME TAX MCIT Income Tax production of finished goods, such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse.
1998 P50,000 P75,000 P25,000
In the case of sales of services, the term "gross income" means gross receipts less sales returns,
1998 amount of tax payable P75,000 allowances, discounts and cost of services. "Cost of services" means all direct costs and
expenses necessarily incurred to provide the services required by the customers and clients
1999 P60,000 P100,000 P40,000 including (a) salaries and employee benefits of personnel, consultants and specialists directly
1999 amount of tax payable P100,000 rendering the service, and (b) cost of facilities directly utilized in providing the service such as
depreciation or rental of equipment used and cost of supplies: Provided, however, that "cost of
2000 P100,000 P60,000 services" shall not include interest expense except in the case of banks and other financial

105 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
institutions. The term "gross receipts" as used herein means amounts actually or
constructively received during the taxable year; Provided, that for taxpayers employing the
accrual basis of accounting, the term "gross receipts" shall mean amounts earned as gross
income.
(b) The term "substantial losses from a prolonged labor dispute" means losses arising from a
strike staged by the employees which lasted for more than six (6) months within a taxable
period and which has caused the temporary shutdown of business operations.
(c) The term "force majeure" means a cause due to an irresistible force as by "Act of God" like
lightning, earthquake, storm, flood and the like. This term shall also include armed conflicts
like war or insurgency.
(d) The term "legitimate business reverses" shall include substantial losses sustained due to
fire, robbery, theft or embezzlement, or for other economic reason as determined by the
Secretary of Finance.
(5) Specific Rules for Determining the Period When a Corporation Becomes Subject to the MCIT
— accounting period employed) immediately following the taxable year in which the corporation
For purposes of the MCIT, the taxable year in which business operations commenced shall be
the year in which the domestic corporation registered with the Bureau of Internal Revenue.
Firms which were registered with BIR in 1994 and earlier years shall be covered by the MCIT
beginning January 1, 1998.
Firms which were registered with BIR in any month in 1998 shall be covered by the MCIT
three calendar years thereafter (i.e. after the lapse of three calendar years from 1998). For
example, a firm which was registered in May 1998 shall be covered by the MCIT in 2002.
The reckoning point for firms using the fiscal year shall also be 1998. For example, a firm
which registered with the BIR on July 1, 1998 shall be subject to an MCIT on his gross income
earned for the entire fiscal year ending in the year 2002.
Transitory Rule for determining the MCIT for 1998 on firms which are taxable on a fiscal year
basis. For firms using the fiscal year basis and whose first taxable period under the minimum
corporate income tax covers month/months in 1997 (i.e. prior to the imposition of MCIT
under RA 8424), the MCIT which is due for 1998 shall be computed using an apportionment
formula. The ratio to be applied is the number of months in 1998 to twelve (12) months (i.e.
the total number of months in a fiscal year).
(6) Manner of filing and payment — The minimum corporate income tax (MCIT) shall be paid
on a taxable year basis. It shall be covered by a tax return designed for the purpose which will
be submitted together with the corporation's annual final adjustment income tax return.
Domestic corporations shall not be required to pay the minimum corporate income tax on a
quarterly basis, the provisions of Sec. 75 of the Code notwithstanding.
(8) Exceptions — The minimum corporate income tax (MCIT) shall apply only to domestic
corporations subject to the normal corporate income tax prescribed under these Regulations.
Accordingly, the minimum corporate income tax shall not be imposed upon any of the
following:
1. Domestic corporations operating as proprietary educational institutions subject to tax at
ten percent (10%) on their taxable income; or
2. Domestic corporations engaged in hospital operations which are nonprofit subject to tax
at ten percent (10%) on their taxable income; and
3. Domestic corporations engaged in business as depository banks under the expanded
106 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
foreign currency deposit system, otherwise known as Foreign Currency Deposit Units
(FCDUs), on their income from foreign currency transactions with local commercial
banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas
(BSP) to transact business with foreign currency deposit system units and other
depository banks under the foreign currency deposit system, including their interest
income from foreign currency loans granted to residents of the Philippines under the
expanded foreign currency deposit system, subject to final income tax at ten percent
(10%) of such income.
4. Firms that are taxed under a special income tax regime such as those in accordance with
RA 7916 and 7227 (the PEZA law and the Bases Conversion Development Act,
respectively).
Sec. 2.28(A)(2) MINIMUM CORPORATE INCOME TAX (MCIT) ON RESIDENT FOREIGN
CORPORATION — A minimum corporate income tax of two percent (2%) of the gross income
from sources within the Philippines is hereby imposed upon any resident foreign corporation,
beginning on the fourth (4th) taxable year (whether calendar or fiscal year, depending on the
commenced its business operations, whenever the amount of the minimum corporate income
tax is greater than the normal income tax due for such year.
In computing for the minimum corporate income tax due from a resident foreign corporation,
the rules prescribed under Sec. 2.27(E) of these Regulations shall apply: Provided, however,
that only the gross income from sources within the Philippines shall be considered for such
purposes.
Exceptions — The minimum corporate income tax shall only apply to resident foreign
corporations which are subject to normal income tax. Accordingly, the minimum corporate
income tax shall not apply to the following resident foreign corporations:
a. Resident foreign corporations engaged in business as "international carrier" subject to
tax at two and one-half percent (2 ½%) of their "Gross Philippine Billings";
b. Resident foreign corporations engaged in business as Offshore Banking Units (OBUs) on
their income from foreign currency transactions with local commercial banks, including
branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP) to
transact business with Offshore Banking Units (OBUs), including interest income from
foreign currency loans granted to residents of the Philippines, subject to a final income
tax at ten percent (10%) of such income; and
c. Resident foreign corporations engaged in business as regional operating headquarters
subject to tax at ten percent (10%) of their taxable income.
d. Firms that are taxed under a special income tax regime such as those in accordance with
RA 7916 and 7227 (the PEZA law and the Bases Conversion Development Act,
respectively).
THE MANILA BANKING CORP. v. CIR
DOCTRINE:
The intent of Congress relative to the minimum corporate income tax is to grant a four (4)-
year suspension of tax payment to newly formed corporations. Corporations still starting
their business operations have to stabilize their venture in order to obtain a stronghold in the
industry.
FACTS:
  The Manila Banking Corporation was incorporated in 1961 and since then had engaged
in the commercial banking industry until 1987.
 On May 22, 1987, the Monetary Board of the BSP issued Resolution No. 505, pursuant to
Sec. 29 of RA No. 265 (the Central Bank Act), prohibiting petitioner from engaging in
business by reason of insolvency. Thus, petitioner ceased operations that year and its
assets and liabilities were placed under the charge of a government-appointed receiver.
 On June 23, 1999, after 12 years since petitioner stopped its business operations, the BSP
authorized it to operate as a thrift bank. The following year, specifically on April 7, 2000,
it filed with the BIR its annual corporate income tax return and paid P33,816,164.00 for
taxable year 1999 corresponding to their minimum corporate income tax (MCIT), which
they are now claiming as a refund.
 Petitioner relied on a BIR Ruling which held that the petitioner is entitled to the 4-year
grace period given to new corporations as well as existing corporations a leeway or
adjustment period during which the MCIT does not apply.
 The Commissioner of Internal Revenue, maintains that pursuant to R.A. No. 8424,
petitioner should pay its minimum corporate income tax beginning January 1, 1998 as it
did not close its business operations in 1987 but merely suspended the same. Even if
placed under receivership, its corporate existence was never affected. Thus, it falls under
the category of an existing corporation recommencing its banking business operations.
ISSUE:
W/N Manila Banking is entitled to a refund of its minimum corporate income tax paid to the
BIR for taxable year 1999
HELD:
YES. Revenue Reg. No. 4-951 states that the date of commencement of operations of a thrift
bank is the date it was registered with the SEC or the date when the Certificate of Authority to
Operate was issued to it by the Monetary Board of the BSP, whichever comes later.
Let it be stressed that Revenue Reg. No. 9-98,2 implementing R.A. No. 8424 imposing the
minimum corporate income tax on corporations, provides that for purposes of this tax, the
date when business operations commence is the year in which the domestic corporation
registered with the BIR. However, under Revenue Reg. No. 4-95, the date of commencement
1 Sec. 6. Period of exemption. – All thrift banks created and organized under the provisions of the
Act shall be exempt from the payment of all taxes, fees, and charges of whatever nature and
description, except the corporate income tax imposed under Title II of the NIRC and as specified in
Section 2(A) of these regulations, for a period of five (5) years from the date of commencement of
operations; while for thrift banks which are already existing and operating as of the date of
effectivity of the Act (March 18, 1995), the tax exemption shall be for a period of five (5) years
reckoned from the date of such effectivity.
For purposes of these regulations, “date of commencement of operations” shall be understood to
mean the date when the thrift bank was registered with the Securities and Exchange Commission or
the date when the Certificate of Authority to Operate was issued by the Monetary Board of the
Bangko Sentral ng Pilipinas, whichever comes later.
2(5) Specific Rules for Determining the Period When a Corporation Becomes Subject to the MCIT
(minimum corporate income tax) -
For purposes of the MCIT, the taxable year in which business operations commenced shall be the
year in which the domestic corporation registered with the Bureau of Internal Revenue (BIR).
Firms which were registered with BIR in 1994 and earlier years shall be covered by the MCIT
beginning January 1, 1998.
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of operations of thrift banks, such as herein petitioner, is the date the particular thrift bank
was registered with the SEC or the date when the Certificate of Authority to Operate was
issued to it by the Monetary Board of the BSP, whichever comes later.
Clearly then, Revenue Reg. No. 4-95, not Revenue Reg. No. 9-98, applies to petitioner, being a
thrift bank. It is, therefore, entitled to a grace period of four (4) years counted from June 23,
1999 when it was authorized by the BSP to operate as a thrift bank. Consequently, it should
only pay its minimum corporate income tax after four (4) years from 1999.
IX. INCOME TAX ON RESIDENT FOREIGN CORPORATIONS
A. DEFINITION
SEC. 22 Definitions - When used in this Title:
(B) The term "corporation" shall include partnerships, no matter how created or organized,
joint-stock companies, joint accounts (cuentas en participacion), association, or
insurance companies, but does not include general professional partnerships and a joint
venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an
operating consortium agreement under a service contract with the Government "General
professional partnerships" are partnerships formed by persons for the sole purpose of
exercising their common profession, no part of the income of which is derived from
engaging in any trade or business.
(C) The term "domestic", when applied to a corporation, means created or organized in the
Philippines or under its laws.
(D) The term "foreign", when applied to a corporation, means a corporation which is not
domestic.
(H) The term "resident foreign corporation" applies to a foreign corporation engaged in trade
or business within the Philippines.
B. MEANING OF “ENGAGED IN TRADE OR BUSINESS”
REP. ACT NO. 7042 (FOREIGN INVESTMENTS ACT OF 1991)
Section 3. Definitions. - As used in this Act:
d) The praise "doing business" shall include soliciting orders, service contracts, opening
offices, whether called "liaison" offices or branches; appointing representatives or
distributors domiciled in the Philippines or who in any calendar year stay in the country
for a period or periods totalling one hundred eighty (180) days or more; participating in
the management, supervision or control of any domestic business, firm, entity or
corporation in the Philippines; and any other act or acts that imply a continuity of
commercial dealings or arrangements, and contemplate to that extent the performance of
acts or works, or the exercise of some of the functions normally incident to, and in
progressive prosecution of, commercial gain or of the purpose and object of the business
organization: Provided, however, That the phrase "doing business: shall not be deemed
to include mere investment as a shareholder by a foreign entity in domestic corporations
duly registered to do business, and/or the exercise of rights as such investor; nor having
a nominee director or officer to represent its interests in such corporation; nor
appointing a representative or distributor domiciled in the Philippines which transacts
business in its own name and for its own account;
ISLAND POWER CORP. v. CIR
DOCTRINE:
One single or isolated business transaction does not constitute ‘doing business’, and that
transactions which are occasional, incidental and casual, that of a character to indicate a
purpose to engage in business do not constitute the doing or engaging in business. In order
that a foreign corporation may be regarded as doing business in a State, there must be
continuity of conduct and intention to establish a continuous business, such as the
appointment of a local agent, and not one of a temporary character."
FACTS:
Petitioner is a domestic corporation engaged in the business of power generation. On Dec 21,
1993, Petitioner entered into a turn key contract with Edison Global Electric Ltd. for 2 Units of
Electric Generator Sets at San Jose, Occidental Mindoro, Philippines," for a total contract price
of P118,036,870.00. On April 15, 1996, petitioner filed its Annual Income Tax reporting a "nil"
taxable income as it was still in its pre-operating stage. On March 5, 1998, petitioner received
an assessment deficiency notice from respondent of P63,097,199.81 for Deficiency
Withholding Tax and Interest for 1995 for its failure to withhold 35% on the fees/income
paid to Edison. On January 14, 1999, petitioner filed its letter-protest with the BIR, claiming
that it does not have any obligation to withhold 35% of its payment to Edison because Edison
is a"resident foreign corporation."
A Preliminary Collection Letter was subsequently issued by respondent. For failure of
petitioner to reply, a Final Notice Before Seizure was then issued by respondent. On May 6,
1999, petitioner filed its reply letter and alleged that a protest letter questioning the subject
assessment was filed but which has not yet been resolved; hence, the issuance of the
"Preliminary Collection Letter" and the "Final Notice Before Seizure" was premature as the
assessment has not yet become final. BIR denied petitioner’s protest for petitioner’s failure to
dispute the correctness of the assessment within the 30-day reglementary period. Thus, the
assessment had allegedly become final and executory. Petitioner appealed the denial of its
protest by filing the instant petition for review.
ISSUES:
1. Whether or not Edison Global Limited is a resident foreign corporation? NO.
2. Whether or not petitioner is liable for deficiency withholding tax and interest for the year
1995? YES.
RULING:
Petitioner claimed that Edison is a resident foreign corporation as it is engaged in trade or
business within the Philippines and that it has established a Philippine office. Further, it
asserted that Edison "has been, and still is, engaged in projects similar to petitioner’s Mindoro
project. By entering into such projects, Edison is performing the purpose and object of its
organization. It also shows its intention to continue its commercial dealings and arrangements
here in the Philippines". To support its position that Edison is a resident foreign corporation,
petitioner offered in evidence various documents such as their turn-key contract; letter of
Edison addressed to petitioner to prove that Edison maintains a Philippine office, care of
Edison Energy Corp. P.O. Box 12290 Ortigas Center, Pasig, MM; and certification from the
Bureau of Immigration of the travel records of David Tan for the years 1994 to 1996 to prove
that David Tan, as president and Philippine representative of Edison, traveled between
Hongkong and the Philippines several times from 1994 to 1996.
Respondent maintained that Edison is a non-resident foreign corporation based on the
letterhead of the letter sent by Edison, to petitioner, through its President, Mr. Francis T.
Delgado, whereby it requested "to make all checks payable in favor of Edison Global Electric
Ltd., as follows: "Edison Industries, Inc. for the account of Edison Global Electric Ltd.-IPC
108 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Project". Moreover, respondent’s witness testified that upon his verbal inquiry with the SEC,
he discovered that Edison is a "non-resident foreign corporation, non-existing at the SEC."
The phrase "doing business" shall include soliciting orders, purchases, service contracts,
opening offices, whether called "liaison" offices or branches; appointing representatives or
distributors who are domiciled in the Philippines or who in any calendar year stay in the
Philippines for a period or periods totalling one hundred eighty (180) days or more;
participating in the management, supervision or control of any domestic business firm, entity
or corporation in the Philippines, and any other act or acts that imply a continuity of
commercial dealings or arrangements and contemplate to that extent the performance of acts
or works, or the exercise of some of the functions normally incident to, and in progressive
prosecution of, commercial gain or of the purpose and object of the business corporation."
"It is a rule generally accepted that one single or isolated business transaction does not
constitute ‘doing business’ within the meaning of the law, and that transactions which are
occasional, incidental and casual, that of a character to indicate a purpose to engage in
business do not constitute the doing or engaging in business contemplated by law. In order
that a foreign corporation may be regarded as doing business in a State, there must be
continuity of conduct and intention to establish a continuous business, such as the
appointment of a local agent, and not one of a temporary character."
The letter addressed to petitioner did not prove that Edison was doing business in the
Philippines. While the address of the alleged Philippine office of Edison was printed at the
lower right portion of the letter, it did not, however, establish the fact that it actually
maintained a branch office in the Philippines. It is not even a business address but a postal
office address. Moreover, the travel records of Mr. David C. Tan relative to his Philippine
travels merely showed that he came to the Philippines and Hongkong during the period March
7, 1994 to September 2, 1996. There was, however, no other document to show proof that his
various travels to the Philippines during the said period were incurred in furtherance of the
Contract entered into with herein petitioner, that is, for the purpose of the construction of the
power plant in Occidental Mindoro.
While Edison completed the construction of the power plant in Occidental Mindoro after
almost two years, Edison cannot be considered as doing business in the Philippines as there
was no clear and convincing proof that it continued its business operations in the Philippines
even after the completion of the construction of the power plant. It is, thus, considered, as
engaged in an "isolated transaction" which does not constitute ‘doing business’ within the
meaning of the law.
Assuming arguendo that Edison is in fact a resident foreign corporation, petitioner could have
easily presented the Income Tax Return of Edison which is a vital document to prove that it is,
indeed, a resident foreign corporation. Failure on the part of petitioner to establish such fact,
this court cannot consider Edison as a resident foreign corporation. Thus, the imposition of
the 35% tax rate on the income payments made by petitioner to Edison was proper.
C. INCOME TAX RATE AND TAX BASE, IN GENERAL
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(1) In General. - Except as otherwise provided in this Code, a corporation organized,
authorized, or existing under the laws of any foreign country, engaged in trade or business
within the Philippines, shall be subject to an income tax equivalent to thirty-five percent
(35%) of the taxable income derived in the preceding taxable year from all sources within the
Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty
percent (30%).
In the case of corporations adopting the fiscal-year accounting period, the taxable income
shall be computed without regard to the specific date when sales, purchases and other
transactions occur. Their income and expenses for the fiscal year shall be deemed to have
been earned and spent equally for each month of the period.
The reduced corporate income tax rate shall be applied on the amount computed by
multiplying the number of months covered by the new rate within the fiscal year by the
taxable income of the corporation for the period, divided by twelve.
Provided, however, That a resident foreign corporation shall be granted the option to be taxed
at fifteen percent (15%) on gross income under the same conditions, as provided in Section 27
(A).
SEC. 31. Taxable Income Defined. - The term taxable income means the pertinent items of
gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.
D. SPECIAL RESIDENT FOREIGN CORPORATIONS
1. INTERNATIONAL CARRIERS
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(3) International Carrier. - An international carrier doing business in the Philippines shall pay
a tax of two and one-half percent (2 1/2%) on its "Gross Philippine Billings" as defined
hereunder: (a) International Air Carrier. - "Gross Philippine Billings" refers to the amount of
gross revenue derived from carriage of persons, excess baggage, cargo and mail originating
from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale
or issue and the place of payment of the ticket or passage document: Provided, That tickets
revalidated, exchanged and/or indorsed to another international airline form part of the Gross
Philippine Billings if the passenger boards a plane in a port or point in the
Philippines: Provided, further, That for a flight which originates from the Philippines, but
transshipment of passenger takes place at any port outside the Philippines on another airline,
only the aliquot portion of the cost of the ticket corresponding to the leg flown from the
Philippines to the point of transshipment shall form part of Gross Philippine Billings.
(b) International Shipping. - "Gross Philippine Billings" means gross revenue whether for
passenger, cargo or mail originating from the Philippines up to final destination, regardless of
the place of sale or payments of the passage or freight documents.
CIR v. BRITISH OVERSEAS AIRWAYS CORP.
FACTS:
BOAC is a 100% British Government-owned corporation engaged in the international airline
business and is a member-signatory of the Interline Air Transport Association (IATA). As such
it operates air transportation service and sells transportation tickets over the routes of the
other airline members. During the periods covered by the disputed assessments, BOAC had no
landing rights for traffic purposes in the Philippines, and was not granted a Certificate of
public convenience and necessity to operate in the Philippines by the Civil Aeronautics Board
(CAB). Consequently, it did not carry passengers and/or cargo to or from the Philippines,
although during the period covered by the assessments, it maintained a general sales agent in
109 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the Philippines — Warner Barnes and Company, Ltd., and later Qantas Airways — which was
responsible for selling BOAC tickets covering passengers and cargoes.
Petitioner CIR assessed BOAC P2,498,358.56 for deficiency income taxes covering the years
1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in the issuance
of a new assessment for the years 1959 to 1967 of P858,307.79. BOAC paid this new
assessment under protest. BOAC filed a claim for refund of P858,307.79, which claim was
denied by the CIR. But before said denial, BOAC had already filed a petition for review with the
Tax Court assailing the assessment and praying for the refund of the amount paid.
BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal years 1968-
1969 to 1970-1971 of P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 as
compromise penalties for violation of Section 46 (requiring the filing of corporation returns)
penalized under Section 74 of the National Internal Revenue Code (NIRC). BOAC requested
that the assessment be countermanded and set aside. The CIR not only denied the BOAC
request for refund in the First Case but also re-issued in the Second Case the deficiency
income tax assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 as
compromise penalty under Section 74 of the Tax Code. BOAC's request for reconsideration
was denied by the CIR. This prompted BOAC to file the Second Case before the Tax Court
praying that it be absolved of liability for deficiency income tax for the years 1969 to 1971.
The Tax Court reversed the CIR and held that the proceeds of sales of BOAC passage tickets in
the Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, do not
constitute BOAC income from Philippine sources "since no service of carriage of passengers or
freight was performed by BOAC within the Philippines" and, therefore, said income is not
subject to Philippine income tax. The CTA position was that income from transportation is
income from services so that the place where services are rendered determines the source.
Hence, this Petition for Review on certiorari of the Decision of the Tax Court.
ISSUE:
Whether or not the revenue derived by BOAC from sales of tickets in the Philippines for air
transportation, while having no landing rights here, constitute income of BOAC from
Philippine sources, and, accordingly, taxable?
RULING:
BOAC is a resident foreign corporation. In order that a foreign corporation may be regarded as
doing business within a State, there must be continuity of conduct and intention to establish a
continuous business, such as the appointment of a local agent, and not one of a temporary
character.
BOAC, during the periods covered by the subject - assessments, maintained a general sales
agent in the Philippines, That general sales agent, from 1959 to 1971, "was engaged in (1)
selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in
the series corresponding to a different airline company; (3) receiving the fare from the whole
trip; and (4) consequently allocating to the various airline companies on the basis of their
participation in the services rendered through the mode of interline settlement. Those
activities were in exercise of the functions which are normally incident to, and are in
progressive pursuit of, the purpose and object of its organization as an international air
carrier. In fact, the regular sale of tickets, its main activity, is the very lifeblood of the airline
business, the generation of sales being the paramount objective. Thus, BOAC was "engaged in"
business in the Philippines through a local agent during the period covered by the
assessments. Accordingly, it is a resident foreign corporation subject to tax upon its total net
income received in the preceding taxable year from all sources within the Philippines.
The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to
1970-71 amounted to P10,428,368. The source of an income is the property, activity or
service that produced the income. For the source of income to be considered as coming from
the Philippines, it is sufficient that the income is derived from activity within the Philippines.
In BOAC's case, the sale of tickets in the Philippines is the activity that produces the income.
The tickets exchanged hands here and payments for fares were also made here in Philippine
currency. The site of the source of payments is the Philippines. The flow of wealth proceeded
from, and occurred within, Philippine territory, enjoying the protection accorded by the
Philippine government. In consideration of such protection, the flow of wealth should share
the burden of supporting the government.
The absence of flight operations to and from the Philippines is not determinative of the source
of income or the site of income taxation. Admittedly, BOAC was an off-line international airline
at the time pertinent to this case. The test of taxability is the "source"; and the source of an
income is that activity ... which produced the income. Unquestionably, the passage
documentations in these cases were sold in the Philippines and the revenue therefrom was
derived from a business activity regularly pursued within the Philippines. And even if the
BOAC tickets sold covered the "transport of passengers and cargo to and from foreign
cities", it cannot alter the fact that income from the sale of tickets was derived from the
Philippines. The word "source" conveys one essential idea, that of origin, and the origin of the
income herein is the Philippines.
FELICIANO, J., dissenting:
The liability of BOAC to Philippine income taxation in respect of such income depends, not on
BOAC's status as a "resident foreign corporation" or alternatively, as a "non-resident foreign
corporation," but rather on whether or not such income is derived from "source within the
Philippines."
For purposes of income taxation, the "source of income" relates not to the physical sourcing of
a flow of money or the physical situs of payment but rather to the "property, activity or service
which produced the income." Income may be derived from three possible sources
only: (1) capital and/or (2) labor and/or (3) the sale of capital assets. If the income is from
labor (services) the place where the labor is done should be decisive. If the income is from
capital, the place where the capital is employed should be decisive. If the income is from the
sale of capital assets, the place where the sale is made should be likewise decisive. Thus, if
income is to taxed, the recipient thereof must be resident within the jurisdiction, or the
property or activities out of which the income issue or is derived must be situated within the
jurisdiction so that the source of the income may be said to have a situs in this country.
There are two possibly relevant source of income rules that must be confronted; (a) the
source rule applicable in respect of contracts of service; and (b) the source rule applicable in
respect of sales of personal property. Where a contract for the rendition of service is involved,
the applicable source rule may be simply stated as follows: the income is sourced in the place
where the service contracted for is rendered. Section 37 (a) (3) and (c) (3) of the Tax Code
apply in respect of services rendered by individual natural persons and a juridical
person. Further, a contract of carriage or of transportation is assimilated in our Tax Code and
Revenue Regulations to a contract for services. Transportation was a service and that the
source of the income derived therefrom was to be treated as being the place where the service of
transportation was rendered.
Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides
in part as follows: Gross income from sources within the Philippines includes compensation
for labor or personal services within the Philippines regardless of the residence of the payer, of
the place in which the contract for services was made, or of the place of payment.
Source of income from the sale of personal property would depend upon two factors: (a) the
place where the sale of such personal property occurs; and (b) the place where such personal
110 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
property was produced or manufactured. If the personal property involved was both
produced or manufactured and sold outside the Philippines, the income derived therefrom
will be regarded as sourced entirely outside the Philippines, although the personal property
had been produced outside the Philippines, or if the sale of the property takes place outside
the Philippines and the personal was produced in the Philippines, then, the income derived
from the sale will be deemed partly as income sourced without the Philippines. In other
words, the income (and the related expenses, losses and deductions) will be allocated
between sources within and sources without the Philippines. In contrast, income derived from
the purchase and sale of personal property — i. e., trading — is, under the Tax Code, regarded
as sourced wholly in the place where the personal property is sold.
The basic problem is one of characterization of the transactions entered into by BOAC in the
Philippines. Those transactions may be characterized either as sales of personal property (i. e.,
"sales of airline tickets") or as entering into a lease of services or a contract of service or
carriage. The appropriate characterization, in my opinion, of the BOAC transactions is that of
entering into contracts of service, i.e., carriage of passengers or cargo between points located
outside the Philippines.
The airline ticket in and of itself has no monetary value, even as scrap paper. The value of the
ticket lies wholly in the right acquired by the "purchaser" — the passenger — to demand a
prestation from BOAC, which prestation consists of the carriage of the "purchaser" or
passenger from the one point to another outside the Philippines. The ticket is really
the evidence of the contract of carriage entered into between BOAC and the passenger. The
money paid by the passenger changes hands in the Philippines. But the passenger does not
receive undertaken to be delivered by BOAC. The "purchase price of the airline ticket" is
the compensation paid for the undertaking of BOAC to transport the passenger or cargo outside
the Philippines.
International carriers issuing for compensation passage documentation in the Philippines for
uplifts from any point in the world to any other point in the world, are not charged any
Philippine income tax on their Philippine billings (i.e., billings in respect of passenger or cargo
originating from the Philippines). Under this new approach, international carriers who service
port or points in the Philippines are treated in exactly the same way as international carriers
not serving any port or point in the Philippines. Thus, the source of income rule applicable to
transportation or other services rendered partly within and partly without the Philippines, or
wholly without the Philippines, has been set aside in place of Philippine income taxation, the
Tax Code now imposes this 2½ per cent tax computed on the basis of billings in respect of
passengers and cargo originating from the Philippines regardless of where embarkation and
debarkation would be taking place.
REV. REGS. 15-2002
SECTION 1. Scope. — Pursuant to the provisions of Section 244 of the National Internal
Revenue Code of 1997 (hereinafter referred to as the "Code"), the following Regulations are
hereby promulgated to implement the provisions of Sections 28(A)(3)(a) , 28(A)(1) , and 118
of the Code, relative to the imposition of income tax on the Gross Philippine Billings and Other
income of international air carriers doing business in the Philippines as well as the imposition
of common carrier's tax. These Regulations further prescribe the manner of claiming the
deductions for travel expenses and freight charges incurred pursuant to Section 34 of the
same Code.
SECTION 2. Definition of Terms. — For purposes of these Regulations, the following terms
shall be construed as follows:
(a) International air carrier — shall refer to a foreign airline corporation doing business in
the Philippines having been granted landing rights in any Philippine port to perform
 international air transportation services/activities or flight operations anywhere in the
world.
(b) Off-line carrier — shall refer to an international air carrier having no flight operations to
and from the Philippines.
(c) On-line carrier — shall refer to an international air carrier having or maintaining flight
operations to and from the Philippines.
(d) Off-line flights — shall refer to flight operations carried out or maintained by an
international air carrier between ports or points outside the territorial jurisdiction of the
Philippines, without touching a port or point situated in the Philippines, except when in
distress or due to force majeure.
(e) On-line flights — shall refer to flight operations carried out or maintained by an
international air carrier between ports or points in the territorial jurisdiction of the
Philippines and any port or point outside the Philippines.
(f) Chartered flight — shall refer to flight operation which includes operations between
ports or points situated in the Philippines and ports and points outside the Philippines,
which includes block charter, placed under the custody and control of a charterer by a
contract/charter for rent or hire relating to a particular airplane.
(g) "Originating from the Philippines" — shall include the following:
(1) Where passengers, their excess baggage, cargo and/or mail originally commence
their flight from any Philippine port to any other port or point outside the
Philippines;
(2) Chartered flights of passengers, their excess baggage, cargo and/or mail originally
commencing their flights from any foreign port and whose stay in the Philippines is
for more than forty-eight (48) hours prior to embarkation save in cases where the
flight of the airplane belonging to the same airline company failed to depart within
forty-eight (48) hours by reason of force majeure;
(3) Chartered flights of passengers, their excess baggage, cargo and/or mail originally
commencing their flights from any Philippine port to any foreign port; and
(4) Where a passenger, his excess baggage, cargo and/or mail originally commencing
his flight from a foreign port alights or is discharged in any Philippine port and
thereafter boards or is loaded on another aircraft, owned by the same airline
company, the flight from the Philippines to any foreign port shall not be considered
originating from the Philippines, unless the time intervening between arrival and
departure of said passenger, his excess baggage, cargo and/or mail from the
Philippines exceeds forty-eight (48) hours, except, however, when the failure to
depart within forty-eight (48) hours is due to reasons beyond his control, such as,
when the only next available flight leaves beyond forty-eight (48) hours or by force
majeure. Provided, however, that if the second aircraft belongs to a different airline
company, the flight from the Philippines to any foreign port shall be considered
originating from the Philippines regardless of the intervening period between the
arrival and departure from the Philippines by said passenger, his excess baggage,
cargo and/or mail.
(h) "Continuous and Uninterrupted Flight" — shall refer to a flight in the carrier of the same
airline company from the moment a passenger, excess baggage, cargo, and/or mail is
lifted from the Philippines up to the point of final destination of the passenger, excess
baggage, cargo and/or mail. The flight is not considered continuous and uninterrupted if
transshipment of passenger, excess baggage, cargo and/or mail takes place at any port
111 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
outside the Philippines on another aircraft belonging to a different airline company.
(i) "Place of Final Destination" — shall refer to the place of final disembarkation designated
or agreed upon by the parties in a contract of air transportation where the passengers,
their excess baggage, cargo and/or mail are to be transported and unloaded by the
contracting airline company.
(j) "Transient Passengers" — shall refer to a passenger who originated from outside of the
Philippines towards a final destination also outside of the Philippines but stops in the
Philippines for a period of less than forty eight (48) hours, or even more than forty-eight
(48) hours, if the delay is due to force majeure or reasons beyond his control, wherein in
both cases the passenger boarded an airplane of the same airline company bound to the
place of final destination.
(k) "Non-revenue passengers" — shall refer to the non-revenue passengers as defined under
Resolution No. 788 of the International Air Transport Association regarding Free and
Reduced Fare or Rate Transportation and any other Free/Reduced Rate Mileage Programs
Administered by individual International Air Carriers.
(l) "Adult passenger" — shall refer to a passenger who has attained his twelfth birthday.
(m) "Children" — shall refer to passengers who have attained their second but not their
twelfth birthday.
(n) "Infant" — shall refer to a passenger who has not attained his second birthday.
(o) "Baggage" — shall refer to such articles, effects and other personal property of a
passenger as are necessary or appropriate for wear, use, comfort or convenience in
connection with his trip.
(p) "Excess baggage" — shall refer to that part of the baggage which is in excess of that
baggage which may be carried free of charge.
(q) "Refund" — shall refer to the repayment to the purchaser of all or a portion of the fare,
rate or charge for unused carriage or service.
SECTION 3. Foreign Airline Companies Without Flights Starting From or Passing Through Any
Point in the Philippines. — An off-line airline having a branch office or a sales agent in the
Philippines which sells passage documents for compensation or commission to cover off-line
flights of its principal or head office, or for other airlines covering flights originating from
Philippine ports or off-line flights, is not considered engaged in business as an international
air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax
provided for in Section 28(A)(3)(a) of the Code nor to the three percent (3%) common
carrier's tax under Section 118(A) of the same Code. This provision is without prejudice to
classifying such taxpayer under a different category pursuant to a separate provision of the
same Code.
SECTION 4. Tax Imposed on International Air Carrier With Flights Originating from Philippine
Ports. — An international air carrier having flights originating from any port or point in the
Philippines, as clarified in Sec. 2(g) and (h) hereof, irrespective of the place where passage
documents are sold or issued, is subject to the Gross Philippine Billings Tax of 2½% imposed
under Section 28(A)(3)(a) of the Code unless subject to a different tax rate under the
applicable tax treaty to which the Philippines is a signatory.
SECTION 5. Determination of Gross Philippine Billings. —
(a) In computing for "Gross Philippine Billings", there shall be included the total amount of
gross revenue derived from passage of persons, excess baggage, cargo and/or mail,
originating from the Philippines in a continuous and uninterrupted flight, irrespective of
the place of sale or issue and the place of payment of the passage documents:
The gross revenue for passengers whose tickets are sold in the Philippines shall be the
actual amount derived for transportation services, for a first class, business class or
economy class passage, as the case may be, on its continuous and uninterrupted flight
from any port or point in the Philippines to its final destination in any port or point of a
foreign country, as reflected in the remittance area of the tax coupon forming an integral
part of the plane ticket. For this purpose, the Gross Philippine Billings shall be determined
by computing the monthly average net fare of all the tax coupons of plane tickets issued
for the month per point of final destination, per class of passage (i.e., first class, business
class, or economy class) and per classification of passenger (i.e., adult, child or infant), and
multiplied by the corresponding total number of passengers flown for the month as
declared in the flight manifest.
For tickets sold outside the Philippines, the gross revenue for passengers for first class,
business class or economy class passage, as the case may be, on a continuous and
uninterrupted flight from any port or point in the Philippines to final destination in any
port or point of a foreign country shall be determined using the locally available net fares
applicable to such flight taking into consideration the seasonal fare rate established at the
time of the flight, the class of passage (whether first class, business class, economy class or
non-revenue), the classification of passenger (whether adult, child or infant), the date of
embarkation, and the place of final destination. Correspondingly, the Gross Philippine
Billings for tickets sold outside the Philippines shall be determined in the manner as
provided in the preceding paragraph.
Passage documents revalidated, exchanged and/or endorsed to another on-line
international airline shall be included in the taxable base of the carrying airline and shall
be subject to Gross Philippine Billings tax if the passenger is lifted/boarded on an aircraft
from any port or point in the Philippines towards a foreign destination.
The gross revenue on excess baggage which originated from any port or point in the
Philippines and destined to any part of a foreign country shall be computed based on the
actual revenue derived as appearing on the official receipt or any similar document for the
said transaction.
The gross revenue for freight or cargo and mail shall be determined based on the revenue
realized from the carriage thereof. The amount realized for freight or cargo shall be based
on the amount appearing on the airway bill after deducting therefrom the amount of
discounts granted which shall be validated using the monthly cargo sales reports
generated by the IATA Cargo Accounts Settlement System (IATA CASS) for airway bills
issued through their cargo agents or the monthly reports prepared by the airline
themselves or by their general sales agents for direct issues made. The amount realized for
mails shall, on the other hand, be determined based on the amount as reflected in the
cargo manifest of the carrier.
Provided, however, that in the case of the passenger's passage documents or flights from
any port or point in the Philippines and back, that portion of revenue pertaining to the
return trip to the Philippines shall not be included as part of "Gross Philippine Billings".
In cases where a flight is interrupted by force majeure resulting in the transshipment of
the passengers, their excess baggage, freight, cargo and/or mail to another airplane
operated by another airline company and transshipment takes place in another country,
the Gross Philippine Billings shall be determined based on that portion of flight from the
Philippines up to the point of said transshipment.
112 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(b) Non-revenue passengers shall not be given value for purposes of computing the taxable
base subject to tax. Refunded tickets shall likewise not be included in the computation of
Gross Philippine Billings.
(c) In the case of a flight that originates from the Philippines but transshipment of passenger,
excess baggage, cargo and/or mail takes place elsewhere in another aircraft belonging to a
different airline company, the Gross Philippine Billings shall be that portion of the revenue
corresponding to the leg flown from any point in the Philippines to the point of
transshipment.
(d) In computing the taxable amount, the foreign exchange conversion rate to be used shall be
the average monthly Airline Rate as provided in the Bank Settlement Plan (BSP) Monthly
sales report or the Bankers Association of the Philippines (BAP) rate, whichever is higher.
The average monthly BAP rate shall be computed by adding all the different BAP rates
during the month and dividing the same by the number of days during the month.
2. OBUs/FCDUs
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(4) Offshore Banking Units - The provisions of any law to the contrary notwithstanding,
income derived by offshore banking units authorized by the Bangko Sentral ng Pilipinas (BSP)
from foreign currency transactions with nonresidents, offshore banking units in the
Philippines, local commercial banks including branches of foreign banks that may be
authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with offshore
banking units shall be exempt from all taxes, except net income from such transactions as may
be specified by the Secretary of Finance, upon recommendation by the Monetary Board which
shall be subject to the regular income tax payable by banks: Provided, however, That any
interest income derived from foreign currency loans granted to residents other than offshore
banking units or local commercial banks, including local branches of foreign banks that may
be authorized by the BSP to transact business with offshore banking units, shall be subject
only to a final tax at the rate of ten percent (10%).
Any income of nonresidents, whether individuals or corporations, from transactions with said
offshore banking units shall be exempt from income tax.
REV. REGS. 10-76
SECTION 2. Definition of Terms. —
a. "Offshore Banking" shall refer to the conduct of banking transactions in foreign currencies
involving the receipt of funds principally from external sources and the utilization of such
funds as provided in Presidential Decree No. 1034.
b. "Offshore Banking Unit" hereinafter referred to as OBU, shall mean a branch, subsidiary or
affiliate of a foreign banking corporation which is duly authorized by the Central Bank of
the Philippines, as a separate accounting unit, to transact offshore banking business in the
Philippines in accordance with the provisions of P.D. 1034 as implemented by Central Bank
Circular No. 546.
c. "Deposits" shall mean funds in foreign currencies which are accepted and held by an off-
shore banking unit in the regular course of business, with the obligation to return an
equivalent amount to the owner thereof, with or without interest.
d. "Resident" shall mean —
(1) an individual citizen of the Philippines residing therein; or
(2) an individual who is not a citizen of the Philippines but is permanently residing therein;
or
(3) a corporation or other juridical person organized under the laws of the Philippines.
(4) a branch, subsidiary, affiliate, extension office or any other unit of corporations or
juridical persons organized under the laws of any foreign country operating in the
Philippines.
e. "Non-resident" shall mean an individual, corporation or other juridical person not included
in the above definition of "residents".
f. "Foreign Currency Deposit Unit" (FCDU) shall mean an accounting unit or department in a
local bank or in an existing local branch of foreign banks, which is authorized by the Central
Bank of the Philippines to operate under the expanded foreign currency deposit system, in
accordance with the provisions of P.D. 1035, as implemented by Central Bank Circular No.
547. The FCDU authority shall be distinguished from the authority to accept foreign
currency deposits under R.A. No. 6426, as implemented by Central Bank Circular No. 343.
g. "Gross offshore income" shall mean all income arising from transactions allowed by the
Central Bank of the Philippines conducted by and between —
1) in the case of an offshore banking unit with another offshore banking unit or with an
expanded Foreign Currency Deposit unit or with a non-resident;
2) in the case of an expanded Foreign Currency Deposit Unit with another expanded Foreign
Currency Deposit Unit or with an Offshore Banking Unit or with a non-resident.
h. "Gross onshore income" shall mean gross interest income arising from foreign currency
loans and advances to and/or investments with residents made by Offshore Banking Units
or expanded Foreign Currency Deposit Units. Such gross interest income shall include all
fees, commissions and other charges which are integral parts of the income from the above
transactions.
SECTION 3. Rates of income tax to be imposed. —
The rates or income tax to be imposed, which shall be in lieu of all other taxes such as, but not
limited to privilege tax, gross receipts tax, documentary and science stamp tax and profit
remittance tax, are as followers:
(a) On offshore income, there shall be imposed an income tax of five percent (5%) based on
net offshore income as computed in Section 4.
Income realized by offshore banking units on transactions with local commercial banks
including branches of foreign banks that may be authorized by the Central Bank of the
Philippines to transact business with offshore banking units shall likewise be subject to
the same tax, except net income from such transactions as may be specified by the
Secretary of Finance, upon recommendation of the Monetary Board, to be subject to the
usual income tax payable by banks.
(b) In the case of gross onshore income as defined in Section 2(h) above, the tax shall be ten
percent (10%) thereof and shall be a final tax.
(c) Income not covered by paragraphs (a) and (b) above shall be subject to the usual
corporate taxes imposed by the National Internal Revenue Code, as amended.
113 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
SECTION 4. Manner of computation of net income. —
(a) Net offshore income for purposes of Section 3, paragraph (a) above, shall be the amount
remaining after deducting from the gross offshore income during the taxable year the
following items:
1) the proportion of total interest expenses for the same period based on the ratio of
offshore interest income which bears to the total gross interest income;
2) the proportion of general administrative expenses based on the ratio of net offshore
income which bears to the total net income after deducting only interest expenses
mentioned in sub-paragraph (1) above.
3) Likewise, there shall be allowed a reasonable amount of head office expenses in
accordance with the ratio specified in sub-paragraph (2) above.
(b) In the case of onshore income, the gross interest income without the benefit of any
deduction corresponding to the allocable onshore income, shall be the amount upon which
the ten percent (10%) withholding income tax shall be computed.
SECTION 5. Manner of filing returns and payment of taxes. —
Within sixty (60) days after the end of each of the first three quarters of the calendar or fiscal
year.
(a) for offshore income and other income mentioned In Section 3(c) —
a return of net taxable offshore income shall be filed with, and the tax due thereon paid, to
the Commissioner of Internal Revenue, Revenue Regional Director, Revenue District
Officer or the Collection Agent of the City or Municipality where the corporation's
principal office is located and where its books of accounts and other data from which the
return is prepared are kept, by every offshore banking units and expanded Foreign
Currency Deposit Units, regardless of whether there is tax due or not. For these purposes,
B.I.R. Form No. 17.02-Q shall be used and the appropriate rates, as enumerated in Section
3 above, shall be applied accordingly.
(b) for onshore income —
in the case of onshore income realized by an offshore banking unit or by an expanded
Foreign Currency Deposit Unit, the income need not be included in the quarterly income
tax return to be filed as required above as the payor-borrower under Section 53, in
relation to Section 54, of the National Internal Revenue Code, is constituted as the
withholding agent charged with the obligation of deducting, withholding and remitting to
the Commissioner of Internal Revenue the income tax due thereon within the period
prescribed by law with the appropriate return in accordance with existing revenue and
Central Bank regulations.
A copy of the quarterly return filed, together with the copy of the official receipt denoting
payments thereon, shall be furnished direct to the offshore banking unit or foreign currency
deposit unit concerned, which shall in turn submit to the Bureau of Internal Revenue said
documents accompanied by statement showing a list of all its domestic borrowers, amount
borrowed and interest income thereon. The statement with its attachments, shall be filed
together with the quarterly return required above.
A final consolidated return or an adjustment return on B.I.R. Form 1702 covering the total
taxable onshore and offshore income for the preceding calendar or fiscal year shall be filed on
or before the 15th day of the fourth month following the close of the calendar or fiscal year.
The return shall include all the items of gross income and deductions for the whole taxable
year. The tax shown on the final or adjustment return, after deducting therefrom the quarterly
income taxes paid and withheld during the preceding three quarters of the same taxable year,
shall either be paid upon filing, or refunded as the case may be.
SECTION 6. Statement to be attached to the return. —
There shall be attached to the final consolidated return or adjustment return of the taxpayer
for such taxable year a sworn statement, a specimen form of which is hereto attached, by a
responsible officer setting forth in summarized form the pertinent information required by
these regulations with respect to the computation of the net offshore income, gross onshore
income and taxes paid or withheld.
SECTION 7. Records to be kept. —
Every offshore banking unit, as well as expanded Foreign Currency Deposit Unit, which is duly
authorized by the Central Bank of the Philippines to transact offshore banking business in the
Philippines shall maintain books of account which shall be kept in the place of its principal
place of business for inspection.
In addition, all the supporting data which were used in compiling the summary statement
required to be attached to the income tax returns to be filed as prescribed under Section 6
hereof must likewise be made readily available at its principal place of business.
SECTION 8. Income of non-resident. —
Any income of non-residents from transactions with either an offshore banking unit or with
an expanded Foreign Currency Deposit Unit shall be exempt from any and all taxes.
SECTION 9. Income of foreign personnel. —
There shall be levied, collected and paid for each taxable year upon the gross income received
by every alien individual employed by offshore banking units in the Philippines as salaries,
wages, annuities, compensations, remunerations and emoluments from such offshore banking
units a tax equal to fifteen (15%) percent of such gross income. The aforesaid tax shall be
deducted and withheld at source in the same manner and condition as that provided under
Supplement "A" — Withholding on Wages of Commonwealth Act No. 466, as amended.
SECTION 10. Privileges of the offshore banking units. —
The offshore banking units shall be exempt from all forms of local licenses, fees, dues, imposts
or any other local taxes or burdens.
The license fee paid by offshore banking units shall be allowed as a deduction in accordance
with Section 4 of these regulations.
SECTION 11. Registration. —
Offshore a Banking Units and expanded Foreign Currency Deposit Units shall, upon receipt of
advice from the Central Bank, register with the Bureau of Internal Revenue its business name
for the purpose of —
a. registering its trade name;
b. registering as an employer pursuant to the provision of R. A. 466;
c. registering its name for the purpose of securing its taxpayer account number (TAN).
114 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
REV. REGS. 14-77
SECTION 1. Section 2(h) is hereby amended to read as follows:
"SEC. 2(h). Gross onshore income shall mean gross interest income arising from foreign
currency loans and advances to and/or investments with residents made by offshore banking
units or expanded foreign currency deposit units. In the case of foreign currency loan
transactions, such gross interest income shall refer only to the stipulated interest and shall not
include any and all fees, commissions and other charges which are integral parts of the income
from the above transactions." cdt
SECTION 2. Section 3(b) is hereby amended to read as follows:
"SEC. 3(b). In the case of gross onshore income as defined in Section 2(h) above, the tax shall
be ten percent (10%) thereof and shall be a final tax. Any and all fees, commissions and other
charges which are integral parts of the charges imposed on foreign currency loan transactions
are exempt from the tax herein imposed."
SECTION 3. Section 5(b) is hereby amended to read as follows:
"SEC. 5(b). For onshore income — In the case of onshore income realized by an offshore
banking unit or by an expanded Foreign Currency Deposit Unit, the income need not be
included in the quarterly income tax return to be filed as required above as the payor-
borrower under Section 53, in relation to Section 54, of the National Internal Revenue Code, is
constituted as the withholding agent charged with the obligation of deducting, withholding
and remitting to the Commissioner of Internal Revenue the income tax due thereon within the
period prescribed by law with the appropriate return in accordance with existing revenue and
Central Bank regulations. Regardless, therefore, of whether the accounting method of an OBU-
creditor in cash or accrual basis, the withholding tax will be withheld and remitted only after
the due date of payment of the interest incurred by an onshore borrower.
REV. REGS. 10-98
Sec. 2.24. Income Tax Rate of Interest Income from Foreign Currency Deposit. —
(A) Individual Income Tax on Interest Income from a Depository Bank under the Foreign
Currency Deposit System
(1) Interest income which is actually or constructively received by a resident citizen of the
Philippines or by a resident alien individual from a foreign currency bank deposit shall be
subject to a final withholding tax of seven and one-half percent (7.5%). The depository bank
shall withhold and remit the tax pursuant to Sections 57 and 58 (withholding tax at source) of
the Code.
(2) If a bank account is jointly in the name of a non-resident citizen such as an overseas
contract worker, or a Filipino seaman, and his spouse or dependent who is a resident in the
Philippines, fifty percent (50%) of the interest income from such bank deposit shall be treated
as exempt while the other fifty percent (50%) shall be subject to a final withholding tax of
seven and one-half percent (7.5%).
(B) Compliance and Administrative Procedures for Non-Resident Citizen and Non-Resident Alien.
The tax on interest income from foreign currency deposit shall be imposed unless the
depositor who is a non-resident citizen or a non-resident alien can present documentary
evidence that he is not a resident of the Philippines. Such evidence shall consist of the original
or certified copy of any of the following:
b. an immigration visa issued by the foreign government in the country where he is a
 resident of; or
c. a certificate of residency which is issued by the Philippine Embassy or Consulate in the
foreign country of his residence; or
d. a certificate of the contract of employment of an overseas contract worker which is duly
registered with the Philippine Overseas Employment Agency (POEA); or a Seaman's
Certificate, in the case of a Filipino seaman; or
e. a certification from the Bureau of Immigration of the Philippines that a non-resident
alien is not a resident of the Philippines; or
f. a certification from the Department of Foreign Affairs (DFA) of the Philippines that the
individual is a regular member of the diplomatic corps of a foreign government and is
entitled to income tax exemption under an international agreement to which the
Philippines is a signatory.
(C) Name of the Foreign Currency Bank Account — To be entitled to an exemption from the tax
on interest income on foreign currency deposit, the Foreign Currency Bank Account shall be in
the name of the non-resident individual or non-resident corporation. Otherwise, the interest
income therefrom shall be considered as subject to the tax imposed herein.
Sec. 2.27 and Sec. 2.28 — Corporate Income Tax on Interest Income from a Depository Bank
under the Foreign Currency Deposit System.
(A) Interest income which is actually or constructively received by a domestic corporation or
a resident foreign corporation from a foreign currency bank deposit shall be subject to a final
withholding tax at the rate of seven and one-half percent (7.5%) based on the gross amount of
such interest income. The depository bank shall withhold and remit the tax pursuant to the
provisions of Sections 57 and 58 (withholding tax at source) of the Code.
(B) Compliance and Administrative Procedures for a Non-resident Corporation. The tax on
interest income from foreign currency deposit shall be imposed unless the depositor, which is
a non-resident corporation, can present documentary evidence that it is not a resident of the
Philippines. Such evidence shall consist of the original or certified copy of all the following
requirements:
O) Certificate of registration of the corporation abroad; and
P) Certification from the Securities and Exchange Commission (SEC) that the non-resident
corporation is not licensed to do business in the Philippines.
(C) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions. In general,
income derived by an FCDU or an OBU from foreign currency transactions with residents of
the Philippines, including local commercial banks, local branches of foreign banks, and other
depository banks under the foreign currency deposit system, shall be subject to a final
withholding tax of ten percent (10%) based on gross income pursuant to Sec. 27(D)(3) and
Sec. 28(A)(4) of the Code. Income from foreign currency transactions shall include interest
income from lending operations, including bank charges, commissions, service fees, and net
foreign exchange transaction gains.
Income from foreign currency transactions with non-residents of the Philippines shall not be
subject to income tax.
The person making the income payment shall withhold and remit the tax withheld pursuant to
the provisions of Sections 57 and 58 of the Code. Thus, in the case of interest payment by a
resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the
withholding agent shall be the said resident.
115 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(D) Taxation of Other Incomes of an FCDU or an OBU . Income derived by an FCDU or an OBU
from activities other than foreign currency transactions shall be subject to the pertinent
income tax/taxes prescribed under Section 27 or Section 28 of the Code. To illustrate: Income
derived by an FCDU from consultancy services and rentals shall be subject to an income tax
based on net income at the tax rates prescribed under Section 27(A) of the Code. Capital gains
derived from the sale, barter, exchange or disposition of shares of stocks in a domestic
corporation shall be subject to tax prescribed under Section 27(D) of the Code.
The aforesaid depository bank shall file its corporate income tax return for income referred to
in the preceding paragraph in accordance with the provisions of Section 52 of the Code. It
shall also declare thereunder all other incomes derived during the taxable period which are
subject to the final withholding taxes, the fact that such final withholding taxes have been
withheld therefrom by the payor notwithstanding, indicating the following information:
(h) Name of the withholding agent;
(i) His/its address;
(j) His/its Taxpayer Identification Number (TIN);
(k) Period covered;
(l) Gross Income;
(m) R ate of final withholding tax applied; and
(n) Amount of final withholding tax withheld.
The submission of the foregoing information shall not be required with respect to its interest
income derived from bank deposits.
3. RHQs and ROHQs
SEC. 22 Definitions - When used in this Title:
(DD)The term "regional or area headquarters" shall mean a branch established in the
Philippines by multinational companies and which headquarters do not earn or derive
income from the Philippines and which act as supervisory, communications and
coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific
Region and other foreign markets.
(EE) The term "regional operating headquarters" shall mean a branch established in the
Philippines by multinational companies which are engaged in any of the following
services: general administration and planning; business planning and coordination;
sourcing and procurement of raw materials and components; corporate finance advisory
services; marketing control and sales promotion; training and personnel management;
logistic services; research and development services and product development; technical
support and maintenance; data processing and communications; and business
development.
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(6) Regional or Area Headquarters and Regional Operating Headquarters of Multinational
Companies. - (a) Regional or area headquarters as defined in Section 22(DD) shall not be
subject to income tax.
(b) Regional operating headquarters as defined in Section 22(EE) shall pay a tax of ten percent
(10%) of their taxable income.
E. BRANCH PROFIT REMITTANCE TAX
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(5) Tax on Branch Profits Remittances. - Any profit remitted by a branch to its head office shall
be subject to a tax of fifteen (15%) which shall be based on the total profits applied or
earmarked for remittance without any deduction for the tax component thereof (except those
activities which are registered with the Philippine Economic Zone Authority).
The tax shall be collected and paid in the same manner as provided in Sections 57 and 58 of
this Code: provided, that interests, dividends, rents, royalties, including remuneration for
technical services, salaries, wages premiums, annuities, emoluments or other fixed or
determinable annual, periodic or casual gains, profits, income and capital gains received by a
foreign corporation during each taxable year from all sources within the Philippines shall not
be treated as branch profits unless the same are effectively connected with the conduct of its
trade or business in the Philippines.
BANK OF AMERICA NT & SA v. CA
DOCTRINE:
In the 15% remittance tax, the law specifies its own tax base to be on the “profit remitted
abroad.” There is absolutely nothing equivocal or uncertain about the language of the
provision. The tax is imposed on the amount sent abroad, and the law calls for nothing further.
FACTS:
Bank of America is a foreign corporation licensed to engage in business in the Philippines
through a branch in Makati. The Bank paid 15% branch profit remittance tax amounting to
PhP7.5M from its REGULAR UNIT OPERATIONS and another 405K PhP from its FOREIGN
CURRENCY DEPOSIT OPERATIONS. The tax was based on net profits after income tax without
deducting the amount corresponding to the 15% tax. Bank of America thereafter filed a claim
for refund with the BIR for the portion that corresponds with the 15% branch profit
remittance tax.
BOA’s claim: “BIR should tax us based on the profits actually remitted (45M), and NOT on the
amount before profit remittance tax (53M)... The basis should be the amount actually remitted
abroad.”
CIR contends otherwise and holds that in computing the 15% remittance tax, the tax should
be inclusive of the sum deemed remitted.
ISSUE/S:
Whether or not the branch profit remittance tax should be based on the amount actually
remitted? - YES
RULING:
It should be based on the amount actually committed, NOT what was applied for. There is
nothing in Section 24 which indicates that the 15% tax/branch profit remittance is on the
total amount of profit; where the law does NOT qualify that the tax is imposed and collected at
source, the qualification should not be read into law.
Rationale of 15%: To equalize/ share the burden of income taxation with foreign
116 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
corporations.
COMPANIA GENERAL DE TABACOS DE FILIPINAS v. CIR
FACTS:
 Petitioner paid the 15% branch profit remittance tax for 1985 & 1986 in the amount of
P3M
 1988 petitioner filed a claim for refund for P593k representing an alleged overpaid
branch remittance taxes
ISSUES:
1) w/n branch profits tax are computed based on the profits actually remitted abroad or on
the total branch profits out of which remittance is made
2) w/n passive income which are already subjected to the final tax are still included for
purposes of computing the brach profits remittance tax
RULING:
Petitioner contends that the 15% branch profits remittance tax should be based on the profits
ACTUALLY REMITTED abroad (Jan 1980 ruling)
Respondent contends that the 15% branch profit remittance tax is imposed and collected at
source, tax base should be the amount actually paid for by the branch with the Central Bank as
profit to be remitted abroad - relied on RMC 8-82 - "any profit remitted abroad" - means the
profit to be remitted - Example: if total branch profit is P115,000 but the amount to be
remitted is P100,000, then the tax base should be P100,000 - 15% is an income tax and
therefore non- deductible from gross income
The case is distinguishable from Burroughs Limited case where the SC upheld the application
of BIR RULING 1989 because the branch profit remittance tax was paid on 1979
* Petitioner's branch profit remittance tax was paid on 1988 - AFTER THE EFFECTIVITY OF
RMC 6-82 ==> then what should apply as tax base is the amount applied for with the Central
Bank as profit to be remitted abroad and not the total amount of branch profits Petitioner
argues that passive income already subjected to the final tax should not be included in the tax
base for computing the 15% branch profits remittance tax.
- SECTION 24 (b) (2) (ii) - That interest, dividends, rents, royalties, including remunerations
for technical services, salaries, wages, premiums, annuities, emoluments or other fixed or
determinable annual, periodical or casual gains, profits, income and capital gains received by a
foreign corporation during each taxable year from all sources within the Philippines shall not
be considered as branch profits unless the same are effectively connected with the conduct of
trade or business in the Philippines
- Respondent rejected the arguments of petitioner and pointed that "under Section
24(b)(2)(ii) of the Tax Code, interest and dividends, as a rule, are considered branch profits
except when the same are not effectively connected with the trade or business of the foreign
corporation in the Philippines."
- More credible is the stand of petitioner. As worded in Section 24(b)(2)(ii), the rule is interest
and dividends received by a foreign corporation during each taxable year from all sources
within the Philippines shall not be considered as branch profits unless the same are effectively
connected with the conduct of its trade or business. The phrase "effectively connected" was
interpreted to mean income derived from the business activity in which the corporation is
engaged.
-In all the corporate quarterly income tax returns filed by petitioner with respondent's office,
it was indicated as it was shown that the petitioner is engaged in the business as leaf tobacco
dealer, exporter, importer and general merchants. Petitioner claims that interests received
from savings deposit with PhilTrust, interests received from money market placements and
interest on Land Bank Bonds and cash dividends received from Philippine Long Distance
Telephone Company (PLDT) and Tabacalera Industrial Development Corporation of the Phils.
are not effectively connected with its trade or business.
HELD: Petitioner entitled to refund
REVENUE MEMORANDUM CIRCULAR 55-80
Section 24(b) (2) (b) of the Tax Code, as amended by P.D. No. 1705, is quoted as follows:
"(b) Tax on branch profits remittances. — Any profit remitted abroad by a branch office to
its mother company shall be subject to a tax of fifteen (15%) per cent (Except those
registered with the Export Processing Zone Authority): Provided, that, any profit remitted
by a branch office to its mother company authorized to engage in petroleum operations in
the Philippines shall be subject to tax at seven and one-half (7.5%) per cent; And provided,
further that fixed or determinable annual periodical gains, profits, and income or certain
gains described in Section 24(b) (1) or 53(b)(2) of this code shall not be considered as
branch profits unless the same are effectively connected with the conduct of a trade or
business in the Philippines by foreign corporation."
FEATURES OF THE AMENDMENT
Two (2) amendments to Sec. 24(b) (2) (b) of the 1977 Tax Code on branch profit remittances
have been effected by P.D. No. 1705. They are:
2. Reduction of the tax rate on the profits remitted by a branch office to its mother company
authorized to engage in petroleum operations. — The tax on profits remitted by a branch
office to its mother company authorized to engaged in petroleum operations in the
Philippines has been reduced to 7.5%.
3. Imposition of a branch profits tax on income effectively connected with business. — Fixed or
determinable annual periodical gains, profits, and income on certain gains described in
Section 24 (b)(1) or 53(b) (2) of the 1977 Tax Code, (i.e. income earned from Philippine
sources by non-resident foreign corporations) are generally not considered branch profits
subject to the 15% remittance tax unless the same are effectively connected with the
conduct of a trade or business in the Philippines by the foreign corporation.
To be "effectively connected" it is not necessary that the income be derived from the actual
operation of taxpayer-corporation's trade or business; it is sufficient that the income arises
from the business activity in which the corporation is engaged.
For example, if a resident foreign corporation is engaged in the buying and selling of
machineries in the Philippines and invests in some shares of stock on which dividends are
subsequently received, the dividends thus earned are not considered effectively connected
with its trade or business in this country.
On the other hand, if a resident foreign corporation with a branch office in the Philippines
engaged in the canning business allows its trade name or brand to be used and royalties are
received by its parent company, such royalties which constitute passive income, are
effectively connected with its trade or business and should be subject to tax, if remitted
abroad.
Effectivity. — The foregoing amendment took effect upon the promulgation of P.D. No. 1705
on August 1, 1980.
117 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Enforcement. — It is desired that this Circular be given as wide a publicity as possible.
BIR RUL. 157-81
DOCTRINE:
Only profits remitted abroad by a branch office to its head office which are effectively
connected with its trade or business in the Philippines are subject to the 15% profit
remittance tax.
FACTS:
Marubeni is duly licensed and actually engaged in several lines of business in the Philippines;
that its office is located at the 4th Floor, FMII Building, Aduana Street, Intramuros, Manila, and
that it has equity investments in AG&P (domestic corporation), which investments were made
directly by its Head Office in Tokyo, Japan and from which, Marubeni receives cash dividends
declared by AG&P from time to time.
ISSUE:
Whether or not dividends received by Marubeni Corporation of Tokyo, Japan, from AG&P are
subject to 15% branch profit remittance tax? No.
RULING:
Pursuant to Section 24(b)(2) of the Tax Code, only profits remitted abroad by a branch office
to its head office which are effectively connected with its trade or business in the Philippines
are subject to the 15% profit remittance tax. To be "effectively connected" it is not necessary
that the income be derived from the actual operation of taxpayer-corporation's trade or
business; it is sufficient that the income arises from the business activity in which the
corporation is engaged. For example, if a resident foreign corporation is engaged in the buying
and selling of machineries in the Philippines and invests in some shares of stock on which
dividends are subsequently received, the dividends thus earned are not considered
"effectively connected" with its trade or business in this country.
In the instant case, the dividends received by Marubeni from AG&P are not income arising
from the business activity in which Marubeni is engaged. Accordingly, said dividends if
remitted abroad are not considered branch profits for purposes of the 15% profit remittance
tax imposed by Section 24(b)(2) of the Tax Code, as amended by Presidential Decree Nos.
1705-1773.
BIR RUL. 80-89
DOCTRINE:
For purposes of the 15% profit remittance tax, "any form of remittance, direct or indirect,
made to the mother company abroad shall be presumed to have been made from the
accumulated profits of the branch."
FACTS:
Philippine Branch of Hitachi, Ltd. is duly registered with the Board of Investments (BOI) and
with the Securities and Exchange Commission (SEC). The National Power Corporation (NPC)
has commissioned Marubeni Corporation (MC) to do some works on the Malaya THERMAL
Power Plant and Sucat Thermal Power Plant. MC has sub-contracted some of those works to
Hitachi, Ltd. MC pays direct to Hitachi, Tokyo in Yen for services rendered by its branch in the
Philippines. Hitachi, Tokyo then remits to the Philippine Branch approximately 4% of the total
receipts from MC for payment of various expenses incurred in the Philippines.
ISSUE:
Whether or not Hitachi, Ltd. (Philippine Branch) is subject to the branch profit remittance tax?
YES.
RULING:
Hitachi, Ltd. (Philippine Branch) is subject to the 15% branch profit remittance tax. While
there is no direct remittance of profits made by the branch to its head office in Tokyo, there is
indirect remittance. The direct payment made by MC to Hitachi, Tokyo obviously includes
profit attributable to the latter. For purposes of the 15% profit remittance tax, "any form of
remittance, direct or indirect, made to the mother company abroad shall be presumed to have
been made from the accumulated profits of the branch."
Since said services were rendered in this country, the direct payments are considered
Philippine source income, "regardless of the residence of the payor, of the place in which the
contract of services was made, or of the place of payment." Accordingly, the Philippine Branch
shall be subject to the income tax at 35% of its taxable income based on the total receipts
derived by MC and not merely 4% thereof pursuant to Section 25(a)(1) of the Tax Code.
Likewise, the Philippine branch is subject to the 10% VAT under Section 102(a) of the same
Code.
BIR RUL. 49-86
DOCTRINE:
Dividends to be considered branch profits must be effectively connected with the conduct of
its (head office) trade or business in the Philippines.
FACTS:
THE COCA-COLA EXPORT CORPORATION (TCCEC) is a U.S. corporation with branch office in
the Philippines, engaged in the manufacturing of beverage base and concentrates. The
Philippine Branch of TCCEC sells its manufactured beverage base and concentrate to COCA-
COLA BOTTLERS PHILIPPINES, INC., (CCBPI), a Philippine corporation, which the latter
processes and packages into bottled or canned softdrinks. The Home Office of TCCEC owns
30% of the outstanding capital stock of CCBPI.
ISSUE:
Whether or not the dividends to be paid and remitted by CCBPI to the Home Office of TCCEC in
the United States are considered branch profit subject to the 15% branch profit remittance
tax? NO.
RULING:
Under Section 24(b)(2)(ii) of the Tax Code, the 15% branch profit remittance tax is imposed
on profits remitted abroad by a branch to its head office; and the profits, which in this case
consist of dividends, shall not be considered branch profits unless the same are effectively
connected with the conduct of its (head office) trade or business in the Philippines. However,
in the instant case, the dividends to be remitted were earned by the Home Office of TCCEC as
owner of 30% of the stocks of CCBPI; and the dividends were to be remitted to TCCEC (Home
Office) not by its branch Office, TCCEC (Phil. Branch) but by CCBPI. In other words, the
dividends do not represent profit earned by TCCEC (Phil. Branch) which are effectively
connected with the conduct of TCCEC's (Home Office) trade or business in the Philippines. It
is, however, understood in this connection, that the dividends are subject to the 10% final tax
on the total amount thereof imposed by Section 24(c) of the Tax Code.
F. MCIT
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(2) Minimum Corporate Income Tax on Resident Foreign Corporations. - A minimum corporate
income tax of two percent (2%) of gross income, as prescribed under Section 27 (E) of this
Code, shall be imposed, under the same conditions, on a resident foreign corporation taxable
118 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
under paragraph (1) of this Subsection.
G. TAX ON CERTAIN INCOMES OF RESIDENT FOREIGN CORPORATIONS
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(A) Tax on Resident Foreign Corporations. -
(7) Tax on Certain Incomes Received by a Resident Foreign Corporation. –
(a)Interest from Deposits and Yield or any other Monetary Benefit from Deposit Substitutes,
Trust Funds and Similar Arrangements and Royalties - Interest from any currency bank deposit
and yield or any other monetary benefit from deposit substitutes and from trust funds and
similar arrangements and royalties derived from sources within the Philippines shall be
subject to a final income tax at the rate of twenty percent (20%) of such interest:Provided,
however, That interest income derived by a resident foreign corporation from a depository
bank under the expanded foreign currency deposit system shall be subject to a final income
tax at the rate of seven and one-half percent (7 1/2%) of such interest income.
(b) Income Derived under the Expanded Foreign Currency Deposit System - Income derived by a
depository bank under the expanded foreign currency deposit system from foreign currency
transactions with nonresidents, offshore banking units in the Philippines, local commercial
banks including branches of foreign banks that may be authorized by the Bangko Sentral ng
Pilipinas (BSP) to transact business with foreign currency deposit system units and other
depository banks under the expanded foreign currency deposit system shall be exempt from
all taxes, except net income from such transactions as may be specified by the Secretary of
Finance, upon recommendation by the Monetary Board to be subject to the regular income tax
payable by banks: Provided, however, That interest income from foreign currency loans
granted by such depository banks under said expanded foreign currency deposit system to
residents other than offshore banking units in the Philippines or other depository banks
under the expanded system, shall be subject to a final income tax at the rate of ten percent
(10%).
Any income of nonresidents, whether individuals or corporations, from transactions with
depository banks under the expanded system shall be exempt from income tax.
(c) Capital Gains from Sale of Shares of Stock Not Traded in the Stock Exchange. - 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 except shares sold or disposed of through the stock exchange:
Not over P100,000………….… 5%
On any amount in excess of P100,000…….10%
(d) Intercorporate Dividends. - Dividends received by a resident foreign corporation from a
domestic corporation liable to tax under this Code shall not be subject to tax under this Title.
1. INTEREST, YIELDS, ROYALTIES
2. FCDU INCOME
3. CAPITAL GAIN FROM SALE OF SHARES
4. INTERCORPORATE DIVIDENDS

