INCOME TAX 2 SEMESTER 11-12

ND

THE NATIONAL INTERNAL REVENUE CODE 1. Taxes imposed under the NIRC 2. Bureau of Internal Revenue (Secs 2 to 20, NIRC) a. b. c. Powers and Duties of the Bureau of Internal Revenue Exclusive and original power to interpret tax laws, subject to review by Sec of Finance Assess & collect i. CIR v. Pascor Realty & Dev Corp, 309 SCRA 402 (1999), Meaning of Assessment [1] ii. Marcos II v. CA, 270 SCRA 47(1997)Burden of Proof on taxpayer to prove erroneous assessment[2] iii. Meralco Securities Corp v Savellano, 117 SCRA 804 (BIR cannot be compelled by Mandamus to issue assessment) [2]

2.4 Enforce forfeitures, penalties & fines, execute decision of CTA & ordinary courts

i.

Republic v CA 366 SCRA 489(2001); Aznar v CIR 58 SCRA 519 (1974); CIR v Benigno Toda, 438 SCRA 290 (2004) ( meaning of fraud]

2.5 Effect police powers 2.6 Obtain information, etc. 2.6.1 Sy Po v CTA, GR No. 81446, 18 Aug 1988 (best evidence to support assessment)[4]; CIR v Hantex Trading L 136975, Mar 31, 2005. 2.6.2 Bache & Co. v. Ruiz, 37 SCRA 823 (requirement for a search warrant)[5] 3. BIR Rules and Regulations o CIR v CA, ROH Auto Products Phil, Inc. and CTA, GR No. 108358, 20 Jan 1995, 240 SCRA 368. (Nature of administrative rules & regulations)[6] x o CIR v CA, CTA and Fortune Tobacco Corp, GR No. 119761, 29 Aug 1996, 261 SCRA 236 (Extent of BIR interpretative rule)[7] o CIR v Burroughs, Ltd., GR No. 66653, 19 Jun 1986, 142 SCRA 324 (Effect of revocation of ruling)[8] o PBC v CIR, GR No. 112024, 29 Jan 1999 (wrong interpretation will not prejudice the government)[9] o ABS-CBN v CTA & CIR GR52306 Oct 12, 1981 [Circulars or rulings prospective] o CIR v Benguet Corporation, 463 SCRA 28 (2005) Non-retroactivity of ruling; while government is not bound by the error of its agents issuing ruling, in the interest of justice and fair play, it may not be given retro effect. [same holding in Sy Po v CTA, GR No. 81446, 18 Aug 1988: o CIR v Bursmeiters & Wain Scandinavian, GR 153205, Jan 2007) Non retroactivity of BIR ruling; 0% VAT on export of services.

Concept of Income A. Definition of Terms (Sec. 22 NIRC) 1. Person 2. Shares of Stock 3. Taxpayer 4. Taxable year 5. Fiscal year 6. Paid or incurred/paid or accrued

