Interest on Foreign Loans

SEC. 28. Rates of Income Tax on Foreign Corporations.

(B) Tax on Nonresident Foreign Corporation.
(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation.

(b) Intercorporate Dividends. - A final withholding tax at the rate of fifteen

percent (15%) is hereby imposed on the amount of cash and/or property dividends
received from a domestic corporation, which shall be collected and paid as provided in
Section 57(A) of this Code, subject to the condition that the country in which the
nonresident foreign corporation is domiciled, shall allow a credit against the tax due
from the nonresident foreign corporation taxes deemed to have been paid in the
Philippines equivalent to twenty percent (20%), which represents the difference
between the regular income tax of thirty-five percent (35%) and the fifteen percent
(15%) tax on dividends as provided in this subparagraph: Provided, That effective
January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent
(15%), which represents the difference between the regular income tax of thirty
percent (30%) and the fifteen percent (15%) tax on dividends;

1
CIR vs P&G 204 SCRA 377

Facts:
Procter and Gamble Philippines declared dividends payable to its parent company and sole
stockholder, P&G USA. Such dividends amounted to Php 24.1M. P&G Phil paid a 35% dividend
withholding tax to the BIR which amounted to Php 8.3M It subsequently filed a claim with the
Commissioner of Internal Revenue for a refund or tax credit, claiming that pursuant to Section
24(b)(1) of the National Internal Revenue Code, as amended by Presidential Decree No. 369,
the applicable rate of withholding tax on the dividends remitted was only 15%.

Issue:
Whether or not P&G Philippines is entitled to the refund or tax credit

Ruling:
YES. P&G Philippines is entitled. Sec 24 (b) (1) of the NIRC states that an ordinary 35% tax rate
will be applied to dividend remittances to non-resident corporate stockholders of a Philippine
corporation. This rate goes down to 15% ONLY IF he country of domicile of the foreign
stockholder corporation “shall allow” such foreign corporation a tax credit for “taxes deemed
paid in the Philippines,” applicable against the tax payable to the domiciliary country by the
foreign stockholder corporation. However, such tax credit for “taxes deemed paid in the
Philippines” MUST, as a minimum, reach an amount equivalent to 20 percentage points which
represents the difference between the regular 35% dividend tax rate and the reduced 15% tax
rate. Thus, the test is if USA “shall allow” P&G USA a tax credit for ”taxes deemed paid in the
Philippines” applicable against the US taxes of P&G USA, and such tax credit must reach at
least 20 percentage points. Requirements were met.

Since the US Congress desires to avoid or reduce double taxation of the same income stream,
it allows a tax credit of both (i) the Philippine dividend tax actually withheld, and (ii) the tax
credit for the Philippine corporate income tax actually paid by P&G Philippines but “deemed
paid” by P&G USA.

Moreover, under the Philippines-United States Convention “With Respect to Taxes on

Income,” the Philippines, by treaty commitment, reduced the regular rate of dividend tax to
a maximum of 20% of he gross amount of dividends paid to US parent corporations, and
established a treaty obligation on the part of the United States that it “shall allow” to a US
parent corporation receiving dividends from its Philippine subsidiary “a [tax] credit for the
appropriate amount of taxes paid or accrued to the Philippines by the Philippine [subsidiary].

2
Income covered by Tax Treaties

COMMISSIONER OF INTERNAL REVENUE vs. MIRANT (PHILIPPINES) OPERATIONS,

CORPORATION- Tax Credit and Tax Refund

FACTS:

Mirant filed its final adjusted Annual Income Tax Return for fiscal year ending 1999 declaring
a net loss. It then amended the said return this time reflecting an increased net loss and
showing that it opted to carry over as tax credit its overpayment to the succeeding taxable
year. This excess tax credit was unutilized in 2000 as Mirant still reported a net loss. Mirant
then filed a claim for refund of its excess creditable income tax for 1999.

ISSUE:

Can Mirant claim for refund its excess credits from 1999?

HELD:

NO. Mirant’s choice to carry over its 1999 excess income tax credit to succeeding taxable
years is irrevocable, regardless of whether it was able to actually apply the said amount to a
tax liability. It is a mistake to understand the phrase "for that taxable period" as a prescriptive
period for the irrevocability rule – i.e., that since the tax credit in this case was acquired in
1999, and Respondent opted to carry it over to 2000, then the irrevocability of the option to
carry over expired by the end of 2000, leaving Respondent free to again take another option
as regards its 1999 excess income tax credit. The Court ruled that this interpretation
effectively renders nugatory the irrevocability rule.

3
 Deutsche Bank AG Manila Branch v. Commissioner of Internal Revenue
GR Number 188550

Facts:
Pursuant to the National Internal Revenue Code of 1997, on October 21, 2003, the petitioner
remitted to the respondent the amount of Php 67,688,553.51, representing fifteen (15)
percent of the branch profit remittance tax (BPRT) on its regular banking unit (RBU) net
income remitted to the Deutsche Bank of Germany (DB Germany) for 2002 and prior taxable
years.

Believing that they made an overpayment of the BPRT, on October 4, 2005, the petitioner filed
with the BIR Large Taxpayers Assessment and Investigation Division an administrative claim
for refund or a tax credit certificate representing the alleged excess BPRT paid (amount of
Php 22,562,851.17). The petitioners also requested from the International Tax Affairs Division
(ITAD) for a confirmation of its entitlement to a preferential tax rate of 10% under the RP-
Germany Tax Treaty.

Because of the alleged inaction of the BIR on the administrative claim, on October 18, 2005,
the petitioner filed a petition for review with the Court of Tax Appeals (CTA), reiterating its
claim for refund or tax credit certificate representing the alleged excess BPRT paid. The claim
was denied on the ground that application for tax treaty relief was not filed with ITAD prior to
the payment of BPRT, thereby violating the fifteen-day period mandated under Section III,
paragraph 2 of the Revenue Memorandum Order No. 1-2000. Also, the CTA Second Division
relied on an en banc decision of the CTA that before the benefits of a tax treaty may be
extended to a foreign corporation, the latter should first invoke the provisions of the tax
treaty and prove that they indeed apply to the corporation (Mirant Operations Corporation v
Commissioner of Internal Revenue).
Issue:
Whether or not the failure to strictly comply with the provisions of RMO No. 1-2000 will
deprive persons or corporations the benefit of a tax treaty.
Ruling:
No. The constitution provides for the adherence to the general principles of international law
as part of the law of the land (Article II, Section 2). Every treaty is binding upon the parties, and
obligations must be performed (Article 26, Vienna Convention on the Law on Treaties). There

4
is nothing in RMO 1-2000 indicating a deprivation of entitlement to a tax treaty for failure to
comply with the fifteen-day period. The denial of availment of tax relief for the failure to apply
within the prescribed period (under the administrative issuance) would impair the value of
the tax treaty. Also, the obligation to comply with the tax treaty must take precedence over
the objective of RMO 1-2000 because the non-compliance with tax treaties would have
negative implications on international affairs and would discourage foreign investments.

Dispositive:
The petition was granted, the CTA en banc decision was set aside and reversed. The
respondent was ordered to refund or issue a tax credit certificate (the amount of Php
22,562,851.17) in favor of the petitioner.

5
Withholding Tax

TITLE II
TAX ON INCOME

CHAPTER I - DEFINITIONS

Section 22. Definitions - When used in this Title:

(K) The term 'withholding agent' means any person required to deduct and
withhold any tax under the provisions of Section 57.

6
Final Withholding Tax at Source

Section 57. Withholding of Tax at Source. -

(A) Withholding of Final Tax on Certain Incomes. - Subject to rules and regulations the
Secretary of Finance may promulgate, upon the recommendation of the
Commissioner, requiring the filing of income tax return by certain income payees, the
tax imposed or prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2),
25(A)(3), 25(B), 25(C), 25(D), 25(E), 27(D)(!), 27(D)(2), 27(D)(3), 27(D)(5), 28 (A)(4),
28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4),
28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of this Code on specified items of
income shall be withheld by payor-corporation and/or person and paid in the same
manner and subject to the same conditions as provided in Section 58 of this Code.

