INCOME TAXATION - PPTX Updated

SALIENT FEATURES OF
THE PRESENT
INCOME TAX SYSTEM
1
INDIVIDUAL INCOME TAXATION
A. Schedular Tax Treatment
1. It classifies income.
2. It provides for different tax rules.
3. It imposes different tax rates.
2
B. Net Income Taxation
1. Resident citizen (RC)

2. Non-resident citizen (NRC)
3. Resident alien (RA)
4. Non-resident alien engaged in trade or
business (NRA – ETB)
3
C. Gross Income Taxation
Non-resident alien not engaged in trade

or business (NRA-NETB)
D. Income Tax Situs
1. Residence - RA, RC
2. Place - NRA, NRC
3. Citizenship - RC
4
CORPORATE INCOME TAXATION
A. Global Tax Treatment
1. It generally provides for uniform rules.

2. It generally imposes uniform tax rate.
3. It does not generally classify income.
B. Net Income Taxation

1. Domestic Corporation (DC)
2. Resident Foreign Corporation (RFC)
5
CORPORATE INCOME TAXATION
C. Gross Income Taxation

1. Non-resident Foreign Corporation (NRFC)
D. Income Tax Situs
1. Residence – RFC
2. Place - NRFC
3. Nationality - DC
6
COMMON FEATURES
A. Pay as You File System
1. Individuals – upon filing of their income tax

returns
2. Corporations – upon filing of their quarterly

corporate income tax returns and final adjustment
corporate returns
7
COMMON FEATURES
B. Creditable Withholding Tax System
1. Withholding agent (source) – withholds the tax and

remits the same to the BIR
2. Tax withheld – creditable against income tax due
8
COMMON FEATURES
C. Final Withholding Tax System
1. Withholding agent (source) – withholds the tax

and remits the same to the BIR
2. Tax withheld – final settlement of the tax liability

on the income covered
9
COMMON FEATURES
D. Operational Rules of the Withholding Tax System
1. Withholding agent – the payor, agent of the

government for the collection of the tax in order to
ensure its payments.
- It is a payee by fiction of law;

a mere tax collector. The liability is direct and
independent from the taxpayer, because the income tax
is still imposed on and due from the latter.
10
COMMON FEATURES
D. Operational Rules of the Withholding Tax System
1. Withholding agent – As agent, it is personally liable for

the tax arising from the breach of its legal duty to
withhold. Ergo, the agent is not liable for the tax as no
wealth flowed into him – he earned no income.
2. Taxpayer – the person subject to tax imposed by law.

He should not answer for the non-performance by the
withholding agent of its legal duty.
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DEFINITION OF INCOME
In a broad sense, income means all wealth

that flows into the taxpayer 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.
12
Judicial definitions
- gain derived from capital, or from labor, or from

both capital and labor, including the gain derived from
the sale or exchange of capital assets. (Fisher v.
Trinidad, 43 Phil. 973; Eisner v. Macomber, 252 US
189, 40 S. Ct. 189, 64 L. Ed. 521 1920)
13
Judicial definitions
- amount of money coming to a person or corporation

within a specified time, whether as payment for
services, interest, or profit from investment. (CONWI
v. CTA, 213 SCRA 83)
14
Economist’s definition
- money value of the net accretion to one’s economic

power between two points of time.
15
INCOME, CAPITAL, REVENUE, RECEIPTS;
DISTINCTIONS
Capital v. Income
Fund Flow
Wealth Service of wealth
Tree (property) Fruit (metaphorical language)
16
INCOME, CAPITAL, REVENUE, RECEIPTS; DISTINCTIONS
Gross receipt includes receipts which may constitute
capital as well as income; therefore, broader in scope.
Income connotes a narrower concept limited only to gain

derived from labor, capital or property, excluding non-income items
such as capital invested, cost of goods sold or those excluded by law
from income taxation.
Revenue refers to all funds or income derived by the

government whether from tax or other sources. Revenue is to
the government as income is to private persons or corporations.
17
SOURCES OF INCOME
- Property (Capital)
- Labor (service)
- Sale/Exchange of capital asset and activity
Source of income is any property, activity or service

that produced the income. (COM v. BOAC, 149 SCRA
395) It may also be in the form of proceeds from sales
of transport documents.
18
SOURCES OF INCOME
- Under the Tax Code, however, income derived from

whatever source forms part of the taxpayer’s income. This
includes the following:
1. Treasure found or punitive damages representing profits

lost;
2. Amount received by mistake (Javier v. CA, 199 SCRA 824;

Javier v. Com, CTA Case No. 3393, July 27, 1983)
19
SOURCES OF INCOME
- Ifa foreign bank erroneously remitted US $1 million

instead of US $1,000 and it appears subsequently that
the recipients spent the difference of US $999,000 on
various purchases of property both here and abroad of
their own material benefit, the said sum constitutes
taxable income.
20
SOURCES OF INCOME
It has been held that if a taxpayer receives earnings
under a claim of right without restrictions as to its
disposition, he has received income 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. This is an exception to the rule that income
received through mistake is not taxable as its receipt is
offset by liability to the party making the excessive
payment. (North American Consolidated v. Burnet, 286 US
417)
21
SOURCES OF INCOME
3. Cancellation of the taxpayer’s indebtedness
4. Payment of usurious interest;
5. Illegal gains – gambling, theft, embezzlement,

extortion, fraud – income to embezzler if forgiven by
the owner;
6. Tax refund – must be claimed as deduction from

gross income in the preceding year. It means that the
tax must be a deductible one;
22
SOURCES OF INCOME
7. Bad debt recovery – must be claimed as deduction

from gross income in the preceding year. It assumes
that the taxpayer has a net income, not a net loss.
* Recovery of bad debt and tax refund finds a

jurisprudential hook in Tax Benefit Rule.
23
TAX BENEFIT RULE
- Itis a rule which limits the recognition of income
from the recovery of an expense or loss properly
deducted in a prior taxable year to the amount of
the deduction that generated a tax savings. Under
this rule, if an amount deducted from gross income
in a prior taxable year is recovered in a later year,
the recovery is income in the last year. (Tennessee
Carolina Transp., Inc. V. CIR, 6, 582 F 2nd 378, 379)
24
INCOME TAX; BASIS, NATURE, FUNCTIONS
1. It is a tax on all yearly profits arising from property,

profession, trades or offices or as a tax on a person’s
income, emoluments, profits and the like.
2. It is based on income, either gross or net, realized in one

taxable year.
3. Excise tax – it is not levied upon the person or property but

upon the right of a person to receive income or profits.
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4. Functions of income tax:
a. to provide large amounts of revenues;

b. to offset regressive sales and consumption taxes;
c. to mitigate the evils arising from the inequalities in the
distribution of income and wealth which are considered
deterrents to social progress, by a progressive scheme of
taxation. (Report of the Tax Commission of the Phil., Vol. II;
Madrigal v. Rafferty, 38 Phil. 414)
26
5. The basis of the right of the government to tax

income emanates from its partnership in the
production of income by providing the protection,
resources, incentive, and proper climate for such
production. (Com. V. Lednicky, 11 SCRA 603) This is
called the Partnership Theory which has spawned the
following principles:
27
a) Protection theory. It dictates that when the flow

of wealth proceeded from, and occurred within,
Philippine territory, enjoying the protection
accorded by the Philippine government, the same, in
consideration of such protection should share the
burden of supporting the government. (CIR v. BOAC,
149 SCRA 395)
28
b) Theory of favorable business climate. Domestic

corporations owe their corporate existence and privilege
to do business to the government. They also benefit from
the efforts of the government to improve the financial
market and to ensure a favorable business climate. It is
therefore fair for the government to require them to make
a reasonable contribution to the public expenses. (CREBA
v. Romulo, 614 SCRA 605)
29
REQUISITES FOR INCOME TO BE TAXABLE
1. There must be gain or profit, whether in cash or its

equivalent.
2. The gain must be realized or received. This implies that not

all economic gains constitute taxable income.
3. The gain must not be excluded by law or treaty from

taxation. This means that not all income is required to be
included in computing the taxable income.
30
The gain must be realized or received. This implies that
not all economic gains constitute taxable income.
a. Mere increase in the value of property is not income

(unrealized increase in capital).
b. Increases in the taxpayer’s net worth are not taxable

increases in net worth if they are not the result of the
receipt by it of unreported or unexplained taxable
income, but are shown to be merely the result of the
correction of errors in its entries in its books relating
to its indebtedness to certain creditors, which had
been erroneously
31
overstated or listed as outstanding when they had in
fact been duly paid. (Fernandez v. CIR, 29 SCRA 553)
c. But if the increase in the net worth of a taxpayer is

the result of the receipt by it of unreported or
unexplained taxable income, the correction is taxable
income.
d. Receipt includes constructive receipt.
32
DOCTRINE OF CONSTRUCTIVE RECEIPT OF INCOME
- Income which is credited to the account of and

set apart for a taxpayer and which may be drawn by him at
any time is subject to tax for the year during which it was
so credited or set apart although not yet then actually
received or reduced to his possession. To constitute
receipt in such case, the income must be credited to the
taxpayer without any substantial limitation or condition
upon which payment is to be made.
33
EXAMPLES OF CONSTRUCTIVE RECEIPT:
1. Matured interest coupons due and demandable (convertible into

cash);
2. Share in the profits of a partner in a partnership;
3. Interest credited on savings bank deposit;
4. Dividends applied by the corporation against the indebtedness of a
stockholder;
5. Rental payments refused by the lessor when the lessee tendered
payment and the latter made a judicial deposit of the rental (Limpan
Investment Corporation v. CIR, 17 SCRA 703)
6. Amount credited to shareholders of a building and loan association
when such credit passes without restriction to the shareholder.
34
- The Doctrine of Constructive Receipt is designed to
prevent the taxpayer using the cash basis from deferring
or postponing the actual receipt of taxable income.
Without the rule, the taxpayer can conveniently select
the year in which he will report the income.
35
- In Filipinas Synthetic Corporation v. CA, 316 SCRA 480,

the Supreme Court ruled that it is the right to receive
income, and not the actual receipt, that determines
when to include the amount in gross income.
36
- For 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? The
accrual of income is permitted when the all-events test has
been met. This test requires: 1) fixing of a right to income
to pay; and 2) the availability of the reasonable accurate
determination of such income. (CIR v. Isabela Cultural
Corp., 515 SCRA 556)
37
DOCTRINES ON DETERMINATION OF TAXABLE INCOME
1) Claim of Right Doctrine – illegally acquired income

constitutes realized gain. (Rutkin v. US, 343 US 130)
2) Severance Test Theory – separation from capital of

something which is of exchangeable value. (Eisner v.
Macomber, 252 US 189)
3) Control Test – power to procure the payment of

income and enjoy the benefit thereof. (Helvering v.
Horst, 311 US 112)
38
DOCTRINES ON DETERMINATION OF TAXABLE INCOME
4) Doctrine of Propriety Interest – treats stock options,

shares of stock or other assets transferred by an
employer to an employee to secure better services as
taxable.
5) Realization Test – revenue is generally recognized

when the earning process is complete or virtually
complete and an exchange has taken place.
39
GROSS INCOME
A. GENERAL STATUTORY DEFINITION
In a narrow sense, gross income means all income derived

from whatever source, including but not limited to the
following:
1. Compensation for services in whatever form paid

including but not limited to fees, salaries, wages,
commissions and similar items;
40
2. Gross income derived from the conduct of trade or
business or the exercise of profession;
3. Gains derived from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
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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.
42
GROSS INCOME
B. BROAD DEFINITION
In a broad sense, gross income means income

less income which by statutory definition or
otherwise, is exempt from the tax imposed by law.
Stated otherwise, gross income means all items of
income less exclusions.
43
GROSS INCOME
C. JURISPRUDENTIAL DEFINITION
Gross income means total income from all

sources before deductions, exemptions or other tax
reductions.
44
FORMULA: GROSS INCOME; NET INCOME; TAXABLE
COMPENSATION INCOME; INCOME TAX DUE; INCOME TAX
PAYABLE
Gross Income = All income less exclusions

Net or Taxable Income = Gross income less allowable deductions
Taxable Compensation = Gross compensation less personal and additional
Income exemptions (Individual Taxpayers)
Income Tax Due = Taxable or net income multiplied by income tax rate
Income Tax Payable = Income Tax due less creditable withholding tax or
tax credit
45
GROSS INCOME TAXATION AND NET INCOME TAXATION;
DISTINCTIONS; ADVANTAGES AND DISADVANTAGES
GROSS INCOME TAXATION NET INCOME TAXATION

Allows no deductions Deductions are allowed
Grants no exemptions Exemptions are granted
Tax base: Gross income Tax base: Net income
46
ADVANTAGES OF ADVANTAGES OF
Simplifies the income tax system Fair and just due to grant of deductions
Does away with wastage of Tax audit minimizes fraud

manpower and supplies
Substantial reduction in corruption Provides equitable reliefs in the form of
and tax evasion – exercise of deductions, exemptions and tax credits
discretion to allow or disallow
deductions dispensed with
47
DISADVANTAGES OF DISADVANTAGES OF
No deductions and exemptions Vulnerable to corruption on account of

allowed margin of discretion in the grant of
deduction
Susceptible of fraud in the Confusing and complex process of filing
absence of general audit income tax return
Taxpayers lose interest to earn Difficult/costly to administer
more thereby lessening their
purchasing capacity
48
EXCLUSIONS FROM GROSS INCOME
A. REASONS FOR EXCLUSION
1) The item of receipt does not fall within the definition of income for income
tax purposes.
* Damages recovered in libel and slander suits

* Damages recovered for alienation of affection
* Damages recovered for breach of promise to marry
* Damages recovered for loss of life of spouse
* Damages recovered in annulment of marriage
2) A provision of the Tax Code or special law exempts it from income tax.
49
1. Proceeds of life insurance

2. Amount received as return of premium
3. Gifts, bequests and devises
4. Compensation for injuries or sickness
5. Income exempt under treaty
6. Retirement benefits, pensions, gratuities, etc.
7. Miscellaneous items
50
1. Proceeds of life insurance – received in a single sum or

installments – not taxable
Reason: indemnity rather than as gain or profit.

Insurance contract is a contract of indemnity.
Exception: Interest payments shall be included in

gross income if such amount is held by the insurer under
the agreement to pay interest thereon.
51
However, proceeds of life insurance where the
beneficiary is revocable is subject to estate tax. The
exclusion from income taxation applies regardless of who
the beneficiary is, whether a family member, or other
individual, corporation, or partnership.
Exclusion applies to group insurance, death benefits

under the Workmen’s Compensation Insurance or under
health or accident insurance contract having the
characteristics of life insurance proceeds by reason of
death. (El Oriente v. Posadas, 56 Phil. 147)
52
Transfer of insurance contract – amount excludible
should only be the amount or value of actual
consideration paid and the premiums paid later by the
transferee.
Where the consideration and premiums paid

exceed the proceeds, no amount is includible in the
gross income of the transferee.
53
OTHER TAX IMPLICATIONS OF LIFE
INSURANCE PROCEEDS
a) Included in the gross estate:
* Third person is revocably designated as

beneficiary;
* Estate, executor or administrator is designated

as beneficiary, revocable or irrevocable.
54
OTHER TAX IMPLICATIONS OF LIFE
INSURANCE PROCEEDS
b) Excluded from the gross estate:
* Third person is irrevocably designated as

beneficiary;
* Proceeds of group insurance.
55
2. Amount received as a return of premium – under life

insurance, endowment or annuity contracts, either during
the term or at the maturity of the contract. Cash surrender
value of the policy is also non-taxable. Return of premium
means a repayment of a part or the whole of the
premiums paid. (Com. V. Winslow, 113F [Ed.] 418)
Reason for the exclusion: Return of capital
56
Amount other than amount paid by reason of

death. Excess of the amounts received over the
aggregate premiums or consideration paid is taxable.
Hence, if a taxpayer took out a Ᵽ100,000.00

endowment policy in which he paid Ᵽ80,000.00 as
aggregate premiums and upon maturity he received
Ᵽ100,000.00, only Ᵽ20,000.00 is taxable.
57
3. Gifts, bequests and devises
Reason: Not a product of capital nor industry.
* Gifts are subject to donor’s tax, whereas bequests

and devises are subject to estate tax.
* But the income from such property is taxable. If

the taxpayer inherits securities, the value of such
securities does not constitute income but the
58
dividends and interest paid on such securities are

taxable.
* Principal paid under a marriage settlement and

alimony or allowance based on separation agreement
are considered as gifts.
* Remuneratory donations are subject to income tax.

(see Pirovano v. CIR, 14 SCRA 832)
59
4. Compensation for injuries or sickness
Reason: Compensatory; not gain/profit; adds

nothing to the individual.
* Through accident or health insurance
* Workmen’s Compensation;
* Damages received whether by suit or agreement

on account of such injuries or sickness;
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* Damages recovered are taxable if the amount
represents loss of anticipated profits; not taxable if
it represents a return of capital or investment. (BIR
Ruling, September 8, 1954)
* If the recovery represents damages for lost

profits, it is taxable as ordinary income.
* Disability benefits paid under life insurance are also

excluded although the law refers to accidents and health
insurance.
61
5. Income exempt under treaty. This is premised on

our adherence to the generally accepted principles
of international law. In this category, the following
items of income are tax-exempt:
* Income derived by the US Consular officials

in the Philippines in connection with such consular
service (USPI Consular Convention).
* Income exempt under tax treaty with foreign

countries. 62
6. Retirement benefits, pensions, gratuities, etc.
a) Retirement benefits received by officials and

employees of private firms, individuals or
corporations. Requisites for exclusions:
i. Reasonable private plan maintained by the

employer duly approved by the BIR for exclusive
benefit of the members-employees;
63
ii. Retiring official or employee who has rendered at

least 10 years of service;
iii. At least 50 years of age at the time of the

retirement;
iv. The benefit of exclusion shall be availed of only

once. (Santos v. Servier Philippines, Inc. 572 SCRA 487)
64
* Even if the member has attained 50 years of

age with at least 10 years of service, if the
employee-member is still on active employment
with the company, any and all amounts distributed from
the fund to the private member over and above his
personal contributions shall be taxable to the said
employee recipient as wages were received before his
retirement from the service of his employer. (BIR Ruling
97-86, April 4, 1986)
65
* An agreement to pay the taxes on the

retirement benefits as an incentive to prospective
retirees and for them to avail of the optional
retirement scheme is not contrary to law or public
morals. (International Broadcasting Corporation v.
Amarilla, 505 SCRA 687)
b) Retirement benefits paid to employees who have

reached the age of 60 or more but not beyond 65
years with at least five years of credited service.
(RA No. 7641) 66
* The age and service requirements imposed under

the Tax Code are deemed as minimum requirements for
retirement benefits to qualify for income tax exemption.
c) Separation benefits due to death, sickness or other

physical disability or for any cause beyond the control of the
said official or employee.
* Any amount received from an employer as a result of

separation from service due to sickness is exempt from all
taxes.
67
* Separation benefits paid to retrenched employees

as a consequence of either the sale of the entire
business to another corporation of the cessation of
the employer’s business are exempt from income
tax.
* Benefits received as a result of voluntary

resignation are taxable. Reason: It is a cause within
the control of the said official or employee.
68
* The exemption holds regardless of the employee’s age

and length of service.
* The law does not require that the exclusion be

enjoyed once.
* Separation of employee due to dissolution of a law

firm is a cause beyond the control of said employee.
69
* Compulsory retirement – cause beyond the

control of the employee.
* Terminal leave pay is excluded from gross income.