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Filipinas Synthetic Fiber Corp. vs. CA, CTA, CIR (G.R. Nos. 118498 & 124377 October 12, 1999) B. Taxable Income General Principles of Income Taxation (sec. 23 NIRC) 1. Individuals 1. Kinds of Individuals (Sec 22, 25) 2. Types & rates of Income (Sec 24) 2. Estates & Trusts (Sec 60-66) CIR vs. Visayan Electric 23 SCRA 715 CIR vs. CA, CTA, GCL Retirement Plan 207 SCRA 487 3. Corporation 1. Definition Sec 22 (B) Jose Obillos vs CIR CTA Case 3211 11/30/83 2. Domestic Sec. 22 (c) a. Profit-oriented (32%); effective July 1, 2005 35% per RA 9337; 2009-30% b. Proprietary educ & non-profit hospital 10% of taxable inc, except passive income; contrast with a tax exempt non-stock and non-profit educational institution. c. Govt corps - SSS, GSIS, PHIC, PAGCOR & PCSO 3. Foreign corp Sec 22 (d) Res. Foreign corp Sec 22 (h); Sec 28 (a) as amended by RA 9337 a. 11/1/2005 35% taxable b. 1/1/2009 30% Non Res. Foreign corp Sec 22(I); Sec. 28 (b) as amended by RA 9337 a. 11/1/2005 35% gross b. 1/1/2009 30% Marubeni vs CIR 177 SCRA 500 CIR vs. Proctor & Gamble 204 SCRA 377 4. Special types of corp. Sec. 27 (B) Sec. 27 (C) 1. Pascual v CIR, 166 SCRA 560 [1988][10] x Sharing not taxable 2. Co-ownership is not taxable - Ona v CIR, 45 SCRA 74 [11]; Obillos v CIR 139 SCRA 436 [1985][12] x Cited Ona, Evangelista cases. 3. Afisco Insurance v. CIR, L-112675, 25 Jan 1999[13] x Taxed a corporation the pool of insurance companies. 4. Joint Emergency Operations Col v Batangas 54 OG 6724 [14] 5. GENERAL PROFESSIONAL PARTNERSHIP (Sec 26) a. Exempt from income tax but its partners are taxable on their share whether distributed or not b. Its exclusion is a classification clause not an exemption thus construed in favor of taxpayer, CIR v Ledesma, 31 SCRA 95, Jan 30, 1970. [26] 5. Rates of Tax Sec. 27 1. In General (Sec 27 (A)) as amended by RA 9337 a. 11/1/2005 35% b. 2009 30% 2. Gross Corporate Income tax 3. Passive Income

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Sec. 27 (d) (1-5) RR 10-98 4. Minimum Corporate Income Tax Sec. 27 (e) (1); RR 9-98 Imposition Carry Forward of excess minimum tax Relief from MCIT Gross Income Sec 27 (e) (4) Gross Income

A.

What is income 1. Section 32 NIRC 1997, Sec. 49 Rev. Reg. No. 2 2. Haig-Simons definition: "personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in value of the store of property rights between the beginning and end of the period in question a. problems of administration of that definition: (1) what about property devaluation (e.g., car value depreciation) --who decides the value of one's property rights (2) liquidity without a sale of one's property, an individual may not have available cash to pay for tax on the property, even though the assessed value has increased 3. Eisner vs. Macomber, 252 US 189, 207 (1920) a. Definition of Income b. CIR v CA 301 SCRA 52 Severance test theory separation from capital of something w/c of exchangeable value; refers to taxability of stock dividends 4. Comm'r v. Glenshaw Glass (S.Ct. 1955) 348 U.S. 426 (1995) a. H: punitive damages rec'd were included in gross income b. 3 part test (to determine what's income) an accession to wealth (is richer?) (2) clearly realized (has some event happened such that has received the money) (3) complete dominion (does the have a choice about how to spend it) (a) even though you may have credit liabilities, you incurred those liabilities voluntarily 5. CIR vs. CA & Castaneda, G.R. No. 96016 October 17, 1991 a: Terminal leave pay is not considered part of income subject to income tax

(1)

7.

CIR v BOAC 149 SCRA 395 [1] x - Source of income of airlines - [ sale of airline tickets of an offline airline considered income derived from Phil by majority of SC; source rule discussed; minority considered airline tickets as contract of carriage or service, thus situs is where rendered; characterization becomes moot given the new tax provision on 2 % Phil Gross Billings regardless of where sold or paid provided cargo or passenger originates from Phil. NDC v CIR, 151 SCRA 472 [1987][2] x - Source of interest income [Exemption strictly construed; Sec. 37 {now Sec 42} Income from sources within the Philippines applied; also exclusions from gross income. CIR v Lednicky 11 SCRA 603 [3] x - Partnership Theory the right to tax income emanates from partnership in the production of income by

8.

9.

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providing protection, resources, incentives and climate to produce income. [Was income tax paid to fx govt by resident alient deductible though income exclusively came from the Phils.? No.] 10. Madrigal v. Rafferty GR12287 aug71918 38 Phil 14 [4] x - Functions of income tax - The aim has been to mitigate the evils arising from the inequalities of wealth by a progressive scheme of taxation, which places the burden on those best able to pay.; income distinguished from capital. Income as contrasted with capital or property is to be the test. The essential difference between capital and income is that capital is a fund; income is a flow. Capital is wealth, while income is the service of wealth. "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." Madrigal Espouses reported income from conjugal partnership separately resulting to lower tax due. SC said under law at the time they shld report jointly. The partnership is not a bus partnership; right of espouses enchoate. Helvering v. Horst 311 U.S. 112 Control test power to procure the payment of inc and enjoy the benefit thereof determines who is subject to tax on coupon bond donated to his son. ,

11.