7
COMMISSIONER OF INTERNAL REVENUE VS. SMART COMMUNICATION, INC.- Tax Refund

FACTS:

Smart entered into an Agreement with Prism, a nonresident foreign corporation domiciled in
Malaysia, whereby Prism will provide programming and consultancy services to Smart.
Thinking that the payments to Prism were royalties, Smart withheld 25% under the RP-
Malaysia Tax Treaty. Smart then filed a refund with the BIR alleging that the payments were
not subject to Philippine withholding taxes given that they constituted business profits paid
to an entity without a permanent establishment in the Philippines.

ISSUE:

Does Smart have the right to file the claim for refund?

HELD:

YES. The Court reiterated the ruling in Procter & Gamble stating that a person “liable for tax”
has sufficient legal interest to bring a suit for refund of taxes he believes were illegally
collected from him. Since the withholding agent is an agent of the beneficial owner of the
payments (i.e., nonresident), the authority as agent is held to include the filing of a claim for
refund. The Silkair case was held inapplicable as it involved excise taxes and not withholding
taxes.

Smart was granted a refund given that only a portion of its payments represented royalties
since it is only that portion over which Prism maintained intellectual property rights and the
rest involved full transfer of proprietary rights to Smart and were thus treated as business
profits of Prism.

8
Creditable Withholding Tax

Section 57 of the NIRC, as amended, is hereby further amended to read as follows:

"Sec. 57. Withholding of Tax at Source. -

(B) Withholding of Creditable Tax at Source. - The Secretary of Finance may, upon the
recommendation of the Commissioner, require the withholding of a tax on the items of
income payable to natural or juridical persons, residing in the Philippines, by payor-
corporation/persons as provided for by law, at the rate of not less than one percent (1%) but
not more than thirty-two percent (32%) thereof, which shall be credited against the income
tax liability of the taxpayer for the taxable year: Provided, That, beginning January 1, 2019, the
rate of withholding shall not be less than one percent (1%) but not more than fifteen percent
(15%) of the income payment.

9
FILIPINAS SYNTHETIC FIBER CORPORATION vs. COURT OF APPEALS, COURT OF TAX
APPEALS and COMMISSIONER OF INTERNAL REVENUE

FACTS:
Before the Court are two consolidated Petitions for Review on Certiorari under Rule 45 of the
Revised Rules of Court seeking to set aside the Decisions of the Court of Appeals. The
controversies arose when Filipinas Synthetic Fiber Corporation, a domestic corporation
received a demand letter from the Commissioner of Internal Revenue assessing it for
deficiency withholding tax with interest and compromise penalties. The basis of such
assessment was two BIR Rulings and a CTA decision stating that: "For Philippine internal
revenue tax purposes, the liability to withhold and pay income tax withheld at source from
certain payments due to a foreign corporation is at the time of accrual and not at the time of
actual payment or remittance thereof" and "the withholding agent/corporation is obliged to
remit the tax to the government since it already and properly belongs to the government.”
Since the taxpayer failed to pay the withholding tax on interest, royalties, and guarantee fee
at the time of their accrual and in the books of the corporation the aforesaid assessment is
therefore legal and proper. A protest was filed which was denied.

ISSUE:
Whether the liability to withhold tax at source on income payments to non-resident
foreign corporations arises upon remittance of the amounts due to the foreign creditors or
upon accrual thereof.

HELD:
It is petitioner's submission that the withholding taxes on the said interest income and
royalties were paid to the government when the subject interest and royalties were actually
remitted abroad.

Petitioner adopted the accrual basis method of accounting. Under the accrual basis
method of accounting, income is reportable when all the events have occurred that fix the
taxpayer's right to receive the income, and the amount can be determined with reasonable
accuracy. Thus, it is the right to receive income, and not the actual receipt, that determines
when to include the amount in gross income." 5 Gleanable from this notion are the following
requisites of accrual method of accounting, to wit: "(1) that the right to receive the amount
must be valid, unconditional and enforceable, i.e., not contingent upon future time; (2) the
amount must be reasonably susceptible of accurate estimate; and (3) there must be a
reasonable expectation that the amount will be paid in due course."

In the case at bar, the Court concurred in the finding by the Court of Appeals "that
there was a definite liability, a clear and imminent certainty that at the maturity of the loan

10
contracts, the foreign corporation was going to earn income in an ascertained amount, so
much so that petitioner already deducted as business expense the said amount as interests
due to the foreign corporation.

11
G.R. No. 206019, March 18, 2015

PHILIPPINE NATIONAL BANK, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE,

Respondent.

FACTS:
Gotesco is a Filipino corporation engaged in the real estate business. It entered into a
syndicated loan agreement with petitioner Philippine National Bank (PNB) and three (3) other
banks. To secure the loan, Gotesco mortgaged a six-hectare expanse in favor of PNB. Gotesco
defaulted on its loan obligations. PNB then foreclosed the mortgaged property. A certificate
of sale was then issued in favor of PNB. As PNB was preparing for the consolidation of its
ownership over the foreclosed property, it paid the BIR documentary stamp tax. PNB also
withheld and remitted to the BIR withholding taxes equivalent to 6% of the bid price. Pending
the issuance of the Certificate Authorizing Registration, the BIR informed PNB that it is
imposing interests, penalties and surcharges on capital gains tax and on documentary stamp
tax. To facilitate the release of the Certificate Authorizing Registration, petitioner paid all the
surcharges, interests and penalties assessed against it. Later on, PNB claimed that what it paid
to the BIR was not entirely due. This prompted PNB to file for an administrative claim for the
refund of the excess withholding taxes with the BIR. PNB claimed that it inadvertently applied
the 6% creditable withholding tax rate on the sale of real property classified as ordinary asset,
when it should have applied 5%. Therefore, PNB maintained that it erroneously withheld and
remitted to the BIR excess taxes of 12,400,004.71. PNB filed another claim for refund claiming
erroneous assessment and payment of the surcharges, penalties and interests. Petitioner
then filed its corresponding Petition for Review before the CTA.
The CTA Special First Division ordered the CIR to refund to PNB P77,172,555.28,
representing its claim for refund of interests, surcharges and penalties on capital gains taxes
and documentary stamp taxes for the year 2003. However, the CTA First Division denied PNB’s
claim for the refund of excess creditable withholding taxes for insufficiency of evidence. PNB
then filed a motion for reconsideration. The First Division denied PNB’s Motion for
Reconsideration mainly because there were no documents or schedules to support its claims.
The CTA stated that PNB should have presented the Certificate of Creditable Tax Withheld at
Source (BIR Form No. 2307) issued to Gotesco in relation to the creditable taxes withheld
reported in its 2003 ITR. BIR Form No. 2307 will confirm whether or not that the amount being
claimed by PNB was indeed not utilized by Gotesco to offset its taxes. PNB filed an appeal
before the CTA En Banc by way of a Petition for Review. However, the CTA en banc denied
PNB’s Petition for Review.