X. INCOME TAX ON NON-RESIDENT FOREIGN CORPORATIONS
A. INCOME TAX RATE AND TAX BASE, IN GENERAL
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(B) Tax on Nonresident Foreign Corporation. –
(1) In General. - Except as otherwise provided in this Code, a foreign corporation not engaged
in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the
gross income received during each taxable year from all sources within the Philippines, such
as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums),
annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits
and income, and capital gains, except capital gains subject to tax under subparagraph
5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent
(30%).
MARUBENI CORP. v. CIR
DOCTRINE:
Tax on dividends remitted to foreign corporations - Each tax has a different tax basis. Under
the Philippine-Japan Tax Convention, the 25% rate fixed is the maximum rate, as reflected in
the phrase “shall not exceed.” This means that any tax imposable by the contracting state
concerned should not exceed the 25% limitation and said rate would apply only if the tax
imposed by our laws exceeds the same.
FACTS:
Marubeni Corp. of Japan has equity investments in AG&P of Manila. For the first quarter of
1981 ending March 31, AG&P declared and paid cash dividends to petitioner in the amount of
P849,720 and withheld the corresponding 10% final dividend tax thereon. Similarly, for the
third quarter of 1981 ending September 30, AG&P declared and paid P849,720 as cash
dividends to petitioner and withheld the corresponding 10% final dividend tax thereon. AG&P
directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not only of
the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of 1981,
but also of the withheld 15% profit remittance tax based on the remittable amount after
deducting the final withholding tax of 10%.
The 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of
P114,712.20 for the first quarter of 1981 were paid to the BIR by AG&P, same with the 10%
final dividend tax of P84,972 and the 15% branch profit remittance tax of P114,712 for the
third quarter of 1981. Subsequently, the 10% final dividend tax of P84,972 and the 15%
branch profit remittance tax of P114,712.20 for the first quarter of 1981 were paid to the BIR,
same with the 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of
P114,712 for the third quarter of 1981.
Marubeni, through SGV and Co., sought a ruling from the BIR on on whether or not the
dividends petitioner received from AG&P are effectively connected with its conduct or
business in the Philippines as to be considered branch profits subject to the 15% profit
remittance tax imposed under Section 24 (b) (2) of the National Internal Revenue Code as
amended by Presidential Decrees Nos. 1705 and 1773.
In reply, Acting Commissioner Ancheta said that such dividends were not branch profits for
purposes of the 15% profit remittance tax imposed by Section 24 (b) (2) of the Tax Code, as
amended.
119 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
A. Only profits remitted abroad by a branch office to its head office which are effectively
connected with its trade or business in the Philippines are subject to the 15% profit
remittance tax.
B. To be effectively connected it is not necessary that the income be derived from the actual
operation of taxpayer-corporation's trade or business; it is sufficient that the income
arises from the business activity in which the corporation is engaged. (E.g. if a resident
foreign corporation is engaged in the buying and selling of machineries in the Philippines
and invests in some shares of stock on which dividends are subsequently received, the
dividends thus earned are not considered 'effectively connected' with its trade or
business in this country.)
Consequently, Marubeni filed with the CIR a claim for refund of or issuance of a tax credit of
P229,424.40, representing the profit tax remittance incorrectly paid on the dividends
remitted by AG&P to Marubeni’s head office in Tokyo. CIR denied the claim, saying that while
it is not covered by the 15% profit remittance tax and the 10% inter-corporate dividend tax, it,
as a non-resident stockholder, is subject to the 25 % tax pursuant to Article 10 (2) (b) of the
Tax Treaty dated February 13, 1980 between the Philippines and Japan.
The CTA affirmed the denial. It stated that the dividends in question are income taxable to the
Marubeni. The said dividends were distributions made by AG&P to its shareholder out of its
profits on the investments of the Marubeni, a non-resident foreign corporation. The
investments in AG&P of Marubeni were directly made by it and the dividends on the
investments were likewise directly remitted to and received by the latter.
Subject to certain exceptions not pertinent hereto, income is taxable to the person who earned
it. Admittedly, the dividends under consideration were earned by the Marubeni Corporation
of Japan, and hence, taxable to the said corporation. While it is true that the Marubeni
Corporation Philippine Branch is duly licensed to engage in business under Philippine laws,
such dividends are not the income of the Philippine Branch and are not taxable to the said
Philippine branch.
ISSUES:
1. W/N Marubeni Corporation is resident foreign corporation. – No
2. W/N the dividends Marubeni Corporation received from Atlantic Gulf and Pacific Co. are
effectively connected with its conduct or business in the Philippines as to be considered
branch profits subject to 15% profit remittance tax imposed under Section 24(b)(2) of the
National Internal Revenue Code. - No
RULING:
According to Marubeni, following the principal-agent relationship theory, Marubeni Japan is
likewise a resident foreign corporation subject only to the 10 % intercorporate final tax on
dividends received from a domestic corporation in accordance with Section 24(c) (1) of the
Tax Code of 1977.
1. Precisely because it is engaged in business in the Philippines through its Philippine
branch that it must be considered as a resident foreign corporation.
2. Since the Philippine branch and the Tokyo head office are one and the same entity,
whoever made the investment in AG&P, Manila does not matter at all.
According to CIR and CTA w/c the SC affirmed, Marubeni, Japan, being a non-resident foreign
corporation and not engaged in trade or business in the Philippines, is subject to tax on
income earned from Philippine sources at the rate of 35 % of its gross income under Section
24 (b) (1) of the tax code but expressly made subject to the special rate of 25% under Article
10(2) (b) of the Tax Treaty of 1980 concluded between the Philippines and Japan3.
The general rule that a foreign corporation is the same juridical entity as its branch office in
the Philippines cannot apply here. This rule is based on the premise that the business of the
foreign corporation is conducted through its branch office, following the principal agent
relationship theory. It is understood that the branch becomes its agent here. So that when the
foreign corporation transacts business in the Philippines independently of its branch, the
principal-agent relationship is set aside. The transaction becomes one of the foreign
corporation, not of the branch. Consequently, the taxpayer is the foreign corporation, not the
branch or the resident foreign corporation.
Marubeni is clearly a non-resident foreign corporation. The alleged overpaid taxes were
incurred for the remittance of dividend income to the head office in Japan which is a separate
and distinct income taxpayer from the branch in the Philippines. The investment (totaling
283.260 shares including that of nominee) was made for purposes peculiarly germane to the
conduct of the corporate affairs of Marubeni Japan, but certainly not of the branch in the
Philippines.
Pursuant to Section 24(b)(2) of the Tax Code, as amended, only profits remitted abroad by a
branch office to its head office which are effectively connected with its trade or business in the
Philippines are subject to the 15% profit remittance tax. The dividends received by Marubeni
Corporation from Atlantic Gulf and Pacific Co. are not income arising from the business
activity in which Marubeni Corporation is engaged. Accordingly, said dividends if remitted
abroad are not considered branch profits for purposes of the 15% profit remittance tax
imposed by Section 24(b)(2) of the Tax Code, as amended.
To simply add the two taxes [10% inter-corporate tax + 15% profit remittance tax = 25% tax
under the Phil. – Japan Treaty] to arrive at the 25 % tax rate is to disregard a basic rule in
taxation that each tax has a different tax basis. While the tax on dividends is directly levied on
the dividends received, "the tax base upon which the 15 % branch profit remittance tax is
imposed is the profit actually remitted abroad."
The 25% tax rate should not have been imposed as if it was a fixed rate. A closer look at the
Treaty reveals that the tax rates fixed by Article 10 are the maximum rates as reflected in the
phrase "shall not exceed." This means that any tax imposable by the contracting state
concerned should not exceed the 25 % limitation and that said rate would apply only if the tax
imposed by our laws exceeds the same. In other words, by reason of our bilateral negotiations
with Japan, we have agreed to have our right to tax limited to a certain extent to attain the
goals set forth in the Treaty.
Lastly, At what rate should Marubeni be taxed? = 15% - Marubeni, being a non-resident
foreign corporation with respect to the transaction in question, the applicable provision of the
Tax Code is Section 24 (b) (1) (iii) in conjunction with the Philippine-Japan Treaty of 1980.
Being a non-resident foreign corporation, as a general rule, Marubeni is taxed 35 % of its gross
income from all sources within the Philippines. However, a discounted rate of 15% is given to
petitioner on dividends received from a domestic corporation (AG&P) on the condition that its
3Article 10 (1) Dividends paid by a company which is a resident of a Contracting State to a resident of the
other Contracting State may be taxed in that other Contracting State.
(2) However, such dividends may also be taxed in the Contracting State of which the company paying the
dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the
beneficial owner of the dividends the tax so charged shall not exceed;
(b) 25 per cent of the gross amount of the dividends in all other cases.
120 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
domicile state (Japan) extends in favor of petitioner, a tax credit of not less than 20 % of the
dividends received.
N.V. REEDERIJ “AMSTERDAM” AND ROYAL INTEROCEAN LINES v. CIR
DOCTRINE:
A casual business activity in the Philippines by a foreign corporation does not amount to
engaging in trade or business in the Philippines for income tax purposes.
FACTS:
On 1963, M.V. Amstelmeer and on 1964, MV "Amstelkroon" both are vessels of N.B. Reederij
"AMSTERDAM," called on Philippine ports to load cargoes for foreign destination. The freight
fees of US$98,175.00 in 1963 and US$137,193.00 in 1964 were paid abroad. In both instances,
Royal Interocean Lines acted as husbanding agent for a fee or commission on said vessels. No
income tax appears to have been paid by N.V. Reederij "AMSTERDAM" on the freight receipts.
Respondent CIR filed the corresponding income tax returns for and in behalf of the former
under Section 15 of the NIRC. Applying the prevailing market conversion rate of P3.90 to
US$1.00, the gross receipts of N.V. Reederij "Amsterdam" for 1963 and 1964 amounted to
P382,882.50 and P535,052.00, respectively. On June 1967, respondent Commissioner
assessed petitioner of P193,973.20 and P262,904.94 as deficiency income tax for 1963 and
1964, as "a non-resident foreign corporation not engaged in trade or business in the
Philippines under Section 24 (b) (1) of the Tax Code.
On the assumption that petitioner is a foreign corporation engaged in trade or business in the
Philippines, Royal Interocean Lines filed an income tax return of the vessels computed at the
exchange rate of P2.00 to US$1.00 and paid the tax of P1,835.52 and P9,448.94, respectively,
pursuant to Section 24 (b) (2) in relation to Section 37 (B) (e) of the NIRC and Section 163 of
Revenue Regulations No. 2. Royal Interocean Lines as the husbanding agent of N.V. Reederij
"AMSTERDAM" filed a written protest against the assessment made by the respondent
Commissioner which protest was denied by said respondent. Petitioners filed a petition for
review with the CTA praying for the cancellation of the assessment. CTA modified the
assessments by eliminating the 50% fraud compromise penalties imposed upon petitioners.
Petitioners filed a motion for reconsideration of said decision but this was denied by the
respondent court.
ISSUE: Whether or not N.V. Reederij “Amsterdam” should be taxed as a foreign corporation
not engaged in trade or business in the Philippines?
RULING:
N.V. Reederij "AMSTERDAM" is a foreign corporation not authorized or licensed to do
business in the Philippines. It does not have a branch office in the Philippines and it made only
two calls in Philippine ports, one in 1963 and the other in 1964. In order that a foreign
corporation may be considered engaged in trade or business, its business transactions must
be continuous. A casual business activity in the Philippines by a foreign corporation, as in the
present case, does not amount to engaging in trade or business in the Philippines for income
tax purposes.
A foreign corporation engaged in trade or business within the Philippines, or which has an
office or place of business therein, is taxed on its total net income received from all sources
within the Philippines at the rate of 25% upon the amount but which taxable net income does
not exceed P100,000.00, and 35% upon the amount but which taxable net income exceeds
P100,000.00. On the other hand, a foreign corporation not engaged in trade or business within
the Philippines and which does not have any office or place of business therein is taxed on
income received from all sources within the Philippines at the rate of 35% of the gross
income.
Petitioner relies on Section 24 (b) (2) and Section 37 (B) (e) of the Tax Code and
implementing Section 163 of the Income Tax Regulations but these provisions refer to a
foreign corporation engaged in trade or business in the Philippines and not to a foreign
corporation not engaged in trade or business in the Philippines like petitioner-shipowner
herein.
B. SPECIAL NON-RESIDENT FOREIGN CORPORATIONS
1. NON-RESIDENT CINEMATOGRAPHIC FILM OWNER, LESSOR OR DISTRIBUTOR
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(B) Tax on Nonresident Foreign Corporation. –
(2) Nonresident Cinematographic Film Owner, Lessor or Distributor. - A cinematographic film
owner, lessor, or distributor shall pay a tax of twenty-five percent (25%) of its gross income
from all sources within the Philippines.
2. NON-RESIDENT OWNER OR LESSOR OF VESSELS CHARTERED BY PHILIPPINE
NATIONALS
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(B) Tax on Nonresident Foreign Corporation. –
(3) Nonresident Owner or Lessor of Vessels Chartered by Philippine Nationals. - A nonresident
owner or lessor of vessels shall be subject to a tax of four and one-half percent (4 1/2%) of
gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations,
as approved by the Maritime Industry Authority.
3. NON-RESIDENT OWNER OR LESSOR OF AIRCRAFT, MACHINERY AND OTHER
EQUIPMENT
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(B) Tax on Nonresident Foreign Corporation. –
(4) Nonresident Owner or Lessor of Aircraft, Machineries and Other Equipment. - Rentals,
charters and other fees derived by a nonresident lessor of aircraft, machineries and other
equipment shall be subject to a tax of seven and one-half percent (7 1/2%) of gross rentals or
fees.
C. TAX ON CERTAIN INCOMES OF NON-RESIDENT FOREIGN CORPORATIONS
SEC. 28. Rates of Income Tax on Foreign Corporations. -
(B) Tax on Nonresident Foreign Corporation. –
(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. –
(a) Interest on Foreign Loans. - A final withholding tax at the rate of twenty percent (20%) is
hereby imposed on the amount of interest on foreign loans contracted on or after August 1,
1986;
(b) Intercorporate Dividends - A final withholding tax at the rate of fifteen percent (15%) is
hereby imposed on the amount of cash and/or property dividends received from a domestic
corporation, which shall be collected and paid as provided in Section 57 (A) of this Code,
121 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
subject to the condition that the country in which the nonresident foreign corporation is
domiciled, shall allow a credit against the tax due from the nonresident foreign corporation
taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%), which
represents the difference between the regular income tax of thirty-five percent (35%) and the
fifteen percent (15%) tax on dividends as provided in this subparagraph; Provided, that
effective January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent
(15%), which represents the difference between the regular income tax of thirty percent
(30%) and the fifteen percent (15%) tax on dividends;
(c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange. - 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, except shares sold, or disposed of through the stock exchange:
Not over P100,000…………..5%
On any amount in excess of P100,000………… 10%
1. INTEREST ON FOREIGN LOANS
2. INTERCORPORATE DIVIDENDS
BIR RUL. 8-00
DOCTRINE:
A final withholding tax at the rate of 15% is imposed on the amount of cash and/or property
dividends received from a domestic corporation, subject to the condition that the country in
which the non-resident foreign corporation is domiciled, shall allow a credit against the tax
due from the non-resident foreign corporation taxes deemed to have been paid in the
Philippines equivalent to the difference between the regular income tax and the 15% tax on
dividends.
FACTS:
SGS Philippines, Inc. is a domestic corporation engaged in the business of laboratory,
certification, and inspection services. It is wholly owned by Societe Generale de Surveillance
based in Switzerland. SGS Philippines, Inc. paid a dividend of P4.0M to its parent company,
Societe Generale de Surveillance on which 33% withholding tax thereof of P1,320,000.00 was
withheld and paid to the BIR as evidenced by FEBTC Official Receipt. SGS Philippines, Inc. is of
the opinion that the dividends paid to its parent company is only subject to tax at the rate of
15% instead of the 33% and the SGS Philippines, Inc. is still entitled to a refund of
P720,000.00 representing overpaid withholding tax on dividends.
ISSUE:
Whether or not SGS Philippines, Inc. is entitled to a refund of overpaid withholding tax on
dividends? YES.
RULING:
In accordance with Section 28(B)(5)(b) of the Tax Code of 1997, SGS Philippines, Inc., being a
subsidiary of Societe Generale de Surveillance, is subject to the preferential tax rate of 15%
withholding tax on the dividends remitted to its foreign parent company, Societe Generale de
Surveillance of Switzerland, a non-resident foreign corporation, subject to the condition that
Switzerland in which the non-resident foreign corporation is domiciled shall allow a credit
against the tax due from the non-resident foreign corporation taxes deemed to have been paid
in the Philippines equivalent to 18% which represents the difference between the regular
income tax (33%) on corporations for the taxable year 1999 and the 15% tax on dividends.
Otherwise, to run counter to the very spirit and intent of said law will definitely affect the
foreign corporations' interest here and discourage them from investing capital in our country.
Accordingly, SGS Philippines, Inc. may now file with the BIR, a claim for the refund of
P720,000.00 representing overpaid withholding tax on dividends within a period of 2 years
after the payment of the said tax.
3. CAPITAL GAIN FROM SALE OF SHARES
4. INCOME COVERED BY TAX TREATIES
ITAD Ruling 102-02
FACTS:
Eveready Battery Company, Inc. is a non-resident foreign corporation (US Corp). It is not
registered either as a corporation or as a partnership licensed to do business in the
Philippines as evidenced by the Certificate of Non-Registration issued by SEC. Energizer
Philippines Inc. is a domestic corporation. Eveready and Energizer entered into a Renewal
Agreement whereby Eveready granted to Energizer the right to use its trademarks and
patents, technical information, business information, data, and know-how relating to the
manufacture, use and sale of licensed products. The Agreement was duly registered with the
then Technology Transfer Registry and was renewed for another 10 years ending on October
15, 2009. In consideration of the rights granted to Energizer, Energizer shall pay Eveready a
royalty of 3% based on the net sales or net sale value of all the licensed products
manufactured, used, sold or assigned by Energizer during the term of the Agreement.
ISSUE: Whether or not the royalty payments by Energizer to Eveready are subject to a 15%
preferential tax pursuant to the “most favored nation” clause of the RP-US tax treaty? YES.
RULING:
Based on the RP-US tax treaty and RP-Netherlands tax treaty, the tax imposed on royalties
derived by a US resident from sources within the Philippines shall be the lowest rate of
Philippine tax that may be imposed an royalties of the same kind paid under similar
circumstances to a resident of a third State. This is the "most-favored nation"` clause found in
Article 13(2)(b)(iii) of the RP-US tax treaty. In this connection, the royalties arising from the
Philippines and paid to a resident of the Netherlands may also be taxed in the Philippines but
the tax so charged shall not exceed 15% of the gross amount of royalties in cases other than
royalties paid by in enterprise registered in preferred areas of activities in the Philippines.
The term "royalties" as used in this Article means any payment of any kind received as a
consideration for the use of, or right to use, any patent, trademark, design or model, secret
formula or process, or for the use of, or the right to use of, industrial, commercial or scientific
equipment, or for information concerning industrial, commercial or scientific experience.
The SC interpreted the "most-favored-nation" clause, particularly the phrase "paid under
similar circumstances," as referring to the manner of payment or taxes and not to the subject
matter of the tax which is royalties. Hence, the "most-favored-nation" clause of the RP-US tax
treaty must be interpreted not only in relation to Article 12 of the RP-Netherlands tax treaty
but also in connection with the provisions on the elimination of double taxation of both. A
perusal of the RP-US and the RP-Netherlands tax treaties, particularly their provisions on the
avoidance of double taxation, shows a similarity on the manner of payment of taxes, that is,
the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines.
Since Energizer is not registered and engaged in preferred areas of activities in the
Philippines, the royalty payments by Energizer to Eveready are subject to the preferential tax
rate of 15% of the gross amount of royalties pursuant to the "most-favored-nation" provision
of the RP-US tax treaty in relation to the RP-Netherlands tax treaty. Moreover, the royalty
payments by Energizer shall be subject to the 10% value-added tax (VAT) under Section
108(A)(1) and (3) of the Tax Code of 1997.
122 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Energizer shall be responsible for the withholding of income tax at the rate of 15% of the
gross amount of royalties and the withholding of the 10% VAT of the contract amount by filing
a separate return which, if duly validated, shall be sufficient evidence in claiming input tax
credit.
XI. IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)
SEC. 29. Imposition of Improperly Accumulated Earnings Tax -
(A) In General. - In addition to other taxes imposed by this Title, there is hereby imposed for
each taxable year on the improperly accumulated taxable income of each corporation
described in Subsection B hereof, an improperly accumulated earnings tax equal to ten
percent (10%) of the improperly accumulated taxable income.
(B) Tax on Corporations Subject to Improperly Accumulated Earnings Tax. -
(1) In General - The improperly accumulated earnings tax imposed in the preceding
Section shall apply to every corporation formed or availed for the purpose of
avoiding the income tax with respect to its shareholders or the shareholders of any
other corporation, by permitting earnings and profits to accumulate instead of being
divided or distributed.
(2) Exceptions - The improperly accumulated earnings tax as provided for under this
Section shall not apply to:.
(a) Publicly-held corporations;
(b) Banks and other nonbank financial intermediaries; and
(c) Insurance companies.
(C) Evidence of Purpose to Avoid Income Tax. –
(1) Prima Facie Evidence. - the fact that any corporation is a mere holding company or
investment company shall be prima facie evidence of a purpose to avoid the tax
upon its shareholders or members.
(2) Evidence Determinative of Purpose. - The fact that the earnings or profits of a
corporation are permitted to accumulate beyond the reasonable needs of the
business shall be determinative of the purpose to avoid the tax upon its
shareholders or members unless the corporation, by the clear preponderance of
evidence, shall prove to the contrary.
(D) Improperly Accumulated Taxable Income - For purposes of this Section, the term
'improperly accumulated taxable income' means taxable income' adjusted by:
(1) Income exempt from tax;
(2) Income excluded from gross income;
(3) Income subject to final tax; and
(4) The amount of net operating loss carry-over deducted; And reduced by the sum of:
(1) Dividends actually or constructively paid; and
(2) Income tax paid for the taxable year Provided, however, That for corporations
using the calendar year basis, the accumulated earnings under tax shall not
apply on improperly accumulated income as of December 31, 1997.
In the case of corporations adopting the fiscal year accounting period, the improperly
accumulated income not subject to this tax, shall be reckoned, as of the end of the month
comprising the twelve (12)-month period of fiscal year 1997-1998.
(E) Reasonable Needs of the Business - For purposes of this Section, the term 'reasonable
 needs of the business' includes the reasonably anticipated needs of the business.
THE MANILA WINE MERCHANTS, INC. v. CIR
FACTS:
Petitioner a domestic corporation is principally engaged in the importation and sale of whisky,
wines, liquors and distilled spirits. Its original subscribed and paid capital was P500,000.00. It
was reduced to P250,000.00 in 1950 and was increased to P1,000,000.00 in 1958.
On 1957, CIR found that petitioner has unreasonably accumulated surplus of 428,934.32 for
the calendar year 1947 to 1957, in excess of the reasonable needs of the business subject to
the 25% surtax imposed by Section 25 of the Tax Code. On February 26, 1963, the CIR
demanded upon the Manila Wine Merchants, Inc. payment of P126,536.12 as 25% surtax and
interest on the latter's unreasonable accumulation of profits and surplus for the year 1957.
Respondent contends (1) that petitioner has accumulated earnings beyond the reasonable
needs of its business because the average ratio of the cash dividends declared and paid by
petitioner from 1947 to 1957 was 40.33% of the total surplus available for distribution at the
end of each calendar year and (2) that that the accumulated earnings tax should be based on
25% of the total surplus available at the end of each calendar year.
Petitioner contends: (1) that in 1957, it distributed 100% of its net earnings after income tax
and part of the surplus for prior years and (2) that the 25% surtax is imposed on the total
surplus or net income for the year after deducting therefrom the income tax due. Another
basis of respondent in assessing petitioner for accumulated earnings tax is its substantial
investment of surplus or profits in unrelated business. These investments are itemized as
follows:
1. Acme Commercial Co., Inc. P 27,501.00
Petitioner: We thought it prudent to invest in a business which patronizes us. As a
supermarket, Acme Commercial Co., Inc. is one of our best customers. The investment has
proven to be beneficial to the stockholders of this Company.
2. Union Insurance Society of Canton amounting to 1,145.76 and WackWack Golf &Country
Club- 1 .00
Petitioner: 'Theses items are small amounts which we believe would not affect this case
substantially.
3. U.S.A. Treasury Bonds amounting to P347,217.50
Petitioner: The Company had deposited in current account in various banks P629,403.64
which was not earning any interest. We decided to utilize part of this money as reserve to
finance our importations and to take care of future expansion including acquisition of a lot
and the construction of our own officebuilding and bottling plant. At that time, we believed
that a dollar reserve abroad would be useful to the Company in meeting immediate urgent
orders of its local customers.
Respondent found that the accumulated surplus in question was invested to 'unrelated
business' which was not considered in the 'immediate needs' of the Company such that the
25% surtax be imposed therefrom."
Petitioner appealed to the Court of Tax Appeals.
CTA: (1) the average percentage of cash dividends distributed was 85.77% for a period of 11
years from 1946 to 1957 and not only 40.33% of the total surplus available for distribution at
the end of each calendar year actually distributed by the petitioner to its stockholders, which
123 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
is indicative of the view that the Manila Wine Merchants, Inc. was not formed for the purpose
of preventing the imposition of income tax upon its shareholders.
(2) investment of petitioner with Acme Commercial Co., Inc., Union Insurance Society of
Canton and with the WackWack Golf and Country Club are harmless accumulation of surplus
and, therefore, not subject to the 25% surtax provided in Section 25 of the Tax Code.
(3) As to the U.S.A. Treasury Bonds, its purchase was in no way related to petitioner's business
of importing and selling wines, whisky, liquors and distilled spirits. It was availed of by
petitioner for the purpose of preventing the imposition of the surtax upon petitioner's
shareholders by permitting its earnings and profits to accumulate beyond the reasonable
needs of business.
ISSUES:
WON U.S.A. Treasury Bills in 1951 was an investment in unrelated business subject to the
25% surtax in 1957 as surplus profits improperly accumulated in the latter Years (YES).
WON The Court of Tax Appeals erred in not finding that petitioner did not accumulate its
surplus profits improperly in 1957, and in not holding that such surplus profits, including the
so-called unrelated investments, were necessary for its reasonable business needs. (NO)
HELD:
The pertinent provision of the National Internal Revenue Code reads as follows:
"Sec. 25. Additional tax on corporations improperly accumulating profits or surplus. —
(a) Imposition of Tax. — If any corporation, except banks, insurance companies, or personal
holding companies whether domestic or foreign, is formed or availed of for the purpose of
preventing the imposition of the tax upon its shareholders or members or the shareholders or
members of another corporation, through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied and assessed against such
corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed
portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four and shall be computed, collected and paid in the same manner and subject
to the same provisions of law, including penalties, as that tax: Provided, that no such tax shall
be levied upon any accumulated profits or surplus, if they are invested in any dollarproducing
or dollar-saving industry or in the purchase of bonds issued by the Central Bank of the
Philippines.
(c) Evidence determinative of purpose. — The fact that the earnings of profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the contrary."
(1)A prerequisite to the imposition of the tax has been that the corporation be formed or
availed of for the purpose of avoiding the income tax (or surtax) on its shareholders, or on the
shareholders of any other corporation by permitting the earnings and profits of the
corporation to accumulate instead of dividing them among or distributing them to the
shareholders. If the earnings and profits were distributed, the shareholders would be required
to pay an income tax thereon whereas, if the distribution were not made to them, they would
incur no tax in respect to the undistributed earnings and profits of the corporation.
The touchstone of liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation. Thus, if the failure to pay dividends is due to some other
cause, such as the use of undistributed earnings and profits for the reasonable needs of the
business, such purpose does not fall within the interdiction of the statute. An accumulation of
earnings or profits (including undistributed earnings or profits of prior years) is unreasonable
if it is not required for the purpose of the business, considering all the circumstances of the
case.
To determine the "reasonable needs" of the business in order to justify an accumulation of
earnings, the Courts of the United States have invented the so-called "Immediacy Test" which
construed the words "reasonable needs of the business" to mean the immediate needs of the
business, and it was generally held that if the corporation did not prove an immediate need for
the accumulation of the earnings and profits, the accumulation was not for the reasonable
needs of the business, and the penalty tax would apply.
To avoid the 25% surtax, petitioner has to prove that the purchase of the U.S.A. Treasury
Bonds in 1951 with a face value of $175,000.00 was an investment within the reasonable
needs of the Corporation.
The records further reveal that from May 1951 when petitioner purchased the U.S.A. Treasury
shares, until 1962 when it finally liquidated the same, it (petitioner) never had the occasion to
use the said shares in aiding or financing its importation. This militates against the purpose
enunciated earlier by petitioner that the shares were purchased to finance its importation
business. To justify an accumulation of earnings and profits for the reasonably anticipated
future needs, such accumulation must be used within a reasonable time after the close of the
taxable year.
Petitioner advanced the argument that the U.S.A. Treasury shares were held for a few more
years from 1957, in view of a plan to buy a lot and construct a building of their own; that at
that time (1957), the Company was not yet qualified to own real property in the Philippines,
hence it (petitioner) had to wait until 60% of the stocks of the Company would be owned by
Filipino citizens before making definite plans.
In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the surtax upon shareholders, the controlling intention of the taxpayer is
that which is manifested at the time of accumulation not subsequently declared intentions
which are merely the product of afterthought. A speculative and indefinite purpose will not
suffice. The mere recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled with action taken towards
its consummation are essential.
(2)The rule is now settled in our jurisprudence that undistributed earnings or profits of prior
years are taken into consideration in determining unreasonable accumulation for purposes of
the 25% surtax. The case of Basilan Estates, Inc. vs. Commissioner of Internal Revenue further
strengthen this rule: 'In determining whether accumulations of earnings or profits in a
particular year are within the reasonable needs of a corporation, it is necessary to take into
account prior accumulations, since accumulations prior to the year involved may have been
sufficient to cover the business needs and additional accumulations during the year involved
would not reasonably be necessary.'"
CIR v. TUASON
DOCTRINE:
If the failure to pay dividends were for the purpose of using the undistributed earnings and
profits for the reasonable needs of the business, that purpose would not fall within the
interdiction of the statute. It is plain to see that the company's failure to distribute dividends
to its stockholders in 1975-1978 was for reasons other than the reasonable needs of the
business, thereby falling within the interdiction of Section 25 of the Tax Code of 1977.
FACTS:
The petitioner, Commissioner of Internal Revenue, assessed Antonio Tuason, Inc.:
124 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(a) Deficiency income tax for the years 1975,1976 and 1978 . . . . . . . ……………………..…………
P37,491.83.
(b) Deficiency corporate quarterly income tax for the first quarter of 1975 . . . …. . . . . . . . . . . . . . .
. . . 161.49.
(c) 25% surtax on unreasonable accumulation of surplus for the years 1975-1978 . . . . . . . . . . . .
1,151,146.98.
The private respondent did not object to the first and second items and, therefore, paid the
amounts demanded. However, it protested the assessment on a 25% surtax on the third item
on the ground that the accumulation of surplus profits during the years in question was solely
for the purpose of expanding its business operations as real estate broker. The request for
reinvestigation was granted on condition that a waiver of the statute of limitations should be
filed by the private respondent. The latter replied that there was no need of a waiver of the
statute of limitations because the right of the Government to assess said tax does not
prescribe.
No investigation was conducted nor a decision rendered on Antonio Tuazon Inc.'s protest.
Meantime, the Revenue Commissioner issued warrants of levy to enforce collection of the
total amount originally assessed including the amounts already paid.
The private respondent filed a petition for review in the Court of Tax Appeals with a request
that pending determination of the case on the merits, an order be issued restraining the
Commissioner and/or his representatives from enforcing the warrants of levy. Since the right
asserted by the Commissioner to collect the taxes involved herein by the summary methods of
levy was not clear, and it was shown that portions of the tax liabilities involved in the
assessment had already been paid, a writ of injunction was issued by the Tax Court, ordering
the Commissioner to refrain from enforcing said warrants of levy. It did not require the
petitioner to file a bond.
ISSUE/S:
1. Whether or not private respondent Antonio Tuason, Inc. is a holding company and/or
investment company? YES.
2. Whether or not private respondent Antonio Tuason, Inc. accumulated surplus for the years
1975 to 1978? YES.
3. Whether or not Antonio Tuason, Inc. is liable for the 25% surtax on undue accumulation of
surplus for the years 1975 to 1978? YES.
RULING:
The petition for review is meritorious. Section 25 of the Tax Code at the time the surtax was
assessed, provided:
Sec. 25. Additional tax on corporation improperly accumulating profits or surplus.—
(a) Imposition of tax. — If any corporation, except banks, insurance companies, or personal
holding companies, whether domestic or foreign, is formed or availed of for the purpose of
preventing the imposition of the tax upon its shareholders or members or the shareholders or
members of another corporation, through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied and assessed against such
corporation, for each taxable year, a tax equal to twenty-five per centum of the undistributed
portion of its accumulated profits or surplus which shall be in addition to the tax imposed by
section twenty-four, and shall be computed, collected and paid in the same manner and
subject to the same provisions of law, including penalties, as that tax.
(b) Prima facie evidence. — The fact that any corporation is a mere holding company shall be
prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Similar
presumption will lie in the case of an investment company where at any time during the
taxable year more than fifty per centum in value of its outstanding stock is owned, directly or
indirectly, by one person.
(c) Evidence determinative of purpose. — The fact that the earnings or profits of a corporation
are permitted to accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the contrary.
The Court of Tax Appeals conceded that the Revenue Commissioner's determination that
Antonio Tuason, Inc. was a mere holding or investment company, was "presumptively correct"
for the corporation did not involve itself in the development of subdivisions but merely
subdivided its own lots and sold them for bigger profits. It derived its income mostly from
interest, dividends and rental realized from the sale of realty.
Another circumstance supporting that presumption is that 99.99% in value of the outstanding
stock of Antonio Tuason, Inc., is owned by Antonio Tuason himself. The Commissioner
"conclusively presumed" that when the corporation accumulated a surplus of over P3 million
from its earnings in 1975 up to 1978, the purpose was to avoid the imposition of the
progressive income tax on its shareholders. That Antonio Tuason, Inc. accumulated surplus
profits amounting to P3,263,305.88 for 1975 up to 1978 is not disputed. However, the private
respondent vehemently denies that its purpose was to evade payment of the progressive
income tax on such dividends by its stockholders. According to the private respondent,
surplus profits were set aside by the company to build up sufficient capital for its expansion
program which included the construction in 1979-1981 of an apartment building, and the
purchase in 1980 of a condominium unit which was intended for resale or lease.
However, while these investments were actually made, the Commissioner points out that the
corporation did not use up its surplus profits. It allegation that P1,525,672.74 was spent for
the construction of an apartment building in 1979 and P1,752,332.87 for the purchase of a
condominium unit in Urdaneta Village in 1980 was refuted by the Declaration of Real
Property on the apartment building which shows that its market value is only P429,890.00,
and the Tax Declaration on the condominium unit which reflects a market value of
P293,830.00 only. The enormous discrepancy between the alleged investment cost and the
declared market value of these pieces of real estate was not denied nor explained by the
private respondent. Since the company as of the time of the assessment in 1981, had invested
in its business operations only P 773,720 out of its accumulated surplus profits of
P3,263,305.88 for 1975-1978, its remaining accumulated surplus profits of P2,489,858.88 are
subject to the 25% surtax.
All presumptions are in favor of the correctness of petitioner's assessment against the private
respondent. Unfortunately, the private respondent failed to overcome the presumption of
correctness of the Commissioner's assessment. The touchstone of liability is the purpose
behind the accumulation of the income and not the consequences of the accumulation. The
petitioner's assessment of a 25% surtax against the Antonio Tuason, Inc. is reinstated but only
on the latter's unspent accumulated surplus profits of P2,489,585.88.
CYANAMID PHILIPPINES, INC. v. CA
FACTS:
Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a
wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the
manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished
goods, and an importer/indentor.
125 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the
payment of deficiency income tax of P119,817.00 for taxable year 1981.
Petitioner protested the assessments particularly, (1) the 25% Surtax Assessment of
P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency
Percentage Assessment of P8,846.72. Petitioner, through its external accountant, Sycip,
Gorres, Velayo & Co., claimed that the surtax for the undue accumulation of earnings was not
proper because the said profits were retained to increase petitioner’s working capital and it
would be used for reasonable business needs of the company. Petitioner contended that it
availed of the tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil
and criminal prosecution granted by the law.
The CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the assessment
notices and rendered its resolution, saying that EO 41 applies only for the cancellation of the
assessment issued after August 21, 1986. The availment does not, therefore, result in
cancellation of assessments issued before August 21, 1986, as in the instant case.
Petitioner appealed to the CTA (during the pendency though they had a compromise reducing
tax liability but the surcharge was still unpaid). Petitioner claimed that CIR’s assessment
representing the 25% surtax on its accumulated earnings for 1981 had no legal basis because
petitioner accumulated its earnings and profits for reasonable business requirements to meet
working capital needs and retirement of indebtedness.
CTA denied the appeal saying that (a) there was no need for petitioner to set aside a portion of
its retained earnings as working capital reserve as it claims since it had considerable liquid
funds; (b) under Sec. 25 of the NIRC, the exceptions to the accumulated earnings tax are
expressly enumerated, to wit: Bank, non-bank financial intermediaries, corporations
organized primarily, and authorized by the Central Bank of the Philippines to hold shares of
stock of banks, insurance companies, or personal holding companies, whether domestic or
foreign. The law on the matter is clear and specific. Hence, there is no need to resort to
applicable cases decided by the American Federal Courts (as petitioner did) for guidance and
enlightenment as to whether the provision of Sec. 25 of the NIRC should apply to petitioner.
CA affirmed this decision.
ISSUE/S: Whether respondent court erred in holding that the petitioner is liable for the
accumulated earnings tax for 1981? NO.
RULING:
Sec. 25 of the old NIRC of 1977 discouraged tax avoidance through corporate surplus
accumulation. When corporations do not declare dividends, income taxes are not paid on the
undeclared dividends received by the shareholders. The tax on improper accumulation of
surplus is essentially a penalty tax designed to compel corporations to distribute earnings so
that the said earnings by shareholders could, in turn, be taxed.
Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated
earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned
company. Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, whereby the
Court therein had taken the position that the accumulated earnings tax could only apply to a
closely held corporation.
A review of American taxation history on accumulated earnings tax will show that the
application of the accumulated earnings tax to publicly held corporations has been
problematic. Initially, the Tax Court and the Court of Claims held that the accumulated
earnings tax applies to publicly held corporations. Then, the Court ruled in Golconda that the
accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the
Internal Revenue Service asserted that the tax could be imposed on widely held corporations
including those not controlled by a few shareholders or groups of shareholders. The Service
indicated it would not follow the Court regarding publicly held corporations. In 1984,
American legislation nullified the Golconda ruling and made it clear that the accumulated
earnings tax is not limited to closely held corporations. Clearly, Golconda is no longer a
reliable precedent.
The amendatory provision of Sec. 25 of the 1977 NIRC, which was PD 1739, enumerated the
corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-
bank financial intermediaries; (c) insurance companies; and (d) corporations organized
primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of
banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration
is that the express mention of one person, thing, act, or consequence is construed to exclude
all others. Laws granting exemption from tax are construed strictissimi juris against the
taxpayer and liberally in favor of the taxing power. Taxation is the rule and exemption is the
exception. The burden of proof rests upon the party claiming exemption to prove that it is, in
fact, covered by the exemption so claimed, a burden which petitioner here has failed to
discharge.
Another point raised by the petitioner in objecting to the assessment, is that increase of
working capital by a corporation justifies accumulating income. Petitioner asserts that
respondent court erred in concluding that Cyanamid need not infuse additional working
capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of current
assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula, which allowed
retention, as working capital reserve, sufficient amounts of liquid assets to carry the company
through one operating cycle. The “Bardahl" formula was developed to measure corporate
liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid
assets to pay all of its current liabilities and any extraordinary expenses reasonably
anticipated, plus enough to operate the business during one operating cycle. Operating cycle
is the period of time it takes to convert cash into raw materials, raw materials into inventory,
and inventory into sales, including the time it takes to collect payment for the sales.
Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as
working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts
that Cyanamid had a working capital deficit of P7,986,633.00. Therefore, the P9,540,926.00
accumulated income as of 1981 may be validly accumulated to increase the petitioner’s
working capital for the succeeding year.
However, the companies where the "Bardahl" formula was applied, had operating cycles much
shorter than that of petitioner. In the case of Cyanamid, the operating cycle was 288.35 days,
or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three
quarters of the year, to cover the operating costs of the business. In times when there is no
recurrence of a business cycle, the working capital needs cannot be predicted with accuracy.
As stressed by American authorities, although the "Bardahl" formula is well-established and
routinely applied by the courts, it is not a precise rule. It is used only for administrative
convenience. Petitioner’s application of the "Bardahl" formula merely creates a false illusion of
exactitude.
Other formulas are also used, e.g. the ratio of current assets to current liabilities and the
adoption of the industry standard. The ratio of current assets to current liabilities is used to
determine the sufficiency of working capital. Ideally, the working capital should equal the
current liabilities and there must be 2 units of current assets for every unit of current liability,
hence the so-called "2 to 1" rule.
As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its
current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working
capital. Said working capital was expected to increase further when more funds were
126 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
generated from the succeeding year’s sales. Available income covered expenses or
indebtedness for that year, and there appeared no reason to expect an impending ‘working
capital deficit’ which could have necessitated an increase in working capital, as rationalized by
petitioner.
Basilan Estates, Inc. vs. CIR: There is no need to have such a large amount at the beginning of
the following year because during the year, current assets are converted into cash and with
the income realized from the business as the year goes, these expenses may well be taken care
of.
If the CIR determined that the corporation avoided the tax on shareholders by permitting
earnings or profits to accumulate, and the taxpayer contested such a determination, the
burden of proving the determination wrong, together with the corresponding burden of first
going forward with evidence, is on the taxpayer.
In order to determine whether profits are accumulated for the reasonable needs of the
business to avoid the surtax upon shareholders, it must be shown that the controlling
intention of the taxpayer is manifested at the time of accumulation, not intentions declared
subsequently, which are mere afterthoughts. Furthermore, the accumulated profits must be
used within a reasonable time after the close of the taxable year. In the instant case, petitioner
did not establish, by clear and convincing evidence, that such accumulation of profit was for
the immediate needs of the business.
Manila Wine Merchants, Inc. vs. CIR: To determine the ‘reasonable needs’ of the business in
order to justify an accumulation of earnings, the Courts of the United States have invented the
so-called ‘Immediacy Test’ which construed the words ‘reasonable needs of the business’ to
mean the immediate needs of the business, and it was generally held that if the corporation
did not prove an immediate need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and the penalty tax would
apply.
In the present case, the Tax Court opted to determine the working capital sufficiency by using
the ratio between current assets to current liabilities. The working capital needs of a business
depend upon the nature of the business, its credit policies, the amount of inventories, the rate
of turnover, the amount of accounts receivable, the collection rate, the availability of credit to
the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to
impress the tax court with the required definiteness envisioned by the statute. The Tax Court
properly ruled that the burden of proof to establish that the profits accumulated were not
beyond the reasonable needs of the company, remained on the taxpayer. This it failed to do.
REV. REGS. 2-01
SECTION 2. Concept of Improperly Accumulated Earnings Tax (IAET). — Pursuant to Section 29
of the Code, there is imposed for each taxable year, in addition to other taxes imposed under
Title II of the Tax Code of 1997, a tax equal to 10% of the improperly accumulated taxable
income of corporations formed or availed of for the purpose of avoiding the income tax with
respect to its shareholders or the shareholders of any other corporation, by permitting the
earnings and profits of the corporation to accumulate instead of dividing them among or
distributing them to the shareholders. The rationale is that if the earnings and profits were
distributed, the shareholders would then be liable to income tax thereon, whereas if the
distribution were not made to them, they would incur no tax in respect to the undistributed
earnings and profits of the corporation. Thus, a tax is being imposed in the nature of a penalty
to the corporation for the improper accumulation of its earnings, and as a form of deterrent to
the avoidance of tax upon shareholders who are supposed to pay dividends tax on the
earnings distributed to them by the corporation.
The touchstone of the liability is the purpose behind the accumulation of the income and not
the consequences of the accumulation. Thus, if the failure to pay dividends is due to some
other causes, such as the use of undistributed earnings and profits for the reasonable needs of
the business, such purpose would not generally make the accumulated or undistributed
earnings subject to the tax. However, if there is a determination that a corporation has
accumulated income beyond the reasonable needs of the business, the 10% improperly
accumulated earnings tax shall be imposed.
SECTION 3. Determination of Reasonable Needs of the Business. — An accumulation of earnings
or profits (including undistributed earnings or profits of prior years) is unreasonable if it is
not necessary for the purpose of the business, considering all the circumstances of the case. To
determine the "reasonable needs" of the business in order to justify an accumulation of
earnings, these Regulations hereby adhere to the so-called "Immediacy Test" under American
jurisprudence as adopted in this jurisdiction. Accordingly, the term "reasonable needs of the
business" are hereby construed to mean the immediate needs of the business, including
reasonably anticipated needs. In either case, the corporation should be able to prove an
immediate need for the accumulation of the earnings and profits, or the direct correlation of
anticipated needs to such accumulation of profits. Otherwise, such accumulation would be
deemed to be not for the reasonable needs of the business, and the penalty tax would apply.
For purposes of these Regulations, the following constitute accumulation of earnings for the
reasonable needs of the business:
a) Allowance for the increase in the accumulation of earnings up to 100% of the paid-up
capital of the corporation as of Balance Sheet date, inclusive of accumulations taken
from other years;
b) Earnings reserved for definite corporate expansion projects or programs requiring
considerable capital expenditure as approved by the Board of Directors or equivalent
body;
c) Earnings reserved for building, plants or equipment acquisition as approved by the
Board of Directors or equivalent body;
d) Earnings reserved for compliance with any loan covenant or pre-existing obligation
established under a legitimate business agreement;
e) Earnings required by law or applicable regulations to be retained by the corporation
or in respect of which there is legal prohibition against its distribution;
f) In the case of subsidiaries of foreign corporations in the Philippines, all undistributed
earnings intended or reserved for investments within the Philippines as can be proven
by corporate records and/or relevant documentary evidence.
SECTION 4. Coverage. — The 10% Improperly Accumulated Earnings Tax (IAET) is imposed
on improperly accumulated taxable income earned starting January 1, 1998 by domestic
corporations as defined under the Tax Code and which are classified as closely-held
corporations. Provided, however, that Improperly Accumulated Earnings Tax shall not apply
to the following corporations:
a) Banks and other non-bank financial intermediaries;
b) Insurance companies;
c) Publicly-held corporations;
d) Taxable partnerships;
e) General professional partnerships;
f) N on- taxable joint ventures; and
g) Enterprises duly registered with the Philippine Economic Zone Authority (PEZA)
under R.A. 7916, and enterprises registered pursuant to the Bases Conversion and
Development Act of 1992 under R.A. 7227, as well as other enterprises duly registered
under special economic zones declared by law which enjoy payment of special tax rate
127 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
on their registered operations or activities in lieu of other taxes, national or local.
For purposes of these Regulations, closely-held corporations are those corporations at least
fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of
the total combined voting power of all classes of stock entitled to vote is owned directly or
indirectly by or for not more than twenty (20) individuals. Domestic corporations not falling
under the aforesaid definition are, therefore, publicly-held corporations.
For purposes of determining whether the corporation is closely held corporation, insofar as
such determination is based on stock ownership, the following rules shall be applied:
(1) Stock Not Owned by Individuals. — Stock owned directly or indirectly by or for a
corporation, partnership, estate or trust shall be considered as being owned
proportionately by its shareholders, partners or beneficiaries.
(2) Family and Partnership Ownership. — An individual shall be considered as owning the
stock owned, directly or indirectly, by or for his family, or by for his partner. For
purposes of this paragraph, the family of an individual includes his brothers or sisters
(whether by whole or half-blood), spouse, ancestors and lineal descendants.
(3) Option to Acquire Stocks. — If any person has an option to acquire stock, such stock shall
be considered as owned by such person. For purposes of this paragraph, an option to
acquire such an option and each one of a series of option shall be considered as an option
to acquire such stock.
(4) Constructive Ownership as Actual Ownership. — Stock constructively owned by reason of
the application of paragraph (1) or (3) hereof shall, for purposes of applying paragraph
(1) or (2), be treated as actually owned by such person; but stock constructively owned
by the individual by reason of the application of paragraph (2) hereof shall not be treated
as owned by him for purposes of again applying such paragraph in order to make
another the constructive owner of such stock.
Provided, however, that a branch of a foreign corporation is not covered by these Regulations,
the same being a resident foreign corporation.
SECTION 5. Tax Base of Improperly Accumulated Earnings Tax. — For corporations found
subject to the tax, the "Improperly Accumulated Taxable Income" for a particular year is first
determined by adding to that year's taxable income the
following:
(a) income exempt from tax;
(b) income excluded from gross income;
(c) income subject to final tax; and
(d) the amount of net operating loss carry-over (NOLCO) deducted.
The taxable income as thus determined shall be reduced by the sum of:
a. income tax paid/payable for the taxable year;
b. dividends actually or constructively paid/issued from the applicable year's taxable
income;
c. amount reserved for the reasonable needs of the business as defined in these
Regulations emanating from the covered year's taxable income.
The resulting "Improperly Accumulated Taxable Income" is thereby multiplied by 10% to get
the Improperly Accumulated Earnings Tax (IAET).
Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in
later years even if not declared as dividend. Notwithstanding the imposition of the IAET,
profits which have been subjected to IAET, when finally declared as dividends, shall
nevertheless be subject to tax on dividends imposed under the Tax Code of 1997 except in
those instances where the recipient is not subject thereto.
For purposes of determining the source of earnings or profits declared or distributed from
accumulated income for each taxable year, the dividends shall be deemed to have been paid
out of the most recently accumulated profits or surplus and shall constitute a part of the
annual income of the distributee for the year in which received pursuant to Section 73(C) of
the Code. Provided, however, that where the dividends or portion of the said dividends
declared forms part of the accumulated earnings as of December 31, 1997, or emanates from
the accumulated income of a particular year and, therefore, is an exception to the proceeding
statement, such fact must be supported by a duly executed Board Resolution to that effect.
SECTION 6. Period for Payment of Dividend/Payment of IAET. — The dividends must be
declared and paid or issued not later than one year following the close of the taxable year,
otherwise, the IAET, if any, should be paid within fifteen (15) days thereafter.
SECTION 7. Determination of Purpose to Avoid Income Tax. — The fact that a corporation is a
mere holding company or investment company shall be prima facie evidence of a purpose to
avoid the tax upon its shareholders or members. Likewise, the fact that the earnings or profits
of a corporation are permitted to accumulate beyond the reasonable needs of the business
shall be determinative of the purpose to avoid the tax upon its shareholders or members. In
both instances, the corporation may, by clear preponderance of evidence in its favor, prove
the contrary.
For purposes of these Regulations, the term "holding or investment company" shall refer to a
corporation having practically no activities except holding property, and collecting the income
therefrom or investing the same.
The following are prima facie instances of accumulation of profits beyond the reasonable
needs of a business and indicative of purpose to avoid income tax upon shareholders:
(a) Investment of substantial earnings and profits of the corporation in unrelated business
or in stock or securities of unrelated business;
(b) Investment in bonds and other long-term securities;
(c) Accumulation of earnings in excess of 100% of paid-up capital, not otherwise intended
for the reasonable needs of the business as defined in these Regulations.
In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the imposition of the improperly accumulated earnings tax, the
controlling intention of the taxpayer is that which is manifested at the time of accumulation,
not subsequently declared intentions which are merely the product of afterthought. A
speculative and indefinite purpose will not suffice. The mere recognition of a future problem
or the discussion of possible and alternative solutions is not sufficient. Definiteness of plan/s
coupled with action/s taken towards its consummation are essential.
SECTION 8. Transitory Provision. — The IAET shall not apply on improperly accumulated
income as of December 31, 1997 in the case of corporations using the calendar year basis. In
the case of corporations adopting the fiscal year accounting period, the IAET shall not apply
on improperly accumulated taxable income as of the end of the month comprising the twelve-
month period of fiscal year 1997-1998.
Taxable income improperly accumulated, as heretofore discussed, prior to the effectivity of
these regulations if declared as dividend and paid/issued within one month from the
effectivity hereof will not be subjected to the 10% Improperly Accumulated Earnings Tax.
128 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
BIR RUL. 25-02
DOCTRINE:
 The ownership of a domestic corporation for purposes of determining whether it is a
closely held corporation or a publicly held corporation is ultimately traced to the individual
shareholders of the parent company.
 Thus, where at least 50% of the outstanding capital stock or at least 50% of the total
combined voting power of all classes of stock entitled to vote in a corporation is owned
directly or indirectly by at least 21 or more individuals, the corporation is considered
publicly-held corporation as the term is defined under the Regulations.
FACTS:
 Abbott-Phils. is a corporation duly organized and existing under the laws of the
Philippines
 It is engaged in the business of manufacturing, buying, selling, importing, exporting,
dealing of various drugs, pharmaceutical products and supplies as provided in its Articles
of Incorporation
 Abbott-Phils. is a wholly owned subsidiary of Abbott Laboratories (USA)
 Abbott-US is a corporation organized and existing under the laws of the State of Illinois,
USA whose shares are listed and traded in the New York Stock Exchange (NYSE) and six
other stock exchanges;
 As of year-end 2000, Abbott-US had 101,272 shareholders holding a combined
1,545,934,133 shares of common stock
 A duly authenticated Certification of the Vice-President and Treasurer of Abbott-US as of
September 30, 2001 (the most recent date for which the Securities and Exchange
Commission Schedule 13F filings are available) claims that the twenty largest
shareholders of Abbott-US owned an aggregate of 30.1 percent of Abbott-US's issued and
outstanding common shares.
ISSUE/S:
Whether or not Abbott-Phils. is a publicly held corporation and hence, exempt from the
Improperly Accumulated Earnings Tax (IAET)? YES
RULING:
Section 29 of the Tax Code of 1997 provides, viz :
"Sec. 29.Imposition of Improperly Accumulated Earnings Tax. —
(B) Corporations Subject to Improperly Accumulated Earnings Tax. —
(1) In General. — The improperly accumulated earnings tax imposed in the preceding Section
shall apply to every corporation formed or availed for the purpose of avoiding the income tax
with respect to its shareholders or the shareholders of any other corporation, by permitting
earnings and profits to accumulate instead of being divided or distributed.
(2) Exceptions. — The improperly accumulated earnings tax as provided for under this Section
shall not apply to:
(a) Publicly-held corporation;
(b) Banks and other non-bank financial intermediaries; and
(c) Insurance Companies.
Thus, Abbott-Phils. is considered a publicly-held corporation exempt from the Improperly
Accumulated Earnings Tax (IAET), based on the representation that as of the year-end 2000,
Abbott-US had 101,272 shareholders holding a combined 1,545,934,133 shares of common
stock and the twenty largest shareholders of Abbott-US as of September 30, 2001 own an
aggregate of 30.1 percent of Abbott-US' issued and outstanding shares.
XII. TAX-EXEMPT CORPORATIONS
SEC. 30. Exemptions from Tax on Corporations - The following organizations shall not be
taxed under this Title in respect to income received by them as such:
(B) Labor, agricultural or horticultural organization not organized principally for profit;
(C) Mutual savings bank not having a capital stock represented by shares, and cooperative
bank without capital stock organized and operated for mutual purposes and without
profit;
(D) A beneficiary society, order or association, operating fort he exclusive benefit of the
members such as a fraternal organization operating under the lodge system, or mutual
aid association or a nonstock corporation organized by employees providing for the
payment of life, sickness, accident, or other benefits exclusively to the members of such
society, order, or association, or nonstock corporation or their dependents;
(E) Cemetery company owned and operated exclusively for the benefit of its members;
(F) Nonstock corporation or association organized and operated exclusively for religious,
charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans,
no part of its net income or asset shall belong to or inures to the benefit of any member,
organizer, officer or any specific person;
(G) Business league chamber of commerce, or board of trade, not organized for profit and no
part of the net income of which inures to the benefit of any private stock-holder, or
individual;
(H) Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;
(I) A nonstock and nonprofit educational institution;
(J) Government educational institution;
(K) Farmers' or other mutual typhoon or fire insurance company, mutual ditch or irrigation
company, mutual or cooperative telephone company, or like organization of a purely
local character, the income of which consists solely of assessments, dues, and fees
collected from members for the sole purpose of meeting its expenses; and
(L) Farmers', fruit growers', or like association organized and operated as a sales agent for
the purpose of marketing the products of its members and turning back to them the
proceeds of sales, less the necessary selling expenses on the basis of the quantity of
produce finished by them;
Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and
character of the foregoing organizations from any of their properties, real or personal, or from
any of their activities conducted for profit regardless of the disposition made of such income,
shall be subject to tax imposed under this Code.
129 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
CIR v. G. SINCO EDUCATIONAL CORP.
DOCTRINE:
 Whatever payment is made to those who work for a school or college, as remuneration
for their services is not considered as distribution of profit as would make the school one
conducted for profit.
 The amount of fees charged by a school, college or university depends, ultimately, upon
the policy and a given administration, at a particular time. It is not conclusive of the
purposes of the institution. Otherwise, such purpose would vary with the particular
persons in charge of the administration of the organization.
FACTS:
 In June 1949, Vicente G. Sinco established and operated an educational institution known
as Foundation College of Dumaguete.
 Department of Education required that as far as practicable schools and colleges
recognized by the government should be incorporated, and so, the V. G. Sinco Educational
Institution was organized.
 This corporation was non-stock and was capitalized by V. G. Sinco and members of his
immediate family. This corporation continued the operations of Foundation College of
Dumaguete. Since its operation, this college derived, by way of tuition fees, yearly gross
profits
 The investigation conducted by an income tax examiner of the Bureau of Internal
Revenue revealed that the college realized a taxable net income for the year 1949 in the
sum of P3,098.06 and for the year 1950 in the sum of P17,038.59. For the years 1951 to
1953, inclusive, the income tax returns of the college have not as yet been verified but it
reported a taxable net profit of P26,868.60 for the year 1951; a loss of P9,129.80 for the
year 1952 and a profit of P223.56 for the year 1953.
 The Collector of Internal Revenue assessed against the college an income tax for
the years 1950 and 1951 in the aggregate sum of P5,364.77, which was paid by the
college.
 Invoking section 27 (e) of the National Internal Revenue Code, the Appellee claims that it
is exempt from the payment of the income tax because it is organized and maintained
exclusively for the educational purposes and no part of its net income inures to the
benefit of any private individual. On the other hand, the Appellant maintains that part of
the net income accumulated by the Appellee inured to the benefit of V. G. Sinco, president
and founder of the corporation, and therefore the Appellee is not entitled to the
exemption prescribed by the law.
In support of his stand, Appellant invokes the yearly statements of operation or balance sheets
submitted by the corporation. Thus, in the balance sheets for the years 1951, 1952 and 1953,
there appear the following entries:
1951 LIABILITIES
ACCOUNTS PAYABLE:
Community Publishers, Inc. P20,751.95
Vicente G. Sinco, Personal 7,435.83
TOTAL LIABILITIES P28,187.78
1952 LIABILITIES.
ACCOUNTS PAYABLE:
Vicente G. Sinco, Personal
Community Publishers, Inc.
TOTAL LIABILITIES
1953 LIABILITIES
since its organization it has never distributed any dividend or profit to its stockholders.
Of course, part of its income went to the payment of its teachers or professors and to the
12,669.07 other expenses of the college incident to an educational institution but none of the
32,135.50 income has ever been channeled to the benefit of any individual stockholder. The
authorities are clear to the effect that whatever payment is made to those who work for a
P44,804.57 school or college as a remuneration for their services is not considered as distribution of
profit as would make the school one conducted for profit.

ACCOUNTS PAYABLE:  Of course, it is not denied that the Appellee charges tuition fees and other fees for the
different services it renders to the students and in fact it is its only source of income, but
Vicente G. Sinco, Personal such fact does not in itself make the school a profit-making enterprise that would place it
beyond the purview of the law.
Cash Advanced P9,716.36
 At any rate, it has been held by several authorities that the mere provision for the
Accrued Salaries 7,599.71 P17,316.07 distribution of its assets to the stockholders upon dissolution does not remove the right
Community Publishers, Inc. of an educational institution from tax exemption.

Cash Advanced P18,762.68
Printing Account 13,262.72 P32,025.40
TOTAL LIABILITIES P49,341.47
 Considering the above quoted entries, Appellant claims that a great portion of the net
profits realized by the corporation was channeled and redounded to the personal benefit
of V. G. Sinco, who was its founder and president. Another benefit that accrued to Sinco
according to Appellant is represented by the several amounts which appear payable to
the Community Publishers, Inc. because, being the biggest stockholder of this entity, the
money to be paid by the Appellee to that entity as appearing in the above quoted entries
would redound to the personal benefit of Sinco.
ISSUE:
Whether or not Appellee is an educational institution in which part of its income inures to the
benefit of one of its stockholders as maintained by Appellant? NO.
RULING:
 With regard to this accounts, Dean Sinco made the following clarification: He acted as
president of the Foundation College and as chairman of its Board of Directors; in 1949 he
served as its teacher for a time; the accountant of the college suggested that a certain
amount be set aside as his salary for purposes of orderly and practical accounting; but
notwithstanding this suggestion, he never collected his salary for which reason it was
carried in the books as accrued expenses. With regard to the account of the Community
Publishers, Inc., Sinco said that this is a distinct and separate corporation although he is
one of its stockholders. The account represents payment for services rendered by this
entity to the college. These are two different entities and whatever relation there is
between the two is that the former merely extends help to the latter to enable it to
comply with the requirements of the law and to fill its needs for educational purposes.
This clarification made by Sinco stand undisputed.
 Considering this explanation, it is indeed too sweeping if not unfair to conclude that part
of the income of the Appellee as an institution inured to the benefit of one of its
stockholders simply because part of the income was carried in its books as accumulated
salaries of its president and teacher. Much less can it be said that the payments made by
the college to the Community Publishers, Inc. redounded to the personal benefit of Sinco
simply because he is one of its stockholders.
 The fact is that, as it has been established, the Appellee is a non-profit institution and
Regarding the proof of exemption required by section 24, Regulation No. 2, Department of
Finance which, according to the Defendant, is a condition precedent before an educational
institution can avail itself of the exemption under consideration, we understand that it was
probably promulgated for the effective enforcement of the provisions of the Tax Code
pursuant to Section 338 of the National Internal Revenue Code. Intended to relieve the
taxpayer of the duty of filing returns and paying the tax, it cannot be said that the failure to
observe the requirement called for therein constitutes a waiver of the right to enjoy the
exemption. To hold otherwise would be tantamount to incorporating into our tax laws some
legislative matter by administrative regulation.
EXECUTIVE ORDER 226
Article 39. Incentives to Registered Enterprises. All registered enterprises shall be granted
the following incentives to the extent engaged in a preferred area of investment;
(a) Income Tax Holiday.
(1) For six (6) years from commercial operation for pioneer firms and four (4) years for
non-pioneer firms, new registered firms shall be fully exempt from income taxes
levied by the National Government. Subject to such guidelines as may be prescribed
by the Board, the income tax exemption will be extended for another year in each of
the following cases:
i. the project meets the prescribed ratio of capital equipment to number of
workers set by the Board;
ii. utilization of indigenous raw materials at rates set by the Board;
iii. the net foreign exchange savings or earnings amount to at least US$500,000.00
annually during the first three (3) years of operation.
The preceding paragraph notwithstanding, no registered pioneer firm may avail of
this incentive for a period exceeding eight (8) years.
(2) For a period of three (3) years from commercial operation, registered expanding
firms shall be entitled to an exemption from income taxes levied by the National
Government proportionate to their expansion under such terms and conditions as the
Board may determine; Provided, however, That during the period within which this
incentive is availed of by the expanding firm it shall not be entitled to additional
deduction for incremental labor expense.