B. Income from whatever source B. 1 Compensation for Services ( Sec. 32) 1. includes: wages, salaries, fees, commissions, fringe benefits, royalties, percentage of profits, tips, legal and medical fees 2. not necessary for there to be an employer-employee relationship 3. form of payment irrelevant (e.g., stock, notes, property, etc.) a. value = fair market value (fmv) of the transferred item b. Old Colony Trust Co. v. Comm'r 279 U.S. 716 R: Employer tax payments considered additional compensation (THUS: taxable) (2) b/c of equity concerns, have to treat (Wood) as if he'd rec'd the $681,000 and $351,000 (amts of taxes paid directly by his company, but on his behalf) (3) didn't matter that Wood had never touched the money (4) instead, crucial that his company was willing to pay him if he asked (a) he still rec'd a benefit from that $ (b) this money was paid in compensation of his being a valued officer of the company (5) if had won, he would have been in a lower tax bracket Progressive Tax Rate Structure:

(1)

c. Tax Rates 32%

Highest marginal rate is paid only on this income

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30% 25% 20% 15% 10% 5%

Will always pay 30% on this amount Will always pay 25% on this amount Will always pay 20 % on this amount Will always pay 15% on this amount ( B) Will always pay 10% on this amount ( A) Will always pay 5% on this amount P10K P 30K P 70K P 140 K P 250 K P 500 K Over P 500 K Taxable Income (See Sec. 24 NIRC) 1. A is taxed at a 5% marginal rate -- B is taxed at a 10% marginal rate 2. marginal rate: rate of tax that you pay on your last peso of income 1. e.g., if you earned P22,101.00 would pay 5% on P 10,000.00 of it, and 15% on the last Peso 1. THUS, 10% is your marginal rate (3) taxable income = gross income deductions \ can be lowered through exemptions 1. Fisher v Trinidad GR17518 Oct 30, 1922 43 Phil 973 [5] x Income defined; stock dividends construed] 2. CONWI V CTA, G.R. No. 48532, August 31, 1992, 213 SCRA 83 [6] x Income may be defined as an amount of money coming to a person or corporation within a specified time, whether as payment for services, interest or profit from investment. Unless otherwise specified, it means cash or its equivalent. Income can also be thought of as a flow of the fruits of one's labor. The issue here is which exchange rate to use on $-denominated salaries of P&G employees earned abroad. RR issued by Sec Finance required application of floating rate is applicable in this case not the CB Circular. Thus, refund claim is denied. 3. Javier v CA 199 SCRA 824 [7] x Received by mistake is income. 4. Limpan Investment Corp v. CIR 17 SCRA 703 [1966][8] -Constructive receipt of rent income1958 deposited in court in 1957 withdrawn in 5. Fernandez v CIR 29 SCRA 553 [9]Book error not income - [liability to an insurance co. overstated, thus when corrected the net worth went up. This is not taxable.

B.2

B.3 B.4 B.5

Recovery of Damages a. Farmers and Merchants Bank vs. CIR 59 F2nd 912 CIR vs. Glenshaw Raytheon v. CIR 144 F2nd 110 b. Employment Related Awards Backpay awards. See Republic Act 304 Separation Pay BIR Ruling 142-99,050-90 Sec. 32 (B) (6) c. Actual Moral and Exemplary damages. See EO 37 Recovery of items previosly deducted from gross income a. Perry vs. US 160 F. Supp 270 Forgiveness of indebtedness a. Bradford vs. CIR 233 F2nd 935 b. BIR Ruling 076-89 dated April 17, 1989 Income derived from Illegal business

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1. 2.

3.

4.

5.