12
ISSUE:
Whether or not PNB is entitled to the refund of creditable withholding taxes erroneously paid
to the BIR.
HELD:
Yes. The petition is impressed with merit. PNB has presented sufficient evidence showing its
entitlement to the refund of the excess creditable taxes it erroneously withheld and paid to
the BIR. Although PNB was not able to submit Gotesco’s BIR Form No. 2307, the Court is
persuaded and so declares that PNB submitted evidence sufficiently showing Gotesco’s non-
utilization of the taxes withheld subject of the refund. In this case, PNB was able to establish,
through the evidence it presented, that Gotesco did not in fact use the claimed creditable
withholding taxes to settle its tax liabilities, to reiterate: (1) Gotesco’s 2003 Audited Financial
Statements, which still included the mortgaged property in the asset account “Properties and
Equipment,” proving that Gotesco did not recognize the foreclosure sale and therefore, the
payment by PNB of the creditable withholding taxes corresponding to the same; (2) Gotesco’s
2003 ITRs, which the CTA Special First Division required to show that the excess creditable
withholding tax claimed for refund was not used by Gotesco, along with the 2003 Schedule of
Prepaid Tax which itemized in detail the withholding taxes claimed by Gotesco for the year
2003 amounting to P6,014,433.00; (3) the testimony of Gotesco’s former accountant, proving
that the amount subject of PNB’s claim for refund was not included among the creditable
withholding taxes stated in Gotesco’s 2003 ITR; and(4) the Withholding Tax Remittance
Returns (BIR Form 1606) proving that the amount of P74,400,028.49 was withheld and paid
by PNB in the year 2003. Ergo, the evidence on record sufficiently proves that the claimed
creditable withholding tax was withheld and remitted to the BIR, that such withholding and
remittance was erroneous, and that the claimed creditable withholding tax was not used by
Gotesco to settle its tax liabilities.

DOCTRINE: In claims for excess and unutilized creditable withholding tax, the submission of BIR
Forms 2307 is to prove the fact of withholding of the excess creditable withholding tax being
claimed for refund. Hence, the probative value of BIR Form 2307, which is basically a statement
showing the amount paid for the subject transaction and the amount of tax withheld therefrom,
is to establish only the fact of withholding of the claimed creditable withholding tax. There is
nothing in BIR Form No. 2307, which would establish either utilization or non-utilization, as the
case may be, of the creditable withholding tax.

13
Return and Payment of Tax

Section 58 of the NIRC, as amended, is hereby further amended to read as follows:

Sec. 58. Return and Payment of Taxes Withheld at Source. -

"(A) x x x

"x x x

"The return for final and creditable withholding taxes shall be filed and the payment made
not later than the last day of the month following the close of the quarter during which
withholding was made.

14
Withholding on Wages

CHAPTER XIII - WITHHOLDING ON WAGES

Section 78. Definitions. - As used in this Chapter:

(A) Wages. - The term 'wages' means all remuneration (other than fees paid to a public
official) for services performed by an employee for his employer, including the cash
value of all remuneration paid in any medium other than cash, except that such term
shall not include remuneration paid:

(1) For agricultural labor paid entirely in products of the farm where the labor is
performed, or

(2) For domestic service in a private home, or

(3) For casual labor not in the course of the employer's trade or business, or

(4) For services by a citizen or resident of the Philippines for a foreign

government or an international organization.

If the remuneration paid by an employer to an employee for services performed during

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

(B) Payroll Period. - The term 'payroll period' means a period for which payment of
wages is ordinarily made to the employee by his employer, and the term
'miscellaneous payroll period' means a payroll period other than, a daily, weekly,
biweekly, semi-monthly, monthly, quarterly, semi-annual, or annual period.

(C) Employee. - The term 'employee' refers to any individual who is the recipient of
wages and includes an officer, employee or elected official of the Government of the
Philippines or any political subdivision, agency or instrumentality thereof. The term
'employee' also includes an officer of a corporation.

(D) Employer. - The term 'employer' means the person for whom an individual
performs or performed any service, of whatever nature, as the employee of such
person, except that:

15
 (1) If the person for whom the individual performs or performed any service
does not have control of the payment of the wages for such services, the term
'employer' (except for the purpose of Subsection(A) means the person having
control of the payment of such wages; and

(2) In the case of a person paying wages on behalf of a nonresident alien

individual, foreign partnership or foreign corporation not engaged in trade or
business within the Philippines, the term 'employer' (except for the purpose of
Subsection(A) means such person.

Sec. 79. Income Tax Collected at Source. -

"x x x

"(C) Refunds or Credits. -

"(1) Employer. - x x x

"(2) Employees. - x x x

"x x x

"(D) Withholding on Basis of Average Wages. - x x x

"(1) x x x

"(2) x x x; and

"(3) x x x.

"(E) Nonresident Aliens - x x x

"(F) Year-end Adjustment. - x x x."

Section 80. Liability for Tax. -

(A) Employer. - The employer shall be liable for the withholding and remittance of the
correct amount of tax required to be deducted and withheld under this Chapter. If the
employer fails to withhold and remit the correct amount of tax as required to be
withheld under the provision of this Chapter, such tax shall be collected from the
employer together with the penalties or additions to the tax otherwise applicable in
respect to such failure to withhold and remit.

16
 (B) Employee. - Where an employee fails or refuses to file the withholding exemption
certificate or willfully supplies false or inaccurate information thereunder, the tax
otherwise required to be withheld by the employer shall be collected from him
including penalties or additions to the tax from the due date of remittance until the
date of payment. On the other hand, excess taxes withheld made by the employer due
to:

(1) failure or refusal to file the withholding exemption certificate; or

(2) false and inaccurate information shall not be refunded to the employee but
shall be forfeited in favor of the Government.

Section 81. Filing of Return and Payment of Taxes Withheld. - Except as the
Commissioner otherwise permits, taxes deducted and withheld by the employer on wages of
employees shall be covered by a return and paid to an authorized agent bank; Collection
Agent, or the duly authorized Treasurer of the city or municipality where the employer has his
legal residence or principal place of business, or in case the employer is a corporation, where
the principal office is located.

The return shall be filed and the payment made within twenty-five (25) days from the close of
each calendar quarter: Provided, however, That the Commissioner may, with the approval of
the Secretary of Finance, require the employers to pay or deposit the taxes deducted and
withheld at more frequent intervals, in cases where such requirement is deemed necessary to
protect the interest of the Government.

The taxes deducted and withheld by employers shall be held in a special fund in trust for the
Government until the same are paid to the said collecting officers.

Section 82. Return and Payment in Case of Government Employees. - If the employer is
the Government of the Philippines or any political subdivision, agency or instrumentality
thereof, the return of the amount deducted and withheld upon any wage shall be made by
the officer or employee having control of the payment of such wage, or by any officer or
employee duly designated for the purpose.

Section 83. Statements and Returns. -

(A) Requirements. - Every employer required to deduct and withhold a tax shall furnish
to each such employee in respect of his employment during the calendar year, on or
before January thirty-first (31st) of the succeeding year, or if his employment is
terminated before the close of such calendar year, on the same day of which the last
payment of wages is made, a written statement confirming the wages paid by the
employer to such employee during the calendar year, and the amount of tax deducted
and withheld under this Chapter in respect of such wages. The statement required to
be furnished by this Section in respect of any wage shall contain such other

17
information, and shall be furnished at such other time and in such form as the Secretary
of Finance, upon the recommendation of the Commissioner, may, by rules and
regulation, prescribe.

(B) Annual Information Returns. - Every employer required to deduct and withhold the
taxes in respect of the wages of his employees shall, on or before January thirty-first
(31st) of the succeeding year, submit to the Commissioner an annual information
return containing a list of employees, the total amount of compensation income of
each employee, the total amount of taxes withheld therefrom during the year,
accompanied by copies of the statement referred to in the preceding paragraph, and
such other information as may be deemed necessary. This return, if made and filed in
accordance with rules and regulations promulgated by the Secretary of Finance, upon
recommendation of the Commissioner, shall be sufficient compliance with the
requirements of Section 68 of this Title in respect of such wages.

(C) Extension of time. - The Commissioner, under such rules and regulations as may be
promulgated by the Secretary of Finance, may grant to any employer a reasonable
extension of time to furnish and submit the statements and returns required under
this Section.