Compulsory retirement may be considered as a cause
beyond the control of the said official or employee.
Consequently, the amount received by way of
commutation of his accumulated leave credits as a result
thereof falls within the enumerated exclusion from gross
income. It is not considered compensation for services
rendered. 70
Reason: It is paid when the employer has

already severed his connection with his
employees and who is no longer working.
d) Social security benefits, retirement gratuities received by

resident or non-resident citizens or resident aliens from
foreign government agencies and other private or public
institutions.
Pensions received by retirees from foreign sources.

71
e) Benefits received from US Veterans Administration (RA

360) by veterans residing in the Philippines.
f) Payment of benefits under the SSS in accordance with the

provisions of RA No. 8282.
g) Benefits received from the GSIS under RA No. 8291

including retirement gratuity.
72
a) Income received by foreign governments from

their investments in the Philippines.
Reason: To lessen the burden of foreign loans

inasmuch as the interest of these loans are, by
contractual arrangement, borne by the domestic
borrowers.
73
Foreign governments include financing institutions

owned, controlled and financed by them and international or
regional financing institutions established by governments.
* To be exempt, the creditor must be the foreign

government or financing institutions owned, controlled, and
established by it.
* Income of foreign government from operation in the

Philippines of vessels owned or chartered by it is taxable.
(Opinion of the Sec. Of Justice, 40 O.G. 785)
74
b) Income derived by the Government of the

Philippines or any political subdivision from any public
utility or from the exercise of any essential
governmental function (e.g. Income derived by a
municipality from the operation of a market or an
electric power plant) – This is in recognition of the
principle of exemption from taxation of government
agencies or entities.
75
c) Prizes and awards under the following

conditions:
i. Received in recognition of religious,

charitable, scientific, educational, artistic, literary or
civic achievement;
76
ii. Recipient was selected without any action

on his part to enter the contest or proceeding;
iii. Recipient is not required to render

substantial future services as a condition to
receiving the prize or award.
77
d) Prizes and awards in sports competition granted

to athletes whether held in the Philippines or abroad
and sanctioned by their national sports associations;
* National sports associations must be

accredited by the Philippine Olympic Committee
(POC). (Sec. 13, RA No. 6847)
78
e) 13th-month pay and other benefits;
i. Other benefits cover productivity incentives

and Christmas bonus;
ii. Total exclusion shall not exceed Ᵽ90,000.

(RA No. 10963)
79
f) GSIS, SSS, Medicare and other contributions;
g) Gains from the sale or exchange of 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

Company.
80
TAX EXEMPT INCOME UNDER SPECIAL
LAWS/AGREEMENTS
i. Prizes received in charity, horse racing, sweepstakes
from the Philippine Charity Sweepstakes Office. (RA No.
1169)
* Under the new TRAIN law, a 20-percent tax will

be imposed on winnings of more than P10,000 from
lotto, keno, Small Town Lottery, sweepstakes and other
PCSO products. The law had also removed the corporate
tax exemption on the charity agency.
81
LAWS/AGREEMENTS
Under the NIRC, lotto winnings and other PCSO

prizes used to be tax-exempt.
PCSO is not exempted from the TRAIN law because the

PCSO is also a revenue collection body.
82
LAWS/AGREEMENTS
ii. Salaries and stipend in dollars received by non-Filipino

citizens serving as staff of:
* International Rice Research Institute (RA No.

2707)
* Ford Foundation Grants (RA No. 3538)
83
LAWS/AGREEMENTS
* Agricultural Department of the Southeast Asian Fisheries
Development Center (SEAFDEC) (PD No. 246)
* Population Council of New York (PD No. 246)
iii. Income from bonds and securities:
* For sale in the international market (PD No. 81)
* Issued by EPZA (PD No. 66)

84
LAWS/AGREEMENTS
iv. Income derived from the installment sales of houses
to their employees and workers or to low-income groups in
housing projects or income derived from rental thereof. (PD
Nos. 745 and 1217 – Housing Program of the Government).
v. Officers and staff of Asian Development Bank (ADB),

experts and consultants performing missions for the Bank
shall be exempt from Philippine income tax. (Art. XII, Sec. 45,
Government Agreement with ADB
85
LAWS/AGREEMENTS
vi. Awards given by the Ramon Magsaysay Award
Foundation are exempt from the payment of income tax.
(RA No. 2062)
vii. Holiday pay, overtime pay, night shift

differential pay and hazard pay received by minimum
wage earners shall be exempt from income tax. (Sec. 2,
RR 10-2008; RA No. 9504)
86
INDIVIDUAL INCOME
TAXATION
87
CLASSIFICATION OF INDIVIDUAL TAXPAYERS
1. Resident Citizen (RC)

2. Non-Resident Citizen (NRC)
3. Resident Alien (RA)
4. Non-Resident Alien (NRA)
5. Non-Resident Alien Not Engaged in Trade or Business
(NRA-NETB)
88
1. Resident Citizen (RC) – citizens of the Philippines who
are residing therein. (Article IV, Constitution)
2. Non-Resident Citizen (NRC) – citizens of the Philippines

who are physically present abroad for an uninterrupted
period covering an entire taxable year. NRC means who
establishes to the satisfaction of the BIR Commissioner
the fact of his physical presence abroad with definite
intention to reside therein, either as:
89
NON-RESIDENT CITIZEN (NRC)
a) Immigrant;
b) Employee on a more or less permanent basis;
c) Contract workers whose contracts of employment are
renewed from time to time within or during the taxable
year.
NRC may be considered RC or NRC depending upon his

departure and arrival. In this regard, NRC shall submit
proof to the BIR to show his intention of leaving the
Philippines to reside permanently abroad or to return to
and reside in the Philippines for this purpose.
90
3)
RESIDENT ALIEN (RA)
3. Resident Alien (RA) – non-citizens who reside in the

Philippines:
a) He must be a resident not mere transient or sojourner

(whether he is a transient or not is determined by his
intention with regard to the length and nature of his
stay).
b) Alien living in the Philippines and has no definite

intention (floating intention) as to the time of return to
his country or his stay in the Philippines.
91
RESIDENT ALIEN (RA)
c) Those who come to the Philippines and whose

extended stay may be necessary to accomplish the
purpose and to that end they may have the intention
at any time to return home, when their purpose of
stay is accomplished/completed.
92
RESIDENT ALIEN (RA)
* BIR regulation provides no fixed or definite criterion of
determining residency beyond stating that NRA must have
no residence in the Philippine. The difficulty, however, arises
where an alien lives in the Philippines, though he does not
maintain residence therein. Maintenance of residence is the
test but actual stay is a basic factor in determining residency.
Therefore, the following must be considered:
i. Maintenance of residence in the Philippines;
93
RESIDENT ALIEN (RA)
ii. Actual physical residence in the Philippines;
iii. His temporary stay (with intention to return) is on an

extended stay;
iv. Considered resident alien if he resides for more than

one year;
v. Loses his residence if he stays outside the Philippines

for a continuous period exceeding three months as of and
including December 31.
94
NON-RESIDENT ALIEN (NRA)
4. Non-Resident Alien (NRA) – neither citizen nor resident

of the Philippines
a) NRA-ETB – comes and stays in the Philippines for an aggregate

period of more than 180 days during the calendar year.
(Section 25(A)(1), NIRC, as amended.
b) ETB – includes the performance of personal services within the

Philippines;
c) Foreign technician on a job contract for one year.

95
NON-RESIDENT ALIEN NOT ENGAGED IN TRADE OR BUSINESS
(NRA-NETB)
5. Non-Resident Alien Not Engaged in Trade or Business –

NRA-NETB. In general, his income is taxed at 25% final
tax based on gross or entire income. However, NRA-
NETB is taxed at a special rate of 15% if employed by the
following:
a) Regional or area headquarters of multi-national

corporations (RHQs, RAQs);
96
NON-RESIDENT ALIEN NOT ENGAGED IN TRADE OR BUSINESS
(NRA-NETB)
b) Offshore banking units established in the
Philippines (OBUs);
c) Petroleum service contractors or sub-contractors.
The preferential rate does not apply to employees

of RHQs, RAQs, OBUs and petroleum contractors and
subcontractors registered with the SEC after January
1, 2018 (RA No. 10963).
97
GENERAL PRINCIPLES: SOURCES OF INCOME: TAX BASE
Sources of Income Tax Base

RC Within and without Taxable income
NRC Within Taxable income
RA Within Taxable income
NRA-ETB Within Taxable income
NRA-NETB Within Gross income
98
APPLICABLE RATES
Self-employed individuals and/or professionals

whose gross sales or gross receipts and other non-
operating income do not exceed the VAT Threshold
(Ᵽ3M) shall have the option to avail of an eight percent
(8%) tax on gross sales or receipts and other non-
operating income in excess of Two Hundred Fifty
Thousand Pesos (Ᵽ250,000) in lieu of graduated income
tax rates (0% to 35%) and the percentage tax under
Section 116 of the Tax Code. (RA No. 10963)
99
TAX SCHEDULE EFFECTIVE JANUARY 1, 2018
UNTIL DECEMBER 31, 2022
Not over Ᵽ250,000 - 0%

Over Ᵽ250,000 but not over - 20% of the excess of Ᵽ250,000
Ᵽ400,000
Over Ᵽ400,000 but not over - Ᵽ30,000 + 25% of the excess over
Ᵽ800,000 Ᵽ400,000
Over Ᵽ800,000 but not over - Ᵽ130,000 + 30% of the excess over
Ᵽ2,000,000 Ᵽ800,000
Over Ᵽ2,000,000 but not over - Ᵽ490,000 + 32% of the excess over
Ᵽ8,000,000 Ᵽ2,000,000
Over Ᵽ8,000,000 - Ᵽ2,410,000 + 35% of the excess over
Ᵽ8,000,000
100
CATEGORIES OF INCOME
Compensation Income
Business income derived by self-employed
Professional income derived by professionals
Passive investment income
Gains derived from dealings in property

101
COMPENSATION INCOME
102
DEFINITION OF COMPENSATION INCOME
All remuneration for services rendered

by an employee for his employer unless
specifically excluded under the Tax Code. (RR 2-
98)
It includes salaries, wages,

emoluments, honoraria, bonuses, allowances
(transportation, representation, entertainment
and the like), fringe benefits (monetary and non-
monetary fees)
103
DEFINITION OF COMPENSATION INCOME
including director’s fee, taxable pensions and

retirement pay and other income of similar nature
including compensation paid in kind.
Income of similar nature – proceeds from

property sharing; COLA, PERA, housing allowance,
overtime pay, emergency pay, hazard pay, rice and
clothing allowance, medical allowance, grocery
allowance.
104
BASIS/TEST OF COMPENSATION INCOME
Designation/Name of the remuneration

upon which it is paid and the manner of payment is
IMMATERIAL. What is important is that it is derived
from employer-employee relationship.
* However, not every compensation income is

includible under the term gross compensation income.
Compensation for services rendered by an independent
contractor does not fall under the legal category of
“gross compensation income.”
105
* Amounts paid either as advances or

reimbursement for transportation, representation, and
other bona fide ordinary and necessary expenses
incurred in the performance of his duties – not taxable
compensation income. Only the excess, if any, over
actual expenses is taxable.
106
* Three years backwages shall be taxable to

an illegally separated employee but not attorney’s fees
which are not subject to tax. (BIR Ruling, July 13, 1992)
* Income derived by partner from

professional partnership does not form part of the gross
compensation income.
107
REQUISITES FOR TAXABILITY
OF COMPENSATION INCOME
1) Personal services actually rendered;
2) Payment is for such services rendered;
3) Payment is reasonable.
108
FORMS OF COMPENSATION INCOME
Form/Kind – Measure of Income:
1. Cash or in money – Amount of money received.
2. Property or in kind (Doctrine of Cash Equivalent) – Fair

Market Value.
3. Price is stipulated – FMV of the compensation in the

absence of contrary evidence.
109
4. Promissory notes or other evidence of indebtedness

(not mere security) -
Not Discounted: Face Value
Discounted:
1) Year of Receipt – Discounted value;
2) Maturity Date – Difference between
Face Value and Fair Market Value
110
5. Cancellation or forgiveness of indebtedness made in

consideration of debtor’s services rendered – amount of
debt cancelled.
• Other tax implications of condonation of

indebtedness:
• i. If no consideration is given, it amounts
111
to taxable donation and therefore subject

to donor’s tax as far as the creditor (donor) is
concerned.
ii. It amounts to taxable indirect dividend if

the creditor is a corporation and the debtor is
the stockholder.
112
6. Premiums paid by employer on the life insurance policy

of employee whose family, executor, administrator or his
estate is the beneficiary – amount of the premium paid.
* Conversely, premiums are not taxable if the

beneficiary is the employer whether directly or
indirectly designated.
113
OTHER TAX IMPLICATIONS OF PREMIUMS
PAID BY EMPLOYER:
i. Employer may claim the premiums as deductible

from gross income if the beneficiary designated is the
family, executor, administrator or the estate of the
employee.
ii. Employer is not allowed to claim premiums paid

as deductible if he is directly or indirectly designated as
beneficiary. (Section 36(A)[4])
114
7. Income tax paid by employer in consideration of the

employee’s services rendered – amount of such tax paid.
8. Personal services performed partly within and partly

without – apportion on the time basis
115
9. Tax exempt compensation income (benefits, privileges,

facilities, etc.)
a. Convenience of the Employer Rule. It grants

exemption to benefits which are given for the
exclusive benefit or convenience of the employer.
116
TAX EXEMPT COMPENSATION INCOME (BENEFITS, PRIVILEGES,
FACILITIES, ETC.)
* If such quarters and other facilities exceed the

employee’s needs, only a ratable part of the value
thereof as employee would have spent therefor
constitutes taxable income. The remainder is considered
expense of the employer. (Collector v. Henderson, 1
SCRA 649)
117
FACILITIES, ETC.)
* Lodging quarters furnished to an employee by or on

behalf of the employer shall be excluded from
employee’s gross income if the living quarter is situated
within the business premises of the employer and the
employee is required to accept such lodging facility as a
condition of his employment. (Revenue Audit Memo.
Order No. 1-87, April 23, 1987)
118
FACILITIES, ETC.)
* The value of meal 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 in
the business premises of the employer and the meals
are for the convenience of the employer.
119
FACILITIES, ETC.)
* Under Revenue Regulations 3-98, the monetary

value of housing unit or the rental value thereof is
tax exempt if the housing unit is situated within the
business premises of the employer. In this case, the
recipient must be a managerial or supervisory
employee.
120
FACILITIES, ETC.)
b. De minimis Benefits. These refer 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
health, goodwill, contentment or efficiency of
his employees.
121
DE MINIMIS BENEFITS
These include ONLY, pursuant to RR 5-2011, the
following:
i. Monetized unused vacation leave credits of private

employees not exceeding ten (10) days during the
year;
ii. Monetized value of leave credits paid to

government officials and employees;
122
DE MINIMIS BENEFITS
iii. Medical cash allowance to dependents of
employees not exceeding Ᵽ750.00 per employee per
semester or Ᵽ125.00 per month;
iv. Rice subsidy of Ᵽ1,500.00 or one (1) sack of 50 kg.

Rice per month amounting to not more than
Ᵽ1,500.00 (RR 5-2008);
123
DE MINIMIS BENEFITS
v. Uniform and clothing allowance not exceeding
Ᵽ5,000.00 per annum; (RR 8-2012);
vi. Actual medical assistance, e.g., medical allowance

to cover medical and health care needs, annual
medical/executive check-up, maternity assistance,
and routine consultations, not exceeding Ᵽ10,000.00
per annum;
124
DE MINIMIS BENEFITS
vii. Laundry allowance not exceeding Ᵽ300.00 per month;
viii. Employee achievement awards, e.g., for length of

service or safety achievement, which must be in the form
of tangible personal property other than cash or gift
certificate, with an annual monetary value not exceeding
Ᵽ10,000.00 received by the employee under an
established written plan which does not discriminate in
favor of highly paid employees;
125
DE MINIMIS BENEFITS
ix. Gifts given during Christmas and major anniversary
celebrations not exceeding Ᵽ5,000.00 per employee per
annum;
x. Daily meal allowance for overtime and night/graveyard

shift work not exceeding twenty-five (25%) of the basic
minimum wage;
xi. Collective bargaining agreement benefits and benefits

derived from productivity incentive schemes not
exceeding Ᵽ10,000.00 per annum. (RR 1-2015)
126
SPECIAL RULES ON FRINGE BENEFITS
Fringe benefits – refer to goods, services, or

other benefits furnished or granted by an employer,
in cash or in kind, in addition to basic salaries, to
managerial or supervisory employees such as, but
not limited to the following:
• Housing;
• Expense account;
• Vehicle of any kind;
• Household personnel, such as maid, driver and
others; 127
• Interest on loan at less than market rate

(benchmark rate of 12%) to the extent of the
difference between the market rate and actual
rate granted;
• Membership fees, dues and other expenses borne
by the employer for the employee in social and
athletic clubs or other similar organizations;
• Expenses for foreign travel;
• Holiday and vacation expenses;
128
• Educational assistance to the employee or his

dependents; and
• Life or health insurance and other non-life insurance
premiums or similar amounts in excess of what the
law allows.
129
NOT ALL BENEFITS GIVEN BY AN EMPLOYER
TO HIS EMPLOYEES ARE SUBJECT TO
FRINGE BENEFIT TAX (FBT)
The following benefits are not subject to FBT:
a. Fringe benefits which are authorized and exempted

from income tax under the Code or under special law.
For instance, separation benefits which are given to
employees who are involuntarily separated from work
are not subject to FBT.
130
b. Contributions of the employer for the benefit of the

employee to retirement, insurance and hospitalization
benefit plans;
c. Benefits given to the rank and file, whether granted

under a collective bargaining agreement or not;
d. De minimis benefits;
131
e. Benefits granted to employee as required by the nature

of, or necessary to the trade, business or profession of
the employer;
f. Benefits granted for the convenience of the employer.
132
BENEFITS WHICH ARE CONSIDERED NECESSARY TO THE
BUSINESS OF THE EMPLOYER, OR ARE GRANTED FOR THE
CONVENIENCE OF THE EMPLOYER
The following fringe benefits are not subject to FBT
because they are given primarily for the convenience of the
employer:
a) Housing privilege of military officials of the AFP

located inside or near military camps;
b) A housing unit which is situated inside or at most 50

meters from the perimeter of the business premises;
133
c. Temporary housing for an employee for three (3)
months or less;
d. Expenses of the employee which are reimbursed by

the employer if they are supported by receipts in the
name of the employer and do not partake the nature of
a personal expense of the employee;
134
e. Motor vehicles used for sales, freight, delivery
service and other non-personal uses;
f. The use of aircraft (including helicopters) owned and

maintained by the employer;
g. Business expenses which are paid by the employer for

the foreign travel of his employees in connection with
business meetings or conventions. 135
The expenses should be supported by

documents proving the actual occurrences of the
meetings/conventions, or official communications
from business associates.
136
NATURE OF FRINGE BENEFITS TAX
The Fringe Benefits Tax is a tax imposed

on fringe benefits which are granted or are
paid by an employer to an employee occupying
a managerial or supervisory position.
A final tax of 35% based on the grossed-up

monetary value. (RA No. 10963)
137
PURPOSE OF THE FRINGE BENEFITS TAX
The Fringe Benefits Tax is a measure to ensure

that an income tax is paid on fringe benefits (FBs).
If they were given in cash, an income is
automatically withheld and collected by
government. An additional compensation which is
given in non-cash form is virtually untaxed. The situation
has caused inequity in the distribution of the tax
burden. The FBT can enhance the progressiveness and
fairness of the tax system.
138
WHO SHOULD PAY THE FRINGE BENEFITS TAX (FBT)?
The FBT is a tax on the income of an employee

which is paid by the employer on behalf of the
employee.
The FBT is collected from the employer even if

