Income Taxation Reviewer: Mariano Marcos State University-College of Law 2011

INCOME TAXATION REVIEWER
Mariano Marcos State University- College of Law 2011
Prepared by: Kristelle Joy Ann Quibuyen Dandy Cruz Moera Joy Galing-Luna Rizza Joy SantosVallestero Myrel Tajon May Encarnina Gaoiran
INCOME TAXATION
BASIC CONCEPTS OF PHILIPPINE INCOME TAXATION
THE CONCEPT OF INCOME Note: personal withdrawals are added to capital bec they decrease the ending capital but might have been taken from the earnings during the year b.2 (corporation) B reported the following during the taxable year: Sold 1000 shares at 100 pesos Paid dividend amounting to 80,000 How income? Conwi Vs CIR, 213 Scra 83 An income is the amount of money coming to a perosn or corporation within a specified time, whether as payment for services, interest or profit form investment. Unless otherwise specified, income means cash or its equivalent Item Rule of thumb test- to determine income is the increase in net worth Example: b.1 (individual) As capital from the beginning (Jan 2000) is 100,000 As capital ending (Dec 2000) is 90,000 As additional investment during the year(Feb 2000) is 5,000 As personal withdrawal during the year(May 2000) is 40,000 How much is Mr. As income for calendar year 2000? 140,000 95,000 = 45,000 Increase in cash Decrease in accounts receivable Increase in inventory Decrease in accounts payable Increase in notes payable Total Net increase (Increasedecrease) Add dividend paid during the year Since dividends are obtained from earnings total Increase net assets 20,000 Decrease net assets 80,000 150,000 60,000 30,000 230,000 110,000 120,000 80,000 much is the net
1. Income is a flow of service rendered by

capital by the payment of money from such capital or any benefit rendered by a fund of capital thourgh a period of time. Refers to all gains, profits or income derived from any source such as services whether constituting a demandable debt or not or from the use of capital.
200,000
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Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
INCOME TAXATION
Less proceeds from sale of capital stock (return of capital) Net income 100,000 Example: Directors fee deemed by law as compensation income ;
Non- compensation income any

100,000 other income that is not derived from personal services or not related to an employeremployee relationship and is subject to tax on net income basis. It includes: Capital gain gains from dealings in capital assets; Business income gains from selling merchandise Professional income fees derived from engaging in an endeavor requiring special training as professional
Taxable income pertinent items of gross income specified in NIRC less the deductions and or personal and additional exemptions if any.Synonymous with net income. It does not include items received which do not add to the taxpayers net worth or redound to his benefit such as amounts merely deposited or entrusted to him
3 categories of taxable income:
Passive
investment income subject to final tax no longer included in the taxpayers taxable income Example: royalties, interest income from Philippine currency bank deposits
Note: in corporations, both compensation and non compensation are subjectto tax in the basis of net income since gross tax scheme is limited to compensation arising from personal and not corporater services.
Non taxable income those excluded

by law or treaty from taxation. Ex: 13th month pay
Compensation
income income from personal services under employeremployee relationship; allowable deductions are only premiums paid for health and hospitalization insurance. Tax is computed on gross income in case of individuals. (Note difference in gross income in indiv. And gross income perse). Requisites: b.1 it must arise from personal services under and employer employee relationship b.2 It is in the nature of income to the recipient employee
Income tax tax on all yearly profits

arising from property, professions, trades or offices or as a tax on a persons income, emoluments, profits and the like. It is also a direct tax on actual or presumed income of a taxpayer received,accrued or realized during the taxable year.
Types of income tax: Personal income tax on individuals
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INCOME TAXATION
Regular corporate corporations income tax on Differences capital Between income and
Minimum corporate income tax on corporations Capital gains tax on sale of shares of stocks of domestic corporation by a person who is not a dealer in securities Capital gains tax on sale of real property classified as a capital asset by a person who is not a real estate dealer or developer; if it is classified as ordinary asset subject to ordinary income tax Tax on passive investment income, such as interest, dividend and royalty Fringe benefits tax Branch profit remittance Philippine branches of corporations tax on foreign
Madrigal Vs Rafferty 38 Phil 414
Income All wealth other than mere return of capital Flow of wealth Service of wealth Income is subject to tax
Capital Fund or property existing at an instant of time, which can be used in producing goods or services Fund or property Wealth Return of capital is not subject to tax
Revenue Distinguished from income:

Revenue pertains to all funds accruing to the treasury of the government derived from tax, donation, grants and any other source. Income refers to the earnings of individual persons, partnership, corporation or estate and trust whethero or not subject to tax.
Tax on improperly accumulated earnings tax of corporations Final withholding taxes on certain income from sources within the Philippines payable to resident or non resident persons
Capital denotes original investment or fund used in order to generate earnings which is called income Example: Amount of money deposited is 100,000 for 5 years. Interest rate is 12% per annum. How much is capital? How much is income per year? Car bought for 100,000 in year 2008 was sold for 100,000 in year 2010. Depreciation rate is 5% per annum. How much is capital? How much is income in year 2010?
TESTS APPLIED IN DETERMINING EXISTENCE OF INCOME
THE
1. Severance test income is recognized

when there is separation of something which is of exchangeable value
2. Realization test no taxable income until

there is a separation from capital of something of exchangeable value (money), thereby supplying the realization or transmutation which would result in the receipt of income. 3. Tax Benefit Rule
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INCOME TAXATION
4.
Economic Benefit Test any economic benefit to the employee that increases his net worth whatever may have been the mode by which it is effected is taxable Example: 1. Mr x purchased a land for 10,000. After 3 yrs the value of the land was 15,000. On the fourth year Mr X sold the land for 13,000. He paid 1,000 to B as brokers commission. Formula: Income = Sales proceeds (Cost of land + necessary expenses for the sale of land) = 13,000 (10,000 + Principle of Constructive receipt of Income 1,000) = 2,000 Income should be reported on the fourth year only since it was in that year that it was realized. 2. B sold to C a car with FMV of 40 pesos, for 50 pesos on installment with 1/5 purchase price to be paid annually. C in year 2 paid 20 pesos to B as payment for years 2 and 3. How much is Bs income in year 2? Ans: 4 pesos.
5. Claim of Right Doctrine a taxable gain is

conditioned upon the presence of a claim of right to the alleged gain and the absence of a definite unconditional obligation to return or repay.
Income
which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at anytime is subject to tax for the year during which so credited or set apart although not then actually reduced to possesion.
6. Income from Whatever Source Income sources whether legal or illegal
b. Constructive (sec 26) an income is

REQUISITES FOR THE TAXABILITY OF AN INCOME 1. Existence of a gain- the value received in the form of cash or its equivalent as a result of rendition of service or earnings in excess of capital invested. Example: cancellation of a taxpayers indebtedness as a remuneration for service rendered is an income. Note: mere expectation of profit is not an income and therefore not taxable. 2. Realization of a gain realization of gain may take the form of actual receipt of cash or may occur as a constructive receipt of income. Mere increase in the value of property is not income but merely an unrealized increase in invested capital. a. Actual considered constructively received when it is credited to the account of or segregated in favor of a person. The person may withdraw the said account credited in his favor anytime without any substantial limitations or conditions upon which payment or enjoyment is to be made or exercised. Example: Dividends applied by the corporation against the indebtedness of a stockholder. c. Presumptive (24 d) As If theory of constructive income it presumes the existence of income on transactions supposedly not subject to tax. Example: Real property sold at a loss is subject to capital gains tax of 6% of
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INCOME TAXATION
the selling price or fair market value whichever is higher. 3. Gain must not be excluded (Sec 32 B) law or treaty does not exclude the gain from taxation. Solution: CGT = 500,000 x 6% Ans: 30,000 b) Sale of stocks subjected to graduated tax rates (Sample only) Taxbase: value of stocks sold >100,000 (10%) >200,000 (20% excess)
THE PHILIPPINE INCOME TAX SYSTEM 1. Types of Income Tax Systems
a. Schedular System- Different types of