Rationale for taxing this: a. shouldn't give tax benefit to thieves when taxing law-abiding citizens b. enforcement of non-tax criminal issues Yet, reporting illegal income not inconsistent with 5th Amendment a. Tax agents couldn't care where the income comes from, just that you pay taxes on it b. thus, have to use separate line "other income" c. tp is not required to reveal the source of illegal income Collins v. Comm'r (2d Cir. 1993) a. OTB dealer, illegally issued $80,000 in tickets to self b. H: illegal gains are taxable to their full amount (1) any restitution paid may be ded'ble in the year paid c. gambling losses are irrelevant unless being ded'd to offset gambling gains Consensual agreement James vs. U.S. 366 U.S. 213 a. must be a consensual agreement/ recognition of an obligation to repay b. claim for taxes has priority over victim's claim for stolen funds Embezzlement v. Loans a. Hobson v. Comm'r (1992)

Court interpreted James to apply only when embezzler personally benefited from the funds 6. Rutkin v US 343 U.S. 130 Claim of right doctrine illegally acquired (extortion) is income,

(1)

B.6 Fringe Benefits Sec. 33 (A) NIRC; RR 3-98; RR 8-2000; RR 10-2000;RR 102008 (limit of de minimis) a. loose definition: in-kind benefits transferred to an employee (sec. 33 (B)) (1) may be clearly additional compensation or essential to the performance of the employee's job (2) PATTERN: whenever an employer provides an economic benefit to an employee, there is a possibility of finding income (a) esp. when employer's motive is compensatory (b) eg., cash reimbursements (they look an awful lot like compensation) b. many fbs are not taxable solely b/c Congress has chosen to treat them specially Sec. 33 (c) NIRC c. equity concerns: (1) (horizontal) equity requires the treatment of taxpayers in similar economic situations similarly (a) e.g., A rec'vs P15,000 cash, B rec'vs P10,000 cash and P5,000 in tax-free airfare (violates equity, but not so much so that the law has changed) d. efficiency (1) if income tax is to raise a certain amt of revenue, exclusion of fbs requires higher tax rates e. complexity (1) inherent difficulty in distinguishing in-kind compensation from goods/services related to an employee's work which also provide a benefit (a) e.g., a free book to a book critic would be an incident of employment -- whereas that same book to a mechanic would be non-cash compensation

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f.

g.

(2) Congress is unwilling to accept the principle that all non-cash compensation designed to reward the employee for services rendered should be subject to income tax Work-Related Fringe Benefits (1) excludable fbs (a) those granted under special laws; (b) those given for the benefit of the employee to retirement, insurance and hospitalization benefit plans; (c) given under cba (d) de minimis benefits (2) two objectives for providing for fbs tax-free in Code (a) many industries have long-standing practices that employees may receive certain products (services) that the employer provides to the general public (b) provide clear boundaries for the provision of tax-free benefits (3) "working condition benefits" regarded as primarily for the benefit of the employer, and therefore not includable in the income of the employee. Employer benefit rule (4) valuation: standard is that the amount of value of fbs is fmv (5) U.S. v. Gotcher 401F.2nd 118 (a) husb & wife to Germany at VW's request. (b) H: Gotcher's trip was NOT income -- wife's trip was (c) R: Meals & lodging not taxable if they are primarily for the convenience of the employer (d) R: taxable only when the payment of expenses serves NO LEGITIMATE PURPOSE (e) if, however, Gotcher got a prize of the trip to Germany, his trip would be income Meals & Lodging Comm'r v. Kowalski 434 U.S. 77 (a) state trooper -- sought meal allowance to be excluded (b) I: is cash allowance equal to value of meals (c) H: NO. 119 applies only to meals furnished, not to cash reimbursements for meals i) this was no Congressional oversight (d) justification for difference: lack of employee choice (property transferred for services) compensation (1) e.g., stock options (2) BUT -- if there are restrictions on it, then non-compensatory purpose is there (a) eg., risk of forfeiture (b) employer's purpose = golden handcuffs Interest-Free Loans (RR 3-98) (definition of treatment of loans w/ below-market interest rates) BIR Ruling 076-99 Education Plan for children BIR Ruling 189-99 Free Housing Assistance BIR Ruling dated December 28, 1999 to Toyota Autoparts Philippines Inc.