130 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 (3) The provision of Article 7 (14) notwithstanding, registered firms shall not be entitled
to any extension of this incentive.
(b) Additional Deduction for Labor Expense. For the first five (5) years from registration a
registered enterprise shall be allowed an additional deduction from the taxable income of
fifty percent (50%) of the wages corresponding to the increment in the number of direct
labor for skilled and unskilled workers if the project meets the prescribed ratio of capital
equipment to number of workers set by the Board: Provided, That this additional
deduction shall be doubled if the activity is located in less developed areas as defined in
Art. 40.
(c) Tax and Duty Exemption on Imported Capital Equipment. Within five (5) years from the
effectivity of this Code, importations of machinery and equipment and accompanying
spare parts of new and expanding registered enterprise shall be exempt to the extent of
one hundred percent (100%) of the customs duties and national internal revenue tax
payable thereon: Provided, That the importation of machinery and equipment and
accompanying spare parts shall comply with the following conditions:
(1) They are not manufactured domestically in sufficient quantity, of comparable quality
and at reasonable prices;
(2) They are reasonably needed and will be used exclusively by the registered enterprise
in the manufacture of its products, unless prior approval of the Board is secured for
the part-time utilization of said equipment in a non-registered activity to maximize
usage thereof or the proportionate taxes and duties are paid on the specific
equipment and machinery being permanently used for non-registered activities; and
(3) The approval of the Board was obtained by the registered enterprise for the
importation of such machinery, equipment and spare parts.
In granting the approval of the importations under this paragraph, the Board may
require international canvassing but if the total cost of the capital equipment or
industrial plant exceeds US$5,000,000, the Board shall apply or adopt the provisions of
Presidential Decree Numbered 1764 on International Competitive Bidding.
If the registered enterprise sells, transfers or disposes of these machinery, equipment
and spare parts without prior approval of the Board within five (5) years from date of
acquisition, the registered enterprise and the vendee, transferee, or assignee shall be
solidarily liable to pay twice the amount of the tax exemption given it.
The Board shall allow and approve the sale, transfer or disposition of the said items
within the said period of five (5) years if made:
(aa) to another registered enterprise or registered domestic producer enjoying similar
incentives;
(bb) for reasons of proven technical obsolescence; or
(cc) for purposes of replacement to improve and/or expand the operations of the
registered enterprise.
(d) Tax Credit on Domestic Capital Equipment. A tax credit equivalent to one hundred
percent (100%) of the value of the national internal revenue taxes and customs duties
that would have been waived on the machinery, equipment and spare parts, had these
items been imported shall be given to the new and expanding registered enterprise
which purchases machinery, equipment and spare parts from a domestic manufacturer:
Provided, That (1) That the said equipment, machinery and spare parts are reasonably
needed and will be used exclusively by the registered enterprise in the manufacture of its
131 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
products, unless prior approval of the Board is secured for the part-time utilization of
said equipment in a non-registered activity to maximize usage thereof; (2) that the
equipment would have qualified for tax and duty-free importation under paragraph (c)
hereof; (3) that the approval of the Board was obtained by the registered enterprise; and
(4) that the purchase is made within five (5) years from the date of effectivity of the Code.
If the registered enterprise sells, transfers or disposes of these machinery, equipment
and spare parts, the provisions in the preceding paragraph for such disposition shall
apply.
(e) Exemption from Contractor's Tax. The registered enterprise shall be exempt from the
payment of contractor's tax, whether national or local.
(f) Simplification of Customs Procedure. Customs procedures for the importation of
equipment, spare parts, raw materials and supplies, and exports of processed products
by registered enterprises shall be simplied by the Bureau of Customs.
(g) Unrestricted Use of Consigned Equipment. Provisions of existing laws notwithstanding,
machinery, equipment and spare part consigned to any registered enterprises shall not
be subject to restrictions as to period of use of such machinery, equipment and spare
parts Provided, that the appropriate re-export bond is posted unless the importation is
otherwise covered under subsections (c) and (m) of this Article. Provided, further, that
such consigned equipment shall be for the exclusive use of the registered enterprise.
If such equipment is sold, transferred or otherwise disposed of by the registered
enterprise the related provision of Article 39 (c) (3) shall apply. Outward remittance of
foreign exchange covering the proceeds of such sale, transfer or disposition shall be
allowed only upon prior Central Bank approval.
(h) Employment of Foreign Nationals. Subject to the provisions of Section 29 of
Commonwealth Act Number 613, as amended, a registered enterprise may employ
foreign nationals in supervisory, technical or advisory positions for a period not
exceeding five (5) years from its registration, extendible for limited periods at the
discretion of the Board: Provided, however, That when the majority of the capital stock of
a registered enterprise is owned by foreign investors, the position of president, treasurer
and general manager or their equivalents may be retained by foreign nationals beyond
the period set forth herein.
Foreign nationals under employment contract within the purview of this incentive, their
spouses and unmarried children under twenty-one (21) years of age, who are not
excluded by Section 29 of Commonwealth Act Numbered 613, as amended, shall be
permitted to enter and reside in the Philippines during the period of employment of such
foreign nationals.
A registered enterprise shall train Filipinos as understudies of foreign nationals in
administrative, supervisory and technical skills and shall submit annual reports on such
training to the Board.
(i) Exemption on Breeding Stocks and Genetic Materials. The importation of breeding stocks
and genetic materials within ten (10) years from the date of registration or commercial
operation of the enterprise shall be exempt from all taxes and duties: Provided, That such
breeding stocks and genetic materials are (1) not locally available and/or obtainable
locally in comparable quality and at reasonable prices; (2) reasonably needed in the
registered activity; and (3) approved by the Board.
(j) Tax Credit on Domestic Breeding Stocks and Genetic Materials. A tax credit equivalent to
one hundred percent (100%) of the value of national internal revenue taxes and customs
duties that would have been waived on the breeding stocks and genetic materials had
 these items been imported shall be given to the registered enterprise which purchases
breeding stocks and generic materials from a domestic producer: Provided, 1) That said
breeding stocks and generic materials would have qualified for tax and duty free
importation under the preceding paragraph; 2) that the breeding stocks and genetic
materials are reasonably needed in the registered activity; 3) that the approval of the
board has been obtained by the registered enterprise; and 4) that the purchase is made
within ten (10) years from date of registration or commercial operation of the registered
enterprise.
(k) Tax Credit for Taxes and Duties on Raw Materials. Every registered enterprise shall enjoy
a tax credit equivalent to the National Internal Revenue taxes and Customs duties paid on
the supplies, raw materials and semi-manufactured products used in the manufacture,
processing or production of its export products and forming part thereof, exported
directly or indirectly by the registered enterprise: Provided, however, that the taxes on
the supplies, raw materials and semi- manufactured products domestically purchased
are indicated as a separate item in the sales invoice.
Nothing herein shall be construed as to preclude the Board from setting a fixed
percentage of export sales as the approximate tax credit for taxes and duties of raw
materials based on an average or standard usage for such materials in the industry.
(l) Access to Bonded Manufacturing/Trading Warehouse System. Registered export
oriented enterprises shall have access to the utilization of the bonded warehousing
system in all areas required by the project subject to such guidelines as may be issued by
the Board upon prior consultation with the Bureau of Customs.
(m) Exemption from Taxes and Duties on Imported Spare Parts. Importation of required
supplies and spare parts for consigned equipment or those imported tax and duty free by
a registered enterprise with a bonded manufacturing warehouse shall be exempt from
customs duties and national internal revenue taxes payable thereon, Provided, However,
That at least seventy percent (70%) of production is exported; Provided, further, that
such spare parts and supplies are not locally available at reasonable prices, sufficient
quantity and comparable quality; Provided, finally, That all such spare parts and supplies
shall be used only in the bonded manufacturing warehouse of the registered enterprise
under such requirements as the Bureau of Customs may impose.
(n) Exemption from Wharfage Dues and any Export Tax, Duty, Impost and Fee. The
provisions of law to the contrary notwithstanding, exports by a registered enterprise of
its non- traditional export products shall be exempted of its non-traditional export
products shall be exempted from any wharfage dues, and any export tax, duty, impost
and fee.
REPUBLIC ACT 7916
SECTION 23. Fiscal Incentives. — Business establishments operating within the ECOZONES
shall be entitled to the fiscal incentives as provided for under Presidential Decree No. 66, the
law creating the Export Processing Zone Authority, or those provided under Book VI of
Executive Order No. 226, otherwise known as the Omnibus Investment Code of 1987.
Furthermore, tax credits for exporters using local materials as inputs shall enjoy the same
benefits provided for in the Export Development Act of 1994.
SECTION 24. Exemption from Taxes Under the National Internal Revenue Code. — Any
provision of existing laws, rules and regulations to the contrary notwithstanding, no taxes,
local and national, shall be imposed on business establishments operating within the
ECOZONE. In lieu of paying taxes, five percent (5%) of the gross income earned by all
132 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
businesses and enterprises within the ECOZONE shall be remitted to the national
government. This five percent (5%) shall be shared and distributed as follows:
(a) Three percent (3%) to the national government;
(b) One percent (1%) to the local government units affected by the declaration of the
ECOZONE in proportion to their population, land area, and equal sharing factors; and
(c) One percent (1%) for the establishment of a development fund to be utilized for the
development of municipalities outside and contiguous to each ECOZONE: Provided,
however, That the respective share of the affected local government units shall be
determined on the basis of the following formula:
(1) Population — fifty percent (50%);
(2) Land area — twenty-five percent (25%); and
(3) Equal sharing — twenty-five percent (25%).
SECTION 25. Applicable National Taxes. — All income derived by persons and all service
establishments in the ECOZONE shall be subject to taxes under the National Internal Revenue
Code.
CIR v. CA, CTA AND YOUNG MEN’S CHRISTIAN ASSOC. OF THE PHIL., INC.
DOCTRINE:
The tax exemption on certain organizations covers only income received by them “as such”
and does not include: a) income derived from real or personal properties; and b) income
derived from activities conducted for profit.
FACTS:
YMCA (Young Men's Christian Association of the Philippines, Inc.) is a non-stock, non-profit
institution, which conducts various programs and activities that are beneficial to the public,
especially the young people, pursuant to its religious, educational and charitable objectives.
In 1980, YMCA earned, among others, an income of P677k from leasing out a portion of its
premises to small shop owners, like restaurants and canteen operators, and P44k from
parking fees collected from non-members.
CIR assessed YMCA deficiency income tax and deficiency withholding taxes based on Section
27 (now Section 30) of the NIRC.
"SEC. 27. Exemptions from tax on corporations. — The following organizations shall not be
taxed under this Title in respect to income received by them as such —
(g) Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;
(h) Club organized and operated exclusively for pleasure, recreation, and other non-
profitable purposes, no part of the net income of which inures to the benefit of any private
stockholder or member;
Notwithstanding the provisions in the preceding paragraphs, the income of whatever
kind and character of the foregoing organizations from any of their properties, real
or personal, or from any of their activities conducted for profit, regardless of the
disposition made of such income, shall be subject to the tax imposed under this Code.
YMCA argues that the rentals and parking fees were just enough to cover the costs of
operation and maintenance, and that the last paragraph of Section 27 should be subject to the
qualification that the income from the properties must arise from activities 'conducted for
profit' before it may be considered taxable.
ISSUE: W/N the rental income of YMCA from real estate is subject to income tax? YES>
RULING:
Because taxes are the lifeblood of the nation, the Court has always applied the doctrine of
strict interpretation in construing tax exemptions.
In the instant case, the exemption claimed by the YMCA is expressly disallowed by the very
wording of the last paragraph of then Section 27 of the NIRC which mandates that the income
of exempt organizations (such as the YMCA) from any of their properties, real or personal, be
subject to the tax imposed by the same Code.
The phrase "any of their activities conducted for profit" does not qualify the word
"properties." This makes income from the property of the organization taxable, regardless of
how that income is used — whether for profit or for lofty non-profit purposes.
Constitutional Provisions on Taxation invoked by YMCA:
Article VI, Section 28 of par. 3: Charitable institutions, churches and parsonages or convents
appurtenant thereto, mosques, non-profit cemeteries, and all lands, buildings, and
improvements, actually, directly, and exclusively used for religious, charitable, or educational
purposes shall be exempt from taxation.
YMCA claims that the exemption includes payment of income tax, but the Supreme Court held
that it only pertains to property tax as supported by the debates, interpellations and
expressions of opinion of the framers of the Constitution.
Article XIV, Section 4, par. 3: All revenues and assets of non-stock, non-profit educational
institutions used actually, directly, and exclusively for educational purposes shall be exempt from
taxes and duties. xxx
The Court ruled that YMCA does not qualify as an educational institution under the above
provision. The term "educational institution " or "institution of learning" has acquired a well-
known technical meaning, of which the members of the Constitutional Commission are
deemed cognizant. Under the Education Act of 1982, such term refers to schools. The school
system is synonymous with formal education, which "refers to the hierarchically structured
and chronologically graded learnings organized and provided by the formal school system and
for which certification is required in order for the learner to progress through the grades or
move to the higher levels." The Court has examined the Amended Articles of
Incorporation"and By-Laws of the YMCA, but found nothing in them that even hints that it is a
school or an educational institution.
CIR v. ST. LUKE'S MEDICAL CENTER, INC.
FACTS:
St. Luke's is a hospital organized as a non-stock and non-profit corporation. BIR assessed St.
Luke's deficiency taxes of P76,063,116.06 for 1998, comprised of deficiency income tax, value-
added tax, withholding tax on compensation and expanded withholding tax. The BIR reduced
the amount to P63,935,351.57. St. Luke's filed an administrative protest with the BIR against
the deficiency tax assessments. The BIR did not act on the protest within the 180-day period
under Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.
The BIR argued that Section 27(B) of the NIRC, which imposes a 10% preferential tax rate on
the income of proprietary non-profit hospitals, should be applicable to St. Luke's. According to
the BIR, Section 27(B) is a specific provision which prevails over the general exemption on
133 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
income tax granted under Section 30(E) and (G) for non-stock, non-profit charitable
institutions and civic organizations promoting social welfare.
The BIR claimed that St. Luke's was actually operating for profit in 1998 because only 13% of
its revenues came from charitable purposes. Moreover, the hospital's board of trustees,
officers and employees directly benefit from its profits and assets. St. Luke's had total
revenues of approximately P1.73 billion from patient services in 1998. St. Luke's contended
that the BIR should not consider its total revenues, because its free services to patients was
P218,187,498 or 65.20% of its 1998 operating income (i.e., total revenues less operating
expenses) of P334,642,615. St. Luke's also claimed that its income does not inure to the
benefit of any individual. St. Luke's maintained that it is a non-stock and non-profit institution
for charitable and social welfare purposes under Section 30(E) and (G) of the NIRC. It argued
that the making of profit per se does not destroy its income tax exemption.
The CTA En Banc ordered St. Luke’s to pay deficiency income tax and deficiency expanded
withholding tax for the taxable year 1998 of P6,275,370.38 for failure of St. Luke’s to prove
that part of its income in 1998 (declared as "Other Income-Net") came from charitable
activities. The CTA cancelled the remainder of the P63,113,952.79 deficiency assessed by the
BIR based on the 10% tax rate under Section 27(B) of the NIRC, which the CTA En Banc held
was not applicable to St. Luke's. The CTA ruled that St. Luke's is a non-stock and non-profit
charitable institution covered by Section 30(E) and (G) of the NIRC. This ruling would exempt
all income derived by St. Luke's from services to its patients, whether paying or non-paying.
The generation of income from paying patients does not per se destroy the charitable nature
of St. Luke's.
ISSUE: Whether St. Luke's is liable for deficiency income tax in 1998 under Section 27(B) of
the NIRC, which imposes a preferential tax rate of 10% on the income of proprietary non-
profit hospitals?
RULING:
The effect of Section 27(B) is to subject the taxable income of two specific institutions, namely,
proprietary non-profit educational institutions and proprietary non-profit hospitals, among
the institutions covered by Section 30, to the 10% preferential rate instead of the ordinary
30% corporate rate. A "proprietary educational institution" is "any private school maintained
and administered by private individuals or groups" with a government permit. "Non-profit"
means no net income or asset accrues to or benefits any member or specific person, with all
the net income or asset devoted to the institution's purposes and all its activities conducted
not for profit.
"Non-profit" does not necessarily mean "charitable." To be a charitable institution, it must
provide for free goods and services to the public which would otherwise fall on the shoulders
of government. Charitable institutions, however, are not ipso facto entitled to a tax exemption.
As a general principle, a charitable institution does not lose its character as such and its
exemption from taxes simply because it derives income from paying patients, whether out-
patient, or confined in the hospital, or receives subsidies from the government, so long as the
money received is devoted or used altogether to the charitable object which it is intended to
achieve; and no money inures to the private benefit of the persons managing or operating the
institution.
Section 30(E) of the NIRC provides that a charitable institution must be:
(1) A non-stock corporation or association;
(2) Organized exclusively for charitable purposes;
(3) Operated exclusively for charitable purposes; and
(4) No part of its net income or asset shall belong to or inure to the benefit of any member,
organizer, officer or any specific person.
There is no dispute that St. Luke's is organized as a non-stock and non-profit charitable
institution. However, this does not automatically exempt St. Luke's from paying taxes. Even if
St. Luke's meets the test of charity, a charitable institution is not ipso facto tax exempt. To be
exempt from real property taxes, Section 28(3), Article VI of the Constitution requires that a
charitable institution use the property "actually, directly and exclusively" for charitable
purposes. To be exempt from income taxes, Section 30(E) of the NIRC requires that a
charitable institution must be "organized and operated exclusively" for charitable purposes.
Likewise, to be exempt from income taxes, Section 30(G) of the NIRC requires that the
institution be "operated exclusively" for social welfare.
It cannot be disputed that a hospital which receives approximately P1.73 billion from paying
patients is not an institution "operated exclusively" for charitable purposes. Clearly, revenues
from paying patients are income received from "activities conducted for profit." St. Luke's
admits that it derived profits from its paying patients. St. Luke's declared P1,730,367,965 as
"Revenues from Services to Patients" in contrast to its "Free Services" expenditure of
P218,187,498. St. Luke's claims that its charity expenditure of P218,187,498 is 65.20% of its
operating income in 1998. However, if a part of the remaining 34.80% of the operating income
is reinvested in property, equipment or facilities used for services to paying and non-paying
patients, then it cannot be said that the income is "devoted or used altogether to the charitable
object which it is intended to achieve." The income is plowed back to the corporation not
entirely for charitable purposes, but for profit as well. In any case, the last paragraph of
Section 30 of the NIRC expressly qualifies that income from activities for profit is taxable
"regardless of the disposition made of such income."
A tax exemption is effectively a social subsidy granted by the State because an exempt
institution is spared from sharing in the expenses of government and yet benefits from them.
Tax exemptions for charitable institutions should therefore be limited to institutions
beneficial to the public and those which improve social welfare. A profit-making entity should
not be allowed to exploit this subsidy to the detriment of the government and other taxpayers.
St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to be
completely tax exempt from all its income. However, it remains a proprietary non-profit
hospital under Section 27(B) of the NIRC as long as it does not distribute any of its profits to
its members and such profits are reinvested pursuant to its corporate purposes. St. Luke's, as
a proprietary non-profit hospital, is entitled to the preferential tax rate of 10% on its net
income from its for-profit activities. St. Luke's is therefore liable for deficiency income tax in
1998 under Section 27(B) of the NIRC. However, St. Luke's has good reasons to rely on the
letter dated 6 June 1990 by the BIR, which opined that St. Luke's is "a corporation for purely
charitable and social welfare purposes" and thus exempt from income tax. Good faith and
honest belief that one is not subject to tax on the basis of previous interpretation of
government agencies tasked to implement the tax law, are sufficient justification to delete the
imposition of surcharges and interest.
XIII. FRINGE BENEFITS TAX (FBT)
SEC. 33. Special Treatment of Fringe Benefit. -
(A) Imposition of Tax.- A final tax of thirty-four percent (34%) effective January 1, 1998;
thirty-three percent (33%) effective January 1, 1999; and thirty-two percent (32%)
effective January 1, 2000 and thereafter, is hereby imposed on the grossed-up monetary
value of fringe benefit furnished or granted to the employee (except rank and file
employees as defined herein) 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 employer, or when the fringe benefit is for the convenience or
advantage of the employer). The tax herein imposed is payable by the employer which
134 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
tax shall be paid in the same manner as provided for under Section 57 (A) of this Code.
The grossed-up monetary value of the fringe benefit shall be determined by dividing the
actual monetary value of the fringe benefit by sixty-six percent (66%) effective January 1,
1998; sixty-seven percent (67%) effective January 1, 1999; and sixty-eight percent (68%)
effective January 1, 2000 and thereafter: Provided, however, That fringe benefit furnished
to employees and taxable under Subsections (B), (C), (D) and (E) of Section 25 shall be
taxed at the applicable rates imposed thereat: Provided, further, That the grossed-up
monetary value of the fringe benefit shall be determined by dividing the actual monetary
value of the fringe benefit by the difference between one hundred percent (100%) and
the applicable rates of income tax under Subsections (B), (C), (D), and (E) of Section 25.
(B) Fringe Benefit defined. - For purposes of this Section, the term "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 as defined herein) such as, but
not limited to, the following:
(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;
(9) Educational assistance to the employee or his dependents; and
(10) Life or health insurance and other non-life insurance premiums or similar amounts
in excess of what the law allows.
(C) Fringe Benefits Not Taxable. - The following fringe benefits are not taxable under this
Section:
(1) fringe benefits which are authorized and exempted from tax under special laws;
(2) Contributions of the employer for the benefit of the employee to retirement,
insurance and hospitalization benefit plans;
(3) Benefits given to the rank and file employees, whether granted under a collective
bargaining agreement or not; and
(4) De minimis benefits as defined in the rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the Commissioner.
The Secretary of Finance is hereby authorized to promulgate, upon recommendation of the
Commissioner, such rules and regulations as are necessary to carry out efficiently and fairly
the provisions of this Section, taking into account the peculiar nature and special need of the
trade, business or profession of the employer.
REV. REGS. 3-98
SEC. 2.33. SPECIAL TREATMENT OF FRINGE BENEFITS
(A) Imposition of Fringe Benefits Tax — A final withholding tax is hereby imposed on the
grossed-up monetary value of fringe benefit furnished, granted or paid by the employer to the
employee, except rank and file employees as defined in these Regulations, whether such
employer is an individual, professional partnership or a corporation, regardless of whether
the corporation is taxable or not, or the government and its instrumentalities except when: (1)
the fringe benefit is required by the nature of or necessary to the trade, business or profession
of the employer; or (2) when the fringe benefit is for the convenience or advantage of the
employer. The fringe benefit tax shall be imposed at the following rates:
Effective January 1, 1998 - 34%
Effective January 1, 1999 - 33%
Effective January 1, 2000 - 32%
The tax imposed under Sec. 33 of the Code shall be treated as a final income tax on the
employee which shall be withheld and paid by the employer on a calendar quarterly basis as
provided under Sec. 57 (A) (Withholding of Final Tax on certain Incomes) and Sec. 58 A
(Quarterly Returns and Payments of Taxes Withheld) of the Code.
The grossed-up monetary value of the fringe benefit shall be determined by dividing the
monetary value of the fringe benefit by the following percentages and in accordance with the
following schedule:
Effective January 1, 1998 - 66%
Effective January 1, 1999 - 67%
Effective January 1, 2000 - 68%
The grossed-up monetary value of the fringe benefit represents the whole amount of income
realized by the employee which includes the net amount of money or net monetary value of
property which has been received plus the amount of fringe benefit tax thereon otherwise due
from the employee but paid by the employer for and in behalf of his employee, pursuant to the
provisions of this Section.
Coverage — These Regulations shall cover only those fringe benefits given or furnished to
managerial or supervisory employees and not to the rank and file.
The term, "RANK AND FILE EMPLOYEES" means all employees who are holding neither
managerial nor supervisory position. The Labor Code of the Philippines, as amended, defines
"managerial employee" as one who is vested with powers or prerogatives to lay down and
execute management policies and/or to hire, transfer, suspend, lay-off, recall, discharge,
assign or discipline employees. "Supervisory employees" are those who, in the interest of the
employer, effectively recommend such managerial actions if the exercise of such authority is
not merely routinary or clerical in nature but requires the use of independent judgment.
Moreover, these regulations do not cover those benefits properly forming part of
compensation income subject to withholding tax on compensation in accordance with
Revenue Regulations No. 2-98. Fringe benefits which have been paid prior to January 1, 1998
shall not be covered by these Regulations.
Determination of the Amount Subject to the Fringe Benefit Tax — In general, the computation
of the fringe benefits tax would entail (a) valuation of the benefit granted and (b)
determination of the proportion or percentage of the benefit which is subject to the fringe
benefit tax. That the Tax Code allows for the cases where only a portion (i.e. less than 100 per
cent) of the fringe benefit is subject to the fringe benefit tax is clearly stated in Section 33 (a)
of R.A. 8424 which stipulates that fringe benefits which are "required by the nature of, or
necessary to the trade, business or profession of the employer, or when the fringe benefit is
for the convenience or advantage of the employer" are not subject to the fringe benefit tax.
Thus, in cases where the fringe benefits entail joint benefits to the employer and employee,
the portion which shall be subject to the fringe benefits tax and the guidelines for the
valuation of fringe benefits are defined under these rules and regulations.
Unless otherwise provided in these regulations, the valuation of fringe benefits shall be as
follows:
135 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(1) If the fringe benefit is granted in money, or is directly paid for by the employer, then the
value is the amount granted or paid for.
(2) If the fringe benefit is granted or furnished by the employer in property other than money
and ownership is transferred to the employee, then the value of the fringe benefit shall be
equal to the fair market value of the property as determined in accordance with Sec. 6 (E) of
the Code (Authority of the Commissioner to Prescribe Real Property Values).
(3) If the fringe benefit is granted or furnished by the employer in property other than money
but ownership is not transferred to the employee, the value of the fringe benefit is equal to the
depreciation value of the property.
Taxation of fringe benefit received by a non-resident alien individual who is not engaged in trade
or business in the Philippines — A fringe benefit tax of twenty-five percent (25%) shall be
imposed on the grossed-up monetary value of the fringe benefit. The said tax base shall be
computed by dividing the monetary value of the fringe benefit by seventy-five per cent (75%).
Taxation of fringe benefit received by (1) an alien individual employed by regional or area
headquarters of a multinational company or by regional operating headquarters of a
multinational company; (2) an alien individual employed by an offshore banking unit of a
foreign bank established in the Philippines; (3) an alien individual employed by a foreign service
contractor or by a foreign service subcontractor engaged in petroleum operations in the
Philippines; and (4) any of their Filipino individual employees who are employed and occupying
the same position as those occupied or held by the alien employees. — A fringe benefit tax of
fifteen per cent (15%) shall be imposed on the grossed-up monetary value of the fringe
benefit. The said tax base shall be computed by dividing the monetary value of the fringe
benefit by eighty-five per cent (85%).
Taxation of fringe benefit received by employees in special economic zones — Fringe benefits
received by employees in special economic zones, including Clark Special Economic Zone and
Subic Special Economic and Free Trade Zone, are also covered by these regulations and
subject to the normal rate of fringe benefit tax or the special rates of 25% or 15% as provided
above.
(B) Definition of Fringe Benefit — In general, except as otherwise provided under these
regulations, for purposes of this Section, the term "FRINGE BENEFIT" means any good,
service, or other benefit furnished or granted by an employer in cash or in kind, in addition to
basic salaries, to an individual employee (except rank and file employee as defined in these
regulations) such as, but not limited to the following:
For this purpose, the guidelines for valuation of specific types of fringe benefits and the
determination of the monetary value of the fringe benefits are given below. The taxable value
shall be the grossed-up monetary value of the fringe benefit.
(1) Housing privilege —
a) If the employer leases a residential property for the use of his employee and the said
property is the usual place of residence of the employee, the value of the benefit
shall be the amount of rental paid thereon by the employer, as evidenced by the
lease contract. The monetary value of the fringe benefit shall be fifty per cent (50%)
of the value of the benefit.
b) If the employer owns a residential property and the same is assigned for the use of
his employee as his usual place of residence, the annual value of the benefit shall be
five percent (5%) of the market value of the land and improvement, as declared in
the Real Property Tax Declaration Form, or zonal value as determined by the
Commissioner pursuant to Section 6(E) of the Code (Authority of the Commissioner
 to Prescribe Real Property Values), whichever is higher. The monetary value of the
fringe benefit shall be fifty percent (50%) of the value of the benefit.
The monetary value of the housing fringe benefit is equivalent to the following:
MV = [5%(FMV or ZONAL VALUE] X 50%
WHERE:
MV = MONETARY VALUE
FMV = FAIR MARKET VALUE
c) If the employer purchases a residential property on installment basis and allows his
employee to use the same as his usual place of residence, the annual value of the
benefit shall be five per cent (5%) of the acquisition cost, exclusive of interest. The
monetary value of fringe benefit shall be fifty per cent (50%) of the value of the
benefit.
d) If the employer purchases a residential property and transfers ownership thereof in
the name of the employee, the value of the benefit shall be the employer's
acquisition cost or zonal value as determined by the Commissioner pursuant to
Section 6(E) of the Code (Authority of the Commissioner to Prescribe Real Property
Values), whichever is higher. The monetary value of the fringe benefit shall be the
entire value of the benefit.
e) If the employer purchases a residential property and transfers ownership thereof to
his employee for the latter's residential use, at a price less than the employer's
acquisition cost, the value of the benefit shall be the difference between the fair
market value, as declared in the Real Property Tax Declaration Form, or zonal value
as determined by the Commissioner pursuant to Sec. 6(E) of the Code (Authority of
the Commissioner to Prescribe Real Property Values), whichever is higher, and the
cost to the employee. The monetary value of the fringe benefit shall be the entire
value of the benefit.
f) 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 be readily on call to
meet the exigencies of their military service.
g) 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
maximum of fifty (50) meters from the perimeter of the business premises.
h) Temporary housing for an employee who stays in a housing unit for three (3)
months or less shall not be considered a taxable fringe benefit.
(2) Expense account —
(a) 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
the nature of a personal expense attributable to the employee.
(b) 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
136 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the name of the employer and the expenditures do not partake the nature of a
personal expense attributable to the said employee.
(c) 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.
(d) Representation and transportation allowances which are fixed in amounts and are
regular received by the employees as part of their monthly compensation income
shall not be treated as taxable fringe benefits but the same shall beconsidered as
taxable compensation income subject to the tax imposed under Sec. 24 of the Code.
(3) Motor vehicle of any kind —
(a) If the employer purchases the motor vehicle in the name of the employee, the value
of the benefit is the acquisition cost thereof. The monetary value of the fringe benefit
shall be the entire value of the benefit, regardless of whether the motor vehicle is
used by the employee partly for his personal purpose and partly for the benefit of
his employer.
(b) If the employer provides the employee with cash for the purchase of a motor
vehicle, the ownership of which is placed in the name of the employee, the value of
the benefits shall be the amount of cash received by the employee. The monetary
value of the fringe benefit shall be the entire value of the benefit regardless of
whether the motor vehicle is used by the employee partly for his personal purpose
and partly for the benefit of his employer, unless the same was subjected to a
withholding tax as compensation income under Revenue Regulations No. 2-98.
(c) If the employer purchases the car on installment basis, the ownership of which is
placed in the name of the employee, the value of the benefit shall be the acquisition
cost exclusive of interest, divided by five (5) years. The monetary value of the fringe
benefit shall be the entire value of the benefit regardless of whether the motor
vehicle is used by the employee partly for his personal purpose and partly for the
benefit of his employer.
(d) If the employer shoulders a portion of the amount of the purchase price of a motor
vehicle the ownership of which is placed in the name of the employee, the value of
the benefit shall be the amount shouldered by the employer. The monetary value of
the fringe benefit shall be the entire value of the benefit regardless of whether the
motor vehicle is used by the employee partly for his personal purpose and partly for
the benefit of his employer.
(e) If the employer owns and maintains a fleet of motor vehicles for the use of the
business and the employees, the value of the benefit shall be the acquisition cost of
all the motor vehicles not normally used for sales, freight, delivery service and other
non-personal used divided by five (5) years. The monetary value of the fringe
benefit shall be fifty percent (50%) of the value of the benefit.
The monetary value of the motor vehicle fringe benefit is equivalent to the
following:
MV = [(A)/5] X 50%
where:
MV = Monetary value
 A = acquisition cost
(f) If the employer leases and maintains a fleet of motor vehicles for the use of the
business and the employees, the value of the benefit shall be the amount of rental
payments for motor vehicles not normally used for sales, freight, delivery, service
and other non-personal use. The monetary value of the fringe benefit shall be fifty
per cent (50%) of the value of the benefit.
(g) 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.
(h) 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.
(4) Household expenses — 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.
(5) Interest on loan at less than market rate
(a) 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 by the employee and the rate of twelve per cent (12%) shall be
treated as a taxable fringe benefit.
(b) The benchmark interest rate of twelve per cent (12%) shall remain in effect until
revised by a subsequent regulation.
(c) This regulation shall apply to installment payments or loans with interest rate lower
than twelve per cent (12%) starting January 1, 1998.
(6) Membership fees, dues, and other expenses borne by the employer for his employee, in social
and athletic clubs or other similar organizations. — These expenditures shall be treated as
taxable fringe benefits of the employee in full.
(7) Expenses for foreign travel —
(a) 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.
(b) 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.
137 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
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.
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.
(8) Holiday and vacation expenses — Holiday and vacation expenses of the employee borne
by his employer shall be treated as taxable fringe benefits.
(9) Educational assistance to the employee or his dependents —
(a) The cost of the educational assistance to the employee which are borne by the
employer shall, in general, be treated as taxable fringe benefit. However, 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 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.
(b) 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 unless the
assistance was provided through a competitive scheme under the scholarship
program of the company.
(10) Life or health insurance and other non-life insurance premiums or similar amounts in
excess of what the law allows — 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 System (SSS), (R.A. No. 8282, as amended) or under the Government Service
Insurance System (GSIS) (R.A. 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.
(C) Fringe Benefits Not Subject to Fringe Benefits Tax — In general, the fringe benefits tax shall
not be imposed on the following fringe benefits:
(1) Fringe benefits which are authorized and exempted from income tax under the Code or
under any special law;
(2) Contributions of the employer for the benefit of the employee to retirement, insurance
and hospitalization benefit plans;
(3) Benefits given to the rank and file, whether granted under a collective bargaining
agreement or not;
(4) De minimis benefits as defined in these Regulations;
(5) If the grant of fringe benefits to the employee is required by the nature of, or necessary to
the trade, business or profession of the employer; or
(6) If the grant of the fringe benefit is for the convenience of the employer.
The exemption of any fringe benefit from the fringe benefit tax imposed under this Section
shall not be interpreted to mean exemption from any other income tax imposed under the
Code except if the same is likewise expressly exempt from any other income tax imposed
under the Code or under any other existing law. Thus, if the fringe benefit is exempted from
the fringe benefits tax, the same may, however, still form part of the employee's gross
compensation income which is subject to income tax, hence, likewise subject to a withholding
tax on compensation income payment.
The term "DE MINIMIS" benefits which are exempt from the fringe benefit 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 employees not exceeding ten (10) days
during the year;
(2) Medical cash allowance to dependents of employees not exceeding P750 per semester or
P125 per month;
(3) Rice subsidy of P350 per month granted by an employer to his employees;
(4) Uniforms given to employees by the employer;
(5) Medical benefits given to the employees by the employer;
(6) Laundry allowance of P150 per month;
(7) Employee 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 one-half (½) month of the basic salary of
the employee receiving the award under an established written plan which does not
discriminate in favor of highly paid employees;
(8) Christmas and major anniversary celebrations for employees and their guests;
(9) Company picnics and sports tournaments in the Philippines and are participated
exclusively by employees; and
(10) Flowers, fruits, books or similar items given to employees under special circumstances,
e.g. on account of illness, marriage, birth of a baby, etc..
(D) Tax Accounting for the Fringe Benefit Furnished to the Employee and the Fringe Benefit Tax
Due Thereon. — As a general rule, the amount of taxable fringe benefit and the fringe benefits
tax shall constitute allowable deductions from gross income of the employer. However, if the
basis for computation of the fringe benefits tax is the depreciation value, the zonal value as
determined by the Commissioner pursuant to Section 6(E) of the Code or the fair market value
as determined in the current real property tax declaration of a certain property, only the
actual fringe benefits tax paid shall constitute a deductible expense for the employer. The
value of the fringe benefit shall not be deductible and shall be presumed to have been tacked
on or actually claimed as depreciation expense by the employer. Provided, however, that if the
aforesaid zonal value or fair market value of the said property is greater than its cost subject
to depreciation, the excess amount shall be allowed as a deduction from the employer's gross
income as fringe benefit expense.
REV. REGS. 8-00
SECTION 2. Amendments. — Sec. 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), (B)(11)(b) and(B)(13) of
Revenue Regulations No. 2-98 are hereby amended to read as follows:
"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —
"(1) Compensation paid in kind. — . . .
''Where compensation is paid in property other than money, the employer shall make necessary
arrangements to ensure that the amount of the tax required to be withheld is available for
payment to the Commissioner.
"(3) Facilities and privileges of relatively small value. — Ordinarily, facilities and privileges
(such as entertainment, medical services, or so-called "courtesy discounts" on purchases),
138 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
otherwise known as "de minimis benefits," furnished or offered by an employer to his
employees, are not considered as compensation subject to INCOME TAX AND CONSEQUENTLY
TO withholding tax, if such facilities are offered or furnished by the employer merely as means
of promoting the health, goodwill, contentment, or efficiency of his employees.
"THE FOLLOWING SHALL BE CONSIDERED AS "DE MINIMIS" BENEFITS NOT SUBJECT TO
WITHHOLDING TAX ON COMPENSATION INCOME OF BOTH MANAGERIAL AND RANK AND FILE
EMPLOYEES:
(a) MONETIZED UNUSED VACATION LEAVE CREDITS OF EMPLOYEES NOT EXCEEDING TEN
(10) DAYS DURING THE YEAR;
(b) MEDICAL CASH ALLOWANCE TO DEPENDENTS OFEMPLOYEES NOT EXCEEDING P750.00
PER EMPLOYEE PER SEMESTER OR P125 PER MONTH;
(c) RICE SUBSIDY OF P1,000.00 OR ONE (1) SACK OF 50-KG. RICE PER MONTH AMOUNTING TO
NOT MORE THAN P1,000.00.
(d) UNIFORMS AND CLOTHING ALLOWANCE NOT EXCEEDING P3,000 PER ANNUM;
(e) ACTUAL YEARLY MEDICAL BENEFITS NOT EXCEEDING P10,000 PER ANNUM;
(f) LAUNDRY ALLOWANCE NOT EXCEEDING P300 PER MONTH;
(g) 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 THE EMPLOYEE UNDER AN ESTABLISHED WRITTEN PLAN WHICH
DOES NOT DISCRIMINATE IN FAVOR OF HIGHLY PAID EMPLOYEES;
(h) GIFTS GIVEN DURING CHRISTMAS AND MAJOR ANNIVERSARY CELEBRATIONS NOT
EXCEEDING P5,000 PER EMPLOYEE PER ANNUM;
(i) 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
(j) DAILY MEAL ALLOWANCE FOR OVERTIME WORK NOT EXCEEDING TWENTY FIVE PERCENT
(25%) OF THE BASIC MINIMUM WAGE."
THE AMOUNT OF "DE MINIMIS' BENEFITS CONFORMING TO THE CEILING HEREIN
PRESCRIBED SHALL NOT BE CONSIDERED IN DETERMINING THE P30,000 CEILING OF "OTHER
BENEFITS"
PROVIDED UNDER SECTION 32(B)(7)(e) OF THE CODE. HOWEVER, IF THE EMPLOYER PAYS
MORE THAN THE CEILING PRESCRIBED BY THESE REGULATIONS, THE EXCESS SHALL BE
TAXABLE TO THE EMPLOYEE RECEIVING THE BENEFITS ONLY IF SUCH EXCESS IS BEYOND
THE P30,000.00 CEILING. PROVIDED, FURTHER, THAT ANY
AMOUNT GIVEN BY THE EMPLOYER AS BENEFITS TO ITS EMPLOYEES,WHETHER CLASSIFIED
AS DE MINIMIS BENEFITS OR FRINGE BENEFITS, SHALL CONSTITUTE AS DEDUCTIBLE
EXPENSE UPON SUCH EMPLOYER.
"(6) Fixed or variable transportation, representation and other allowances. —
"(a) IN GENERAL, fixed or variable transportation, representation and other allowances which
are received by a public officer or employee of a private entity, in addition to the regular
compensation fixed for his position or office, is compensation subject to withholding.
PROVIDED, HOWEVER, THAT REPRESENTATION AND TRANSPORTATION ALLOWANCE (RATA)
GRANTED TO PUBLIC OFFICERS AND EMPLOYEES UNDER THE GENERAL APPROPRIATIONS
ACT AND THE PERSONNEL ECONOMIC RELIEF ALLOWANCE (PERA) WHICH ESSENTIALLY
CONSTITUTE REIMBURSEMENT FOR EXPENSES INCURRED IN THE PERFORMANCE OF
GOVERNMENT PERSONNEL'S OFFICIAL DUTIES SHALL NOT BE SUBJECT TO INCOME TAX AND
CONSEQUENTLY TO WITHHOLDING TAX. PROVIDED FURTHER, THAT PURSUANT TO E.O. 219
WHICH TOOK EFFECT ON JANUARY 1, 2000, ADDITIONAL COMPENSATION ALLOWANCE (ACA)
GIVEN TO GOVERNMENT PERSONNEL SHALL NOT BE SUBJECT TO WITHHOLDING TAX
PENDING ITS FORMAL INTEGRATION INTO THE BASIC PAY. CONSEQUENTLY, AND EFFECTIVE
FOR THE TAXABLE YEAR 2000, ACA SHALL BE CLASSIFIED AS PART OF THE "OTHER
BENEFITS" UNDER SECTION 32(B)(7)(e) OF THE CODE WHICH ARE EXCLUDED FROM GROSS
COMPENSATION INCOMEPROVIDED THE TOTAL AMOUNT OF SUCH BENEFITS DOES NOT
EXCEED P30,000.00.
"(b) Any amount paid specifically, either as advances or reimbursements for traveling,
representation and other bona fide ordinary and necessary expenses incurred or reasonably
expected to be incurred by the employee in the performance of his duties are not
compensation subject to withholding, if the following conditions are satisfied:
"(i) It is for ordinary and necessary traveling and representation or entertainment expenses
paid or incurred by the employee in the pursuit of the trade, business or profession; and
"(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with
the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the
Code. The excess of actual expenses over advances made shall constitute taxable income if such
amount is not returned to the employer. Reasonable amounts of reimbursements/advances for
traveling and entertainment expenses which are pre-computed on a daily basis and are paid to an
employee while he is on an assignment or duty need not be subject to the requirements of
substantiation and to withholding."
"(B) Exemptions from withholding tax on compensation. The following income payments are
exempted from the requirement of withholding tax on compensation:
"(11) Thirteenth (13th) month pay and other benefits. —
"(b) Other benefits such as Christmas bonus, productivity incentives, loyalty award, gift in
cash or in kind and other benefits of similar nature actually received by officials and
employees of both government and private offices, INCLUDING THE ADDITIONAL
COMPENSATION ALLOWANCE ("ACA") GRANTED AND PAID TO ALL OFFICIALS AND
EMPLOYEES OF
THE NATIONAL GOVERNMENT AGENCIES (NGAs) INCLUDING STATE UNIVERSITIES AND
COLLEGES (SUCs), GOVERNMENT-OWNED AND/OR CONTROLLED CORPORATIONS (GOCCs),
GOVERNMENT FINANCIAL INSTITUTIONS (GFIs) AND LOCAL GOVERNMENT UNITS (LGUs)
"The above stated exclusions (a) and (b) shall cover benefits paid or accrued during the year
provided that total amount shall not exceed thirty thousand pesos (P30,000.00) which may be
increased through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering, among others, the effect on the same
of the inflation rate at the end of the taxable year."
"(13) FACILITIES AND PRIVILEGES OF RELATIVELY SMALL VALUE OR 'DE MINIMIS' BENEFITS
AS DEFINED UNDER THESE REGULATIONS."
REV. REGS. 10-00
SECTION 1. Section 2.78.1(A)(3), (6)(b)(ii) and (7) of Revenue Regulations No. 2-98, as last
amended by Revenue Regulations No. 8-2000, is hereby further amended to read as follows:
139 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —
"(3) Facilities and privileges of relatively small value. —
"The following shall be considered as "de minimis" benefits not subject to INCOME TAX AS
WELL AS withholding tax on compensation income of both managerial and rank and file
employees:
(a) 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;
"(6) Fixed or variable transportation, representation and other allowances —
"(b)(ii) The employee is required to account/liquidate for the expenses in accordance with the
specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of
the Code. The excess of ADVANCES MADE over ACTUAL EXPENSES shall constitute taxable
income if such amount is not returned to the employer. Reasonable amounts of
reimbursements/advances for travelling and entertainment expenses which are pre-
computed on a daily basis and are paid to an employee while he is on an assignment or duty
need not be subject to the requirements of substantiation and to withholding."
(7) Vacation and sick leave allowances. Amounts of "vacation allowances or sick leave credits"
which are paid to an employee constitute compensation. Thus, the salary of an employee on
vacation or on sick leave, which IS paid notwithstanding his absence from work constitutes
compensation. However, the monetized value of unutilized vacation leave credits of ten (10)
days or less which ARE paid to PRIVATE employees during the year AND THE MONETIZED
VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES SHALL NOT BE
SUBJECT TO INCOME TAX AND CONSEQUENTLY TO WITHHOLDING TAX."
XIV. CAPITAL GAINS AND LOSSES
A. CAPITAL ASSETS
SEC. 39. Capital Gains and Losses. -
(A) Definitions.chanrobles virtual law library - As used in this Title -
(1) 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 stock in trade of the
taxpayer or other property of a kind which would properly be included in the inventory of the
taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily
for sale to customers in the ordinary course of his trade or business, or property used in the
trade or business, of a character which is subject to the allowance for depreciation provided in
Subsection (F) of Section 34; or real property used in trade or business of the taxpayer.
(2) Net Capital Gain. - The term "net capital gain" means the excess of the gains from sales or
exchanges of capital assets over the losses from such sales or exchanges.
(3) Net Capital Loss. - The term "net capital loss" means the excess of the losses from sales or
exchanges of capital assets over the gains from such sales or exchanges.
(B) Percentage Taken Into Account. - In the case of a taxpayer, other than a corporation, only
the following percentages of the gain or loss recognized upon the sale or exchange of a capital
asset shall be taken into account in computing net capital gain, net capital loss, and net
income:
(1) One hundred percent (100%) if the capital asset has been held for not more than twelve
(12) months; and
(2) Fifty percent (50%) if the capital asset has been held for more than twelve (12) months;
(C) Limitation on Capital Losses. - Losses from sales or exchanges of capital assets shall be
allowed only to the extent of the gains from such sales or exchanges. If a bank or trust
company incorporated under the laws of the Philippines, a substantial part of whose business
is the receipt of deposits, sells any bond, debenture, note, or certificate or other evidence of
indebtedness issued by any corporation (including one issued by a government or political
subdivision thereof), with interest coupons or in registered form, any loss resulting from such
sale shall not be subject to the foregoing limitation and shall not be included in determining
the applicability of such limitation to other losses.
(D) Net Capital Loss Carry-over. - If any taxpayer, other than a corporation, sustains in any
taxable year a net capital loss, such loss (in an amount not in excess of the net income for such
year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a
capital asset held for not more than twelve (12) months.
(E) Retirement of Bonds, Etc. - For purposes of this Title, amounts received by the holder
upon the retirement of bonds, debentures, notes or certificates or other evidences of
indebtedness issued by any corporation (including those issued by a government or political
subdivision thereof) with interest coupons or in registered form, shall be considered as
amounts received in exchange therefor.
(F) Gains or Losses From Short Sales, Etc. - For purposes of this Title -
(1) Gains or losses from short sales of property shall be considered as gains or losses from
sales or exchanges of capital assets; and
(2) Gains or losses attributable to the failure to exercise privileges or options to buy or sell
property shall be considered as capital gains or losses.
REV. REGS. No. 2, SECTION 132. Definition of "capital assets." — The law provides that the
term "capital assets" shall be held to mean property held by the taxpayer (whether or not
connected with his trade or business), but does not include stock in trade of the taxpayer or
other property of a kind which would properly be included in the inventory of the taxpayer if
on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or business, or property, used in the trade or
business, of a character which is subject to the allowance for depreciation provided in
subsection (f) of Section 30 of the Code. The term "capital asset" includes all classes of
property not specifically excluded by Section 30(a).
The exclusion from the term "capital assets" of property used in the trade or business of a
taxpayer of a character which is subject to the allowance for depreciation provided in Section
30(f) of the Code is limited to property used by the taxpayer in the trade or business at the
time of the sale or exchange. It has no application to gains or losses arising from the sale of
real property used in the trade or business to the extent that such gain or loss is allocable to
the land, as distinguished from depreciable improvements upon the land. To such gain or loss
allocable to the land, the limitations of Section 34(b) and (c) apply (such limitation may be
inapplicable to a dealer in real estate, but, if so, it is because he holds the land primarily for
sale to customers in the ordinary course of his trade or business, not because land is subject to
a depreciation allowance). Gains or losses from the sale or exchange of property used in the
trade or business of the taxpayer of a character which is subject to the allowance for
depreciation provided in Section 30(f) of the Code, will not be subject to the percentage
provisions of Section 34(b) and losses from such transactions will not be subject to the
140 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
limitation of losses provided in Section 30(c). (Real property used in taxpayer's trade or
business is no longer capital asset per Am. R.A. 82.)
CORN PRODUCTS REFINING CO. v. CIR
DOCTRINE:
Congress intended that profits and losses arising from the everyday operation of a business be
considered as ordinary income or loss rather than capital gain or loss.
FACTS:
Petitioner is manufacturer of products made from grain corn. It manufactures starch, syrup,
sugar, and their byproducts, feeds and oil. Its average yearly grind of raw corn during the
period 1937 through 1942 varied from 35 to 60 million bushels. Most of its products were
sold under contracts requiring shipment in 30 days at a set price or at market price on the
date of delivery, whichever was lower. It permitted cancellation of such contracts, but from
experience it could calculate with some accuracy future orders that would remain firm.
In 1934 and in 1936 droughts in the corn belt caused a sharp increase in the price of spot
corn. With a storage capacity of only 2,300,000 bushels of corn, a bare 3 weeks' supply, Corn
Products found itself unable to buy at a price which would permit its refined corn sugar,
cerelose, to compete successfully with cane and beet sugar. To avoid a recurrence of this
situation, petitioner, in 1937, began to establish a long position in corn futures "as a part of its
corn buying program" and "as the most economical method of obtaining an adequate supply
of raw corn" without entailing the expenditure of large sums for additional storage facilities.
At harvest time each year it would buy futures when the price appeared favorable. It would
take delivery on such contracts as it found necessary to its manufacturing operations and sell
the remainder in early summer if no shortage was imminent. If shortages appeared, however,
it sold futures only as it bought spot corn for grinding. In this manner it reached a balanced
position with reference to any increase in spot corn prices. It made no effort to protect itself
against a decline in prices.
In 1940 it netted a profit of $680,587.39 in corn futures, but in 1942 it suffered a loss of
$109,969.38. In computing its tax liability, Corn Products reported these figures as ordinary
profit and loss from its manufacturing operations for the respective years. It now contends that
its futures were "capital assets" and that gains and losses therefrom should have been treated
as arising from the sale of a capital asset. In support of this position it claims that its futures
trading was separate and apart from its manufacturing operations and that in its futures
transactions it was acting as a "legitimate capitalist." It denies that its futures transactions were
"hedges" or "speculative" dealings.
Both the Tax Court and the Court of Appeals found petitioner's futures transactions to be an
integral part of its business designed to protect its manufacturing operations against a price
increase in its principal raw material and to assure a ready supply for future manufacturing
requirements. Corn Products does not level a direct attack on these two-court findings but
insists that its futures were "property" entitled to capital-asset treatment and as such were
distinct from its manufacturing business.
ISSUE: Whether or not the futures are capital assets? NO.
RULING:
The transactions were vitally important to the company's business as a form of insurance
against increases in the price of raw corn. Also, the petitioner's sales policy, selling in the future
at a fixed price or less, continued to leave it exceedingly vulnerable to rises in the price of corn.
Further, the purchase of corn futures assured the company a source of supply which was
admittedly cheaper than constructing additional storage facilities for raw corn.
Likewise the claim of Corn Products that it was dealing in the market as a "legitimate
capitalist" lacks support in the record. There can be no quarrel with a manufacturer's desire to
protect itself against increasing costs of raw materials. Transactions which provide such
protection are considered a legitimate form of insurance. However, in labeling its activity as
that of a "legitimate capitalist" exercising "good judgment" in the futures market, petitioner
ignores the testimony of its own officers that in entering that market the company was "trying
to protect a part of [its] manufacturing costs"; that its entry was not for the purpose of
"speculating and buying and selling corn futures" but to fill an actual "need for the quantity of
corn [bought] in order to cover what [products] we expected to market over a period of 15 or
18 months." For tax purposes petitioner's purchases have been found to "constitute an
integral part of its manufacturing business" by both the Tax Court and the Court of Appeals,
and on essentially factual questions the findings of two courts should not ordinarily be
disturbed.
Petitioner also claims its transactions did not constitute "true hedging." It is true that Corn
Products did not secure complete protection from its market operations. Under its sales policy
petitioner could not guard against a fall in prices. It is clear, however, that petitioner feared
the possibility of a price rise more than that of a price decline. It therefore purchased partial
insurance against its principal risk, and hoped to retain sufficient flexibility to avoid serious
losses on a declining market.
Admittedly, petitioner's corn futures do not come within the literal language of the exclusions
set out in Section 117. They were not stock in trade, actual inventory, property held for sale to
customers or depreciable property used in a trade or business. But the capital-asset provision
of 117 must not be so broadly applied as to defeat rather than further the purpose of Congress.
Congress intended that profits and losses arising from the everyday operation of a business be
considered as ordinary income or loss rather than capital gain or loss. The preferential
treatment provided by 117 applies to transactions in property which are not the normal source
of business income. It was intended "to relieve the taxpayer from excessive tax burdens on
gains resulting from a conversion of capital investments.
The Treasury issued G. C. M. 17322, distinguishing speculative transactions in commodity
futures from hedging transactions. It held that hedging transactions were essentially to be
regarded as insurance rather than a dealing in capital assets and that gains and losses
therefrom were ordinary business gains and losses. The interpretation outlined in this
memorandum has been consistently followed by the courts as well as by the Commissioner.
The statute clearly refutes the contention of Corn Products. To hold otherwise would permit
those engaged in hedging transactions to transmute ordinary income into capital gain at will.
The hedger may either sell the future and purchase in the spot market or take delivery under
the future contract itself. But if a sale of the future created a capital transaction while delivery
of the commodity under the same future did not, a loophole in the statute would be created
and the purpose of Congress frustrated.
ARKANSAS BEST CORP. v. CIR
DOCTRINE:
A taxpayer's motivation in purchasing an asset is irrelevant to the question whether it falls
within the broad definition of "capital asset". Section 1221 provides that "capital asset" means
"property held by the taxpayer, but does not include" the five classes of property listed as
exceptions. We believe this locution signifies that the listed exceptions are exclusive.
FACTS:
Between 1968 and 1974, Arkansas Best, a diversified holding company, acquired
approximately 65% of the National Bank of Commerce. These acquisitions were prompted
principally by the Bank’s need for added capital asset. The bank was apparently prosperous
141 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
until 1972, when federal examiners classified it as a problem bank. The infusion of capital
after 1972 was prompted by the loan portfolio problems of the bank.
In 1975, petitioner sold the bulk of the stock at a loss, which it claimed as an ordinary-loss
deduction on its federal income tax return for that year. The Commissioner of Internal
Revenue disallowed the deduction, finding that the loss was a capital loss rather than an
ordinary loss, and that it therefore was subject to the capital loss limitations in the Internal
Revenue Code.
The Tax Court, relying on cases interpreting the Corn Products Refining case, held that, since
the stock acquired through 1972 was purchased with a substantial investment purpose, it was
a capital asset under 1221 and therefore gave rise to a capital loss when it was sold; however,
the loss realized on the stock acquired after
1972 was subject to ordinary-loss treatment since that stock had been bought and held
exclusively for the business purpose of protecting petitioner's reputation by fending off the
bank's failure. The Court of Appeals reversed the latter determination, ruling that all of the
stock sold in 1975 was subject to capital-loss treatment.
ISSUE: W/N the loss arising from the sale is a capital loss? YES
RULING:
A taxpayer's motivation in purchasing an asset is irrelevant to the question whether it falls
within the broad definition of "capital asset" in 1221. Petitioner's reading of Corn Products as
authorizing ordinary-asset treatment for any asset acquired and held for business rather than
investment purposes is too expansive. That reading finds no support in 1221's language,
which does not mention a business-motive test, and is in direct conflict with 1221's broad
definition of capital asset. Similarly, the contention that 1221's five listed exceptions are
merely illustrative rather than exhaustive is refuted by the statute's "does not include" phrase,
and by the legislative history and the applicable Treasury regulation. Moreover, petitioner's
reading would make surplusage of three of the statutory exceptions, whose excluded classes
of property would undoubtedly satisfy a business-motive test. Corn Products must instead be
interpreted as standing for the narrow proposition that "hedging" transactions that are an
integral part of a business' inventory-purchase system fall within 1221's first exception for
"property which would properly be included in the taxpayer's inventory." Since petitioner,
which is not a dealer in securities, has never suggested that its bank stock falls within the
inventory exclusion, Corn Products has no application in the present context. Because
petitioner's bank stock falls within 1221's broad definition of "capital asset" and is outside the
classes of excluded property, the loss arising from its sale is a capital loss.
CALASANZ v. CIR
DOCTRINE:
A sale of inherited real property usually gives capital gain or loss even though the property
has to be subdivided or improved to make it salable. However, if the inherited property is
substantially improved or very actively sold, it may be treated as held primarily for sale to
customers in the ordinary course of the heir’s business.
FACTS:
Calasanz inherited agricultural land from her father. In order to liquidate her inheritance, she
had the land surveyed and subdivided. Improvements such as roads, gutters, drainage, and
lighting systems were introduced. The lots were then individually sold at a profit.
In their joint income tax return, petitioners disclosed profit realized and reported 50% thereof
as taxable capital gains.
CIR contended that petitioners are engaged in business as real estate dealers and are required
to pay real estate dealer’s tax.
Petitioner’s contention:
They partitioned and developed the land only to effect liquidation of the capital asset
inherited. They claimed that it was difficult to dispose of it in one single transaction.
CIR’s contention:
Petitioners are deemed to be engaged in real estate business for having been involved in a
series of real estate transactions pursued for profit. CIR also argued that property acquired by
inheritance may be converted from an investment property to a business property if it was
subdivided, improved, and subsequently sold and the number, continuity and frequency of the
sales were such as to constitute “doing business.”
ISSUE/S:
1. W/N petitioners are real estate dealers liable for real estate dealer’s tax – THEY ARE
2. W/N gains realized from the sale are taxable in full as ordinary income or capital gains –
ORDINARY INCOME
RULING:
Property initially classified as a capital asset may thereafter be treated as an ordinary asset if a
combination of the factors indubitably tends to show that the activity was in furtherance of or
in the course of the taxpayer’s trade or business.
One strong factor against petitioner’s contention is the business element of development.
Petitioners did not sell the land in the condition in which they acquired it. The agricultural
land was converted into a residential subdivision.
The sale based on installment basis also suggests the number, frequency, and continuity of
sales.
BIR RUL. 27-02
FACTS:
This is a request for a ruling on the tax consequences of the following sales transactions:
1. Sale of a real estate property wherein the seller and the buyer are both corporations and
are engaged in real estate business. Both corporations are issued a certification by the
HLURB to that effect. The seller has also been issued a License to Sell by the HLURB;
2. Sale of real estate property by a corporation engaged in real estate business to another
corporation not engaged in real estate business. The corporation engaged in real estate
business, being the seller, is issued a certification by the HLURB to that effect. The seller
has also been issued a License to Sell by the HLURB;
3. Sale of a real estate property by a corporation not engaged in real estate business to
another corporation engaged in real estate business; and
4. Sale of real estate property by a corporation engaged in real estate business to individual
buyer. The corporation engaged in real estate business, being the seller, is issued a
certification by the HLURB. The seller has also been issued a License to Sell by the
HLURB.
ISSUE: Whether or not the 4 instances constitute a capital asset?
RULING:
Except for No. 3, the situations involve a seller that is engaged in real estate business.
142 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
However, it was not specified, whether the property being sold is an ordinary asset or a
capital asset in the hands of the seller.
It is necessary to first determine the character of the real property being sold. Thus, if the
real property is a land or building which is not actually used in the business of the seller-
corporation and is treated as a capital asset, then a final tax of 6% shall be imposed on the
gain presumed to have been realized on its sale, exchange or disposition of such land or
building based on the gross selling price or fair market value, whichever is higher. This rule
applies, whether or not the seller-corporation is engaged in real estate business.
It is only when the real property being sold is an ordinary asset that the withholding tax rates
imposed under Section 2.57.2 of Revenue Regulations No. 2-98 shall apply. The rate of
withholding tax will depend on whether, first, the seller is exempt or taxable; second,
whether the seller is habitually engaged in real estate business or not; and third, if the seller
is habitually engaged in real estate business, the gross selling price, as that term is defined in
the above-mentioned Revenue Regulations.
1. Section 2.57.2 of Revenue Regulations No. 2-98 provides that where the seller is a
corporation duly registered with the HLURB as habitually engaged in the real estate business,
a creditable withholding tax based on the gross selling price/total amount of consideration or
the fair market value, whichever is higher, paid to the seller/owner for the sale, transfer or
exchange of real property, other than capital asset, shall be deducted by the withholding
agent/buyer, in accordance with the following schedule:
A. Where the seller/transferor is exempt from creditable withholding tax
in accordance with Sec. 2.57.5 of these Regulations Exempt
B. Upon the following values of real property, where the seller/transferor is
habitually engaged in the real estate business:
With a selling price of Five Hundred Thousand
Pesos (P500,000.00) or less 1.5%
With a selling price of more than
Five Hundred Thousand Pesos
(P500,000.00) but not more
than Two Million Pesos (P2,000,000.00) 3.0%
With a selling price of more than Two Million
Pesos (P2,000,000.00) 5.0%
2. The above tax treatment shall likewise apply in cases where the seller-corporation is
habitually engaged in the real estate business, even if the buying corporation is not
engaged in real estate business.
3. Section 2.57.2(J) of Revenue Regulations No. 2-98 applies only in cases where the real
estate property is an ordinary asset. Thus, if the property is an ordinary asset, since
the seller is not habitually engaged in the real estate business, the rate of creditable
withholding tax is 6% of the gross selling price. If the real property is land or building
which is not actually used in the business of the seller-corporation, and is treated as a
capital asset, a final tax of 6% is hereby imposed on the gain presumed to have been
realized on the sale, exchange or disposition of land and/or building pursuant; and
4. Section 3 of Revenue Regulations No. 6-2001, provides that where the seller-
corporation who is habitually engaged in the real estate business sell real property/ies
held as ordinary asset to an individual not engaged in trade or business, the following
rules shall apply:
 (i) If the sale is a sale of property on the installment plan (that is, payments in the year
of sale do not exceed 25% of the selling price), no withholding of tax is required to
be made on the periodic installment payments. In such a case, the applicable rate of
tax based on the gross selling price or fair market value of the property, whichever
is higher, shall be withheld on the last installment or installments to be paid to the
seller until the tax is fully paid.
(ii) If the sale is on a "cash basis" or is a "deferred-payment" sale not on the
installment plan" (that is, payments in the year of sale exceed 25% of the selling
price), the buyer shall withhold the tax based on the gross selling price or fair
market value of the property, whichever is higher, on the first installment.
However, if the buyer is engaged in trade or business, whether a corporation or otherwise,
these rules shall apply:
(i) If the sale is a sale of property on the installment plan (that is payments in the year
of sale do not exceed 25% of the selling price), the tax shall be deducted and
withheld by the buyer on every installment.
(ii) If the sale is on a "cash basis" or is a "deferred-payment sale not on the
installment plan" (that is, payments in the year of sale exceed 25% of the selling
price), the buyer shall withhold the tax based on the gross selling price or fair
market value of the property, whichever is higher, on the first installment.
For purposes of applying the foregoing rules, "gross selling price" shall mean the
consideration stated in the sales document or the fair market value, whichever is higher.
Finally, registration with the HLURB or HUDCC shall be sufficient for a seller/transferor to be
considered as habitually engaged in the real estate business. If the seller/transferor is not
registered with HLURB or HUDCC, he/it may prove that he/it is engaged in the real estate
business by offering other satisfactory evidence (for example, he/it consummated during the
preceding year at least six taxable real estate transactions, regardless of amount).
B. ORDINARY INCOME
SEC. 22 Definitions - When used in this Title:
(Z) The term "ordinary income" includes any gain from the sale or exchange of property which
is not a capital asset or property described in Section 39(A)(1).
Any gain from the sale or exchange of property which is treated or considered, under other
provisions of this Title, as 'ordinary income' shall be treated as gain from the sale or exchange
of property which is not a capital asset as defined in Section 39(A)(1).
The term 'ordinary loss' includes any loss from the sale or exchange of property which is not a
capital asset.
Any loss from the sale or exchange of property which is treated or considered, under other
provisions of this Title, as 'ordinary loss' shall be treated as loss from the sale or exchange of
property which is not a capital asset.
TUASON v. LINGAD
FACTS:
Petitioner inherited from his mother several tracts of land. When the petitioner’s mother was
still alive, she had 2 parcels of land divided into 29 lots. – 28 lots were leased to third persons,
the 29th lot was not because it needed filling for its low elevation.
143 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Later on, the 28 lots were sold to their respective occupants on a 10-year installment basis.
The 29th lot could not be sold due to its low elevation. Petitioner’s attorney-in-fact –ANTONIO
ARANETA – had lot 29 filled and then sold on a 10year annual amortization basis. Araneta did
not employ any broker nor did he put up advertisements in the matter of the sale.
Petitioner reported his income from the sale of the lots as capital gains and included only ½
thereof as taxable income. Petitioner deducted the real estate dealer’s tax, payment of which
was on account of rentals received from the 28 lots.
Collector of Internal Revenue approved the petitioner’s treatment of his income from the sale
of the lots.
CIR reversed and considered petitioner’s profits from the sales as ordinary gains. Petitioner
received a letter from the BIR advising him to pay deficiency income tax.
ISSUE:
Whether or not CIR erred in concluding that petitioner was engaged in the business of leasing
the lots he inherited from his mother and that the subsequent sales cannot be recognized as
capital assets but of real property used in trade or business of the taxpayer
HELD:
Income of petitioner from the sales of the lots should be considered as ordinary income.
RULING:
Petitioner’s arguments:
a) He is not the one who leased the lots
b) Lots were residential and not commercial
Capital assets as defined by the NIRC
 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 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,
b. or property held by the taxpayer primarily for sale to customers in the
ordinary course of business,
c. or property used in the trade or business, of a character which is subject to the
allowance for depreciation;
d. or real property used in the trade or business of the taxpayer
 As defined by law, CAPITAL ASSETS include all the properties of a taxpayer whether or not
connected with his trade or business except those enumerated by law. If the taxpayer sells or
exchanges any of the properties, any gain or loss relative thereto is an ordinary gain or an
ordinary loss
 under the Tax Code, if a gain is realized by a taxpayer from the sale or exchange of capital
assets held for more than 12 months, only 50% of the net capital gain shall be taken into
account in computing the net income.
 The field of application of the term CAPITAL ASSETS is necessarily narrow, while its
exclusions must be interpreted broadly. It is the taxpayer’s duty to bring himself clearly
within the terms of a tax-exempting statutory provision.
 When petitioner obtained by inheritance the parcels in question, transferred to him
was not merely the duty to respect the terms of any contract, but as well as the
correlative right to receive and enjoy the fruits of the business and property which
the decedent had established and maintained.
 From 1957, petitioner was receiving rental payments from the mentioned 28 lots
even if the leases executed by his deceased mother thereon expired in 1953.
Petitioner’s sales of lots forming part of his rental business cannot be characterized
as other than sales of non-capital assets.
 Petitioner’s actions show that he was engaged in real estate business:
improvements were introduced for the purpose of not simply liquidating the estate
but not making the lots more saleable to the general public//sales were made
continuously//relationship between petitioner and Araneta was that of owner-
realty broker.
 However, surcharged were not granted because petitioner relied in good faith in the
earlier opinion of CIR
C. NET CAPITAL GAIN, NET CAPITAL LOSS
JARDINE DAVIES, INC. v. CIR
DOCTRINE:
It is clear from the statute that what is being taxed is only the "net capital gains" realized from
the sale or exchange or other disposition of shares of stock not traded through a local stock
exchange. If the legislature had intended to impose the tax on "capital gains", it would not
have added the word “net” before capital gains in then Section 24(e)(2).
FACTS:
Petitioner Davies is a domestic corporation engaged in distribution of building and industrial
materials, middle income housing and agri-business. Petitioner owned, either directly or
indirectly, shares of stock in some other domestic corporation (e.g. Cargoswift, Aerotel, UIS
Transport, Jardine Davies Transport, CMG Life Insurance, Hardie Jardine). Petitioner alleged
that none of these stocks are listed and traded in the PSE.
In 1997, Petitioner sold its 1,500 shares in Cargoswift for 41,000; 7,000 shares in Aerotel for
705,000; 18,000 shares in UTS for 1,869,000; 155,000 shares in Jardine Davies Transport for
2,213,000 - all to Jardine Matherson (Europe) B.V. All of these transactions, EXCEPT the
shares in UTS, resulted in capital losses.
Then, Petitioner sold its 100,000 shares in CMG Life Insurance to CMG Asia Pty for
$14,995,000 or 394,683,395 pesos at the rate of $1:26.321 – the BSP prevailing rate in March
1997. This time the transaction resulted in capital gain. Petitioner later sold its 570,000
preferred and 46,667 common shares in Hardie Jardine for 225,076,417 to RCI Pty – this
results to capital loss
On various Occasion, Petitioner filed in BIR, separate Capital gains tax returns for each stock
transaction consummated in 1997 and paid the capital gains tax thereon. In 1998 Petitioner
claims that there has been an overpayment of capital gains tax from its sale of shares not
traded through local stock exchange in the amount of 17,815,615.96:
Selling Price of Current Transaction P624,387,812.00
Cost and Other Selling Expenses 316,348,493.00
144 TAXATION 1 (ATTY. BELLO)
Net Gain (Loss) 308,039,319.00
Add: Prior Capital Gains/(Loss) During the Year
Total Taxable Capital Gains/(Loss) 308,039,319.00
Total Capital Gains Tax 61,597,863.80
Less: Prior Tax Paid per Return Filed During
the Year 79,413,479.76
The controversy arose when the CIR did not issue a Tax clearance to allow the registration of
CMG Life insurance of the transfer of the shares in the name of the buyer. CIR refused to issue
said certificate alleging that Petitioner may not deduct from capital gain it derived from the
sale of its shares of stock in CMG Life the capital losses it sustained during the taxable year
when it sold its shares in Cargoswift, Aerotel, and Jardine Davies Transport. As a consequence,
CIR alleged a deficiency of capital gains tax plus surcharge, penalty and interest totaling
4,904,458.86
Petitioner paid the deficiency under protest, but it filed a request with the CIR to resolve the
issue on W/N it may deduct from the capital gain it derived from the sales of its shares in CMG
Life insurance, the capital losses it sustained during 1997. CIR issued BIR-Ruling 37-98
affirming that petitioner may deduct its losses from its capital gains. Because of this,
Petitioner filed with CIR a formal claim of refund of 17,815,615.46. CIR did not respond so
Petitioner elevated the case to CTA.
ISSUE: W/N capital losses sustained during the taxable year from sales of shares classified as
capital asses may be deducted currently (as opposed to year end) from capital gains derived
during the same taxable year.
RULING:
In reply, please be informed that under then Section 24(e)(2) of the Tax Code, as amended
(now Section 27(D)(2) of the Tax Code of 1997), reading:
"(e) Tax on certain incomes derived by domestic corporations. -x x x.
(2) Capital gains from sales of shares of stock. -Capital gains realized from the sale,
exchange or disposition of shares of stock in any domestic corporation shall be taxed as
follows:
(A) Net capital gains as defined in Section 33 (a) (2) realized during each taxable
year from sale or exchange or other disposition of shares of stock not traded through a local
stock exchange:
Not over P100,000 - 10%
Over P 1 00,000 - 20%
The term "net capital gain" and "net capital loss" are defined under Sees. 33(a)(2) and (3) of
the Tax Code, as amended [now Sees. 39(A)(2) & (3) of the Tax Code of 1997], as follows:
"(2) Net capital gain. -The term 'net capital gain' means the excess of the gains from
sales or exchanges of capital assets over the losses from such sales or exchanges.
(3) Net Capital loss. -The 'net capital loss' means the excess of the losses from sales
or exchanges of capital assets over gains from such sales or exchanges."
It is clear from the statute that what is being taxed is only the "net capital gains" realized from
the sale or exchange or other disposition of shares of stock not traded through a local stock
exchange. If the legislature had intended to impose the tax on "capital gains", it would not
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
have added the word “net” before capital gains in then Section 24(e)(2). Conformably,
Petitioner’s capital losses sustained during the taxable year from the sale of shares may be
deducted from its capital gains derived during the same taxable year. CTA ordered CIR to
REFUND or ISSUE TAX CREDIT CERTIFICATES for the amount of 17,815,615.96.
D. PERCENTAGE TAKEN INTO ACCOUNT
E. LIMITATION ON CAPITAL LOSS
CHINA BANKING CORPORATION v. COURT OF APPEALS
DOCTRINE:
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived
from the sale or exchange of capital assets, and not from any other income of the taxpayer.
FACTS:
China Bank made a 53% equity investment in the First CBC Capital (Asia) Ltd., a Hongkong
subsidiary engaged in financing and investment with "deposit-taking" function. The
investment amounted to P16,227,851.80, consisting of 106,000 shares with a par value of
P100 per share. In the course of BSP’s regular examination of the financial books and
investment portfolios of petitioner in 1986, it was shown that First CBC Capital (Asia), Ltd.,
has become insolvent. With BSP’s approval, petitioner wrote-off as being worthless its
investment in First CBC Capital (Asia), Ltd., in its 1987 Income Tax Return and treated it as a
bad debt or as an ordinary loss deductible from its gross income.
CIR disallowed the deduction and assessed petitioner for income tax deficiency of
P8,533,328.04, inclusive of surcharge, interest and compromise penalty. The disallowance of
the deduction was made on the ground that the investment should not be classified as being
"worthless" and that, although the Hongkong Banking Commissioner had revoked the license
of First CBC Capital as a "deposit-taking" company, the latter could still exercise, however, its
financing and investment activities. Assuming that the securities had indeed become
worthless, CIR held the view that they should then be classified as "capital loss," and not as a
bad debt expense there being no indebtedness to speak of between petitioner and its
subsidiary.
Petitioner contested the ruling before the CTA. The Commissioner's disallowance was
sustained by the CTA. When the ruling was appealed to the Court CA, the appellate court
upheld the CTA.
ISSUE: Whether or not the equity investment is deductible as a capital loss? YES.
RULING:
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of
which results in either a capital gain or a capital loss. The gain or the loss is ordinary when the
property sold or exchanged is not a capital asset. A capital asset means property held by the
taxpayer (whether or not connected with his trade or business), but does not include stock in
trade of the taxpayer or other property of a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of the taxable year, or property held by the
taxpayer primarily for sale to customers in the ordinary course of his trade or business, or
property used in the trade or business, of a character which is subject to the allowance for
depreciation provided in subsection (f) of section twenty-nine; or real property used in the
trade or business of the taxpayer.
Thus, shares of stock, like the other securities defined in Section 20(t) 4(4) of the NIRC, would
be ordinary assets only to a dealer in securities or a person engaged in the purchase and sale of,
or an active trader (for his own account) in, securities.
145 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Dealer in securities means a merchant of stocks or securities, whether an individual,
partnership or corporation, with an established place of business, regularly engaged in the
purchase of securities and their resale to customers; that is, one who as a merchant buys
securities and sells them to customers with a view to the gains and profits that may be derived
therefrom."
In the hands, however, of another who holds the shares of stock by way of an investment, the
shares to him would be capital assets. When the shares held by such investor become
worthless, the loss is deemed to be a loss from the sale or exchange of capital assets. A capital
gain or a capital loss normally requires the concurrence of two conditions for it to result: (1)
There is a sale or exchange; and (2) the thing sold or exchanged is a capital asset. A similar
kind of treatment is given by the NIRC on the retirement of certificates of indebtedness with
interest coupons or in registered form, short sales and options to buy or sell property where
no sale or exchange strictly exists.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived
from the sale or exchange of capital assets, and not from any other income of the taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary
corporation of petitioner bank whose shares in said investee corporation are not intended
for purchase or sale but as an investment. Unquestionably then, any loss therefrom would be
a capital loss, not an ordinary loss, to the investor.
The exclusionary clause in Section 33 does not include all forms of securities but specifically
covers only bonds, debentures, notes, certificates or other evidence of indebtedness, with
interest coupons or in registered form, which are the instruments of credit normally dealt
with in the usual lending operations of a financial institution. Equity holdings cannot come
close to being within the purview of "evidence of indebtedness". Verily, the loss of petitioner
bank in its equity investment in the Hongkong subsidiary cannot also be deductible as a bad
debt. The shares of stock in question do not constitute a loan extended by it to its subsidiary
(First CBC Capital) or a debt subject to obligatory repayment by the latter, essential elements
to constitute a bad debt, but a long term investment made by CBC.
In sum —
(a) The equity investment in shares of stock held by CBC of approximately 53% in its
Hongkong subsidiary, the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is a
capital, not an ordinary, asset.
(b) Assuming that the equity investment of CBC has indeed become "worthless," the loss
sustained is a capital, not an ordinary, loss.
(c) The capital loss sustained by CBC can only be deducted from capital gains if any derived
by it during the same taxable year that the securities have become "worthless."
XV. DETERMINATION OF GAIN OR LOSS FROM SALE OR EXCHANGE
OF PROPERTY
SEC. 40
REV. REGS. NO. 2, SECTION 136. Basis for determining gain or loss from sale of property. —
For the purpose of ascertaining the gain or loss from the sale or exchange of property, the
basis is the cost of such property, or in the case of property which should be included in the
inventory, its latest inventory value. But in the case of property acquired before March 1,
1913, when its fair market value as of that date is in excess of its cost, the gain to be included
in gross income is the excess of the amount realized therefor over such fair market value. (See
illustration I, Section 137 of these regulations). Also in the case of property acquired before amount realized. Loss attributable to
March 1, 1913, when its fair market value as of that date is lower than its cost the deductible the period prior to March 1, 1913, not
loss is the excess of such fair market value over the amount realized therefor. (See Illustration deducible.
II, Id.). No gain or loss is recognized in the case of property sold or exchanged (a) at more than
cost but less than its fair market value as of March 1, 1913 (See Illustration III, Id.), or (b) at No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold
less than cost but at more than its fair market value as of March 1, 1913. (See Illustration IV, or disposed of at more than cost but at less than its fair market value as of that date.
Id., Id., Id.) In any case proper adjustment must be made in computing gain or loss from the ILLUSTRATION III
exchange or sale of property for any depreciation or depletion sustained and allowable as
deduction in computing net income; the amount of depreciation previously charged off by the F air Market
taxpayer shall be deemed to be true depreciation sustained unless shown by clear and Cost Value Sale Price Taxable gain
convincing evidence to be incorrect. What the fair market value of property was as of March 1, Mar. 1, 1913
1913, is a question of fact to be established by evidence which will reasonably and adequately P 20,000 P 60,000 P 40,000 No taxable gain or deductible loss.
make it appear. The nature and extent of the sales and the circumstances under which they Reason: A gain on whole transaction,
were made should be considered. Prices received at forced sales or for small lots of property which gain is attributed to period
may be and often are no real indication of the value of the amount of property in question. For prior to March 1,1913.
instance, sales from time to time of a small number of shares of stock is little indication of the
value of a large or controlling interest in the corporation. If the taxpayer can not determine No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold
the cost of securities purchased prior to March 1, 1913, because of the loss, destruction, or or disposed of at less than cost but at more than its fair market value as of that date.
failure to keep records, the value of the securities at the date of approximate date of
acquisition may be used in determining the cost basis for purposes of computing the gain or ILLUSTRATION IV
loss from the sale of the securities. When the date or approximate date of acquisition is F air Market
unknown, no general rule can be stated for determining the cost value of such securities. Each Cost Value Sale Price Taxable gain
case must be considered separately upon its own facts. Mar. 1, 1913
SECTION 137. Illustrations of the computation of gain or loss from the sale or exchange of P 20,000 P6,000 P10,000 No taxable gain or deductible loss.
property acquired prior to March 1, 1913. — To avoid complexity no adjustment has been Reason: A loss on whole transaction,
made in these examples for depreciation or depletion. which loss is attributable to period
In the case of property acquired before March 1, 1913, when its fair market value as of that prior to March 1, 1913.
date is in excess of its cost, the taxable gain is the excess of the amount realized therefor over Where the cost is equal to or greater than the fair market value as of March 1, 1913, and the
such fair market value. selling price exceeds the cost, the gain to be included in gross income is the excess of the
ILLUSTRATION I selling price over the cost.