incomes are subject to different sets of graduated or flat income tax rates. Applicable tax rates will depend on the classification of the taxable income and the basis could be gross income(without deductions) or net income (deductions were already subracted). (Applic to phil from Jan 1, 1982 to Dec 31, 1985) The Recipient of the income files separate regular income tax return or capital gains tax return except for passive income subject to final witholding tax. Reason for the exception: It is the witholding agent who is responsible for filing the witholding tax return and payment of income tax to the BIR on such passive income of the investor. Example: a) Sale of real property subjected to flat income tax rates: Lot classified as capital asset sold at 500,000 with fair market value of 300,000. Tax base is either consideration from sale or FMV whichever is higher Formula: Taxbase x 6% Capital gains tax = 10,000 Subtract (-) personal and additional exemption (does not apply in case of corporations) =10,000
b. Global System The taxpayer is

required to lump up all items of income earned during a taxable period and pay a single set of income tax rates on these different items of income. Net taxable income is subject to the graduated income tax rates in case of individuals and to corporate income tax rates in case of corporations. It does not matter whether the income received by the taxpayer is classified as compensation income, business professional income, passive investment income, capital gain or other income. All items of gross income as well as deductions and personal and additional exemptions are reported in ONE income tax return to be filed at least annually and the applicable tax rate is applied on the tax base. (applic to phil up to dec 1981) Example: Gross income = 100,000
Subtract (-) allowable deductions =
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INCOME TAXATION
Difference is Net taxable income = 80,000 80,000 is subjected to graduated tax rates to arrive at tax due adopted the semi-global or semi-schedular tax system by reducing the graduated rates on business and professional income from 60% to 35% and by increasing the preferential tax rates on capital gains and passive investment incomes. RA 8424 (1998) retained the semiglobal or semischedular tax system by introducing some structural and administrative reforms and by reducing the tax rates on corporations by 1% every year from 35% to 32%. The same tax system was maintained under RA 9337 in 2005 but corporate tax rate was increased to 35% and reduced to 30% in Jan 1, 2009.
c. Semi-schedular or semi Global tax

system Under this system, compensation income, business or professional income, capital gain and passive income not subject to FWIT (final withholding income tax) and other income are added together to arrive at the gross income. Obtain net taxable income by subtracting from the gross income the sum of allowable deductions from business or professional incom, capital gain, passive income not subject to FWIT in the case of corporations and personal and additional exemption in case of individuals and subject such taxable income to one set of graduated tax rates (individual) or normal corporate income tax rate (corporation)
3. Features of Income tax law:

a. Direct tax burden is borne by income recipient upon whom the tax is imposed b. Progressive tax tax base increases as tax rate increases c. Comprehensive tax situs- by adopting nationality, residence and source principle d. Philippines has retained more schedular than global features with respect to individual taxpayers but has maintained a more global treatment on corporations e. American origin great weight should be given to the construction placed upon a revenue law whose meaning is doubtful by the department charged with its execution CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES 1. Place where income was earned or the source
Note: Passive investment income subject to FWIT, Captal gains from sale or transfer of stocks of a domestic corp and real properties classified as capital assets remain subject to different sets of tax rates and covered by differect tax returns. Case: Sison Vs Ancheta GR No. L59431, Jult 25 1984 d. Schedular Rates of Taxes Vs Schedular System Schedular rates of taxes rates of taxes that applies to each category of income.
An alien is subject to Philippine income tax 2. The Philippine Income Tax System as a
Semi Global or Mixed System - Effective jan 1, 1986, Executive order No. 37
because he derives income from sources within the Philippines. Thus, a nonresident alien is liable to pay Philippine income tax on his income from sources
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INCOME TAXATION
within the Philippines, such as dividend, interest, rent, or royalty, despite the fact that he has not set foot in the Philippines. 2. Residency Resident Alien A citizen of the Philippines is subject to Philippine income tax:
Resident citizen on his worldwide income

from within and without the Philippines
An alien was subject to Philippine income

tax on his worldwide income because of his residence in the Philippines. This principle is however discarded in R.A. 8424 (1998) in view of the complexity in tax administration it brings. Thus, a resident alien is now liable to pay Philippine income tax only on his income from sources within the Philippines and is exempt from tax on his income from sources outside the Philippines. Nonresident Alien Engaged in Trade or Business in the Philippines If the aggregate period of his stay in the Philippines is more than 180 days during any calendar year Taxed on his income from sources within the Philippines At graduated income tax rate of 5% to 32%, white his passive investment incomes shall generally be subject to 20% final tax Not Engaged in Trade or Business in the Philippines If the aggregate period of his stay in the Philippines does not exceed 180 days during any calendar year His compensation income, business or professional income, capital gain, passive investment income, and other income from sources within the Philippines is taxed at the flat rate of 25% Capital gains from sale or exchange of shares of stocks in a domestic corporation and from real property located in the Philippines shall be subject to capital gains tax or stock transaction tax, as the case may be. 3. Citizenship
Nonresident citizen only on his sources