18
Withholding Tax by Government Agencies

(RR 2-98)

19
Special Rules

Minimum Corporate Income Tax

CHAPTER IV - TAX ON CORPORATIONS

Section 27. Rates of Income tax on Domestic Corporations. -

(E) Minimum Corporate Income Tax on Domestic Corporations. -

(1) Imposition of Tax. - A minimum corporate income tax of two percent (2%0
of the gross income as of the end of the taxable year, as defined herein, is
hereby imposed on a corporation taxable under this Title, beginning on the
fourth taxable year immediately following the year in which such corporation
commenced its business operations, when the minimum income tax is greater
than the tax computed under Subsection (A) of this Section for the taxable
year.

(2) Carry Froward of Excess Minimum Tax. - Any excess of the minimum
corporate income tax over the normal income tax as computed under
Subsection (A) of this Section shall be carried forward and credited against the
normal income tax for the three (3) immediately succeeding taxable years.

(3) Relief from the Minimum Corporate Income Tax Under Certain Conditions. -
The Secretary of Finance is hereby authorized to suspend the imposition of the
minimum corporate income tax on any corporation which suffers losses on
account of prolonged labor dispute, or because of force majeure, or because of
legitimate business reverses.

The Secretary of Finance is hereby authorized to promulgate, upon

recommendation of the Commissioner, the necessary rules and regulation that
shall define the terms and conditions under which he may suspend the
imposition of the minimum corporate income tax in a meritorious case.

(4) Gross Income Defined. - For purposes of applying the minimum corporate
income tax provided under Subsection (E) hereof, the term 'gross income' shall
mean gross sales less sales returns, discounts and allowances and cost of goods
sold. "Cost of goods sold' shall include all business expenses directly incurred
to produce the merchandise to bring them to their present location and use.

For a trading or merchandising concern, 'cost of goods sold' shall include the invoice
cost of the goods sold, plus import duties, freight in transporting the goods to the
place where the goods are actually sold including insurance while the goods are in
transit.

20
 For a manufacturing concern, cost of 'goods manufactured and sold' shall include all
costs of production of finished goods, such as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance premiums and other costs incurred to
bring the raw materials to the factory or warehouse.

In the case of taxpayers engaged in the sale of service, 'gross income' means gross
receipts less sales returns, allowances, discounts and cost of services. 'Cost of services'
shall mean all direct costs and expenses necessarily incurred to provide the services
required by the customers and clients including (A) salaries and employee benefits of
personnel, consultants and specialists directly rendering the service and (B) cost of
facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies: Provided, however, That in the case of banks,
'cost of services' shall include interest expense.

Section 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

(2) Minimum Corporate Income Tax on Resident Foreign Corporations. - A

minimum corporate income tax of two percent (2%) of gross income, as
prescribed under Section 27 (E) of this Code, shall be imposed, under the same
conditions, on a resident foreign corporation taxable under paragraph (1) of
this Subsection.

21
CHAMBER OF REAL ESTATE AND BUILDERS' ASSOCIATIONS, INC.
vs.
THE HON. EXECUTIVE SECRETARY ALBERTO ROMULO

G.R. No. 160756 March 9, 2010

FACTS:

Petitioner is an association of real estate developers and builders in the Philippines. It assails
the validity of the imposition of minimum corporate income tax (MCIT) on corporations and
creditable withholding tax (CWT) on sales of real properties classified as ordinary assets.

Petitioner argues that the MCIT violates the due process clause because it levies income tax
even if there is no realized gain. Petitioner also asserts that the enumerated provisions of the
subject revenue regulations violate the due process clause because, like the MCIT, the
government collects income tax even when the net income has not yet been determined.
They contravene the equal protection clause as well because the CWT is being levied upon
real estate enterprises but not on other business enterprises, more particularly those in the
manufacturing sector.

ISSUE:

Whether the imposition of the MCIT on domestic corporations and CWT on income from
sales of real properties classified as ordinary assets are unconstitutional.

RULING:

NO. MCIT is not violative of due process. The MCIT is imposed on gross income which is arrived
at by deducting the capital spent by a corporation in the sale of its goods, i.e., the cost of
goods and other direct expenses from gross sales. Clearly, the capital is not being taxed.
Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the normal
net income tax, and only if the normal income tax is suspiciously low. The MCIT merely
approximates the amount of net income tax due from a corporation, pegging the rate at a
very much reduced 2% and uses as the base the corporation’s gross income.

It is also stressed that the CWT is creditable against the tax due from the seller of the property
at the end of the taxable year. The seller will be able to claim a tax refund if its net income is
less than the taxes withheld. Nothing is taken that is not due so there is no confiscation of
property repugnant to the constitutional guarantee of due process. More importantly, the
due process requirement applies to the power to tax. The CWT does not impose new taxes

22
nor does it increase taxes. It relates entirely to the method and time of payment. Petitioner,
in insisting that its industry should be treated similarly as manufacturing enterprises, fails to
realize that what distinguishes the real estate business from other manufacturing
enterprises, for purposes of the imposition of the CWT, is not their production processes
but the prices of their goods sold and the number of transactions involved. The income from
the sale of a real property is bigger and its frequency of transaction limited, making it less
cumbersome for the parties to comply with the withholding tax scheme.

23
CIR vs PAL

FACTS:

PHILIPPINE AIRLINES, INC. had zero taxable income for 2000 but would have been liable for
Minimum Corporate Income Tax based on its gross income. However, PHILIPPINE AIRLINES,
INC. did not pay the Minimum Corporate Income Tax using as basis its franchise which
exempts it from “all other taxes” upon payment of whichever is lower of either (a) the basic
corporate income tax based on the net taxable income or (b) a franchise tax of 2%.

ISSUE:

Is PAL liable for Minimum Corporate Income Tax?

HELD:

NO. PHILIPPINE AIRLINES, INC.’s franchise clearly refers to "basic corporate income tax"
which refers to the general rate of 35% (now 30%). In addition, there is an apparent distinction
under the Tax Code between taxable income, which is the basis for basic corporate income
tax under Sec. 27 (A) and gross income, which is the basis for the Minimum Corporate Income
Tax under Section 27 (E). The two terms have their respective technical meanings and cannot
be used interchangeably. Not being covered by the Charter which makes PAL liable only for
basic corporate income tax, then Minimum Corporate Income Tax is included in "all other
taxes" from which PHILIPPINE AIRLINES, INC. is exempted.

The CIR also can not point to the “Substitution Theory” which states that Respondent may
not invoke the “in lieu of all other taxes” provision if it did not pay anything at all as basic
corporate income tax or franchise tax. The Court ruled that it is not the fact tax payment
that exempts Respondent but the exercise of its option. The Court even pointed out the
fallacy of the argument in that a measly sum of one peso would suffice to exempt PAL from
other taxes while a zero liability would not and said that there is really no substantial
distinction between a zero tax and a one-peso tax liability. Lastly, the Revenue
Memorandum Circular stating the applicability of the MCIT to PAL does more than just
clarify a previous regulation and goes beyond mere internal administration and thus cannot
be given effect without previous notice or publication to those who will be affected thereby.

24
Improperly Accumulated Earnings Tax

Section 29. Imposition of Improperly Accumulated Earnings Tax. -

(A) In General. - In addition to other taxes imposed by this Title, there is hereby imposed
for each taxable year on the improperly accumulated taxable income of each
corporation described in Subsection B hereof, an improperly accumulated earnings tax
equal to ten percent (10%) of the improperly accumulated taxable income.

(B) Tax on Corporations Subject to Improperly Accumulated Earnings Tax. -

(1) In General. - The improperly accumulated earnings tax imposed in the

preceding Section shall apply to every corporation formed or availed for the
purpose of avoiding the income tax with respect to its shareholders or the
shareholders of any other corporation, by permitting earnings and profits to
accumulate instead of being divided or distributed.

(2) Exceptions. - The improperly accumulated earnings tax as provided for under
this Section shall not apply to:

(a) Publicly-held corporations;

(b) Banks and other nonbank financial intermediaries; and

(c) Insurance companies.