the employer is a tax-exempt corporation, or an
instrumentality of the Philippine government.
139
WHY IS THE FBT COLLECTED FROM THE EMPLOYER?
Valuation of benefits is easier at the level of

the firm. The problem of allocating the benefits
among individual employees is avoided. Collection of
the FBT is also ensured because the FBT is withheld at
source and does not depend on the self-declaration of
the individual.
140
FBT IS NOT AN ADDITIONAL TAX ON THE EMPLOYER
The FBT is not an additional tax on the

employer. He can claim the fringe benefit and the
FBT as a deductible expense from his gross income.
141
BENEFITS SUBJECT TO THE FBT
The FBT is imposed on fringe benefits given or

furnished to managerial or supervisory employees
on or after January 1, 1998. Fringe benefits granted
to rank and file employees are not subject to FBT.
142
WHO ARE CONSIDERED AS MANAGERS? SUPERVISORS? RANK-
AND-FILE?
“Managerial employees” refer to those who

are given powers or prerogatives to lay down and
execute management policies and/or to hire,
transfer, suspend, lay-off, recall, discharge, assign
or discipline employees.
143
WHO ARE CONSIDERED AS MANAGERS? SUPERVISORS? RANK-
AND-FILE?
“Supervisory employees” are those who 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.
“Rank-and-file employees” mean all employees

who are holding neither managerial nor supervisory
position.
144
DECISION RULES
The car plan extended by PAGCOR to its qualified

employees is considered a fringe benefit. Thus, PAGCOR
should withhold the final fringe benefit tax thereon.
Payment of the membership dues and fees

cannot be considered as fringe benefits because
they are not borne by PAGCOR for its employees.
Hence, they are not subject to FBT. (CIR v. PAGCOR,
GR No. 177387, 9 November 2016)
145
DOCTRINE OF CASH EQUIVALENT
It provides that any economic benefit to the

employee whatever may have been the mode by which
it is effected is compensation income.
In stock option, for instance, the difference

between the FMV of the shares at the time the option is
exercised and the option price constitutes additional
compensation income to the employee.
146
BUSINESS/TRADE/
PROFESSIONAL INCOME
147
INCOME COVERED
1. Income derived by self-employed from trade or

business (trading, manufacturing, merchandising,
farming, and others).
* 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.
148
Self-employed means a person engaged in
trade or business or performs services for others
for a fee and who derived personal income from
such trade or business or from the performance of
such services.
Business is any activity that entails the time,

attention and effort of an individual or group of
individuals for livelihood or profit.
149
IN THE CASE OF MANUFACTURING, MERCHANDISING, OR
MINING BUSINESS, HOW IS THE GROSS INCOME COMPUTED?
Gross income means the total sales, less the

cost of goods sold plus any income from
investments and incidental operations. (Section 48,
Rev. Regs. No. 2)
150
HOW IS INCOME FROM LONG-TERM CONTRACTS (BUILDING
INSTALLATIONS OR CONSTRUCTION CONTRACTS COVERING
A PERIOD OF MORE THAN 1 YEAR TREATED FOR INCOME TAX
PURPOSES?
Percentage of completion basis – gross

income already earned though not yet received,
based on estimates of architects or engineers duly
certified by them is reported in a taxable year and all
deductions relating to such for the taxable year, even if
not yet paid, are taken into account.
151
HOW IS INCOME FROM LONG-TERM CONTRACTS (BUILDING
INSTALLATIONS OR CONSTRUCTION CONTRACTS COVERING
A PERIOD OF MORE THAN 1 YEAR TREATED FOR INCOME TAX
PURPOSES?
Completed contract basis – taxpayer reports

his income and deductions in the year the contract
is finally completed. (Sec. 44, Rev. Regs. No. 2)
152
INCOME DERIVED BY PROFESSIONALS FROM THE
PRACTICE OF PROFESSIONS
Professionals – refer to persons who derive their

income from the practice of their profession.
153
GROSS INCOME OF FARMERS INCLUDE:
a. Sale of livelihood and farm products received

from the farm;
b. Value of merchandise and other property received
from such sales;
c. Profit from the sale of livestock and other items
purchased;
d. Gross income from all other sources, rent received
on crop shares, proceeds of income of growing
crops.
154
INTEREST INCOME
a. Definition – amount of compensation paid for the

use of money or forbearance from such use.
b. Includes such interest arising from indebtedness -

business or non-business, legal or illegal, usurious or
not.
i. Interest on government securities – taxable

effective January 1, 1998;
155
INTEREST INCOME
ii. Interest on savings deposit, time deposits

and deposit substitutes subject to 20% final
tax;
iii. Interest income from long-term deposit or

investment certificate is exempt under the
following conditions:
156
INTEREST INCOME
iii.1. The depositor or investor is an

individual citizen (resident or non-resident)
or resident alien or non-resident alien
engaged in trade or business in the
Philippines and not a corporation;
iii.2. The long-term deposits or investments

certificates should be under the name of the
individual and not under
157
INTEREST INCOME
the name of the corporation or the bank or
the trust department/unit of the bank;
iii.3. The long-term deposits or

investments must be 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);
158
INTEREST INCOME
investments must be issued by banks only
and not by other financial institutions;

investments must have a maturity period of
not less than five (5) years;

investments must be in denominations of
159
INTEREST INCOME
Ten Thousand Pesos (Ᵽ10,000,00) and other
denominations as may be prescribed by the
BSP;
iii.7. Only the interest income from long-

term deposits or investments certificates are
covered by income tax exemption;
iii.8. Income tax exemption does not

cover any other income such as gains
160
INTEREST INCOME
from trading, foreign exchange gain;
iii.9. The long-term deposits or investments

should not be terminated by the investor
before the fifth year, otherwise it shall be
subjected to the graduated rates of 5%, 12%
or 20% on interest income earnings.
(Revenue Memo. Circular No. 18-2011)
161
RENTAL INCOME
a. Definition – fixed sum either in cash or property

equivalent, to be paid at a definite period for the use or
enjoyment of a thing or right.
b. Scope – all rentals (including royalties) derived from

lease of property, whether used in business or not, from
real estate or personal property; earnings from
copyrights, trademarks, patents and natural resources
under lease.
162
RENTAL INCOME
c. Items considered likewise as rental income
• Obligations of lessor to third parties assumed by the

lessee:
• i. Real estate taxes on leased premises;

• ii. Insurance premiums paid by lessee on property;
• iii. Dividends paid by lessee to stockholders of lessor-
corporation;
• iv. Interest paid by lessee to holder of bonds issued by
lessor-corporation.
163
RENTAL INCOME
• Value of permanent improvements made by lessee

on leased property that will become the property of
the lessor upon the expiration of the lease. The
lessor shall report such an income under any of the
following methods:
• Outright method – Fair Market Value of the

completed building or improvement shall be
reported as additional rent income;
164
RENTAL INCOME
• Spread out method – Allocate the depreciated

value over the remaining term of the lease
contract.
165
RENTAL INCOME
d. Are advance rentals taxable?
i. Prepaid rentals – taxable if so received under a

claim of right and without restriction as to its use.
ii. Security deposit – not taxable. However, it is

taxable if the lessee violates any provision of the
contract.
iii. Loan – not taxable.

166
DIVIDEND INCOME
Definition – corporate profit set aside, declared and

distributed by the director of a corporation to be paid
to stockholders on demand or at a fixed time. Under
the Tax Code, any distribution made by a corporation
to its stockholders, whether in money or property
out of its earnings and profit accrued since March 1,
1913.
167
KINDS OF DIVIDEND
i. Cash dividend – paid in given sum of money;
ii. Property dividend – one paid by corporation in

securities (not its own stock) or other property;
iii. Stock dividend – one paid by a corporation with its

own stock. It represents transfer of surplus to capital
account. It may be of the same kind or different from
that on which it is issued.
168
KINDS OF DIVIDEND
A dividend paid in stock of another corporation is not a
stock dividend. This is technically known as “dividend in
stock”. (Sec. 251, Rev. Regs. No. 2)
As a general rule, stock dividends are not taxable.
Reason: They are considered unrealized gain, and cannot be

subjected to income tax until that gain has been realized.
Mere issuance thereof is not yet subject to income tax as
they are nothing but an enrichment through increase in value
of capital investment. (Commissioner v. CA, 301 SCRA 152)
169
EXCEPTIONS, HOWEVER, ARE AS FOLLOWS:
• Change in the stockholder’s equity, right/interest in

the net assets of the corporation;
• Recipient is other than shareholder. Stock dividend is

taxable to usufructuary (Bachrach v. Siefert, 87 Phil.
483)
• Cancellation or redemption of shares of stock;
170
EXCEPTIONS, HOWEVER, ARE AS FOLLOWS:
• Distribution of treasury stocks;
• Dividends declared in the guise of treasury stock

dividend to avoid the effects of income taxation
(Commissioner v. Manning, 66 SCRA 14)
• Different classes of stock were issued.
171
Illustration of taxability/non-taxability of stock dividend
Case Authorized Issued and Stock Taxable/

C/S Outstanding Dividend Not Taxable
I Common Common Common Not Taxable

II Com & Pref. Common Preferred Not Taxable
III Com. & Pref. Com. & Pref. Common Taxable
IV Com. & Pref. Com. & Pref. Preferred Taxable
172
KINDS OF DIVIDEND
iv. Scrip dividend – one that is paid in the form of

promissory notes.
v. Indirect dividend – one made through the exercise of

right or other means of payment, e.g., cancellation or
condonation of indebtedness.
173
KINDS OF DIVIDEND
vi. Liquidating dividend – one resulting from the

distribution by a corporation of all its property or assets in
complete liquidation or dissolution. It is generally a return
of capital, and hence, it is not income. However, it is
taxable income with respect to the excess of amount
received over cost of the share surrendered.
174
Giver Recipient Taxable (tax rate) Exempt
Domestic Domestic/RFC Tax exempt
Domestic RC, NRC, RA 10% - effective taxable year 2000
Domestic NRA – ETB 20%
Domestic NRA – ETB 25%
Domestic NRFC 15% subject to allowance for tax credit
175
* Dividend received from foreign corporation is subject
to Philippine income tax if at least 50% of the world
(total) income of the foreign corporation must be
derived from the Philippines for three years preceding
the declaration of such dividend.
176
Decisional rules on redemption of shares of stock
i. Not taxable
• Shares are redeemed in the absence of the availability of

unrestricted earnings. (CIR v. Goodyear Phils. Inc., 799 SCRA 489)
• Not in the nature of a recurring return on stock. (Wise & Co., Inc. V.
Meer, 78 Phil. 655)
• The source of redemption is the original capital subscription upon

establishment of the corporation or initial capital investment in an
existing enterprise. (CIR v. CA, 301 SCRA 152)
177
Decisional rules on redemption of shares of stock
ii. Taxable
• The redeemed shares are from stock dividend

declarations other than as initial capital investment.
• There is redemption or cancellation; the transaction

involves stock dividends; and the “time and manner” of
the transaction makes it essentially equivalent to a
distribution of taxable dividends.
178
PASSIVE INVESTMENT INCOME
a. It is an income subject to final withholding tax.
b. The withholding agent withholds the tax and remits the

same to the BIR.
c. The recipient is not required to include the income in his

gross income. Neither is the taxpayer required to include
it in the taxable income. (CIR v. PAL, 504 SCRA 90)
179
d. Taxpayer is not required to file ITR if his or her income

consists solely of income subject to final tax.
e. The tax withheld constitutes final settlement of the tax

liability on the income.
180
Examples of income subject to final tax:
• Interest income from bank deposit;

• Royalties
• Dividend received from domestic corporation by
individual or non-resident foreign corporation (NRFC);
• Prizes amounting to more than Ᵽ10,000;
• Winnings (except sweepstakes and lotto);
• Partner’s share from the net income after tax of
business partnership, joint account, joint venture or
consortium.
181
Other Sources:
a. Capital Gain from Sale of Shares of Stock
i. If not listed and traded through stock exchange –

15% of the net capital gain (RA No. 10963)
182
Other Sources:
a. Capital Gain from Sale of Shares of Stock
ii. If listed and traded through local stock exchange –

6/10 of 1% of Gross Selling Price. (RA No. 10963).
The tax is in the nature of percentage tax, not an
income tax.
183
b. Interest income received by a resident individual
taxpayer from a depository bank under the
expanded foreign currency deposit system – Final tax
of 15% (RA No. 10963)
c. Acquisition and disposition of capital stock which

include sales and retirement of bonds.
d. Illegal gains – gambling, betting, lotteries extortion

or fraud.
184
e. Recovery of damages – taxable – it represents lost
profit/income.
f. Bad Debts Recovery – taxable if it results in reduction of the

taxpayer’s tax liability in the previous year. “Tax Benefit Rule”
or the “Doctrine of equitable benefit” applies in this case.
* It must be claimed as a deduction from the gross income

in the preceding year.
* The reduction results in a tax benefit.
185
g. Tax refund – taxable if it results in reduction of

the taxpayer’s liability in the preceding year.
This means that the tax refunded must be
previously claimed as deduction from gross
income. Tax benefit rule likewise applies.
186
CORPORATE
INCOME TAXATION
187
DEFINITION UNDER THE NIRC
- Corporation includes partnerships, no matter
how created or organized, joint stock
companies, joint accounts, associations or
insurance companies except:
• Joint construction venture;

• General professional partnership;
• Joint venture for engaging in petroleum, coal, geothermal
and other energy operations pursuant to a consortium
agreement with the government.
188
1. Unregistered or registered partnership – taxable
provided that the following requisites concur:
a. Agreement, oral or writing, to contribute money,

property or industry to a common fund;
b. Intention to divide the profits.
i. Two sisters purposely created a common fund

without being registered for the
189
purpose of engaging in a series of transactions for profit
– taxable unregistered partnership is created. The
qualifying expression – no matter how created or
organized – clearly indicates that a joint venture need
not be undertaken in any of the standard forms, or in
conformity with the usual requirements of the law on
partnership, in order that one could be deemed
constituted for purposes of the tax on corporations.
(Evangelista v. Collector, 102 Phil. 140)
190
ii. Two persons entered into agreement to operate
a cockpit under which one was to contribute his
services and the other to provide the capital –
taxable partnership is formed. (Rallos v. Rallos, 2
Phil. 509)
iii. As a rule, co-ownership is tax-exempt. It

becomes taxable if it is converted into an
unregistered partnership. Converted into
partnership if the properties and income are
191
used as common fund with intention to produce
profits. If after partition, the shares of the heirs
are held under a single management for profit
making, unregistered partnership is formed.
(Ona, et al. V. Commissioner, 45 SCRA 74)
iv. Pascual and Dragon bought 2 parcels of land

from Bernardino and 3 from Roque. Thereafter,
the first 2 were sold to Meirenir
192
Development Corporation at a profit of P165,
224.70 and the 3 to Reyes and Samson for a profit
of P60,000.00. They divided the profits between
the 2 of them.
RULING: There was no partnership formed. 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. (Article 1769, NCC) (Pascual and
Dragon v. Commissioner, 166 SCRA 560)
193
v. On March 1973, Joe Obillos, Sr. transferred his
rights under contract with Ortigas Co. to this 4
children to enable them to build residences on
the lots. TCTs were issued. Instead of building
houses, the Obillos children sold them after 1
year to Walled City Securities Corp. and Olga
Cruz Canda. The Supreme held that the Obillos
children are co-owners. It is an isolated act which
show no intention to form a partnership. It
appears
194
that they decided to sell it after they found it
expensive to build houses. (Obillos, Sr. V.
Commissioner, 139 SCRA 436)
195
2. Joint accounts or joint ventures formed for profits .
Joint Emergency Operation – (no legal personality)

operates the business affairs of the two companies as
though they constitute a single entity thereby obtaining
substantial economy and profit in operation – taxable.
(Collector v. Batangas Co., 54 OG 6724)
196
3. Joint Stock Companies – generally classified as a
partnership possessing some of the characteristics of a
corporation. They appear to be like corporations to the
extent that they have capital stock but when capital is
divided or made transferable even without the consent
of the co-partner, they partake of the nature of
partnership. (Brocki v. American Express Co., CA
Michigan, 279F 2d 785, 787)
197
MAJOR GROUPS OF CORPORATIONS FOR INCOME
TAX PURPOSES (Sources, tax base, tax rate)
1. DOMESTIC CORPORATIONS
Source: Within and without
Tax base: Taxable Income
Tax rate: 30% effective January 1, 2009

(RA No. 9337)
198
SPECIAL DOMESTIC CORPORATIONS:
a. Private Educational Institution –
* Subject to ten percent (10%) on their taxable income

provided that its gross income from unrelated trade,
business or other activity does not exceed fifty percent
(50%) of the total income Conversely, it is subject to
thirty-five percent (35%) if its income from unrelated
trade or business exceeds fifty percent (50%) of the
total (gross) income.
199
- is any “private school” maintained and administered

by private individuals or groups issued a permit to
operate by Secretary of DECS in accordance with
existing laws and regulations.
* Unrelated trade, business, or other activity – the

conduct of which is not substantially related to the
exercise or performance by such educational
institution of its educational purpose or function.
200
• Related activities include income derived from auxiliary

activities – school owned canteen, cafeteria, dormitory
and bookstore within the school premises. (BIR Ruling
237-87, 16 December 1987)
201
b. Non-profit hospital
* Same rules as private educational institution.
* Unrelated trade, business, or other activity - the

conduct of which is not substantially related to the
exercise or performance by such hospital of its
primary purpose or function.
* St. Luke’s Medical Center, Inc., as a proprietary

non-profit hospital, is entitled to the preferential
202
b. Non-profit hospital
rate of 10% on its net income from its for-profit

activities. It remains as a proprietary non-profit
hospital under Sec. 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. (CIR v. St. Luke’s Medical Center, Inc. 682
SCRA 66)
203
c. Government-owned and controlled corporation
i. Philippine Amusement and Gaming Corporation

(PAGCOR)
* Tax Exempt – income from gaming operations, such

as casino, dollar pit, regular bingo and mobile bingo
operations.
* Contractees and licensees of PAGCOR are

likewise exempt from the payment of corporate
204
income tax and other taxes since Sec. 13(b) of PD No.