within the Philippines Types of nonresident citizen 1. Immigrants 2. Employees of a foreign entity on a permanent basis 3. Overseas contract workers
(1) and (2) are treated as nonresidents citizens from the time they depart from the Philippines (3) must be physically present abroad most of the time (at least 183 days) to qualify as nonresident citizens. His presence abroad is however need not be continuous.
THE INCOME TAXPAYERS AND THE GENERAL PRINCIPLES OF THEIR TAXABILITY (Tax Situs for Income Tax Purposes) 1. Section 23 of the NIRC 2. Individual Taxpayers (Section 24-26) 3. Corporations (Section 27-30 R.A. 9337) 4. Estates and Trusts (Section 60-66) 5. Definition of Terms Under Section 22
SOURCES OF INCOME (Section 42) 1. Services: Place of performance of the service If the service is performed in the Philippines, the income is treated as from sources within the Philippines
It includes compensation for labor or

personal services performed within the Philippines, regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of payment Compensation is either in cash or in kind Example: Juliane a non-resident alien appointed as a commission agent by a domestic
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INCOME TAXATION
corporation with a sales commission of 10% all sales actually concluded and collected through her efforts. The local company withheld the amount of P107,000 from her sales commission and remitted the same to the BIR. She filed a claim for refund alleging that her sales commission is not taxable because the same was a compensation for her services rendered in Germany and therefore considered as income from sources outside the Philippines. Is her contention correct ? SUGGESTED ANSWER: Yes. The important factor which determines the source of income of personal services is not the residence of the payor, or the place where the contract for service is entered into, or the place of payment, but the place where the serviceswere actually performed. Since the activity of securing the sales were in Germany, thenthe income did not originate from sources from within the Philippines. (Commissioner of Internal Revenue v. BaierNickel, G. R. No. 153793, August 29, 2006) NOTE AND COMMENTS: In the above case, the SupremeCourt reiterated the rule that source of income relates to the property, activity or service that produced the income. With respect to rendition of labor or personal service, it is the place where the labor or service was performed that determines the source of the income. 2. Interest Income: Residence of the debtor dividends was derived from sources within the Philippines, in which case, only the amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income from all sources shall be treated as income from sources within the Philippines. 4. Rents and Royalties: Location of the property or interest in such property If the property or interest is located or used in the Philippines, the gain or income is treated as income from sources within the Philippines 5. Sale of property a. Real Property: Location of real property If the real property sold is located within the Philippines, the gain is considered as income from the Philippines b. Personal Property Personal property produced (in whole or in part) by the taxpayer within the Philippines and sold without the Philippines, or produced without and sold within Any gain, profit or income shall be treated as derived partly from sources within and partly from sources without the Philippines Purchase of personal property within and its sale without the Philippines, or purchase of personal property without and its sale within the Philippines
If the obligor or debtor (corporation or