(C) Evidence of Purpose to Avoid Income Tax. -

(1) Prima Facie Evidence. - the fact that any corporation is a mere holding
company or investment company shall be prima facie evidence of a purpose to
avoid the tax upon its shareholders or members.

(2) Evidence Determinative of Purpose. - The fact that the earnings or profits of
a corporation are permitted to accumulate beyond the reasonable needs of the
business shall be determinative of the purpose to avoid the tax upon its
shareholders or members unless the corporation, by the clear preponderance
of evidence, shall prove to the contrary.

(D) Improperly Accumulated Taxable Income. - For purposes of this Section, the term
'improperly accumulated taxable income' means taxable income' adjusted by:

(1) Income exempt from tax;

25
 (2) Income excluded from gross income;

(3) Income subject to final tax; and

(4) The amount of net operating loss carry-over deducted;

And reduced by the sum of:

(1) Dividends actually or constructively paid; and

(2) Income tax paid for the taxable year.

Provided, however, That for corporations using the calendar year basis, the
accumulated earnings under tax shall not apply on improperly accumulated
income as of December 31, 1997. In the case of corporations adopting the fiscal
year accounting period, the improperly accumulated income not subject to this
tax, shall be reckoned, as of the end of the month comprising the twelve (12)-
month period of fiscal year 1997-1998.

(E) Reasonable Needs of the Business. - For purposes of this Section, the term
'reasonable needs of the business' includes the reasonably anticipated needs of the
business.

26
THE MANILA WINE MERCHANTS, INC. VS. THE COMMISSIONER OF INTERNAL REVENUE
GR NO. L-26145. FEBRUARY 20, 1984

FACTS:
 Manila Wine Merchants Inc. is a domestic corporation principally engaged in the
importation and sale of whisky, wines, liquors and distilled spirits.
 In 1957 the CIR caused the examination of petitioner’s book of accounts and found the
latter having unreasonably accumulated surplus of P428,934.32 for the calendar year
1947 to 1957, in excess of the reasonable needs of the business subject to the 25%
surtax imposed by Section 25 of the Tax Code.
 The total amount due as of February 26, 1963 amounted to P 126,536.12 representing
the surtax and interest thereon.
 Respondent contends that petitioner has accumulated earnings beyond the
reasonable needs of its business because the average ratio of the cash dividends
declared and paid by petitioner from 1947 to 1957 was 40.33% of the total surplus
available for distribution at the end of each calendar year.
 On the other hand, petitioner contends that in 1957, it distributed 100% of its net
earnings after income tax and part of the surplus for prior years. Respondent further
submits that the accumulated earnings tax should be based on 25% of the total surplus
available at the end of each calendar year while petitioner maintains that the 25%
surtax is imposed on the total surplus or net income for the year after deducting
therefrom the income tax due.
 Another basis of respondent in assessing petitioner for accumulated earnings tax is its
substantial investment of surplus or profits in unrelated business. These investments
are itemized as follows:
Particulars Amount

1 Acme Commercial Co. Inc. P27,501.00

2 Union Insurance Society of Canton 1,145.76

3 U.S.A. Treasury Bond 347,217.50

4 Wack Wack Golf & Country Club 1.00

TOTAL P 375,865.26

 Respondent found that the accumulated surplus in question were invested to

‘unrelated business’ which were not considered in the ‘immediate needs’ of the
Company such that the 25% surtax be imposed therefrom.

27
  On appeal to the Court of Tax Appeals, it found that:
o The petitioner was not formed for the purpose of preventing the imposition of
income tax upon its shareholders since it has distributed an average of 85.77%
of its total surplus available for distribution at the end of each calendar year for
11 years and not 40.33%.
o The investments 1, 2, & 4 were harmless accumulation of surplus and therefore
not subject to surtax.
o As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax
Appeals ruled that its purchase was in no way related to petitioner’s business
of importing and selling wines, whisky, liquors and distilled spirits.
o That it was one for the purpose of preventing the imposition of surtax upon
petitioner’s shareholders by permitting its earnings and profits to accumulate
beyond the reasonable needs of the business. Hence, it modified the
respondent’s decision by imposing 25% surtax only on the USA Treasury Bond
in the amount of P86,804.38.
 Defenses of petitioner on the USA Treasury Bond:
o That the investment made in 1951 would be used in meeting immediate urgent
orders of its local customers.
o That they decided sometime in 1957 to hold the bills for a few more years in
view of their plan to buy a lot and construct their own building.
o Since they were not yet 60% Filipino owned, they waited until the ownership
would reach that much before making definite plans.
o That in 1959 they were already more than 60% Filipino owned and thus in 1961,
they bought a lot.

ISSUE/S:
(1) Whether the purchase of the U.S.A. Treasury bonds by petitioner in 1951 can be
considered as an improper accumulation of earnings, and
(2) If so, whether the penalty tax of twenty-five percent (25%) can be imposed on such
improper accumulation in 1957 despite the fact that the accumulation occurred in 1951.

RULING:
(1) Yes the purchase of the U.S.A. Treasury bonds by petitioner in 1951 can be considered as
improper accumulation of earnings. It was an investment to an unrelated business and
was made for the purpose of preventing the imposition of the surtax upon petitioner’s
shareholders by permitting its earnings and profits to accumulate beyond the reasonable
needs of the business.

28
A prerequisite to the imposition of the tax has been that the (1) corporation be formed
or availed of for the purpose of avoiding the income tax (or surtax) on its shareholders,
or on the shareholders of any other corporation (2) by permitting the earnings and
profits of the corporation to accumulate instead of dividing them among or
distributing them to the shareholders. If the earnings and profits were distributed, the
shareholders would be required to pay an income tax thereon whereas, if the
distribution were not made to them, they would incur no tax in respect to the
undistributed earnings and profits of the corporation. The touchstone of liability is the
purpose behind the accumulation of the income and not the consequences of the
accumulation. Thus, if the failure to pay dividends is due to some other cause, such as
the use of undistributed earnings and profits for the reasonable needs of the business,
such purpose does not fall within the interdiction of the statute.

An accumulation of earnings or profits (including undistributed earnings or profits of

prior years) is unreasonable if it is not required for the purpose of the business,
considering all the circumstances of the case.

To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the
purchase of the U.S.A. Treasury Bonds in 1951 with a face value of $175,000.00 was an
investment within the reasonable needs of the Corporation. This, the petitioner failed
to prove.

To determine the "reasonable needs" of the business in order to justify an

accumulation of earnings, the Courts of the United States have invented the so-called
"Immediacy Test" which construed the words "reasonable needs of the business" to
mean the immediate needs of the business, and it was generally held that if the
corporation did not prove an immediate need for the accumulation of the earnings and
profits, the accumulation was not for the reasonable needs of the business, and the
penalty tax would apply. American cases likewise hold that investment of the earnings
and profits of the corporation in stock or securities of an unrelated business usually
indicates an accumulation beyond the reasonable needs of the business.

The records reveal that from May 1951 when petitioner purchased the U.S.A. Treasury
shares, until 1962 when it finally liquidated the same, it (petitioner) never had the
occasion to use the said shares in aiding or financing its importation. This militates
against the purpose enunciated earlier by petitioner that the shares were purchased
to finance its importation business. To justify an accumulation of earnings and profits
for the reasonably anticipated future needs, such accumulation must be used within a
reasonable time after the close of the taxable year.

29
 The arguments of petitioner indicate that it considers the U.S.A. Treasury shares not
only for the purpose of aiding or financing its importation but likewise for the purpose
of buying a lot and constructing a building thereon in the near future, but conditioned
upon the completion of the 60% citizenship requirement of stock ownership of the
Company in order to qualify it to purchase and own a lot. The time when the company
would be able to establish itself to meet the said requirement and the decision to
pursue the same are dependent upon various future contingencies.