(1)

h.

i. j. k.

B.7

Imputed Income a. definition: the benefits derived from labor on one's own behalf or the benefits from ownership of the property b. excluded from income

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c.

d.
B.8

reasons for not taxing (1) conceptually: impossible to know where to stop (2) practically: (a) no political wisdom in a rule no one would understand or accept (b) valuation and record-keeping nightmares (c) privacy concerns implicated if the Service had to enforce compliance in accounting for services performed for one's self most significant form: imputed rental-value of owner-occupied homes (1) e.g., if rented out house instead, would earn $600/mo (2) THUS $600/mo is income BIR Ruling No. 114-97 October 30, 1997

Gifts & Bequests -- (Sec. 32 B 3) a. Gifts (not income --> excludable) (1) CLEAR that employer gifts to employees are NOT excluded (a) such a transaction may be a de minimis fringe Tips -- taxable income (1) collection has proven difficult b/c of reporting insufficiencies (2) See par. 717, p. 231, US Master Tax Guide (1969) re: tips (3) See Sec. 2.78.1 (4) of Rev. Reg. 02-98 (4) Comm'r v. Duberstein (S.Ct. 1960) a. R: "gift" in 102 proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, etc b. DONOR'S INTENT IS KEY (5) Wolder v. Comm'r a. creative attempt to avoid tax b. calling it a "bequest" is not enough c. attempt to defer compensation of the attorney

b.

B.9

Support and government transfer payments a. Support provided by family members, like intra-family gifts, is NOT included in gross income b. exclude most government benefits and other welfare payments BUT, Congress can clearly choose to tax such payments Prizes: generally must be included a. subject to final tax of 20%, except if P 10,000 pesos or less, which is subject to the graduated rates. Sec. 24 (B)(1) b. however, excludes certain prizes if: (a) The recipient was selected without any action on his part ot enter the contest or proceeding; and (b) The recipient is not required to render substantial future service as a condition to receiving the prize or award : Sec. 32 B 7 (c) Capital Appreciation and Recovery of Basis (gains derived from dealings in property) ** Kindly note that the rules applicable in sales of real property held as capital assets, the capital gains tax is based on the selling price or fmv or zonal value whichever is higher, regardless of the cost.

B. 10

B.11

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** In cases of shares of stock, not traded through the stock exchange, the BIR can use the following values: value at the stock exchange, book value, selling price as basis for the Net gain or loss following the rule of sales less cost. A. Capital Recovery & Basis definitions (1) Computation of gain or loss = total sales less the costs of goods sold (Sec. 40) (2) Sec. 39 Capital Assets a. RR 6-2008 (3) Sec. 40 Gains on dealings in property (4) Sec. 40 (A) determines amount of gain or loss (5) Sec. 40 (A) amt realized = any cash rec'd + fmv of any property rec'd (6) See Revenue Regulation 07-2003

B. Determining the Basis of Property 1. definitions (1) Sec. 40 (B)adjusted basis (2) Sec. 40 (B) (1) basis = cost (except as otherwise provided) (3) (4) (5) (6) 2. not helpful if you don't buy the property Sec. 40 (B) (2) property transferred by death Sec. 40 (B) (3) property transferred by gift Sec. 40 (B) (4) adjustments to basis Sec. 40 (B) (5) basis in cases of tax free transfers. See Rev. Regulation No. 18-2001 and RMO no. 32-2001

(a)

initial investment should not be taxed, just the interest or other gain resulting from that investment ensures that you will be taxed at least (but no more than) once on that amount basis = cost even when tp has overpaid/underpaid for property (a) if property is purchased at less than fmv, purchaser takes cost basis 1. is not taxed on gain until disposal of property (b) if property is purchased at over fmv, basis = amt paid, and loss will be realized only when sells property at fmv Basis of Property Acquired by Gift (a) basis will be same as in hands of donor (1) "carryover basis" (c) formula: gain (or loss) = amount realized at sale basis (c) gift of cash = entire amount is excluded under Sec 32 (B) (3) (1) basis of cash = face value of cash (d) of LOSS (1) basis = either donor's or last preceding owner by whom it was not acquired by gift, except if basis is higher than fmv at the time of the gift, the value would be the fmv. (2) CHOICE ONLY APPLIES IF A LOSS (3) IF GAIN, BASIS IS ALWAYS COST Basis of Property Acquired From a Decedent (1) basis = fmv of property

3.