otherwise) is a resident of the Philippines, the interest income is treated as income from within the Philippines. It does not matter whether the loan agreement is signed in the Philippines or abroad or the loan proceeds will be used in a project inside or outside the country 3. Dividends: Residence of the corporation paying dividend
Dividends
received from a domestic corporation or from a foreign corporation are treated as income from sources within the Philippines, unless less than 50% of the gross income of the foreign corporation for the three-year period preceding the declaration of such
Any gain, profit or income shall be treated as derived entirely from sources within the country in which sold. Accordingly, if the goods are shipped in a foreign port under Free-on-Board (FOB) shipping point arrangement, title to the good is transferred at the foreign port and any gain from the sale of such goods to a Philippine importer
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INCOME TAXATION
shall be treated as income from sources outside the Philippines. Exclusions from Gross Income. - The following items shall not be included in gross income and shall be exempt from taxation under this title: (code: MARC GIL) (1) Life Insurance. The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise, but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income. (2) Amount Received by Insured as Return of Premium. The amount received by the insured, as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract.
DETERMINATION OF GROSS INCOME AND THE RULES OF INCLUSION AND EXCLUSION FROM GROSS INCOME
A. THE CONCEPT OF GROSS INCOME a. Gross income definition Sec 32. General definition: Except when otherwise provided in this title (II), gross income means all income derived from whatever source including but not limited to the following items: a. Compensation for services in whatever form paid including but not limited to fees, salaries, wages, commissions and other similar items b. Conduct of trade or business or the exercise of a profession c. Gains derived from the dealings in property d. Interests e. Rents f. Royalties g. Dividends h. Annuities i. Prizes and winnings j. Pensions k. Partners distributive share from the net income of the general professional partnership b. Gross sales- total sales for a period before discounts, returns and freight expenses have been deducted. B. THE GENERAL RULES ON INCLUSION AND EXCLUSION OF INCOME OF ITEMS (Section 31, 32A and 32B) Sec 31. Taxable income defined Gross Income Less -Deductions allowed by law -Personal exemptions Taxable income Exclusions Sec 32 B.
(3) Gifts, Bequests, and Devises.

The value of property acquired by gift, bequest, devise, or descent: Provided, however, That income from such property, as well as gift, bequest, devise or descent of income from any property, in cases of transfers of divided interest, shall be included in gross income.
(4) Compensation for Injuries or Sickness.