F air Market ILLUSTRATION V

Cost Value Sale Price Taxable gain F air Market
Mar. 1, 1913 Cost Value Sale Price Taxable gain
P 20,000 P 30,000 P 40,000 P 10,000 Mar. 1, 1913

Excess of amount realized over fair P 20,000 P 10,000 P 40,000 P 20,000

market value as of March 1, 1913. Reason: Gain on whole transaction,
Gain attributed to the period prior all of which is attributable to period
to March 1, 1913 not taxable. subsequent to March 1, 1913.
In the case of property acquired before March 1, 1913, when its fair market value as of that Where the fair market value as of March 1, 1913, is equal to or greater than the cost and the
date is lower than its cost, the deductible loss is the excess of such fair market value over the selling price is less than the cost, the deductible loss is the amount by which the cost exceeds
amount realized therefor. the selling price.
ILLUSTRATION II ILLUSTRATION VI
F air Market F air Market
Cost Value Sale Price Taxable gain Cost Value Sale Price Taxable gain
Mar. 1, 1913 Mar. 1, 1913
P 20,000 P 10,000 P6,000 P 4,000 P 20,000 P 30,000 P 10,000 P 10,000
Excess of fair market value over
146 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 Reason: Loss on whole transaction, all
of which is attributable to period
subsequent to March 1, 1913. Only
actual loss sustained deductible.
SECTION 138. Sale of property acquired by gift. — In computing the gain or loss from the sale
or other disposition of property acquired by gift, the basis shall be the selling price and the
fair market value of the property at the time the gift was made, or its fair market value as of
March 1, 1913, if acquired prior thereto, determined in accordance with the next two
preceding sections. In the case of gifts made on or after July 1, 1939, the value taken as a basis
for gift tax purposes shall be considered as the fair market value in computing gain or loss
from the sale or other disposition of the property.
SECTION 139. Sale of property acquired by devise, bequests, or inheritance. — In computing the
gain or loss from the sale or other disposition of property acquired by devise, bequest, or
inheritance, the basis shall be the fair market price or value of such property at the time of the
death of the decedent. The term "property acquired by bequest, devise, or inheritance" as
used herein includes (a) such property interests as the taxpayer has received as the result of a
transfer, or creation of a trust, in contemplation of or intended to take effect in possession or
enjoyment at or after death, and (b) such property interest as the taxpayer has received as the
result of the exercise by a person of a general power of appointment (1) by will, or (2) by deed
executed in contemplation of or intended to take effect in possession or enjoyment at or after
death. In the case of property acquired by gift, bequest, devise, or inheritance, prior to March
1, 1913, the taxable gain or deductible loss from the sale or other disposition thereof shall be
computed in accordance with sections 136 and 137 of these regulations. In the case of
property acquired by bequest, devise or inheritance, its value as appraised for the purpose of
the inheritance tax shall be deemed to be its fair market value when acquired.
SECTION 140. Exchange of property. — Gain or loss arising from the acquisition and
subsequent disposition of property is realized only when as the result of a transaction
between the owner and another person the property is converted into other property (a) that
is essentially different from the property disposed of, and (b) that has a market value. The
requirement that the property received in exchange must be "essentially different from the
property disposed of" implies that there must be a change in substance and not merely a
change in form. By way of illustration, if a taxpayer owning ten shares of stock exchanges his
stock certificate for a voting trust certificate, no income is realized. The term "market value"
means the fair value of the property in money as between one who wishes to purchase and
one who wishes to sell. It is not, however, what can be obtained for the property when the
owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely
speculative value which an owner could not reasonably expect to obtain for the property
although he might possibly be fortunate enough to do so. "Market value" is the price at which
a seller willing to sell at a fair price and a buyer willing to buy at a fair price, both having
reasonable knowledge of the facts, will trade. Evidence as to the assets and liabilities of a
corporation and as to its earnings may furnish definite indications of the market value of its
stock.
SECTION 141. Determination of gain or loss from the exchange of property. — The amount of
income derived or loss sustained from an exchange of property is the difference between the
market value at the time of the exchange of the property received in exchange and the original
cost, or other basis, of the property exchange. If the property exchanged was acquired prior to
March 1, 1913, see Sections 136 and 137 of these regulations.
SECTION 142. Readjustment of interest in a registered copartnership. — When a partner
retires from a duly registered copartnership, or the partnership is dissolved, he realizes a gain
or loss measured by the difference between the price received for his interest and the cost to
147 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
him of his interest in the partnership including in such cost the amount of his share in any
undistributed partnership net income earned since he became a partner on which the income
tax has been paid. However, if such interest in the partnership was acquired prior to March 1,
1913, both the cost as hereinbefore provided and the amount of such interest as of date, plus
the amount of the shares in any undistributed partnership net income earned since March 1,
1913, on which the income tax has been paid, shall be ascertained and the taxable gain
derived or the deductible loss sustained shall be computed as provided in Sections 136 and
137 of these regulations. If the partnership distributes its assets in kind and not in cash, the
partner realizes gain or suffers loss according to the market value of the property received in
liquidation. Whenever a new partner is admitted, to a partnership, or any existing partnership
is reorganized, the facts as to such change or reorganization should be fully set forth in the
next return of income, in order that the Commissioner of Internal Revenue may determine
whether any gain or loss has been realized by any partner.
SECTION 143. Basis of stock or securities acquired in "wash sales". — In the sale or other
disposition of stocks or securities the acquisition of which (or the contract or option to
acquire which) resulted in the non deductibility of the loss from the sale or other disposition
of substantially identical stock or securities the basis shall be the basis of the substantially
identical stock so sold or disposed of, increased or decreased, as the case may be, by the
difference, if any, between the price at which the stock or securities was acquired and the
price at which such substantially identical stock or securities were sold or otherwise disposed
of. The application of this rule may be illustrated by the following examples:
EXAMPLE (1): A purchased a share of common stock of the X Corporation
for P100 in 1936, which he sold January 15, 1940, for P80.00. On February 1, 1940, he
purchased a share of common stock of the same corporation for P90.00. No loss from the sale
is recognized under Section 33 of the Code. The basis of the new share is P110; that is, the
basis of the old share (P100) increased by P10, excess of the price at which the new share was
acquired (P90) over the price at which the old share was sold (P80).
EXAMPLE (2): A purchased a share of common stock of the X corporation for P100 in 1936,
which he sold January 15, 1940, for P80. On January 1, 1940, he purchased a share of common
stock of the same corporation for P70. No loss from the sale is recognized under Section 33 of
the Code. The basis of the new share is P90; that is, the basis of the old share (P100) decreased
by P10, the excess of the price at which the old share was sold (P80) over the price at which
the new share was acquired (P70). (See Section 131 of these regulations).
A. COMPUTATION OF GAIN OR LOSS
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(A) Computation of Gain or Loss. - 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, and the loss shall be the excess of the basis or adjusted basis for
determining loss over the amount realized.
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;
CRANE v. CIR
FACTS:
Petitioner was the sole beneficiary and the executrix of the will of her husband, who died
January 11, 1932. He then owned an apartment building and lot subject to a mortgage, which
secured a principal debt of $ 255,000.00 and interest in default of $7,042.50. As of that date,
the property was appraised for federal estate tax purposes at a value exactly equal to the total
amount of this encumbrance. Shortly after her husband's death, petitioner entered into an
agreement with the mortgagee whereby she was to continue to operate the property-
collecting the rents, paying for necessary repairs, labor, and other operating expenses, and
reserving $200. 00 monthly for taxes-and was to remit the net rentals to the mortgagee. This
plan was followed for nearly seven years, during which period petitioner reported the gross
rentals as income, and claimed and was allowed deductions for taxes and operating expenses
paid on the property, for interest paid on the mortgage, and for the physical exhaustion of the
building. Meanwhile, the arrearage of interest increased to $15,857.71. On November 29,
1938, with the mortgagee threatening foreclosure, petitioner sold to a third party for
$3,000.00 cash, subject to the mortgage, and paid $500.00 expenses of sale.
Petitioner reported a taxable gain of $1,250.00. Her theory was that the 'property' which she
had acquired in 1932 and sold in 1938 was only the equity, or the excess in the value of the
apartment building and lot over the amount of the mortgage. This equity was of zero value
when she acquired it. No depreciation could be taken on a zero value. Neither she nor her
vendee ever assumed the mortgage, so, when she sold the equity, the amount she realized on
the sale was the net cash received, or $2,500.00. This sum less the zero basis constituted her
gain, of which she reported half as taxable on the assumption that the entire property was a
'capital asset'.
The Commissioner determined that petitioner realized a net taxable gain of $23,767.03. His
theory was that the 'property' acquired and sold was not the equity but rather the physical
property itself, or the owner's rights to possess, use, and dispose of it, undiminished by the
mortgage. The original basis thereof was $262,042.50, its appraised value in 1932. Of this
value $55,000.00 was allocable to land and $207,042.50 to building. During the period that
petitioner held the property, there was an allowable depreciation of $28, 045.10 on the
building, so that the adjusted basis of the building at the time of sale was $178,997.40. The
amount realized on the sale was said to include not only the $2,500.00 net cash receipts, but
also the principal amount of the mortgage subject to which the property was sold, both
totaling $257,500.00. The selling price was allocable in the proportion, $54,471.15 to the land
and $203,028.85 to the building. The Commissioner agreed that the land was a 'capital asset',
but thought that the building was not. Thus, he determined that petitioner sustained a capital
loss of $528.85 on the land, of which 50% or $264.42 was taken into account, and an ordinary
gain of $24. 031.45 on the building, or a net taxable gain as indicated.
The Tax Court agreed with the Commissioner that the building was not a 'capital asset.' In all
other respects it adopted petitioner's contentions, and expunged the deficiency. Petitioner did
not appeal from the part of the ruling adverse to her, and these questions are no longer at
issue. On the Commissioner's appeal, the Circuit Court of Appeals reversed, one judge
dissenting.
ISSUE: Whether or not taxpayer who acquires depreciable property subject to an unassumed
mortgage, holds it for a period, and finally sells it still so encumbered, must compute her
taxable gain on the basis of the net cash received? NO.
RULING:
If 'property' means the same thing as 'equity', it would necessarily follow that the basis of
petitioner's property was zero. If, on the contrary, it means the land and building themselves,
or the owner's legal rights in them, undiminished by the mortgage, the basis was $262,042.50.
The words of statutes-including revenue acts-should be interpreted where possible in their
ordinary, everyday senses which is either that 'property' is the physical thing which is a
subject of ownership, or that it is the aggregate of the owner's rights to control and dispose of
that thing. 'Equity' is not given as a synonym as it is defined as 'the value of a property above
148 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the total of the liens. The Commission's position has the approval of the administrative
construction of 113(a)(5). With respect to the valuation of property, 'the value of property as
of the date of the death of the decedent as appraised for the purpose of the federal estate tax
shall be deemed to be its fair market value.
The land and building involved were so appraised in 1932, and their appraised value-
$262,042.50-was reported by petitioner as part of the gross estate in accordance with the
estate tax law and regulations, which had always required that the value of decedent's
property, undiminished by liens, be so appraised and returned, and that mortgages be
separately deducted in computing the net estate. As the provision of the Regulations has been
in effect since 1918, and as the relevant statutory provision has been repeatedly reenacted
since then in substantially the same form, the former may itself now be considered to have the
force of law.
A further reason why the word 'property' in 113(a) should not be construed to mean 'equity'
is the bearing such construction would have on the allowance of deductions for depreciation
and on the collateral adjustments of basis. Section 23(l) permits deduction from gross income
of 'a reasonable allowance for the exhaustion, wear and tear of property.
Under these provisions, if the mortgagor's equity were the 113(a) basis, they will represent
only a fraction of the cost of the corresponding physical exhaustion, and any recoupment by
the mortgagor of the remainder of that cost can be effected only by the reduction of his
taxable gain in the year of sale. If, however, the amount of the annual allowances were to be
computed on the value of the property, and then deducted from an equity basis, we would
have to accept deductions from a minus basis or deny deductions altogether. The
Commissioner also argues that taking the mortgagor's equity as the 113(a) basis would
require the basis to be changed with each payment on the mortgage, and that the attendant
problem of repeatedly recomputing basis and annual allowances would be a tremendous
accounting burden on both the Commissioner and the taxpayer. Moreover, the mortgagor
would acquire control over the timing of his depreciation allowances. Thus it appears that the
applicable provisions of the Act expressly preclude an equity basis. The proper basis under
113(a)(5) is the value of the property, undiminished by mortgages thereon, and that the
correct basis here was $262,042.50.
The Tax Court found adequate evidence that the apartment house was property of a kind
subject to physical exhaustion, that it was used in taxpayer's trade or business, and
consequently that the taxpayer would have been entitled to a depreciation allowance under
23(l), except that, the basis of the property was zero, and it was thought that depreciation
could not be taken on a zero basis. The correct basis of the property was not zero, but
$262,042.50, and that an adjustment should be made as the Commissioner determined.
Petitioner urges to the contrary that she was not entitled to depreciation deductions,
whatever the basis of the property, because the law allows them only to one who actually
bears the capital loss, and here the loss was not hers but the mortgagee's. However, there was
no finding of the Tax Court to that effect, nor to the effect that the value of the property was
ever less than the amount of the lien. Nor was there evidence in the record, or any indication
that petitioner could produce evidence, that this was so. The facts that the value of the
property was only equal to the lien in 1932 and that during the next six and one-half years the
physical condition of the building deteriorated and the amount of the lien increased, are
entirely inconclusive, particularly in the light of the buyer's willingness in 1938 to take subject
to the increased lien and pay a substantial amount of cash to boot.
Section 111(b) defines the 'amount realized' from 'the sale of property' as 'the sum of any
money received plus the fair market value of the property (other than money) received,' and
111(a) defines the gain on 'the sale of property' as the excess of the amount realized over the
basis. If the 'property' to be valued on the date of acquisition is the property free of liens, the
'property' to be priced on a subsequent sale must be the same thing. We could not accept
petitioner's contention that the $2,500.00 net cash was all she realized on the sale except on
the absurdity that she sold a quarter-of-a-million dollar property for roughly one per cent of
its value, and took a 99 per cent loss. Petitioner argues that because only $ 2,500.00 was
realized on the sale, the 'property' sold must have been the equity only, and that consequently
we are forced to accept her contention as to the meaning of 'property' in 113.
Petitioner concedes that if she had been personally liable on the mortgage and the purchaser
had either paid or assumed it, the amount so paid or assumed would be considered a part of
the 'amount realized' within the meaning of 111(b). A mortgagor, not personally liable on the
debt, who sells the property subject to the mortgage and for additional consideration, realizes
a benefit in the amount of the mortgage as well as the boot. If a purchaser pays boot, it is
immaterial whether the mortgagor is a debtor on the mortgage, or whether the benefit to him
is a receipt of money or property. We are rather concerned with the reality that an owner of
property, mortgaged at a figure less than that at which the property will sell, must and will
treat the conditions of the mortgage exactly as if they were his personal obligations. If he
transfers subject to the mortgage, the benefit to him is as real and substantial as if the
mortgage were discharged, or as if a personal debt in an equal amount had been assumed by
another.
Therefore, the Commissioner was right in determining that petitioner realized $257,500.00 on
the sale of this property. The taxpayer is not allowed to exclude allowable deductions from
consideration in computing gain as doing such would allow taxpayer to enjoy a double
deduction, in effect, on the same loss of assets.
Mr. Justice JACKSON, dissenting.
The Tax Court concluded that this taxpayer acquired only an equity worth nothing. The
mortgage was in default, the mortgage debt was equal to the value of the property, and
possession by the taxpayer was forfeited and terminable immediately by foreclosure, and
perhaps by a receiver pendente lite. It can be argued that the taxpayer received the whole
property and thereupon came to owe the whole debt. Likewise it is argued that when she sold
she transferred the entire value of the property and received release from the whole debt. But
these arguments are not so conclusive that it was not within the province of the Tax Court to
find that she received an equity which at that time had a zero value. The taxpayer never
became personally liable for the debt, and hence when she sold she was released from no
debt. The mortgage debt was simply a subtraction from the value of what she did receive, and
from what she sold. The subtraction left her nothing when she acquired it and a small margin
when she sold it. She acquired a property right equivalent to an equity of redemption and sold
the same thing. It was the 'property' bought and sold as the Tax Court considered it to be
under the Revenue Laws. We are not required to decide whether depreciation was properly
taken, for there is no issue about it here.
B. AMOUNT REALIZED
SEC. 40(A)
C. COST OR BASIS FOR DETERMINING GAIN OR LOSS
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(B) Basis for Determining Gain or Loss from Sale or Disposition of Property. - The basis of
property shall be -
(1) The cost thereof in the case of property acquired on or after March 1, 1913, if such
property was acquired by purchase; or
149 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(2) The fair market price or value as of the date of acquisition, if the same was acquired by
inheritance; or
(3) If the property was acquired by gift, the basis shall be the same as if it would be in the
hands of the donor or the last preceding owner by whom it was not acquired by gift, except
that if such basis is greater than the fair market value of the property at the time of the gift
then, for the purpose of determining loss, the basis shall be such fair market value; or
(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; or
(5) The basis as defined in paragraph (C)(5) of this Section, if the property was acquired in a
transaction where gain or loss is not recognized under paragraph (C)(2) of this Section.
PHILADELPHIA PARK AMUSEMENT CO. v. U.S.
DOCTRINE:
The cost basis of property received in a taxable exchange is the fair market value of the
property received. Every taxable year stands alone. Where the taxpayer does not know, or
cannot reasonably ascertain the value of the property received in the exchange, all he needs to
do is determine the value of the property received as consideration; he will then be able to
assume that the value of the property given is equal to the value of property received.
FACTS:
Taxpayer was granted a 50-year franchise to operate a passenger railway in Philadelphia. He
built a bridge at a cost of $381,000 which was used by its streetcars. Strawberry Bridge was
owned by the taxpayer and, after it was discovered that the bridge needed significant repairs,
the taxpayer gave the bridge to the City of Philadelphia in exchange for a 10-year extension of
the taxpayer's railway franchise in Fairmount Park which was owned by the City of
Philadelphia. Since the 10-year extension had no market value, the taxpayer used the
depreciating bridge as his new basis, then proceeded to claim overpayment of tax due to his
failure to claim any depreciation. The Internal Revenue Service disagreed with the taxpayer’s
reasoning, and disallowed his claim for a larger depreciation deduction.
Initially, a disagreement also arose out of the fact that the Commissioner amortized the
original cost of the franchise over the period beginning on the date the franchise was granted,
while the taxpayer amortized it over the period beginning on the date the railway began
operating. However, this disagreement was abandoned by the both parties and is not
mentioned in either parties’ brief, nor was there any mention of it during the oral arguments.
The extended franchise was abandoned with three years left. Taxpayer asserted depreciation
deductions based on the cost of the extension and a loss upon abandonment of the franchise.
ISSUE:
May the taxpayer use the fair market value of the franchise extension on the date of the
exchange as the cost basis?
RULING:
The court found that both Strawberry Bridge and the 10-year exchange had a value and the
contract between the taxpayer and the City of Philadelphia had the proper amount of
consideration. Looking to §1012 (then §113) of the tax code, which defines basis as the cost of
the property the court found that “one view is that the cost basis of property received in a
taxable exchange is the fair market value of the property given in the exchange.” The reverse,
that one could determine the value of the property given by considering the value of the
property received, was likewise true. Thus, the court found that in order to maintain
harmonization between the different sections of the tax code, it was necessary that the cost
basis of the property received be equal to its fair market value at the time of the exchange.
Though the taxpayer contested that the value of either the extended franchise or the
Strawberry Bridge was not ascertainable, the court disagreed. Though the court
acknowledged that it was possible that a piece of property’s value was not quantifiable, it
believed that those circumstances were rare. Therefore, the case was remanded back to the
Commissioner to determine the price.
D. EXCHANGE OF PROPERTY
1. GENERAL RULE – GAIN RECOGNITION
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. - (1) General Rule. - Except as herein provided, upon the sale or
exchange or property, the entire amount of the gain or loss, as the case may be, shall be
recognized.
2. EXCEPTION – NON-RECOGNITION TRANSACTIONS (TAX-FREE EXCHANGE)
a. TRANSFER OF PROPERTY TO A CONTROLLED CORPORATION
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(6) Definitions. -
(c) The term "control", when used in this Section, shall mean ownership of stocks in a
corporation possessing at least fifty-one percent (51%) of the total voting power of all classes
of stocks entitled to vote.
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(2) Exception. - No gain or loss shall be recognized if in pursuance of a plan of merger or
consolidation –
(a) 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
(b) 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; or
(c) 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 such corporation,
a party to the merger or consolidation.
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, gains
control of said corporation: Provided, That stocks issued for services shall not be considered
as issued in return for property.
DELPHER TRADES CORP. v. IAC
FACTS:
Pacheco and his sister Pelagia owned a parcel of real estate land identified that was registered
150 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
in Bulacan. They then leased the land to Construction Components Inc, and providing that
during the existence or after the term of the lease, the lessor (Pacheco and Pelagia) should he
decide to sell the property leased, shall first offer the same to the lessee (Construction) and
the lessee has the priority to buy under similar conditions. Construction then assigned its
rights and obligations to Hydro Pipes w/ the consent of the Pachecos.
A deed of exchange was executed between the Pachecos and Delpher Trades where Pachecos
conveyed to Delpher the leased property together w/ another parcel of land also located in
Malinta Estate, Valenzuela for 2,500 shares of stock of Delpher w/ a total value of P1.5M. On
the ground that it was not given the first option to buy the leased property pursuant to the
proviso in the lease agreement, Hydro Pipes filed an amended complaint for reconveyance of
the subject lot in its favor under conditions similar to those where Delpher acquired the
property from the Pacheco’s. The CFI of Bulacan ruled in favor of Hydro Pipes who had the
preferential right to acquire the property (right of first refusal), and Pacheco was ordered to
immediately convey the property to Hydro Pipes. The IAC affirmed this decision. Delpher
argued that the “deed of exchange” executed between Pacheco and Delpher was NOT a
contract of sale, so it did not prejudice the right of first refusal in the contract between
Pacheco and Hydro Pipes
ISSUE: W/N the deed of exchange was conducted to avail of certain tax exemptions and
benefits. (Main Issue: W/N there was a contract of sale and a violation of right of first refusal)
HELD:
The deed of exchange was NOT a contract of sale; thus, there was no violation of the right of
first refusal. The "Deed of Exchange" of property between the Pachecos and Delpher Trades
Corporation cannot be considered a contract of sale because there was no transfer of actual
ownership interests by the Pachecos to a third party. The Pacheco family merely changed
their ownership from one form to another. The ownership remained in the same hands.
Hence, Hydro Pipes has no basis for its claim of a light of first refusal under the lease contract.
In order to perpetuate their control over the property through the corporation and to avoid
taxes, the two pieces of real estate w/c had been leased to Hydro Pipes, were transferred to
the corporation by virtue of a deed of exchange of property.
In exchange for these properties, Pelagia and Delfin acquired 2,500 unissued no par value
shares of stock which are equivalent to a 55% majority in the corporation because the other
owners only owned 2,000 shares; they refer to this scheme as "estate planning." By their
ownership of a capital equal to 55% of the shares, the Pachecos have the control of the
petitioner corporation. In effect, the Delpher Trades Corporation is a business conduit or
alter ego of the Pachecos. What they really did was to invest their properties and change the
nature of their ownership from unincorporated to incorporated form by organizing Delpher
Trades Corporation to take control of their properties and at the same time save on
inheritance taxes. Its other advantages are continuous control of the property, tax exemption
benefits, and other inherent benefits in a corporation.
A no-par value share does not purport to represent any stated proportionate interest in the
capital stock measured by value, but only an aliquot part of the whole number of such shares
of the issuing corporation. The holder of no-par shares may see from the certificate itself that
he is only an aliquot sharer in the assets of the corporation. Thus, by removing the par value of
shares, the attention of persons interested in the financial condition of a corporation is
focused upon the value of assets and the amount of its debts. The execution of the deed of
exchange on the properties for no par value shares, the Pacheco’s were able to provide for a
tax-free exchange of property and acquire a corporation.
The execution of the deed of exchange on the properties for no par value shares, the Pachecos
were able to provide for a tax free exchange of property, such that they were able to execute
the deed of exchange free from income tax and acquire a corporation. Sec. 35 of the NIRC
provides that “No gain or loss shall also be recognized if a person exchanges his property for
stock in a corporation of which as a result of such exchange said person alone or together with
others not exceeding four persons gains control of said corporation." The Court believes that
there is nothing wring about the “estate planning” scheme resorted to by the Pachecos. The
legal right of a taxpayer to decrease the amount of what otherwise could be his taxes or
altogether avoid them, by means which the law permits, cannot be doubted.
BIR RUL. NO. 274-87
DOCTRINE:
No gain or loss shall be recognized if property is transferred to a corporation by a person in
exchange for stock in such a corporation of which as a result of such exchange, said person
alone or together with others, not exceeding four persons, gains control of said corporation.
The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of
the total voting power of all classes of stocks entitled to vote. Control is determined by the
amount of stock received i.e., subscribed and paid-up, whether for property or for services by
the transferor or transferors. In determining the 51% stock ownership, only those persons
who transferred property for stock in the same transaction may be counted up to a maximum
of five.
FACTS:
Messrs. De Rivera, Asuncion, Esguerra, Madlangsacay, Cruz and Mendoza (transferors)
transferred to Maray Maray Farms, Inc., a domestic corporation, their real properties situated
at Maramag, Bukidnon in payment for their unpaid subscription and for additional issues of
shares of capital stock of the corporation. The corporation has an authorized capital stock of
P2,500,000.00 divided into 250,000 shares with a par value of P10.00 per share. The
corporation issued additional shares to the transferors amounting to 31,200 shares with a
value of P312,500.00 from its unissued shares. As a result of the exchange, the transferors
gained control of the corporation by owning more than 51% of the total voting power of all
classes of stocks entitled to vote.
ISSUE: W/N there is gain or loss to be recognized as a result of the exchange? NO.
RULING:
Pursuant to Section 35, paragraph (c)(2)(c) of the Tax Code, no gain or loss shall be
recognized if property is transferred to a corporation by a person in exchange for stock in
such a corporation of which as a result of such exchange, said person alone or together with
others, not exceeding four persons, gains control of said corporation.
The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of
the total voting power of all classes of stocks entitled to vote. Control is determined by the
amount of stock received i.e., subscribed and paid-up, whether for property or for services by
the transferor or transferors. In determining the 51% stock ownership, only those persons
who transferred property for stock in the same transaction may be counted up to a maximum
of five.
Accordingly, no gain or loss shall be recognized to each of the 6 transferors and the transferee
corporation, Maray Maray Farms, Inc., considering that after the exchange and as a result of
the said exchange not more than 5 of the transferors will gain control of the transferee
corporation.
However, Section 35 (c)(2)(c) of the Tax Code merely defers recognition of gain or loss from
such transaction, for in determining the gain or loss from a subsequent transaction of the
properties or of the stocks involved in the exchange, the original or historical cost of the
properties or the stock is considered. Thus, if the transferors later sell or exchange the shares
of stock acquired by them in exchange, they shall be subject to income tax on gains derived
151 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
from such sale or exchange taking into consideration that the cost basis of the shares of stock
shall be the same as the original acquisition cost or adjusted cost basis to the transferors of
the properties exchange therefor; and that the cost basis to the transferee of the properties
exchanged for stocks shall be the same as it would be in the hands, of the transferors.
REVENUE MEMORANDUM RULING NO. 01-01
Tax Consequences of Tax-Free Exchange of Property for Shares of Stock of a Controlled
Corporation Pursuant to Section 40(C)(2) of the NIRC of 1997
I. Facts
1. A domestic corporation (the "Transferor") owns certain property, consisting, for
example, of the following:
1.1 Land encumbered by a real estate mortgage (REM);
1.2 Buildings;
1.3 100 shares of stock in G Corporation with a par value of P10 per share;
1.4 50 shares of stock in D Corporation without par value;
1.5 Unsecured receivables;
1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;
1.7 Cash.
2. X Corporation (the "Transferee") is a domestic corporation.
3. The Transferor transfers the property to the Transferee. In exchange, the Transferee
issues shares to the Transferor out of the unissued portion of its existing authorized
capital stock, or, if such existing authorized capital stock is insufficient, out of shares from
an increase in the Transferee's authorized capital stock. The Transferor does not receive
any money or property other than the aforementioned shares of the transferee.
4. The property transferred by the Transferor-corporation constitutes less than 80% of the
Transferor's assets, including cash.
5. In addition to the transfer of the property, the Transferee assumes liabilities of the
Transferor. However, the sum total of the amount of liabilities assumed, plus the amount
of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of
1997 — "liabilities to which the property is subject") do not exceed the basis of the
property transferred.
6. The shares are neither issued in payment for services, nor for settlement of an
outstanding liability that arises from the performance of services rendered by the
Transferor to the Transferee.
7. As a result of the above-mentioned transfer, the Transferor acquires at least 51% of the
total outstanding capital stock of the Transferee entitled to vote.
II. TAX CONSEQUENCES
1. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the
property to the Transferee. Consequently, the Transferor will not be subject to capital
gains tax, income tax, or to creditable withholding tax on the transfer of such property to
the Transferee. Neither may the Transferor recognize a loss, if any, incurred on the
transfer. The last paragraph of Section 40(C)(2) and (6)(c) of the Tax Code of 1997 state:
 "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 corporation of
which as a result of such exchange said person, alone or together with others, not
exceeding four (4) persons, gains control of said corporation: Provided, That stocks
issued for services shall not be considered as issued in return for property."
"(c) The term "control", when used in this Section, shall mean ownership of stocks in
a corporation possessing at least fifty-one percent (51%) of the total voting power
of all classes of stocks entitled to vote."
In addition, the assumption of liabilities or the transfer of property that is subject to a
liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the
Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed
the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:
"(4) Assumption of liability. —
(a) If the taxpayer, in connection with the exchanges described in the foregoing
exceptions, receives stock or securities which would be permitted to be received
without the recognition of the gain if it were the sole consideration, and as a part of the
consideration, another party to the exchange assumes a liability of the taxpayer, or
acquires from the taxpayer property, subject to a liability, then such assumption or
acquisition shall not be treated as money and/or other property, and shall not prevent
the exchange from being within the exceptions.
(b) If the amount of the liabilities assumed plus the amount of the liabilities to which
the property is subject exceed the total amount of the adjusted basis of the property
transferred pursuant to such exchange, then such excess shall be considered as a gain
from the sale or exchange of a capital asset or of property which is not a capital asset,
as the case may be."
In addition, the Transferee is not subject to income tax on its receipt of the property as
contribution to its capital, even if the value of such property exceeds the par value or
stated value of the shares issued to the Transferor: Section 55 of Revenue Regulations
No. 2 ("Income Tax Regulations") states:
"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . .
The receipt by a corporation of the subscription price of shares of its capital stock
upon their original issuance gives rise to neither taxable gain nor deductible loss,
whether the subscription or issue price be in excess of, or less than the par or stated
value of such stock.
However, stocks shall not be issued for a consideration less than par or issued price
thereof. (Section 62, Corporation Code of the Philippines)
1. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value
of the property transferred exceeds the par/stated value of the Transferee shares issued
to the Transferor, there being no intent to donate on the part of the Transferor.
2. Value-added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer
of the property if it is not engaged in a business that is subject to the VAT under Title IV
of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to
VAT, it is nonetheless not subject to VAT on the transfer of the property to the
Transferee. Section 4.100-5(b)(1) & (3) of Revenue Regulations No. 7-95, as amended
states:
"(b) Not subject to output tax. — The VAT shall not apply to goods or properties
152 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
existing as of the occurrence of the following:
1) Change of control of a corporation by the acquisition of the controlling interest of
such corporation by another stockholder or group of stockholders, Example: transfer
of property to a corporation in exchange for its shares of stock under Section 34(c)(2)
and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].
3) Merger or consolidation of corporations. The unused input tax of the dissolved
corporation as of the date of merger or consolidation shall be absorbed by the
surviving or new corporation."
Thus, since a de facto merger is considered within the definition of a merger under
Section 40(C)(6) of the Tax Code of 1997, the transfer of the property by the Transferor
to the Transferee shall not be subject to VAT. However, the second sentence of Section
4.100-5(b)(3), supra, is inapplicable in de facto mergers, and therefore, the Transferor's
unused input tax cannot be absorbed by or transferred to the Transferee. The above
sentence contemplates only a statutory merger or consolidation that, by operation of law,
results in a "dissolved corporation" and a "surviving or new corporation". Furthermore,
pursuant to Section 80 of the Corporation Code of the Philippines, the unused input tax,
being an asset, is transferred in statutory merger by operation of law.
3. Documentary stamp tax. The documentary stamp tax consequences of the transfer are as
follows:
3.1 Either the Transferor or the Transferee is subject to documentary stamp tax as
follows:
3.1.1 On the transfer of real property (Section 196, Tax Code of 1997) — P15 on
each P1,000 or fractional part thereof, based on the higher of: (i) the
consideration contracted to be paid for such real property, and (ii) the fair
market value as determined in accordance with Section 6(E) of the Tax Code
of 1997.
3.1.1.1 The "consideration contracted to be paid for such real property" shall
be computed in accordance with the following rules. "Stock in a
corporation is a valuable consideration for the transfer of real
property." (Section 177, Revenue Regulations No. 26) Therefore, the
consideration for the real property shall be computed as the
par/stated value of the Transferee shares issued to the Transferor in
exchange for such property plus the value of such property in excess
of such par/stated value recognized in the books of the Transferee as
premium, additional capital contribution, or donated surplus, or the
like. For instance, if the value of the property is P1,000,000, but only
shares with an aggregate par value of P250,000 are issued, there
being a premium above par of P750,000, which the Transferee
records as additional capital contribution, donated surplus, or the
like, the consideration is P1,000,000 (that is, par value of P250,000 +
premium of P750,000).
3.1.1.2 On the other hand, the fair market value of the property as
determined in accordance with Section 6(E) of the Tax Code of 1997
whichever is higher between (1) the fair market value as determined
by the Commissioner (that is, zonal value), and (2) the fair market
value as shown in the schedule of values of the Provincial and City
Assessors.
3.1.1.3 The value of the improvements thereon shall be based on the formula
 provided under Revenue Audit Memorandum Order (RAMO) No. 1-
2001 but shall not be lower than the fair market value in the Tax
Declaration in the year of exchange.
According to the said RAMO, the value of the improvement shall be
determined by deducting the zonal value of the land from the total
selling price/consideration per Deed of Exchange. Thus, if the total
selling price/consideration per Deed of Exchange is P1,000,000.00
and the zonal value of the land is P600,000.00, then the value of the
improvement is P400,000.00.
The fair market value of the improvement shall be determined per
latest tax declaration at the time of its sale or disposition (in this
particular case, the exchange of such property). If the tax declaration
was issued three (3) or more years prior to the date of sale or
disposition, the Transferor shall be required to submit a certification
from the city/municipal assessor as to the fact that such tax
declaration is the latest tax declaration covering the real property.
Absent such certification; the Transferor must secure a copy of the
latest tax declaration duly certified by the assessor.
3.1.2 On the transfer of shares of stock held by the Transferor (Section 176, Tax Code
of 1997) —
3.1.2.1 The transfer of the shares of G Corporation, which have a par value, is
subject to documentary stamp tax of P1.50 on each P200 or fractional
part thereof of the par value of such shares.
3.1.2.2 The transfer of the shares of D Corporation, which are without par
value, is subject to the documentary stamp tax of 25% of the
documentary stamp tax that was paid when those shares were
originally issued.
3.1.3 Transfer of mortgage (Section 198, in relation to Section 195, Tax Code of
1997) — The transfer of the real estate mortgage, as a consequence of the
transfer of the loan to Q ("Borrower/Mortgagor"), is subject to documentary
stamp tax at the following rate:
(a) When the amount secured does not exceed five thousand pesos
(P5,000) — twenty pesos (P20);
(b) On each five thousand pesos (P5,000), or fractional part thereof in
excess of five thousand pesos (P5,000), an additional tax of ten pesos
(P10).
3.2 The Transferee is subject to documentary stamp tax on the original issuance of its
shares (Section 175, Tax Code of 1997), at the following rate, depending on whether
such shares are par or no-par shares:
3.2.1 If the Transferee's shares are with par value, the documentary stamp tax is
imposed at the rate of P2 on each P200 or fractional part thereof of the par
value of such shares, regardless of whether the shares are issued at par value
or for a premium (that is, for a consideration in excess of par value).
3.2.2 If the Transferee's shares are without par value, the documentary stamp tax
is imposed at the rate of P2 on each P200 or fractional part thereof of the
actual consideration paid for such shares.
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4. Time of payment of Documentary Stamp Taxes. The time for the payment of the
documentary stamp tax liabilities, whether the taxpayer is an e-filer or not, shall be as
follows:
4.1 With respect to the transfer of property mentioned in 4.1 above, the documentary
stamp tax shall be paid on or before the fifth (5th) day after the close of the month
when the deed of assignment/transfer transferring such property was executed;
made, signed, accepted, or transferred (Section 5, Revenue Regulations No. 6-2001).
4.2 With respect to the original issuance of shares mentioned in 4.2, above, the
documentary stamp tax shall be paid on or before the fifth (5th) day after the close
of the month of —
4.2.1 Approval of SEC registration, in case of original incorporation;
4.2.2 Approval of the increase in authorized capital stock, in case the shares
issued to the Transferor come from the increase in authorized capital stock
of the Transferee; or
4.2.3 Execution of the deed of assignment/transfer of the property for which the
Transferee's shares are issued, in case the shares issued to the Transferor
come from the unissued portion of the Transferee's existing authorized
capital stock.
III. ADDITIONAL FACTS AND VARIATIONS NOT AFFECTING TAX CONSEQUENCES
The following additional facts or variations will not affect the tax consequences of the
transaction, as described above:
1. In no. 1 of "I. Facts" stated above, if the total number of Transferors does not exceed five
persons, whether such persons are natural persons or juridical persons.
2. In no. 7 of "I. Facts" stated above, the tax consequences are not affected by whether the
Transferor is/was a shareholder prior to the transaction, or that, prior to the transaction,
the Transferor already possessed control of the Transferee by owning 51% or more of
the total outstanding capital stock of the Transferee entitled to vote. In such a case, the
Transferor is deemed to have acquired "further control" of the Transferee, which places
the transaction within the purview of Section 40(C)(2) of the Tax Code of 1997.
However, a Transferor who, prior to the transaction was an existing shareholder of the
Transferee, but who owned less than 51% of the voting stocks of the Transferee (even if
it, together with not more than four (4) persons, owned more than 51% of all classes of
stocks entitled to vote of the Transferee) cannot be deemed to have gained control or
further control of the Transferee if, after a transaction in which it is the sole transferor, it
still owned by itself less than 51% of the voting stocks of the Transferee. For instance,
assume in the above facts that, prior to the transfer, the Transferor, together with
Stockholders E, B, M and R, owned 100% of the voting stocks of the Transferee. However,
by itself the Transferor owned only 32% of the voting stocks of the Transferee (the
balance of the 68% voting stocks being owned by Stockholders E, B, M and R). The
Transferor transfers property to the Transferee in exchange for shares of stock. After this
exchange, the Transferor owned, including the initial 32%, a total of 49% — or less than
51% — of the voting stocks of the Transferee. In this situation, the Transferor is not
deemed to have gained control or further control of the Transferee.
IV. FURTHER CLARIFICATION OF FACTS AND TAX CONSEQUENCES
1. No. 1 of "I. Facts" mentions "property". For purposes of Section 40(C)(2) of the Tax Code
of 1997, this term excludes services, accounts receivable for services rendered by the
 Transferor for the Transferee, cash and the conversion of debt into equity.
2. No. 3 of "I. Facts" mentions the issuance of the Transferee's shares from the "unissued
portion of its existing authorized capital stock, or, if such existing authorized capital stock
is insufficient, out of shares from an increase in the Transferee's authorized capital
stock". This statement of fact excludes the following, which if present, would give rise to a
different tax consequence treated elsewhere other than in this Revenue Memorandum
Ruling —
2.1 The issuance of treasury shares, which have previously been issued but were
subsequently re-acquired by the Transferee and have not been retired.
2.2 Settlement of subscription receivables. Therefore, the tax consequences described
above shall not apply to the extent that the property is transferred in payment for
the unpaid balance of the subscription to shares.
3. No. 4 of "I. Facts" mentions the property transferred constituting "less than 80% of the
Transferor's assets, Including cash". This requirement is necessary to distinguish this
transaction from a de facto merger as described in Section 40(C)(6)(b) of the Tax Code of
1997 in relation to BIR Circular No. V-253 dated July 16, 1957, the tax consequences of
which will be discussed in a different Revenue Memorandum Ruling.
4. No. 5 of "I. Facts" mentions the term "adjusted basis of the property", as well as the fact
that such liabilities assumed and to which the property is subject "do(es) not exceed the
adjusted basis of the property transferred". These terms are clarified as follows:
4.1 The basis or "original basis" of the property is its "historical cost". "Historical cost"
is the value of the property as determined pursuant to Section 40(B) of the Tax Code
of 1997. The term "adjusted basis" is the value of the property as determined
pursuant to the said Section, modified by adjustments to the historical cost. For
example, the "adjusted basis" of a property acquired by purchase is the historical
cost (acquisition cost) of such property increased by, among others, the amount of
improvements that materially add to the value of the property or appreciably
prolong its life and decreased by accumulated depreciation. "Adjusted basis"
excludes re-appraisal surplus, whether or not recorded in the books of the
Transferor.
4.2 "Property" does not include services or accounts receivable for services rendered
by the Transferor to the Transferee, cash, or the conversion of debt into equity.
Therefore, in determining whether liabilities assumed and to which the property is
subject "do(es) not exceed the adjusted basis of the property transferred", the value
of services rendered, cash and the conversion of debt into equity will be excluded
from the computation of "adjusted basis of the property transferred".
the time of the transfer (that is, "historical cost/original basis" or "adjusted basis",
as the case may be) decreased by (1) the money received by the Transferor, and (2)
the fair market value of the other property received by the Transferor, and
increased by (a) the amount treated as dividend of the shareholder and (b) the
amount of any gain that was recognized on the exchange. If, as in this case, the
Transferee assumed liabilities of the Transferor and/or acquired property of the
Transferor that is subject to liabilities, the amount of liabilities shall be treated as
money for purposes of determining the substituted basis. In the particular facts
covered by this Revenue Memorandum Ruling, the substituted basis of the
Transferee's shares acquired by the Transferor is the historical cost/original basis
or adjusted basis of the properties mentioned in no. 1 of "I. Facts" (excluding cash),
less the total of (a) the amount of liabilities assumed by the Transferee and (b) the
amount of real estate mortgage on the Land.
Section 40(C)(5)(a) of the Tax Code of 1997 states:
"(5) Basis. —
(a) The basis of the stock or securities received by the transferor upon the exchange
specified in the above exception shall be the same as the basis of the property, stock
or securities exchanged, decreased by (1) the money received, and (2) the fair
market value of the other property received, and increased by (a) the amount
treated as dividend of the shareholder and (b) the amount of any gain that was
recognized on the exchange; Provided, That the property received as "boot" shall
have as basis its fair market value; provided, further, that if as part of the
consideration to the transferor, the transferee of property assumes a liability of the
transferor or acquires from the latter property subject to a liability, such
assumption or acquisition (in the amount of the liability) shall, for purposes of this
paragraph, be treated as money received by the transferor on the exchange;
provided, finally, that if the transferor receives several kinds of stock or securities,
the Commissioner is hereby authorized to allocate the basis among the several
classes of stocks or securities."
5.2 On the other hand, the substituted basis of the property in the hands of the
Transferee for purposes of computing gain or loss on the subsequent disposition of
such property by the Transferee is the Transferor's original or adjusted basis in
such property at the time of transfer plus the gain recognized to the transferor on
the exchange. Section 40(C)(5)(b) of the Tax Code of 1997 states:
"The basis of the property transferred in the hands of the transferee shall be
same as it would be in the hands of the transferor increased by the amount of
the gain recognized to the transferor on the transfer."

5. The term "adjusted basis" should be distinguished from the term "substituted basis",
since they are not necessarily synonymous. The terms "original basis" and "adjusted
basis" are used in reference to the value of the property before it was transferred by the
Transferor; whereas, the term "substituted basis" is used in reference to both the value of
the property in the hands of the Transferee after its transfer and the shares received by
the Transferor from the Transferee. The term "substituted basis" is significant in
determining the tax basis of the aforementioned property or shares for purposes of
computing the gain or loss on the subsequent disposition of such property or shares. The
following rules will apply in determining substituted basis:
5.1 In general, the substituted basis of the Transferee's shares received by the
Transferor for purposes of computing gain or loss on the subsequent disposition of
such shares by the Transferor is equal to the Transferor's basis in the property at
154 TAXATION 1 (ATTY. BELLO)
In the particular facts of this Revenue Memorandum Ruling, there are no
circumstances under which the Transferor recognizes gain. Thus, in this case, the
substituted basis of the property in the hands of the Transferee is equal to the
Transferor's original or adjusted basis in such property at the time of the transfer.
6. No. 7 of "I. Facts" mentions that the Transferor acquires "at least 51% of the total
outstanding capital stock of the Transferee entitled to vote". Shares of stock "entitled to
vote" excludes those shares that have been denied voting rights in the Transferee's
Articles of Incorporation, in accordance with the provisions of Batas Pambansa Blg. 68
("The Corporation Code of the Philippines" or the "Corporation Code") (although the
Corporation Code may retain the right of holders of preferred shares to vote in certain
instances specified in the Code).
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 For instance, assume in the above Facts, that the Transferee has an authorized capital constructive remittance of branch profits to the head office which is converted into
stock of P32,550,000.00 divided into 265,000 common shares and 2,990,000 preferred equity of the Transferee corporation. The 15% rate may be reduced under applicable
non-voting shares with a par value of P10.00 per share. Only common shares have voting provisions of the various tax treaties to which the Philippines is a signatory.
rights. The stockholders of the Transferee before the transfer are the following:
Stockholders Common Preferred
INTERMOUNTAIN LUMBER v. CIR
Transferor 135,490 9
FACTS:
B 10 8 Consolidated cases:
C 64,000 651,244 Petitioners are the Intermountain Co., previously known as Intermountain Lumber Co., and its
affiliates. Petitioner filed consolidated income tax returns for fiscal years ending June 30, 1967
D 64,000 651,246
and 1968. Intermountain Lumber Co. and Tree Farmers, Inc., each filed a separate income tax
E 1 ,497 530,340 return for the fiscal year ending June 30, 1965. They all filed their tax returns in Helena, Mont.
(I assume Montana? Haha)
F 1 1
Intermountain’s principal place of business during the years in controversy and until 1973,
G 1 1 when it merged with Hoerner Waldorf Corp., was located in Missoula, Mont. Hoerner Waldorf
H 1 1 Corp.’s principal place of business is located in St. Paul, Minn.
———— ———— Mr. Dee Shook (hereinafter Shook) individually owned a sawmill at Conner, Mont. During
TOTAL 265,000 1,832,850 that time Mr. Milo Wilson (hereinafter Wilson) had logs processed there into rough lumber for
======== ======== a fee. Shook owned the remaining logs processed at the sawmill, which constituted about half
The Transferee increases its authorized capital stock by increasing only the number of its of all the logs processed there. Sometime after, fire damaged the sawmill. To rebuild the
common shares. Out of this increase, the Transferor subscribes to 298,450 common sawmill and so that they both have an “equal voice” in the rebuilding, they decided to
shares for a total subscription price of P2,984,500.00, which subscription is paid in incorporate with two others, calling it S & W Sawmill, Inc.
property. Shook executed a bill of sale for his sawmill equipment and deeded his sawmill site to S & W.
As a result of the subscription the Transferor gains control of the Transferee by owning In exchange, Shook received 364 S & W shares. Shook and Wilson also received 1 share each
77.01% (433,940/563,450 common shares) of the latter's outstanding shares of stock as incorporators. The 364 shares and the 4 incorporation shares constituted all outstanding
that are entitled to vote, to wit: capital stock of S & W.