In order to determine whether profits are accumulated for the reasonable needs of
the business as to avoid the surtax upon shareholders, the controlling intention of the
taxpayer is that which is manifested at the time of accumulation not subsequently
declared intentions which are merely the product of afterthought. A speculative and
indefinite purpose will not suffice. The mere recognition of a future problem and the
discussion of possible and alternative solutions is not sufficient. Definiteness of plan
coupled with action taken towards its consummation are essential.

Profits may only be accumulated for the reasonable needs of the business, and implicit
in this is further requirement of a reasonable time.

(2) The petition was wrong in its contention that the 25% surtax should be based on the
surplus accumulated in 1951 and not in 1957.

The rule is now settled in Our jurisprudence that undistributed earnings or profits of
prior years are taken into consideration in determining unreasonable accumulation for
purposes of the 25% surtax. The case of Basilan Estates, Inc. v. Commissioner of Internal
Revenue further strengthen this rule in determining unreasonable accumulation for
the year concerned. ’In determining whether accumulations of earnings or profits in a
particular year are within the reasonable needs of a corporation, it is necessary to take
into account prior accumulations, since accumulations prior to the year involved may
have been sufficient to cover the business needs and additional accumulations during
the year involved would not reasonably be necessary.’

30
CIR vs. ANTONIO TUASON, INC. and CTA (May 15, 1989)
Facts
On February 27, 1981, the Commissioner of Internal Revenue, assessed Antonio Tuason, Inc.
1. P37,491.83 as deficiency income tax for the years 1975,1976, and 1978.
2. P161.49 as Deficiency corporate quarterly income tax for the first quarter.
3. P1,151,146.98 as 25% surtax on unreasonable accumulation of surplus for the years 1975-
1978.

Antonio Tuason, Inc did not object to the first and second items and paid the amounts
demanded. However, it protested the assessment on a 25% surtax on the third item on the
ground that the accumulation of surplus profits during the years in question was solely for the
purpose of expanding its business operations as real estate broker. The request for
reinvestigation was granted on condition that a waiver of the statute of limitations should be
filed by the private respondent. The latter replied that there was no need of a waiver of the
statute of limitations because the right of the Government to assess said tax does not
prescribe.
No investigation was conducted nor a decision rendered on Antonio Tuazon Inc.'s protest. In
the meantime, the Revenue Commissioner issued warrants of distraint and levy to enforce
collection of the total amount originally assessed including the amounts already paid.
Antonio Tuason, Inc filed a petition for review in the CTA with a request that pending
determination of the case on the merits, an order be issued restraining the Commissioner
and/or his representatives from enforcing the warrants of distraint and levy.
CTA: Ordered the Commissioner to refrain from enforcing the warrants of distraint and levy.
CIR appealed to this Court, raising the following issues:
Issues
1. Whether or not private respondent Antonio Tuason, Inc. is a holding company and/or
investment company;
2. Whether or not private respondent Antonio Tuason, Inc. accumulated surplus for the years
1975 to 1978; and
3. Whether or not Antonio Tuason, Inc. is liable for the 25% surtax on undue accumulation of
surplus for the years 1975 to 1978.
Section 25 of the Tax Code at the time the surtax was assessed, provided:
Sec. 25. Additional tax on corporation improperly accumulating profits or surplus.—

31
 (a) Imposition of tax. — If any corporation, except banks, insurance companies, or
personal holding companies, whether domestic or foreign, is formed or availed of for
the purpose of preventing the imposition of the tax upon its shareholders or members
or the shareholders or members of another corporation, through the medium of
permitting its gains and profits to accumulate instead of being divided or distributed,
there is levied and assessed against such corporation, for each taxable year, a tax equal
to twenty-five per centum of the undistributed portion of its accumulated profits or
surplus which shall be in addition to the tax imposed by section twenty-four, and shall
be computed, collected and paid in the same manner and subject to the same
provisions of law, including penalties, as that tax.
(b) Prima facie evidence. — The fact that any corporation is a mere holding company
shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or
members. Similar presumption will lie in the case of an investment company where at
any time during the taxable year more than fifty per centum in value of its outstanding
stock is owned, directly or indirectly, by one person.
(c) Evidence determinative of purpose. — The fact that the earnings or profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business
shall be determinative of the purpose to avoid the tax upon its shareholders or
members unless the corporation, by clear preponderance of evidence, shall prove the
contrary.
Held: The petition is meritorious.
1) The CTA conceded that the Revenue Commissioner's determination that Antonio Tuason,
Inc. was a mere holding or investment company, was "presumptively correct", for the
corporation did not involve itself in the development of subdivisions but merely subdivided
its own lots and sold them for bigger profits. It derived its income mostly from interest,
dividends and rental realized from the sale of realty.
Another circumstance supporting that presumption is that 99.99% in value of the outstanding
stock of Antonio Tuason, Inc., is owned by Antonio Tuason himself. The Commissioner
"conclusively presumed" that when the corporation accumulated (instead of distributing to
the shareholders) a surplus of over P3 million fron its earnings in 1975 up to 1978, the purpose
was to avoid the imposition of the progressive income tax on its shareholders.
2)The fact that Antonio Tuason, Inc. accumulated surplus profits amounting to P3,263,305.88
for 1975 up to 1978 is not disputed. However, the Antonio Tuason, Inc. vehemently denies that
its purpose was to evade payment of the progressive income tax on such dividends by its
stockholders. It claims the surplus profits were set aside by the company to build up sufficient
capital for its expansion program which included the construction in 1979-1981 of an
apartment building, and the purchase in 1980 of a condominium unit intended for resale or
lease.
32
However, while these investments were actually made, the Commissioner points out that the
corporation did not use up its surplus profits. Its allegation that P1,525,672.74 was spent for
the construction of an apartment building in 1979 and P1,752,332.87 for the purchase of a
condominium unit in Urdaneta Village in 1980 was refuted by the Declaration of Real Property
on the apartment building (Exh. C) which shows that its market value is only P429,890.00, and
the Tax Declaration on the condominium unit which reflects a market value of P293,830.00
only. The enormous discrepancy between the alleged investment cost and the declared
market value of these pieces of real estate was not denied nor explained by the respondent.
3) Since the company as of the time of the assessment in 1981, had invested in its business
operations only P 773,720 out of its accumulated surplus profits of P3,263,305.88 for 1975-
1978, its remaining accumulated surplus profits of P2,489,858.88 are therefore subject to the
25% surtax.
All presumptions are in favor of the correctness of CIR's assessment against the respondent.
It is incumbent upon the taxpayer to prove the contrary (Mindanao Bus Company vs.
Commissioner of Internal Revenue, 1 SCRA 538). Unfortunately, the respondent failed to
overcome the presumption of correctness of the Commissioner's assessment.
The touchstone of liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation. Thus, if the failure to pay dividends were for the purpose
of using the undistributed earnings and profits for the reasonable needs of the business, that
purpose would not fall within the interdiction of the statute" (Mertens Law of Federal Income
Taxation, Vol. 7, Chapter 39, p. 45 cited in Manila Wine Merchants, Inc. vs. Commissioner of
Internal Revenue, 127 SCRA 483, 493).
It is plain to see that the company's failure to distribute dividends to its stockholders in 1975-
1978 was for reasons other than the reasonable needs of the business, thereby falling within
the interdiction of Section 25 of the Tax Code of 1977.
Dispositive: CTA reversed. The assessment of a 25% surtax against the Antonio Tuason, Inc. is
reinstated but only on the latter's unspent accumulated surplus profits of P2,489,585.88.