amounts received, through Accident or Health Insurance or under Workmen's Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness.
(5) Income Exempt under Treaty. Page 10
INCOME TAXATION
Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. the earnings and principal of the fund thus accumulated, and wherein its is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees. (b) Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death sickness or other physical disability or for any cause beyond the control of the said official or employee. (c) The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public. (d) Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States administered by the United States Veterans Administration. (e) Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282. (f) Benefits received from the GSIS under Republic Act No. 8291,
(6) Retirement
Benefits, Pensions, Gratuities, etc.(a) Retirement benefits received under Republic Act No. 7641 and those received by officials and employees of private firms, - whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer: Provided, That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement: Provided, further, That the benefits granted under this subparagraph shall be availed of by an official or employee only once. For purposes of this Subsection, the term 'reasonable private benefit plan' -means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the purpose of distributing to such officials and employees
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INCOME TAXATION
including retirement gratuity received by government officials and employees. (7) Miscellaneous Items. (a) Income Derived by Foreign Government. Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments. (b) Income Derived by the Government or its Political Subdivisions. - Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof. (c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if: (i) The recipient was selected without any action on his part to enter the contest or proceeding; and (ii) The recipient is not required to render substantial future services as a condition to receiving the prize or award. (d) Prizes and Awards in sports Competition. - All prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations. (e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and employees of public and private entities: Provided, however, That the total exclusion under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall cover: (i) Benefits received by officials and employees of the national and local government pursuant to Republic Act No. 6686; (ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; (iv) Benefits received by officials and employees not covered by Presidential decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and (iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the ceiling of Thirty thousand pesos (P30,000) may be increased through rules and regulations issued by the
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INCOME TAXATION
Secretary of Finance, upon recommendation of the Commissioner, after considering among others, the effect on the same of the inflation rate at the end of the taxable year. (f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig contributions, and union dues of individuals. (g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. Gains realized from the same or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years. (h) Gains from Redemption of Shares in Mutual Fund. - Gains realized by the investor upon redemption of shares of stock in a mutual fund company as defined in Section 22 (BB) of this Code. C. THE RULES AS COMPENSATION INCOME BENEFITS APPLIED TO AND OTHER unless specifically excluded under the tax code. Implications of the definition: a. There are really tax exempt or excluded gross compensation income from gross income as provided in Sec32 B. b. Not all compensation for services rendered may be subjected to tax. Example: in the case of services performed by an independent contractor in the absence of ER-EE relationship, the income received by the contractor shall be recorded as trade or business income. Professional income should not be included in the gross compensation income in the absence of ee-er relationship. Test whether income is compensation income: It is not the name of the remuneration upon which it is paid and the manner of payment, what is important is that it is derived from ER-EE relationship. Test to determine the existence of ER-EE relationship (code: AC-DC) A-appointment/selection C- Compensation or payment of wages D- Dismissal C-Compensation Tax implications when the payment is made for services rendered 1. For the employer- it may be claimed as deductible expense. Sec 34 A (1,a,i) provides reasonable allowance for salaries, wages 2. For the employee- it is a taxable income. Convenience of the employer rule (Henderson Doctrine) Allowances in kind furnished to the employee for and as a necessary incident to the performance of his duties are not taxable. (Valencia p 174) -this is the justification that may be used in granting exemptions from income tax on certain benefits that may be received under an ER-EE relationship.
a. Taxability of compensation income and the application of the employers convenience rule Compensation income as defined in sec 32 : compensation for services in whatever form paid including but not limited to fees, salaries, wages, commissions and similar items. However, this is not the correct definition. Rev. Reg. 2-98 defines compensation income all remuneration for services rendered by an employee for his employer under an ER-EE relationship,
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-examples: food and lodging benefit by a household maid, driver, etc. Rules on the application of the doctrine: A. Living quarters and meals (Valencia p 174) 1. When living quarters are furnished in addition to cash salary, the rental value of such quarters should be reported as income. 