1869 is clear and unequivocal that said exemption
inures to their benefit. (Bloomberry Resorts and
Hotels, Inc. v. BIR, 800 SCRA 123)
* Taxable – income from other related operations which

include income from casinos, traditional bingo,
electronic bingo, internet casino poker and betting
operated by licensed private operators,
205
junket operations, SM demo units, and other necessary

and related services, shows and entertainment.
(PAGCOR v. BIR, 744 SCRA 712)
206
2. RESIDENT FOREIGN CORPORATIONS
Source: Within
Tax base: Taxable Income

(RA No. 9337)
207
SPECIAL RESIDENT FOREIGN CORPORATIONS:
a. International Carriers – within – Gross Philippine
Billings – 2.5%;
b. Offshore banking unit – within – Gross on shore
income – 10%;
c. Foreign currency deposit unit – within – Gross onshore
income – 10%.
Transacting business – means continuity of commercial

dealings and arrangements. (Far East Int’l. Import and
Export Corp. V. Nankai Kogyo Co., Ltd. 6 SCRA 725)
208
Special Resident Foreign Corporations:
Gross Philippine Billings – refers to the amount
of gross revenue realized 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.
209
Foreign airline companies without flights starting from or
passing through any point in the Philippines -
An offline airline having a branch office or a

sales agent in the Philippines which sells passage
documents for compensation or commission to
cover offline flights of its principal or head office,
or for other airlines covering flights originating
from Philippine ports or offline 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
210
Foreign airline companies without flights starting from or
passing through any point in the Philippines -
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. (Rev. Regs. No. 15-2002)
211
International Air Carrier and International
Shipping – shall be taxed on the basis of their
Gross Philippine Billings.
The 2.5% attaches only when the carriage of

persons, excess baggage, cargo and mails
originated from the Philippines in a continuous
and uninterrupted flight, regardless of where the
passage documents were sold.
212
An offline international air carrier having no
flights to and from the Philippines is clearly not
liable for the Gross Philippine Billings tax. (Air
Canada v. CIR, 778 SCRA 131)
Offline international airline is subject to

corporate income tax.
213
The general rule is that resident foreign
corporations shall be liable for a 32% (now 30%)
income tax on their income from within the
Philippines, except for resident foreign
corporations that are international carriers that
derive income “from carriage of persons, excess
baggage, cargo and mail originating from the
Philippines” which shall be taxed at 2 ½% of their
Gross Philippine Billings. South African Airways,
being an international carrier with no flights
214
originating from the Philippines, does not fall
under the exception. As such, petitioner must fall
under the general rule. This principle is embodied
in the Latin maxim, exception firmat regulam in
casibus non exceptis, which means, a thing not
being excepted must be regarded as coming
within the purview of the general rule.
To reiterate, the correct interpretation of the

above provisions is that, if an international air
carrier maintains flights to and from the
215
Philippines, it shall be taxed at the rate of 2 ½% of
its Gross Philippines Billings, while international
air carriers that do not have flights to and from the
Philippines but nonetheless earn income from
other activities in the country will be taxed at the
rate of 32% (now 30%) of such income. (South
African Airways v. CIR, 612 SCRA 665)
216
An offline international air carrier selling passage
tickets in the Philippines, through a general sales agent,
is a resident foreign corporation doing business in the
Philippines.
Doing business includes appointing representatives

or distributors operating under full control of the foreign
corporation, domiciled in the Philippines or who in any
calendar year stay in the country for a period totalling
180 days or more.
217
Upon this point, an offline carrier, a foreign air
carrier not certified by the Civil Aeronautics Board, that
maintains office or has designated or appointed agents
or employees in the Philippines, through whom, it sells
or offers for sale any air transportation, or negotiates
for, or holds itself out by solicitation, advertisement, or
otherwise sells, provides, furnishes, contracts, or
arranges for such transportation, is undoubtedly “doing
business” or
“engaged in trade or business in the Philippines.
218
As such, it is taxable under Sec. 28(A)(1), and not
Sec. (A)(3) of the 1997 National Internal Revenue Code,
subject to any applicable tax treaty to which the
Philippines is a signatory. Pursuant to Article 8 of the RP-
Canada Tax Treaty, Air Canada may only be imposed a
maximum tax of 1 ½% of its gross revenues earned from
the sale of its tickets in the Philippines. (Air Canada v.
CIR, 778 SCRA 131)
219
3. NON-RESIDENT FOREIGN CORPORATIONS
Source: Within
Tax base: Gross Income

(RA No. 9337)
220
SPECIAL NON-RESIDENT FOREIGN CORPORATIONS:
a. NR – lessor of cinematographic film – within – Gross

Income – 25% final tax;
b. NR – owner or lessor of vessels chartered by Phil.

Nationals – within – Gross rental – 4.5% final tax;
c. NR – owner or lessor of aircraft, machinery and

equipment – within – Gross rental – 7.5% final tax.
221
SPECIAL NON-RESIDENT FOREIGN CORPORATIONS:
Two vessels of V. Reederij Amsterdam called on

Philippine ports twice to unload cargoes for foreign
destination. It has no office in the Philippines. The fees
were collected by its husbanding agent, Royal
International Ocean Lines. The Supreme Court held that
the corporation is considered non-resident foreign
corporation. Casual activity as in this case, does not
amount to engaging in trade or business in the
Philippines. (N.V. Reederij “Amsterdam” v. CIR, 162 SCRA
487)
222
MINIMUM CORPORATE INCOME TAX (Sections 27[E],
28A[2], Implemented by Revenue Regulations No. 9-98
as amended by Revenue Regulations No. 12-2007)
1) Concept and Rationale of the MCIT
The MCIT on domestic corporations is a new

concept introduced by RA No. 8424 to the Philippine
taxation system. It came about as a result of the
perceived inadequacy of the self-assessment system in
capturing the true income of corporations. It was
devised as a relatively simple and effective revenue-
raising instrument compared
223
to the normal income tax which is more difficult to control
and enforce. It is a means to ensure that everyone will
make some minimum contribution to the support of the
public sector. xxx.
Congress intended to put a stop to the practice of

corporations which, while having large turn-overs, report
minimal or negative net income resulting in minimal or
zero income taxes year in and year out, through under-
declaration of income or over-deduction of expenses
otherwise called tax shelters. xxx
224
The MCIT serves to put a cap on such tax
shelters. As a tax on gross income, it prevents
tax evasion and minimizes tax avoidance
schemes achieved through sophisticated and
artful manipulations of deductions and other
stratagems. Since the tax base was broader, the
tax rate was lowered.
225
To further emphasize the corrective nature of the
MCIT, the following safeguards were incorporated into the
law:
First, recognizing the birth pangs of businesses and

the reality of the need to recoup initial major capital
expenditures, the imposition of the MCIT commences only
on the fourth taxable year immediately following the year
in which the corporation commenced its operations. This
grace period allows a new business to stabilize first and
make its ventures viable before it is subjected to the MCIT.
226
Second, the law allows the carrying forward of any
excess of the MCIT paid over the normal income tax which
shall be credited against the normal income tax for the
three immediately succeeding years.
Third, since certain businesses may be incurring

genuine repeated losses, the law authorizes the Secretary
of Finance to suspend the imposition of MCIT if a
corporation suffers losses due to prolonged labor dispute,
force majeure and legitimate business reverses. (CREBA v.
Romulo, 614 SCRA 605)
227
PURPOSE OF MCIT
The imposition of the MCIT is designed to forestall

the prevailing practice of corporations of over claiming
deductions in order to reduce their income tax payment.
228
NATURE OF MCIT
The MCIT is an estimate of the income tax that is
due from a firm. It is equal to two percent (2%) of the
gross income of a corporation at the close of each
taxable quarter.
Being a minimum income tax, a corporation should

pay the MCIT whenever its regular (normal) income tax
is lower than the MCIT, or when the firm reports a net
loss in its tax return. Conversely, the regular income tax
is paid when it is higher than the MCIT.
229
MCIT IS NOT AN ADDITIONAL TAX TO THE REGULAR
OR NORMAL INCOME TAX
At the end of the taxable quarter, the MCIT is

compared with the regular income tax which is due from
a corporation. If the regular income is higher than the
MCIT, then the corporation does not pay the MCIT.
Newly established firms, or those which are on

their first three years of operations are not covered by
the MCIT.
230
COVERAGE OF THE MCIT
The MCIT covers domestic and resident foreign

corporations which are subject to the regular income
tax.
The term “regular income tax” refers to the regular

income tax rates under the Tax Code. The tax rate is 33%
for 1999, 32% for 2000, 35% effective July 1, 2005 and
30% effective January 1, 2009.
231
EXCLUDED IN THE COVERAGE OF THE MCIT
Thus, corporations which are subject to a special

corporate tax system do not fall within the coverage of
the MCIT. These are as follows:
* Schools, hospitals, and income of Offshore

Banking Units (OBUs), and Foreign Currency Deposit
Unit (FCDU) from foreign currency transactions;
232
EXCLUDED IN THE COVERAGE OF THE MCIT
* Regional operating headquarters –
The incomes of these corporations are subject to

a 10% preferential tax rate;
* Firms under a special income tax regime such as those

under the PEZA law and the Bases Conversion Development
Act;
* International carriers subject to tax at 2 ½% of their Gross

Philippine Billings.
233
For corporations whose operations or activities are
partly covered by the regular income tax system and partly
covered under a special income tax system, the MCIT shall
apply on operations covered by the regular income tax
system.
For example, the MCIT does not cover an activity of a

firm which is registered with the BOI and is granted an
income tax holiday. The MCIT shall cover its other activities
which are not covered by the BOI tax incentives.
234
WHEN DOES A CORPORATION START TO BE COVERED
BY THE MCIT?
A corporation starts to be covered by the MCIT

on the 4th year of its business operations. The period
of reckoning the start of its business operations is the
year when the corporation was registered with the
BIR. This rule will apply regardless of whether the
corporation is using the calendar year or fiscal year as
its taxable year. (Manila Banking Corp. v. CIR, 499
SCRA 782)
235
SUSPENSION OF THE PAYMENT OF MCIT
The Secretary of Finance, upon the recommendation

of the BIR Commissioner, may suspend the imposition
of the MCIT on a corporation in any of the following
cases:
* Sustained losses from prolonged labor dispute;

* Force majeure;
* Legitimate business reverses.
236
“Sustained losses from a prolonged labor dispute” means
losses arising from a strike staged by employees which
lasted for more than six (6) months within a taxable period
and which has caused the temporary shutdown of business
operations.
“Force majeure” means a cause due to an irresistible

force as by “Act of God” like storm, flood and other natural
calamities. This term would also include armed conflicts
like war or insurgency.
237
“Legitimate business reverses” shall include substantial
losses due to fire, robbery, theft or embezzlement, or for
other economic reason as determined by the Secretary of
Finance.
238
HOW IS THE MCIT COMPUTED?
The MCIT is equal to 2% of the gross income of the

corporation at the end of the taxable quarter.
“Gross income” means gross sales less sales returns,

discounts and allowances and cost of goods sold. It will also
include all items of gross income enumerated under Sec.
32(A) of the Tax Code, as amended, except income exempt
from income tax and income subject to final withholding
tax.
239
Cost of goods sold 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 means the invoice cost of 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.
240
For a manufacturing concern, cost of goods sold
manufactured and sold means 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.
For sale of services, gross income means gross

receipts less sales returns, allowances, discounts and cost
of services which cover all direct costs and
241
expenses necessarily incurred to provide the services
required by the customers and clients including:
* Salaries and employees benefits of personnel,

consultants and specialists directly rendering the service;
* Cost of facilities directly utilized in providing the

service such as depreciation or rental of equipment used:
242
* Cost of supplies.
Interest expense is not included as part of cost of

service, except in the case of banks and other financial
institutions.
The term “gross receipts” means amounts actually or

constructively received during the taxable year. However, for
taxpayers employing the accrual basis of accounting, it means
amounts earned as gross income.
243
WHEN IS THE MCIT REPORTED AND PAID?
The MCIT shall be paid in the same manner

prescribed for the payment of the normal corporate
income tax which is on a quarterly and on a yearly basis.
The taxpayer shall pay the MCIT whenever it is

greater than the regular or normal corporate income tax
which is imposed under Sec. 27(A) and Sec. 28(A)(1) of
the Code.
244
Thus, in the computation of the tax due for the
taxable quarter, if the computed quarterly MCIT is higher
than the quarterly normal income tax, the tax due to be
paid for such taxable quarter and the time of filing the
quarterly corporate income tax return shall be the MCIT
which is 2% of the gross income as of the end of the
taxable quarter.
245
The final comparison between the normal income
tax payable by the corporation and the MCIT shall be
made at the end of the taxable year and the payable or
excess payment in the Annual Income Tax Return shall be
computed taking into consideration corporate income
tax payment made at the time of filing of quarterly
corporate income tax return whether this be MCIT or
normal income tax.
246
CAN THE COMPANY CLAIM THE MCIT IT PAID AS
A DEDUCTION FROM GROSS INCOME?
Since the MCIT is an estimate of the normal

income tax, it cannot be claimed as deduction.
247
WHAT IS THE CARRY-FORWARD PROVISION UNDER
THE MCIT?
Any excess of the MCIT over the normal

income tax may be carried forward on an annual
basis and be credited against the normal income
tax for the 3 immediately succeeding taxable years.
248
Illustration:
2000 2001 2002
Normal income tax 50,000 60,000 100,000
MCIT 75,000 100,000 60,000
Amount of tax to be paid 75,000 100,000 100,000
Less: Excess MCIT
2000 - 25,000 - -
2001- - 40,000 - - 65,000
Net amount of tax payable 75,000 100,000 35,000
249
The taxpayer is required to pay the MCIT
whenever it is greater than the regular income tax.
Thus, in 2000, the taxpayer will pay MCIT of P75,000
since this is greater than the normal income tax of
P50,000.
250
In 2001, the taxpayer will pay the MCIT of P100,000
because its MCIT in 2001 is still higher than the regular
income tax. The excess MCIT of P25,000 in 2000 (or the
difference between the MCIT and the regular income
tax in 2000) cannot be used in this instance.
251
In 2002, when the regular income tax of P100,000
is higher than the MCIT of P60,000, the taxpayer is
allowed to claim as credit the excess MCIT of P25,000
and P40,000 for 2000 and 2001 respectively, or a total
credit of P65,000. Hence, the taxpayer will pay only
P35,000 (P100,000 – P65,000).
252
IMPROPERLY ACCUMULATED EARNINGS TAX (Sec. 29
as implemented by Revenue Regulations No. 2-2001)
Rationale of improperly accumulated earnings tax of
10%
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
253
IMPROPERLY ACCUMULATED EARNINGS TAX (Sec. 29
as implemented by Revenue Regulations No. 2-2001)
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 on
shareholders who are supposed to pay dividend tax
on the earnings distributed to them by the
corporation.
254
WHAT IS THE TOUCHSTONE OF THE LIABILITY?
It 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, 10%
improperly accumulated earnings tax shall be imposed.
255
COVERAGE OF IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)
The 10% IAET is imposed on improperly

accumulated taxable income earned starting
January 1, 1998 by domestic corporation as defined
under the Tax Code and which are classified as
closely-held corporations.
256
WHAT ARE CLOSELY-HELD CORPORATIONS?
Closely-held corporations are those

corporations at least 50% in value of the
outstanding capital stock or at least 50% of the total
combined voting power of all classes of stock
entitled to vote is owned directly or indirectly by
not more than 20 individuals.
257
CORPORATIONS NOT SUBJECT TO IAET:
• Banks and other non-bank financial intermediaries;
• Insurance companies;
• Publicly-held corporations;
• Taxable partnerships;
• General professional partnerships;
• Non-taxable joint ventures;
• Enterprises duly registered with the Phil. Economic Zone
Authority (PEZA) under RA No. 7916, and enterprises
registered pursuant to the Bases Conversion Development
Act of 1992 under RA No. 7227.
258
IAET IS NOT COVERED BY THE PRESCRIPTIVE PERIOD
FOR ASSESSMENT
• It would not be proper for the law to compel a

corporation to report improper accumulation of
surplus. A tax imposed upon unreasonable
accumulation of surplus is in the nature of a penalty.
(Helvering v. National Grocery Co., 304 US 282)
259
OTHER CORPORATE TAXES
• Common Tax Rates
• a. Capital gain from sale of share of stock.
• i. If not listed and traded through stock exchange –

15% of net capital gain (RA 10963)
• ii. If listed and traded through local stock exchange –

6/10 of 1% of Gross Selling Price (RA No. 10963). It is
in the nature of percentage tax.
260
• Domestic Corporations
• a. Corporations have the option to be taxed at 15% of

gross income. In this regard, the President may, upon
the recommendation of the Secretary of Finance,
effective 1 January 2000, allow corporations the option
to be taxed at 15% of gross income, after the following
conditions have been satisfied:
261
i. A tax effort ratio of 20% of Gross National Product
(GNP);
ii. A ratio of 40% of income tax collection to total tax

revenues;
iii. A VAT tax effort of 4% of GNP; and
iv. A 0.9% ratio of the Consolidated Public Sector Financial

Position to GNP.
262
• 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
55%.
• The election of the gross income tax option by the

corporation shall be irrevocable for 3 consecutive
taxable years during which the corporation is qualified
under the scheme.
263
• 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.
264
• b. Interest on currency deposit and royalties derived
from sources within the Philippines – 20% Final Tax.
• c. Interest income from deposit under the expanded

foreign currency system – 15% Final Tax (RA No. 10963)
265
• Resident Foreign Corporations
• a. Branch Profit Remittance Tax
• Tax base: Profits applied for or earmarked for

remittance. This took effect on January 1, 1998.
• Tax rate: 15% final tax.
• Condition: Branch profits are effectively connected
with the conduct of its trade or business in the
Philippines.
266
• The dividend income remitted to Marubeni Corporation of
Japan arising from its equity investments in Atlantic, Gulf
and Pacific Company of Manila is considered separate and
distinct income from the branch office in the Phils. There
can be no other logical conclusion that the investment was
made for purposes peculiarly germane to the conduct of
the corporate affairs of Marubeni, Japan, but certainly not
of the branch in the Phils. (Commissioner v. Marubeni, 177
SCRA 500)
267
• Exempt profits remitted: Derived from activities registered
with the PEZA.
• The branch office in the Philippines of a resident of the

Federal Republic of Germany may be subjected to the branch
profits remittance tax withhold at source in accordance with
Philippine law but shall not exceed 10% of the gross amount
of the profits remitted by that branch to the head office. This
is pursuant to paragraph 6, Article 10 of the RP-Germany Tax
Treaty. (Deutsche Ban AG Manila Branch v. CIR, 704 SCRA
216)
268
PURPOSE OF REMITTANCE TAX
• The remittance tax was conceived in an attempt to

equalize the income tax burden on foreign corporations
maintaining, on the one hand, local branch offices and
organizing, on the other hand, subsidiary domestic
corporations where at least a majority of all the latter’s
shares of stock are owned by such foreign corporations.
(Bank of America NT & SA v. Court of Appeals, 234 SCRA
302)
269
• Non-Resident Foreign Corporations
• a. Interest on foreign loan – 20% Final Tax.
• b. Dividend received from domestic corporation. This is

known as the tax sparing credit rule (Sec. 28 B 5[b],
NIRC).
• Tax rate: 15% final tax
270
• Condition: foreign government shall allow a credit
against the tax due from the foreign corporation
taxes deemed to have been paid.
• Tax credit allowed: 15% effective January 1, 2009

(RA No. 9337).
271
Issues:
• May a subsidiary corporation (withholding agent) file an
action for refund?
Answer: Procter and Gamble Phils., subsidiary corporation of P

& G-USA is properly regarded as a “taxpayer” within the
meaning of Sec. 309, NIRC (now Sec. 22[N] and therefore,
authorized to file refund. Withholding agent is technically
considered as taxpayer.
Reason: It is also an agent of the taxpayer in reporting such
an income. (Com. v. Procter, 204 SCRA 377)
272
Does the phrase “deemed paid” tax credit mean tax credit
actually granted by the foreign country?
• Answer: The Tax Code merely requires that the

foreign country (USA) shall allow a credit against the
tax due from Procter and Gamble-USA for taxes
deemed to have been paid in the Phils. There is no
statutory provision or revenue regulation requiring
“Actual Grant”. Therefore, the phrase “deemed paid”
“tax credit” does not imply tax credit actually granted
by the foreign government.
273
PURPOSE OF TAX SPARING CREDIT
• To encourage foreign investments and to attract

foreign investors.
274
TAX EXEMPT CORPORATIONS UNDER THE NIRC
1) Labor, Agriculture, or Horticultural Organization Not