Stockholders Common Preferred Shook also announced that he and Wilson had entered into an agreement whereby
Wilson was to purchase 182 shares of Shook’s stock, entitled “Agreement for Sale and
Transferor 433,940 9 Purchase of Stock”. Shook deposited stock certificates representing 182 shares with an escrow
agent. They agreed to purchase additional shares thereafter.
B 10 8
Wilson made all payments in 1965 and 1966 specified in the agreement for sale and
C 64,000 651,244
accordingly claimed interest deductions on his federal income tax returns for those years.
D 64,000 651,246
Before principal payments were required by the agreement for sale, petitioner purchased all
E 1 ,497 530,340 outstanding S & W stock. In anticipation of this purchase, a letter to petitioner signed by
Shook and Wilson stated as follows:
F 1 1
“To have it in the record, Milo E. Wilson owes Dee Shook $91,000 for 182 shares of S & W
G 1 1 Sawmill Inc. stock in escrow at Citizens State Bank Hamilton Montana. On the purchase
H 1 1 contract, Intermountain Lumber Co. would pay Dee Shook $91,000.00 more over the 14 yrs.
———— ———— than Milo E. Wilson.”
TOTAL 563,450 1,832,850 ISSUE/S:
======== ======== Whether, under all facts and circumstances surrounding the agreement for sale of 182 shares
7. If the Transferor is a Philippine branch of a foreign corporation, and the branch is between Shook and Wilson, ownership of those shares was in Shook or Wilson
incorporated into the Transferee corporation (such that the branch will no longer exist RULING:
after the incorporation of the Transferee) directly owned by the head office, in addition Section 351 provides, in part, that no gain shall be recognized if property is transferred to a
to the tax consequences described above, the branch will be subject to the 15% branch corporation by one or more persons solely in exchange for stock or securities in such
profits remittance tax to the extent that there are unremitted branch profits at the time of corporation and immediately after the exchange such person or persons are in control of
transfer (Section 28(A)(5), Tax Code of 1997), since the transaction will be considered a
155 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
the corporation. “Control” is defined for this purpose in section 368(c) as ownership of
stock possessing at least 80 percent of the total combined voting power of all classes of
stock entitled to vote and at least 80 percent of the total number of shares of all other classes
of stock of the corporation.
Respondent is unusually arguing that a transfer to a corporation in return for stock was
nontaxable under section 351, and Intermountain is in the equally unusual posture of arguing
that the transfer was taxable because section 351 was inapplicable. The explanation is simply
that Intermountain purchased all stock of the corporation, S & W, from its incorporators, and
that Intermountain and S & W have filed consolidated income tax returns for years in issue.
Accordingly, if section 351 was applicable to the incorporators when S & W was formed, S & W
and Intermountain must depreciate the assets of S & W on their consolidated returns on the
incorporators’ basis. If section 351 was inapplicable, and the transfer of assets to S & W was
accordingly to be treated as a sale,
S & W and Intermountain could base depreciation on those returns on the fair market
value of those assets at the time of incorporation, which was higher than the incorporators’
cost and which would accordigly provide larger depreciation deductions.
Petitioner thus maintains that the transfer to S & W of all of S & W’s property at the time of
incorporation by the primary incorporator, one Dee Shook, was a taxable sale. It asserts that
section 351 was inapplicable because an agreement for sale required Shook, as part of the
incorporation transaction, to sell almost half of the S & W shares outstanding to one Milo
Wilson over a period of time, thereby depriving Shook of the requisite percentage of stock
necessary for “control” of S & W immediately after the exchange.
Respondent, on the other hand, maintains that the agreement between Shook and Wilson did
not deprive Shook of ownership of the shares immediately after the exchange, as the stock
purchase agreement merely gave Wilson an option to purchase the shares. Shook accordingly
was in “control” of the corporation and the exchange was thus nontaxable under section 351.
A determination of “ownership,” as that term is used in section 368(c) and for purposes of
control under section 351, depends upon the obligations and freedom of action of the
transferee with respect to the stock when he acquired it from the corporation. Such traditional
ownership attributes as legal title, voting rights, and possession of stock certificates are not
conclusive. If the transferee, as part of the transaction by which the shares were acquired, has
irrevocably foregone or relinquished at that time the legal right to determine whether to keep
the shares, ownership in such shares is lacking for purposes of section 351.
By contrast, if there are no restrictions upon freedom of action at the time he acquired the
shares, it is immaterial how soon thereafter the transferee elects to dispose of his stock or
whether such disposition is in accord with a preconceived plan not amounting to a binding
obligation.
Thus, Shook and Wilson intended to consummate a sale of the S & W stock, that they never
doubted that the sale would be completed, that the sale was an integral part of the
incorporation transaction, and that they considered themselves to be co-owners of S & W
upon execution of the stock purchase agreement in 1964. These conclusions are supported by
minutes of the first stockholders meeting at which Shook characterized the agreement for sale
as a “sale”; minutes of a special meeting, at which Shook stated Wilson was to “purchase” half
of Shook’s stock; the “Agreement for Sale and Purchase of Stock” itself, which is drawn as an
installment sale and which provides for payment of interest on unpaid principal;
Wilson’s deduction of interest expenses in connection with the agreement for sale, which
would be inconsistent with an option; the S & W loan agreement, in which Shook and Wilson
held themselves
156 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
out as the “principal stockholders” of S & W and in which S & W covenanted to equally insure
Shook and Wilson for $100,000; the stock purchase agreement with S & W, which indicated
that Shook
and Wilson “are to remain equal”shareholders in S & W; the letter Shook and Wilson to
Intermountain, which indicated that Wilson owed Shook the principal balance due on the
shares as an unpaid obligation; and all surrounding facts and circumstances leading to
corporate formation and execution of the above documents. Inconsistent and self-serving
testimony of Shook and Wilson regarding their intent and understanding of the documents
in evidence is unpersuasive in view of the record as a whole to alter interpretation of the
transaction as a sale of stock by Shook to Wilson.
Respondent’s contention cannot be accepted, that the substance varied from the form of
this transaction, which was, of course, labeled a “sale.” The parties executed an “option”
agreement on the same day that the “agreement for sale” was executed, and we have no doubt
that they could and indeed did correctly distinguish between a sale and an option.
The agreement for sale’s forfeiture clause, which provided that Wilson forfeited the right to
purchase a proportionate number of shares for which timely principal payments were not
made, did not convert it into an option agreement. Furthermore, the agreement for sale made
no provision for forgiving interest payments on the remaining principal due should principal
payments not be made on earlier dates.
Thus, Shook, as part of the same transaction by which the shares were acquired (indeed, the
agreement for sale was executed before the sawmill was deeded to S & W), had relinquished
when he acquired those shares the legal right to determine whether to keep them. Shook was
under an obligation, upon receipt of the shares, to transfer the stock as he received Wilson’s
principal payments.
The agreement for sale gave Wilson the right to prepay principal and receive all 182 shares at
any time in advance. Shook therefore did not own, within the meaning of section 368(c), the
requisite percentage of stock immediately after the exchange to control the corporation as
required for nontaxable treatment under section 351.
The basic premise of section 351 is to avoid recognition of gain or loss resulting from transfer
of property to a corporation which works a change of form only.
Petitioner wins.
b. STATUTORY MERGER OR CONSOLIDATION
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(6) Definitions. -
(a) The term "securities" means bonds and debentures but not "notes" of whatever class or
duration.
(b) The term "merger" or "consolidation", when used in this Section, shall be understood to
mean: (i) the ordinary merger or consolidation, or (ii) the acquisition by one corporation of all
or substantially all the properties of another corporation solely for stock: Provided, That for a
transaction to be regarded as a merger or consolidation within the purview of this Section, it
must be undertaken for a bona fide business purpose and not solely for the purpose of
escaping the burden of taxation: Provided, further, That in determining whether a bona fide
business purpose exists, each and every step of the transaction shall be considered and the
whole transaction or series of transaction shall be treated as a single unit: Provided, finally ,
That in determining whether the property transferred constitutes a substantial portion of the
property of the transferor, the term 'property' shall be taken to include the cash assets of the
transferor.
SEC. 40(C)(2)(a),(b),(c)
CIR v. RUFINO
DOCTRINE:
 The criterion laid down by the law is that the merger "must be undertaken for a bona
fide" business purpose and not solely for the purpose of escaping the burden of
taxation.
 Where stocks for stocks were exchanged, and distributed to the stockholders of the
corporations, parties to the merger or consolidation, pursuant to a plan of
reorganization, such exchange is exempt from capital gains tax
FACTS:
 These were originally four cages involving appeals from the decision of the
Commissioner of Internal Revenue, holding the said respondents, liable for deficiency
income tax, surcharge and interest in the sums of P44,294.88, P27,229.44, P58,082.60
and P58,074.24, respectively, for the year 1959.
 The private respondents were the majority stockholders of the defunct Eastern
Theatrical Co., Inc., a corporation organized in 1934, for a period of twenty-five years
terminating on January 25, 1959. It had an original capital stock of P500,000.00, which
was increased in 1949 to P2,000,000.00, divided into 200,000 shares at P10.00 per
share, and was organized to engage in the business of operating theaters, opera
houses, places of amusement and other related business enterprises, more particularly
the Lyric and Capitol Theaters in Manila. The President of this corporation (hereinafter
referred to as the Old Corporation) during the year in question was Ernesto D. Rufino.
 The private respondents are also the majority and controlling stockholders of another
corporation, the Eastern Theatrical Co Inc., which was organized on December 8, 1958,
for a term of 50 years, with an authorized capital stock of P200,000.00, each share
having a par value of P10.00. This corporation is engaged in the same kind of business
as the Old Corporation. The General-Manager of this corporation (hereinafter referred
to as the New Corporation) at the time was Vicente A. Rufino.
 In a special meeting of stockholders of the Old Corporation a resolution was passed
authorizing the Old Corporation to merge with the New Corporation by transferring its
business, assets, goodwill, and liabilities to the latter, which in exchange would issue
and distribute to the shareholders of the Old Corporation one share for each share held
by them in the said Corporation.
 Pursuant to the said resolution, the Old Corporation, represented by Ernesto D. Rufino
as President, and the New Corporation, represented by Vicente A. Rufino as General
Manager, signed a Deed of Assignment providing for the conveyance and transfer of all
the business, property, assets and goodwill of the Old Corporation to the New
Corporation in exchange for the latter's shares of stock to be distributed among the
shareholders on the basis of one stock for each stock held in the Old Corporation;
 The assumption by the New Corporation of all obligations and liabilities of the Old
Corporation under its bargaining agreement with the Cinema Stage & Radio
Entertainment Free Workers (FFW) which included the retention of all personnel in
the latter's employ; and the increase of the capitalization of the New Corporation in
157 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
compliance with their agreement. This agreement was made retroactive to January
1, 1959.
 It was this above-narrated series of transactions that the Bureau of Internal Revenue
examined later, resulting in the petitioner declaring that the merger of the aforesaid
corporations was not undertaken for a bona fide business purpose but merely to avoid
liability for the capital gains tax on the exchange of the old for the new shares of stock.
 Accordingly, he imposed the deficiency assessments against the private respondents
for the amounts already mentioned. The private respondents' request for
reconsideration having been denied, they elevated the matter to the Court of Tax
Appeals, which reversed the petitioner.
ISSUE/S:
Whether or not that there was a valid merger between the Old Corporation and the New
Corporation. YES
RATIO:
 In view of the foregoing, we are of the opinion and so hold that no taxable gain was
derived by petitioners from the exchange of their old stocks solely for stocks of the New
Corporation pursuant to Section 35(c) (2), in relation to (c) (5), of the National Internal
Revenue Code, as amended by Republic Act 1921. [read SEC. 35(c) (2)]
PETITIONER’S CONTENTION: In support of its position that the Deed of Assignment was
concluded by the private respondents merely to evade the burden of taxation, the petitioner
points to the fact that the New Corporation did not actually issue stocks in exchange for the
properties of the Old Corporation at the time of the supposed merger on January 9, 1959. The
exchange, he says, was only on paper. The increase in capitalization of the New Corporation
was registered with the Securities and Exchange Commission 37 days after the Old
Corporation expired. Consequently, as there was no merger, the automatic dissolution of the
Old Corporation on its expiry date resulted in its liquidation, for which the respondents are
now liable in taxes on their capital gains.
RESPONDENT’S CONTENTION: There was a genuine merger between the Old Corporation
and the New Corporation pursuant to a plan aimed at enabling the latter to continue the
business of the former in the operation of places of amusement, specifically the Capitol and
Lyric Theaters. The plan was evolved through the series of transactions above narrated, all of
which could be treated as a single unit in accordance with the requirements of Section 35.
 Obviously, all these steps did not have to be completed at the time of the merger, as there
were some of them, such as the increase and distribution of the stock of the New
Corporation, which necessarily had to come afterwards.
 Contrary to the claim of the petitioner, there was a valid merger although the actual
transfer of the properties subject of the Deed of Assignment was not made on the date of
the merger.
 The Court finds no impediment to the exchange of property for stock between the two
corporations being considered to have been effected on the date of the merger. That, in
fact, was the intention, and the reason why the Deed of Assignment was made retroactive
to January 1, 1959. Such retroaction provided in effect that all transactions set forth in
the merger agreement shall be deemed to be taking place simultaneously on January 1,
1959, when the Deed of Assignment became operative.
 The certificates of stock subsequently delivered by the New Corporation to the
private respondents were only evidence of the ownership of such stocks.
 The basic consideration, of course, is the purpose of the merger, as this would determine
 whether the exchange of properties involved therein shall be subject or not to the capital
gains tax. The criterion laid down by the law is that the merger" must be undertaken for a
bona fide business purpose and not solely for the purpose of escaping the burden of
taxation." We must therefore seek and ascertain the intention of the parties; we see no
such furtive intention in the instant case.
 It is clear, in fact, that the purpose of the merger was to continue the business of the Old
Corporation, whose corporate life was about to expire, through the New Corporation to
which all the assets and obligations of the former had been transferred. What argues
strongly, indeed, for the New Corporation is that it was not dissolved after the merger
agreement in 1959. On the contrary, it continued to operate the places of amusement
originally owned by the Old Corporation and transferred to the New Corporation,
particularly the Capitol and Lyric Theaters, in accordance with the Deed of Assignment.
 By this decision, the government is, of course, not left entirely without recourse, at least
in the future. The fact is that the merger had merely deferred the claim for taxes, which
may be asserted by the government later, when gains are realized and benefits are
distributed among the stockholders as a result of the merger. In other words, the
corresponding taxes are not forever foreclosed or forfeited but may at the proper time
and without prejudice to the government still be imposed upon the private respondents,
in accordance with Section 35(c) (4) of the Tax Code. The only inhibition now is that time
has not yet come.
 The reason for this conclusion is traceable to the purpose of the legislature in adopting
the provision of law in question:
“The exemption from the tax of the gain derived from exchanges of stock solely for stock of
another corporation resulting from corporate mergers or consolidations under the above
provisions, as amended, was intended to encourage corporations in pooling, combining or
expanding their resources conducive to the economic development of the country.”
c. TRANSFER OF “SUBSTANTIALLY ALL” THE ASSETS (DE FACTO MERGER)
SEC. 40(C)(6)(a),(b)
SEC. 40(C)(2)(a),(b),(c)
BIR RUL. 19-97
DOCTRINE:
No gain or loss shall be recognized in pursuance of a plan of merger or consolidation with a
bona fide business purpose and not solely for the purpose of escaping the burden of taxation.
FACTS:
- Gothong Lines, Aboitiz Shipping and WG&A are domestic corporations and are all
authorized to engage in the shipping business.
- In order to achieve several benefits (optimization of resources, increase financial
strength, better serve the market) in line with their common business purposes they
agreed to enter into a reorganization/merger whereby Gothong Lines and Aboitiz
Shipping will transfer substantially all (more than 80%) of their assets in exchange for
WG&A shares of stock.
ISSUE: W/N gain/loss shall be recognized on the transfer of properties in pursuit of a de facto
merger
RULING: NO. Pursuant to Section 34 paragraphs (c)(2) & (6)(b) of the Tax Code, as amended
no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation
158 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
— (a) 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 and, (b) 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. The
term "merger" or "consolidation" shall be understood to mean: (1) the ordinary merger or
consolidation or (2) the acquisition by one corporation of all or substantially all the
properties of another corporation solely for stock: Provided, That for a transaction to be
regarded as merger or consolidation within the purview of this section, it must be undertaken
for a bona fide business purpose and not solely for the purpose of escaping the burden of
taxation: Provided further, That in determining whether a bona fide business purpose exists
each and every step of the transaction shall be considered and the whole transaction or series
of transactions shall be treated as a single unit: Provided finally, That in determining whether
the property transferred constitutes a substantial portion of the property of the transferor,
the term "property" shall be taken to include the cash assets of the transferor.
In addition, "substantially all" was defined in BIR General Circular No. V-253 dated July 16,
1957 to mean "the acquisition by one corporation of at least 80% of the assets, including cash,
of another corporation," which "has the element of permanence and not merely momentary
holding."
REVENUE MEMORANDUM RULING NO. 01-02
Tax Consequences of De Facto Merger Pursuant to Section 40(C)(2) and (6)(b) of the NIRC of
1997
V. Facts
8. A domestic corporation (the "Transferor") owns certain property, consisting, for
example, of the following:
8.1 Land encumbered by a real estate mortgage (REM);
8.2 Buildings;
8.3 100 shares of stock in G Corporation with a par value of P10 per share;
8.4 50 shares of stock in D Corporation without par value;
8.5 Unsecured receivables;
8.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;
8.7 Cash.
9. The property transferred by the Transferor constitutes at least 80% of the Transferor's
assets, including cash.
10. The Transferor transfers the property to the Transferee. In exchange, the Transferee
issues shares to the Transferor out of the unissued portion of its existing authorized
capital stock, or, if such existing authorized capital stock is insufficient, out of shares from
an increase in the Transferee's authorized capital stock. The Transferor does not receive
any money or property other than the aforementioned shares of the transferee.
11. In addition to the transfer of the property, the Transferee assumes liabilities of the
Transferor. However, the sum total of the amount of liabilities assumed, plus the amount
of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of
1997 — "liabilities to which the property is subject") do not exceed the basis of the
property transferred.
VI. GENERAL PRINCIPLES
1. A de facto merger involves the acquisition by one corporation of all or substantially all
the properties of another solely for stock. Section 40(C)(6)(b) of the Tax Code of 1997
states:
"The term "merger" or "consolidation," when used in this Section, shall be
understood to mean: (i) the ordinary merger or consolidation; or (ii) the acquisition
by one corporation of all or substantially all the properties of another corporation
solely for stock: Provided, That for a transaction to be regarded as a merger or
consolidation within the purview of this Section, it must be undertaken for a bona
fide business purpose and not solely for the purpose of escaping the burden of
taxation: Provided, further, That in determining whether a bona fide business
purpose exists, each and every step of the transaction shall be considered and the
whole transaction or series of transactions shall be treated as a single unit: Provided,
finally, That in determining whether the property transferred constitutes a substantial
portion of the property of the transferor, the term "property" shall be taken to include
the cash assets of the transferor."
The phrase "substantially all the properties of another corporation" is defined in BIR General
Circular No V-253 dated July 16, 1957 to mean "the acquisition by one corporation of at least
80% of the assets, including cash, of another corporation," which 'has the element of
permanence and not merely momentary holding'.
To constitute a de facto merger, the following elements must concur: (1) there must be a
transfer of all or substantially all of the properties of the transferor corporation solely for
stock, and (2) it must be undertaken for a bona fide business purpose and not solely for the
purpose of escaping the burden of taxation.
One basic difference between a de facto merger and a statutory merger is that the Transferor
is not automatically dissolved in the case of the former. Likewise, there is no automatic
transfer to the Transferee of all the rights, privileges, and liabilities of the Transferor. It is, in
fact, in procedure, similar to a transfer to a controlled corporation under the same Section
40(C)(2) of the Tax Code of 1997, except that at least 80% of the Transferor's assets, including
cash, are transferred to the Transferee, with the element of permanence and not merely
momentary holding. However, a de facto merger and a transfer to a controlled corporation are
different in that, (1) the Transferor in a de facto merger is a corporation, while in a transfer to
a controlled corporation, the Transferors may either be a corporation or an individual, and (2)
in a de facto merger, there is no requirement that the transferor gains control (that is, 51% of
the total voting powers of all classes of stocks of the Transferee entitled to vote) of the
Transferee as a prerequisite to enjoying the benefit of non-recognition of gain or loss. What is
essential in a de facto merger is that the Transferee acquires all or substantially all of the
properties of the Transferor.
VII. TAX CONSEQUENCES
5. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the
property to the Transferee. Consequently, the Transferor will not be subject to capital
gains tax, income tax, nor to creditable withholding tax on the transfer of such property
to the Transferee. Neither may the Transferor recognize a loss, if any, incurred on the
transfer.
"(4) Assumption of liability. —
(a) If the taxpayer, in connection with the exchanges described in the foregoing
exceptions, receives stock or securities which would be permitted to be received
without the recognition of the gain if it were the sole consideration, and as a part of the
consideration, another party to the exchange assumes a liability of the taxpayer, or
acquires from the taxpayer property, subject to a liability, then such assumption or
acquisition shall not be treated as money and/or other property, and shall not prevent
the exchange from being within the exceptions.
(b) If the amount of the liabilities assumed plus the amount of the liabilities to which
the property is subject exceed the total amount of the adjusted basis of the property
transferred pursuant to such exchange, then such excess shall be considered as a gain
from the sale or exchange of a capital asset or of property which is not a capital asset,
as the case may be."
Moreover, the Transferee is not subject to income tax on its receipt of the property as
contribution to its capital, even if the value of such property exceeds the par value or
stated value of the shares issued to the Transferor: Section 55 of Revenue Regulations
No. 2 ("Income Tax Regulations") states:
"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . .
The receipt by a corporation of the subscription price of shares of its capital stock
upon their original issuance gives rise to neither taxable gain nor deductible loss,
whether the subscription or issue price be in excess of, or less than the par or stated
value of such stock.
However, stocks shall not be issued for a consideration less than par or issued price
thereof. (Section 62, Corporation Code of the Philippines)
6. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value
of the property transferred exceeds the par/stated value of the Transferee shares issued
to the Transferor, there being no intent to donate on the part of the Transferor.
7. Value-added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer
of the property if it is not engaged in a business that is subject to the VAT under Title IV
of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to
VAT, it is nonetheless not subject to VAT on the transfer of the property to the
Transferee. Section 4.100-5(b)(1) & (3) of Revenue Regulations No. 7-95, as amended
states:
"(b) Not subject to output tax. — The VAT shall not apply to goods or properties
existing as of the occurrence of the following:
1) Change of control of a corporation by the acquisition of the controlling interest of
such corporation by another stockholder or group of stockholders, Example: transfer
of property to a corporation in exchange for its shares of stock under Section 34(c)(2)
and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].
3) Merger or consolidation of corporations. The unused input tax of the dissolved
corporation as of the date of merger or consolidation shall be absorbed by the
surviving or new corporation."

In addition, the assumption of liabilities or the transfer of property that is subject to a
liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the
Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed
the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:
159 TAXATION 1 (ATTY. BELLO)
Thus, since a de facto merger is considered within the definition of a merger under
Section 40(C)(6) of the Tax Code of 1997, the transfer of the property by the Transferor
to the Transferee shall not be subject to VAT. However, the second sentence of Section
4.100-5(b)(3), supra, is inapplicable in de facto mergers, and therefore, the Transferor's
unused input tax cannot be absorbed by or transferred to the Transferee. The above
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 sentence contemplates only a statutory merger or consolidation that, by operation of law,
results in a "dissolved corporation" and a "surviving or new corporation". Furthermore,
pursuant to Section 80 of the Corporation Code of the Philippines, the unused input tax,
being an asset, is transferred in statutory merger by operation of law.
8. Documentary stamp tax. The documentary stamp tax consequences of the transfer are as
follows:
8.1 Either the Transferor or the Transferee is subject to documentary stamp tax as
follows:
8.1.1 On the transfer of real property (Section 196, Tax Code of 1997) — P15 on
each P1,000 or fractional part thereof, based on the higher of: (i) the
consideration contracted to be paid for such real property, and (ii) the fair
market value as determined in accordance with Section 6(E) of the Tax Code
of 1997.
8.1.1.1 The "consideration contracted to be paid for such real property" shall
be computed in accordance with the following rules. "Stock in a
corporation is a valuable consideration for the transfer of real
property." (Section 177, Revenue Regulations No. 26) Therefore, the
consideration for the real property shall be computed as the
par/stated value of the Transferee shares issued to the Transferor in
exchange for such property plus the value of such property in excess
of such par/stated value recognized in the books of the Transferee as
premium, additional capital contribution, or donated surplus, or the
like. For instance, if the value of the property is P1,000,000, but only
shares with an aggregate par value of P250,000 are issued, there
being a premium above par of P750,000, which the Transferee
records as additional capital contribution, donated surplus, or the
like, the consideration is P1,000,000 (that is, par value of P250,000 +
premium of P750,000).
8.1.1.2 On the other hand, the fair market value of the property as
determined in accordance with Section 6(E) of the Tax Code of 1997
whichever is higher between (1) the fair market value as determined
by the Commissioner (that is, zonal value), and (2) the fair market
value as shown in the schedule of values of the Provincial and City
Assessors.
8.1.1.3 The value of the improvements thereon shall be based on the formula
provided under Revenue Audit Memorandum Order (RAMO) No. 1-
2001 but shall not be lower than the fair market value in the Tax
Declaration in the year of exchange.
According to the said RAMO, the value of the improvement shall be
determined by deducting the zonal value of the land from the total
selling price/consideration per Deed of Exchange. Thus, if the total
selling price/consideration per Deed of Exchange is P1,000,000.00
and the zonal value of the land is P600,000.00, then the value of the
improvement is P400,000.00.
The fair market value of the improvement shall be determined per
latest tax declaration at the time of its sale or disposition (in this
particular case, the exchange of such property). If the tax declaration
was issued three (3) or more years prior to the date of sale or
160 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
disposition, the Transferor shall be required to submit a certification
from the city/municipal assessor as to the fact that such tax
declaration is the latest tax declaration covering the real property.
Absent such certification; the Transferor must secure a copy of the
latest tax declaration duly certified by the assessor.
8.1.2 On the transfer of shares of stock held by the Transferor (Section 176, Tax Code
of 1997) —
8.1.2.1 The transfer of the shares of G Corporation, which have a par value, is
subject to documentary stamp tax of P1.50 on each P200 or fractional
part thereof of the par value of such shares.
8.1.2.2 The transfer of the shares of D Corporation, which are without par
value, is subject to the documentary stamp tax of 25% of the
documentary stamp tax that was paid when those shares were
originally issued.
8.1.3 Transferee is subject to documentary stamp tax on the original issuance of its
shares (Section 175, Tax Code of 1997), at the following rate, depending on
whether such shares are par or no-par shares:
8.1.4 If the Transferee's shares are with par value, the documentary stamp tax is
imposed at the rate of P2 on each P200 or fractional part thereof of the par
value of such shares, regardless of whether the shares are issued at par value
or for a premium (that is, for a consideration in excess of par value).
8.1.5 If the Transferee's shares are without par value, the documentary stamp tax
is imposed at the rate of P2 on each P200 or fractional part thereof of the
actual consideration paid for such shares.
9. Time of payment of Documentary Stamp Taxes. The time for the payment of the
documentary stamp tax liabilities, whether the taxpayer is an e-filer or not, shall be as
follows:
9.1 With respect to the transfer of property mentioned in 4.1 above, the documentary
stamp tax shall be paid on or before the fifth (5th) day after the close of the month
when the deed of assignment/transfer transferring such property was executed;
made, signed, accepted, or transferred (Section 5, Revenue Regulations No. 6-2001).
9.2 With respect to the original issuance of shares mentioned in 4.2, above, the
documentary stamp tax shall be paid on or before the fifth (5th) day after the close
of the month of —
9.2.1 Approval of SEC registration, in case of original incorporation;
9.2.2 Approval of the increase in authorized capital stock, in case the shares
issued to the Transferor come from the increase in authorized capital stock
of the Transferee; or
9.2.3 Execution of the deed of assignment/transfer of the property for which the
Transferee's shares are issued, in case the shares issued to the Transferor
come from the unissued portion of the Transferee's existing authorized
capital stock.
VIII. ADDITIONAL FACTS AND VARIATIONS NOT AFFECTING TAX CONSEQUENCES
The following additional facts or variations will not affect the tax consequences of the
transaction, as described above:
1. In no. 1 of "I. Facts" stated above, the total number of Transferors in a de facto merger is
not relevant in determining whether it qualifies for non-recognition of gain or loss.
However, non-recognition of gain or loss will apply to the Transferors that meet the
requirements for a de facto merger described in "II. General Principles".
2. In no. 3 of "I. Facts" stated above, the shares issued by the Transferee may either be
voting or non-voting stocks since the voting requirement applies only to a transfer to a
controlled corporation, pursuant to Section 40(C)(2) in relation to 40(C)(6)(c) of the Tax
Code of 1997.
3. The tax consequences are not affected by whether the Transferor is/was a shareholder
prior to the transaction.
4. Paragraph IV(4) & (5) of Revenue Memorandum Ruling 1-2001 dated November 29,
2001, which discuss the tax basis of property and shares involved in a merger,
consolidation or transfer to a controlled corporation, are hereby reproduced and adopted
by reference in this Revenue Memorandum Ruling.
IX. FURTHER CLARIFICATION OF FACTS AND TAX CONSEQUENCES
8. No. 1 of "I. Facts" mentions "property". For purposes of Section 40(C)(2) of the Tax Code
of 1997, this term excludes services, accounts receivable for services rendered by the
Transferor for the Transferee, cash and the conversion of debt into equity.
9. No. 2 of "I. Facts" mentions the property transferred constituting "at least 80% of the
Transferor's assets, including cash". This distinguishes this transaction from a transfer to
a controlled corporation as described in Section 40(C)(2) of the Tax Code of 1997 and
Revenue Memorandum Ruling No. 1-2001 dated November 29, 2001.
10. No. 3 of "I. Facts" mentions the issuance of the Transferee's shares from the "unissued
portion of its existing authorized capital stock, or, if such existing authorized capital stock
is insufficient, out of shares from an increase in the Transferee's authorized capital
stock". This statement of fact excludes the following, which if present, would give rise to a
different tax consequence treated elsewhere other than in this Revenue Memorandum
Ruling —
10.1 The issuance of treasury shares, which have previously been issued but were
subsequently re-acquired by the Transferee and have not been retired.
10.2 Settlement of subscription receivables. Therefore, the tax consequences described
above shall not apply to the extent that the property is transferred in payment for
the unpaid balance of the subscription to shares.
d. EXCHANGE NOT SOLELY IN KIND (BOOT)
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(3) Exchange Not Solely in Kind. –
(a) If, in connection with an exchange described in the above exceptions, an individual, a
shareholder, a security holder or a corporation receives not only stock or securities permitted
to be received without the recognition of gain or loss, but also money and/or property, the
gain, if any, but not the loss, shall be recognized but in an amount not in excess of the sum of
the money and fair market value of such other property received: Provided, That as to the
161 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
shareholder, if the money and/or other property received has the effect of a distribution of a
taxable dividend, there shall be taxed as dividend to the shareholder an amount of the gain
recognized not in excess of his proportionate share of the undistributed earnings and profits
of the corporation; the remainder, if any, of the gain recognized shall be treated as a capital
gain.
(b) If, in connection with the exchange described in the above exceptions, the transferor
corporation receives not only stock permitted to be received without the recognition of gain
or loss but also money and/or other property, then (i) if the corporation receiving such money
and/or other property distributes it in pursuance of the plan of merger or consolidation, no
gain to the corporation shall be recognized from the exchange, but (ii) if the corporation
receiving such other property and/or money does not distribute it in pursuance of the plan of
merger or consolidation, the gain, if any, but not the loss to the corporation shall be
recognized but in an amount not in excess of the sum of such money and the fair market value
of such other property so received, which is not distributed.
e. ASSUMPTION OF LIABILITY IN TAX-FREE EXCHANGES
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(4) Assumption of Liability. –
(a) If the taxpayer, in connection with the exchanges described in the foregoing exceptions,
receives stock or securities which would be permitted to be received without the recognition
of the gain if it were the sole consideration, and as part of the consideration, another party to
the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property,
subject to a liability, then such assumption or acquisition shall not be treated as money and/or
other property, and shall not prevent the exchange from being within the exceptions.
(b) If the amount of the liabilities assumed plus the amount of the liabilities to which the
property is subject exceed the total of the adjusted basis of the property transferred pursuant
to such exchange, then such excess shall be considered as a gain from the sale or exchange of a
capital asset or of property which is not a capital asset, as the case may be.
f. CARRY-OVER/SUBSTITUTED BASIS IN TAX-FREE EXCHANGES
SEC. 40. Determination of Amount and Recognition of Gain or Loss. -
(C) Exchange of Property. –
(5) Basis –
(a) The basis of the stock or securities received by the transferor upon the exchange specified
in the above exception shall be the same as the basis of the property, stock or securities
exchanged, decreased by (1) the money received, and (2) the fair market value of the other
property received, and increased by (a) the amount treated as dividend of the shareholder
and (b) the amount of any gain that was recognized on the exchange: Provided, That the
property received as "boot" shall have as basis its fair market value: Provided, further, That if
as part of the consideration to the transferor, the transferee of property assumes a liability of
the transferor or acquires form the latter property subject to a liability, such assumption or
acquisition (in the amount of the liability) shall, for purposes of this paragraph, be treated as
money received by the transferor on the exchange: Provided, finally, That if the transferor
receives several kinds of stock or securities, the Commissioner is hereby authorized to
allocate the basis among the several classes of stocks or securities.
(b) The basis of the property transferred in the hands of the transferee shall be the same as it
would be in the hands of the transferor increased by the amount of the gain recognized to the
transferor on the transfer.
REVENUE REGULATIONS NO. 18-01
SECTION 2. Basis. —
A. Substituted Basis of Stock or Securities Received by the Transferor. — The substituted basis
of the stock or securities received by the transferor on a tax-free exchange shall be as
follows:
1. The original basis of the property, stock or securities to be transferred;
2. Less: (a) money received, if any, and (b) the fair market value of the other property
received, if any;
3. Plus: (a) the amount treated as dividend of the shareholder, if any, and (b) the amount
of any gain that was recognized on the exchange, if any.
However, the property received as 'boot' shall have as basis its fair market value. The term
"boot" refers to the money received and other property received in excess of the stock or
securities received by the transferor on a tax-free exchange.
If the transferee of property assumes, as part of the consideration to the transferor, a liability
of the transferor or acquires from the latter property subject to a liability, such assumption or
acquisition (in the amount of the liability) shall, for purposes of computing the substituted
basis, be treated as money received by the transferor on the exchange.
Finally, if the transferor receives several kinds of stock or securities, the Commissioner is
authorized to allocate the basis among the several classes of stocks or securities.
B. Substituted Basis of the Transferred Property in the Hands of the Transferee. The substituted
basis of the property transferred in the hands of the transferee shall be as follows:
increased by the amount of improvements that materially add to the value of the
property or appreciably prolong its life less accumulated depreciation.
(f) The substituted basis, if the property was acquired in a previous tax-free exchange
under Section 40(C)(2) of the Tax Code of 1997.
D. Basis for Determining Gain or Loss on a Subsequent Sale or Disposition of Property Subject of
the Tax-free Exchange.
The substituted basis as defined in Section 40(C)(5) of the Tax Code of 1997, and
implemented in Section 2.A and 2.B above, shall be the basis for determining gain or loss on a
subsequent sale or disposition of property subject of the tax-free exchange.
g. BUSINESS PURPOSE
GREGORY V. HELVERING`
DOCTRINE:
Although tax avoidance is allowed, it cannot be done beyond the intent of the statute.
FACTS:
- Gregory was the owner of all the stock of United Mortgage Corp. That corporation held
among its assets 1,000 shares of the Monitor Securities Corp.
- For the sole purpose of procuring a transfer of the Monitor shares to herself in order to
sell them for her individual profit, and, at the same time, diminish the amount of income
tax which would result from a direct transfer by way of dividend, she sought to bring
about a 'reorganization' under section 112(g) of the Revenue Act of 1928.
- To that end, she caused the Averill Corporation to be organized under the laws of
Delaware on September 18, 1928.
- Three days later, the United Mortgage Corporation transferred to the Averill Corporation
the 1,000 shares of Monitor stock, for which all the shares of the Averill Corporation
were issued to the petitioner.

(a) the original basis in the hands of the transferor;
(b) Plus: the amount of the gain recognized to the transferor on the transfer.
C. The Original Basis of Property to be Transferred. The original basis of the property to be
transferred shall be the following, as may be appropriate:
(a) The cost of the property, if acquired by purchase on or after March 1, 1913;
(b) The fair market price or value as of the moment of death of the decedent, if acquired
by inheritance;
(c) The basis in the hands of the donor or the last preceding owner by whom the
property was not acquired by gift, if the property was acquired by donation.
If the basis, however, is greater than the fair market value of the property at the
time of donation, then, for purposes of determining loss, the basis shall be such fair
market value; or,
(d) The amount paid by the transferee for the property, if the property was acquired for
less than an adequate consideration in money or money's worth.
(e) The adjusted basis of (a) to (d) above, if the acquisition cost of the property is
162 TAXATION 1 (ATTY. BELLO)
- On September 24 (6 days after being organized), the Averill Corporation was dissolved,
and liquidated by distributing all its assets, namely, the Monitor shares, to the petitioner.
No other business was ever transacted, or intended to be transacted, by that company.
- Petitioner immediately sold the Monitor shares for $133,333. 33. She returned for
taxation, as capital net gain, the sum of $76,007.88, based upon an apportioned cost of
$57,325.45.
ISSUE: W/N the reorganization was ineffective thus making Gregory liable for higher taxes
(tax on dividends)
RULING: YES. While the plan conformed to the terms of the statute, there was no
reorganization within the intent of the statute.
Section 112 of the Revenue Act of 1928 deals with the subject of gain or loss resulting from
the sale or exchange of property. Such gain or loss is to be recognized in computing the tax,
except as provided in that section.
“Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a
plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock
or securities in such corporation or in another corporation a party to the reorganization,
without the surrender by such shareholder of stock or securities in such a corporation, no gain
to the distributee from the receipt of such stock of securities shall be recognized. . . ."
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of its
assets to another corporation if immediately after the transfer the transferor or its stockholders
or both are in control of the corporation to which the assets are transferred. . . ."
When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a
transfer made "in pursuance of a plan of reorganization" of corporate business, and not a
transfer of assets by one corporation to another in pursuance of a plan having no relation to
the business of either, as plainly is the case here.
The whole undertaking, though conducted according to the terms of subdivision (B), was in
fact an elaborate and devious form of conveyance masquerading as a corporate
reorganization, and nothing else. The rule which excludes from consideration the motive of
tax avoidance is not pertinent to the situation, because the transaction, upon its face, lies
outside the plain intent of the statute.
3. LOSSES FROM WASH SALES OF STOCKS OR SECURITIES
SEC. 38. Losses from Wash Sales of Stock or Securities. -
(A) In the case of any loss claimed to have been sustained from any sale or other disposition of
shares of stock or securities where it appears that within a period beginning thirty (30) days
before the date of such sale or disposition and ending thirty (30) days after such date, the
taxpayer has acquired (by purchase or by exchange upon which the entire amount of gain or
loss was recognized by law), or has entered into a contact or option so to acquire,
substantially identical stock or securities, then no deduction for the loss shall be allowed
under Section 34 unless the claim is made by a dealer in stock or securities and with respect
to a transaction made in the ordinary course of the business of such dealer.
(B) If the amount of stock or securities acquired (or covered by the contract or option to
acquire) is less than the amount of stock or securities sold or otherwise disposed of, then the
particular shares of stock or securities, the loss form the sale or other disposition of which is
not deductible, shall be determined under rules and regulations prescribed by the Secretary of
Finance, upon recommendation of the Commissioner.
(C) If the amount of stock or securities acquired (or covered by the contract or option to
acquire which) resulted in the non-deductibility of the loss, shall be determined under rules
and regulations prescribed by the Secretary of Finance, upon recommendation of the
Commissioner.
REV. REGS. NO. 2
SECTION 131. Losses from wash sales of stock or securities. — (a) A taxpayer cannot deduct
any loss claimed to have been sustained from the sale or other disposition of stock or
securities, if, within a period beginning thirty days before the date of such sale or disposition
and ending thirty days after such date (referred to in this section as the sixty-one-day period),
he has acquired (by purchase or by an exchange upon which the entire amount of gain or loss
was recognized by law), or has entered into a contract or option so to acquire, substantially
identical stock or securities. However, this prohibition does not apply in the case of a dealer in
stock or securities if the sale or other disposition of stock or securities is made in the ordinary
course of its business as such dealer.
(b) Where more than one loss is claimed to have been sustained within the taxable year from
the sale or other disposition of stock or securities, the provisions of this section shall be
applied to the losses in the order in which the stock or securities the disposition of which
resulted in the respective losses were disposed of (beginning with the earliest disposition). If
the order of disposition of stock or securities disposed of at a loss on the same day cannot be
163 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
determined, the stock or securities will be considered to have been disposed of in the order in
which they were originally acquired (beginning with earliest acquisition).
(c) Where the amount of stock or securities acquired within the sixty-one day period is less
than the amount of stock or securities sold or otherwise disposed of, then the particular
shares of stock or securities the loss from the sale or other disposition of which is not
deductible shall be those with which the stock or securities acquired are matched in
accordance with the following rule:
The stock or securities acquired will be matched in accordance with the order of their
acquisition (beginning with the earliest acquisition) with an equal number of the shares of
stock or securities sold or otherwise disposed of.
(d) Where the amount of stock or securities acquired within the sixty one-day period is not
less than the amount of stock or securities sold or otherwise disposed of, then the particular
shares of stock or securities the acquisition of which resulted in the nondeductibility of the
loss shall be those with which the stock or securities disposed of are matched in accordance
with the following rule:
The stock or securities sold or otherwise disposed of will be matched with an equal number of
the shares of stock or securities acquired in accordance with the order of acquisition
(beginning with the earliest acquisition) of the stock or securities acquired.
(e) The acquisition of any security which results in the non-deductibility of a loss under the
provisions of this section shall be disregarded in determining the deductibility of any other
loss.
(f) The word "acquired" as used in this section means acquired by purchase or by an exchange
upon which the entire amount of gain or loss was recognized by law, and comprehends cases
where the taxpayer has entered into a contract or option within the sixty-one-day period to
acquire by purchase or by such an exchange.
EXAMPLE (1): A, whose taxable year is the calendar year, on December 1, 1939, purchased
100 shares of common stock in the M Company for P10,000 and on December 15, 1939,
purchased 100 additional shares for P9,000. On January 2, 1940, he sold the 100 shares
purchased on December 1, 1939, for P9,000. Because of the provisions of Section 33 no loss
from the sale is allowable as a deduction.
EXAMPLE (2): A, whose taxable year is the calendar year, on September 21, 1939, purchased
100 shares of the common stock of the M Company for P5,000. On December 21, 1939, he
purchased 50 shares of substantially identical stock for P2,750, and on December 26, 1939, he
purchased 25 additional shares of such stock for P1,125. On January 2, 1940, he sold for
P4,000 the 100 shares purchased on September 21, 1939. There is an indicated loss of P1,000
on the sale of the 100 shares. Since within the sixty-one-day period A purchased 75 shares of
substantially identical stock, the loss on the sale of 75 of the shares (P3,750 less P3,000, or
P750) is not allowable as a deduction because of the provisions of Section 33. The loss on the
sale of the remaining 25 shares (P1,250 less P1,000, or P250) is deductible subject to the
limitations provided in Sections 31(b) and 34. The basis of the 50 shares purchased December
21, 1939, the acquisition of which resulted in the non-deductibility of the loss (P500)
sustained on 50 of the 100 shares sold on January 2, 1940, is P2,500 (the cost of 50 of the
shares sold on January 2, 1940), plus P750 [the difference between the purchase price of the
50 shares acquired on December 21, 1939, (P2,750) and the selling price of 50 of the shares
sold on January 2, 1940 (P2,000)], or P3,250. Similarly the basis of the 25 shares purchased on
December 26, 1939, the acquisition of which resulted in the nondeductibility of the loss
(P250) sustained on 25 of the shares sold on January 2, 1940, is P1,250 plus P125, or P1,375.
(See Section 143 of these regulations.)
EXAMPLE (3): A, whose taxable year is the calendar year, on September 15, 1938, purchased
100 shares of the stock of the M Company for P5,000. He sold these shares on February 1,
1940, for P4,000. On each of the four days from February 15, 1940, to February 18, 1940, he
purchased 50 shares of substantially identical stock for P2,000. There is an indicated loss of
P1,000 from the sale of the 100 shares on February 1, 1940, but since within the sixty-one-day
period A purchased not less than 100 shares of substantially identical stock, the loss is not
deductible. The particular shares of stock the purchase of which resulted in the
nondeductibility of the loss are the first 100 shares purchased within such period, that is, the
50 shares purchased on February 15, 1940, and the 50 shares purchased on February 16,
1940.
(2) Dividends. - The amount received as dividends:.
(a) from a domestic corporation; and
(b) from a foreign corporation, unless less than fifty percent (50%) of the gross income of
such foreign corporation 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) was derived from sources within the Philippines as
determined under the provisions of this Section; but only in an amount which bears
the same ration to such dividends as the gross income of the corporation for such
period derived from sources within the Philippines bears to its gross income from all
sources.

XVI. SITUS OF TAXATION
SEC. 42. Income from Sources Within the Philippines. -
(B) Taxable Income From Sources Within the Philippines. –
(1) General Rule. - From the items of gross income specified in Subsection (A) of this Section,
there shall be deducted the expenses, losses and other deductions properly allocated thereto
and a ratable part of expenses, interests, losses and other deductions effectively connected
with the business or trade conducted exclusively within the Philippines which cannot
definitely be allocated to some items or class of gross income: Provided, That such items of
deductions shall be allowed only if fully substantiated by all the information necessary for its
calculation.
The remainder, if any, shall be treated in full as taxable income from sources within the
Philippines.
(2) Exception. - No deductions for interest paid or incurred abroad shall be allowed from the
item of gross income specified in subsection (A) unless indebtedness was actually incurred to
provide funds for use in connection with the conduct or operation of trade or business in the
Philippines.
(D) Taxable Income From Sources Without the Philippines. - From the items of gross
income specified in Subsection (C) of this Section there shall be deducted the expenses, losses,
and other deductions properly apportioned or allocated thereto and a ratable part of any
expense, loss or other deduction which cannot definitely be allocated to some items or classes
of gross income.
(3) Services. - Compensation for labor or personal services performed in the Philippines;
(4) Rentals and Royalties. - Rentals and royalties from property located in the Philippines or
from any interest in such property, including rentals or royalties for –
(a) The use of or the right or privilege to use in the Philippines any copyright, patent,
design or model, plan, secret formula or process, goodwill, trademark, trade brand or
other like property or right;
(b) The use of, or the right to use in the Philippines any industrial, commercial or scientific
equipment;
(c) The supply of scientific, technical, industrial or commercial knowledge or information;
(d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a
means of enabling the application or enjoyment of, any such property or right as is
mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or
any such knowledge or information as is mentioned in paragraph (c);
(e) The supply of services by a nonresident person or his employee in connection with the
use of property or rights belonging to, or the installation or operation of any brand,
machinery or other apparatus purchased from such nonresident person;
(f) Technical advice, assistance or services rendered in connection with technical
management or administration of any scientific, industrial or commercial undertaking,
venture, project or scheme; and
(g) The use of or the right to use:

The remainder, if any, shall be treated in full as taxable income from sources without the
Philippines.
(F) Definitions. – As used in this Section the words “sale” or “sold” include “exchange” or
“exchanged”; and the word “produced” includes “created”, “fabricated”, “manufactured”,
“extracted”, “processed”, “cured” or “aged”.
A. GROSS INCOME FROM SOURCES WITHIN AND WITHOUT THE PHILS.
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(1) Interests. - Interests derived from sources within the Philippines, and interests on bonds,
notes or other interest-bearing obligation of residents, corporate or otherwise;
164 TAXATION 1 (ATTY. BELLO)
i. Motion picture films;
ii. Films or video tapes for use in connection with television; and
iii. Tapes for use in connection with radio broadcasting.
(5) Sale of Real Property. - Gains, profits and income from the sale of real property located in
the Philippines; and
(6) Sale of Personal Property. - Gains; profits and income from the sale of personal property,
as determined in Subsection (E) of this Section.
(C) Gross Income From Sources Without the Philippines. - The following items of gross
income shall be treated as income from sources without the Philippines:
(1) Interests other than those derived from sources within the Philippines as provided in
paragraph (1) of Subsection (A) of this Section;
(2) Dividends other than those derived from sources within the Philippines as provided in
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 paragraph (2) of Subsection (A) of this Section;
(3) Compensation for labor or personal services performed without the Philippines;
(4) Rentals or royalties from property located without the Philippines or from any interest
in
such property including rentals or royalties for the use of or for the privilege of using
without the Philippines, patents, copyrights, secret processes and formulas, goodwill,
trademarks, trade brands, franchises and other like properties; and
(5) Gains, profits and income from the sale of real property located without the Philippines.
1. INTEREST
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(1) Interests. - Interests derived from sources within the Philippines, and interests on bonds,
notes or other interest-bearing obligation of residents, corporate or otherwise;
(C) Gross Income From Sources Without the Philippines. - The following items of gross
income shall be treated as income from sources without the Philippines:
(1) Interests other than those derived from sources within the Philippines as provided in
paragraph (1) of Subsection (A) of this Section;
2. DIVIDENDS
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(2) Dividends. - The amount received as dividends:.
(a) from a domestic corporation; and
(b) from a foreign corporation, unless less than fifty percent (50%) of the gross
income of such foreign corporation 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) was derived from
sources within the Philippines as determined under the provisions of this
Section; but only in an amount which bears the same ration to such dividends
as the gross income of the corporation for such period derived from sources
within the Philippines bears to its gross income from all sources.
(C) Gross Income From Sources Without the Philippines. - The following items of gross
income shall be treated as income from sources without the Philippines:
(2) Dividends other than those derived from sources within the Philippines as provided in
paragraph (2) of Subsection (A) of this Section;
165 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
3. COMPENSATION FOR PERSONAL SERVICES
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(3) Services. - Compensation for labor or personal services performed in the Philippines;
(C) Gross Income From Sources Without the Philippines. - The following items of gross
income shall be treated as income from sources without the Philippines:
(3) Compensation for labor or personal services performed without the Philippines;
CIR v. MARUBENI CORP.
DOCTRINE:
A contractor's tax is a tax imposed upon the privilege of engaging in business. It is generally in
the nature of an excise tax on the exercise of a privilege of selling services or labor rather than
a sale on products; and is directly collectible from the person exercising the privilege. Being an
excise tax, it can be levied by the taxing authority only when the acts, privileges or business
are done or performed within the jurisdiction of said authority. Like property taxes, it cannot
be imposed on an occupation or privilege outside the taxing district.
FACTS:
Respondent Marubeni Corporation is a foreign corporation organized and existing under the
laws of Japan. It is engaged in general import and export trading, financing and the
construction business. It is duly registered to engage in such business in the Philippines and
maintains a branch office in Manila.
In November 1985, CIR issued a letter of authority to examine the books of accounts of the
Manila branch office of Marubeni for the fiscal year ending March 1985. In the course of the
examination, petitioner found respondent to have undeclared income from two (2) contracts
in the Philippines, both of which were completed in 1984. One of the contracts was with the
National Development Company (NDC) in connection with the construction and installation of
a wharf/port complex at the Leyte Industrial Development Estate in the municipality of Isabel,
province of Leyte. The other contract was with the Philippine Phosphate Fertilizer
Corporation (Philphos) for the construction of an ammonia storage complex also at the Leyte
Industrial Development Estate.
CIR's revenue examiners recommended an assessment for deficiency income, branch profit
remittance, contractor's and commercial broker's taxes. Respondent questioned this
assessment in a letter dated June 5, 1986.
A 50% surcharge was imposed for the client's failure to report for tax purposes the aforesaid
taxable revenues while the 25% surcharge was imposed because of your client's failure to pay
on time the above deficiency percentage taxes.
CIR found that the NDC and Philphos contracts were made on a "turn-key" basis and that the
gross income from the two projects amounted to P967,269,811.14. Each contract was for a
piece of work and since the projects called for the construction and installation of facilities in
the Philippines, the entire income therefrom constituted income from Philippine sources,
hence, subject to internal revenue taxes.
On September 26, 1986, respondent filed two (2) petitions for review with the Court of Tax
Appeals. The first petition, CTA Case No. 4109, questioned the deficiency income, branch
profit remittance and contractor's tax assessments in petitioner's assessment letter. The
second, CTA Case No. 4110, questioned the deficiency commercial broker's assessment in the
same letter.
Earlier, on August 2, 1986, Executive Order (E.O.) No. 412 declaring a one-time amnesty
covering unpaid income taxes for the years 1981 to 1985 was issued. Respondent filed its tax
amnesty return dated October 30, 1986 and attached thereto its sworn statement of assets
and liabilities and net worth as of Fiscal Year (FY) 1981 and FY 1986.
The tax court found that respondent had properly availed of the tax amnesty under E.O. Nos.
41 and 64 and declared the deficiency taxes subject of said case as deemed cancelled and
withdrawn.
ISSUE:
Whether or not Marubeni is liable to pay the income, branch profit remittance, and
contractor's taxes assessed by petitioner.
RULING:
In the case at bar, it is undisputed that respondent was an independent contractor under the
terms of the two subject contracts. Respondent, however, argues that the work therein were
not all performed in the Philippines because some of them were completed in Japan in
accordance with the provisions of the contracts.
Between Marubeni and the two Philippine corporations, payments for all materials and
equipment under Japanese Yen Portion I were made to Marubeni by NDC and Philphos also in
Japan. The NDC, through the Philippine National Bank, established letters of credit in favor of
respondent through the Bank of Tokyo. The letters of credit were financed by letters of
commitment issued by the OECF with the Bank of Tokyo. The Bank of Tokyo, upon
respondent's submission of pertinent documents, released the amount in the letters of credit
in favor of respondent and credited the amount therein to respondent's account within the
same bank.
Clearly, the service of "design and engineering, supply and delivery, construction, erection and
installation, supervision, direction and control of testing and commissioning, coordination. . .
" of the two projects involved two taxing jurisdictions. These acts occurred in two countries —
Japan and the Philippines. While the construction and installation work were completed
within the Philippines, the evidence is clear that some pieces of equipment and supplies were
completely designed and engineered in Japan. The two sets of ship unloader and loader, the
boats and mobile equipment for the NDC project and the ammonia storage tanks and
refrigeration units were made and completed in Japan. They were already finished products
when shipped to the Philippines. The other construction supplies listed under the Offshore
Portion such as the steel sheets, pipes and structures, electrical and instrumental apparatus,
these were not finished products when shipped to the Philippines. They, however, were
likewise fabricated and manufactured by the sub-contractors in Japan. All services for the
design, fabrication, engineering and manufacture of the materials and equipment under
Japanese Yen Portion I were made and completed in Japan. These services were rendered
outside the taxing jurisdiction of the Philippines and are therefore not subject to contractor's
tax.
CIR v. BRITISH OVERSEAS AIRWAYS CORP. read dissenting opinion of J. Feliciano
FACTS:
BOAC is a 100% British Government-owned corporation engaged in the international airline
business and is a member-signatory of the Interline Air Transport Association (IATA). As such
it operates air transportation service and sells transportation tickets over the routes of the
other airline members. During the periods covered by the disputed assessments, BOAC had no
landing rights for traffic purposes in the Philippines, and was not granted a Certificate of
166 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
public convenience and necessity to operate in the Philippines by the Civil Aeronautics Board
(CAB). Consequently, it did not carry passengers and/or cargo to or from the Philippines,
although during the period covered by the assessments, it maintained a general sales agent in
the Philippines — Warner Barnes and Company, Ltd., and later Qantas Airways — which was
responsible for selling BOAC tickets covering passengers and cargoes.
Petitioner CIR assessed BOAC P2,498,358.56 for deficiency income taxes covering the years
1959 to 1963. This was protested by BOAC. Subsequent investigation resulted in the issuance
of a new assessment for the years 1959 to 1967 of P858,307.79. BOAC paid this new
assessment under protest. BOAC filed a claim for refund of P858,307.79, which claim was
denied by the CIR. But before said denial, BOAC had already filed a petition for review with the
Tax Court assailing the assessment and praying for the refund of the amount paid.
BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal years 1968-
1969 to 1970-1971 of P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 as
compromise penalties for violation of Section 46 (requiring the filing of corporation returns)
penalized under Section 74 of the National Internal Revenue Code (NIRC). BOAC requested
that the assessment be countermanded and set aside. The CIR not only denied the BOAC
request for refund in the First Case but also re-issued in the Second Case the deficiency
income tax assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 as
compromise penalty under Section 74 of the Tax Code. BOAC's request for reconsideration
was denied by the CIR. This prompted BOAC to file the Second Case before the Tax Court
praying that it be absolved of liability for deficiency income tax for the years 1969 to 1971.
The Tax Court reversed the CIR and held that the proceeds of sales of BOAC passage tickets in
the Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, do not
constitute BOAC income from Philippine sources "since no service of carriage of passengers or
freight was performed by BOAC within the Philippines" and, therefore, said income is not
subject to Philippine income tax. The CTA position was that income from transportation is
income from services so that the place where services are rendered determines the source.
Hence, this Petition for Review on certiorari of the Decision of the Tax Court.
ISSUE:
Whether or not the revenue derived by BOAC from sales of tickets in the Philippines for air
transportation, while having no landing rights here, constitute income of BOAC from
Philippine sources, and, accordingly, taxable?
RULING:
BOAC is a resident foreign corporation. In order that a foreign corporation may be regarded as
doing business within a State, there must be continuity of conduct and intention to establish a
continuous business, such as the appointment of a local agent, and not one of a temporary
character.
BOAC, during the periods covered by the subject - assessments, maintained a general sales
agent in the Philippines, That general sales agent, from 1959 to 1971, "was engaged in (1)
selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in
the series corresponding to a different airline company; (3) receiving the fare from the whole
trip; and (4) consequently allocating to the various airline companies on the basis of their
participation in the services rendered through the mode of interline settlement. Those
activities were in exercise of the functions which are normally incident to, and are in
progressive pursuit of, the purpose and object of its organization as an international air
carrier. In fact, the regular sale of tickets, its main activity, is the very lifeblood of the airline
business, the generation of sales being the paramount objective. Thus, BOAC was "engaged in"
business in the Philippines through a local agent during the period covered by the
assessments. Accordingly, it is a resident foreign corporation subject to tax upon its total net
income received in the preceding taxable year from all sources within the Philippines.
The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to
1970-71 amounted to P10,428,368. The source of an income is the property, activity or
service that produced the income. For the source of income to be considered as coming from
the Philippines, it is sufficient that the income is derived from activity within the Philippines.
In BOAC's case, the sale of tickets in the Philippines is the activity that produces the income.
The tickets exchanged hands here and payments for fares were also made here in Philippine
currency. The site of the source of payments is the Philippines. The flow of wealth proceeded
from, and occurred within, Philippine territory, enjoying the protection accorded by the
Philippine government. In consideration of such protection, the flow of wealth should share
the burden of supporting the government.
The absence of flight operations to and from the Philippines is not determinative of the source
of income or the site of income taxation. Admittedly, BOAC was an off-line international airline
at the time pertinent to this case. The test of taxability is the "source"; and the source of an
income is that activity ... which produced the income. Unquestionably, the passage
documentations in these cases were sold in the Philippines and the revenue therefrom was
derived from a business activity regularly pursued within the Philippines. And even if the
BOAC tickets sold covered the "transport of passengers and cargo to and from foreign
cities", it cannot alter the fact that income from the sale of tickets was derived from the
Philippines. The word "source" conveys one essential idea, that of origin, and the origin of the
income herein is the Philippines.
FELICIANO, J., dissenting:
The liability of BOAC to Philippine income taxation in respect of such income depends, not on
BOAC's status as a "resident foreign corporation" or alternatively, as a "non-resident foreign
corporation," but rather on whether or not such income is derived from "source within the
Philippines."
For purposes of income taxation, the "source of income" relates not to the physical sourcing of
a flow of money or the physical situs of payment but rather to the "property, activity or service
which produced the income." Income may be derived from three possible sources
only: (1) capital and/or (2) labor and/or (3) the sale of capital assets. If the income is from
labor (services) the place where the labor is done should be decisive. If the income is from
capital, the place where the capital is employed should be decisive. If the income is from the
sale of capital assets, the place where the sale is made should be likewise decisive. Thus, if
income is to taxed, the recipient thereof must be resident within the jurisdiction, or the
property or activities out of which the income issue or is derived must be situated within the
jurisdiction so that the source of the income may be said to have a situs in this country.
There are two possibly relevant source of income rules that must be confronted; (a) the
source rule applicable in respect of contracts of service; and (b) the source rule applicable in
respect of sales of personal property. Where a contract for the rendition of service is involved,
the applicable source rule may be simply stated as follows: the income is sourced in the place
where the service contracted for is rendered. Section 37 (a) (3) and (c) (3) of the Tax Code
apply in respect of services rendered by individual natural persons and a juridical
person. Further, a contract of carriage or of transportation is assimilated in our Tax Code and
Revenue Regulations to a contract for services. Transportation was a service and that the
source of the income derived therefrom was to be treated as being the place where the service of
transportation was rendered.
Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides
in part as follows: Gross income from sources within the Philippines includes compensation
for labor or personal services within the Philippines regardless of the residence of the payer, of
the place in which the contract for services was made, or of the place of payment.
167 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Source of income from the sale of personal property would depend upon two factors: (a) the
place where the sale of such personal property occurs; and (b) the place where such personal
property was produced or manufactured. If the personal property involved was both
produced or manufactured and sold outside the Philippines, the income derived therefrom
will be regarded as sourced entirely outside the Philippines, although the personal property
had been produced outside the Philippines, or if the sale of the property takes place outside
the Philippines and the personal was produced in the Philippines, then, the income derived
from the sale will be deemed partly as income sourced without the Philippines. In other
words, the income (and the related expenses, losses and deductions) will be allocated
between sources within and sources without the Philippines. In contrast, income derived from
the purchase and sale of personal property — i. e., trading — is, under the Tax Code, regarded
as sourced wholly in the place where the personal property is sold.
The basic problem is one of characterization of the transactions entered into by BOAC in the
Philippines. Those transactions may be characterized either as sales of personal property (i. e.,
"sales of airline tickets") or as entering into a lease of services or a contract of service or
carriage. The appropriate characterization, in my opinion, of the BOAC transactions is that of
entering into contracts of service, i.e., carriage of passengers or cargo between points located
outside the Philippines.
The airline ticket in and of itself has no monetary value, even as scrap paper. The value of the
ticket lies wholly in the right acquired by the "purchaser" — the passenger — to demand a
prestation from BOAC, which prestation consists of the carriage of the "purchaser" or
passenger from the one point to another outside the Philippines. The ticket is really
the evidence of the contract of carriage entered into between BOAC and the passenger. The
money paid by the passenger changes hands in the Philippines. But the passenger does not
receive undertaken to be delivered by BOAC. The "purchase price of the airline ticket" is
the compensation paid for the undertaking of BOAC to transport the passenger or cargo outside
the Philippines.
International carriers issuing for compensation passage documentation in the Philippines for
uplifts from any point in the world to any other point in the world, are not charged any
Philippine income tax on their Philippine billings (i.e., billings in respect of passenger or cargo
originating from the Philippines). Under this new approach, international carriers who service
port or points in the Philippines are treated in exactly the same way as international carriers
not serving any port or point in the Philippines. Thus, the source of income rule applicable to
transportation or other services rendered partly within and partly without the Philippines, or
wholly without the Philippines, has been set aside in place of Philippine income taxation, the
Tax Code now imposes this 2½ per cent tax computed on the basis of billings in respect of
passengers and cargo originating from the Philippines regardless of where embarkation and
debarkation would be taking place.
HOWDEN & CO., LTD. v. COLLECTOR
DOCTRINE:
Reinsurance premiums remitted by domestic insurance corporation to foreign reinsurance
companies are considered income of the latter derived from sources within the Philippines.
FACTS:
Commonwealth Insurance entered into reinsurance contracts with 32 British insurance
companies not engaged in trade or business in the Philippines. Alexander Howden & Co.
represented the aforesaid British insurance companies. The reinsurance contracts were
prepared and signed by the foreign reinsurers in England and sent to Manila where
Commonwealth Insurance signed them.
Pursuant to the aforesaid contracts, Commonwealth Insurance remitted P798,297.47 to
Howden as reinsurance premiums. In behalf of Howden, Commonwealth Insurance filed an
income tax return declaring the amount of reinsurance premiums and also paid the BIR the
income tax thereon.
Within the two-year period provided for by law, Howden filed with the BIR a claim for refund
invoking a ruling of the Commissioner stating that it exempted from withholding tax
reinsurance premiums received from domestic insurance companies by foreign insurance
companies not authorized to do business in the Philippines. The Tax Court denied the claim.
ISSUE: W/N the reinsurance premiums in question came from sources within the Philippines
RULING: YES
The source of an income is the property, activity or service that produced the income. The
reinsurance premiums remitted to Howden by virtue of the reinsurance contracts,
accordingly, had for their source the undertaking to indemnify Commonwealth Insurance
against liability. Said undertaking is the activity that produced the reinsurance premiums, and
the same took place in the Philippines.
In the first place, the reinsured, the liabilities insured and the risks originally underwritten by
Commonwealth Insurance, upon which the reinsurance premiums and indemnity were based,
were all situated in the Philippines. Secondly, the reinsurance contracts were perfected in the
Philippines, for Commonwealth Insurance signed them last in Manila. And, thirdly, the parties
to the reinsurance contracts in question evidently intended Philippine law to govern. Article
11 thereof provided for arbitration in Manila, according to the laws of the Philippines.
Furthermore, the contracts provided for the use of Philippine currency as the medium of
exchange and for the payment of Philippine taxes.
Appellants should not confuse activity that creates income with business in the course of
which an income is realized. An activity may consist of a single act; while business implies
continuity of transactions. An income may be earned by a corporation in the Philippines
although such corporation conducts all its business abroad. Section 24 of the Tax Code does
not require a foreign corporation to be engaged in business in the Philippines, in order for its
income from sources within the Philippines to be taxable.
Furthermore, as used in our income tax law, "income" refers to the flow of wealth. Such flow,
in the instant case, proceeded from the Philippines. Such income enjoyed the protection of the
Philippine government. As wealth flowing from within the taxing jurisdiction of the
Philippines and in consideration for protection accorded it by the Philippines, said income
should properly share the burden of maintaining the government.
Appellants further contend that reinsurance premiums not being among those mentioned in
Section 37 of the Tax Code as income from sources within the Philippines, the same should not
be treated as such. Section 37, however, is not an all-inclusive enumeration. It states that "the
following items of gross income shall be treated as gross income from sources within the
Philippines". It does not state or imply that an income not listed therein is necessarily from
sources outside the Philippines.
KORFUND CO., INC. v. CIR
DOCTRINE:
Income and privileges which might have been received by the taxpayer but was foregone by
him for a valuable consideration was income earned and produced where such privilege could
have been received.
FACTS:
Petitioner is a New York corporation organized in 1924, with its principal place of business in
New York City, for the purpose of manufacturing and selling foundation material, such as cork
168 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
plates and vibration absorbers.
The Emil Zorn Aktiengesellschaft, hereinafter referred to as Zorn, is a nonresident foreign
corporation engaged in the same business as petitioner, with its principal office in Berlin,
Germany.
Hugo Stoessel, a nonresident alien and citizen of Germany, hold shares of stock in both
companies. In 1932, Stoessel became the sole owner of stock of Zorn.
Petitioner entered into a written contract in the United States with Zorn whereby Zorn agreed
(a) not to compete with petitioner in this country and Canada or to form, or give any data for
the purpose of forming, a competitive company in that territory until the end of 1945, and (b)
to give technical and business advice to petitioner upon its request, and petitioner agreed (a)
not to furnish material, for the isolation of noise and vibration, outside of the United States
and Canada except specified territory outside of European countries. Each party agreed to
turn over inquiries received from territory of the other and to exchange without charge
improvements, inventions, and patents involving isolation against noise and vibration. Zorn
did not own any patents at that time. One of the purposes of the contract was to eliminate
competition.
Subsequently, petitioner entered into a written agreement with Stoessel in the United States
whereby Stoessel undertook to act as consultant and adviser of petitioner in matters relating
to the business of petitioner and to communicate to it information of value to petitioner's
business. One of the purposes of the agreement was to eliminate competition.
Zorn and Stoessel faithfully performed their agreements not to compete with petitioner and
not to give advice to its competitors. Subsequently, petitioner canceled the contracts with
Stoessel and Zorn, and refused to make further payments to them. The contract with Stoessel
was canceled on account of his failure to communicate technical information relating to
petitioner's business as required by the agreement.
Zorn then assigned to Bernard Voges, New York City, all sums due it from petitioner under
their agreement, and Stoessel assigned to the same individual salary in the amount of $
1,984.04 alleged to be payable by petitioner for services rendered and the balance of $
2,227.60 payable to him from surplus account, plus interest on the claims of each, with power
to recover the amounts for the account of the assignors.
Voges instituted suit against petitioner in August 1934 under the assignments. An
understanding was reached in 1934 to settle the claims by a payment of $ 2,750 to Stoessel
and $ 3,250 to Zorn. The claim of Zorn for $ 3,250 and the claim of Stoessel for $ 2,227.60
were allowed in full. Final settlement was made in 1938 when $ 2,508 was paid to Stoessel
and $ 2,964 to Zorn and $ 608 was withheld for payment of withholding taxes.
CIR: The allowance of $ 2,786.67 to Stoessel and $ 3,293.33 to Zorn, which amounts include
the proportionate share of each in the interest of $ 80, constituted income from sources within
the United States on which petitioner, as withholding agent, should have paid a tax equal to
10% of the former amount and 15 percent% of the latter amount in accordance with the
provisions of the Revenue Act of 1938.
ISSUE/S:
Whether this income was received from sources within the United States
Contentions:
Petitioner: The income was paid for agreements to refrain from doing specific things --
negative acts. No defaults occurred and during the period of compliance the promisors were
residents of Germany. Petitioner's contention is that negative performance is based upon a
continuous exercise of will, which has its source at the place of location of the individual, and
that, as the mental exertion involved herein occurred in Germany, the source of the income
was in that country, not in the United States where the promise was given.
Respondent: As the place of performance would be in the United States if Zorn and Stoessel
had violated their contractual obligations, abstinence of performance occurs in the same
place.
RULING:
Yes, received from sources within the US.
Zorn had a right to compete with petitioner in the United States and Canada and for that
purpose to form a competitive company or to assist others in forming one. Likewise, Stoessel
had a right to serve other corporations or individuals in the United States engaged in a
business similar to petitioner's as a consultant and to furnish them information of value to
their business. They were willing to and did give up these rights in this country for a limited
time for a consideration payable in the United States, just as did Sabatini (in Sabatini v.
Commissioner) in "foregoing his right to authorize others for a time to publish the works
here." The Circuit Court in that case calls the exclusive right to publish an interest in property
in the United States; so here, in our opinion, the rights of Stoessel and Zorn to do business in
this country, in competition with the petitioner, were interests in property in this country.
They might have received amounts here for services or information, but were willing to forego
that right and possibility for a limited period for a consideration. What they received was in
lieu of what they might have received. The situs of the right was in the United States, not
elsewhere, and the income that flowed from the privileges was necessarily earned and
produced here. Petitioner is merely using it, so to speak, for a specified time, subject to
periodical payments to the owners of the rights. Upon the termination of the contracts the
rights reverted to Zorn and Stoessel, and they were then free to exercise them independent of
the agreements entered into with petitioner. These rights were property of value and the
income in question was derived from the use thereof in the United States.
We find and hold that the source of all of the income in question was in the United States and
is subject to withholding tax in the taxable year. CIR won.
STEMKOWSKI v. CIR
FACTS:
Taxpayer was traded before the taxable year 1970 to the New York Rangers who play their
home games at Madison Square Garden in NYC. The TP had previously signed a 2-yaer NHL
Standard Player’s Contract with the Detroit Red Wings – this contract was assigned to and
assumed by the Rangers.
The ff are the TP’s compensation/bonuses:
 Compensation as per contract - $ 31,500 (1970-71 season)
 $ 35,000 (71-72 season)
 $ 1,500 bonus for each round won in the play-offs
 $ 25/exhibition game + $25/week of training camp
 Medical and disability coverage
 Per diem expenses while traveling during the regular seasons
 Other benefits
NHL player’s year is divided into 4 periods:
169 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
1) Training camp
2) League championship (regular season)
3) Play-off competition
4) Off-season
Stemkowski lived in Canada during all of the off-season and most of the training camp period.
He played in Canada 15 days out of 179 during the regular season and 5 out of 28 during the
play-offs.
When he was not living in Canada, he lived in NYC. On his tax return, he reported $44,271 in
income and excluded $10,625 as earned in Canada + $3,000 miscellaneous deductions.
CIR issued a notice of deficiency holding that Stemkowski underestimated the proportion of
his income derived from services in the US and had not established that his claimed
deductions were for ordinary and necessary business expenses connected with his US income.
TAX COURT HELD THAT:
 Stemkowski could reduce his tax liability by showing that he was in Canada for a
longer period during the time covered by the contract.
 The total number of days that the TP was compensated was not 234 but only 179 –
the number of days in the regular season.
 TP could not use days spent in Canada during training camp and off-season in
calculating his foreign-source exclusion from income.
 The TP’s off-season physical conditioning expenses were not income from the
conduct of trade or business and were thus not deductible.
 Expenses incurred in NY were held not to have been incurred while away from
home and in the pursuit of business
ISSUE: The tax liability of Stemkowski as a non resident alien
RULING:
Allocation of Income
 As a nonresident alien, the TP was taxable on income connected with the conduct of a trade
or business, including the performance of personal services, within the US.
 The basic contract salary covered both play-off and training camp services.
 Pertinent US tax regulation: The amount to be included in the gross income will be
that amount which bears the same relation to the total compensation as the number of
days of performance of the labor or services within the US bears to the total number of
days of performance of labor or services for which the payment is made. – this
regulation applies to the TP because the NHL Standard Player’s Contract does not
distinguish between payments for services performed within and outside the US.
 Coach and GM of Rangers testified that the contract salary covered the regular
season, the training camp, and exhibition games, and the play-offs.
 The contract clearly provides that players are to show up in the training camps and
failure to do so would amount to payment of fines.
 The contract also requires player’s participation in play-off games in exchange for a
basic contract salary. Failure to do so may even entail termination.
 Off-season is not covered by the contract.
 During off-season, contract imposes no obligations on a player.
 The obligation to appear in good condition is not a contractual obligation because
fitness is not a service performed in fulfillment of the contract but a condition of
employment.
Off-season Physical Conditioning expenses
 golf, bowling, tennis, running, swimming, YMCA health club
 TP claimed these as deductible business expenses
 Tax Court claimed that off-season conditioning was related only to arriving fit at training
camp and nondeductible
 Stemkowski’s off-season conditioning expenses were at least in part connected to US
income. The expenses were non-deductible.
 Not every physical activity done to develop one’s body is necessarily for business.
 For a hockey-player, weight-lifting, jogging, bicycling may be for business because
these activities may contribute directly to professional hockey playing ability.
HOWEVER – golf, tennis, squash or bowling (at least for a hockey player) may well
be at the fun-and-relaxation end.
 This issue is remanded to the Tax Court for factual determination.
 Other miscellaneous expenses (i.e. newspapers, magazines, etc.) were also not
deductible because they are for personal use and not for furtherance of business.
Team City Living Expenses
 3rd requirement (CIR v. Flowers case) was not met: there must be a direct connection
between the expense and the carrying on of the trade or business of the TP
 TP’s travel from Canada was not a business necessity but due rather to his personal choice
to live in Canada.
4. RENTALS AND ROYALTIES
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(4) Rentals and Royalties. - Rentals and royalties from property located in the Philippines or
from any interest in such property, including rentals or royalties for –
(a) The use of or the right or privilege to use in the Philippines any copyright, patent, design or
model, plan, secret formula or process, goodwill, trademark, trade brand or other like
property or right;
(b) The use of, or the right to use in the Philippines any industrial, commercial or scientific
equipment;
(c) The supply of scientific, technical, industrial or commercial knowledge or information;
(d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a
means of enabling the application or enjoyment of, any such property or right as is mentioned
in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge
170 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
or information as is mentioned in paragraph (c);
(e) The supply of services by a nonresident person or his employee in connection with the use
of property or rights belonging to, or the installation or operation of any brand, machinery or
other apparatus purchased from such nonresident person;
(f) Technical advice, assistance or services rendered in connection with technical management
or administration of any scientific, industrial or commercial undertaking, venture, project or
scheme; and
(g) The use of or the right to use:
(i) Motion picture films;
(ii) Films or video tapes for use in connection with television; and
(iii) Tapes for use in connection with radio broadcasting.
(C) Gross Income From Sources Without the Philippines. - The following items of gross
income shall be treated as income from sources without the Philippines:
(4) Rentals or royalties from property located without the Philippines or from any interest in
such property including rentals or royalties for the use of or for the privilege of using
without the Philippines, patents, copyrights, secret processes and formulas, goodwill,
trademarks, trade brands, franchises and other like properties;
REVENUE RULING NO. 68-443
DOCTRINE:
Royalties for the use of a foreign trademark on products that are ultimately used in foreign
countries are income from sources without the United States even though the initial sale of the
articles took place in the United States.
FACTS:
X, a resident foreign corporation, owns a trademark for certain products in many foreign
countries. X corporation entered into a license agreement with Y, a domestic corporation,
pursuant to which Y was given the right to place the foreign trademark owned by X on Y's
products and sell the trademarked products. The United States trademark for these products
is owned by Z, an unrelated party. The license agreement between X and Y is a conventional
trademark license agreement for a limited period of time and includes customary provisions
to identify and protect the licensor's proprietorship of this mark. Under the terms of the
license, Y corporation pays X corporation a royalty measured by a percentage of the initial
sales price of the trademarked products.
Y manufactures the trademarked products in the United States and sells them to foreign
buyers in the United States for resale and consumption in foreign countries; all rights, title,
and interest of Y in the products pass to the foreign buyers within the United States. Thus, the
initial sale of the trademarked products is regarded as having taken place in the United States.
ISSUE: Whether or not the place of initial sale of a product that bears a trademark is the
controlling factor in the determination of the source of the royalties paid for the use of the
trademark? NO.
RULING:
Section 861(a)(4) of the Internal Revenue Code of 1954 states, in part, that royalties for the
use of or for the privilege of using in the United States trademarks and other like property
shall be treated as income from sources within the United States.
Section 862(a)(4) of the Code states, in part, that royalties for the use of or for the privilege of
using without the United States trademarks and other like properties shall be treated as
income from sources without the United States.
The gist of a trademark is its association in the public mind with the product, it being the
identifying mark of the trade. The function of a trademark is to designate the goods as the
product of a particular trader and to protect his goodwill against the sale of another's product
as his.
In the instant case the character of X corporation's income is royalty income measured by a
percentage of the sales of the foreign trademarked products. The initial sale of the
trademarked products to foreign shippers is a means of placing the products in the avenues of
commerce with a view towards their ultimate consumption outside the United States.
Although the amount of the royalty income is measured by the sales of the trademarked
products, the place of sale does not necessarily determine the source of such royalty income.
Since Z owns the United States trademark to these products, the products manufactured by Y
and identified by the trademark under the license from X cannot be sold in the United States
for consumption in the United States. Moreover, the foreign countries do not protect the
foreign trademarks in the United States. It is concluded, therefore, that the royalties paid by Y
to X are paid for the use of the trademarks in the foreign countries and that the place of initial
sale of the trademarked products is not the controlling factor in the determination of the
source of income.
Accordingly, in the instant case, where products are ultimately used in the foreign country
where their trademark is protected, a royalty, received by X for the use of the foreign
trademark, is income from sources outside the United States despite the fact that the initial
sale of the trademarked articles took place in the United States.
PHIL. AMERICAN LIFE INS. CO., INC. v. CTA
DOCTRINE:
In our jurisprudence, the test of taxability is the 'source', and the source of an income is "that
activity . . . which produced the income". It is not the presence of any property from which one
derives rentals and royalties that is controlling, but rather as expressed under the expanded
meaning of "royalties", it includes " royalties for the supply of scientific, technical, industrial,
or commercial knowledge or informations; and the technical advice, assistance or services
rendered in connection with the technical management and administration of any scientific,
industrial or commercial undertaking, venture, project or scheme", and others (Section 37 (a)
(7) as amended
FACTS:
Philamlife, a domestic corp., entered into a Management Service Agreement w/ American
Internatinal Reinsurance Co. (Airco), a non-resident foreign corp. w/ principal place of
business in Pembroke Bermuda, whereby Airco shall perform a series of advisory service to
Philamlife for a fee not exceeding $250,000.00 per annum. Later on Airco merged w/
American International Group Inc. (Aigi) w/ the latter as surviving corporation. CIR issued to
Philamlife a tax credit of P643,125 representing erroneous payment of w/holding tax at surce
on remittances to Aigi for services rendered in 1979. Because of the tax refund, Philamlife
filed a claim for refund. W/o waiting for the CIR to resolve the claim for refund, Philamlife
filed w/ the CTA (Case No. 3540) the claim for refund. While the CTA case was pending, CIR
issued a denial of the request for refund and they also cancelled the tax credit granted to
Philamlife. Instead, CIR now claims the Philamlife has deficiency of P643,125. W/o protesting
the CIR assessment of deficiency, Philamlife filed w/ the CTA (Case No. 3943) a petition to
annul the said assessment. CTA favors CIR and ordered Philamlife to pay the deficiency taxes
of 1979.
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ISSUE:
W/N compensation for advisory services admittedly performed abroad by the personnel of a
non-resident foreign corporation not doing business in the Philippines (AIGI) are subject to
Philippines withholding income tax - YES
W/N the revoking of the tax credit was proper? - YES
HELD:
Philamlife insist that that there is no legal nor factual bias for the respondent court to
conclude that the compensation paid for advisory services rendered outside the Philippines to
petitioner AIGI, a non-resident foreign corporation not engaged in trade or business in the
Philippines, is considered "rentals and royalties from properties locate d in the Philippines"
pursuant to Section 37 (a) (4) of the National Internal Revenue Code. Petitioners contend that
petitioner AIGI is not covered by the above provision of the Tax Code considering that it has
no properties located in the Philippines from which rentals and royalties can be derived.
Pursuant to Section 37 (a)(3) of the Tax Code, compensation for labor or personal services are
considered from sources within the Philippines where the services are performed within the
Philippines and since the services were ascertained by the Examiner to have been rendered
outside the Philippines the same should not have been subjected to Philippine tax.
A reading of the various management services enumerated in the said Management Services
Agreement will show that they can easily fall under Section 37 expanded meaning of royalties.
Basically, from the heading 'Investments' to 'Personnel', the services call for the supply by the
non-resident foreign corporation of technical and commercial information, knowledge,
advice, assistance or services in connecton with technical management or administration of an
insurance business — a commercial undertaking. Therefore, the income derived for the
services performed by AIGI for PHILAMLIFE under the said management contract shall be
considered as income from services within the Philippines. AIGI being a non-resident foreign
corporation not engaged in trade or business in the Philippines 'shall pay a tax equal to thirty-
five (35%) percent of the gross income received during each taxable year from all sources
within the Philippines as interest, dividends, rents, royalties (including remuneration for
technical services) , salaries, premiums, annuities, emoluments or other fixed or determinable
annual, periodical or casual gains, profits and income and capital gains: . . . (Section 12(6) (I)
of the National Internal Revenue Code.
The argument of Philamlife may be true perhaps prior to the amendment of section 37(a)(4)
by P.D. 1457 on June 11, 1978. Prior of said amendment, the term 'rentals or royalties' has a
very limited meaning. It refers only to rentals or royalties for 'the use of or for the privilege of
using in the Philippine patents, copyrights, secret processes and formulas, goodwill,
trademarks, trade brand, franchise and other like properties'. However, when the said
provision of law was amended to include the expanded meaning of royalties, this
jurisprudence is accordingly modified to exclude all the type of services enumerated in the
amended law." Thus, this Court rules that while it is true petitioner AIGI has no properties in
the Philippines, agreement with PHILAMLIFE necessary for the latter company's efficient
operation and growth, with petitioner AIGI deriving income form said agreement, petitioner
AIGI is well-within the ambit of Section 37 (a)(7) of the Tax Code.
This Court believes that the rule on prescription of assessment and the filing of formal protest
will not apply in the C.T.A. Case No. 3943. The decision of the Commissioner of Internal
Revenue revoking the tax credit memo he has issued and issuing an assessment accordingly
was actually a denial of the claim for refund covering the 1979 withholding tax at source
which was previously granted. Therefore, the rules on prescription of action in the case of
recovery of tax erroneously or illegally collected shall apply. Pursuant to Section 292 (now
230) of the NIRC 'no such suit or proceeding shall be begun after the expiration of two years
from the date of payment of the tax or penalty regardless of any supervening cause that may
arise after payment'.
a. COMPENSATION FOR PERSONAL SERVICES OR ROYALTY?
KARRER v. U.S.
DOCTRINE:
The only criterion for imposing the tax is that the ‘source’ of the income to be taxed must be
within the United States. The ‘source’ of income is not necessarily the payor, but may be the
property or the services from which the particular income is derived. If the payments to were
for the use of property located in the United States, then those payments are properly
characterized as income from sources within the United States and subject to tax. If
payments were compensation for labor or services performed without the United States,
then these are tax exempt.
FACTS:
Paul Karrer is a professor of chemistry at the University of Zurich in Switzerland, where he
is Director of the Chemical Institute. Professor Karrer became interested in the flavins,
particulary lactoflavin, which could be obtained from sweet whey, a by-product of the
manufacture of cheese, and is present in very small quantities only. Karrer approached the
F. Hoffmann-LaRoche & Co. Ltd. of Basle, Switzerland (Basle), and asked it to support his
investigations in the vitamin B-2 field by processing a large quantity of whey in accordance
with his instructions. Basle and Karrer, through exchange of letters, agreed that if the
process led to a patent, Basle would grant Karrer a participation in the net proceeds of the
sales of vitamin B-2 products manufactured and sold by it. Under Swiss law the exchange of
letters constituted a special employment contract in which all patents resulting from
Karrer's discoveries belonged to Basle, the employer. In turn, Basle would pay Karrer a
percentage of the net proceeds of the sale of such products.
Karrer determined the chemical structure of natural vitamin B-2 and he turned this discovery
over to Basle, which proceeded to develop the manufacturing processes for the commercial
exploitation of vitamin B-2. The parties entered into a formal contract specifying the
percentage of net proceeds to be paid by Basle to Karrer as 5% for 12 years.
Karrer began the study of vitamin E. Karrer asked Basle to perform certain experiments for
him on extracts from the wheat germ. Dr. Otto Isler, a Basle employee, performed extensive
experiments in connection with the synthesis of vitamin E, and Basle kept Karrer informed of
Isler's work in that connection. After Basle received the vitamin E synthesis from Karrer,
Basle proceeded to develop the manufacturing process that made it possible to exploit the
synthesis commercially.
Karrer and Basle entered into a formal contract where Karrer and Basle would collaborate in
the synthesis of vitamin E as partners. Basle had the sole right to take out patents resulting
from the collaboration either in its own name or that of Karrer. Patents taken in Karrer's name
had to be transferred to Basle upon its request, irrespective of whether the patents were
applied before or during the collaboration. Basle had the exclusive right to commercial
utilization of the products and Karrer was to receive 3% of the net proceeds of synthetic
vitamin E for a period of 12 years. Karrer agreed to inform Basle before publishing any article
with respect to vitamin B-2 and E. In all of his collaboration with Basle, Karrer never was
asked by Basle to participate in the manufacture or sale of the vitamins, nor did he direct or
exercise any control over the marketing of the vitamin products.
Basle did not have a place of business or a permanent establishment in the United States, nor
did it engage in any trade or business in this country. In 1941, Basle and Nutley, a chemical
manufacturing firm, entered into a contract whereby Nutley was granted the exclusive
employment and use within the US of all of Basle's secret process and scientific
172 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
developments pertaining to certain products, including the vitamins which had been
synthesized by Karrer. In return, Nutley agreed to pay Basle 4% of the net proceeds of sales
made by Nutley.
In the US, a patent application can be filed only by a natural person, the inventor. Basle
therefore required Karrer to file the applications on his discoveries at Basle’s expense. At
Basle's request, Karrer assigned the US patent applications to Nutley before the patents were
granted. These were recorded in the US Patent Office, and the patents themselves were issued
to Nutley as owner and assignee of Karrer (and Dr. Isler with respect to Vitamin E).
Nutley produced and marketed vitamin B-2 and vitamin E products. It paid to Karrer a
percentage of all its sales of products containing vitamin B-2 and vitamin E based on the
amounts specified in the contracts entered into between Karrer and Basle which Nutley had
copies of. These payments to Karrer were made pursuant to instructions by the president of
Nutley. He thought that, although Nutley had no contract with Karrer, since it manufactured
synthetic vitamin products under Karrer inventions, Nutley should make the payments
called for by the inventor's contracts with Basle. These payments to Karrer were
characterized on the books of Nutley as royalties.
Nutley withheld and paid US income taxes on behalf of Karrer of $92,978.22 for the years
1941 through 1945. Karrer filed US income tax returns for 1941-1946 and paid a balance of
$108,526.66. Karrer filed claims for refund of $201,504.88, representing the US taxes paid and
withheld from him. Defendant says that the payments from Nutley to Karrer were subject to
Federal income tax because they were fixed, periodical income to Karrer from sources within
the United States (royalty payments). It is Karrer's position that the payments made to him by
Nutley were for services performed outside of the United States, thus, exempt.
ISSUE: Whether or not the compensation received by Karrer is taxable in the United States as
royalty? NO.
RULING:
Section 211(a)(1)(A) prescribes a tax upon income from sources within the United States
which consists of fixed or determinable, annual or periodical, income. Karrer received fixed,
periodical income. If the payments to Karrer by Nutley were for the use of Karrer's property
located in the United States, then those payments are properly characterized as income from
sources within the United States and subject to tax. If payments were compensation for labor
or services performed by Karrer without the United States, then these are tax exempt.
The fact that the payments were made by a United States corporation is not determinative of
the right to tax the nonresident alien who is the recipient of such payments. The only criterion
for imposing the tax is that the ‘source’ of the income to be taxed must be within the United
States. The ‘source’ of income is not necessarily the payor, but may be the property or the
services from which the particular income is derived. In the instant case, the patents, together
with the right to use and sell their commercial values were income producing property and
thus a ‘source’ of income. Although these were properties located within the United States, the
payment made by Nutley to Karrer were not payments for the right of Nutley to use any
income producing property or interest therein belonging to Karrer.
The right to use and exploit in the US the patents was granted to Nutley by Basle, and not by
Karrer. Basle was the owner of the commercial rights in Karrer's discoveries and it alone
could convey this right to another. Karrer's only interest in the sales of the vitamins produced
and sold arose out of his contractual relationship with Basle. It does not appear that there ever
existed between Basle and Karrer any relationship other than that of special employment. The
arrangement was analogous to the usual one of a person employed to make inventions for his
employer, the employment thereby acquiring title to such inventions and to any patents
secured thereon. Payments made to such an employee, even though based on a percentage of
the proceeds of the sales of the invented process or object, would be compensation for the
employee's services rather than royalties, because the employee's right to such payments
derives from his services to his employer and not from any rights in inventions owned by the
employee. If the services just described were rendered in a foreign country by a nonresident
alien they would not be taxable.
The fact that Karrer received the payments from Nutley does not alter the character of the
obligation or of the payments made pursuant thereto. Since Nutley paid Karrer amounts due
on an obligation owing to Karrer by Basle for services performed for Basle by Karrer in
Switzerland, they do not represent payments for Karrer's rights or interest in property located
in the US, but rather payments for services performed outside the United States, and are
therefore exempt from taxation. Nutley's denomination of the payments as royalties on its
books cannot change the true character of these payments.
BOULEZ v. CIR
FACTS:
Boulez, a French citizen residing in Germany, is a world-renowned musical director and
orchestra conductor. He concluded a contract with CBS records under which recordings
would be made by the New York Philharmonic Orchestra and several other orchestras under
his direction.
The Contract provided that “royalties” would be paid to Boulez based upon a percentage of the
proceeds derived by CBS from the sale of the records. Under the contract CBS retained the
property rights to the master recordings, matrices and phonograph records produced under
the agreement.
The recordings were made in the US and the IRS took the position that payments, although
characterized as “royalties” in the contract, were in substance compensation payments
measured by record sales.
ISSUE: By the contract entered into between Boulez and CBS, did the parties agree that Boulez
was licensing or conveying to CBS a property interest in the recordings which he was retained
to make, and in return for which he was to receive “royalties”?
HELD:
NO. Boulez derived US source compensation from services income. Before a person can derive
income from royalties, it is fundamental that he must have an ownership interest in the
property whose licensing or sale gives rise to the income.
“Royalty” defined as “a share of the product or profit reserved by the owner for permitting
another to use the property”. Also, for a payment to constitute a royalty, the payee must have
an ownership interest in the property whose use generates the payment.
Thus, the existence of a property right in the payee is fundamental for the purpose of
determining whether royalty income exists.
5. SALE OR REAL PROPERTY
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(5) Sale of Real Property. - Gains, profits and income from the sale of real property located in
the Philippines; and
(C) Gross Income From Sources Without the Philippines. - The following items of gross
173 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
income shall be treated as income from sources without the Philippines:
(5) Gains, profits and income from the sale of real property located without the Philippines.
6. SALE OF PERSONAL PROPERTY
SEC. 42. Income from Sources Within the Philippines. -
(A) Gross Income From Sources Within the Philippines. - The following items of gross
income shall be treated as gross income from sources within the Philippines:
(6) Sale of Personal Property. - Gains; profits and income from the sale of personal property,
as determined in Subsection (E) of this Section.
(E) Income From Sources Partly Within and Partly Without the Philippines. - Items of gross
income, expenses, losses and deductions, other than those specified in Subsections (A) and (C)
of this Section, shall be allocated or apportioned to sources within or without the Philippines,
under the rules and regulations prescribed by the Secretary of Finance, upon recommendation
of the Commissioner.
Where items of gross income are separately allocated to sources within the Philippines, there
shall be deducted (for the purpose of computing the taxable income therefrom) the expenses,
losses and other deductions properly apportioned or allocated thereto and a ratable part of
other expenses, losses or other deductions which cannot definitely be allocated to some items
or classes of gross income.
The remainder, if any, shall be included in full as taxable income from sources within the
Philippines.
In the case of gross income derived from sources partly within and partly without the
Philippines, the taxable income may first be computed by deducting the expenses, losses or
other deductions apportioned or allocated thereto and a ratable part of any expense, loss or
other deduction which cannot definitely be allocated to some items or classes of gross income;
and the portion of such taxable income attributable to sources within the Philippines may be
determined by processes or formulas of general apportionment prescribed by the Secretary of
Finance.
Gains, profits and income from the sale of personal property produced (in whole or in part) by
the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the
taxpayer without and sold within the Philippines, shall be treated as derived partly from
sources within and partly from sources without the Philippines.
Gains, profits and income derived from the purchase of personal property within and its sale
without the Philippines, or from the purchase of personal property without and its sale within
the Philippines shall be treated as derived entirely form sources within the country in which
sold: Provided, however, That gain from the sale of shares of stock in a domestic corporation
shall be treated as derived entirely form sources within the Philippines regardless of where
the said shares are sold.
The transfer by a nonresident alien or a foreign corporation to anyone of any share of stock
issued by a domestic corporation shall not be effected or made in its book unless: (1) the
transferor has filed with the Commissioner a bond conditioned upon the future payment by
him of any income tax that may be due on the gains derived from such transfer, or (2) the
Commissioner has certified that the taxes, if any, imposed in this Title and due on the gain
realized from such sale or transfer have been paid.
It shall be the duty of the transferor and the corporation the shares of which are sold or
transferred, to advise the transferee of this requirement.
a. SALE BY PRODUCER OR MANUFACTURER OF PERSONAL PROPERTY
b. PURCHASE AND SALE OF PERSONAL PROPERTY
c. SALE OF SHARES OF STOCK IN A DOMESTIC CORPORATION
d. OUTRIGHT SALE OR ASSIGNMENT OF INTANGIBLES
REVENUE MEMORANDUM CIRCULAR NO. 44-05
SECTION 1. Scope. — This Circular shall provide for the guidelines for the taxation of
computer software payments.
SECTION 2. Definition of Software. — "Software" is a program, or a series of programs,
containing instructions for a computer required either for the operational processes of the
computer itself (operational software) or for the accomplishment of other tasks (application
software). It can be transferred through a variety of media, for example in writing or
electronically, on a magnetic tape or disk, or on a laser disk or CD-ROM, or it can be
downloaded through the Internet or through a network. It may be standardized with a wide
range of application or be customized for specific users. It can be transferred as an integral
part of computer hardware or in an independent form available for use on a variety of
hardware.
SECTION 3. Payments For the Use of Software As Royalties.
a. Definition of ROYALTIES — The term "royalties", as generally used, means payments of any
kind received as a consideration for the use of, or the right to use, any copyright of literary,
artistic or scientific work including cinematograph films, or films or tapes used for radio or
television broadcasting, any patent, trade mark, design or model, plan, secret formula or
process, or for the use of, or the right to use, industrial, commercial, or scientific equipment,
or for information concerning industrial, commercial or scientific experience.
The definition covers both payments made under a license and compensation which a
person would be obliged to pay for fraudulently copying or infringing the right.
b. Definition of royalties includes payments for the use of copyright over software — Software is
generally assimilated as a literary, artistic or scientific work protected by the copyright
laws of various countries. Thus, payments in consideration for the use of or the right to use
a copyright relating to software are generally royalties.
SECTION 4. Categories of Transactions. — Transactions involving software may take any one
or more of the following categories:
a. A (full or partial) transfer of a copyright right in software;
b. A transfer of a copy of the software (a copyrighted article);
c. The provision of services for the development or modification of the software; or
d. The provision of know-how relating to software programming techniques.
Any transaction involving software which consists of more than one of the transactions above
shall be treated as a separate transaction, with the appropriate provisions of this Circular
being applied to each such transaction. However, any transaction that is de minimis, taking
into account the overall transaction and the surrounding facts and circumstances, shall not be
treated as a separate transaction, but merely as a part of another transaction.
SECTION 5. Characterization of Transactions. — The character of payments received in a
transaction involving the transfer of computer software depends on the nature of the rights
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that the transferee acquires under the particular arrangement regarding the use and
exploitation of the program.
a. Transfers of copyright rights. — A transfer of software is classified as a transfer of a
copyright right if, as a result of the transaction, a person acquires any one or more of the
rights described below:
i. The right to make copies of the software for purposes of distribution to the public by
sale or other transfer of ownership, or by rental, lease or lending;
ii. The right to prepare derivative computer programs based upon the copyrighted
software;
iii. The right to make a public performance of the software;
iv. The right to publicly display the computer program; or
v. Any other rights of the copyright owner, the exercise of which by another without
his authority shall constitute infringement of said copyright.
The determination of whether a transfer of a copyright right in a software is a sale or
exchange of property is made on the basis of whether, taking into account all facts and
circumstances, there has been a transfer of all substantial rights in the copyright. A
transaction that does not constitute a sale or exchange because not all substantial rights
have been transferred will be classified as a license generating royalty income.
When only copyright rights are transferred, payments made in consideration therefor are
royalties. On the other hand, when copyright ownership is transferred, payments made in
consideration therefor are business income.
b. Transfer of copyrighted articles. — A copyrighted article incorporating a software includes a
copy of a software from which the work can be perceived, reproduced, or otherwise
communicated, either directly or with the aid of a machine or device. The copy of the
software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main
memory or hard drive of a computer, or in any other medium.
If a person acquires a copy of a software but does not acquire any of the rights described
above (or only acquires a de minimis grant of such rights), and the transaction does not
involve the provision of services or of know-how, the transfer of the copy of the software is
classified solely as a transfer of a copyrighted article and payments for which constitute
business income.
The determination of whether a transfer of a copyrighted article or right in a software is a
sale or exchange of property is made on the basis of whether, taking into account all facts
and circumstances, the benefits and burdens of ownership have been transferred. A
transaction that does not constitute a sale or exchange because insufficient benefits and
burdens of ownership of the copyrighted article have been transferred, such that a person
other than the transferee is properly treated as the owner of the copyrighted article, will be
classified as a lease generating rental income.
c. After-Sales Service. — Contracts for the use of software are often accompanied with the
provision of services (e.g., installation, maintenance, and customization of the software) by
personnel of the relevant foreign licensor/owner or of the relevant local subsidiary,
reseller, and distributor. Payments as consideration for after-sales service in a mixed
contract are not royalties alone, but will include income from services. The appropriate
course to take with such a contract is, in principle, to break down, on the basis of the
information contained in the contract or by means of a reasonable apportionment, the
whole amount of the stipulated payments according to the various parts of what is being
provided under the contract, and then to apply to each part of it so determined the taxation
treatment proper thereto. Thus, the part of the payments representing the use of the
 software will be treated as royalties and taxable as such and the other part of the payments
representing the provision of services will be treated as income from services and taxable as
such.
If, however, one part of what is being provided constitutes by far the principal purpose of
the contract and the other parts stipulated therein are only of an ancillary and largely
unimportant character, then the treatment applicable to the principal part should generally
be applied to the whole amount of the consideration. (De minimis)
d. "Site License" / "Enterprise License" / "Network License Arrangements". — These refer to
arrangements in which the transferee obtains rights to make multiple copies of the
program for operation only within its own business. Although these arrangements permit
the making of multiple copies of the program, such rights are generally limited to those
necessary for the purpose of enabling the operation of the program on the licensee's
computers or network, and reproduction for any other purpose is not permitted under the
license. Payments under such arrangements will generally be dealt with as business income.
e. Supply of information. — Another type of transaction involving the transfer of computer
software is the more unusual case where a software house or computer programmer agrees
to supply information about the ideas and principles underlying the program, such as logic,
algorithms or programming languages or techniques. In these cases, the payments may be
characterized as royalties to the extent that they represent consideration for the use of, or
right to use, secret formulas or for information concerning industrial, commercial or
scientific experience which cannot be separately copyrighted.
f. Transfer of Ownership. — Where consideration is paid for the transfer of full or partial
ownership of the rights in the copyright, the payments made therefore are, in general, not
royalties but business income or capital gains.
SECTION 6. Computer Hardware Bundled With Software. — The tax treatment of payments
involving the sale of computer hardware bundled with software, where the software is
bundled in the Philippines, are covered by this Circular. On the other hand, computer
hardware bundled with software, where the software is bundled abroad will be dealt with in
another revenue issuance.
SECTION 7. Modes of Acquiring Software And the Relevant Tax Treatment Thereof.
A. Acquisition of ownership over a copyright
1. From a local owner of a copyright. — Payments made to a copyright owner for a full or
partial transfer of a copyright shall be subject to Philippine income tax as follows:
a. Transfer by a resident individual owner of copyright — A resident individual owner of a
copyright is subject to the graduated income tax rates (5% - 32%) under Section 24 of
the National Internal Revenue Code of 1997 (NIRC). The amount paid in consideration of
the copyright or portions thereof transferred shall form part of the copyright owner's
gross income (Section 32, NIRC), from which his taxable income shall be computed.
b. Transfer by a domestic corporation owner — The amount paid in consideration of the
copyright or portions thereof transferred shall form part of the copyright owner's gross
income (Section 32, NIRC), from which his taxable income, subject to 32% income tax
under Section 27 of the NIRC, shall be computed.
2. From a foreign licensor. — Payments made to a copyright owner for a full or partial transfer
of a copyright shall be subject to Philippine income tax as follows:
a. Transfer by a nonresident alien individual — A nonresident alien individual engaged in
trade or business in the Philippines shall be taxed in the same manner as a resident
175 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
individual owner of a copyright.
b. Transfer by a foreign corporation — The amount paid in consideration of the copyright
or portions thereof transferred by a resident foreign corporation engaged in trade or
business within the Philippines shall form part of the copyright owner's gross income
(Section 32, NIRC), from which his taxable income, subject to 32% income tax under
Section 28 of the NIRC, shall be computed.
The amount paid in consideration of the copyright or portions thereof transferred by a
nonresident foreign corporation shall be subject to a final tax of 32%, based on the gross
income (Section 28, NIRC).
However, if the foreign owner of the copyright is a resident of a country which has an
existing tax treaty with the Philippines, royalties paid to such owner are subject to the
reduced tax rates on royalties under the relevant tax treaty, provided the conditions
prescribed therein are complied with by the owner.
B. Acquisition of copyright rights
1. By a Local Subsidiary/Reseller/Distributor/Retailer —
a. From a local licensor or reseller/distributor licensee
Payments made by a local subsidiary/reseller/distributor/retailer to a domestic
corporation owner of a copyright or a reseller/distributor licensee of a copyright shall be
subject to a final income tax of 20%, based on the gross amount of royalties under
Section 27(D) of the NIRC, to be withheld by the local
subsidiary/reseller/distributor/retailer making the payments.
b. From a nonresident foreign licensor
Payments made by the local subsidiaries/resellers/distributors/retailers to a
nonresident foreign licensor/owner of the software are royalties subject to 32 percent
final income tax, based on the gross amount thereof (Section 28[B][1], NIRC), the full
amount of which shall be withheld and collected by the
subsidiary/reseller/distributor/retailer making the payments (Section 2.57-1[I][1], RR
2-98).
However, if the foreign licensor/owner is a resident of a country which has an existing
tax treaty with the Philippines, royalties paid to such licensor/owner are subject to the
reduced tax rates on royalties under the relevant tax treaty, provided the conditions
prescribed therein are complied with by the licensor/owner.
2. By an End-user —
a. From local subsidiaries, resellers, distributors of resellers — Payments made by the end-
user to the local subsidiaries, resellers, distributors of resellers for the purchase of
copyrighted articles are business income subject to 32 percent income tax, based on the
net taxable income of a domestic corporation (Section 27[A]), National Internal Revenue
Code of 1997 [NIRC]). When making payments to the local subsidiaries, resellers,
distributors of resellers, the end-user shall withhold 2 percent income tax of the gross
amount of the payments creditable against the taxable income of the local subsidiaries,
reseller or distributors (Section 2.57.2[E][4][m], Revenue Regulations [RR] 2-98, as
amended by Section 2 of RR 14-02), provided the end-user is any of the following persons
(under Section 2.57.3. of RR 2-98, as amended by Section 3 of RR 14-02) required to
withhold such tax:
(a) A juridical person, whether or not engaged in trade or business;
 (b) An individual, with respect to payments made in connection with his trade or
business; or
(c) A government office including a government-owned or controlled corporation, a
provincial, city, or municipal government.
b. Directly from the foreign owner and/or licensor of the software. — A local end-user may
acquire license to use software directly from the foreign licensor/owner of the software.
Payments made by the end-user to the licensor/owner are royalties subject to 32 percent
income tax, based on the gross amount thereof, imposed on royalties derived by a
nonresident foreign corporation (Section 28[B][1], NIRC), which amount shall be
withheld and collected by the end-user making the payments (Section 2.57-1[I][1], RR 2-
98).
However, if the foreign licensor/owner is a resident of a country which has an existing
tax treaty with the Philippines, royalties paid thereto are subject to the reduced tax rates
on royalties under the relevant tax treaty, provided the condition prescribed therein are
complied with by the licensor/owner.
* SECTION 7. Value-Added Tax. —
A. The following payments for software transactions shall be subject to the 10% value-added
tax (VAT) pursuant to Sections 106 and 108 of the NIRC:
1. Royalty payments for the use of a copyright over a software;
2. Payments made to resellers/distributors/retailers who are engaged in the trade or
business of distributing or selling software; and
3. Payments for services rendered in the Philippine in connection with software purchased.
B. Withholding of the VAT for nonresident payees
The payor in control of the payment of VAT in the software transactions enumerated under
(A) above shall be responsible for the withholding of VAT on such fees on behalf of the
nonresident payee, by filing a separate VAT return for and on behalf of such payee using
BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage
Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall
serve as sufficient basis for the claim of input tax to be applied against the output tax that
may be due from the payor. In addition, the payor is required to issue the Certificate of
Creditable Tax Withheld at Source (BIR Form No. 2307) in quadruplicate upon the request
of the non-resident payee, the first three copies thereof to be given to the payee and the
fourth copy to be retained by the payor as its file copy.
B. INCOME FROM SOURCES PARTLY WITHIN OR WITHOUT THE
PHILIPPINES
CIR v. CTA AND SMITH KLINE & FRENCH OVERSEAS
DOCTRINE:
The overhead expenses incurred by a parent company in connection with finance,
administration, and research and development, all of which direct benefit its branches all over
the world, including the Philippines, cannot be definitely allocated or identified with the
operations of the Philippine branch. The Philippine branch can claim as its deductible share a
rateable part of such expenses based upon the ratio of the local branch's gross income to the
total gross income, worldwide, of the multinational corporation.
FACTS:
In its 1971 original income tax return, Smith Kline declared a net taxable income of
P1,489,277 and paid P511,247 as tax due. Among the deductions claimed from gross income
176 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
was P501,040 as its share of the head office overhead expenses. However, in its amended
return filed on March 1, 1973, there was an overpayment of P324,255 arising from under
deduction of home office overhead . It made a formal claim for the refund of the alleged
overpayment. It appears that sometime in October, 1972, Smith Kline received from its
international independent auditors, an authenticated certification to the effect that the
Philippine share in the unallocated overhead expenses of the main office for the year ended
December 31, 1971 was actually P1,427,484. It further stated in the certification that the
allocation was made on the basis of the percentage of gross income in the Philippines to gross
income of the corporation as a whole. By reason of the new adjustment, Smith Kline's tax
liability was greatly reduced from P511,247 to P186,992 resulting in an overpayment of
P324,255.
Without awaiting the action of the Commissioner of Internal Revenue on its claim Smith Kline
filed a petition for review with the Court of Tax Appeals. In its decision, the Tax Court ordered
the Commissioner to refund the overpayment or grant a tax credit to Smith Kline. The
Commissioner appealed to this Court. The Commissioner maintains there exists a contract
which Smith Kline has entered into with its home office, prescribing the amount that a branch
can deduct as its share of the main office's overhead expenses, that contract is binding. The
Commissioner contends that since the share of the Philippine branch has been fixed at
$77,060 (which was less than P 1,427,484), Smith Kline itself cannot claim more than the said
amount, as to allow Smith Kline to deduct more than what was expressly provided in the
agreement would be to ignore its existence.
ISSUE:
Whether or not Smith Kline can deduct more than what was expressly provided in the
contract stipulated
RULING:
Yes. The governing law is found in section 37 of the old National Internal Revenue Code,
Commonwealth Act No. 466, which is reproduced in Presidential Decree No. 1158, the
National Internal Revenue Code of 1977 and which reads:
SEC. 37. Income from sources within the Philippines. —
(b) Net income from sources in the Philippines. — From the items of gross income specified in
subsection (a) of this section there shall be deducted the expenses, losses, and other deductions
properly apportioned or allocated thereto and a rateable part of any expenses, losses, or other
deductions which cannot definitely be allocated to some item or class of gross income. The
remainder, if any, shall be included in full as net income from sources within the Philippines.
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on
the deductions to be made to determine the net income from Philippine sources:
SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being
derived specifically from sources within the Philippines there shall be deducted the expenses,
losses, and other deductions properly apportioned or allocated thereto and a rateable part of
any other expenses, losses or deductions which cannot definitely be allocated to some item or
class of gross income. The remainder shall be included in full as net income from sources within
the Philippines. The rateable part is based upon the ratio of gross income from sources within the
Philippines to the total gross income.
From the foregoing provisions, it is manifest that where an expense is clearly related to the
production of Philippine-derived income or to Philippine operations, that expense can be
deducted from the gross income acquired in the Philippines without resorting to
apportionment. The overhead expenses incurred by the parent company in connection with
finance, administration, and research and development, all of which direct benefit its branches
all over the world, including the Philippines, fall under a different category however. These
are items which cannot be definitely allocated or identified with the operations of the
Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under
section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as
its deductible share a rateable part of such expenses based upon the ratio of the local branch's
gross income to the total gross income, worldwide, of the multinational corporation.
The Commissioner argues that the Tax Court erred in relying on the certification of Peat,
Marwick, Mitchell and Company that Smith Kline is entitled to deduct P1,427,484 as its
allotted share and that Smith Kline has not presented any evidence to show that the home
office expenses chargeable to Philippine operations exceeded $77,060. On the other hand,
Smith Kline submits that the contract between itself and its home office cannot amend tax
laws and regulations. The matter of allocated expenses which are deductible under the law
cannot be the subject of an agreement between private parties nor can the Commissioner
acquiesce in such an agreement. Smith Kline likewise submits that it has presented ample
evidence to support its claim for refund. To this end, it has presented before the Tax Court the
authenticated statement of Peat, Marwick, Mitchell and Company to show that since the gross
income of the Philippine branch was P7,143,155 for 1971 as per audit report prepared by
Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole was
$6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses was
P1,427,484.
Clearly, the weight of evidence bolsters its position that the amount of P1,427,484 represents
the correct rateable share, the same having been computed pursuant to section 37(b) and
section 160. Smith Kline declared that with respect to its share of the head office overhead
expenses in its income tax returns for the years 1973 to 1981, it deducted its rateable share of
the total overhead expenses of its head office for those years as computed by the independent
auditors hired by the parent company in Philadelphia, Pennsylvania U.S.A., as soon as said
computations were made available to it. We hold that Smith Kline's amended 1971 return is in
conformity with the law and regulations. The Tax Court correctly held that the refund or
credit of the resulting overpayment is in order.
REVENUE AUDIT MEMORANDUM ORDER NO. 1-95
soliciting orders, purchases, service contracts, trading, constructions and other activities
becomes more practical, easy and equitable. At the same time, this Order addresses taxation of
construction and other activities by the same Philippine branches and liaison offices of MNEs
as separate undertakings.
REVENUE AUDIT MEMORANDUM ORDER NO. 1-95
SUBJECT: Audit Guidelines and Procedures on the Proper Determination of the Income Tax
Liability of Philippine Branches and Liaison Offices of Multi-National Enterprises (MNEs)
Engaged in Soliciting Orders, Purchaser, Service Contracts, Trading, Construction and Other
Activities in the Philippines.
I. RATIONALE
Whereas Revenue Audit Memorandum Order (RAMO) No. 1-86 dated April 25, 1986 imposes
income tax on the gross income generated from constructive trading and commission income
derived from brokering activities of Philippines branches of MNEs engaged in trading
activities.
Whereas RAMO No. 1-86 makes no recognition of such factors as the nature of item traded,
the risk involved and participation of the local branch;
Whereas the implementation of RAMO No. 1-86 makes use of much approximations and
estimates;
Therefore, this Order is issued to revise RAMO No. 1-86 and to cover taxation of Philippine
branches and liaison offices of MNEs engaged in soliciting orders, purchases, services
contracts, trading, construction and other activities.
With this Order, taxation of Philippine branches and liaison offices of MNEs engaged in
soliciting orders, purchases, service contracts, trading, constructions and other activities
becomes more practical, easy and equitable. At the same time, this Order addresses taxation of
construction and other activities by the same Philippine branches and liaison offices of MNEs
as separate undertakings.