2. However if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as part of compensation income. Henderson vs. CIR 1 SCRA 650 Unless provided for the exclusive benefit of the employer, the rental value of living quarters is compensation income to the employee to the extent of his reasonable needs and the excess shall be considered as expenses of the corporation. The exclusion for meals is allowed only when: a. They are furnished within the employers business premises. The exclusion for lodging is allowed only when it is furnished within the business premises of the employer; and b. The employee accepts the lodging as a condition of his employment in order to perform his duties properly. Unless the above conditions are met, the value of any board and lodging furnished by an employer is ordinarily taxable to the employee. Rev. Reg 10-2000 : meal allowance for overtime work is tax exempt under the convenience rule provided that the meal allowance does not exceed 25% of the basic minimum wage and it applies only to managerial/supervisory employee. b.Retirement Payments, Pensions and Gratuities. c. Separation payments d. leave benefits e.13th month pay and other bonuses f. SSS/GSIS benefits g. SSS/GSIS/Philhealth/ Pag ibig/Union dues Items excluded Retirement benefit from a private retirement plan Conditions /particulars Requisites (code: FORT) a. Retiring official must be at least Fifty (50) years of age. b. Approved or availed only Once c. Reasonable private benefit plan approved by the BIR d. Ten (10) years in service Note: if the employee is still on active employment with the company, any and all the funds distributed from the fund to the active member over and above his personal contributions shall be taxable. Separation pay The benefit shall be tax exempt, whether his employee is a private firm or the government provided the pay is given on account of: a. Death b. Sickness c. Other physical disability d. Or any cause beyond the control of the official or employee Received by RC, NRC, and RA from foreign
Social security benefits; retirement
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gratuities and other similar benefits Benefits from US Veterans Administration SSS RA 8282 GSIS- RA 8291 government agencies and other private or public institutions By veterans residing in the Pilippines etc Tax exempt Tax exempt i. helicopters or aircrafts since they are considered as business expense of the employer d. Household personnel-maid, driver, e. Interest on loan at less than market rate (12% benchmark rate) to the extent of the difference between the market rate and the actual rate granted If the actual interest imposed is less than 12%, the same is taxable. If it is exactly 12% or more, it is tax exempt. f. Membership fees, dues and other expenses borne by the employer for the employee in social and athletics clubs or other similar organizations g. Holiday and vacation expenses h. Expenses for foreign travel Exempt if: 1. Required by the nature of the employers trade, business, or exercise of profession 2. Paid or incurred in connection with the business conventions, meetings or seminars abroad 3. All expenses are substantiated by receipts or records 4. There must be an official communication coming from the business associates abroad 5. Allowance exempt only up to 300.00 dollars. Tax treatment of the cost of airline ticket Economy class-exempt Business class- exempt 1st class tickets- exempt only up to 70% i. Educational assistance to the EE or his dependents Exempt in 2 cases: 1. Scholarship grant to managerial or supervisory employees Exemption:
COMMUTATION OR MONETIZED VALUE OF LEAVE PAY Vacation Leave If it forms part of the terminal leave pay -not taxable If given during the taxable year with NO retirement to: a. Government employees Tax exempt Exempt up to 10 days Tax exempt Unusedtaxable -not taxable Sick Leave
b.
Rank and file
h.
Fringe benefits Means any good, services or other benefit Furnished or granted by employer In cash or in kind, given in addition to the basic salary of an individual employee, except rank and file such as but not limited to the following ( HEV HIM HEEL) a. Housing Exemption: i. Military housing ii. temporary housing unit ( 3 months or less stay in the premises) iii. business premise of the ER including housing unit w/in 50 meters from the perimeter of the business premise b. Expense Account c. Vehicle of any kind
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2. Scholarship grant to dependents of an employee j. Life or health insurance and other non life premiums or similar amounts in excess of the law allows. 3 tax exempt life insurance premium 1. GSIS 2. SSS 3. Group insurance policy Rules on fringe benefits 1. It is subject to final tax 2. Need not be reported as part of the gross income, since it is subject to final tax. Sec 33-C Fringe benefits not taxable 1. Fringe benefits which are authorized and exempt 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 rand and file EE whether granted under a collective baragaining agreement or not. 4. De minimis benefits Recent regulation is Rev Reg 10-2000 These refer to facilities or privileges furnished or offered by an employer to his employee that are 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. D. THE RULES AS APPLIED TO TRADE/BUSINESS OF PROFESSIONAL INCOME Income covered: 1. Income derived by self employed from trade or business (trading, manufacturing, merchandising, farming and others) Self employment income- consist of the earnings derived by te individual from: a. Practice of profession b. Conduct of trade or business, as sole proprietor or c. A partnership of which he is a member 2. Income derived by professionals from the practice of profession Professionals- persons who derive their income from the practice of their profession-lawyers and other persons registered with the PRC. It may also refer to one who pursues an art and make living there from such as artists, athletes and others similarly situated. Business income- one which entails time, effort and activity for purpose of livelihood and profit
Formula of gross income: Example: Gross sales: Less: Cost of investment: Cost of sale Cost of goods Sales allowance Sales discount
1,000,000,000.00
530,000.00 Gross business income: 470,000.00 Example: Suppose Corporation A gave 100,000 to a customs official to process their license. Is the 100,000 taxable as income? May the corporation deduct the same as business expense? Ans: On the part of the official: included in taxable gross income(income from whatever source)
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INCOME TAXATION
On the corporation: not deductible. Unlawful expenses not deductible from gross income constituting themselves into a partnership taxable as a corporation. Joint venture; how created A joint venture is created when two corporations, while registered and operating separately, were placed under a sole management which operated the business affairs of said companies as though they constituted a single entity thereby obtaining substantial economy and profits in the operation. As stated, a joint venture is not taxed as a corporation, just like a general professional partnership.
General professional partnerships
General professional partnerships are partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business, [Sec. 22 (b), NIRC]. Persons engaging in business as partners in a general professional partnership shall be liable for income tax only in their separate and individual capacities, [Sec. 26, NIRC]. For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the same manner as a corporation, [Sec. 26, NIRC]. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership,[Sec. 26, NIRC] Income of a general professional partnership are deemed constructively received by the partners, [Sec. 73 (d), NIRC].