Organized Principally for Profit
a. Provincial fairs and like associations of a quasi-

public character designed to encourage development
of better agricultural and horticultural products
through a system of awards, prizes or premiums and
whose income derived from gate receipts, entry fees,
donations,
275
etc. is used exclusively to meet necessary expenses of

upkeep and operation are thus exempt.
b) On the other hand, the holding of periodical race

meets by associations, the profits from which inure to
the benefit of their stockholder are not tax-exempt.
Similarly, corporations engaged in growing agricultural
or horticultural products or
276
raising livestock or similar products for profit are

subject to tax. (Section 25, Rev. Regs. No. 2)
2) Mutual Savings Banks and Cooperative Banks
a) Requisites for exemption:
i. No capital stock represented by shares;
277
operating are distributable wholly among the

depositors (Section 26, Rev. Regs. No. 2);
iii. Operated for mutual purposes and without profit.
b) Exemption applies to foreign as well as domestic banks.
278
c) Not qualified as mutual savings bank if deposits are

made compulsory under contracts between the bank
and depositors and is operated for speculation rather
than for savings.
3) Fraternal Beneficiary Society, Order or Association
279
i. Operated under the lodge system or for the

exclusive benefit of the members of a society – they
have parent and local organizations which are active;
ii. Established system of payment to its members or

their dependents of life, sick, accident, or other
benefits (Sec. 27, Rev. Regs. No. 2);
280
iii. No part of the net income inures to the benefit of

the stockholders or members.
b) A grand lodge established for the care of the members,

their dependents, and members of an affiliated lodge
unable to earn a livelihood by reason of the
infirmities of age was held tax exempt.
281
c) Mutual protective societies not operating under

the lodge system and traveller's association providing
for fixed death benefits to the beneficiaries or
members are not tax exempt. (Commercial Travellers
Life and Accident Association v. Rodway, 235 Fed. 370)
282
4) Cemetery Companies
i. Owned and operated exclusively for the benefit of

its owners;
ii. Not operated for profit.
b) Any cemetery corporation chartered solely for

283
burial purposes and not permitted by its charter to
engage in any business not necessarily incident to
that purpose, is exempt from income, provided that
no part of its net earnings inures to the benefit of any
private shareholder or individual.
c) Cemetery company which fulfills the other

requirements of the Statute may be exempt, even
though it issues preferred stock entitling the
284
holders to dividend at a fixed rate, provided that its
articles of incorporation require:
i. That the preferred stock shall be retired at par as

soon as the sufficient funds are realized from sales;
and
ii. That all funds not required for the payment of

dividends upon or for the retirement of preferred
stock shall be used by the company
285
for the care and improvement of the
cemetery/property.
d) Cemetery having a capital stock represented by shares,

or which is operated for profit or for the benefit of
persons other than its members, does not come
within the exempted class. (Section 29, Rev. Regs. No.
2)
286
5) Religious, Charitable, Scientific, Athletic or Cultural
Corporations
i. Organized and operated for one or more of the

specified purposes;
ii. No part of its net income must inure to the

benefit of private stockholders or individuals.
287
b) In the case of religious activities, income
from the conduct of strictly religious activities,
such as fees received for administering baptismal,
solemnizing marriages, attending burials, holding
masses, and other like income is EXEMPT. (Section
30, Rev. Regs. No. 2)
288
c) Charitable corporation includes association
for the relief of the families of clergymen, even
though the latter make contributions to the fund
established for this purpose, or for furnishing
the series of trained nurses to persons unable to
pay for them or for aiding the general body of
litigants by improving the efficient administration of
justice.
289
d) St. Luke’s Medical Center, Inc., fails to meet an
indispensable requirement under Section 30(E) –
operated exclusively for charitable purposes – to
be completely tax exempt from all its income. It
admitted having derived profits from its paying
patients. (CIR v. St. Luke’s Medical Center, Inc.,
682 SCRA 66)
290
e) To be exempt under Section 30(E) of the
NIRC, a charitable institution must be: (1) A non-
stock corporation or association; (2) Organized
exclusively for charitable purposes; (3) Operated
exclusively for charitable purposes; (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.
291
f) To be clear, for an institution to be completely exempt from income
tax, Sec. 30(E) of the NIRC requires said institution to operate exclusively for
charitable purpose. But in case an exempt institution under Sec. 30(E) of the said
Code earns income from its for-profit activities, it will not lose its tax
exemption. However, its income from for-profit activities will be subject to
income tax at the preferential 10% rate pursuant to Sec. 27(B) thereof.
(CIR vs. St. Luke’s Medical Center, Inc., G.R. No. 203514, 13 Feb. 2017)
292
6) Business, Chamber of Commerce, or Board of Trade

i. Association of persons having some common
business interest;
ii. Limited its activities to work for such common
interests;
iii. Not engaged in a regular business for profit;
iv. No part of the net income inures to the benefit of
any private stockholder or individual.
293
b) Ceases to be tax exempt if it engages in a regular
business for profit even if it conducts business on a
cooperative basis or produces only sufficient income to
be self-assessing.
c) An association engaged in furnishing

information to prospective investors, to enable them to
make sound investment, is not exempt, since its
members have no common business interest even though
all its income is devoted to the purpose stated.
294
d) A clearing house association, not organized for
profit, no part of the net income of which inures to
the benefit of any private shareholder or individual, is
exempt provided its activities are limited to the
exchange of checks and similar work for the common
benefit of its member.
e) An association of persons who are engaged in

the transportation business whether by land or water,
which is designed to promote the legitimate objects of
such business, and all of
295
the income of which is derived from membership
fee dues and is expended for office expenses is exempt.
(Sec. 31, Rev. Regs. No. 2)
f) Makati Stock Exchange is not a business league,

chamber of commerce, or board of trade within the
purview of Sec. 30(f) of the Tax Code, as amended, and
must pay income tax on its taxable income. Earnings
inure to the benefit of its members. (BIR Ruling No. 64-
027)
296
7) Civic League
i. Not organized for profit but operated

exclusively for purposes beneficial to the
community as a whole. In general,
organizations engaged in promoting the
welfare of mankind. (Sec. 32, Rev. Regs. No. 2)
297
ii. Sworn affidavit with the BIR showing the
following:
• Character of the league or organization;

• Purpose for which it was organized;
• Actual activities;
• Sources of income and disposition there;
• All facts relating to the operation of the
organization which affects its right to
exemption.
298
iii. The copy of articles of incorporation, by-laws
and financial statements should be attached
to the sworn affidavit. (BIR Ruling No. 21. 23
January 1961)
299
8) Non-stock, Non-Profit Educational Institutions
(Revenue Memorandum Circular No. 76-2003)
a) The exemption of non-stock, non-profit

educational institutions refers to internal revenue
taxes imposed by the National Government on all
revenues and assets used actually, directly and
exclusively for educational purposes (paragraph 3,
Sec. 4, Article XIV of the Constitution).
300
b) Furthermore, revenues derives from assets used
in the operation of cafeterias/canteens and
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.
c) However, they shall be subject to internal revenue

taxes on income from trade,
301
business or other activity, the conduct of which is
not related to the exercise or performance by
such educational institutions of their educational
purposes or functions i.e., rental payment from
their building/premises.
d) Unlike non-stock, non-profit corporations, their

interest income from currency bank deposits and
yield from deposit substitute instruments used
actually, directly and
302
exclusively in pursuance of their purposes as an
educational institution, are exempt from the 20%
final tax and 7 ½% tax on interest income under
the expanded foreign currency deposit system
imposed under Section 27 (D) [1] of the Tax Code
of 1997, subject to compliance with the
conditions that as a tax-exempt educational
institution, they shall on annual basis submit to
the Revenue District Office concerned an annual
information
303
return and duly audited financial statement
together with the following:
i. Certification from their depository banks

as to the amount of interest income
earned from passive investment not
subject to the 20% final withholding tax
and 7 ½% tax on interest income under the
expanded foreign currency deposit system
304
imposed by Section 27(D)[1] of the Tax
Code of 1997;
ii. Certification of actual utilization of the said

income; and
iii. Board Resolution by the school

administration on proposed projects (i.e.,
construction and/or improvement of
school buildings and facilities,
305
acquisition of equipment, books and the
like) to be funded out of the money
deposited in banks or placed in money
markets, on or before the 14th day of the
fourth month following the end of its
taxable year. (Sec. 3, Finance Department
Order No. 137-87)
306
e) The exemption does not cover withholding taxes.
As an educational institution, they are constituted
as withholding agents for the government
required to withhold the tax on compensation
income of their employees, or the withholding tax
on income payments to persons subject to tax
pursuant to Sec. 57 of the Tax Code of 1997.
307
JURISPRUDENTIAL REQUISITES FOR EXEMPTION:
1. The school must be non-stock and non-profit;
2. The income is actually, directly and exclusively
used for educational purposes.
There are no other conditions and limitations. (CIR

v. St. Paul College of Makati, GR No. 215383, 8
March 2017, citing RMO No. 44-2016)
308
DOCTRINAL RULINGS
1. The income and revenues of DLSU, a non-stock and non-
profit institution actually, directly and exclusively used for
educational purposes are exempt from duties and taxes.
2. The last paragraph of Sec. 30 of the Tax Code is without
force and effect for being contrary to the Constitution
insofar as it subjects to tax the income and revenues of non-
stock, non-profit educational institutions used actually,
directly and exclusively for educational purposes. (CIR v. De
La Salle University, Inc., GR Nos. 196596, 198841, 198941, 9
November 2016)
309
9) Government Educational Institution
a) UP (Act No. 1870, as amended) is subject to 20% final

tax. Other government educational institutions are
likewise subject thereto. Reason: Income from
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 (BIR Ruling 21-90, 28 Feb. 1990)
310
10) Mutual Fire Insurance Companies and Like
Organizations
a. Requisites for exemption:
i. Income is derived solely from assessments, dues

and fees collected from members;
ii. Fees collected from members are for the sole
purpose of meeting its expenses.
311
11. Farmers, Fruit Growers or Like Association
a. Requisites for exemption:
i. Formed and organized as sales agent for the purpose of

marketing the product of its members;
ii. No net income to the members;
iii. Proceeds of the sale shall be turned over to them less
necessary selling expenses on the basis of the quantity of
produce finished by them.
312
COMMON REQUISITES:
a) Not organized and operated principally for profit;
b) No part of the net income inures to the benefit of any
member or individual;
c) No capital represented by shares of stock;
d) Educational or instructive in character.
Objectives: betterment of the conditions engaged in such

pursuits, the improvement of the grade of their product
and the development of a higher degree of efficiency in
their respective occupations.
313
COMMON LIMITATIONS:
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.
314
COMMON LIMITATIONS:
i. The income of such organizations which is
considered as income from their properties, real or
personal, generally consists of income from corporate
dividend, rentals received from their properties,
interests from Philippine currency bank deposits or
capital loaned to other persons, income from
agricultural lands, owned by such corporations,
profits from the sale of property, real or personal and
other similar income are taxable.
EXCEPTION: When earned by a non-stock, non-profit

educational institution (Article XIV, Section
315 4[3], 1987
COMMON LIMITATIONS:
EXCEPTION: When earned by a non-stock, non-profit
educational institution (Article XIV, Section 4[3], 1987
Constitution)
316
COMMON LIMITATIONS:
ii. Young Men’s Christian Association of the Phils., Inc.
(YMCA) established as “ a welfare educational and
charitable non-profit corporation” is subject to
income tax on the rental income derived from the
lease of its properties, real or personal, and is
therefore not exempt from income taxation, even is
such income is exclusively used for the
accomplishment of its objectives. The exemption
claimed by the YMCA is expressly disallowed by
317
COMMON LIMITATIONS:
the very wording of the last paragraph of then Sec. 26
(now last paragraph of Sec. 30) of the NIRC which
mandates that 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. Because
the last paragraph of said section unequivocally subjects to
tax the rent income of the YMCA from its real property, the
Court is duty-bound to abide strictly by its literal meaning
and to refrain from resorting to any convoluted attempt at
construction. (CIR v. CA, 298 SCRA 83)
318
COMMON LIMITATIONS:
iii. The last paragraph of Sec. 30 provides that if a tax
exempt charitable institution conducts “any” activity
for profit, such activity is not tax exempt even as its
not-for-profit activities remain tax exempt. This
paragraph qualifies the requirements in Sec. 30(E)
that the “non-stock corporation or association must
be organized and operated exclusively for xxx
charitable xxx purposes xxx.” It likewise qualifies the
requirement in Sec. 30(G) that the civic
319
COMMON LIMITATIONS:
organization must be “operated exclusively” for the
promotion of social welfare.
Thus, even if the charitable institution must be

“organized and operated exclusively” for charitable
purposes, it is nevertheless allowed to engage in
“activities conducted for profit” without losing its tax
exempt status for its not-for-profit activities. The only
consequence is that the “income of whatever kind
and character” of a
320
COMMON LIMITATIONS:
charitable institution “from any of its activities
conducted for profit, regardless of the disposition
made of such income, shall be subject to tax.” Prior to
the introduction of Sec. 27(B), the tax rate on such
income from for-profit activities was the ordinary
corporate rate under Sec. 27(A). With the
introduction of Sec. 27(B), the tax rate is now 10%.
(CIR v. St. Luke’s Medical Center, Inc. 682 SCRA 66)
321
TAX EXEMPT GOVERNMENT-OWNED AND CONTROLLED
CORPORATIONS (GOCC)
(SEC. 27[C] AS AMENDED BY RA NO. 10963
i. Government Service Insurance System;

ii. Social Security System;
iii. Philippine Health Insurance Corporation;
iv. Local Water Districts.
322
TAX-EXEMPT CORPORATIONS UNDER SPECIAL LAWS
1. Cooperatives are exempted from taxes subject to

certain conditions under RA No. 6938. (Revenue
Memo. Circular No. 48-91)
2. Foundation created for scientific advancement is
exempt from tax under Section 24 of RA No. 2067.
323
ALLOWABLE DEDUCTIONS FROM
GROSS INCOME
324
BASIC PRINCIPLES
1. The taxpayer must point to some specific provisions

of the statute authorizing the deduction; and
2. He must be able to prove that he is entitled to the

deduction authorized or allowed. (Atlas Consolidated
Mining v. Com., 102 SCRA 246)
325
BASIC PRINCIPLES
• If a taxpayer fails to deduct certain expenses for the
taxable year, he cannot deduct them from the income
of the next or any succeeding year. (Sec. 76, Rev. Regs.
No. 2)
• Not allowed to claim deductions (Tax base: Gross

Income):
• i. NRA – NETB
• Ii. NRFC
326
THE COHAN RULE PRINCIPLE
- If there is a showing that expenses have been incurred
but the exact amount thereof cannot be ascertained
due to the absence of documentary evidence, it is the
duty of the BIR to make an estimate of deduction that
may be allowed in computing the taxpayer’s taxable
income bearing heavily against the taxpayer whose
inexactitude is of his own making. A disallowance of
50% of the taxpayer’s claimed deduction is valid. (Rev.
Memo. Circular No. 23-2000)
327
STATUTORY TEST PRINCIPLE
- An expense shall be allowed as a deduction from

the gross income under the NIRC as long as the
expense is: (a) both ordinary and necessary; (b)
incurred in carrying a business or trade; and (c)
paid or incurred within the taxable year. (Pilmico-
Mauri Foods Corp. V. CIR, 802 SCRA 619)
328
DEDUCTIONS VERSUS EXCLUSIONS
DEDUCTIONS v. EXCLUSIONS
Amounts deducted from Amounts/items to exempt

gross income arrive at net from tax by virtue of the Tax
income Code or special law
329
DEDUCTIONS VERSUS PERSONAL EXEMPTIONS
DEDUCTIONS v. PERSONAL EXEMPTIONS
Business expenses represent Personal expenses cover personal,

cost of doing business living or family expenses
Both individual and corporate Only individual is entitled

taxpayers may claim
330
KINDS OF ALLOWABLE DEDUCTIONS
ITEMIZED DEDUCTIONS OPTIONAL STANDARD
DEDUCTION (OSD)
a. Business expenses
b. Interest
c. Taxes
d. Losses
e. Bad debts
f. Depreciation
g. Depletion
h. Charitable and other contributions
i. Research and development expenditures
j. Pension trust contribution
331
KINDS OF
ITEMIZED DEDUCTIONS
332
BUSINESS EXPENSES
Requisites for deductibility:
1. The expense must be ordinary and necessary.

2. The expenses must be incurred in trade or business
carried on by the taxpayer.
3. The expenses must be substantiated by proof.
4. The expenses must be reasonable.
5. Paid or incurred during the taxable year.
6. Expenses must not be against public policy, public
moral or law.
7. If subject to withholding tax, proof of payment to BIR
must be shown.
333
THE EXPENSE MUST BE ORDINARY AND NECESSARY
Sec. 34(A)[1a] of the NIRC, as amended by RA

No. 8424, provides that expenses are
considered “ordinary and necessary” if they are
directly attributable to development,
management, operation, and or conduct of the
trade or business of the taxpayer, or in the
exercise of the taxpayer’s profession.
334
GUIDING PRINCIPLES
Ordinary, when it is normal (common or usual) in

relation to the business of the taxpayer and the
surrounding circumstances. Need not be recurring,
e.g., lawyer’s fee to prosecute infringement suit. It is
called ordinary in most cases to distinguish it from a
capital expenditure.
335
GUIDING PRINCIPLES
• Recapitalization and reorganization expenses are

capital expenditure as well as cost of obtaining
stock subscription and promotion expenses. (Atlas
Consolidated Mining and Development Corp. V.
Com., 120 SCRA 246)
336
GUIDING PRINCIPLES
Necessary, where it is appropriate and helpful in the

development of the taxpayer’s business. It is intended
to realize a profit or to minimize a loss. (Visayan Cebu
Terminal Co. V. Collector, CTA Case No. 28, 29 June
1957)
337
THE EXPENSES MUST BE INCURRED IN TRADE
OR BUSINESS CARRIED ON BY THE TAXPAYER
• Fees paid by the taxpayer to recover its lost assets

occasioned by the war and to rehabilitate its
business – business connected expenses.
(Collector v. Phil. Education Co., GR No. L-8505, 30
May 1953)
338
THE EXPENSES MUST BE INCURRED IN TRADE
OR BUSINESS CARRIED ON BY THE TAXPAYER
• Mere holding of investments cannot be

considered engaging in business so that the
expenses in managing the investments are not
considered ordinary and necessary in the pursuit
of a trade or business. (Hospital De San Juan De
Dios v. CIR, 185 SCRA 273)
339
• Margin fees of P340,822.04 paid to the Central Bank
by ESSO, a foreign corporation doing business in the
Phils., on its profit remittances to its New York head
office are not ordinary and necessary expenses.
REASON: The fees were paid not in the production of
income, but in the disposition of said income after it
had already been earned. Hence, it is an expense
properly attributable to the head office and not in the
carrying on of its trade or business in the Phils. (ESSO
Standard Eastern, Inc. V. CIR, 175 SCRA 149)
340
THE EXPENSES MUST BE SUBSTANTIATED BY PROOF
• It is incumbent upon the taxpayer to

establish proximate relation (logical link or
nexus) between the expense and the
taxpayer’s business. (Atlas Consolidated v.
CIR, 102 SCRA 246)
341
THE EXPENSES MUST BE SUBSTANTIATED BY PROOF
• Receipts are the best proof. Burden of proof lies

upon the taxpayer. In certain cases, this rule is
relaxed.
• Even if no records/receipts are available, the

oral testimony of a CPA, if not contradicted by
the government is sufficient. (Basilan Estates,
Inc. V. CIR, 21 SCRA 17)
342
THE EXPENSES MUST BE REASONABLE
• Promotional expenses incurred or paid by Phil.