SUBJECT: Audit Guidelines and Procedures on the Proper Determination of the Income Tax II. OBJECTIVES
Liability of Philippine Branches and Liaison Offices of Multi-National Enterprises (MNEs)
This Order is issued to:
Engaged in Soliciting Orders, Purchaser, Service Contracts, Trading, Construction and Other
Activities in the Philippines. a) Amend and supersede RAMO No. 1-86 dated April 25, 1986 which provides for the
procedures for tax audit of Philippine branches or foreign corporation.
I . RATIONALE
b) Address the issue on the proper determination of the income tax liability of Philippine
Whereas Revenue Audit Memorandum Order (RAMO) No. 1-86 dated April 25, 1986 imposes
branches and liaison offices of MNEs pursuant to Section 43 of the National Internal
income tax on the gross income generated from constructive trading and commission income
Revenue Code (NIRC) wherein the Commissioner of Internal Revenue (CIR) is authorized
derived from brokering activities of Philippines branches of MNEs engaged in trading
to distribute, apportion or allocate gross income or deduction among organizations in
activities.
order to clearly reflect the income of any such organization.
Whereas RAMO No. 1-86 makes no recognition of such factors as the nature of item traded,
c) Provide guidelines on implementation of policies on the proper determination of the
the risk involved and participation of the local branch;
income tax liability of Philippine branches and liaison offices of MNEs.
Whereas the implementation of RAMO No. 1-86 makes use of much approximations and
d) Prescribed the minimum procedure required in the audit of the income tax liability of
estimates;
Philippine branches and liaison offices of MNEs.
Therefore, this Order is issued to revise RAMO No. 1-86 and to cover taxation of Philippine
III. COVERAGE
branches and liaison offices of MNEs engaged in soliciting orders, purchases, services
contracts, trading, construction and other activities. a) This Order shall pay only to Philippine branches and liaison of Japanese trading firms
which are members of the Sogo Shoshas and registered with the Japanese Chamber of
With this Order, taxation of Philippine branches and liaison offices of MNEs engaged in
Commerce and Industry (JCCI), and also all other foreign trading companies similarly
177 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 situated as determined by the Commissioner of Internal Revenue.
b) Furthermore, the content of this Order will apply only to income tax liabilities of
Philippine branches and liaison offices of MNEs and will not affect the withholding,
including branch profit remittance, and business tax obligations of the same Philippine
branches and liaison offices of MNEs which shall be subject to the provisions of the
National Internal Revenue Code (NIRC).
IV. GUIDELINES
1. The Philippine income tax due from soliciting orders, purchaser, service contracts, trading,
construction and other activities of the Philippine branches and liaison offices of MNEs
will be ascertained using the following formula.
For solicitation and trading activities
{(Worldwide Operating Sales to the Philippines attribution tax)}
{( Income X Worldwide Sales X rate X rate ) }
For construction and other activities
plus {(Net Income from construction and other activities X tax rate )}
2. In implementing the above formula, the following terms shall be construed to mean as
follows:
(a) Worldwide (W/W) shall include head office accounts and those of branches located in
difference countries but shall exclude subsidiary accounts.
(b) W/W Operating Income shall include the Gross Income minus Selling General &
Administrative expenses. Operating Income does not include non-operating and
extraordinary items like interest expense, exchange profit/loss capital gains/losses or
other income/loss not related not related to operation.
(c) Sales to the Philippines shall be defined as the aggregated amount of exports and
offshore transactions to the Philippines by the Head Office, all branches and liaison
offices and shall include the amount of indent transactions from which commissions
are generated. These shall also include imported materials and equipment of
construction projects undertaken in the Philippines, but shall exclude local service
income from construction projects or onshore income from local construction.
(d) W /W Sales shall consist of domestic, export, import and offshore transactions which
include nor only principal transactions but also indent transactions from which
commissions are generated.
(e) Attribution rate shall mean a rate of 75% to be applied against formula.
(f) The tax rate to be applied shall be in accordance with Section 25(a) of the NIRC which
is 35%.
(g) Net income on construction shall consist of local service income from construction
projects income from construction projects less the costs associated with local
construction projects including the cost of locally purchased materials equipment, if
any.
(h) Net income on all other activities shall consist of income such as branches and liaison
offices of MNEs are engaged in, net of costs and expenses associated with such income.
3. In the application of the formula, no offsetting of losses from one line of business to the
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detriment of the other line of business shall be allowed. This would mean that the tax due
from each line of business shall be computed independently from the other line of
business.
V. PROCEDURES
1. Request documents containing information on the nature of business transactions of the
taxpayer as follows:
a) the structure of the Philippine branch or liaison office, the Home Office, other branches
or more than 50% owned or controlled subsidiaries located outside the Philippines
dealing with the local branch;
b) the ownership, relationship, extent of control, directors and officers of the Philippine
branch or liaison office and the Home Office;
c) the business activity of the MNE and how it relates to the activity of the local branch or
liaison office and other branches or more than 50% owned or controlled subsidiaries
dealing with the local company
2. Ascertain the mathematical accuracy and completeness of the income tax return, financial
statements and supporting schedules filed by the taxpayer.
3. Require the submission of financial statements exclusive for transactions dealing with
construction and all other activities and have a certified public accountant render an
opinion as to its fairness and conformity with accepted accounting standards.
For solicitation/trading activities
4. Obtain a copy of the Worldwide Financial Statement duly certified by an independent
public accountant of the country which issues the financial statements and authenticated
by the Philippine Embassy or Consulate situated within the country where the Home
Office of the MNE is located.
5. Verify correctness of Worldwide Operating Income and the Worldwide Sales figures
against the financial statements obtained in 4 above.
6. Request for a summary of Sales to the Philippines duly certified by an independent public
accountant and authenticated by the Philippine Embassy or Consulate situated within the
country where the Home Office of the MNE is located. The Sales to the Philippine shall
include the offshore portion of the local construction projects which includes the supply of
machinery and equipment.
7. Request for presentation of copies of pertinent sales invoices, bills of lading, freight and
insurance coverages and other documents to verify Sales to the Philippines, on a test
sampling basis.
For construction activities
8. Review all Contracts and analyze the nature of the Contracts, the parties involved, the
terms and conditions, the total contract price, the payment and other pertinent
information.
9. Determine method of accounting, whether completed contract or the percentage of
completion, and check the correctness of take up in the books of accounts.
10. Segregate the income from exempt transactions from that of taxable transactions, if
applicable.
11. Determine the total contract price and composition of the project. The total contract price
 includes:
a. Supply of Machinery and Equipment
(Sometimes referred to as the "offshore portion") xx
b. Supply of Labor/Civil Works
(Sometimes referred to as the "onshore portion") xx
Total Contract Price xx
12. Verify that only the supply of local/civil works (onshore portion) is included in
computation of profit/loss on local construction project.
13. Determine if costs and expenses corresponded only to the service portion of the project
referred to in 11 above.
14. Be aware of charging of income and expenses by mere book entries using the
branch/home office account.
For all other activities
15. Verify that all income from other activities are included as part of the gross income
16. Ensure that only expenses related to the activities above are included in the determination
of the net income.
REVENUE AUDIT MEMORANDUM ORDER NO. 1-86
SUBJECT: Procedure for Tax Audit of Philippine Branches of Foreign Corporations.
1. BACKGROUND
1.1 Some branches of foreign corporations engage in business in the Philippines by
soliciting orders from local importers. These branches are called "liaison offices or
branches." Sales made from such solicitations are not reported by these branches as
their own sales purportedly because the branch office merely relays to its head office
abroad purchase orders from local importers and it is purportedly its head office that
actually consummates the sales. At the end of the taxable period, the branch office
simply reports for income tax purposes its purported share of the income generated
from sales but the allocation of this purported share is left entirely at the discretion of
its head office. The revenue service is completely at the mercy of multi-national
companies.
1.2 Some branches engage in business in the Philippines by soliciting orders from local
importers and relays this information to its head office abroad. The head office in
turn solicits prospective exporters for a compensation. At the end of the taxable
period, the head office allocates a certain portion of the compensation to its branch in
the Philippines. The branch in turn reports its purported share for income tax
purposes but does not pay the commercial broker's tax thereon purportedly because
the compensation was received from its head office and purportedly because the
branch cannot be legally considered a commercial broker in relation to its head office
since the branch and its head office possess only a single legal personality.
Again, in this second situation, allocation of the compensation is left at the discretion
of the head office — the revenue service also left at the mercy of these multi-national
companies.
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2. LEGAL CONSEQUENCES
2.1 The foregoing scope of activities of these branch offices is considered under R.A. 5455
as business acts. "'Doing business' shall include soliciting orders, purchases, service
contracts opening offices, whether called 'liaison' offices or branches. . . . any other act
or acts that imply a continuity of commercial dealings or arrangements, and
contemplate to that extent the performance of acts or works, or the exercise of some
of the functions normally incident to, and in progressive prosecution of, commercial
gain or of the purpose and object of the business organization.".
2.2 These branch offices, like any other businesses, are required by law to account for
their business operations in accordance with generally accepted accounting practices
(SEC. 38, NIRC). Thus, a branch office although not possessing a separate and distinct
juridical personality is, however, considered under generally accepted accounting
practices as a distinct character, a separate business unit and should be "supplied by
the home office with cash and merchandise and such other assets as may be needed".
Generally accepted accounting practices also dictate that income and expenses of the
branch shall be segregated from those of the home office in order to clearly reflect
their respective operating results.
2.3 The doctrine on corporate fiction is not absolute - the veil of corporate fiction may be
legally pierced should it be used to subvert just application of laws.
". . . Where the corporate form or organization is adopted or a corporate entity is
asserted in an endeavor to evade a statute or to modify its intent, courts will
disregard the corporation or its entity. This has been applied to violations of . . . tax
laws, . . ."
". . . Where a corporation is a dummy, is unreal or a sham and serves no business
purposes and is intended only as a blind, the corporate form may be ignored for the
law cannot countenance a form that is bald and a mischievous fiction."
". . . To allow a taxpayer to deny tax liability on the ground that the sales were made
through another and distinct corporation when it is proved that the latter is virtually
owned by the former or that they are practically one and the same is to sanction a
circumvention of our tax laws."
Corporate fiction may be inquired upon where there is "inadequacy of capital . . .,
confusion of affairs . . . and direct intervention in management causing inequitable
results
3. BRANCH OPERATION AND CONSEQUENCES
3.1 The Philippine branch solicits purchase orders from local buyers, relays the information
to its home office abroad, and the home office purportedly directly makes the sale.
In this type of operation: (i) Sales purportedly consummated abroad by the home
office shall be treated as sales constructively consummated in the Philippines and
made by the branch office, hence, income therefrom shall be considered income from
sources within the Philippines; (ii) the branch shall record and report the gross
selling price of commodities sold thru its home office; and (iii) report for income tax
purposes its net income therefrom. (iv) Since under this situation, the import taxes,
duties and charges have already been paid by the local buyers, the same shall not
anymore be chargeable against the branch.
Under this paragraph, these transactions are treated sales constructively
consummated by the branch office in accordance with generally accepted accounting
practices required under Section 38 of the Tax Code since the branch solicitations are
 actually trading acts. Accordingly, the home office is obligated to supply its branch
with merchandise in pursuing its trading business in the Philippines. Hence, sales
purportedly made directly by its home office shall be considered no more than
merely a constructive supplying of the merchandise to its branch which eventually
constructively sells the same to Philippine buyers.
3.2 The branch solicits purchase orders from local buyers, relays the information to its
home office, the home office solicits prospective sellers abroad and eventually receives
compensation for services rendered.
In this second type of operation: (i) the branch shall be considered "a commercial
broker" or indentor; (ii) its share from compensation as allocated by its home office
shall be subject to commercial broker gross receipts tax; (iii) the branch shall provide
itself with the corresponding fixed tax as a commercial broker; and (iv) pay income
tax on its share of the compensation.
Under this paragraph, the branch office shall be considered a commercial broker
since its activities is well within the ambit of the term "broker". Brokers are ". . . those
who are engaged for others in the negotiation of contracts relative to property with
the custody of which they have no concern. They act as negotiators in bringing other
persons together to bargain; generally, they ought not to sell in their own names,
have no implied authority to receive payment, are not entrusted with the physical
possession of the principal's goods when engaged to buy or sell, and have no special
property therein or lien thereon."
4. AUDIT PROCEDURE
4.1 For constructive trading by branch office
(a) Determine gross sales generated from branch's constructive trading (from
solicitations made by the branch);
(b) Require the Philippine branch to submit duly authenticated (i) income statement;
and (ii) statement of cost of sales re worldwide operation of the entire
corporation during the taxable year;
(c) Extract the gross income generated from such constructive sales by applying
against the gross constructive sales the gross profit rate shown in the cost of sale
statement referred to in paragraph (b) (ii) above.
Illustration: Assume that the gross profit ratio, based on worldwide statement of
cost of sales, is 20% and the gross constructive sales amounts to P1,000,000.
Gross income therefrom shall be computed as follows:
Gross sales P1,000,000
Gross income therefrom
(20% G/P rate) P200,000
(d) Check from the records of the Bureau of Customs all shipments coming from the
branch's home office during the taxable year in determining the branch's
constructive sales in the Philippines.
(e) Require the branch to reconcile computations of its constructive sales in the
Philippines.
4.2 For broker activity by branch office
(a) Verify veracity of the amount of compensation allocated to the branch by its home
180 TAXATION 1 (ATTY. BELLO)
office;
(b) Require submission of sworn declaration from home office on the correctness of
the allocated share of the branch office and cross check this declaration in
connection with the branch records re extent of solicitations undertaken in the
Philippines during the tax year;
(c) Require the branch to pay the corresponding fixed tax as a commercial broker;
(d) Require the branch to pay the corresponding commercial broker's gross receipts
tax, based on its total share from compensation derived for services rendered in
the Philippines; and
(e) Determine also the branch income tax obligation for the said income which is
being considered income from sources within the Philippines.
REVENUE AUDIT MEMORANDUM ORDER NO. 4-86
SUBJECT: Audit Guidelines in the Allocation of Home Office Overhead Expenses Under Section
37(b) of the National Internal Revenue Code.
In order to avoid delay and conflict in the determination of Philippine sources taxable net
income of foreign taxpayers for purposes of Philippine income tax, this Revenue Audit
Memorandum is issued.
1. Background
1.1 In computing net income from sources within the Philippines, Section 37(b) provides
that from the gross income from sources within the Philippines ". . . there shall be
deducted the expenses, losses and other deductions properly allocated thereto and a
ratable part of any expenses, interests and losses and other deductions effectively
connected with the business or trade conducted exclusively within the Philippines
which cannot be definitely allocated to some items or class of gross income . . . "
1.2 These deductions are difficult to verify because substantial amounts thereof are
incurred in the head office or elsewhere and the corresponding supporting
documents and books of accounts are not accessible to local taxing authorities.
1.3 Heretofore only an audit certificate is presented to substantiate the deductions
incurred abroad which are allocated and pro-rated to Philippine source gross income.
1.4 In implementing the above provision of the National Internal Revenue Code, there is
a need for adequate and satisfactory proof and explanations in order that the claimed
deductions of the foreign taxpayer may be allowed for income tax purposes.
2. Audit Procedure
2.1 Functional analysis — At the start of investigation there should be a detailed
examination of the functions performed both by the Home Office and the Local
Branch. For this purpose, an organization and functional chart of the home office and
local branch should be secured.
2.11 The functions should be determined and then listed. Who does what? What is
required to do it? Who needs whom for what?
2.12 After having listed the functions performed by each entity, the functions
themselves must be analyzed. Could anyone else perform these functions? How
difficult are they? What skill, equipment and processes are needed?
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 2.2 On the basis of the functional analysis, the claimed deduction properly allocable can
now be determined by applying the tests of (a) relevance (necessary) to the local
branch and (b) reasonable (ordinary) charges keeping always in mind the arm's
length principle in transactions between related parties.
2.3 As to the deductions which cannot be definitely allocated, the following are required:
2.31 Breakdown or Schedule of Home or Foreign Office expenses being pro-rated,
together with an explanation of the nature of each expense. Take note of
deductions which are directly allocable to income earned outside the
Philippines.
2.32 Basis of pro-ration — (a) Determine if the basis and method of pro-ration are
being applied consistently from year to year. (b) Is the same amount of Home
Office expenses being allocated world-wide?
3. In all instances, be on the lookout for:
a. Charges applicable to newly opened foreign branches but are being claimed as
deductions by the Philippine branch;
b. Functions are being performed for some branches but not for others, and yet no
adjustments are made on the allocation;
c. or any other scheme of over-allocating costs to the Philippine branch.
4. All pertinent provisions of these Audit Guidelines applicable in the investigations of
subsidiaries by multi-national companies should be observed by all internal revenue
officers concerned.
REVENUE REGULATION NO. 16-86
SUBJECT: Amendment to Section 160 of the Income Tax Regulations (Rev. Regulations No. 2)
regarding the basis of determining ratable part of overseas overhead expenses apportioned
under Section 37(b) of the National Internal Revenue Code.
Pursuant to Sections 4 and 277 of the National Internal Revenue Code, the first paragraph of
Section 160 Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, is
hereby amended to read as follows:
Sec. 160. (a) Apportionment of deductions. — From the items specified in Section 37(a) as
being derived specifically from sources within the Philippines, there shall be deducted the
expenses, losses, and other deductions properly allocated thereto and a ratable part of any
other expenses, losses, and other deductions effectively connected with the business or
trade conducted exclusively within the Philippines which cannot be definitely allocated to
some items or class of gross income. The remainder shall be included in full as net income
from sources within the Philippines. The ratable part shall be based upon any of the
following ratios consistently allowed from year to year:
a. Gross income from sources within the Philippines to the total gross income.
b. Net sales in the Philippines to total net sales.
c. If any other method of allocation is adopted, a written permission from the
Commissioner of Internal Revenue shall first be secured.
(b) External Auditor's certificate. — The income tax return to be filed should be
accompanied by a certification from an independent and reputable Certified Public
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Accountant containing the following information:
1. The home office deductions for the year involved have been examined in accordance
with generally accepted auditing standards and accordingly included such tests of
accounting records and such other auditing procedures as were considered
necessary in the circumstances.
2. The deductions pro-rated to the Philippine branch do not include —
(a) net losses of any operating unit or branch;
(b) income tax payment;
(c) capital expenditures; and
(d) expenses directly changeable to any branch.
3. The amount of allocable overhead expenses used in the pro-rata allocation to the
Philippine branch is the same amount used in the pro-ration to all branches
worldwide and the amount disallowed in other countries because of governmental
requirement is not added back to the allocable amount.
4. Should there be an exception or qualification on the above requested certification,
an explanation with supporting documents should be submitted.
These regulations shall be effective on income tax returns to be filed for the taxable period
which begins on or after January 1, 1986.
XVII. ACCOUNTING PERIODS AND METHODS
SEC. 43. General Rule. - The taxable income shall be computed upon the basis of the
taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in
accordance with the method of accounting regularly employed in keeping the books of such
taxpayer, but if no such method of accounting has been so employed, or if the method
employed does not clearly reflect the income, the computation shall be made in accordance
with such method as in the opinion of the Commissioner clearly reflects the income.
If the taxpayer's annual accounting period is other than a fiscal year, as defined in Section
22(Q), or if the taxpayer has no annual accounting period, or does not keep books, or if the
taxpayer is an individual, the taxable income shall be computed on the basis of the calendar
year.
SEC. 44. Period in which Items of Gross Income Included. - The amount of all items of gross
income shall be included in the gross income for the taxable year in which received by the
taxpayer, unless, under methods of accounting permitted under Section 43, any such amounts
are to be properly accounted for as of a different period.
In the case of the death of a taxpayer, there shall be included in computing taxable income for
the taxable period in which falls the date of his death, amounts accrued up to the date of his
death if not otherwise properly includible in respect of such period or a prior period.
SEC. 45. Period for which Deductions and Credits Taken. - The deductions provided for in
this Title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred",
dependent upon the method of accounting the basis of which the net income is computed,
unless in order to clearly reflect the income, the deductions should be taken as of a different
period.
In the case of the death of a taxpayer, there shall be allowed as deductions for the taxable
period in which falls the date of his death, amounts accrued up to the date of his death if not
otherwise properly allowable in respect of such period or a prior period.
SEC. 46. Change of Accounting Period.
If a taxpayer, other than an individual, changes his accounting period from fiscal year to
calendar year, from calendar year to fiscal year, or from one fiscal year to another, the net
income shall, with the approval of the Commissioner, be computed on the basis of such new
accounting period, subject to the provisions of Section 47.
SEC. 47. Final or Adjustment Returns for a Period of Less than Twelve (12) Months. -
(A) Returns for Short Period Resulting from Change of Accounting Period. - If a taxpayer,
other than an individual, with the approval of the Commissioner, changes the basis of
computing net income from fiscal year to calendar year, a separate final or adjustment return
shall be made for the period between the close of the last fiscal year for which return was
made and the following December 31.
If the change is from calendar year to fiscal year, a separate final or adjustment return shall be
made for the period between the close of the last calendar year for which return was made
and the date designated as the close of the fiscal year.
If the change is from one fiscal year to another fiscal year, a separate final or adjustment
return shall be made for the period between the close of the former fiscal year and the date
designated as the close of the new fiscal year.
(B) Income Computed on Basis of Short Period. - Where a separate final or adjustment
return is made under Subsection (A) on account of a change in the accounting period, and in
all other cases where a separate final or adjustment return is required or permitted by rules
and regulations prescribed by the Secretary of Finance, upon recommendation of the
Commissioner, to be made for a fractional part of a year, then the income shall be computed
on the basis of the period for which separate final or adjustment return is made.
SEC. 48. Accounting for Long-Term Contracts. - Income from long-term contracts shall be
reported for tax purposes in the manner as provided in this Section.
As used herein, the term 'long-term contracts' means building, installation or construction
contracts covering a period in excess of one (1) year.
Persons whose gross income is derived in whole or in part from such contracts shall report
such income upon the basis of percentage of completion.
The return should be accompanied by a return certificate of architects or engineers showing
the percentage of completion during the taxable year of the entire work performed under
contract.
There should be deducted from such gross income all expenditures made during the taxable
year on account of the contract, account being taken of the material and supplies on hand at
the beginning and end of the taxable period for use in connection with the work under the
contract but not yet so applied.
If upon completion of a contract, it is found that the taxable net income arising thereunder has
not been clearly reflected for any year or years, the Commissioner may permit or require an
amended return.
SEC. 49. Installment Basis. -
(A) Sales of Dealers in Personal Property. - Under rules and regulations prescribed by the
Secretary of Finance, upon recommendation of the Commissioner, a person who regularly
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sells or otherwise disposes of personal property on the installment plan may return as income
therefrom in any taxable year that proportion of the installment payments actually received in
that year, which the gross profit realized or to be realized when payment is completed, bears
to the total contract price.
(B) Sales of Realty and Casual Sales of Personality. - In the case (1) of a casual sale or other
casual disposition of personal property (other than 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), for a
price exceeding One thousand pesos (P1,000), or (2) of a sale or other disposition of real
property, if in either case the initial payments do not exceed twenty-five percent (25%) of the
selling price, the income may, under the rules and regulations prescribed by the Secretary of
Finance, upon recommendation of the Commissioner, be returned on the basis and in the
manner above prescribed in this Section.
As used in this Section, the term "initial payments" means the payments received in cash or
property other than evidences of indebtedness of the purchaser during the taxable period in
which the sale or other disposition is made.
(C) Sales of Real Property Considered as Capital Asset by Individuals. - An individual who
sells or disposes of real property, considered as capital asset, and is otherwise qualified to
report the gain therefrom under Subsection (B) may pay the capital gains tax in installments
under rules and regulations to be promulgated by the Secretary of Finance, upon
recommendation of the Commissioner.
(D) Change from Accrual to Installment Basis. - If a taxpayer entitled to the benefits of
Subsection (A) elects for any taxable year to report his taxable income on the installment
basis, then in computing his income for the year of change or any subsequent year, amounts
actually received during any such year on account of sales or other dispositions of property
made in any prior year shall not be excluded.
SEC. 50. Allocation of Income and Deductions. - In the case of two or more organizations,
trades or businesses (whether or not incorporated and whether or not organized in the
Philippines) owned or controlled directly or indirectly by the same interests, the
Commissioner is authorized to distribute, apportion or allocate gross income or deductions
between or among such organization, trade or business, if he determined that such
distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or
clearly to reflect the income of any such organization, trade or business.
REVENUE REGULATIONS NO. 2
SECTION 51. When income is to be reported. — Gains, profits, and income are to be included in
the gross income for the taxable year in which they are received by the taxpayer, unless they
are included when they accrue to him in accordance with the approved method of accounting
followed by him. If a person sues in one year on a pecuniary claim or for property, and money
or property is recovered on a judgment therefore in a later year, income is realized in that
year, assuming that the money or property would have been income in the earlier year if then
received. This is true of a recovery for patent infringement. Bad debts or accounts charged off
subsequent to March 1, 1913, because of the fact that they were determined to be worthless,
which are subsequently recovered, whether or not by suit, constitute income for the year in
which recovered, regardless of the date when amounts were charged off.
SECTION 52. Income constructively received. — Income which is credited to the account of or
set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for
the year during which so credited or set apart, although not then actually reduced to
possession. To constitute receipt in such a case the income must be credited to the taxpayer
without any substantial limitation or restriction as to the time or manner of payment or
condition upon which payment is to be made. A book entry, if made, should indicate an
absolute transfer from one account to another. If the income is not credited, but is set apart,
such income must be unqualifiedly subject to the demand of the taxpayer. Where a
corporation contingently credits its employees with bonus stock, but the stock is not available
to such employees until some future date, the mere crediting on the books of the corporation
does not constitute receipt.
SECTION 53. Examples of constructive receipt. — When interest coupons have matured and
are payable, but have not been cashed, such interest payment though not collected when due
and payable, is nevertheless available to the taxpayer and should therefore be included in his
gross income for the year during which the coupons matured. This is true if the coupons are
exchanged for other property instead of eventually being cashed. Defaulted coupons are
income for the year in which paid. The distributive share of the profits of a partner in a
general co-partnership duly registered is regarded as received by him, although not
distributed. Interest credited on savings bank deposits, even though the bank nominally has a
rule, seldom or never enforced, that it may require so many days' notice in advance of cashing
depositors' checks, is income to the depositor when credited. An amount credited to
shareholders of a building and loan association, when such credit passes without restriction to
the shareholder, has taxable status as income for the year of the credit. When the amount of
such accumulations has not become available to the shareholder until the maturity of a share,
the amount of any share in excess of the aggregate amount paid in by the shareholder is
income for the year of maturity of the share.
SECTION 166. General rule. — The method of accounting regularly employed by the taxpayer
in keeping his books, if such method clearly reflects his income is to be followed with respect
to the time as of which items of gross income and deductions are to be accounted for. If the
taxpayer does not regularly employ a method of accounting which clearly reflects his income,
the computation shall be made in such manner as in the opinion of the Commissioner of
Internal Revenue clearly reflects it. (See Section 137 of these regulations for computation of
net income, and Section 38 for bases of computation. For the use of inventories, see Sections
144 to 151 of these regulations.)
SECTION 167. Methods of accounting. — It is recognized that no uniform method of
accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer
shall adopt such forms and systems of accounting as are in his judgment best suited to his
purpose. Each taxpayer is required by law to make a return of his true income. He must,
therefore, maintain such accounting records as will enable him to do so. Any approved
standard method of accounting which reflects taxpayer's income may be adopted. Among the
essentials are the following:
(1) In all cases in which the production, purchase, or sale of merchandise of any kind is an
income producing factor, inventories of the merchandise on hand (including finished
goods, work in process, raw materials, and supplies) should be taken at the beginning
and end of the year and used in computing the net income of the year in accordance with
Sections 144 to 151 of these regulations;
(2) Expenditures made during the year should be properly classified as between capital and
income; that is to say, expenditures for items of plant, equipment, etc., which have a
useful life extending substantially beyond the year should be charged to a capital account
and not to an expense account; and
(3) In any case in which the cost of capital assets is being recovered through deductions for
wear and tear, depletion, or obsolescence, any expenditure (other than ordinary repairs)
made to restore the property or prolong its useful life should be added to the property
account or charged against the appropriate reserve and not to current expenses.
183 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
SECTION 168. Changes in accounting methods. — The true income, computed under the law
shall in all cases be entered in the return. If for any reason the basis of reporting income
subject to tax is changed, the taxpayer shall attach to his return a separate statement setting
forth for the taxable year and for the preceding year the classes of items differently treated
under the two systems, specifying in particular all amounts duplicated or entirely omitted as
the result of such change.
A taxpayer who changes the method of accounting employed in keeping his book shall, before
computing his income upon such new method for purposes of taxation, secure the consent of
the Commissioner of Internal Revenue. For the purposes of this action, a change in the method
of accounting employed in keeping books means any change in the accounting treatment of
items of income or deductions, such as a change from cash receipts and disbursements
method to the accrual method, or vice versa; a change involving the basis of valuation
employed in the computation of inventories (see Sections 144 to 151 of these regulations); a
change from the cash or accrual method to the long-term contract method, or vice versa; a
change in the long-term contract method from the percentage of completion basis to the
completed contract basis or vice versa (see Section 44 of these regulations); or a change
involving the adoption of, or a change in the use of, any other specialized basis of computing
net income such as the crop basis. Application for permission to change the method of
accounting employed and the basis upon which the return is made shall be filed within 90
days after the beginning of the taxable year to be covered by the return. The application shall
be accompanied by a statement specifying all amounts which would be duplicated or entirely
omitted as a result of the proposed change. Permission to change the method of accounting
will not be granted unless the taxpayer and the Commissioner of Internal Revenue agree to
the terms and conditions under which the change will be effected.
SECTION 169. Accounting period. — Income tax returns, whether for individuals or for
corporations, associations, or partnerships, are required to be made and their income
computed for each calendar year ending on December 31st of every year. However,
corporations, associations, or partnerships may with the approval of the Commissioner of
Internal Revenue first secured, file their returns and compute their income on the basis of a
fiscal year which means an accounting period of twelve months ending on the last day of any
month other than December. But in no instance shall individual taxpayers be authorized to
establish a fiscal year as basis for filing their returns and computing their income. (For
authority to file on fiscal year basis see Section 172 of these regulations.)
SECTION 170. When included in gross income. — Except as otherwise provided in Section 39
in the case of the death of a taxpayer, gains, profits, and income are to be included in the gross
income for the taxable year in which they are received by the taxpayer, unless they are
included as of a different period in accordance with the approved method of accounting
followed by him. If a taxpayer has died there shall also be included in computing net income
for the taxable period in which he died amounts accrued up to the date of his death if not
otherwise properly includible in respect of such period or a prior period, regardless of the fact
that the decedent may have kept his books and made his returns on the basis of cash receipts
and disbursements.
(For income not reduced to possession but considered as constructively received and for
examples of constructive receipt, see Sections 52 and 53 of these regulations. For the
treatment of income from long-term contracts, see Section 44 of these regulations.)
SECTION 171. "Paid or incurred" and "paid or accrued". — (a) The terms "paid or incurred"
and "paid or accrued" will be construed according to the method of accounting upon the basis
of which the net income is computed by the taxpayer. The deductions and credits must be
taken for the taxable year in which "paid or accrued" or "paid or incurred", unless in order
clearly to reflect the income such deductions or credits should be taken as of a different
period. If a taxpayer desires to claim a deduction or a credit as of a period other than the
period in which it was "paid or accrued" or "paid or incurred", he shall attach to his return a
statement setting forth his request for consideration of the case by the Commissioner of
Internal Revenue together with a complete statement of the facts upon which he relies.
However, in his income tax return he shall take the deduction or credit only for the taxable
period in which it was actually "paid or incurred", or "paid or accrued", as the case may be.
Upon the audit of the return, the Commissioner of Internal Revenue will decide whether the
case is within the exception provided by the law, and the taxpayer will be advised as to the
period for which the deduction or credit is properly allowable.
(b) The provisions of paragraph (a) of this section in general are not applicable with respect to
the taxable period during which the taxpayer dies. In such case there shall also be allowed as
deductions and credits for such taxable period amounts accrued up to the date of his death if
not otherwise allowable with respect to such period or a prior period, regardless of the fact
that the decedent was required to keep his books and make his returns on the basis of cash
receipts and disbursements. (See also Section 76 of these regulations.)
SECTION 172. Change of accounting period. — If a corporation, including a duly registered
general co-partnership, desires to change its accounting period from fiscal year to calendar
year or from calendar year to fiscal year, or from one fiscal year to another, it shall at any time
not less than thirty days prior to the date fixed in Section 46(b) of the Code for the filing of its
return on the basis of its original accounting period submit a written application to the
Commissioner of Internal Revenue designating the proposed date for the closing of its new
taxable year, together with a statement of the date on which the books of account were
opened and closed each year for the past three years, the date on which the taxable year began
and ended as shown on the returns filed for the past three years, and the reasons why the
change in accounting period is desired. (See also Section 46(d) of the Code.)
SECTION 173. Returns for periods of less than twelve months. — No return can be made for a
period of more than twelve months. A separate return for a fractional part of a year is
therefore required whenever there is a change, with the approval of the Commissioner of
Internal Revenue, in the basis of computing net income from one taxable year to another
taxable year. The periods to be covered by such separate returns in the several cases are
stated in Section 42(a). The requirements with respect to the filing of a separate return and
the payment of tax for a part of a year are the same as for the filing of a return and the
payment of tax for a full taxable year closing at the same time.
SECTION 174. Sale of personal property on installment plan. — Dealers in personal property
ordinarily sell either for cash or on the personal credit of the purchaser or on the installment
plan. Dealers who sell on the installment plan usually adopt one of four ways of protecting
themselves in case of default —
(a) By an agreement that title is to remain in the vendor until the purchaser has
completely performed his part of the transaction;
(b) By a form of contract in which title is conveyed to the purchaser immediately, but
subject to a lien for the unpaid portion of the selling price;
(c) By a present transfer of title to the purchaser, who at the same time executes a
reconveyance in the form of a chattel mortgage to the vendor; or
(d) By conveyance to a trustee pending performance of the contract and subject to its
provisions.
The general purpose and effect being the same in all of these cases, the same rule is uniformly
applicable. The general rule prescribed is that a person who regularly sells or otherwise
disposes of personal property on the installment plan, whether or not title remains in the
184 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
vendor until the property is fully paid for, may return as income therefrom in any taxable year
that proportion of the installment payments actually received in that year which the total or
gross profit (that is, sales less cost of goods sold) realized or to be realized when the property
is paid for, bears to the total contract price. Thus the income of a dealer in personal property
on the installment plan may be ascertained by taking as income that proportion of the total
payments received in the taxable year from installment sales (such payments being allocated
to the year against the sales of which they apply) which the total or gross profit realized or to
be realized on the total installment sales made during each year bears to the total contract
price of all such sales made during that respective year. No payments received in the taxable
year shall be excluded in computing the amount of income to be returned on the ground that
they were received under a sale the total profit from which was returned as income during a
taxable year or years prior to the change by the taxpayer to the installment basis of returning
income. Deductible items are not to be allocated to the years in which the profits from the
sales of a particular year are to be returned as income, but must be deducted for the taxable
year in which the items are "paid or incurred" or "paid or accrued", as provided by Section 40
and 84(q) of the Code. A dealer who desires to compute his income on the installment basis
shall maintain books of account in such a manner as to enable an accurate computation to be
made on such basis in accordance with the provisions of this section.
The income from a casual sale or other casual disposition of personal property (other than
property of a kind which should properly be included in inventory) may be reported on the
installment basis only if (1) the sale price exceeds P1,000 and (2) the initial payments do not
exceed 25 per cent of the selling price.
If for any reason the purchaser defaults in any of his payments, and the vendor returning
income on the installment basis repossesses the property sold whether title thereto had been
retained by the vendor or transferred to the purchaser, gain or loss for the year in which the
repossession occurs is to be computed upon any installment obligations of the purchaser
which are satisfied or discharged upon the repossession or are applied by the vendor to the
purchase or bid price of the property. Such gain or loss is to be measured by the difference
between the fair market value of the property repossessed and the basis in the hands of the
vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with
proper adjustment for any other amounts realized or costs incurred in connection with the
repossession. The basis in the hands of the vendor of the obligations of the purchaser satisfied,
discharged, or applied upon the repossession of the property shall be the excess of the face
value of such obligations over an amount equal to the income which would be returnable were
the obligations paid in full. No deduction for a bad debt shall in any case be taken on account
of any portion of the obligations of the purchaser which are treated by the vendor as not
having been satisfied, discharged, or applied upon the repossession, unless it is clearly shown
that after the property was repossessed the purchaser remained liable for such portion; and in
no event shall the amount of the deduction exceed the basis in the hands of the vendor of the
portion of the obligations with respect to which the purchaser remained liable after the
repossession. If the property repossessed is bid in by the vendor at a lawful public auction or
judicial sale, the fair market value of the property shall be presumed to be the purchase or bid
price thereof in the absence of clear and convincing proof to the contrary. The property
repossessed shall be carried on the books of the vendor at its fair market value at the time of
the repossession.
If the vendor chooses as a matter of consistent practice to return the income from installment
sales on the straight accrual or cash receipts and disbursement basis, such a course is
permissible.
SECTION 175. Sale of real property involving deferred payments. — Under Section 43
deferred-payment sales of real property include (a) agreements to purchase and sale which
contemplate that a conveyance is not to be made at the outset, but only after all or a
substantial portion of the selling price has been paid, and (b) sales in which there is an
immediate transfer of title, the vendor being protected by a mortgage or other lien as to
deferred payments. Such sales either under (a) or (b), fall into two classes when considered
with respect to the terms of sale, as follows:
(1) Sales of property on the installment plan, that is, sales in which the payments received in
cash or property other than evidences of indebtedness of the purchaser during the
taxable year in which the sale is made do not exceed 25 per cent of the selling price.
(2) Deferred-payment sales not on the installment plan, that is sales in which the payments
received in cash or property other than evidences of indebtedness of the purchaser
during the taxable year in which the sale is made exceed 25 per cent of the selling price.
In the sale of mortgaged property the amount of the mortgage, whether the property is merely
taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be
included as a part of the "selling price" but the amount of the mortgage, to the extent that it
does not exceed the basis to the vendor of the property sold, shall not be considered as a part of
the "initial payments" or of the "total contract price", as those terms are used in Section 43 of
the Code, in Sections 174 and 176 of these regulations, and in this section. The term "initial
payments" does not include amounts received by the vendor in the year of sale from the
disposition to a third person of notes given by the vendee as part of the purchase price which
are due and payable in subsequent years. Commissions and other selling expenses paid or
incurred by the vendor are not to be deducted or taken into account in determining the
amount of the "initial payments," the "total contract price", or "the selling price". The term
"initial payments" contemplates at least one other payment in addition to the initial payment.
If the entire purchase price is to be paid in a lump sum in a later year, there being no payment
during the first year, the income may not be returned on the installment basis. Income may
not be returned on the installment basis where no payment in cash or property, other than
evidences of indebtedness of the purchaser, is received during the first year, the purchaser
having promised to make two or more payments, in later years.
SECTION 176. Sale of real property on installment plan. — In transactions included in class (1)
in the preceding section the vendor may return as income from such transactions in any
taxable year that proportion of the installment payments actually received in that year which
the total profit realized or to be realized when the property is paid for bears to the total
contract price.
If the purchaser defaults in any of his payments, and the vendor returning income on the
installment basis reacquires the property sold, whether title thereto had been retained by the
vendor or transferred to the purchaser, gain or loss for the year in which the reacquisition
occurs is to be computed upon any installment obligations of the purchaser which are
satisfied or discharged upon the reacquisition or are applied by the vendor to the purchase or
bid price of the property. Such gain or loss is to be measured by the difference between the
fair market value of the property acquired (including the fair market value of any fixed
improvements placed on the property by the purchaser) and the basis in the hands of the
vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with
proper adjustment for any other amounts realized or costs incurred in connection with the
reacquisition. The basis in the hands of the vendor of the obligations of the purchaser
satisfied, discharged, or applied upon the reacquisition of the property will be the excess of
the face value of such obligations over an amount equal to the income which would be
returnable were the obligations paid in full. No deduction for a bad debt shall in any case be
taken on account of any portion of the obligations of the purchaser which are treated by the
vendor as not having been satisfied, discharged, or applied upon the reacquisition of the
property, unless it is clearly shown that after the property was reacquired the purchaser
remained liable for such portion; and in no event shall the amount of the deduction exceed the
185 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
basis in the hands of the vendor of the portion of the obligations with respect to which the
purchaser remained liable after the acquisition. If the property reacquired is bid in by the
vendor at a foreclosure sale, the fair market value of the property shall be presumed to be the
purchase or bid price thereof in the absence of clear and convincing proof to the contrary. If
the property reacquired is subsequently sold, the basis for determining gain or loss is the fair
market value of the property at the date of reacquisition (including the fair market value of
any fixed improvements placed on the property by the purchaser).
If the vendor chooses as a matter of consistent practice to turn the income from installment
sales on the straight accrual or cash receipts and disbursements basis, such a course is
permissible, and the sales will be treated as deferred-payment sales not on the installment
plan.
SECTION 177. Deferred-payment sale of real property not on installment plan. — In
transactions included in class (2) in Section 175 of these regulations, the obligations of the
purchaser received by the vendor are to be considered as the equivalent of cash.
If the vendor has retained title to the property and the purchaser defaults in any of his
payments, and the vendor repossesses the property, the difference between (1) the entire
amount of the payments actually received on the contract and retained by the vendor plus the
fair-market value at the time of repossession of fixed improvements placed on the property by
the purchaser and (2) the sum of the profits previously returned as income in connection
therewith and an amount representing what would have been a proper adjustment for
exhaustion, wear and tear, obsolescence, amortization, and depletion of the property during
the period the property was in the hands of the purchaser had the sale not been made will
constitute gain or loss, as the case may be to the vendor for the year in which the property is
repossessed, and the basis of the property in the hands of the vendor will be the original basis
at the time of the sale plus the fair market value at the time of repossession, of fixed
improvements placed on the property by the purchaser. If the vendor has previously
transferred title to the purchaser, and the purchaser defaults in any of his payments and the
vendor reacquired the property, such reacquisition shall be regarded as a transfer by the
vendor, in exchange for the property for such of the purchaser's obligations as are applied by
the vendor to the purchase or bid price of the property. Such an exchange will be regarded as
having resulted in the realization by the vendor of gain or loss, as the case may be for the year
of reacquisition, measured by the difference between the fair market value of the property
including fixed improvements placed by the purchaser on the property, and the amount of the
obligations of the purchaser which were applied by the vendor to the purchase or bid price of
the property. The fair market value of the property reacquired shall be presumed to be the
amount for which it is bid in by the vendor in the absence of clear and convincing proof to the
contrary. If the property reacquired is subsequently sold the basis for determining gain or loss
is the fair market value of the property at the date of reacquisition including the fair market
value of the fixed improvements placed on the property by the purchaser.
A. ACCOUNTING METHOD - CASH (ACTUAL OR CONSTRUCTIVE) OR
ACCRUAL
B. HYBRID METHOD
CONSOLIDATED MINES, INC. v. CTA
FACTS:
The Company (petitioner) has certain mining claims located in Zambales. Because it wanted to
relieve itself of the work and expense necessary for developing the claims, the Company
entered into an agreement with Benguet, whereby the latter undertook to develop and market
the pay ore in said mining claims, with a 90%-10% sharing of profits.
The Company, a domestic corporation engaged in mining, had filed its income tax returns for
1951, 1952, 1953 and 1956. In 1957 examiners of the BIR investigated the income tax returns
filed by the Company because its auditor claimed the refund of the sum of P107,472.00
representing alleged overpayments of income taxes for the year 1951. After the investigation
the BIR examiners reported that:
(a) for the years 1951 to 1954 —
a. the Company had not accrued as an expense the share in the company profits of
Benguet Consolidated Mines as operator of the Company's mines, although for
income tax purposes the Company had reported income and expenses on the
accrual basis;
b. depletion and depreciation expenses had been overcharged; and
c. the claims for audit and legal fees and miscellaneous expenses for 1953 and 1954
had not been properly substantiated;
and that (B) for the year 1956 —
a. the Company had overstated its claim for depletion; and
b. certain claims for miscellaneous expenses were not duly supported by evidence.
Thus, the CIR sent the Company a letter of demand requiring it to pay certain deficiency
income taxes for the years 1951 to 1954, inclusive, and for the year 1956. The Company
requested a reconsideration of the assessment, but the Commissioner refused to reconsider,
hence the Company appealed to the Court of Tax Appeals.
CTA decided that the Company should pay the deficiency taxes, albeit reduced from the
amount assessed by the CIR. CTA subscribed to the theory of the Company that Benguet
Consolidated Mining Company, (Benguet), had no right to share in "Accounts Receivable,"
hence one-half thereof may not be accrued as an expense of the Company for a given year.
Both the Company and the CIR appealed to this Court. The Company questions the rate of
mine depletion adopted by the CTA and the disallowance of depreciation charges and certain
miscellaneous expenses. The CIR, on the other hand, questions what he characterizes as the
"hybrid" or "mixed" method of accounting utilized by the Company, and approved by the CTA,
in treating the share of Benguet in the net profits from the operation of the mines in
connection with its income tax returns.
The Company used the accrual method of accounting in computing its income. One of its
expenses is the amount paid to Benguet as mine operator, which amount is computed as 50%
of "net income." The Company deducts as an expense 50% of cash receipts minus
disbursements, but does not deduct at the end of each calendar year what the Commissioner
alleges is "50% of the share of Benguet" in the accounts receivable. However, it deducts
Benguet's 50% if and when the accounts receivable are actually paid. It would seem, therefore,
that the Company has been deducting a portion of this expense (Benguet's share as mine
operator) on the "cash & carry" basis.
ISSUE:
Whether or not the accounting system used by the Company is the "hybrid method", as
characterized by the Commissioner
HELD:
NO. With respect to methods of accounting, the Tax Code states:
Sec. 38. General Rules. The net income shall be computed upon the basis of the taxpayer's
annual accounting period (fiscal year or calendar year, as the case may be) in accordance
186 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
with the method of accounting regularly employed in keeping the books of such taxpayer
but if no such method of accounting has been so employed or if the method employed does
not clearly reflect the income the computation shall be made in accordance with such
methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the
income ...
Sec. 39. Period in which items of gross income included. — The amount of all items of gross
income shall be included in the gross income for the taxable year in which received by the
taxpayer, unless, under the methods of accounting permitted under section 38, any such
amounts are to be properly accounted for as of a different period ...
Sec. 40. Period for which deductions and credits taken. — The deductions provided for in
this Title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred"
dependent upon the method of accounting upon the basis of which the net income is
computed, unless in order to clearly reflect the income the deductions should be taken as of
a different period …
It is said that accounting methods for tax purposes comprise a set of rules for determining
when and how to report income and deductions. The U.S. Internal Revenue Code allows each
taxpayer to adopt the accounting method most suitable to his business, and requires only that
taxable income generally be based on the method of accounting regularly employed in keeping
the taxpayer's books, provided that the method clearly reflects income.
The CIR is interested in taxes of 1953 and 1954, in each of which years the amount of the
“Accounts Receivable” was less than that of the previous year, and the Company, therefore,
appears to have deducted, as expense, compensation to Benguet bigger (than what the CIR
claims is due) by one-half of the difference between the year's Accounts Receivable and the
previous year's Accounts Receivable, thus apparently understating its income to that extent.
The statement of accounts and the payment part that Benguet must make are both with
respect to "expenditures made and ore settlements received." "Expenditures" are payments of
money. This is the meaning intended by the parties, considering the provision that Benguet
agreed to "provide such funds from its own resources, etc."; and that "such expenditures from
its own resources" were to be reimbursed first. In the term "ore settlements received," the
word "settlement" was not used in the concept of "adjustment," "arrangement" or
"ascertainment of a balance between contending parties," since all these are "made," not
"received." "Payment," then, is the more appropriate equivalent of, and interchangeable with,
the term "Settlement." Hence, "ore settlements received" means "ore payments received,"
which excludes "Accounts Receivable." Thus the agreement refers to "payment," either
received or paid by Benguet.
The 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by
deducting from gross income all operating expenses and all disbursements of any nature
whatsoever as may be made in order to carry out the terms of the agreement." In the accrual
method of accounting "gross income" would include both "cash receipts" and "Accounts
Receivable." But the term "gross income" does not carry a definite and inflexible meaning
under all circumstances, and should be defined in such a way as to ascertain the sense in
which the parties have used it in contracting. It is thus clear from that in the computation of
"net profits" only "cash payments" received and "cash disbursements" made by Benguet were
to be considered. The language used by the parties show their intention to compute Benguet's
50% share on the excess of actual receipts over disbursements, without considering
"Accounts Receivable" and "Accounts Payable" as factors in the computation. Benguet then did
not have a right to share in "Accounts Receivable," and, correspondingly, the Company did not
have the liability to pay Benguet any part of that item. And a deduction cannot be accrued
until an actual liability is incurred, even if payment has not been made.
Here we have to distinguish between (1) the method of accounting used by the Company in
determining its net income for tax purposes; and (2) the method of computation agreed upon
between the Company and Benguet in determining the amount of compensation that was to
be paid by the former to the latter. The parties, being free to do so, had contracted that in the
method of computing compensation the basis were "cash receipts" and "cash payments." Once
determined in accordance with the stipulated bases and procedure, then the amount due
Benguet for each month accrued at the end of that month, whether the Company had made
payment or not. To make the Company deduct as an expense one-half of the "Accounts
Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have
under the contract, and to substitute for the parties' choice a mode of computation of
compensation not contemplated by them.
income, prepare their returns upon the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of
completion. In such case there should accompany the return certificate of architects, or
engineers showing the percentage of completion during the taxable year of the entire work
performed under contract. There should be deducted from such gross income all expenditures
made during the taxable year on account of the contract, account being taken of the material
and supplies on hand at the beginning and end of the taxable period for use in connection with
the work under the contract but not yet so applied. If upon completion of a contract, it is found
that the taxable net income arising thereunder has not been clearly reflected for any year or
years, the Commissioner of Internal Revenue may permit or require an amended return.

Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct
in not accruing said one-half as a deduction. The Company was not using a hybrid method of
accounting, but was consistent in its use of the accrual method of accounting.
To sum up, the Court ruled —
a. that the Company was not using a "hybrid" method of accounting in the preparation of its
income tax returns, but was consistent in its use of the accrual method of accounting;
b. that the rate of depletion per ton of the ore deposit mined and sold by the Company is
P0.6196 per ton 49 not P0.59189 as contended by the Commissioner nor P1.0197 as
claimed by the Company;
c. that the disallowance by the Tax Court of the depreciation charges claimed by the
Company is correct in view of the latter's failure to itemize and/or substantiate with
definite proof that the Commissioner's own method of determining depreciation is
unreasonable or inaccurate;
d. that for lack of supporting evidence to show that the Company's claimed expenses were
legally deductible items, the Tax Court's disallowance of the same is affirmed.
C. PERCENTAGE OF COMPLETION METHOD
SEC. 48. Accounting for Long-Term Contracts. - Income from long-term contracts shall be
reported for tax purposes in the manner as provided in this Section. As used herein, the term
'long-term contracts' means building, installation or construction contracts covering a period
in excess of one (1) year. Persons whose gross income is derived in whole or in part from such
contracts shall report such income upon the basis of percentage of completion. The return
should be accompanied by a return certificate of architects or engineers showing the
percentage of completion during the taxable year of the entire work performed under
contract. There should be deducted from such gross income all expenditures made during the
taxable year on account of the contract, account being taken of the material and supplies on
hand at the beginning and end of the taxable period for use in connection with the work under
the contract but not yet so applied. If upon completion of a contract, it is found that the taxable
net income arising thereunder has not been clearly reflected for any year or years, the
Commissioner may permit or require an amended return.
REVENUE REGULATIONS NO. 2
SECTION 44. Long term contracts. — Income from long-term contracts is taxable for the
period in which the income is determined, such determination depending upon the nature and
terms of the particular contract. As used herein the term "long-term" contracts means
building, installation, or construction contracts covering a period in excess of one year.
Persons whose income is derived in whole or in par from such contracts may, as to such
187 TAXATION 1 (ATTY. BELLO)
(b) Gross income may be reported in the taxable year in which the contract is finally
completed and accepted if the taxpayer elects as a consistent practice to so treat such income,
provided such method clearly reflects the net income. If this method is adopted there should
be deducted from gross income all expenditures during the life of the contract which are
properly allocated thereto, taking into consideration any material and supplies charged to the
work under the contract but remaining on hand at the time of the completion.
Where a taxpayer has filed his return in accordance with the method of accounting regularly
employed by him in keeping his books and such method clearly reflects the income, he will not
be required to change to either of the methods above set forth. If a taxpayer desires to change
his method of accounting in accordance with paragraphs (a) and (b) above, a statement
showing the composition of all items appearing upon his balance sheet and used in connection
with the method of accounting formerly employed by him, should accompany his return.
D. CHANGE OF ACCOUNTING PERIOD
E. INSTALLMENT BASIS
F. ALLOCATION OF INCOME AND DEDUCTIONS
XVIII. RETURNS AND PAYMENT OF TAXES
A. INDIVIDUAL RETURN
SEC. 51. Individual Return. -
(A) Requirements. -
(1) Except as provided in paragraph (2) of this Subsection, the following individuals are
required to file an income tax return:
(a) Every Filipino citizen residing in the Philippines;
(b) Every Filipino citizen residing outside the Philippines, on his income from sources
within the Philippines;
(c) Every alien residing in the Philippines, on income derived from sources within the
Philippines; and
(d) Every nonresident alien engaged in trade or business or in the exercise of profession
in the Philippines.
(2) The following individuals shall not be required to file an income tax return;
(a) An individual whose gross income does not exceed his total personal and additional
exemptions for dependents under Section 35:Provided, That a citizen of the
-Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 Philippines and any alien individual engaged in business or practice of profession
within the Philippine shall file an income tax return, regardless of the amount of gross
income;
(b) An individual with respect to pure compensation income, as defined in Section 32
(A)(1), derived from sources within the Philippines, the income tax on which has been
correctly withheld under the provisions of Section 79 of this Code: Provided, That an
individual deriving compensation concurrently from two or more employers at any
time during the taxable year shall file an income tax return: Provided, further, That an
individual whose compensation income derived from sources within the Philippines
exceeds Sixty thousand pesos (P60,000) shall also file an income tax return;
(c) An individual whose sole income has been subjected to final withholding tax pursuant
to Section 57(A) of this Code; and
(d) A minimum wage earner as defined in Section 22(HH) of this Code or an individual
who is exempt from income tax pursuant to the provisions of this Code and other laws,
general or special.
(3) The forgoing notwithstanding, any individual not required to file an income tax return
may nevertheless be required to file an information return pursuant to rules and regulations
prescribed by the Secretary of Finance, upon recommendation of the Commissioner.
(4) The income tax return shall be filed in duplicate by the following persons:
(a) A resident citizen - on his income from all sources;
(b) A nonresident citizen - on his income derived from sources within the Philippines;
(c) A resident alien - on his income derived from sources within the Philippines; and
(d) A nonresident alien engaged in trade or business in the Philippines - on his income
derived from sources within the Philippines.
(B) Where to File. - Except in cases where the Commissioner otherwise permits, the return
shall be filed with an authorized agent bank, Revenue District Officer, Collection Agent or duly
authorized Treasurer of the city or municipality in which such person has his legal residence
or principal place of business in the Philippines, or if there be no legal residence or place of
business in the Philippines, with the Office of the Commissioner.
(C) When to File. -
(1) The return of any individual specified above shall be filed on or before the fifteenth (15th)
day of April of each year covering income for the preceding taxable year.
(2) Individuals subject to tax on capital gains;
(a) From the sale or exchange of shares of stock not traded thru a local stock exchange as
prescribed under Section 24(c) shall file a return within thirty (30) days after each
transaction and a final consolidated return on or before April 15 of each year covering
all stock transactions of the preceding taxable year; and
(b) From the sale or disposition of real property under Section 24(D) shall file a return
within thirty (30) days following each sale or other disposition.
(D) Husband and Wife. - Married individuals, whether citizens, resident or nonresident
aliens, who do not derive income purely from compensation, shall file a return for the taxable
year to include the income of both spouses, but where it is impracticable for the spouses to
file one return, each spouse may file a separate return of income but the returns so filed shall
188 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
be consolidated by the Bureau for purposes of verification for the taxable year.
(E) Return of Parent to Include Income of Children. - The income of unmarried minors
derived from properly received from a living parent shall be included in the return of the
parent, except (1) when the donor's tax has been paid on such property, or (2) when the
transfer of such property is exempt from donor's tax.
(F) Persons Under Disability. - If the taxpayer is unable to make his own return, the return
may be made by his duly authorized agent or representative or by the guardian or other
person charged with the care of his person or property, the principal and his representative
or guardian assuming the responsibility of making the return and incurring penalties
provided for erroneous, false or fraudulent returns.
(G) Signature Presumed Correct. - The fact that an individual's name is signed to a filed
return shall be prima facie evidence for all purposes that the return was actually signed by
him.
SEC. 56. Payment and Assessment of Income Tax for Individuals and Corporation. -
(A) Payment of Tax. -
(1) In General. - The total amount of tax imposed by this Title shall be paid by the person
subject thereto at the time the return is filed.
In the case of tramp vessels, the shipping agents and/or the husbanding agents, and in their
absence, the captains thereof are required to file the return herein provided and pay the tax
due thereon before their departure.
Upon failure of the said agents or captains to file the return and pay the tax, the Bureau of
Customs is hereby authorized to hold the vessel and prevent its departure until proof of
payment of the tax is presented or a sufficient bond is filed to answer for the tax due.
(2) Installment of Payment. - When the tax due is in excess of Two thousand pesos (P2,000),
the taxpayer other than a corporation may elect to pay the tax in two (2) equal installments in
which case, the first installment shall be paid at the time the return is filed and the second
installment, on or before July 15 following the close of the calendar year.
If any installment is not paid on or before the date fixed for its payment, the whole amount of
the tax unpaid becomes due and payable, together with the delinquency penalties.
(3) Payment of Capital Gains Tax. - The total amount of tax imposed and prescribed under
Section 24 (c), 24(D), 27(E)(2), 28(A)(8)(c) and 28(B)(5)(c) shall be paid on the date the
return prescribed therefor is filed by the person liable thereto: Provided, That if the seller
submits proof of his intention to avail himself of the benefit of exemption of capital gains
under existing special laws, no such payments shall be required : Provided, further, That in
case of failure to qualify for exemption under such special laws and implementing rules and
regulations, the tax due on the gains realized from the original transaction shall immediately
become due and payable, subject to the penalties prescribed under applicable provisions of
this Code: Provided, finally, That if the seller, having paid the tax, submits such proof of intent
within six (6) months from the registration of the document transferring the real property, he
shall be entitled to a refund of such tax upon verification of his compliance with the
requirements for such exemption.
In case the taxpayer elects and is qualified to report the gain by installments under Section 49
of this Code, the tax due from each installment payment shall be paid within (30) days from
the receipt of such payments.
No registration of any document transferring real property shall be effected by the Register of
Deeds unless the Commissioner or his duly authorized representative has certified that such
transfer has been reported, and the tax herein imposed, if any, has been paid.
(B) Assessment and Payment of Deficiency Tax. - After the return is filed, the Commissioner
shall examine it and assess the correct amount of the tax.
The tax or deficiency income tax so discovered shall be paid upon notice and demand from the
Commissioner.
As used in this Chapter, in respect of a tax imposed by this Title, the term "deficiency" means:.
(1) The amount by which the tax imposed by this Title exceeds the amount shown as the tax
by the taxpayer upon his return; but the amount so shown on the return shall be increased by
the amounts previously assessed (or collected without assessment) as a deficiency, and
decreased by the amount previously abated, credited, returned or otherwise repaid in respect
of such tax; or
(2) If no amount is shown as the tax by the taxpayer upon this return, or if no return is made
by the taxpayer, then the amount by which the tax exceeds the amounts previously assessed
(or collected without assessment) as a deficiency; but such amounts previously assessed or
collected without assessment shall first be decreased by the amounts previously abated,
credited returned or otherwise repaid in respect of such tax.
1. WHO ARE REQUIRED TO FILE
2. THOSE NOT REQUIRED TO FILE
3. WHERE TO FILE
4. WHEN TO FILE
5. WHERE TO PAY
6. CAPITAL GAINS ON SHARES OF STOCKS AND REAL ESTATE
7. QUARTERLY DECLARATION OF INCOME TAX
SEC. 74. Declaration of Income Tax for Individuals. -
(A) In General. - Except as otherwise provided in this Section, every individual subject to
income tax under Sections 24 and 25(A) of this Title, who is receiving self-employment
income, whether it constitutes the sole source of his income or in combination with salaries,
wages and other fixed or determinable income, shall make and file a declaration of his
estimated income for the current taxable year on or before April 15 of the same taxable year.
In general, self-employment income consists of the earnings derived by the individual from the
practice of profession or conduct of trade or business carried on by him as a sole proprietor or
by a partnership of which he is a member.
Nonresident Filipino citizens, with respect to income from without the Philippines, and
nonresident aliens not engaged in trade or business in the Philippines, are not required to
render a declaration of estimated income tax.
The declaration shall contain such pertinent information as the Secretary of Finance, upon
recommendation of the Commissioner, may, by rules and regulations prescribe.
An individual may make amendments of a declaration filed during the taxable year under the
rules and regulations prescribed by the Secretary of Finance, upon recommendation of the
189 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Commissioner.
(B) Return and Payment of Estimated Income Tax by Individuals. - The amount of
estimated income as defined in Subsection (C) with respect to which a declaration is required
under Subsection (A) shall be paid in four (4) installments.
The first installment shall be paid at the time of the declaration and the second and third shall
be paid on August 15 and November 15 of the current year, respectively.
The fourth installment shall be paid on or before April 15 of the following calendar year when
the final adjusted income tax return is due to be filed.
(C) Definition of Estimated Tax. - In the case of an individual, the term "estimated tax" means
the amount which the individual declared as income tax in his final adjusted and annual
income tax return for the preceding taxable year minus the sum of the credits allowed under
this Title against the said tax.
If, during the current taxable year, the taxpayer reasonable expects to pay a bigger income tax,
he shall file an amended declaration during any interval of installment payment dates.
B. CORPORATION RETURNS
SEC. 52. Corporation Returns. -
(A) Requirements. - Every corporation subject to the tax herein imposed, except foreign
corporations not engaged in trade or business in the Philippines, shall render, in duplicate, a
true and accurate quarterly income tax return and final or adjustment return in accordance
with the provisions of Chapter XII of this Title.
The return shall be filed by the president, vice-president or other principal officer, and shall
be sworn to by such officer and by the treasurer or assistant treasurer.
(B) Taxable Year of Corporation. - A corporation may employ either calendar year or fiscal
year as a basis for filing its annual income tax return: Provided, That the corporation shall not
change the accounting period employed without prior approval from the Commissioner in
accordance with the provisions of Section 47 of this Code.
(C) Return of Corporation Contemplating Dissolution or Reorganization. - Every
corporation shall, within thirty (30) days after the adoption by the corporation of a resolution
or plan for its dissolution, or for the liquidation of the whole or any part of its capital stock,
including a corporation which has been notified of possible involuntary dissolution by the
Securities and Exchange Commission, or for its reorganization, render a correct return to the
Commissioner, verified under oath, setting forth the terms of such resolution or plan and such
other information as the Secretary of Finance, upon recommendation of the commissioner,
shall, by rules and regulations, prescribe.
The dissolving or reorganizing corporation shall, prior to the issuance by the Securities and
Exchange Commission of the Certificate of Dissolution or Reorganization, as may be defined
by rules and regulations prescribed by the Secretary of Finance, upon recommendation of the
Commissioner, secure a certificate of tax clearance from the Bureau of Internal Revenue which
certificate shall be submitted to the Securities and Exchange Commission.
(D) Return on Capital Gains Realized from Sale of Shares of Stock not Traded in the Local
Stock Exchange. - Every corporation deriving capital gains from the sale or exchange of
shares of stock not traded thru a local stock exchange as prescribed under Sections 24 (c), 25
(A)(3), 27 (E)(2), 28(A)(8)(c) and 28 (B)(5)(c), shall file a return within thirty (30) days after
each transactions and a final consolidated return of all transactions during the taxable year on
or before the fifteenth (15th) day of the fourth (4th) month following the close of the taxable  This case involves a claim for tax refund in the amount of P112,491.00 representing
year. petitioner's tax withheld for the year 1989.
SEC. 53. Extension of Time to File Returns. - The Commissioner may, in meritorious cases,  In its Corporate Annual Income Tax Return for the year 1989, the following items are
grant a reasonable extension of time for filing returns of income (or final and adjustment reflected:
returns in case of corporations), subject to the provisions of Section 56 of this Code.
Income P1,017,931,831.00
SEC. 56
Deductions P1,026,218,791.00

1. QUARTERLY INCOME TAX Net Income (Loss) (P8,286,960.00)

SEC. 75. Declaration of Quarterly Corporate Income Tax. - Every corporation shall file in Taxable Income (Loss) (P8,286,960.00)
duplicate a quarterly summary declaration of its gross income and deductions on a cumulative Less:
basis for the preceding quarter or quarters upon which the income tax, as provided in Title II
of this Code, shall be levied, collected and paid. 1988 Tax Credit P185,001.00

The tax so computed shall be decreased by the amount of tax previously paid or assessed
during the preceding quarters and shall be paid not later than sixty (60) days from the close of
each of the first three (3) quarters of the taxable year, whether calendar or fiscal year.
2. FINAL ADJUSTMENT RETURN
SEC. 76. Final Adjustment Return. - Every corporation liable to tax under Section 27
shall file a final adjustment return covering the total taxable income for the preceding
calendar or fiscal year.
If the sum of the quarterly tax payments made during the said taxable year is not equal to
the total tax due on the entire taxable income of that year, the corporation shall either:
(A) Pay the balance of tax still due; or
(B) Carry-over the excess credit; or
(C) Be credited or refunded with the excess amount paid, as the case may be.
In case the corporation is entitled to a tax credit or refund of the excess estimated
quarterly income taxes paid, the excess amount shown on its final adjustment return may
be carried over and credited against the estimated quarterly income tax liabilities for the
taxable quarters of the succeeding taxable years.
1989 Tax Credit P112,491.00
TOTAL AMOUNT P297,492.00
REFUNDABLE
 It appears from the foregoing 1989 Income Tax Return that petitioner had a total
refundable amount of P297,492 inclusive of the P112,491.00 being claimed as tax refund
in the present case. However, petitioner declared in the same 1989 Income Tax Return
that the said total refundable amount of P297,492.00 will be applied as tax credit to the
succeeding taxable year.
 Subsequently, petitioner filed a written claim for refund in the amount of P112,491.00
with the respondent Commissioner of Internal Revenue alleging that it did not apply the
1989 refundable amount of P297,492.00 (including P112,491.00) to its 1990 Annual
Income Tax Return or other tax liabilities due to the alleged business losses it incurred
for the same year.
 The respondent Court of Tax Appeals dismissed petitioner's petition on the ground that
petitioner failed to present as evidence its corporate Annual Income Tax Return for 1990
to establish the fact that petitioner had not yet credited the amount of P297,492.00
(inclusive of the amount P112,491.00 which is the subject of the present controversy) to
its 1990 income tax liability.

Once the option to carry-over and apply the excess quarterly income tax against income  The CA affirmed the CTA.
tax due for the taxable quarters of the succeeding taxable years has been made, such
ISSUE/S:
option shall be considered irrevocable for that taxable period and no application for cash
Whether or not petitioner is entitled to the refund of P112,491.90, representing excess
refund or issuance of a tax credit certificate shall be allowed therefor.
creditable withholding tax paid for the taxable year 1989. YES (Petitioner Entitled to Refund)

BPI-FAMILY SAVINGS BANK v. COURT OF APPEALS RATIO:

DOCTRINE:
 A final adjustment return shows whether a corporation incurred a loss or gained a profit
during the taxable year.
 If the State expects its taxpayers to observe fairness and honesty in paying their taxes, so
must it apply the same standard against itself in refunding excess payments. When it is
undisputed that a taxpayer is entitled to a refund, the State should not invoke
technicalities to keep money not belonging to it. No one, not even the State, should enrich
oneself at the expense of another.
 It is undisputed that petitioner had excess withholding taxes for the year 1989 and was
thus entitled to a refund amounting to P112,491.
 Pursuant to Section 69 of the 1986 Tax Code which states that a corporation entitled to a
refund may opt either (1) to obtain such refund or (2) to credit said amount for the
succeeding taxable year
 Petitioner indicated in its 1989 Income Tax Return that it would apply the said amount as
a tax credit for the succeeding taxable year, 1990.

FACTS:  The CTA and the CA ruled that petitioner failed to overcome this presumption because it