33
Cyanamid Philippines vs Court of Appeals

Facts:

Petitioner is a corporation organized under Philippine laws and is a wholly owned subsidiary
of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of
pharmaceutical products and chemicals, a wholesaler of imported finished goods and an
imported/indentor. In 1985 the CIR assessed on petitioner a deficiency income tax of P119,817)
for the year 1981. Cyanamid protested the assessments particularly the 25% surtax for undue
accumulation of earnings. It claimed that said profits were retained to increase petitioner’s
working capital and it would be used for reasonable business needs of the company. The CIR
refused to allow the cancellation of the assessments, petitioner appealed to the CTA. It
claimed that there was not legal basis for the assessment because 1) it accumulated its
earnings and profits for reasonable business requirements to meet working capital needs and
retirement of indebtedness 2) it is a wholly owned subsidiary of American Cyanamid Company,
a foreign corporation, and its shares are listed and traded in the NY Stock Exchange. The CTA
denied the petition stating that the law permits corporations to set aside a portion of its
retained earnings for specified purposes under Sec. 43 of the Corporation Code but that
petitioner’s purpose did not fall within such purposes. It found that there was no need to set
aside such retained earnings as working capital as it had considerable liquid funds. Those
corporations exempted from the accumulated earnings tax are found under Sec. 25 of the
NIRC, and that the petitioner is not among those exempted. The CA affirmed the CTA’s
decision.

Issue: Whether or not the accumulation of income was justified.

Held:

In order to determine whether profits are accumulated for the reasonable needs of the
business to avoid the surtax upon the shareholders, it must be shown that the controlling
intention of the taxpayer is manifested at the time of the accumulation, not intentions
subsequently, which are mere afterthoughts. The accumulated profits must be used within
reasonable time after the close of the taxable year. In the instant case, petitioner did not
establish by clear and convincing evidence that such accumulated was for the immediate
needs of the business.

34
To determine the reasonable needs of the business, the United States Courts have invented
the “Immediacy Test” which construed the words “reasonable needs of the business” to
mean the immediate needs of the business, and it is held that if the corporation did not prove
an immediate need for the accumulation of earnings and profits such was not for reasonable
needs of the business and the penalty tax would apply. (Law of Federal Income Taxation Vol
7) The working capital needs of a business depend on the nature of the business, its credit
policies, the amount of inventories, the rate of turnover, the amount of accounts receivable,
the collection rate, the availability of credit and other similar factors. The Tax Court opted to
determine the working capital sufficiency by using the ration between the current assets to
current liabilities. Unless, rebutted, the presumption is that the assessment is correct. With
the petitioner’s failure to prove the CIR incorrect, clearly and conclusively, the Tax Court’s
ruling is upheld.

35
Fringe Benefits Tax

TITLE II
TAX ON INCOME

CHAPTER I - DEFINITIONS

Section 22. Definitions - When used in this Title:

(AA) The term 'rank and file employees' shall mean all employees who are holding
neither managerial nor supervisory position as defined under existing provisions of
the Labor Code of the Philippines, as amended.

Section 33. Special Treatment of Fringe Benefit.-

(A) Imposition of Tax. - A final tax of thirty-four percent (34%) effective January 1,
1998; thirty-three percent (33%) effective January 1, 1999; and thirty-two percent
(32%) effective January 1, 2000 and thereafter, is hereby imposed on the grossed-up
monetary value of fringe benefit furnished or granted to the employee (except rank
and file employees as defined herein) by the employer, whether an individual or a
corporation (unless the fringe benefit is required by the nature of, or necessary to
the trade, business or profession of the employer, or when the fringe benefit is for
the convenience or advantage of the employer). The tax herein imposed is payable
by the employer which tax shall be paid in the same manner as provided for under
Section 57 (A) of this Code. The grossed-up monetary value of the fringe benefit shall
be determined by dividing the actual monetary value of the fringe benefit by sixty-six
percent (66%) effective January 1, 1998; sixty-seven percent (67%) effective January 1,
1999; and sixty-eight percent (68%) effective January 1, 2000 and thereafter:
Provided, however, That fringe benefit furnished to employees and taxable under
Subsections (B), (C), (D) and (E) of Section 25 shall be taxed at the applicable rates
imposed thereat: Provided, further, That the grossed -Up value of the fringe benefit
shall be determined by dividing the actual monetary value of the fringe benefit by the
difference between one hundred percent (100%) and the applicable rates of income
tax under Subsections (B), (C), (D), and (E) of Section 25.

(B) Fringe Benefit defined. - For purposes of this Section, the term 'fringe benefit'
means any good, service or other benefit furnished or granted in cash or in kind by an
employer to an individual employee (except rank and file employees as defined
herein) such as, but not limited to, the following:

(1) Housing;

(2) Expense account;

36
 (3) Vehicle of any kind;

(4) Household personnel, such as maid, driver and others;

(5) Interest on loan at less than market rate to the extent of the difference
between the market rate and actual rate granted;

(6) Membership fees, dues and other expenses borne by the employer for the
employee in social and athletic clubs or other similar organizations;

(7) Expenses for foreign travel;

(8) Holiday and vacation expenses;

(9) Educational assistance to the employee or his dependents; and

(10) Life or health insurance and other non-life insurance premiums or similar
amounts in excess of what the law allows.

(C) Fringe Benefits Not Taxable. - The following fringe benefits are not taxable under
this Section:

(1) fringe benefits which are authorized and exempted from tax under special
laws;

(2) Contributions of the employer for the benefit of the employee to

retirement, insurance and hospitalization benefit plans;

(3) Benefits given to the rank and file employees, whether granted under a
collective bargaining agreement or not; and

(4) De minimis benefits as defined in the rules and regulations to be

promulgated by the Secretary of Finance, upon recommendation of the
Commissioner.

The Secretary of Finance is hereby authorized to promulgate, upon recommendation

of the Commissioner, such rules and regulations as are necessary to carry out
efficiently and fairly the provisions of this Section, taking into account the peculiar
nature and special need of the trade, business or profession of the employer.

37
Benaglia v. Commissioner, 36 B.T.A. 838 (1937)

Facts and Procedural History

Petitioner is manager of hotels in Hawaii, for which he receives both a salary and free room
and board. The IRS Commissioner includes the room and board that he and his wife receive
as part of his taxable income. Petitioner argues he has to live in the hotel room as a
necessary part of his job as manager of the hotel, and that it should not be counted as
constituting part of his salary.

Issue
Should petitioner's receipt of a room and board from his employer be counted as taxable
income when petitioner is living there at the request of his employer?

Holding and Dissent

Reversed in favor of petitioner. Evidence from both the employer and employee was that
residence in the hotel was a necessary part of the job. Corporation’s books carried no
accounting for the petitioner’s meals, rooms, or service. Analogizes case to 1) Jones v.
United States, where the value of military quarters was not included in the taxable income
of an Army officer, and to 2) the English case of Tennant v. Smith, H.L. (1892), where a bank
employee was required to live in quarters located in the bank building, the value of which
was not included in his taxable income. Here, because the meal and room was supplied to
petitioner “merely as a convenience to the hotels”, they should not be included in taxable
income.
DISSENT: During the negotiations for employment, the petitioner made sure to mention
the free room and board. Distinguish this case from Jones v. US, because here the
employment was a matter of private contract, while in Jones, the compensation was fixed
and subject to military law. Petitioner’s constant presence here was not actually needed,
since records show he was responsible for two hotels and did not have a residence at both,
and he was also absent from Honolulu several times. Even if the employer required his
residence in the hotel, petitioner still benefited from it.
Analysis and Discussion
The employer, in giving the room benefit to employee, has a purpose other than to
compensate employee (i.e. a responsibility to be available to fix hotel problems) —>
“convenience of employer”

38
Transfer Pricing

Section 50. Allocation of Income and Deductions. - In the case of two or more
organizations, trades or businesses (whether or not incorporated and whether or not
organized in the Philippines) owned or controlled directly or indirectly by the same interests,
the Commissioner is authorized to distribute, apportion or allocate gross income or
deductions between or among such organization, trade or business, if he determined that
such distribution, apportionment or allocation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any such organization, trade or business.