Sugar Estate Dev’t. Co. to Algue Inc. amounting to
P125,000.00 was reasonable in the light of the
efforts exerted in inducing investors and
prominent businessman to venture in an
experimental enterprise. (Vegetable Oil
Investment Corp.) and to invest in a new business
involving millions of pesos. (Com. v. Algue, 158
SCRA 11)
343
PAID OR INCURRED DURING THE TAXABLE YEAR
a. Cash basis method – deducts expenses in the year

in which they are paid.
b. Accrual basis method – recognizes expenses in the

year they accrue.
344
EXPENSES MUST NOT BE AGAINST PUBLIC POLICY, PUBLIC MORAL
OR LAW
a. Fines and penalties – against public policy.
b. Attorney’s fees incurred in defending civil action
based on illegal act – deductible provided it is
business connected.
c. Even though the defense is unsuccessful – as long
as it is business connected – deductible.
d. Entertainment expenses incurred by officer of a
corporation to entertain government officials to
discuss transactions/dealings at
345
OR LAW
Manila Hotel – against public policy. (Nava v.
Collector, CTA No. 568, 25 Sept. 1961)
e. The purchase price of political influence to obtain
or hold public contracts; dollar allocations from
the Central Bank; import control licenses;
payments in excess of the maximum amount
authorized by law – against public policy.
Reason: To permit a violator to gain a tax
346
OR LAW
advantage through deductions would in effect
lessen the degree of punishment intended, or
would frustrate the purpose and effectiveness of
the public policy that has been violated.
f. Bribe to obtain protection from arrest or
prosecution – against public policy.
347
IF SUBJECT TO WITHHOLDING TAX, PROOF OF
PAYMENT TO BIR MUST BE SHOWN
• Professional expenses – 10%
• Rent expense – 10% (Rev. Regs. No. 6-85, 2

May 1985)
348
KINDS OF BUSINESS EXPENSES
1. Compensation for personal services
2. Travelling expenses
3. Representation and Entertainment Expenses
4. Advertising and Promotional Expenses
5. Rent Expense
6. Cost of material and supplies
7. Repairs
349
KINDS OF BUSINESS EXPENSES
1. Compensation for personal services
Requisites:
a. Personal services actually rendered;

b. Compensation is for such services rendered;
c. Reasonable.
350
WHAT ARE INCLUDED IN COMPENSATION FOR SERVICES WHICH
ARE ALLOWED AS DEDUCTIONS FROM GROSS INCOME?
• wages, salaries, etc.;
• bonuses in good faith;
• commissions, professional fees, vacation-leave
pay, retirement pay;
• management expenses;
• premiums and compensation for injuries if not
compensated for by insurance or otherwise;
351
WHAT ARE INCLUDED IN COMPENSATION FOR SERVICES WHICH
ARE ALLOWED AS DEDUCTIONS FROM GROSS INCOME?
• contribution to pension trust created for the benefit
of the employees, including contribution under SSS
Act;
• other forms of compensation for services actually
rendered.
352
BONUSES ARE DEDUCTIBLE UNDER THE FOLLOWING
CONDITIONS:
a. Paid in good faith as additional compensation for services

rendered;
b. Reasonable amount. To hold otherwise would open the
gate to rampant tax evasion.
c. Not to exceed reasonable compensation when added to
stipulated salaries.
353
SUGGESTED TESTS: (CONSIDER THE DATE WHEN THE
CONTRACT FOR SERVICES WAS MADE, NOT AT THE DATE WHEN
THE CONTRACT IS QUESTIONED)
a. Good faith;
b. Character of business;
c. Salary policy of the corporation;
d. Type and extent of services;
e. Employee’s qualification and contribution;
f. General economic conditions. (C.M. Hoskins & Co., Inc. v.
CIR, 30 SCRA 434)
354
• Bonuses granted to corporate officers for the successful
sale of a piece of land effected through broker – no
services rendered – not deductible as reasonable and
necessary expenses. (Aguinaldo Industries Corporation v.
CIR, 112 SCRA 136)
• It is immaterial whether bonuses are paid in cash or in

kind or partly in cash and partly in kind.
355
OTHER FORMS OF COMPENSATION
a. Housing and meals;

b. Courtesy discounts;
c. Entertainment and gifts to company officers during
Christmas and major anniversary, sports tournament and
company picnics;
d. Legitimate expenses (salaries and miscellaneous
expenses)
356
TRAVELLING EXPENSES
- Include transportation expenses and meals and lodging
(Sections 65 and 66, Rev. Regs. No. 2)
- Requisites for deductibility:
a. Paid or incurred while “away from home.”
i. Transportation expenses from main office to branch,

from branch office to main office – deductible
357
TRAVELLING EXPENSES
ii. Transportation expenses from office to home;
home to office – not deductible.
iii. If a company car is utilized both for business and
personal use – proportion to the use.
b. Paid or incurred in the conduct of trade or business.

c. Reasonable and necessary expenses.
358
REPRESENTATION AND ENTERTAINMENT EXPENSES
Requisites for deductibility:
a) Subject to the rule of substantiation – receipt or

adequate records, amount of expense, date and place
of expense, purpose of expense and professional or
business relationship of expense;
b) Paid or incurred in the pursuit of trade or business;
c) Paid or incurred in the taxable year;
d) Not contrary to law, morals and public policy;
e) Reasonable.
359
REPRESENTATION AND ENTERTAINMENT EXPENSES
Dues paid to social, athletic, or sporting club or
organization per officer, to professional or business
organization (Lions, Kiwanis) – deductible
Purchase of propriety shares and playing rights

– not deductible.
360
ADVERTISING AND PROMOTIONAL EXPENSES
a. Must be substantiated.
b. All payments for the purchase of promotional
giveaways, contest prizes or similar material must be
properly receipted.
All payments for services such as radio and TV time,

print ads, advertising expense must be subjected to
withholding tax.
361
• 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. Corporate taxpayer’s
venture to protect its brand franchise was tantamount
to efforts to establish a reputation. (CIR v. General Foods
[Phils.], Inc., 401 SCRA 545)
362
• Expenses incurred or paid to promote sale of capital
stock for acquisition of additional capital is not
deductible from taxable income. Efforts to establish
reputation are akin to acquisition of capital assets and,
therefore, expenses related thereto are not business
expenses but capital expenditures. (Welch v. Helvering,
290 US 111, 78 L Ed. 212, 545 Ct. 8 [1993]
363
RENT EXPENSE (REV. REGS. NO. 8-90 DATED
15 OCT. 1990
a. Business property – at least P500.00 – 5%.

b. Non-business/residential property – at least P10,000.00
– 5%.
* American tax jurisprudence allows seller-lessee in a

sale-leaseback transaction to claim rental payments as
deduction from gross income.
364
COST OF MATERIAL AND SUPPLIES
• Deductible only to the amount actually consumed or
used in operation.
• Methods utilized to determine materials used:
• a. Actual consumption method (inventory method)

• b. Direct purchase method.
• Taxpayer purchases materials but has no record of
consumption – deductible provided the net income is
clearly reflected by this method. (Sec. 67, Rev. Regs. No. 2)
365
REPAIRS
Rules on deductibility
a. Incidental or ordinary repairs – keeps the asset in its

ordinary working condition (does not add material value
to the property or prolong its life as distinguished from
extraordinary repairs).
b. Extraordinary repairs are not deductible – they are

capital expenditures.
366
REPAIRS
i. Expenses necessitated by radical changes in design
made during construction are not deductible – part of
the cost of the project.
ii. Expenses of repairs to walls and roof of a building to
prevent leakage – deductible.
iii. Cost of demolishing building and erecting a new one is
a capital expenditure.
*Organization costs are amortized over the life of

the corporation.
367
INTEREST EXPENSES
• – amount which one has contracted to pay for the use
of borrowed money or amount of compensation paid
for the use of money or forbearance from such use.
368
REQUISITES FOR DEDUCTIBILITY
a) There must be an indebtedness.
b) Incurred in connection with taxpayer’s trade or
business.
c) Indebtedness must be that of the taxpayer.
d) The interest must have been stipulated in writing in
consonance with Article 1956, New Civil Code which
provides that no interest shall be due unless it has been
expressly stipulated in writing.
e) Paid or accrued within the taxable year.
369
THERE MUST BE AN INDEBTEDNESS
• Indebtedness – unconditional and legally enforceable
obligation for payment of a sum certain in money;
• Embraces not only contractual debts but also interest

accruing as a result of delinquency for payment of the
tax. However, penalties (civil or criminal) are excluded;
370
DEDUCTIBLE INTEREST EXPENSES
a. Interest on taxes. Reason: Taxes for this purpose are indebtedness.
Fines, penalties and surcharges on taxes are not deductible.
b. Interest paid by corporation on scrip dividends.
c. Interest on deposits paid by authorized bank of the Central Bank.
d. Interest paid by legal or equitable owner on mortgage of real
property
* American tax jurisprudence allows buyer-lessor in a sale-leaseback

transaction to claim interest on loan as deduction from gross
income.
371
SOME NON-DEDUCTIBLE INTEREST EXPENSES
1) Interest on preferred stock which is considered interest
on capital by virtue of RMC 17-71 dated July 12, 1971.
2) Interest on undrawn salaries and bonuses. (Keunzle &
Streiff, Inc. v. Collector, 106 Phil. 355)
3) Interest on capital for cost keeping. Reason: No
indebtedness.
4) Interest paid where parties provide no stipulation to pay
interest in writing.
372
5) Interest on indebtedness if incurred to finance
petroleum exploration.
6) Interest on indebtedness paid in advance through
discount or otherwise (cash basis). Deductible in the
year the indebtedness was paid, not when interest was
paid in advance.
7) Interest between related taxpayers.
a. Members of a family – brothers and sisters (full or
half), spouse, ancestors and lineal descendants.
373
b. Individual and corporate – individual owns directly or
indirectly more than 50% of the outstanding stock.
c. Between corporations – more than 50% of the
outstanding stock both owned directly or indirectly by
the same individual.
d. Grantor and fiduciary (trustee) of any trust.
e. Fiduciary and another fiduciary – the same grantor.
f. Fiduciary and beneficiary or such trust.
374
• Theoretical interest is not deductible as it is merely
computed or calculated. It does not arise from interest
bearing obligation. (PICOP v. CA, 250 SCRA 434)
• Optical treatment of interest expense on capital

expenditure. At the option of the taxpayer, interest
expense on a capital expenditure incurred to acquire
property used in trade, business or exercise of a
profession may be allowed as a: (1) deduction
375
• in full in the year when incurred, the provisions of Sec.
36 (A)[2] and [3] of the Tax Code of 1997 to the contrary
notwithstanding, or may be treated as a (2) capital
expenditure for which the taxpayer may claim only as a
deduction the periodic amortization of such
expenditure. (Sec. 34(b)[3] as implemented by Rev.
Regs. No. 13-2000)
376
• Arbitrage rule on deductible interest. The percentage by
which the taxpayer’s otherwise allowable deduction for
interest expense shall be reduced, has been increased
from 38% to 42% of the interest income subjected to
final tax effective July 1, 2005. It shall be reduced to 33%
effective January 1, 2009. (Section 34[B] as amended by
RA No. 9337)
377
TAXES
1. NATURE AND SCOPE – All taxes, whether national or
local, paid or accrued, within the taxable year in
connection with the taxpayer’s trade or business,
except:
a. Philippine income tax;

b. Income, war profit, and excess profit taxes imposed
by the authority of any foreign country provided the
taxpayer chooses to take a tax credit (if a taxpayer is
qualified to take a tax credit for
378
TAXES
income, war profits and excess profits taxes paid or
accrued to a foreign country such taxes, when not taken
as tax credit, may be claimed as deductions from gross
income);
c) Estate and donor’s tax;
d) Special assessment tax;
e) Taxes paid for commodity not connected with the
taxpayer’s business:
• No deductions are allowed for amounts
representing: (1) interest; (2) surcharges; and
379
TAXES
(3) fines or penalties incident to delinquency. (Par. 2,
Sec. 80, Rev. Regs. No. 2)
• Postage is not a tax. Automobile registration fees are
not considered taxes. (Sec. 80, Rev. Regs. No. 2)
• Under Sec. 4(a), RA No. 9257 (Expanded Senior Citizens
Act), the 20% discount granted to senior citizens shall be
allowed as tax deduction from gross income for the
same taxable year that the discount is granted.
380
1) Paid or incurred within the taxable year;
2) Paid or incurred in connection with taxpayer’s

business;
3) Deductible only by the person upon whom the tax is

imposed by law (VAT is deductible only by seller).
381
EXCEPTIONS:
a. Taxes of shareholder upon his interest as such and paid by

the corporation without reimbursement from him can be
claimed by the corporation as deduction.
b. A corporation paying the tax for the holder of its bond or

other obligations containing a tax-free covenant clause
cannot claim deduction for such taxes paid by it pursuant to
such covenant. (Sec. 80, Rev. Regs. No. 2)
382
WHEN MAY DEDUCTION FOR TAXES BE CLAIMED?
Answer: Year paid or incurred in general. However, in the

case of contingent tax liability, the obligation to
deduct arises only when the liability is finally
determined.
383
TAX CREDIT
- Amount allowed by law to reduce the Philippine

income tax due on account of income, war-profit
tax, excess profit tax, paid or accrued to a foreign
country.
384
TAX CREDIT
- Only domestic corporations are entitled to avail of the tax
credit.
- Reason/Purpose: To lessen the harshness of taxation in

cases where an income is subject to both foreign tax and
Philippine income tax.
- The taxpayer has the option either to claim foreign

income taxes paid as deduction from gross income or tax
credit against the Philippine income tax. If claimed as tax
credit, it is no longer deductible from gross income.
385
TAX DEDUCTION VS. TAX CREDIT
TAX DEDUCTION V. TAX CREDIT
Deductible from gross income Deductible from Phil. Income tax
Sources: Deductible taxes Sources: Foreign income war-

such as business tax, excise profits and excess profit tax
tax, percentage tax and other
business-connected taxes
386
TAX DEDUCTION V. TAX CREDIT
• Tax deduction reduces taxable income while tax credit
reduces the taxpayer’s liability. (CIR v. Bicolandia Drug
Corporation, 496 SCRA 176, 182)
387
ADMINISTRATIVE CONDITIONS FOR ALLOWANCE OF CREDIT FOR
FOREIGN TAXES
1. The taxpayer must signify in his income tax return his

desire to claim tax credit;
2. The return must be accompanied by the appropriate
form prescribed by the BIR Commissioner, signed and
sworn, carefully filled up and containing the information
required.
If credit is sought for taxes already paid, receipt for

payment must be attached.
388
LOSSES
- The term implies an unintentional parting with

something of value. It is used in the income tax law in a
very broad sense to comprehend all losses which are
not general or natural to the ordinary course of business
and are not covered under some other heading such as
bad debts, inventory losses, depreciation, etc.
389
TREATMENT OF LOSSES DEPENDS UPON:
a. Class of taxpayers;
b. Nature of losses.
390
KINDS OF LOSSES:
a. Ordinary losses – those incurred in trade or business
b. Those incurred in any transaction entered for profit

though not connected with the trade or business.
c. Casualty losses – those incurred by property connected

with the trade or business. If the loss arises from fire,
storm, shipwreck, or other casualties or from robbery,
theft or embezzlement.
391
KINDS OF LOSSES:
d. Capital losses – deductible only to the extent of capital

gains:
* Losses from sale or exchange of capital assets;
* Losses resulting from securities becoming worthless

which are capital assets.
e. Losses from short sale of property.
392
KINDS OF LOSSES:
f. Losses due to failure to exercise privilege or option to

buy or sell property.
g. Abandonment losses (oil exploration).
393
SPECIAL KINDS OF LOSSES:
a. Wagering losses
b. Losses due to voluntary removal of building incident to

renewal or replacement
c. Loss of useful value of capital asset due to changes in

business condition
394
WAGERING LOSSES
– deductible only to the extent of gain or winning.
Thus, a taxpayer whose gambling transaction resulted in

losses of P500 and gains of P400 in another gambling
game, would be obliged to report the gain of P400 in
order to obtain a deduction of the loss for P500. The
excess of the loss over the gain is NOT DEDUCTIBLE. On
the other hand, the excess of the gain over loss is
TAXABLE.
395
LOSSES DUE TO VOLUNTARY REMOVAL OF BUILDING INCIDENT
TO RENEWAL OR REPLACEMENT
Tax Code does not provide for the deductibility of losses

arising from voluntary removal of old building, or scrapping
of machinery or equipment. Rev. Regs. No. 2, Sec. 87 granted
the deductibility of losses sustained if building, machinery or
equipment is old, and the demolition or scrapping thereof is
made incident to removals or replacements. This
presupposes that the building is already existing on the lot
owned by the taxpayer before the demolition.
396
With respect to the building existing at the time of
purchase of the lot upon which the said building is
erected, the rules are the following:
i. When a taxpayer buys a real estate upon which a

building is built, the cost to build another building and the
cost of removal of the old building is NOT DEDUCTIBLE.
The value of the real estate, exclusive of old
improvements, being presumably equal to the purchase
price of the land and building plus the cost of removing
the useless building.
397
ii. However, if the removal of the building was required
by the authorities because the building was a fire
hazard, the value of the building and the cost of its
removal will be deductible as losses. (Com. v. Prescilla
Estate, Inc. et al., 11 SCRA 130)
398
LOSS OF VALUE OF CAPITAL ASSET DUE TO CHANGES
IN BUSINESS CONDITION
i. When taxpayer discontinues the business or discards such

assets permanently from use in such business, he may claim
as deduction the actual loss sustained. In determining the
amount of loss, adjustment must be made, however, for
improvements, depreciation and salvage value of the
property. This is an exception to the rule requiring a sale or
other disposition of property in order to establish a loss. (Sec.
98, Rev. Regs. No. 2)
399
LOSS OF VALUE OF CAPITAL ASSET DUE TO CHANGES
IN BUSINESS CONDITION
ii. Proof required to establish loss of useful value

(Unforeseen causes):
• Increase in the cost or change in the manufacture of

any product;
• New legislation directly makes the continued

profitable use of the property impossible.
400
iii. Non-deductible loss due to loss of useful value:
• Useful life of property terminates solely as a

result of those gradual processes for which
depreciation is authorized;
• Inventories. (Sec. 98, Rev. Regs. No. 2)
401
Domestic Corporations – All losses actually sustained and
charged off within the taxable year and not
compensated for by insurance.
Foreign Corporations – Losses actually sustained:
a. In business or trade conducted in the Phils.;

b. In transaction entered into for profit in the Phils.;
c. Not compensated for by insurance or otherwise.
402
REQUISITES FOR DEDUCTIBILITY (IN GENERAL):
a. The loss claimed as deduction must be that of a
taxpayer.
i. The taxpayer must prove that the loss was suffered by said
taxpayer.
* Where a taxpayer operates two phases of industry, one

exempt from income tax pursuant to RA No. 901 and the
other taxable, losses sustained in the tax-exempt operation
cannot be deducted from income of the taxable industry.
(Marcelo Steel Corporation v. Collector, 109 Phil. 921)
403
* If the taxpayer is engaged in several businesses
such that its gross income arises from operations of two
or more businesses, loss sustained in one line of
business cannot be claimed as a deduction or be offset
from the income of its other line of businesses. (BIR
Ruling No. 123-87, 4 May 1987)
404
b. The loss must have been sustained during the taxable
year.
* A taxpayer is not allowed to defer the deduction to

some other time other than the year in which the loss
was actually sustained. (CIR v. Asturias Sugar Central,
Inc., 2 SCRA 1140)
405
c. Loss evidenced by a closed and completed transaction.
* There should be an identifiable cause which fixed the

loss.
* Loss from sale. Consumption of the sale is the

identifiable event which fixes the loss.
406
* Building, worth P500,000.00, insured for P500,000; burned in
the year 2000. The insurer refused to acknowledge its liability;
action was brought in court by the insured. In the year 2001, the
parties agreed to compromise the case – P400,000. Loss deductible
= P100,000 in the year 2001 when the insurance recovery is
definitely established and not 2000. Closed and completed
transaction – final settlement and determination of the insurance
recovery, event which took place in 2001.
d. Loss not compensated by insurance or otherwise.
407
CASUALTY LOSSES (FIRE, STORMS, ROBBERY, THEFT
OR EMBEZZLEMENT)
Requisites for deductibility (Rev. Regs. No. 12-77)
a. Sworn declaration of loss must be filed with the BIR.