4.

5.

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(2)
6.

(1) avoids (could receipt formula: gain

problem of trying to determine donor's basis have been purchased 50 years ago, with no -- incredible hassle) (or loss) = amt realized at sale basis

Basis of property acquired for inadequate consideration (1) basis= amount paid by transferee (2) formula: gain (or loss) = amt realized at sale - basis (3) Note: the above transaction may be subjected to donors tax during the acquisition (Sec. 100) in this event, the basis of the property would be the value determined in computing the donors tax, this might render no. 4 above as inapplicable. Basis of property under Sec. 40 (C) (2) tax free exchange of property (1) basis = value of the property exchanged for the shares received, thus the value of the property exchanged will be the new value of the shares received. See Sec 40 (C) (5)

7.

B.12

The Realization Requirement 1. Amts do not need to be rec'd in cash to be included in gross income under Sec. 32 a. fmv of property rec'd is often included in income at the time of the receipt 2. NOT interpreted to include unrealized APPRECIATION in income 3. time of realization is not always clear 4. tps have considerable flexibility in the timing of taxation of gains & losses 5. Windfalls

a.

b.

Cesarini v. U.S. (N.D Ohio 1969) (1) TPs bought piano for $15, found $4,400 in cash inside (2) H: windfall cash is income (3) R: 1964 Treasury Reg states specifically that treasure troves are income dispositive of this issue (4) extra asset: fact that you can sever the cash from the piano shows that there is realization in the cash (5) see class hypos Haverly v. U.S. (7th Cir. 1975)

B.13

R: Can't deduct income without first realized it as income (2) Principal rec'vs review copies of books. Donates them to charity. Claims charitable ded'n in the amount of the books (3) I: Whether the value of the unsolicited textbooks was income (4) H: YES. It's income b/c he claimed a ded'n (5) Justification: want to avoid a double benefit to the taxpayer (6) R: The act of claiming a charitable ded'n does manifest an intent to accept the property as one's own (intent to exercise complete dominion) Annuities and Life Insurance (only generally) (N/19b) 1. Annuities a. payer of policy is also recipient b. proceeds (1) some portion is return of capital (2) some portion is income c. need to determine how much of proceeds represents income/growth element of the investment

(1)

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B. 13

Life Insurance Proceeds a. Sec. 32 (B) (1) excludes life insurance proceeds from income of recipient b. policy (1) proceeds are a result of premiums (2) taxes have already been paid on the amount you sent in for premiums (b/c they were income from salary before you paid insurance co) Borrowed Funds 1. Loans and Discharge of Indebtedness Income a. principal is part of capital, loans are not income b/c they didn't change the balance sheet (even though have asset of P1.00, also have liability of P 1.00) b. no ded'n allowed when making principal payments on the loan c. lender will earn income on the transaction in the form of interest (1) borrower still does not get a ded'n d. Discharge of indebtedness (1) if certain portion of loan is forgiven, tp (borrower) will have income (a) rationale for not including loan money as income was b/c had an offsetting liability (b) when this changes, then will have income b/c no longer have the same offsetting liability e. Zarin v. Comm'r (Tax Ct. 1989) (1) Zarin rec'd $3.4 mil credit to gamble at Resorts. Only repaid $500,000. IRS claims difference in amounts was income and should be taxed (2) H: agreed. Acc'ding to 61(a)(12), forgiveness of indebtedness was income (3) R: value rec'd in exchange for the credit does not constitute the type of property excluded by 108(e)(5) -- thus, no exclusion for this income (4) on appeal to 3d Cir, rev'd unanimously (a) b/c contested liability doctrine i) debt was not enforceable in NJ ii) thus its cancellation was not income (b) b/c chips were not property (dicta)

2.

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