39
Her Majesty the Queen vs GlaxoSmithKline
Facts:
From 1990 to 1993, GSK Canada had acquired the active ingredient for Zantac from a related
company, Adechsa, under a “Supply Agreement” at prices ranging from $1,512 to $1,652 per
kilogram. Under a second agreement (“License Agreement”), GSK Canada obtained the rights
from the Glaxo Group to use the trademark “Zantac”, among st other benefits, for a royalty
of 6%. The Tax Court Judge rejected the taxpayer’s arguments that the agreements should be
considered together in establishing whether the price paid for the active ingredient was
“reasonable in the circumstances”, (the arm’s length standard at the time as required by
section 69 of Canada’s Income Tax Act). Instead, the Tax Court Judge restricted its analysis to
the Supply Agreement only, which it deemed comparable to supply agreements between
generic producers and distributors.
Ruling
The FCA took the opposite view, recognizing that the License Agreement is relevant to
determining the price that would have been reasonable in the circumstances.
Specifically, Glaxo Group’s ownership of the Zantac trademark, the premium that Zantac
commanded over generic ranitidine drugs in the market, the inability of the taxpayer to
compete in the generic market without the Zantac trademark, and, the portfolio of other
products to which the taxpayer had access under the License Agreement, were all relevant
factors in the view of the FCA.
The FCA’s reasons for Judgement specifically note:
“Clearly, in the circumstances in the case, the Judge’s approach was mistaken. In a real
business world, presumably an arm’s length purchaser could always buy ranitidine at market
prices from a willing seller. However the question is whether that arm’s length purchaser
would be able to sell his ranitidine under the Zantac trademark. In my view, as a result of the
approach which he took, the Judge failed to consider the business reality which an arm’s
length purchaser was bound to consider if he intended to sell Zantac.”
In addition: ‘The Judge made his determination in a fictitious business world where a
purchaser is able to purchase ranitidine at a price which does not take into account the
circumstances which make it possible for that purchaser to obtain rights to make and sell
Zantac.”
The FCA’s decision recognizes that the high profitability associated with Zantac (which under
the Tax Court decision remained with GSK Canada) did not belong to GSK Canada, but was a
function of the market power that Glaxo Group contributed under the Licence Agreement.
The FCA referenced the case of “Roche Product Pvt. Limited and Commissioner of Taxation”
[2008] AATA (July 22, 2008) as follows:
“The intellectual property came from very substantial expenditure on research and
development much of which would have produced no results. The profits from the
exploitation of the intellectual property rights was something to which (the parent company
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which invented the product] had a special claim even though the profit would be collected
for Australian sales by the Australian subsidiary.”
The FCA concluded that the Judge erred in law, failing to apply the proper test in determining
the amount that would have been “reasonable in the circumstances”. However, the FCA
returned the matter to the Tax Court Judge for rehearing and reconsideration of what a
reasonable amount would be, giving proper consideration to all the relevant facts.

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Special Entities
Proprietary Educational Institutions and Hospitals

CHAPTER IV - TAX ON CORPORATIONS

Section 27. Rates of Income tax on Domestic Corporations. -

(B) Proprietary Educational Institutions and Hospitals. - Proprietary educational

institutions and hospitals which are nonprofit shall pay a tax of ten percent (10%) on
their taxable income except those covered by Subsection (D) hereof: Provided, that if
the gross income from unrelated trade, business or other activity exceeds fifty percent
(50%) of the total gross income derived by such educational institutions or hospitals
from all sources, the tax prescribed in Subsection (A) hereof shall be imposed on the
entire taxable income. For purposes of this Subsection, the term 'unrelated trade,
business or other activity' means any trade, business or other activity, the conduct of
which is not substantially related to the exercise or performance by such educational
institution or hospital of its primary purpose or function. A 'Proprietary educational
institution' is any private school maintained and administered by private individuals or
groups with an issued permit to operate from the Department of Education, Culture
and Sports (DECS), or the Commission on Higher Education (CHED), or the Technical
Education and Skills Development Authority (TESDA), as the case may be, in
accordance with existing laws and regulations.

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Comm. Of Internal Revenue vs. St. Luke’s Medical Center, Inc.
(G.R. No. 195909-195960; Sept. 26, 2012)
Facts:
St. Luke’s (respondent) is a hospital organized as a non-stock and non-profit organization.
Sometime in 2002, BIR assessed St. Luke’s deficiency taxes amounting to P76M for 1998
which was subsequently reduced to P63M during trial in the CTA. St. Luke’s protested and
filed an administrative protest with BIR but was not acted by the latter within the 180 period
thus reaching to the CTA.
According to BIR, Section 27B of the NIRC imposing a 10% preferential tax rate applies
to St. Luke’s. Its reason is that it amends the exemption on non-profit hospitals and which
prevails over the exemption on income tax granted under Section 30 (E and G) for non-stock,
nonprofit charitable institution and civic organizations promoting social welfare. It further
claimed that St. Luke’s was actually operating for profit because only 13% came from charitable
purposes and that it had a total revenue of P1.73B from patient services in 1998.
Meanwhile, St. Luke’s contended that its operating income only totaled P334 M (less
the operating expenses) and out of that P218M (65%) made up its free services and further
claimed that its income does not inure to the benefit of anyone. Furthermore, it argued that
it falls under the exception provided under Sec. 30 (E) and (G) of NIRC and making of profit
per se does not destroy its tax exemption.
CTA En Banc ruled in favor of St. Luke’s exemption under Sec. 30 and reiterated its
earlier fiding in another case identifying St. Luke’s as a charitable institution. CTA adopted the
test in Hospital de San Juan de Dios, Inc. v. Pasay City, which states that "a charitable
institution does not lose its charitable character and its consequent exemption from taxation
merely because recipients of its benefits who are able to pay are required to do so, where
funds derived in this manner are devoted to the charitable purposes of the institution . . . ."
(The generation of income from paying patients does not per se destroy the charitable nature
of St. Luke's.)

Issue:
WON St. Luke’s is liable for deficiency income tax under Sec. 27 (B) of the NIRC which imposes
a 10% preferential rate.

Held:
Petition partly granted. YES, St. Luke’s is liable under Sec. 27 (B) of the NIRC.

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Under Sec. 30 (E) of the NIRC provides that a charitable institution must be: (1) 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
inure to the benefit of any member , officer or any person. Under the last paragraph of Sec.
30 of the NIRC 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. It simply
means that even if a charitable institution organized and operated exclusively for charitable
purposes is nevertheless allowed to engage in “activities conducted for profit” without losing
its tax exempt status for its no-for-profit activities. However, as a consequence "income of
whatever kind and character" of a charitable institution "from any of its activities conducted
for profit, regardless of the disposition made of such income, shall be subject to tax." (Sec.
30, last par.). Therefore, services rendered to paying patients are activities conducted for
profit and thus taxable under Sec. 27 (B) of the NIRC.
St. Luke's fails to meet the requirements under Section 30 (E) and (G) of the NIRC to be
completely tax exempt from all its income. However, it remains a proprietary non-profit
hospital under Section 27 (B) of the NIRC as long as it does not distribute any of its profits to
its members and such profits are reinvested pursuant to its corporate purposes. St. Luke's, as
a proprietary non-profit hospital, is entitled to the preferential tax rate of 10% on its net
income from its for-profit activities.

Notes:
1. TEST OF CHARITY - as a gift, to be applied consistently with existing laws, for the
benefit of
an indefinite number of persons, either by bringing their minds and hearts under the
influence of education or religion, by assisting them to establish themselves in life or
[by] otherwise lessening the burden of government." (In other words, charitable
institutions provide for free goods and services to the public which would otherwise
fall on the shoulders of government.)
2. Solely is synonymous with EXCLUSIVELY. (Lung center of the Phil.)
3. Proprietary- means private.
4. Non-profit- no net income accrues to the benefit of any person and with all its income
devoted to the institutions purpose and all its activities CONDUCTED NOT FOR PROFIT.

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