i. Nature of the event giving rise to loss and time of
its occurrence;
ii. Description of the damaged property and its
location;
iii. Items needed to compute the loss such as
408
OR EMBEZZLEMENT)
cost or other basis of the property, depreciation allowed

if any, value of the property before and after the event,
cost of repair;
iv. Amount of insurance or other compensation received
or receivable.
b. Filed through the nearest RDO within 45 days after the

date of the occurrence.
409
OR EMBEZZLEMENT)
c. Proof of the elements of the loss claimed, such as the

actual nature and occurrence of the event and the
amount of the loss.
i. Casualty loss – documentary proof of costs,

photograph showing extent of damage, condition or
value of the property after it was repaired, restored or
replaced.
410
OR EMBEZZLEMENT)
ii. Robbery, theft or embezzlement losses – amount of

loss. Police report is necessary although not conclusive
proof of the loss arising therefrom.
411
NON-DEDUCTIBLE LOSSES
1. Losses in dealing between related taxpayers (except in

case of distribution in liquidation)
a. Members of a family. Family means taxpayer’s

brothers and sisters (whether by whole or half-
blood), spouse, ancestors, and lineal descendants.
b. Between an individual and corporation. More than
50% of the outstanding capital stock of the
412
corporation is owned directly or indirectly by the

individual.
c. Between two corporations:
i. One or both of the corporations is a personal
holding company preceding the dale of the sale
or exchange;
ii. More than 50% in value of the stock of each
corporation is owned directly or indirectly by the
same individual;
413
iii. However, the limitation does not apply

where the individual owning more than 50%
of the stock of the purchasing corporation
owned less than 50% of the stock of the
selling corporation.
414
d. Between parties to a trust:
i. Grantor and fiduciary (trustee);

ii. Fiduciary of a trust and fiduciary of another trust
– the same grantor;
iii. Fiduciary and beneficiary.
415
2. Losses on wash sale (61-day sale)
Points to be considered:
a. Taxpayer must have bought or sold stocks or

securities;
b. Substantially identical stock or securities are acquired
within a period beginning 30 days before the date of
sale and ending 30 days after such date;
416
c. There must have been sale or disposition of stocks or
securities;
d. Not limited to situations where the replacement is
acquired by purchase. It also applies to acquisition
through a taxable exchange and the making of an option
contract;
e. The seller is not dealer in securities.
417
REASON FOR NON-DEDUCTIBILITY OF LOSS FROM
WASH SALE
i. Prevent deduction of losses on sales of stock or
securities that were replaced by substantially identical
stocks or securities;
ii. Loss is added to the cost of the subsequently acquired

securities/stock. Hence, a mere artificial loss.
418
3. Loss due to removal of building if purchased (not existing
and not incident to renewal)
* Net Operating Loss Carry Over (NOLCO)
i. Applies to individual and corporate.

ii. Can be carried over in the next three consecutive
taxable years.
iii. Taxpayer is not exempt from income tax.
iv. No substantial change in the ownership of the
419
business or enterprise in that not less than 75% in
nominal value of the outstanding issued shares or paid
capital of the corporation is held by or on behalf of the
same person.
v. Mines other than oil and gas wells may carry over net
operating losses as deduction in the next five years.
420
BAD DEBTS
- Debts due to the taxpayer which are actually

ascertained to be worthless and charged off within
the taxable year.
421
a. Existence of a valid debt and subsisting debt (legal and
factual).
i. A debt is valid if there exists the relationship of a

debtor and a creditor. It is not necessary that the
debt shall be due in the sense that it is then
collectible. It must be an outstanding obligation,
which if not due at the time, will certainly become
due at some future date.
422
ii. Where the debt, however, is subject to a contingency and such
contingency did not occur, there is no valid subsisting debt.
iii. Repayment of the debt is essential for the existence of the

debt.
Exception: Even if the debt be uncollectible from its

inception, it is the right of the endorser or guarantor to
deduct payment which he is required to make upon
default of the primary debtor.
423
b. Debts must be actually ascertained to be worthless.
i. Worthless is not determined by an inflexible formula, but upon

the exercise of sound business judgment. Mere uncertainty of
collection or investigation that the debtor is in an
unsatisfactory financial condition and that the collection of the
debt is doubtful will not suffice. All pertinent facts and
evidence must be considered. The burden of proof to show
worthlessness is on the taxpayer.
424
FACTORS AFFECTING THE WORTHLESSNESS OF A DEBT
1. Bankruptcy or insolvency of the debtor;
2. Insufficiency of the collateral;
3. Statute of limitation;
4. Death of the debtor leaving no assets;
5. Injury of the debtor making it impossible for him to earn a
living;
6. Meager amount involved;
7. Improbability of success of judicial collection;
8. Destruction by fire of original invoices evidencing the
indebtedness. (Goodwill Int’l. Rubber Co. v. Collector, CTA
Case No. 468, 8 June 1963)
425
c. Debt must be charged off within the year of
worthlessness.
A taxpayer may not defer deduction to a later

year of a bad debt. If the charge off is made in a
later year, the deduction will be disallowed. (CIR v.
Goodrich Int’l. Rubber Co., 21 SCRA 1336)
426
LOSS FROM THEFT OR EMBEZZLEMENT:
i. Deductible in the year in which it was sustained.
ii. No means of determining the actual date of
embezzlement – year of discovery.
iii. Modified by the application of the bad debt theory
which holds that since the embezzlement of funds
creates a debtor-creditor relationship the loss is
deductible as BAD DEBT in the year when the right
of recovery become worthless.
427
Deductible bad debts of Domestic and Resident
Foreign Corporations – only business debts.
Non-resident Foreign Corporation – not entitled
428
d. Debt arises from business or trade.
e. Does not arise from transactions between related

taxpayers.
f. Additionally, before a debt can be ascertained to be

worthless, the taxpayer must also show that it is indeed
uncollectible in the future.
429
Furthermore, there are steps outlined to be undertaken
by the taxpayer to prove that he exerted efforts to collect
the debts, viz: (1) sending of statements of accounts; (2)
sending of collection letters; (3) giving the account to a
lawyer for collection; and (4) filing a collection case in court.
(PRC v. Commissioner, 256 SCRA 667)
430
In the case of banks, they shall submit a BSP/Monetary
Board written approval of the writing off of the
indebtedness from the bank’s books of accounts at the end
of the taxable year.
As regards insurance or surety company, writing off of a

receivable from the books and claimed as bad debts
deduction requires declaration of closure due to insolvency
or for any such similar reason by the Insurance
Commissioner.
431
DEPRECIATION
- Gradual diminution in the useful (service) value of
tangible property used in trade, profession or business
resulting from exhaustion, wear and tear, and
obsolescence. It applies also to the amortization of the
value of intangible assets, the use of which in trade or
business is definitely limited in duration. (Basilan
Estates, Inc. v. Com., 21 SCRA 17)
432
a. The allowance for depreciation must be reasonable.
The Tax Code, provides for the use of the following

methods of depreciation, viz:
i. Straight line method;

ii. Declining balance method;
iii. Sum of the years digit method;
iv. Any other method which may be prescribed by
433
the Secretary of Finance upon recommendation of the
BIR Commissioner. The BIR and the taxpayer may agree
in writing on the useful life of the property to be
depreciated. The agreed rate may be modified if
justified by facts or circumstances. The change shall not
be effective before the taxable year on which notice in
writing by registered mail or certified mail is sent by the
party initiating.
434
b. It must be for property used in trade or business or
profession (depreciable assets).
Depreciable assets:
a. Tangible property used in trade or business –

allowance;
b. Intangible property like patent, copyrights and

franchises – amortization.
435
* American tax jurisprudence allows buyer-lessor in a
sale-leaseback transaction to deduct depreciation
expense from gross income. This proceeds from the
theory that as lessor, he is the owner of the property
subject of the transaction.
436
NON-DEPRECIABLE ASSETS:
a. Inventories or stock;
b. Land and improvements;
c. Bodies of minerals subject to depletion;
d. Automobiles or transportation equipment for personal
use (residence);
e. Building and furnitures for personal use;
f. Intangibles – use is unlimited;
g. Personal effects and clothing.
437
• Property kept in repair – subject to depreciation
• Properties and costumes used exclusively in business

such as theatrical business, may be subject to
depreciation. (Sec. 106, Rev. Regs. No. 2)
438
RULES ON THE DEPRECIATIONOF PROPERTIES USED
IN PETROLEUM OPERATION
1. Depreciation is allowed – straight line or declining
balance method at the option of the service contractor;
2. Shift from declining to straight line is allowed;
3. Useful life of properties used – 10 years or such shorter
life as may be permitted by the BIR;
4. Properties not used indirectly in petroleum operation –
5 years.
439
DEPLETION
- It is the exhaustion of natural resources like

mines and oil and gas wells as a result of a
production or severance from such mines or
wells.
440
THEORY AND PURPOSE OF DEPLETION ALLOWANCE
- As the product of the mine is sold, a gradual sale is

being made of the taxpayer’s capital interest in the
property. The purpose is, then, to enable him to recover
that capital interest free of income tax at its cost or on
some other basis.
441
WHO ARE ENTITLED ?
- Only persons having an economic interest in a mineral

land or oil or gas wells. To acquire an economic interest,
the taxpayer must have a capital investment in the
property and not mere economic disadvantage. The
taxpayer must have acquired at least, by investment,
any interest in oil or gas, or mineral in place, and
services, by any form of legal relationship, income
derived from the extraction of the oil, gas or mineral to
which he must look for a return of his capital.
442
1. Depletible asset – natural resources – mines, gas and oil

wells.
2. Charged off within the taxable year.
3. Allowance for depletion is computed in accordance with
the cost depletion method.
443
ESSENTIAL FACTORS
a. Basis of the property;
b. Estimated total recoverable units in the property;
c. Number of units recovered during the taxable year.
444
DEPLETION DEDUCTIBLE
a. Domestic Corporation – oil, gas wells or mines located

within and without;
b. Resident Corporation – gas wells and mines located in

the Philippines.
445
MAY THE TAXPAYER DEDUCT EXPLORATION AND
DEVELOPMENT EXPENDITURES PAID OR INCURRED
DURING THE TAXABLE YEAR
YES. At taxpayer’s option, he may deduct exploration and
development expenditures (mines) provided that it shall not
exceed 25% of the taxable income from mining operations
computed without the benefit of any tax incentives under
existing laws.
NO. With respect to improvements of property subject to

allowance for depreciation (expenditure) and those paid or
incurred for the exploration and development of oil and gas.
446
DEPRECIATION VS. DEPLETION
DEPRECIATION VS. DEPLETION

Depreciable assets Natural resources
447
CHARITABLE AND OTHER CONTRIBUTIONS
KINDS:
a. Ordinary – subject to limitation;
b. Special – deductible in full.
448
ENTITLED:
a. Corporate taxpayer except NRFC – 5% of the Net Income

before Charitable Contribution;
b. Individual taxpayer except NRA – NETB – 10% of the Net

Income before Charitable Contribution.
449
REQUISITES FOR DEDUCTIBILITY:
a. Contribution or gift must be actually paid during the

taxable year.
Requirements/conditions (to be stated in the

return):
i. Name and address of organization;
ii. Approximate date and amount of the gift;
iii. If not in money, FMV of the gift;
iv. Signed by the responsible officer of the
corporation
450
MAY THE DEDUCTION OF CONTRIBUTION BE ALLOWED EVEN IN
THE ABSENCE OF SUPPORTING RECEIPTS?
YES. Attachment of receipts for contribution to the return

is merely an administrative device for the convenience and
facility of the BIR in verifying the income tax return and the
requirement cannot deprive the taxpayer of his right to
prove his contribution in accordance with the rules of
evidence. (Ramirez v. Com. CTA Case No. 544, 14 September
1959)
451
REQUISITES FOR DEDUCTIBILITY:
b. Must be given to the organization specified by Tax Code

or special law.
c. The net income of the institution must not inure to the

benefit of any member or individual.
452
CONTRIBUTIONS DEDUCTIBLE IN FULL
a. Donations to the government or political sub-division
including fully-owned government corporation to be
used exclusively in undertaking priority activities in:
i. education;
ii. health;
iii. youth and sports development;
iv. human settlement;
v. science and culture;
vi. economic development.
453
b. Donations to international organizations or foreign
institutions in compliance with agreements or treaties.
c. Donations to accredited non-government organizations.
i. Exclusively for:
a. Scientific;
b. Research;
454
c. Character building;
d. Youth and sports development;
e. Health;
f. Social welfare;
g. Cultural;
h. Charitable;
i. Any combination thereof.
455
ii. Utilized not later than 15th day of the 3rd month
following the close of its taxable year.
iii. Administrative expense must not exceed 30% of total

expenses.
iv. Upon dissolution, assets must be distributed to

another non-profit domestic corporation or to the state.
456
CONTRIBUTION SUBJECT TO LIMITATION (5% OR 10% OF NET
INCOME BEFORE CHARITABLE CONTRIBUTION)
a. Not in accordance with priority plan.
b. Conditions are not complied with.
c. Donation to the government of the Philippines or political
subdivision exclusive for public purposes.
d. Donations to domestic corporations organized exclusively for:
i. Religious;
ii. Charitable;
iii. Scientific;
iv. Cultural;
v. Educational;
vi. Rehabilitation of veteran;
vii. Social welfare. 457
DEDUCTIBLE UNDER SPECIAL LAWS (IN FULL)
a. IBP (PD No. 1810)
b. Development Academy of the Phils. (PD No. 205)
c. Agricultural Department of Southeast Asian Fisheries
Development Center (PD No. 292)
d. National Social Action Council (PD No. 294)
e. Task Force on Human Settlement
f. National Museum, Library and Archives (PD No. 373)
g. Ministry of Youth and Sports Development (PD No. 604)
458
h. Social Welfare, Cultural and Charitable Institution (PD
No. 507)
i. Museum of Philippine Costumes (PD No. 1388)
j. Intramuros Administration (PD No. 1616)
k. Lungsod ng Kabataan (PD No. 1631)
* Contributions to International Lions Club – not

deductible. (BIR Ruling, 16 July 1955)
459
l. Prizes and awards granted to athletes in local and
international sports tournaments and competitions held
in the Philippines or abroad and sanctioned by their
national sports associations.
460
RESEARCH AND DEVELOPMENT EXPENDITURE
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.
461
LIMITATIONS ON DEDUCTION – THE FOLLOWING EXPENDITURES
ARE NOT DEDUCTIBLE
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
b. Any expenditure paid or incurred for the purpose of

ascertaining the existence, location, extent, or quality of
any deposit of one or other mineral, including oil or gas.
462
EMPLOYER’S CONTRIBUTION TO PENSION TRUST
NATURE – applicable only to the employer on

account of its contribution to a private pension plan
for the benefit of its employee. Purely business in
character.
463
a) Employer must have established a pension or
retirement plan for the payment of reasonable pension
to its employees;
b) Pension plan is reasonable and actuarially sound;
c) Funded by the employer (employer contributes cash);
d) Amount contributed must no longer be subject to
control of the employer;
e) Payment has not yet been allowed as deduction.
464
• There is no need of special permit from the BIR to put up
a pension plan for the benefit of employees. However, the
provision of Section 118 of Rev. Regs. No. 2 must be
complied with. (BIR Ruling, 26 July 1956)
465
TREATMENT OF INCOME FROM PENSION PLAN
a. Not taxable to the employee.
b. In case any portion of the funds is reverted back to the

employer, said fund forms part of the income of the
employer during the taxable year of reversion.
466
DEDUCTIBLE PAYMENTS TO PENSION TRUSTS
a. Employer’s current liability – amount contributed during
the taxable year – ordinary and necessary expenses.
b. Employer’s liability for past services – one-tenth (1/10)

of the reasonable amount paid by the employer to
cover pension liability applicable to the preceding 10
years – payment to pension trust.
467
OPTIONAL STANDARD DEDUCTION (OSD) AS AMENDED
BY RA NO. 9504
a. Individual Taxpayers Entitled: Resident Citizen (RC), Non-
resident Citizen (NRC). Resident Alien (RA).
b. Individual Taxpayers Not Entitled: Non-Resident Alien

whether engaged in trade or business (NRA-ETB and
NRA – NETB).
c. Corporate Taxpayers Entitled: Domestic Corporation

(DC) and Resident Foreign Corp. (RFC)
468
BY RA NO. 9504
Limitation: 40% of:
Gross Income – DC and RFC
Gross sales or receipts – RC, NRC, RA
Option/Election. Taxpayer entitled must signify his intention

in his income tax return which shall be irrevocable for the
taxable year for which the return is made.
469
BY RA NO. 9504
General professional partnership and the partners may
avail of the OSD only once, either by the general
professional partnership or the partners comprising the
partnership. (RA No. 10963)
470
SPECIAL DEDUCTIONS ALLOWED TO INSURANCE
COMPANIES
1) Non-life insurance (domestic or foreign doing business
in the Philippines)
a) Net additions, if any, required by law to be made

within the year to reserve funds;
b) Sums other than dividends paid within the year on

policy and annuity contracts provided that the
released reserve be treated as income for the year
released.
471
COMPANIES
2) Mutual marine insurance companies (Gross income
from gross premiums less reinsurance):
a) Amounts repaid to policy holders on account of

premiums previously paid by them;
b) Interest paid upon those amounts between the date

of ascertainment and the date of its payment.
472
COMPANIES
3) Mutual insurance (other than mutual marine and
mutual life) – mutual fire and mutual employer’s liability
and mutual workmen’s compensation and mutual
casualty insurance companies:
a) Portion of the premium deposits returned to the

policy holders;
b) Portion of the premium deposits retained for

payment of losses, expenses and reinsurance
reserve.
473
COMPANIES
4) Assessment insurance (domestic or foreign)
a) Amount actually deposited with officers of the

government of the Philippines pursuant to law as
addition to guarantee or reserve funds.
474
ITEMS NOT DEDUCTIBLE
a. Personal, living or family expenses.
Reason: Non-business expenses.
b. Amounts paid out for new buildings or for permanent

improvements, or betterment made to increase the value of
any property or estate.
Exception: Intangible drilling and development cost incurred

in petroleum operations.
Reason: Capital expenditure – that results in obtaining

benefits of a permanent nature such as land, buildings, and
machinery. 475
EXAMPLES OF CAPITAL EXPENDITURES (REV.
REGS. NO. 2)
i. Cost of defending or perfecting title to property;
ii.Architect’s fee – part of the cost of building;
iii.
Commissions paid in selling securities – part of the cost;
iv.Expenses of the administrator of the estate – Attorney’s
fee and Executor’s commission – charge to the corpus
of the estate;
v. Corporate expenses for reorganization such as
incorporation fees, attorney’s fee and accountant
charge – amortize.
476
c. Amount expended in restoring property or in making
good the exhaustion thereof for which an allowance has
been made.
Reason: Capital Expenditure
d. Premiums paid on a 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.
477
i. Premiums paid by a family corporation on the life
insurance policy covering the life of its president where
the wife is the beneficiary – NOT DEDUCTIBLE,
corporation being indirectly beneficiary under the policy.
(BIR Ruling, 10 Nov. 1960)
ii. Premiums paid by a corporation on life insurance policies

covering the lives of two executives naming each other
beneficiary – DEDUCTIBLE because the corporation is not
directly and indirectly the beneficiary of the policies. (BIR
Ruling, 27 May 1953)
478
e) Losses from sales or exchanges of property between
related taxpayers.
Reason/Purpose:
i. Members of the same Family – to prevent avoidance
of income tax by means of purported or simulated sale
or exchange.
ii. Others – the law presumes that the transactions are
devoid of free bargain between the seller and the buyer.
It is immaterial whether the sale or exchange is bona
fide or not. (Lake Irrigation Co., Inc. V. Com. 128F [2],
418)
479
ESTATES AND TRUSTS
480
ESTATE
- refers to the mass of properties left by a deceased
person.
1. Taxable estate entity – estate under administration or

judicial settlement.
2. Hence, if not under judicial testamentary or intestate

proceedings, it is not taxable entity. The income thereof
is taxable directly to the heir or beneficiary.
481
ESTATE
3. Subject to income tax in the same manner as
individuals. Its own status is dependent on the status of
the decedent immediately prior to his death.
a. Personal exemption – Ᵽ20,000,00
i. If the taxpayer should die during the taxable

year, his estate may still claim the personal and
additional exemptions for himself;
482
ESTATE
ii. Distribution to the heirs during the taxable year
is deductible from estate income which
distributed share would then form part of the
recipient’s heirs’ respective income. Where no
such distribution to the heirs is made during the
taxable year that the income is earned, which is
then subject to income tax payment by the
estate, the subsequent distribution thereof after
tax, is no longer taxable on the part of its
recipient. (BIR Ruling No. 233-86, 7 Nov. 1986)
483
TRUST
- right to the property, whether real or personal, held by
one person for the benefit of another.
1. Taxable Trusts:
a. Trust, the income of which is to be accumulated;
b. Trust, in which the fiduciary may, at his discretion,

either distribute or accumulate the income.
484
RULES ON TAXABILITY
a) Taxable to the beneficiary – income of the trust for the
taxable year which is to be distributed to the
beneficiaries;
b) Taxable to trustee or fiduciary – income of the trust

which is to be accumulated or held for future
distribution, whether consisting of ordinary income or
gain from sale of assets included in the “corpus” of the
estate (revocable trust)
485
RULES ON TAXABILITY
Exceptions:
i. Revocable trust – taxable to grantor or trustee;

ii. Income is held for the benefit of the grantor –
taxable to the grantor.
“The income of the trust shall be included in

computing the taxable income of the grantor where the
power to revest title to any part of the corpus of the
trust is vested:
486
RULES ON TAXABILITY
1) In the grantor, either alone or in conjunction with
any person not having a substantial adverse interest
in the disposition of the corpus or the income
therefrom; or
2) In any person not having a substantial adverse

interest in the disposition of the corpus or the
income therefrom.”
487
COMPUTATION OF TAX ON ESTATE AND TRUST
1) Allowable deductions same as individual
2) Special deductions
a) Personal exemption – P20,000.00.