190 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
 did not present its 1990 Return, which would have shown that the amount in dispute was
not applied as a tax credit. Hence, the CA concluded that petitioner was not entitled to a
tax refund.
 In the first place, petitioner presented evidence to prove its claim that it did not apply the
amount as a tax credit. During the trial before the CTA, Ms. Yolanda Esmundo, the
manager of petitioner's accounting department, testified to this fact. It likewise
presented its claim for refund and a certification issued by Mr. Gil Lopez, petitioner's
vice-president, stating that the amount of P112,491 "has not been and/or will not be
automatically credited/offset against any succeeding quarters' income tax liabilities for
the rest of the calendar year ending December 31, 1990." Also presented were the
quarterly returns for the first two quarters of 1990.
 The Bureau of Internal Revenue, for its part, failed to controvert petitioner's claim.
In fact, it presented no evidence at all. Because it ought to know the tax records of
all taxpayers, the CIR could have easily disproved petitioner's claim. To repeat, it
did not do so.
 More important, a copy of the Final Adjustment Return for 1990 was attached to
petitioner's Motion for Reconsideration filed before the CTA.
 In this case, that Return clearly showed that petitioner incurred P52,480,173 as net loss
in 1990. Clearly, it could not have applied the amount in dispute as a tax credit.
 To repeat, the undisputed fact is that petitioner suffered a net loss in 1990;
accordingly, it incurred no tax liability to which the tax credit could be applied.
Consequently, there is no reason for the BIR and this Court to withhold the tax
refund which rightfully belongs to the petitioner.
 Respondents' reasoning underscores the weakness of their case. For if they had really
believed that petitioner is not entitled to a tax refund, they could have easily proved that
it did not suffer any loss in 1990. Indeed, it is noteworthy that respondents opted not to
assail the fact appearing therein.
PHILAM ASSET MGT., INC. v. CIR
DOCTRINE:
A taxable corporation with excess quarterly income tax payments may apply for either a tax
refund or a tax credit, but not both. The choice of one precludes the other. Failure to indicate a
choice, however, will not bar valid request for a refund, should this option be chosen by the
taxpayer later on.
FACTS:
- Philam Asset Management, Inc. is a domestic corporation, which acts as the investment
manager of Philippine Fund, Inc. and Philam Bond Fund, Inc. , which are open-end investment
companies.
- Philam is, likewise, PFI’s and PBFI’s principal distributor which takes charge of the sales of
said companies’ shares to prospective investors.
- Philam receives monthly management fees from both Funds, which are subject to a 5%
creditable withholding tax.
a) In its 1997 tax return (filed in April 1998), Philam reported a loss of P2.7Mn, and
consequently failed to utilize the creditable withholding tax (CWT) of P522k. As such, it filed a
claim for refund.
b) In its 1998 tax return (filed in April 1999), Philam reported a loss of P1.5M, with
191 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
unapplied CWT of P460k. In 1999, it had a tax due of P80k, and CWT of P916k. It also
included in the 1999 return the P460k pertaining to unused CWT of the previous year. It
claimed, in Nov. 2000, a refund pertaining to the 1998 CWT of P460k as it is still unused since
it was not applied against its tax liabilities in 1998.
- Note that both claims were filed within the two-year prescriptive period provided by the Tax
Code for the refund of taxes erroneously paid by the taxpayer to the BIR.
- The CIR did not act on both claims for refund. Philam elevated the cases to the CTA, both
were denied.
- The CA likewise denied the claim of petitioner for a refund of the latter’s excess creditable
taxes withheld for the years 1997 and 1998, despite compliance with the basic requirements
of Revenue Regulations (RR) No. 12-94. The appellate court pointed out that, in the respective
Income Tax Returns (ITRs) for both years, petitioner did not indicate its option to have the
amounts either refunded or carried over and applied to the succeeding year. It was held that
to request for either a refund or a credit of income tax paid, a corporation must signify its
intention by marking the corresponding option box on its annual corporate adjustment
return.
- The CA further held that the failure to present the 1998 ITR was fatal to the claim for a
refund of the 1997 CWT, because there was no way to verify if the tax credit for 1997 could
not have been applied against the 1998 tax liabilities of petitioner.
ISSUE:
W/N petitioner is entitled to a refund of its creditable taxes withheld for taxable years: a)
1997 and b) 1998.
RULING:
a) YES. The relevant provision of NIRC in 1997 is as follows:
“Section 76. Final Adjustment Return (FAR). -- Every corporation liable to tax under Section
24 shall file a final adjustment return covering the total net income for the preceding
calendar or fiscal year. If the sum of the quarterly tax payments made during the said
taxable year is not equal to the total tax due on the entire taxable net income of that year
the corporation shall either:
(a) Pay the excess tax still due; or
(b) Be refunded the excess amount paid, as the case may be.
“In case the corporation is entitled to a refund of the excess estimated quarterly income
taxes paid, the refundable amount shown on its final adjustment return may be credited
against the estimated quarterly income tax liabilities for the taxable quarters of the
succeeding taxable year.”
The first option is relatively simple. Any tax on income that is paid in excess of the amount due
the government may be refunded, provided that a taxpayer properly applies for the refund.
The second option works by applying the refundable amount, as shown on the FAR of a given
taxable year, against the estimated quarterly income tax liabilities of the succeeding taxable
year.
The two options are alternative in nature, the choice of one precludes the other. The
corporation must signify its intention as to which option to avail by marking the
corresponding option box in the FAR. However, this requirement is only for the purpose of
facilitating tax collection. One cannot get a tax refund and a tax credit at the same time for the
same excess income taxes paid. Failure to signify one’s intention in the FAR does not mean
outright barring of a valid request for a refund, should one still choose this option later on.
The reason for requiring that a choice be made in the FAR upon its filing is to ease tax
administration, particularly the self-assessment and collection aspects. A taxpayer that makes
a choice expresses certainty or preference and thus demonstrates clear diligence. Conversely,
a taxpayer that makes no choice expresses uncertainty or lack of preference and hence shows
simple negligence or plain oversight.
In the present case, although petitioner did not mark the refund box in its 1997 FAR, neither
did it perform any act indicating that it chose a tax credit. On the contrary, it filed on
September 11, 1998, an administrative claim for the refund of its excess taxes withheld in
1997. The filing of its written claim effectively serves as an expression of its choice to request
a tax refund, instead of a tax credit. To assert that any future claim for a tax refund will be
instantly hindered by a failure to signify one’s intention in the FAR is to render nugatory the
clear provision that allows for a two-year prescriptive period.
As to the failure to present the 1998 ITR, the Court held that the presentation of the
succeeding year’s ITR is not required. It is not mandated by the tax code and the regulations
only require that 1) it is shown on the ITR that the income payment received is being declared
part of he taxpayer’s gross income; and (2) the fact of withholding is established by a copy of
the withholding tax statement, duly issued by the payor to the payee, showing the amount
paid and the income tax withheld from that amount. Both requirements have been complied
with by Philam. In addition there is no need to present the 1998 ITR since the BIR has a copy
of it and CA can take judicial notice of the filing of the claim for refund of the 1998 CWT.
Under these circumstances, petitioner is entitled to a tax refund of its 1997 excess tax credits
in the amount of P522k.
b) NO. Amended by Republic Act (RA) No. 8424, otherwise known as the “Tax Reform Act of
1997,” it now states:
“SEC. 76. Final Adjustment Return. -- Every corporation liable to tax under Section 27 shall
file a final adjustment return covering the total taxable income for the preceding calendar
or fiscal year. If the sum of the quarterly tax payments made during the said taxable year is
not equal to the total tax due on the entire taxable income of that year, the corporation
shall either:
(A) Pay the balance of tax still due; or
(B) Carry over the excess credit; or
(C) Be credited or refunded with the excess amount paid, as the case may be.
“In case the corporation is entitled to a tax credit or refund of the excess estimated
quarterly income taxes paid, the excess amount shown on its final adjustment return may
be carried over and credited against the estimated quarterly income tax liabilities for the
taxable quarters of the succeeding taxable years. Once the option to carry-over and apply
the excess quarterly income tax against income tax due for the taxable quarters of the
succeeding taxable years has been made, such option shall be considered irrevocable for
that taxable period and no application for cash refund or issuance of a tax credit certificate
shall be allowed therefor.”
Although Philam neither chose nor marked the carry-over option box in its 1998 FAR, its
subsequent acts reveal that it has effectively chosen the carry-over option. The fact that it
filled out the portion “Prior Year’s Excess Credits” in its 1999 FAR means that it categorically
availed itself of the carry-over option. If an application for a tax refund has been or will be
filed, then that portion of the BIR form should necessarily be blank, even if the FAR of the
previous taxable year already shows an overpayment in taxes.
It cannot be allowed to avail itself of a tax refund and a tax credit at the same time for the
192 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
same excess income taxes paid. Besides, disallowing it from getting a tax refund of those
excess tax credits will not enervate the two-year prescriptive period under the Tax Code. That
period will apply if the carry-over option has not been chosen.
Once the carry-over option is taken, actually or constructively, it becomes irrevocable.
Petitioner has chosen that option for its 1998 creditable withholding taxes. Thus, it is no
longer entitled to a tax refund of P460k, corresponding to the 1998 CWT. However, it can still
use this amount as a credit in the succeeding taxable years.
3. WHERE TO FILE
4. WHEN TO FILE
SEC. 77. Place and Time of Filing and Payment of Quarterly Corporate Income Tax. -
(A) Place of Filing.- Except as the Commissioner otherwise permits, the quarterly income tax
declaration required in Section 75 and the final adjustment return required in Section 76 shall
be filed with the authorized agent banks or Revenue District Officer or Collection Agent or
duly authorized Treasurer of the city or municipality having jurisdiction over the location of
the principal office of the corporation filing the return or place where its main books of
accounts and other data from which the return is prepared are kept.
(B) Time of Filing the Income Tax Return. - The corporate quarterly declaration shall be filed
within sixty (60) days following the close of each of the first three (3) quarters of the taxable
year.
The final adjustment return shall be filed on or before the fifteenth (15th) day of April, or on or
before the fifteenth (15th) day of the fourth (4th) month following the close of the fiscal year, as
the case may be.
(C) Time of Payment of the Income Tax. - The income tax due on the corporate quarterly
returns and the final adjustment income tax returns computed in accordance with Sections 75
and 76 shall be paid at the time the declaration or return is filed in a manner prescribed by the
Commissioner.
5. WHEN TO PAY
6. CAPITAL GAINS ON SHARES OF STOCK
7.RETURN OF CORPORATIONS CONTEMPLATING
DISSOLUTION/REORGANIZATION
SEC. 52. Corporation Returns. -
(C) Return of Corporation Contemplating Dissolution or Reorganization. - Every
corporation shall, within thirty (30) days after the adoption by the corporation of a resolution
or plan for its dissolution, or for the liquidation of the whole or any part of its capital stock,
including a corporation which has been notified of possible involuntary dissolution by the
Securities and Exchange Commission, or for its reorganization, render a correct return to the
Commissioner, verified under oath, setting forth the terms of such resolution or plan and such
other information as the Secretary of Finance, upon recommendation of the commissioner,
shall, by rules and regulations, prescribe.
The dissolving or reorganizing corporation shall, prior to the issuance by the Securities and
Exchange Commission of the Certificate of Dissolution or Reorganization, as may be defined
by rules and regulations prescribed by the Secretary of Finance, upon recommendation of the
Commissioner, secure a certificate of tax clearance from the Bureau of Internal Revenue which
certificate shall be submitted to the Securities and Exchange Commission.
REVENUE REGULATIONS NO. 2
SECTION 244. Return of corporation contemplating dissolution or retiring from business. — All
corporations, partnership, joint accounts and associations, contemplating dissolution or
retiring from business without formal dissolution shall, within 30 days after the approval of
such resolution authorizing their dissolution, and within the same period after their
retirement from business, file their income tax returns covering the profit earned or business
done by them from the beginning of the year up to the date of such dissolution or retirement
and pay the corresponding income tax due thereon upon demand by the Commissioner of
Internal Revenue to addition to the income tax return required to be filed they shall also
submit within the same period the following:
(a) Copy of the resolution authorizing such dissolution;
(b) Balance sheet at the date of dissolution or retirement and a profit and loss statement
covering the period from the beginning of the taxable year to the date of dissolution or
retirement;
(c) In the case of a corporation, the names and addresses of the shareholders and the
number and par value of the shares held by each; and in the case of a partnership,
joint-account or association, the name of the partners or members and the capital
contributed by each;
(d) The value and a description of, the assets received in liquidation by each shareholder;
(1) (e) The name and address of each individual or corporation, other than shareholders,
if any, receiving assets at the time of dissolution together with a description and the
value of the assets received by such individuals or corporations; and the consideration,
if any, paid by each of them for the assets received.
BANK OF THE PHILIPPINE ISLANDS v. CIR
DOCTRINE:
A dissolving corporation should file its income tax return within 30 days after the cessation of
its business or 30 days after the approval of the merger.
FACTS:
By virtue of the Articles of Merger approved by the SEC on July 1, 1985, BPI became the
successor-in-interest of the Family Bank and Trust Company (FBTC) whose corporate
existence ended on June 30, 1995.
From January 1 to June 30, 1985, FBTC earned incomes consisting of rentals from its leased
properties and interest from treasury notes purchased from the Central Bank. Pursuant to the
Expanded Withholding Tax Regulations, the lessees of FBTC withheld 5% or P118,609.17 on
said rentals while the Central Bank withheld 15% or P55,456.60 on the interest on the
treasury notes. These withheld income taxes of P174,065.77 were remitted to the BIR.
Moreover, the FBTC had a prior years' excess credit of P2,146,072.57. This excess credit plus
the withheld income taxes amounted to P2,320,138.34.
On April 10, 1986, the FBTC filed its final income tax return with the BIR showing a net loss of
P64,502,935.00 and a refundable amount of P174,065.77 representing the creditable income
tax withheld at source from January 1 to June 30, 1985. On October 7, 1986, BPI as successor-
in-interest of FBTC filed a letter claim with the BIR asking for refund of P2,320,138.34. The
BIR however refunded to BPI only P2,146,072.57 (prior years' excess credits).
193 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
Since the BIR refused to refund the withheld income taxes on rentals and interests of
P174,065.77, BPI filed a petition for review with the CTA seeking a reversal of BIR's
resolution. The CTA dismissed the petition on the ground that the claim for tax refund had
already prescribed. A motion for reconsideration was filed but it was denied.
ISSUE: Whether or not BPI's claim for refund of the withheld income taxes of P174,065.77
already prescribed? YES.
RULING:
Citing Sec. 78 of the Tax Code and Sec. 744 of the Income Tax Resolution, the CTA held that
said return should have been filed within 30 days from SEC's approval of the Articles of
Merger on July 1, 1985. Petitioner BPI disagrees and, invoking Sec. 46 (a) and Sec. 70 (B) of
the Tax Code, contends that said return should have been filed on the 15th day of the 4th
month following the close of FBTC's taxable year.
This case was decided under the Tax Code which has already been amended and modified by
R.A. 8424 otherwise known as the Comprehensive Tax Reform Program which became
effective on January 1, 1998.
Upon deep reflection, this Court shares the opinion of the BIR and the CTA. Sec. 78 of the Tax
Code and Sec. 244 of the Revenue Regulations No. 2 required FBTC as a dissolving
corporation to file its income tax return within 30 days after the cessation of its business or
30 days after the approval of the merger on July 1, 1985 or up to July 31, 1985.
Under Sec. 292 of the Tax Code, an action to claim for refund of an excessively collected tax
starts to run from the day in which a corporate taxpayer is required by law to file its final
income tax return. Accordingly, BPI should have filed the action for the refund of the
excessively collected income tax return within 2 years from July 31, 1985 which was July 31,
1987. Unfortunately, petitioner filed said action only on December 29, 1987-which was late
by 151 days. Said action was, therefore, clearly time-barred.
Petitioner contends that Sec. 78 required not an income tax or final adjustment return but an
information return. It submits that Sec. 78 of the 1939 NIRC was found in Chapter IX
(Administrative Provisions) of Title II (Income Tax), together with other sections requiring
the filing of information returns. On the other hand, the requirement to file income tax
return, imposed on individuals, corporations, partnerships, receivers and trustees, and the
manner the income tax would be assessed and paid on such returns was found in Ch. VI. Thus
the requirement of an information return was very different from the requirement of an
income tax return, which later would be called, in the case of corporations, as the 'final
adjustment return.'"
This Court does not agree. Petitioner tried to mislead us by saying that what is required is only
an information return. The amendment merely added a sanction on the part of the officers of
the corporation in case of failure to provide such information return and to secure the
necessary tax clearance. A closer look of Section 46(a) and Chapter X of Title II showed that it
both made specific mention of "income tax return" and "income tax payments", respectively.
All references pointed to by petitioner have some relations to income tax payments and the
filing of an accurate Income Tax Return. We cannot deviate from the fact that indeed 'correct
return' means 'correct income tax return', the Final Adjustment Income Tax Return. Moreover,
this Court gives more weight to Section 244 of Rev. Regs. No. 2 when it stated 'income tax
return'. As a rule, all regulations promulgated by the Secretary of Finance for the effective
enforcement of the provisions of the National Internal Revenue Code are presumed valid
unless they are unreasonable and contrary to law or the Constitution.
8. RETURNS OF GPPS
SEC. 55. Returns of General Professional Partnerships. - Every general professional
partnership shall file, in duplicate, a return of its income, except income exempt under Section
32 (B) of this Title, setting forth the items of gross income and of deductions allowed by this
Title, and the names, Taxpayer Identification Numbers (TIN), addresses and shares of each of
the partners.
XIX. WITHHOLDING TAX
A. FINAL WITHHOLDING TAX AT SOURCE
SEC. 57. Withholding of Tax at Source. -
(A) Withholding of Final Tax on Certain Incomes. - Subject to rules and regulations the
Secretary of Finance may promulgate, upon the recommendation of the Commissioner,
requiring the filing of income tax return by certain income payees, the tax imposed or
prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C),
25(D), 25(E), 27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5), 28 (A)(4), 28(A)(5), 28(A)(7)(a),
28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b),
28(B)(5)(c); 33; and 282 of this Code on specified items of income shall be withheld by payor-
corporation and/or person and paid in the same manner and subject to the same conditions as
provided in Section 58 of this Code.
CIR v. WANDER PHILIPPINES, INC.
DOCTRINE:
The dividends received from a domestic corporation is liable to a 15% withholding tax,
provided that the country in which the foreign corporation is domiciled shall allow a tax credit
(equivalent to 20% which is the difference between the 35% tax due on regular corporations
and the 15% tax due on dividends) against the taxes due to have been paid in the Philippines.
FACTS:
Wander is a domestic corporation which is a wholly-owned subsidiary of Glaro S.A. Ltd.,a
Swiss corporation not engaged in trade/business in the Philippines. In two instances, Wander
filed its withholding tax return and remitted to Glaro (the parent company) dividends
(P222,000 in the first instance and P355,200 in the second), on which 35% tax was withheld
and paid to the BIR.
Wander now files a claim for refund of the withheld tax contending that it is liable only to 15%
withholding tax pursuant to Section 24. B.1 of the Tax Code. The BIR did not act upon the
claim filed by Wander so the corporation filed a petition to the Court of Tax Appeals (CTA).
The CTA held that the corporation is entitled to 15% withholding tax rate on dividends
remitted to Glaro, a non-resident foreign corporation.
ISSUE: Whether or not Wander is entitled to the 15% withholding tax rate.
HELD:
Yes. According to Sec. 24.B.1 of the Tax Code, the dividends received from a domestic
corporation is liable to a 15% withholding tax, provided that the country in which the foreign
corporation is domiciled shall allow a tax credit (equivalent to 20% which is the difference
between the 35% tax due on regular corporations and the 15% tax due on dividends) against
the taxes due to have been paid in the Philippines.
In the case, Switzerland did not impose any tax on the dividends received by Glaro thus it
194 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
should be considered as a full satisfaction of the given condition. To deny respondent the
privilege to withhold 15% would run counter to the spirit and intent of the law and will
adversely affect the foreign corporations’ interest and discourage them from investing capital
in our country.
The petition dismissed for lack of merit.
CIR v. PROCTER & GAMBLE PHIL. MFG. CORP.
DOCTRINE:
With respect to the dividend taxes paid by a foreign mother corporation, the domestic branch
is but a withholding agent of the government and therefore cannot claim reimbursement of
the alleged over paid taxes. The real party in interest is the mother corporation located
abroad, and it follows that the foreign entity is the real party in interest, and should be the
claimant for overpaid taxes.
FACTS:
Private respondent, Procter and Gamble Philippine Manufacturing Corporation (hereinafter
referred to as PMC-Phil.), a corporation duly organized and existing under and by virtue of the
Philippine laws, is engaged in business in the Philippines and is a wholly owned subsidiary of
Procter and Gamble, U.S.A. (herein referred to as PMC-USA), a non-resident foreign
corporation in the Philippines, not engaged in trade and business therein. As such PMC-U.S.A.
is the sole shareholder or stockholder of PMC Phil., as PMC-U.S.A. owns wholly or by 100% the
voting stock of PMC Phil. and is entitled to receive income from PMC-Phil. in the form of
dividends, if not rents or royalties. In addition, PMC-Phil has a legal personality separate and
distinct from PMC-U.S.A. For the taxable year ending June 30, 1974 PMC-Phil. realized a
taxable net income of P56,500,332.00 and accordingly paid the corresponding income tax
thereon equivalent to P25%-35% or P19,765,116.00 as provided for under Section 24(a) of
the Philippine Tax Code, the pertinent portion of which reads:
SEC. 24. Rates of tax on corporation. — a) Tax on domestic corporations. — A tax is hereby
imposed upon the taxable net income received during each taxable year from all sources by every
corporation organized in, or geting under the laws of the Philippines, and partnerships, no
matter how created or organized, but not including general professional partnerships, in
accordance with the following:
Twenty-five per cent upon the amount by which the taxable net income does not exceed one
hundred thousand pesos; and Thirty-five per cent upon the amount by which the taxable net
income exceeds one hundred thousand pesos.
After taxation its net profit was P36,735,216.00. Out of said amount it declared a dividend in
favor of its sole corporate stockholder and parent corporation PMC-U.S.A. in the total sum of
P17,707,460.00 which latter amount was subjected to Philippine taxation of 35% or
P6,197,611.23 as provided for in Section 24(b) of the Philippine Tax Code which reads in full:
SECTION 1. The first paragraph of subsection (b) of Section 24 of the National Bureau Internal
Revenue Code, as amended, is hereby further amended to read as follows:
(b) Tax on foreign corporations. — 41) Non-resident corporation. — A foreign corporation not
engaged in trade or business in the Philippines, including a foreign life insurance company not
engaged in the life insurance business in the Philippines, shall pay a tax equal to 35% of the gross
income received during its taxable year from all sources within the Philippines, as interest
(except interest on foreign loans which shall be subject to 15% tax), dividends, rents, royalties,
salaries, wages, premiums, annuities, compensations, remunerations for technical services or
otherwise, emoluments or other fixed or determinable, annual, periodical or casual gains, profits,
and income, and capital gains: Provided, however, That premiums shall not include re-insurance
premium Provided, further, That cinematograpy film owners, lessors, or distributors, shall pay a
tax of 15% on their gross income from sources within the Philippines: Provided, still further That
on dividends received from a domestic corporation hable to tax under this Chapter, the tax shall
be 15% of the dividends received, which shall be collected and paid as provided in Section 53(d)
of this Code, subject to the condition that the country in which the non-resident foreign
corporation is domiciled shall allow a credit against the tax due from the non-resident foreign
corporation, taxes deemed to have been paid in the Philippines equivalent to 20% which
represents the difference between the regular tax (35%) on corporations and the tax (15%) on
dividends as provided in this section: Provided, finally That regional or area headquarters
established in the Philippines by multinational corporations and which headquarters do not earn
or derive income from the Philippines and which act as supervisory, communications and
coordinating centers for their affiliates, subsidiaries or branches in the Asia-Pacific Region shall
not be subject to tax.
For the taxable year ending June 30, 1975 PMC-Phil. realized a taxable net income of
P8,735,125.00 which was subjected to Philippine taxation at the rate of 25%-35% or
P2,952,159.00, thereafter leaving a net profit of P5,782,966.00. As in the 2nd quarter of 1975,
PMC-Phil. again declared a dividend in favor of PMC-U.S.A. at the tax rate of 35% or
P6,457,485.00. In July, 1977 PMC-Phil., invoking the tax-sparing credit provision in Section
24(b) as aforequoted, as the withholding agent of the Philippine government, with respect to
the dividend taxes paid by PMC-U.S.A., filed a claim with the herein petitioner, Commissioner
of Internal Revenue, for the refund of the 20 percentage-point portion of the 35 percentage-
point whole tax paid, arising allegedly from the alleged "overpaid withholding tax at source or
overpaid withholding tax in the amount of P4,832,989.00
There being no immediate action by the BIR on PMC-Phils' letter-claim the latter sought the
intervention of the CTA, praying that it be declared entitled to the refund or tax credit claimed
and ordering respondent therein to refund to it the amount of P4,832,989.00, or to issue tax
credit in its favor in lieu of tax refund. On the other hand therein respondent, Commissioner
of Internal Revenue, in his answer, prayed for the dismissal of said Petition and for the denial
of the claim for refund. On January 31, 1974 the Court of Tax Appeals in its decision ruled in
favor of the herein petitioner, entitling it to the sought refund or tax credit of the amount
representing the overpaid withholding tax at source.
ISSUES:
1. Whether or not private respondent is entitled to the preferential 15% tax rate on
dividends declared and remitted to its parent corporation? No.
2. Whether or not PMC-Phil. is the proper party to claim the refund? No.
3. Whether or not the U. S. allows as tax credit the "deemed paid" 20% Philippine Tax
on such dividends? No.
RULING:
The petitioner maintains that it is the PMC-U.S.A., the tax payer and not PMC-Phil. the remitter
or payor of the dividend income, and a mere withholding agent for and in behalf of the
Philippine Government, which should be legally entitled to receive the refund if any. It will be
observed at the outset that petitioner raised this issue for the first time in the Supreme Court.
He did not raise it at the administrative level, nor at the Court of Tax Appeals. Issues not raised
in the lower court cannot generally be raised for the first time on appeal. Nonetheless it is
axiomatic that the State can never be in estoppel, and this is particularly true in matters
involving taxation. The errors of certain administrative officers should never be allowed to
jeopardize the government's financial position. The submission of the Commissioner of
Internal Revenue that PMC-Phil. is but a withholding agent of the government and therefore
cannot claim reimbursement of the alleged over paid taxes, is completely meritorious. The
real party in interest being the mother corporation in the United States, it follows that
195 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
American entity is the real party in interest, and should have been the claimant in this case.
Closely intertwined with the first assignment of error is the issue of whether or not PMC-U.S.A.
is entitled under the U.S. Tax Code to a United States Foreign Tax Credit equivalent to at least
the 20 percentage paid portion (of the 35% dividend tax) spared or waived as otherwise
considered or deemed paid by the government. The law pertinent to the issue is Section 902
of the U.S. Internal Revenue Code, as amended by Public Law 87-834, the law governing tax
credits granted to U.S. corporations on dividends received from foreign corporations. To our
mind there is nothing in the aforecited provision that would justify tax return of the disputed
15% to the private respondent. Furthermore, as ably argued by the petitioner, the private
respondent failed to meet certain conditions necessary in order that the dividends received by
the non-resident parent company in the United States may be subject to the preferential 15%
tax instead of 35%. Among other things, the private respondent failed: (1) to show the actual
amount credited by the U.S. government against the income tax due from PMC-U.S.A. on the
dividends received from private respondent; (2) to present the income tax return of its
mother company for 1975 when the dividends were received; and (3) to submit any duly
authenticated document showing that the U.S. government credited the 20% tax deemed paid
in the Philippines. Petition is GRANTED and the decision appealed from, is REVERSED and SET
ASIDE.
REVENUE REGULATIONS NO. 02-98
SECTION 2.57. Withholding of Tax at Source
(A) Final Withholding Tax. — 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 tax
due from the payee on the said income. The liability for payment of the tax rests primarily on
the payor as a 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.
The finality of the withholding tax is limited only to the payee's income tax liability on the
particular income. It does not extend to the payee's other tax liability on said income, such as
when the said income is further subject to a percentage tax. For example, if a bank receives
income subject to final withholding tax, the same shall be subject to a percentage tax.
SECTION 2.57.1. Income Payments Subject to Final Withholding Tax. — The following forms of
income shall be subject to final withholding tax at the rates herein specified;
(A) Income payments to a citizen or to a resident alien individual;
(1) Interest from any peso bank deposit, and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements; royalties (except on
books as well as other literary works and musical compositions), prizes (except prizes
amounting to ten thousand pesos (P10,000.00) or less which shall be subject to tax under
Sec. 24 (A) of the Code) and other winnings (except Philippine Charity Sweepstakes
winnings and lotto winnings) derived from sources within the Philippines — Twenty
percent (20%).
(2) Royalties on books, as well as other literary works and musical compositions — Ten
percent (10%).
(3) Interest income received by a resident individual taxpayer from a depository bank under
the Foreign Currency Deposit System — Seven and one-half percent (7.5%).
(4) Interest income from long-term deposit or investment in the form of savings, common or
individual trust funds, deposit substitutes, investment management accounts and other
investments evidenced by certificates in such form prescribed by the Bangko Sentral ng
 Pilipinas which was pre-terminated by the holder before the fifth (5th) year at the rates
herein prescribed to be deducted and withheld from the proceeds thereof based on the
length of time that the instrument was held by the taxpayer —
Holding Period Rate
Four (4) years to less than five (5) years 5%
Three (3) years to less than four (4) years 12%
Less than three (3) years 20%
(5) Cash and/or property dividends actually or constructively received from a domestic
corporation, joint stock company, insurance or mutual fund companies or on the share of
an individual partner in the distributable net income after tax of a partnership (except
general professional partnership) or on the share of an individual in the net income after
tax of an association, a joint account or a joint venture or consortium of which he is a
member or a co-venturer.
6% - beginning January 1, 1998
8% - beginning January 1, 1999 and
10% - beginning January 1, 2000 and thereafter
The tax on cash and property dividends shall only be imposed on dividends which are
declared from profits of corporations made after December 31, 1997.
(6) On 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 based on the gross
selling price or fair market value as determined in accordance with Sec. 6(E) of the Code
(i.e. the authority of the Commissioner to prescribe the real property values), whichever
is higher — Six percent (6%).
In case of dispositions of real property made by individuals to the government or any of
its political subdivisions or agencies or to government-owned or controlled corporations,
the tax to be imposed shall be determined either under Section 24(A) of the Code for
normal income tax for individual citizens and residents or under Section 24(D)(1) of the
Code for the final tax on capital gains from sale of property at six percent (6%), at the
option of the taxpayer.
(B) Income Payment to Non-resident Aliens Engaged in Trade or Business in the Philippines. —
The following forms of income derived from sources within the Philippines shall be subject to
final withholding tax in the hands of a non-resident alien individual engaged in trade or
business within the Philippines, based on the gross amount thereof and at the rates prescribed
therefor:
(1) On Certain Passive Income — A tax of twenty (20%) percent is hereby imposed on certain
passive income received from all sources within the Philippines.
(a) Cash and/or property dividend from a domestic corporation or from a joint stock
company, or from an insurance or mutual fund company or from a regional
operating headquarter of a multinational company;
(b) Share in the distributable net income after tax of a partnership (except general
professional partnership) of which he is a partner, or share in the net income after
tax of an association, a joint account, or a joint venture of which he is a member or a
co-venturer;
196 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
(c) Interests from any currency bank deposit and yield or any other monetary benefit
from deposit substitutes and from trust funds and similar arrangements;
(d) Royalties (except royalties on books, as well as other literary works and musical
compositions which shall be subject to 10% final withholding tax);
(e) Prizes (except prizes amounting to ten thousand pesos (P10,000.00) or less subject
to tax under Sec. 25 (A) (1) of the Code for the normal rates of income tax for
individuals) and other winnings (except Philippine Charity Sweepstakes winnings
and lotto winnings);
(2) Interest income derived from long-term deposit or investment in the form of savings,
common or individual trust funds, deposit substitutes, investment management accounts
and other investments evidenced by certificates in such form prescribed by the Bangko
Sentral ng Pilipinas which was pre-terminated by the holder before the fifth (5th) year at
the rates herein prescribed to be deducted and withheld from the proceeds thereof based
on the length of time that the instrument was held by the taxpayer —
Holding Period Rate
Four (4) years to less than five (5) years 5%
Three (3) years to less than four (4) years 12%
Less than three (3) years 20%
(3) On 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 based on the gross
selling price or fair market value as determined in accordance with Sec. 6(E) of the Code
(i.e. the authority of the Commissioner to prescribe zonal values), whichever is higher —
Six percent (6%).
In case of dispositions of real property made by individuals to government or any of its
political subdivisions or agencies or to government-owned or controlled corporations,
the tax to be imposed shall be determined either under Section 24(A) of the code for the
normal rate of income tax for individual citizens and residents or under Section 24(D)(1)
of the Code for the final tax on capital gains from sale of property at six percent (6%), at
the option of the taxpayer.
(C) Income Derived from All Sources Within the Philippines by a Non-resident Alien Individual
Not Engaged in Trade or Business Within the Philippines. — The following forms of income
derived from all sources within the Philippines shall be subject to a final withholding tax in
the hands of a non-resident alien individual not engaged in trade or business within the
Philippines based on the following amounts and at the rates prescribed therefor:
(1) On the gross amount of income derived from all sources within the Philippines by a non-
resident alien individual who is not engaged in trade or business in the Philippines as
interest, cash and/or property dividends, rents, salaries, wages, premiums, annuities,
compensation, remuneration, emoluments, or other fixed or determinable annual or
periodic or casual gains, profits and income and capital gains — Twenty five percent
(25%).
(2) On 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 based on the gross
selling price or fair market value as determined in accordance with Sec. 6(E) of the Code
(i.e. the authority of the Commissioner to prescribe the real property values), whichever
 is higher — Six percent (6%).
In case of dispositions of real property made by individuals to government or any of its
political subdivisions or agencies or to government-owned or controlled corporations, the tax
to be imposed shall be determined either under Sec. 24(a) of the Code for the rates of income
tax for individual citizens and residents or under Sec. 24(D)(1) of the Code for the final tax on
capital gains from sale of property at six percent (6%), at the option of the taxpayer.
(D) Income Derived by Alien Individuals Employed by Regional or Area Headquarters and
Regional Operating Headquarters of Multinational Companies. — A final withholding tax
equivalent to fifteen percent (15%) shall be withheld by the withholding agent from the gross
income received by every alien individual occupying managerial and technical positions in
regional or area headquarters and regional operating headquarters and representative offices
established in the Philippines by multinational companies as salaries, wages, annuities,
compensation, remuneration, and other emoluments, such as honoraria and allowances,
except income which is subject to the fringe benefits tax, from such regional or area
headquarters and regional operating headquarters.
The same tax treatment shall apply to Filipinos employed and occupying the same as those of
alien employed by these multinational companies.
The term "multinational company" means a foreign firm or entity engaged in international
trade with its affiliates or subsidiaries or branch offices in the Asia Pacific Region and other
foreign markets.
(E) Income Derived by Alien Individuals Employed by Offshore Banking Units. — A final
withholding tax equivalent to fifteen (15%) shall be withheld by the withholding agent from
the gross income of alien individuals occupying managerial or technical positions in offshore
banking units established in the Philippines, as salaries, wages, annuities, compensations,
remuneration and other emoluments such as honoraria and allowances, received from such
offshore banking units.
The same tax treatment shall apply to Filipinos employed and occupying the same positions as
those of aliens who are employed by these offshore banking units.
(F) Income of Aliens Employed by Foreign Petroleum Service Contractors and Subcontractors. —
A final withholding tax equivalent to fifteen percent (15%) shall be withheld from the gross
income of an alien individual who is a permanent resident of a foreign country but who is
employed and assigned in the Philippines by a foreign service contractor or by a foreign
service subcontractor who is engaged in petroleum operations in the Philippines. His gross
income includes salaries, wages, annuities, compensation, remuneration and other
emoluments, such as honoraria and allowances, received from such contractor or
subcontractor.
The same tax treatment shall apply to Filipinos who are employed and occupying the same
positions as those of aliens employed by a foreign petroleum service contractor or
subcontractor.
(G) Income Payment to a Domestic Corporation. — The following items of income shall be
subject to a final withholding tax in the hands of a domestic corporation, based on the gross
amount thereof and at the rate of tax prescribed therefor:
(1) Interest from any currency bank deposit and yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements derived from sources
within the Philippines — Twenty Percent (20%).
(2) Royalties derived from sources within the Philippines — Twenty percent (20%).
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(3) Interest income derived from a depository bank under the Expanded Foreign Currency
Deposit System, otherwise known as a Foreign Currency Deposit Unit (FCDU) — Seven
and one-half percent (7.5%).
(4) Income derived by a depository bank under the Expanded Foreign Currency Deposit
System from foreign transactions with local commercial banks including branches of
foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to
transact business with Foreign Currency Deposit System Units and other depository
banks under the expanded foreign currency deposit system including interest income
from foreign currency loans granted by such depository bank under the said expanded
foreign currency deposit system to residents — Ten percent (10%).
(5) On 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 based on the gross
selling price or fair market value as determined in accordance with Sec. 6(E) of the Code,
whichever is higher — Six percent (6%).
(H) Income Payment to a Resident Foreign Corporation. — The following forms of income shall
be subject to a final withholding tax in the hands of a foreign corporation, based on the gross
amount thereof and at the rate of tax prescribed therefor:
(1) Offshore Banking Units — On income derived by offshore banking units authorized by the
Bangko Sentral ng Pilipinas (BSP) from foreign currency transactions with local
commercial banks and branches of foreign banks that may be authorized by the BSP to
transact business with offshore banking units and other OBUs including interest income
derived from foreign currency loans granted to resident — Ten percent (10%).
(2) Tax on Branch Profit Remittances — On any profit remitted by the Philippine branch of a
foreign corporation to its head office abroad based on the total profits applied or
earmarked for remittance without any deduction for the tax component thereof except
those registered with the Philippine Economic Zones Authority (PEZA) and other
companies within the special economic zones such as Subic Bay Metropolitan Authority
(SBMA) and Clark Development Authority (CDA) — Fifteen percent (15%).
Interests, dividends, rents, royalties (including remunerations for technical services),
salaries, wages, premiums, annuities, emoluments or other fixed or determinable annual
periodic or casual gains, profits, income and capital gains received by a foreign
corporation during each taxable year from all sources within the Philippines shall not be
considered as branch profits unless the same are effectively connected with the conduct
of its trade or business in the Philippines.
(3) Interest on any currency bank deposit and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements and royalties derived
from sources within the Philippines — Twenty percent (20%).
(4) Interest income derived from a Depository Bank under the Expanded Foreign Currency
Deposit system — Seven and one-half percent (7.5%).
(5) Income derived by a depository bank under the expanded foreign currency deposit
system from foreign currency transactions with local commercial banks including
branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas to
transact business with foreign currency deposit system units and other depository banks
under the expanded foreign currency deposit system including interest income from
foreign currency loans granted by such depository banks under the said expanded
foreign currency deposit system to resident — Ten percent (10%).
(I) Income Derived From all Sources Within the Philippines by Non- Resident Foreign
Corporation. — The following shall be subject to final withholding tax based on the gross
amount of income and at the rate of tax prescribed therefor:
(1) In general — On gross income derived from all sources within the Philippines such as
interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums),
annuities, emoluments, or other fixed or determinable annual, periodic or casual gains,
profits and income and capital gains (except capital gains realized from sale, exchange,
disposition of shares of stock in any domestic corporation which is subject to capital
gains tax under Sec. 28(B)(5)(c) — at the following rates:
34% - beginning January 1, 1998
33% - beginning January 1, 1999 and
32% - beginning January 1, 2000 and thereafter
(2) Gross income from all sources within the Philippines derived by non-resident
cinematographic film owners, lessors or distributors — Twenty five percent (25%).
(3) On the gross rentals, lease and charter fees, derived by non-resident owner or lessor of
vessels from leases or charters to Filipino citizens or corporations as approved by the
Maritime Industry Authority — Four and one-half percent (4.5%).
(4) On the gross rentals, charter and other fees derived by non-resident lessor of aircraft,
machineries and other equipment — Seven and a half percent (7.5%).
(5) Interest on foreign loans contracted on or after August 1, 1986 — Twenty percent (20%).
(6) Dividends received from a domestic corporation — Fifteen percent (15%) of the cash
and/or property dividends received from a domestic corporation subject to the condition
that the country in which the nonresident foreign corporation is domiciled (a) shall allow
a credit against the tax due from the said nonresident foreign corporation which are
equivalent to taxes deemed to have been paid in the Philippines equal to twenty percent
(20%) for 1997, nineteen percent (19%) for 1998, eighteen percent (18%) for 1999 and
seventeen percent (17%) thereafter, which represents the difference between the
regular income tax of thirty-five percent (35%) in 1997, thirty four percent (34%) in
1998, thirty three percent (33%) in 1999, and thirty two percent (32%) thereafter on
corporations and the fifteen percent (15%) tax on dividends as herein provided; or, (b)
does not impose any income tax on dividends received from a domestic corporation.
(J) Fringe Benefits Granted to the Employee (Except Rank and File Employee). — There shall be
imposed a final tax of 34% beginning January 1, 1998; 33% beginning January 1, 1999 and
32% beginning January 1, 2000 and thereafter, on the grossed-up monetary value of fringe
benefits, granted or furnished by the employer to his employees (except rank and file as
defined in the Code). Fringe benefits however, which are required by the nature of or
necessary to the trade, business or profession of the employer, or where such fringe benefit is
for the convenience and advantage of the employer shall not be subject to the fringe benefits
tax.
The term 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, the following:
(1) Housing;
(2) Expense account;
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(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;
(9) Educational assistance to the employee or his dependents; and
(10) Life or health insurance and other non-life insurance premiums or similar amounts
in excess of what the law allows.
Fringe benefits granted to the following employees and taxable under Sec. 25 (B), (C), (D) and
(E) shall also be subject to the fringe benefit tax to wit:
Sec. 25(B) Non-resident alien individual not engaged in trade or business in the Philippines.
Sec. 25(C) Alien individual employed by regional or area headquarters and regional
operating headquarters of a multinational company, including any of its Filipino employees
employed and occupying the same position as those of its aforesaid alien employees;
Sec. 25(D) Alien individual employed by an offshore banking unit of a foreign bank
established in the Philippines, including any of its Filipino employees employed and
occupying the same position as those of its aforesaid alien employees;
Sec. 25(E) A lien individual employed by a foreign service contractor and subcontractor
engaged in petroleum operations in the Philippines, including any of its Filipino employees
employed and occupying the same position as those of its aforesaid alien employees.
The computation and the scheme for withholding the tax on fringe benefits shall be governed
by such revenue orders that the Commissioner shall issue as guidelines and clarifications for
its proper and consistent implementation.
(K) Informer's Reward to Persons Instrumental in the Discovery of Violations of the National
Internal Revenue Code and the Discovery and Seizure of Smuggled Goods. — The following
rewards shall be subject to a final withholding tax at the rate of ten percent (10%):
(1) Those given to persons, except an internal revenue official or employee, or other public
official or employee or his relative within the sixth degree of consanguinity, who
voluntarily gives definite and sworn information not yet in the possession of the BIR,
leading to the discovery of frauds upon the Internal Revenue Laws or violations of any of
the provisions thereof, thereby resulting in the recovery of revenues, surcharges and fees
and/or the conviction of the guilty party and/or imposition of any fine or penalty.
(2) Those given to an informer where the offender has offered to compromise the violation
of law committed by him and his offer has been accepted by the Commissioner and
collected from the offender.
The amount of reward shall be equivalent to ten percent (10%) of the revenues,
surcharges or fees recovered and/or fine or penalty imposed and collected or one million
pesos (P1,000,000.00) per case whichever is lower.
The reward shall be paid under the rules and regulations issued by the Secretary of
 Finance, upon the recommendation of the Commissioner. However, such person shall not
be entitled to a reward, should no revenue, surcharges or fees be actually recovered or
collected nor shall apply to a case already pending or previously investigated or
examined by the Commissioner or any of his deputies or agents or examiners, or the
Secretary of Finance or any of his deputies or agents.
(3) Those given to persons instrumental in the discovery and seizure of such smuggled
goods.
The amount of reward shall be equivalent to ten percent of the market value of the
smuggled and confiscated goods or one million pesos (P1,000,000.00) per case
whichever is lower.
B. CREDITABLE WITHHOLDING TAX
SEC. 57. Withholding of Tax at Source. -
(B) Withholding of Creditable Tax at Source. - The Secretary of Finance may, upon the
recommendation of the Commissioner, require the withholding of a tax on the items of income
payable to natural or juridical persons, residing in the Philippines, by payor-
corporation/persons as provided for by law, at the rate of not less than one percent (1%) but
not more than thirty-two percent (32%) thereof, which shall be credited against the income
tax liability of the taxpayer for the taxable year.
FILIPINAS SYNTHETIC FIBER CORPORATION v. CA
DOCTRINE:
Accrual basis method of accounting
Under the accrual basis method of accounting, income is reportable when all the events have
occurred that fix the taxpayer’s right to receive the income, and the amount can be
determined with reasonable accuracy. Thus, it is the right to receive income, and not the
actual receipt, that determines when to include the amount in gross income.
FACTS:
Filipinas Synthetic Fiber Corporation (FSFC), a domestic corporation, was assessed deficiency
withholding tax at source in the total amount of P829,748.77 for the period from the fourth
quarter of 1974 to the fourth quarter of 1975. The bulk of the deficiency withholding tax
assessment consisted of interest and compromise penalties for alleged late payment of
withholding taxes due on interest loans, royalties and guarantee fees paid by the petitioner to
non-resident corporations.
FSFC protested the assessment. BIR denied the protest. FSFC filed a petition before the CTA.
CTA denied. Hence, this case.
BIR argument:
The liability to withhold and pay income tax withheld at source from certain
payments due to a foreign corporation is at the time of accrual and not at the time of
actual payment or remittance thereof.
In CRA v. CIR the CTA held that "the liability of the taxpayer to withhold and pay the
income tax withheld at source from certain payments due to a non-resident foreign
corporation attaches at the time of accrual payment or remittance thereof" and "the
withholding agent or corporation is obliged to remit the tax to the government
since it already and properly belongs to the government.”
199 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
FSFC argument:
Whatever amount has accrued in the books, the withholding tax due thereon is
ultimately paid to the government upon remittance abroad of the amount accrued.
ISSUE/S:
Whether the liability to withhold tax at source on income payments to non-resident foreign
corporations arises upon remittance of the amounts due to the foreign creditors OR upon
accrual thereof
RULING:
UPON ACCRUAL; particularly in this case where the petitioner had actually already deducted
as business expense the amount due to the foreign corporation.
Accrual basis method of accounting
Under the accrual basis method of accounting, income is reportable when all the events have
occurred that fix the taxpayer’s right to receive the income, and the amount can be
determined with reasonable accuracy. Thus, it is the right to receive income, and not the
actual receipt, that determines when to include the amount in gross income.
Requisites of accrual method of accounting:
(1) that the right to receive the amount must be valid, unconditional and enforceable, i.e.,
not contingent upon future time;
(2) the amount must be reasonably susceptible of accurate estimate; and
(3) there must be a reasonable expectation that the amount will be paid in due course.
Application to this case
There was a definite liability, a clear and imminent certainty that at the maturity of the loan
contracts, the foreign corporation was going to earn income in an ascertained amount, so
much so that petitioner already deducted as business expense the said amount as interests
due to the foreign corporation. This is allowed under the law, petitioner having adopted the
‘accrual method’ of accounting in reporting its incomes.
Petitioner cannot now claim that there is no duty to withhold and remit income taxes as yet
because the loan contract was not yet due and demandable. Having "writtenoff" the amounts
as business expense in its books, it had taken advantage of the benefit provided in the law
allowing for deductions from gross income. Moreover, it had represented to the BIR that the
amounts so deducted were incurred as a business expense in the form of interest and
royalties paid to the foreign corporations.
It is estopped from claiming otherwise now.
REVENUE REGULATIONS NO. 02-98
SECTION 2.57. Withholding of Tax at Source
(B) Creditable Withholding Tax. — Under the creditable withholding tax system, taxes
withheld on certain income payments are intended to equal or at least approximate the tax
due of the payee on said income. The income recipient is still required to file an income tax
return, as prescribed in Sec. 51 and Sec. 52 of the NIRC, as amended, to report the income
and/or pay the difference between the tax withheld and the tax due on the income. Taxes
withheld on income payments covered by the expanded withholding tax (referred to in Sec.
2.57.2 of these regulations) and compensation income (referred to in Sec. 2.78 also of these
regulations) are creditable in nature.
SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates Prescribed
Thereon. — Except as herein otherwise provided, there shall be withheld a creditable income
tax at the rates herein specified for each class of payee from the following items of income
payments to persons residing in the Philippines:
(A) Professional fees, talent fees, etc., for services rendered by individuals — On the gross
professional, promotional and talent fees or any other form of remuneration for the services
of the following individuals — Ten percent (10%);
(1) Those individually engaged in the practice of professions or callings: lawyers;
certified public accountants; doctors of medicine; architects; civil, electrical,
chemical, mechanical, structural, industrial, mining, sanitary, metallurgical and
geodetic engineers; marine surveyors; doctors of veterinary science; dentist;
professional appraisers; connoisseurs of tobacco; actuaries; and interior decorators;
(2) Professional entertainers such as but not limited to actors and actresses, singers and
emcees;
(3) Professional athletes including basketball players, pelotaris and jockeys;
(4) All directors involved in movies, stage, radio, television and musical productions;
(5) Insurance agents and insurance adjusters;
(6) Management and technical consultants;
(7) Bookkeeping agents and agencies;
(8) Other recipients of talent fees;
(9) Fees of directors who are not employees of the company paying such fees, whose
duties are confined to attendance at and participation in the meetings of the board
of directors.
The amounts subject to withholding under this paragraph shall include not only fees, but also
per diems, allowances and any other form of income payments. In the case of professional
entertainers, athletes, and all recipient of talent fees, the amount subject to withholding tax
shall also include amounts paid to them in consideration for the use of their names or pictures
in print, broadcast, or other media or for public appearances, for purposes of advertisements
or sales promotion.
(B) Professional fees, talent fees, etc. for services of taxable juridical persons — On the gross
professional, promotional and talents fees, or any other form of remuneration enumerated in
the preceding subparagraph for the services of taxable juridical persons — Five percent (5%).
(C) Rentals — On gross rental for the continued use or possession of real property used in
business which the payor or obligor has not taken or is not taking title, or in which he has no
equity — Five percent (5%).
(D) Cinematographic film rentals and other payments — On gross payments to resident
individuals and corporate cinematographic film owners, lessors or distributors — Five
percent (5%).
(E) Income payments to certain contractors — On gross payments to the following contractors,
whether individual or corporate — One percent (1%).
(1) General engineering contractors — Those whose principal contracting business in
connection with fixed works requiring specialized engineering knowledge and skill including
the following divisions or subjects:
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(a) Reclamation works;
(b) Railroads;
(c) Highways, streets and roads;
(d) Tunnels;
(e) Airports and airways;
(f) Waste reduction plants;
(g) Bridges, overpasses, underpasses and other similar works;
(h) Pipelines and other systems for the transmission of
(1) petroleum and other liquid or gaseous substances;
(i) Land leveling;
(j) Excavating;
(k) Trenching;
(l) Paving; and
(m) Surfacing work.
(2) General Building contractors — Those whose principal contracting business is in
connection with any structure built, for the support, shelter and enclosure of persons, animals,
chattels, or movable property of any kind, requiring in its construction the use of more than
two unrelated building trades or crafts, or to do or superintend the whole or any part thereto.
Such structure includes sewers and sewerage disposal plants and systems, parks,
playgrounds, and other recreational works, refineries, chemical plants and similar industrial
plants requiring specialized engineering knowledge and skills, powerhouse, power plants and
other utility plants and installation, mines and metallurgical plants, cement and concrete
works in connection with the above-mentioned fixed works.
(3) Specialty Contractors — Those whose operations pertain to the performance of
construction work requiring special skill and whose principal contracting business involves
the use of specialized building trades or crafts.
(4) Other contractors —
(a) Filling, demolition and salvage work contractors and operators of mine drilling
apparatus;
(b) Operators of dockyards;
(c) Persons engaged in the installation of water system, and gas or electric light, heat or
power;
(d) Operators of stevedoring, warehousing or forwarding establishments;
(e) Transportation contractors which include common carriers for the carriage of goods
and merchandise of whatever kind by land, air or water, where the gross payments
by the payor to the same payee amounts to at least two thousand pesos (P2,000) per
month, regardless of the number of shipments during the month;
(f) Printers, bookbinders, lithographers and publishers except those principally
engaged in the publication or printing of any newspaper, magazine, review or
bulletin which appears at regular intervals, with fixed prices for subscription and
 sale;
(g) Messengerial, janitorial, private detective and/or security agencies, credit and/or
collection agencies and other business agencies;
(h) Advertising agencies, exclusive of gross payments to media;
(i) Independent producers of television, radio and stage performances or shows;
(j) Independent producers of "jingles";
(k) Labor recruiting agencies
(l) Persons engaged in the installation of elevators, central air conditioning units,
computer machines and other equipment and machineries and the maintenance
services thereon;
(m) Persons engaged in the sale of computer services;
(n) Persons engaged in landscaping services;
(o) Persons engaged in the collection and disposal of garbage;
(p) TV and radio station operators on sale of TV and radio airtime; and
(q) TV and radio blocktimers on sale of TV and radio commercial spots.
(F) Income distribution to the beneficiaries. — On income distributed to the beneficiaries of
estates and trust as determined under Sec. 60 of the Code, except such income subject to final
withholding tax and tax exempt income — Fifteen percent (15%);
(G) Income payments to certain brokers and agents. — On gross commissions of customs,
insurance, real estate and commercial brokers and fees of agents of professional entertainers
— Five percent (5%);
(H) Income payments to partners of general professional partnerships. — Income payments
made periodically or at the end of the taxable year by a general professional partnership to
the partners, such as drawings, advances, sharings, allowances, stipends, etc. — Ten percent
(10%);
(I) Professional fees paid to medical practitioners. — Any amount collected for and paid to
medical practitioners by hospitals and clinics or paid by patients to the medical practitioners
through the hospital or clinic — Ten percent (10%);
(J) Gross selling price or total amount of consideration or its equivalent paid to the seller/owner
for the sale, exchange or transfer of . — Real property, other than capital assets, sold by an
individual, corporation, estate, trust, trust fund or pension fund and the seller/transferor is
habitually engaged in the real estate business in accordance with the following schedule —
Those which are exempt from a withholding
tax at source as prescribed in Sec. 2.57.5 of
these regulations Exempt
With a selling price of five hundred thousand
pesos (P500,000.00) or less 1.5%
With a selling price of more than five hundred
thousand pesos (P500,000.00) but not more
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than two million pesos (P2,000,000.00) 3.0%
With selling price of more than two million pesos
(P2,000,000.00) 5.0%
A seller/transferor must show proof of registration with HLURB or HUDCC to be considered
as habitually engaged in the real estate business.
Real property, other than capital asset, by an individual, estate, trust, trust fund or pension
fund or by a corporation who is not habitually engaged in the real estate business — Seven
and one-half percent (7.5%).
Gross selling price shall mean the consideration stated in the sales document or the fair
market value determined in accordance with Section 6 (E) of the Code, as amended,
whichever is higher. In an exchange, the fair market value of the property received in
exchange, as determined in the Income Tax Regulations shall be used.
Where the consideration or part thereof is payable on installment, no withholding of tax is
required to be made on the periodic installment payments where the buyer is an individual
not engaged in trade or business. In such a case, the applicable rate of tax based on the entire
consideration shall be withheld on the last installment or installments to be paid to the seller.
However, if the buyer is engaged in trade or business, whether a corporation or otherwise, the
tax shall be deducted and withheld by the buyer on every installment.
(K) Additional income payments to government personnel from importers, shipping and airline
companies, or their agents. — On gross additional payments by importers, shipping and airline
companies, or their agents to government personnel for overtime services as authorized by
law — Fifteen percent (15%);
For this purpose, the importers, shipping and airline companies or their agents, shall be the
withholding agents of the Government;
(L) Certain income payments made by credit card companies. — On the gross amounts paid by
any credit card company in the Philippines to any business entity, whether a natural or
juridical person, representing the sales of goods/services made by the aforesaid business
entity to cardholders — One half percent (1/2%);
(M) Income payments made by the top five thousand (5,000) corporations. — Income payments
made by any of the top five thousand (5,000) corporations, as determined by the
Commissioner, to their local supplier of goods — One percent (1%);
(1) The term "goods" pertains to tangible personal property. It does not include intangible
personal property as well as real property.
(2) The term "local suppliers of goods" pertains to a supplier from whom any of the top
five thousand (5,000) corporations, as determined by the Commissioner, regularly
makes its purchases of goods. As a general rule, this term does not include a casual
purchase of goods, that is, purchases made from non-regular suppliers and oftentimes
involving single purchases. However, a single purchase which involves one hundred
thousand pesos (P100,000.00) or more shall be subject to a withholding tax.
(3) A corporation shall not be considered a withholding agent for purposes of this Section,
unless such corporation has been determined and duly notified in writing by the
Commissioner that it has been selected as one of the top five thousand (5,000)
corporations.
(4) The withholding agent shall submit on a semestral basis a list of its regular suppliers of
 goods to the Revenue District Office (RDO) having jurisdiction over the withholding
agent's principal place of business on or before July 31 and January 31 of each year.
(N) Income payments by government. — Income payments, except any single purchase which
is P10,000 and below, which are made by a government office, national or local, including
government-owned or controlled corporations, on their purchases of goods from local
suppliers — One percent (1%);
A government-owned or controlled corporation which is listed as one of the top five thousand
(5,000) corporations shall withhold the tax in its capacity as a government-owned or
controlled corporation rather than as one of the top five thousand (5,000) corporations.
C. RETURN AND PAYMENT OF TAX
SEC. 58. Returns and Payment of Taxes Withheld at Source. -
(A) Quarterly Returns and Payments of Taxes Withheld. - Taxes deducted and withheld
under Section 57 by withholding agents shall be covered by a return and paid to, except in
cases where the Commissioner otherwise permits, an authorized Treasurer of the city or
municipality where the withholding agent has his legal residence or principal place of
business, or where the withholding agent is a corporation, where the principal office is
located.
The taxes deducted and withheld by the withholding agent shall be held as a special fund in
trust for the government until paid to the collecting officers.
The return for final withholding tax shall be filed and the payment made within twenty-five
(25) days from the close of each calendar quarter, while the return for creditable withholding
taxes shall be filed and the payment made not later than the last day of the month following
the close of the quarter during which withholding was made: Provided, That the
Commissioner, with the approval of the Secretary of Finance, may require these withholding
agents to pay or deposit the taxes deducted or withheld at more frequent intervals when
necessary to protect the interest of the government.
(B) Statement of Income Payments Made and Taxes Withheld. - Every withholding agent
required to deduct and withhold taxes under Section 57 shall furnish each recipient, in respect
to his or its receipts during the calendar quarter or year, a written statement showing the
income or other payments made by the withholding agent during such quarter or year, and
the amount of the tax deducted and withheld therefrom, simultaneously upon payment at the
request of the payee, but not late than the twentieth (20th) day following the close of the
quarter in the case of corporate payee, or not later than March 1 of the following year in the
case of individual payee for creditable withholding taxes. For final withholding taxes, the
statement should be given to the payee on or before January 31 of the succeeding year.
(C) Annual Information Return. - Every withholding agent required to deduct and withhold
taxes under Section 57 shall submit to the Commissioner an annual information return
containing the list of payees and income payments, amount of taxes withheld from each payee
and such other pertinent information as may be required by the Commissioner.
In the case of final withholding taxes, the return shall be filed on or before January 31 of the
succeeding year, and for creditable withholding taxes, not later than March 1 of the year
following the year for which the annual report is being submitted.
This return, if made and filed in accordance with the rules and regulations approved by the
Secretary of Finance, upon recommendation of the Commissioner, shall be sufficient
compliance with the requirements of Section 68 of this Title in respect to the income
202 TAXATION 1 (ATTY. BELLO) -Bacus, Baquiran, Bautista, Capistrano, Evangelista, Lee, Medina, Puno, Rances, Reyes, Sanchez 2016D
payments.
The Commissioner may, by rules and regulations, grant to any withholding agent a reasonable
extension of time to furnish and submit the return required in this Subsection.
(D) Income of Recipient. - Income upon which any creditable tax is required to be withheld at
source under Section 57 shall be included in the return of its recipient but the excess of the
amount of tax so withheld over the tax due on his return shall be refunded to him subject to
the provisions of Section 204; if the income tax collected at source is less than the tax due on
his return, the difference shall be paid in accordance with the provisions of Section 56.
All taxes withheld pursuant to the provisions of this Code and its implementing rules and
regulations are hereby considered trust funds and shall be maintained in a separate account
and not commingled with any other funds of the withholding agent.
(E) Registration with Register of Deeds. - No registration of any document transferring real
property shall be effected by the Register of Deeds unless the Commissioner or his duly
authorized representative has certified that such transfer has been reported, and the capital
gains or creditable withholding tax, if any, has been paid: Provided, however, That the
information as may be required by rules and regulations to be prescribed by the Secretary of
Finance, upon recommendation of the Commissioner, shall be annotated by the Register of
Deeds in the Transfer Certificate of Title or Condominium Certificate of Title: Provided,
further, That in cases of transfer of property to a corporation, pursuant to a merger,
consolidation or reorganization, and where the law allows deferred recognition of income in
accordance with Section 40, the information as may be required by rules and regulations to be
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, shall be
annotated by the Register of Deeds at the back of the Transfer Certificate of Title or
Condominium Certificate of Title of the real property involved: Provided, finally, That any
violation of this provision by the Register of Deeds shall be subject to the penalties imposed
under Section 269 of this Code.
D. WITHHOLDING ON WAGES
SEC. 78. Definitions. - As used in this Chapter:
(A) Wages. - The term 'wages' means all remuneration (other than fees paid to a public
official) for services performed by an employee for his employer, including the cash value of
all remuneration paid in any medium other than cash, except that such term shall not include
remuneration paid:.
(1) For agricultural labor paid entirely in products of the farm where the labor is performed,
or
(2) For domestic service in a private home, or
(3) For casual labor not in the course of the employer's trade or business, or
(4) For services by a citizen or resident of the Philippines for a foreign government or an
international organization.
If the remuneration paid by an employer to an employee for services performed during one-
half (1/2) or more of any payroll period of not more than thirty-one (31) consecutive days
constitutes wages, all the remuneration paid by such employer to such employee for such
period shall be deemed to be wages; but if the remuneration paid by an employer to an
employee for services performed during more than one -half (1/2) of any such payroll period
does not constitute wages, then none of the remuneration paid by such employer to such
employee for such period shall be deemed to be wages.
(B) Payroll Period. - The term 'payroll period' means a period for which payment of wages is
ordinarily made to the employee by his employer, and the term "miscellaneous payroll
period" means a payroll period other than, a daily, weekly, biweekly, semi-monthly, monthly,
quarterly, semi-annual, or annual period.
(C) Employee. - The term 'employee' refers to any individual who is the recipient of wages and
includes an officer, employee or elected official of the Government of the Philippines or any
political subdivision, agency or instrumentality thereof. The term "employee" also includes an
officer of a corporation.
(D) Employer. - The term "employer" means the person for whom an individual performs or
performed any service, of whatever nature, as the employee of such person, except that:
(1) If the person for whom the individual performs or performed any service does not have
control of the payment of the wages for such services, the term "employer" (except for the
purpose of Subsection A) means the person having control of the payment of such wages; and
(2) In the case of a person paying wages on behalf of a nonresident alien individual, foreign
partnership or foreign corporation not engaged in trade or business within the Philippines,
the term "employer"(except for the purpose of Subsection (A) means such person.
SEC. 79. Income Tax Collected at Source. -
(A) Requirement of Withholding. - Except in the case of a minimum wage earner as defined
in Section 22(HH) of this Code, 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.
(B) Tax Paid by Recipient. - If the employer, in violation of the provisions of this Chapter, fails
to deduct and withhold the tax as required under this Chapter, and thereafter the tax against
which such tax may be credited is paid, the tax so required to be deducted and withheld shall
not be collected from the employer; but this Subsection shall in no case relieve the employer
from liability for any penalty or addition to the tax otherwise applicable in respect of such
failure to deduct and withhold.
(C) Refunds or Credits. -
(1) Employer. - When there has been an overpayment of tax under this Section, refund or
credit shall be made to the employer only to the extent that the amount of such overpayment
was not deducted and withheld hereunder by the employer.
(2) Employees. -The amount deducted and withheld under this Chapter during any calendar
year shall be allowed as a credit to the recipient of such income against the tax imposed under
Section 24(A) of this Title.
Refunds and credits in cases of excessive withholding shall be granted under rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner.
Any excess of the taxes withheld over the tax due from the taxpayer shall be returned or
credited within three (3) months from the fifteenth (15th) day of April.
Refunds or credits made after such time shall earn interest at the rate of six percent (6%) per
annum, starting after the lapse of the three-month period to the date the refund of credit is
made.
Refunds shall be made upon warrants drawn by the Commissioner or by his duly authorized
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representative without the necessity of counter-signature by the Chairman, Commission on
Audit or the latter's duly authorized representative as an exception to the requirement
prescribed by Section 49, Chapter 8, Subtitle B, Title 1 of Book V of Executive Order No. 292,
otherwise known as the Administrative Code of 1987.
(D) Personal Exemptions. -
(1) In General. - Unless otherwise provided by this Chapter, the personal and additional
exemptions applicable under this Chapter shall be determined in accordance with the main
provisions of this Title.
(2) Exemption Certificate. - (a) When to File. - On or before the date of commencement of
employment with an employer, the employee shall furnish the employer with a signed
withholding exemption certificate relating to the personal and additional exemptions to which
he is entitled.
(b) Change of Status. - In case of change of status of an employee as a result of which he would
be entitled to a lesser or greater amount of exemption, the employee shall, within ten (10)
days from such change, file with the employer a new withholding exemption certificate
reflecting the change.
(c) Use of Certificates. - The certificates filed hereunder shall be used by the employer in the
determination of the amount of taxes to be withheld.
(d) Failure to Furnish Certificate. - Where an employee, in violation of this Chapter, either fails
or refuses to file a withholding exemption certificate, the employer shall withhold the taxes
prescribed under the schedule for zero exemption of the withholding tax table determined
pursuant to Subsection (A) hereof.
(E) Withholding on Basis of Average Wages. - The Commissioner may, under rules and
regulations promulgated by the Secretary of Finance, authorize employers to:
(1) estimate the wages which will be paid to an employee in any quarter of the calendar year;
(2) determine the amount to be deducted and withheld upon each payment of wages to such
employee during such quarter as if the appropriate average of the wages so estimated
constituted the actual wages paid; and
(3) deduct and withhold upon any payment of wages to such employee during ;such quarter
such amount as may be required to be deducted and withheld during such quarter without
regard to this Subsection.
(F) Husband and Wife. - When a husband and wife each are recipients of wages, whether
from the same or from different employers, taxes to be withheld shall be determined on the
following bases:
(1) The husband shall be deemed the head of the family and proper claimant of the additional
exemption in respect to any dependent children, unless he explicitly waives his right in favor
of his wife in the withholding exemption certificate.
(2) Taxes shall be withheld from the wages of the wife in accordance with the schedule for
zero exemption of the withholding tax table prescribed in Subsection (D)(2)(d) hereof.
(G) Nonresident Aliens. - Wages paid to nonresident alien individuals engaged in trade or
business in the Philippines shall be subject to the provisions of this Chapter.
(H) Year-End Adjustment. - On or before the end of the calendar year but prior to the
payment of the compensation for the last payroll period, the employer shall determine the tax
due from each employee on taxable compensation income for the entire taxable year in
accordance with Section 24(A).
The difference between the tax due from the employee for the entire year and the sum of taxes
withheld from January to November shall either be withheld from his salary in December of
the current calendar year or refunded to the employee not later than January 25 of the
succeeding year.
SEC. 80. Liability for Tax. -
(A) Employer. - The employer shall be liable for the withholding and remittance of the correct
amount of tax required to be deducted and withheld under this Chapter.
If the employer fails to withhold and remit the correct amount of tax as required to be
withheld under the provision of this Chapter, such tax shall be collected from the employer
together with the penalties or additions to the tax otherwise applicable in respect to such
failure to withhold and remit.
(B) Employee. - Where an employee fails or refuses to file the withholding exemption
certificate or willfully supplies false or inaccurate information thereunder, the tax otherwise
required to be withheld by the employer shall be collected from him including penalties or
additions to the tax from the due date of remittance until the date of payment.
On the other hand, excess taxes withheld made by the employer due to:
(1) failure or refusal to file the withholding exemption certificate; or
(2) false and inaccurate information shall not be refunded to the employee but shall be
forfeited in favor of the Government.
SEC. 81. Filing of Return and Payment of Taxes Withheld. - Except as the Commissioner
otherwise permits, taxes deducted and withheld by the employer on wages of employees shall
be covered by a return and paid to an authorized agent bank; Collection Agent, or the duly
authorized Treasurer of the city or municipality where the employer has his legal residence or
principal place of business, or in case the employer is a corporation, where the principal office
is located.
The return shall be filed and the payment made within twenty-five (25) days from the close of
each calendar quarter: Provided, however, That the Commissioner may, with the approval of
the Secretary of Finance, require the employers to pay or deposit the taxes deducted and
withheld at more frequent intervals, in cases where such requirement is deemed necessary to
protect the interest of the Government.
The taxes deducted and withheld by employers shall be held in a special fund in trust for the
Government until the same are paid to the said collecting officers.
SEC. 82. Return and Payment in Case of Government Employees. - If the employer is the
Government of the Philippines or any political subdivision, agency or instrumentality thereof,
the return of the amount deducted and withheld upon any wage shall be made by the officer
or employee having control of the payment of such wage, or by any officer or employee duly
designated for the purpose.
SEC. 83. Statements and Returns. -
(A) Requirements. - Every employer required to deduct and withhold a tax shall furnish to
each such employee in respect of his employment during the calendar year, on or before
January thirty-first (31st) of the succeeding year, or if his employment is terminated before the
close of such calendar year, on the same day of which the last payment of wages is made, a
written statement confirming the wages paid by the employer to such employee during the
calendar year, and the amount of tax deducted and withheld under this Chapter in respect of
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such wages.
The statement required to be furnished by this Section in respect of any wage shall contain
such other information, and shall be furnished at such other time and in such form as the
Secretary of Finance, upon the recommendation of the Commissioner, may, by rules and
regulation, prescribe.
(B) Annual Information Returns. - Every employer required to deduct and withhold the
taxes in respect of the wages of his employees shall, on or before January thirty-first (31st) of
the succeeding year, submit to the Commissioner an annual information return containing a
list of employees, the total amount of compensation income of each employee, the total
amount of taxes withheld therefrom during the year, accompanied by copies of the statement
referred to in the preceding paragraph, and such other information as may be deemed
necessary.
This return, if made and filed in accordance with rules and regulations promulgated by the
Secretary of Finance, upon recommendation of the Commissioner, shall be sufficient
compliance with the requirements of Section 68 of this Title in respect of such wages.
(C) Extension of time. - The Commissioner, under such rules and regulations as may be
promulgated by the Secretary of Finance, may grant to any employer a reasonable extension
of time to furnish and submit the statements and returns required under this Section.
REVENUE REGULATIONS NO. 02-98
SECTION 2.78. Withholding Tax on Compensation. — The withholding of tax on compensation
income is a method of collecting the income tax at source upon receipt of the income. It
applies to all employed individuals whether citizens or aliens, deriving income from
compensation for services rendered in the Philippines. The employer is constituted as the
withholding agent.
E. WITHHOLDING TAX BY GOVERNMENT AGENCIES
REVENUE REGULATIONS NO. 02-98
SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates Prescribed
Thereon. — Except as herein otherwise provided, there shall be withheld a creditable income
tax at the rates herein specified for each class of payee from the following items of income
payments to persons residing in the Philippines:
(N) Income payments by government. — Income payments, except any single purchase which
is P10,000 and below, which are made by a government office, national or local, including
government-owned or controlled corporations, on their purchases of goods from local
suppliers — One percent (1%);
A government-owned or controlled corporation which is listed as one of the top five thousand
(5,000) corporations shall withhold the tax in its capacity as a government-owned or
controlled corporation rather than as one of the top five thousand (5,000) corporations.
XX. ESTATES AND TRUSTS
SEC. 60. Imposition of Tax. -
(A) Application of Tax. - The tax imposed by this Title upon individuals shall apply to the
income of estates or of any kind of property held in trust, including:.
(1) Income accumulated in trust for the benefit of unborn or unascertained person or persons
with contingent interests, and income accumulated or held for future distribution under the
terms of the will or trust;
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and
income collected by a guardian of an infant which is to be held or distributed as the court may
direct;
(3) Income received by estates of deceased persons during the period of administration or
settlement of the estate; and
(4) Income which, in the discretion of the fiduciary, may be either distributed to the
beneficiaries or accumulated.
(B) Exception. - The tax imposed by this Title shall not apply to employee's trust which forms
part of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or
all of his employees (1) if contributions are made to the trust by such employer, or employees,
or both for the purpose of distributing to such employees the earnings and principal of the
fund accumulated by the trust in accordance with such plan, and (2) if under the trust
instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to
employees under the trust, for any part of the corpus or income to be (within the taxable year
or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his
employees: Provided, That any amount actually distributed to any employee or distributee
shall be taxable to him in the year in which so distributed to the extent that it exceeds the
amount contributed by such employee or distributee.
(C) Computation and Payment. –
(1) In General. - The tax shall be computed upon the taxable income of the estate or trust and
shall be paid by the fiduciary, except as provided in Section 63 (relating to revocable trusts)
and Section 64 (relating to income for the benefit of the grantor).
(2) Consolidation of Income of Two or More Trusts. - Where, in the case of two or more trusts,
the creator of the trust in each instance is the same person, and the beneficiary in each
instance is the same, the taxable income of all the trusts shall be consolidated and the tax
provided in this Section computed on such consolidated income, and such proportion of said
tax shall be assessed and collected from each trustee which the taxable income of the trust
administered by him bears to the consolidated income of the several trusts.
SEC. 61. Taxable Income. - The taxable income of the estate or trust shall be computed in the
same manner and on the same basis as in the case of an individual, except that:
(A) There shall be allowed as a deduction in computing the taxable income of the estate or
trust the amount of the income of the estate or trust for the taxable year which is to be
distributed currently by the fiduciary to the beneficiaries, and the amount of the income
collected by a guardian of an infant which is to be held or distributed as the court may direct,
but the amount so allowed as a deduction shall be included in computing the taxable income
of the beneficiaries, whether distributed to them or not. Any amount allowed as a deduction
under this Subsection shall not be allowed as a deduction under Subsection (B) of this Section
in the same or any succeeding taxable year.
(B) In the case of income received by estates of deceased persons during the period of
administration or settlement of the estate, and in the case of income which, in the discretion of
the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be
allowed as an additional deduction in computing the taxable income of the estate or trust the
amount of the income of the estate or trust for its taxable year, which is properly paid or
credited during such year to any legatee, heir or beneficiary but the amount so allowed as a
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deduction shall be included in computing the taxable income of the legatee, heir or
beneficiary.
(C) In the case of a trust administered in a foreign country, the deductions mentioned in
Subsections (A) and (B) of this Section shall not be allowed: Provided, That the amount of any
income included in the return of said trust shall not be included in computing the income of
the beneficiaries.
SEC. 62. Exemption Allowed to Estates and Trusts. - For the purpose of the tax provided for
in this Title, there shall be allowed an exemption of Twenty thousand pesos (P20,000) from
the income of the estate or trust.
SEC. 63. Revocable Trusts. - Where at any time the power to revest in the grantor title to any
part of the corpus of the trust is vested (1) in the grantor either alone or in conjunction with
any person not having a substantial adverse interest in the disposition of such part of the
corpus or the income therefrom, or (2) in any person not having a substantial adverse interest
in the disposition of such part of the corpus or the income therefrom, the income of such part
of the trust shall be included in computing the taxable income of the grantor.
SEC. 64. Income for Benefit of Grantor. -
(A) Where any part of the income of a trust (1) is, or in the discretion of the grantor or of any
person not having a substantial adverse interest in the disposition of such part of the income
may be held or accumulated for future distribution to the grantor, or (2) may, or in the
discretion of the grantor or of any person not having a substantial adverse interest in the
disposition of such part of the income, be distributed to the grantor, or (3) is, or in the
discretion of the grantor or of any person not having a substantial adverse interest in the
disposition of such part of the income may be applied to the payment of premiums upon
policies of insurance on the life of the grantor, such part of the income of the trust shall be
included in computing the taxable income of the grantor.
(B) As used in this Section, the term 'in the discretion of the grantor' means in the discretion of
the grantor, either alone or in conjunction with any person not having a substantial adverse
interest in the disposition of the part of the income in question.
SEC. 65. Fiduciary Returns. - Guardians, trustees, executors, administrators, receivers,
conservators and all persons or corporations, acting in any fiduciary capacity, shall render, in
duplicate, a return of the income of the person, trust or estate for whom or which they act, and
be subject to all the provisions of this Title, which apply to individuals in case such person,
estate or trust has a gross income of Twenty thousand pesos (P20,000) or over during the
taxable year.
Such fiduciary or person filing the return for him or it, shall take oath that he has sufficient
knowledge of the affairs of such person, trust or estate to enable him to make such return and
that the same is, to the best of his knowledge and belief, true and correct, and be subject to all
the provisions of this Title which apply to individuals: Provided, That a return made by or for
one or two or more joint fiduciaries filed in the province where such fiduciaries reside; under
such rules and regulations as the Secretary of Finance, upon recommendation of the
Commissioner, shall prescribe, shall be a sufficient compliance with the requirements of this
Section.
SEC. 66. Fiduciaries Indemnified Against Claims for Taxes Paid. - Trustees, executors,
administrators and other fiduciaries are indemnified against the claims or demands of every
beneficiary for all payments of taxes which they shall be required to make under the
provisions of this Title, and they shall have credit for the amount of such payments against the
beneficiary or principal in any accounting which they make as such trustees or other
fiduciaries. settlement of the estate" is the period required by the executor or administrator to perform
the ordinary duties pertaining to administration, in particular, the collection of assets and the
REVENUE REGULATIONS NO. 2 payment of debts and legacies. Estates during the period of administration have but one
beneficiary and that beneficiary is the estate.
SECTION 207. Estates and trusts. — "Fiduciary" is a term which applies to all persons or
corporations that occupy positions of peculiar confidence towards others, such as trustees, No taxable income is realized from the passage of property to the executor or administrator
executors, or administrators; and a fiduciary, for income tax purposes, is any person or on the death of the decedent, even though it may have appreciated in value since the decedent
acquired it. In the event of delivery of property in kind to a legatee or distributee, no income is
corporation that holds in trust an estate of another person or persons. In order that a fiduciary
realized. Where, however, prior to the settlement of the estate, the executor or administrator
relationship may exist, it is necessary that a legal trust be created.
sells property of a decedent's estate for more than the appraised value placed upon it at the
In general, the income of a trust for the taxable year which is to be distributed to the death of the decedent, the excess is income, taxable to the estate. Where property is sold after
beneficiaries must be returned by and will be taxed to the respective beneficiaries, but the the settlement of the estate by the devisee, legatee or heir at a price greater than the
income of a trust which is to be accumulated or held for future distribution, whether appraised value placed upon it at the time he inherited the property from the decedent, he is
consisting of ordinary income or gain from the sale of assets included in the corpus of the taxable individually on any profit derived. An allowance paid a widow or heir out of the
trust, must be returned by and will be taxed to the trustee. Three exceptions to this general corpus of the estate is not deductible from gross income.
rule are found in the law: (1) in the case of revocable trust (Section 59); (2) in the case of a
trust the income of which, in whole or in part, may be held or distributed for the benefit of the SECTION 212. Liability for tax on estate or trusts. — Liability for payment of the tax attaches
grantor (Section 60); and (3) in the case of a trust administered in a foreign country [Section to the person of an executor or administrator up to and after his discharge, where prior to
57(c)]. In the first case, the income from such part of the trust estate title to which may be distribution and discharge he had notice of his tax obligations or failed to exercise due
revested in the grantor should be included in the grantor's return. In the second case, part of diligence in determining whether or not such obligations existed. Liability for the tax also
the income of the trust, which may be held or distributed for the benefit of the grantor, should follows the estate itself, and when the estate has been distributed, the heirs, devisees, legatees,
be included in the grantor's return. In the third case, the trustee is not entitled to the and distributors may be required to discharge the amount of the tax due and unpaid, to the
deductions mentioned in subsections (a) and (b) of Section 57 and the net income of the trust extent of and in proportion to any share received. The same consideration apply to other
undiminished by any amounts distributed, paid or credited to beneficiaries will be taxed to trusts. Where the tax has been paid on the net income of an estate or trust by the fiduciary, the
the trustees; however, the income included in the return of the trustees is not to be included net income on which the tax is paid is free from tax when distributed to the beneficiaries.
in computing the income of the beneficiaries. SECTION 213. Exemption allowed to estate or trusts. — An estate or a trust is allowed a
SECTION 208. Consolidation of incomes of two or more trusts. — Section 56(b)(2) expressly personal exemption of P1,800. Each beneficiary is entitled to but one personal exemption, no
requires the consolidation of the income of two or more trusts where the creator of the trust matter from how many trusts he may receive income.
in each instance is the same person and the beneficiary in each instance is the same. The tax
due on the consolidated income will be collected from the trustees in proportion to the net A. GENERAL RULE ON TAXABILITY: FIDUCIARY OR BENEFICIARY
income of the of the respective trusts. (See Section 215 of these regulations.)
B. PERSONAL EXEMPTION ALLOWED
SECTION 209. Estates and trusts taxed to fiduciary. — In the case of a decedent's estate the
settlement of which is the object of testamentary or intestate proceedings, the fiduciary, C. DECEDENT’S ESTATE ADMINISTRATION
executor, or administrator is required to file an annual return for the estate up to the final
settlement thereof. In the same manner, the fiduciary is required to file a yearly return D. REVOCABLE TRUSTS
covering the income of a trust, whether created by will or deed, for accumulation of income,
whether for unascertained persons or persons with contingent interests or otherwise. In both
E. INCOME FOR BENEFIT OF GRANTOR
cases the income of the estate or trust is taxed to the fiduciary. Where under the terms of a
will or deed, the trustee, may in his discretion, distribute the income or accumulate it, the
income is taxed to the trustee, irrespective of the exercise of his discretion. The imposition of
the tax is not affected by the fact that an ultimate beneficiary may be a person exempt from
tax.
SECTION 210. Estate and trust taxed to beneficiaries. — In the case of (a) a trust the income of
which is to be distributed annually or regularly; (b) an estate of a decedent the settlement of
which is not the object of judicial testamentary or intestate proceedings; and (c) properties
held under a co-ownership or tenancy in common, the income is taxable directly to the
beneficiary or beneficiaries. Each beneficiary must include in his return his distributive share
of the net income of the trust, estate, or co-ownership. In the case of trusts which are in whole
or in part subject to revocation by the grantor, or which are for the benefit of the grantor, the
income of the trust is to be included in computing the net income of the grantor.
SECTION 211. Decedent's estate administration. — The "period of administration or

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