b) Amount of income which is to be distributed
currently to the beneficiaries.
c) Amount of income collected by a guardian of an
infant which is to be held or distributed as the court
may direct. However, the amount so
488
COMPUTATION OF TAX ON ESTATE AND TRUST
allowed as deduction shall be included in computing
the net income of the heir, legatee or beneficiary.
Trust administered in a foreign country – deductions

in (a) (b) and (c) are not allowed.
489
FORMULA:
Consolidated gross income - Pxxx

Less: Consolidated deduction - xxx
Consolidated net income - Pxxx
Less: Personal exemption P20,000 - xxx
Taxable income of several trusts - Pxxx
Apply 5-32% (year 2000)
Tax due - Pxxx
490
SPECIAL TOPICS IN
INCOME TAXATION
491
DETERMINATION OF SOURCE ACCORDING TO
KINDS OF INCOME
KINDS OF INCOME SOURCE (TAX SITUS)

1. Service or compensation Place of performance of service
2. Rent Location of property (real or personal)
3. Royalties (copyright, patent, design, trademark, etc. Place of use of intangibles
4. Merchandising Place of sale
5. Gain on sale of personal property Place of sale
6. Gain on sale of real property Location of property
7. Mining income Location of the mines
8. Farming income Place of farming activities
9. Gain on sale of domestic stock Income within the Philippines
10. Interest Residence of the debtor
492
TAX SITUS OF THREE POSSIBLE SOURCES OF INCOME
Income from labor (services) – the place where the labor
is done;
Income from capital – the place where the capital is

employed;
Income from sale of capital assets – the place where the

sale is made.
493
TAX SITUS
11. Gain on sale of transport document – Place of activity
that produces income
The source of an income is the property, activity or

service that produced the income. For the income to be
considered as coming from the Philippines, it is sufficient
that the income is derived from activity within the
Philippines. In Commissioner v. BOAC, 149 SCRA 395, the
sale of tickets in the Philippines is the activity that produced
the income. The tickets exchanged hands here and
payments for fares were
494
TAX SITUS
also made here in the Philippine currency. 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 situs of income taxation. Admittedly, BOAC was an
offline international airline at the time
495
TAX SITUS
pertinent to this case. The text of taxability is the “source”
and the source of an income is that activity (sale of airline
tickets) which produced the income. Unfortunately, the
passage documents were sold in the Philippines and the
revenue therefrom was derived from a business activity
regularly pursued within the Philippines xxx. The word
“source” conveys one essential idea, that of origin, and the
origin of the income herein is the Philippines.
However, Rev. Regs. No. 15-2002, implementing
496
TAX SITUS
Section 28A(3), provides that in computing “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.
497
TAX SITUS
12. Manufacturing
a) Produced in whole within and sold within – income

purely within
b) Produced in whole without and sold without – income
purely without
c) Produced within and sold without – income partly
within and income partly without
d) Produced without and sold within – income partly
within and income partly without
498
TAX SITUS
From the income partly within and partly without, income purely within
is derived as follows:
Net income Value of property within

------------------ x ------------------------------------ = Pxxx
2 Value of property within
and without
Add:
Net income Gross sales within
------------------ x ------------------------------------ = Pxxx
2 Gross sales within -----------
and without
Income purely within = ------------------------------------- Pxxx
499
TAX SITUS
13. Dividend income from:
a. Domestic corporation – Income within (Phil.)
b. Foreign corporation
If for the 3 year period preceding the declaration of such dividend,

the ratio of such corporation’s Philippine income to the world
(total) income was:
a. Less than 50% - entirely without

b. 50% to 85% - Proportionate
c. More than 85% - Entirely within (Phil.) 500
TAX SITUS
FORMULA (PROPORTIONATE – 50% TO 85%)
Phil. Gross Income Dividend received

------------------------------ x within (Phil.) = Income
Entire Gross Income
501
CAPITAL TRANSACTIONS
Definition of capital asset. The NIRC (Sec. 39) defines capital
assets by exclusion. The term “capital asset” means
property held by the taxpayer (whether or not connected
with his trade or business) but does not include the
following (these are ordinary assets):
a) Stock in trade of the taxpayer or other property of a

kind which would properly be included in the inventory
if on hand at the close of the taxable year (raw
materials, work in process, finished goods, supplies);
502
b) Property held by the taxpayer primarily for sale for
customers in the ordinary course of trade or business.
Requisites:
i. Property must be held primarily for sale.

ii. Property must be held for sale to customers.
iii. Property must be sold in the ordinary course of
taxpayer’s trade or business.
503
c) Property used in trade or business of a character which
is subject to the allowance for depreciation.
d) Real property used in trade or business of the taxpayer.
504
i. Properties used or connected with trade or business
which are considered capital assets:
* Accounts receivable
* Securities held as investments
* Goodwill
Reason: Not included in the 4 categories of

ordinary assets.
505
ii. Sale of a business to a corporation – Ordinary and
capital assets. Consider the assets involved in the sale.
iii. Sale of partner’s interest in a partnership – capital

asset.
Reason: Not included in the category of ordinary assets.
506
iv. Car used in trade or business and for personal
purpose –
* One-half of the value – ordinary asset – used in

business
* One-half of the value – capital asset – not used in

business.
507
SPECIAL RULES ON CAPITAL TRANSACTIONS
INDIVIDUAL CORPORATE
a. HOLDING / x
PERIOD RULE
b. LOSS LIMITATION / except

RULE trust company and bank
c. NET CAPITAL LOSS / x

CARRY OVER
508
PERCENTAGE OF GAIN OR LOSS RECOGNIZED
100% if the asset was held for not more than 12 months
50% if the asset was held for more than 12 months
Holding period – the length of time the asset was held by the taxpayer.
It covers the period from the date of acquisition of the assets to the
date of sale.
In computing the period, the day on which the property was acquired is
excluded, the day on which it was disposed of is included.
509
LOSS LIMITATION RULE
- capital losses are allowed only to the extent of capital

gains. Therefore, capital losses are not deductible from
ordinary gains.
Reason: To ensure the matching of costs against revenues

consistent with the rule that only business expenses are
deductible from gross income. Capital loss is not a business
expense.
510
SETTLED RULES:
a) Ordinary loss is deductible from ordinary gain;

b) Capital loss is deductible from capital gain;
c) Capital loss is not deductible from ordinary gain;
d) Ordinary loss is deductible from capital gain.
Net capital gain – excess of capital gain over capital loss.
Net capital loss – excess of capital loss over capital gain.
511
NET CAPITAL LOSS (CARRY OVER)
- shall be treated in the succeeding taxable year as loss

from the sale or exchange of capital asset held for not
more than 12 months.
- Limitation – not in excess of the taxable (net) income in

the preceding year or the lower amount between the
net income and the capital loss.
- * The foregoing rules are not applicable to sale of shares

of stock and real property.
512
SPECIAL CAPITAL TRANSACTIONS
a. Short sale. A transaction in which a speculator sells

securities which he does not own in anticipation of a
decline in its price. It represents a debt contracted in
goods rather than cash. Should the price of the
securities decline, the seller makes profit. If the price
goes up, he incurs the loss.
513
SPECIAL CAPITAL TRANSACTIONS
b. Securities becoming worthless.
Requisites:
i. Ascertained to be worthless and charged off within

the taxable year;
ii. Worthlessness occurred during the taxable year;
iii. Deductible on the last day of the taxable year.
*If the loss is due to fluctuation of price in market,
the loss is not deductible until finally disposed of.
514
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. (China Banking
Corporation v. CA, 236 SCRA 178)
515
INCOME TAX RULES ON
DEALINGS IN PROPERTY
CAPITAL GAINS FROM SALE OR

OTHER DISPOSITION OF REAL
PROPERTY
516
TRANSACTION COVERED
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.
517
INDIVIDUAL TAXPAYERS (SEC. 24[D])
a) Final tax rate: 6%
b) Basis: Gross Selling Price or zonal value (current fair
market value), whichever is higher.
c) Taxpayer covered: Citizen or resident alien.
d) Option: apply the tax rates under Sec. 24(A) – 5% to 32%
if the buyer is the government or any of its political
subdivisions or agencies or GOCCs.
e) Payment: 30 days after the sale.
f) Tax avoidance scheme:
i. The proceeds of the sale must be fully utilized in
acquiring or constructing a new principal residence;
518
ii. BIR should be notified of the intention to avail of the
exemption within 30 days from the date of sale or
disposition;
iii. Acquisition or construction of new principal
residence must be made within 18 months from the
date of sale or disposition;
iv. The tax exemption can only be availed of once every
10 years;
v. The buyer/transferee must withhold from the seller
and deduct from the selling price the 6% capital gains
tax which must be deposited in cash
519
or manager’s check with an Authorized Agent Bank
(AAB) under an ESCROW Agreement between the
Revenue District Officer, the seller, transferee and the
AAB.
Definition of ESCROW Agreement – refers to a scroll, writing

or deed, delivered by the grantor, promisor or obligor into
the hands of a third 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. (Rev. Regs. No. 17-2003)
520
vi. After depositing the 6% capital gains tax, the
buyer/transferee and the seller shall jointly file, within
30 days from the date of the sale or disposition of the
principal residence, the Final Capital Gains Tax Return.
521
CORPORATE TAXPAYERS
a. Only domestic corporation is subject to 6% of the gross
selling price or zonal value (fair market value) whichever
is higher. (Section 27[D][5])
b. Real property: lands and/or buildings which are not
actually used in the business.
c. Payment: 30 days following the sale or disposition.
* Income realized from the sale of machineries and
equipment is subject to normal corporate income. (SMI-
Ed Phils. Technology Inc. v. CIR, 739 SCRA 691)
522
PAYMENT OF CAPITAL GAINS TAX ON EXTRAJUDICIAL
FORECLOSURE SALE OF CAPITAL ASSETS
a. In case the mortgagor exercises his right of redemption

within 1 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. xxx
b. In case of non-redemption, the capital gains [tax] on the

foreclosure sale imposed under Sections 24[D](1) and
27[D](5) of the Tax Code of 1997 shall
523
PAYMENT OF CAPITAL GAINS TAX ON EXTRAJUDICIAL
FORECLOSURE SALE OF CAPITAL ASSETS
become due based on the bid price of the highest

bidder but only upon the expiration of the 1 year period
of redemption provided for under Section of Act No.
3135, as amended by Act No. 4118, and shall be paid
within 30 days from the expiration of the said 1 year
redemption period. (RR 4-99 cited in Supreme
Transliner, Inc. v. BPI Family Savings Bank, Inc., 644 SCRA
59)
524
GAINS AND LOSSES FROM DEALINGS IN PROPERTY
CONCEPT
Include all gains or losses derived from the disposition of

property (real, personal or mixed) for MONEY in case of
SALE, or for PROPERTY in case of EXCHANGE, or from a
combination of both sale and exchange.
525
MEASURE OF INCOME OR LOSS
Selling Price - Pxxx
Less: Cost - xxx
--------
Gain (loss) - Pxxx
====
Two conditions:
1. The property received in exchange is essentially

different from the property disposed of;
2. The property received has a market value.
526
TAX-EXEMPT SALES OR EXCHANGES “NO GAIN, NO LOSS
RECOGNIZED” (SECTION 40[C][2])
Exceptions to the rule that the entire amount of gain or loss shall be
recognized;
1. Between corporation which are parties to the merger or

consolidation (Property for Stock).
2. Between a stockholder of a corporation party to a merger or
consolidation and the other party corporation (Stock for Stock).
3. Between a security holder of a corporation party to a merger or
consolidation and the other corporation (Securities for Securities or
Stock)
4. Transfer or exchange of property for stock resulting in acquisition of
corporate control (Property for Stock).
527
“GAIN RECOGNIZED, LOSS NOT RECOGNIZED RULE”
APPLIES TO THE FOLLOWING TRANSACTIONS:
1. Transactions not solely in kind (Exchanges of property,
stocks or securities plus cash or money);
2. Illegal transactions;
3. Transaction between related taxpayers:
a. Members of a family;
b. Corporation and individual – Individual owned more
than 50% of the outstanding capital stock of the
corporation;
528
“GAIN RECOGNIZED, LOSS NOT RECOGNIZED RULE”
APPLIES TO THE FOLLOWING TRANSACTIONS:
c. Two corporations – more than 50% of the outstanding
capital stock is owned by the same individual;
d. Parties to a trust – trustor, trustee, beneficiary and
fiduciary.
4. Wash sale transaction (61-day sale)
• Purchase of substantially identical stock or securities
beginning 30 days before the date of sale and ending 30 days
thereafter.
• Seller must not be a dealer in securities or stock.
• It covers acquisitions through a taxable exchange and the
making of an option contract.
529
TAXPAYERS REQUIRED TO FILE
INCOME TAX RETURNS
530
INDIVIDUALS
1. Resident citizens receiving income from sources within
or outside the Philippines:
a) Individuals deriving compensation income from two

or more employers, concurrently or successively at
anytime during the taxable year;
b) Employees deriving compensation income

regardless of the amount, whether from a single or
several employers during the calendar year, the
income tax of which has not been withheld
531
INDIVIDUALS
correctly (i.e., tax due is not equal to the tax withheld)
resulting to collectible or refundable return;
c) Individuals deriving other non-business, non-

professional related income in addition to
compensation income not otherwise subject to a final
tax;
d) Individuals receiving purely compensation income from

a single employer, although the income of
532
INDIVIDUALS
which has been correctly withheld, but whose spouse is
not entitled to substituted filing;
2. Non-resident citizens receiving income from sources

within the Philippines;
3. Citizens working abroad receiving income from sources

within the Philippines;
4. Aliens, whether resident or not, receiving income from

sources within the Philippines.
533
INDIVIDUALS
RA No. 10963 incorporated the system of substituted
filing of ITR under the following conditions:
1. Individual derives solely compensation income;

2. One employer in the Philippines;
3. Income tax withheld is equal to income tax due;
4. Employer filed information return (BIR Form 1604 C)
showing the income tax withheld on employees
compensation income. This is tantamount to substituted
filing of ITR by employee.
534
INDIVIDUALS
An individual whose taxable income does not exceed
P250,000.00 shall not be required to file an ITR. (RA No.
10963)
Minimum wage earners are not required to file an ITR
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. He is not required to file an ITR.
(Sec. 5, RA No. 9504)
535
CORPORATIONS NO MATTER HOW CREATED OR
ORGANIZED INCLUDING GENERAL PROFESSIONAL
PARTNERSHIPS
1. Domestic corporations receiving income from sources

within and outside the Philippines;
2. Foreign corporations receiving income from sources

within the Philippines.
536
ESTATES AND TRUSTS ENGAGED IN TRADE OR BUSINESS
1. Estate under judicial settlement;
2. Trust – irrevocable, both as to corpus (trust property)

and as to income earnings.
537

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SALIENT FEATURES OF

A. Schedular Tax Treatment

B. Net Income Taxation

1. Resident citizen (RC)

C. Gross Income Taxation

Non-resident alien not engaged in trade

D. Income Tax Situs

A. Global Tax Treatment

1. It generally provides for uniform rules.

B. Net Income Taxation

C. Gross Income Taxation

D. Income Tax Situs

A. Pay as You File System

1. Individuals – upon filing of their income tax

2. Corporations – upon filing of their quarterly

B. Creditable Withholding Tax System

1. Withholding agent (source) – withholds the tax and

2. Tax withheld – creditable against income tax due

C. Final Withholding Tax System

1. Withholding agent (source) – withholds the tax

2. Tax withheld – final settlement of the tax liability

D. Operational Rules of the Withholding Tax System

1. Withholding agent – the payor, agent of the

- It is a payee by fiction of law;

1. Withholding agent – As agent, it is personally liable for

2. Taxpayer – the person subject to tax imposed by law.

In a broad sense, income means all wealth

- gain derived from capital, or from labor, or from

- amount of money coming to a person or corporation

- money value of the net accretion to one’s economic

Wealth Service of wealth

Tree (property) Fruit (metaphorical language)

Income connotes a narrower concept limited only to gain

Revenue refers to all funds or income derived by the

Source of income is any property, activity or service

- Under the Tax Code, however, income derived from

1. Treasure found or punitive damages representing profits

2. Amount received by mistake (Javier v. CA, 199 SCRA 824;

- Ifa foreign bank erroneously remitted US $1 million

4. Payment of usurious interest;

5. Illegal gains – gambling, theft, embezzlement,

6. Tax refund – must be claimed as deduction from

7. Bad debt recovery – must be claimed as deduction

* Recovery of bad debt and tax refund finds a

1. It is a tax on all yearly profits arising from property,

2. It is based on income, either gross or net, realized in one

3. Excise tax – it is not levied upon the person or property but

4. Functions of income tax:

a. to provide large amounts of revenues;

5. The basis of the right of the government to tax

a) Protection theory. It dictates that when the flow

b) Theory of favorable business climate. Domestic

1. There must be gain or profit, whether in cash or its

2. The gain must be realized or received. This implies that not

3. The gain must not be excluded by law or treaty from

a. Mere increase in the value of property is not income

b. Increases in the taxpayer’s net worth are not taxable

c. But if the increase in the net worth of a taxpayer is

d. Receipt includes constructive receipt.

- Income which is credited to the account of and

1. Matured interest coupons due and demandable (convertible into

- In Filipinas Synthetic Corporation v. CA, 316 SCRA 480,

- For taxpayer using the accrual method, the determinative