Non-Resident Alien Engaged in Trade or Business A non-resident alien engaged in trade or business shall be subject to the same income tax rates as a citizen and a resident alien. Exception: Cash and/or property dividends received by a non-resident alien Individual shall be subject to a final tax of 20% for citizens and resident aliens, the rate is 10% since year 2000.
Non-Resident Alien Not Engaged in Trade or Business
Ordinary business partnership An ordinary business partnership is considered as a corporation and is thus subject to tax as such. Partners are considered stockholders and, therefore, profits distributed to them by the partnership are considered as dividends.
Unregistered partnership and co-ownership for tax purposes If the activities of co-owners are limited to the preservation of the property and the collection of income therefrom, in which case, each co-owner is taxed individually on his distributive share in the income of the co-ownership. If the co-owners invest the income in business for profit, they would be
A non-resident alien individual not engaged in trade or business shall pay a tax equivalent to 25% on all items of income, except, for gain on sale of shares of stock in any domestic corporation and real property which shall be subject to the same rate applied to other individual taxpayers. Gain on sale of shares of stock: 1. Not over P100,000 - 5% 2. Over P100,000 -10% Capital gains on sale or disposition of property 6% of GSP or FMV, whichever is higher.
General Professional Partnerships General professional partnerships are partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which
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INCOME TAXATION
is derived from engaging in any trade or business. Persons engaged in business as partners in a general professional partnership shall be liable for income tax only on their separate and individual capacities. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership. The net income of the general professional partnership shall be computed in the sale manner as a corporation for purposes of computing the distributive shares of the partners. lower than 2% of the gross income of such corporate income taxpayer. This is called the Minimum Corporate Income Tax. Optional 15% tax on gross income
The President, upon the recommendation of the Secretary of Finance, may, effective Jan. 1, 2000, allow corporations the option to be taxed at 15% of gross income, provided certain conditions are satisfied. This is available to firms whose ratio of cost of sales to gross sales or receipts form all sources does not exceed 55%. Once elected by the corporation, the option shall be irrevocable for the succeeding three consecutive years.
TAX ON CORPORATIONS CORPORATE TAXPAYER Corporation, includes, partnerships no matter how created or organized, joint account companies, or insurance companies and other associations. It excludes: 1. General Professional Partnerships; 2. Joint venture for the purpose of undertaking construction projects; 3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government. RATES OF INCOME TAX CORPORATIONS IN General Rate of tax, in general: 1997 35% 1998 34% 1999 33% 2000 onwards 32% ON DOMESTIC
Conditions to be satisfied for the availability of the 15% optional corporate tax: 1. A tax effort ratio of twenty percent (20%) of the Gross National Product; 2. A ratio of 40% between total income tax collection and to total tax revenues; 3. A VAT tax effort ratio of 4% of the Gross National Product; 4. A 0.9% ration between the Consolidated Public Sector Financial Position to the GNP. Some definitions for this purpose:
Gross Income derived from business shall be equivalent to gross sales, less sales returns, discounts and allowances, and cost of goods sold. For taxpayers engaged in the sale of services, gross income means gross receipts less sales returns, allowances and discounts. Cost of goods sold shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use. educational
Tax rate for proprietary institutions and hospitals
Tax is imposed on taxable or net income. These rates are not applicable if the amount corresponding to the rates are
10% on taxable income, except of certain passive incomes. Predominance test The ordinary rate on corporations shall apply to proprietary educational institutions and hospitals
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INCOME TAXATION
when their gross income form unrelated trade, business or other activity exceeds 50% of their total gross income derived from all sources. Unrelated trade, business or other activity This 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. Resident Foreign Corporation A resident foreign corporation is one organized, authorized, or existing under the laws of any foreign country, engaged in the trade or business within the Philippines. In order that a foreign corporation may be regarded as doing business within a state, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of temporary character. Tax rates in General Rate of tax, in general: 1997 35% 1998 34% 1999 33% 2000 onwards 32%
Proprietary educational institution A proprietary educational institution is any private school maintained and administered by private individuals or groups with an issued permit to operate from the DepEd, CHED, or TESDA, as the case may be.
GOCCs, AGENCIES OR INSTRUMENTALITIES All corporations, agencies or instrumentalities owned or controlled by the government shall pay such rate of tax upon their taxable income as are imposed upon corporations or associations engaged in a similar business, industry, or activity. Exceptions: GOCCs and instrumentalities not subject to tax are the ff: GSIS SSS Phil Health Insurance Corporation PCSO PAGCOR
1. 2. 3. 4. 5.
Tax is imposed on taxable or net income. These rates are not applicable if the amount corresponding to the rates are lower than 2% of the gross income of such corporate income taxpayer. This is called the Minimum Corporate Income Tax (same as with domestic corporation) Optional 15% tax on gross income The option to be taxed at 15% on its gross income is also available to Resident Foreign Corporations, subject to the same conditions. Available to firms whose ratio of cost of sales to gross sales or receipts from all sources does not exceed 55% resident foreign
Rule for Corporation exempt from taxation General rule: those enumerated under Section 30 are exempt Exception: exempted corporations are subject to income tax on their income from any of their properties, real or personal, or from any activities conducted for profit regardless of the disposition made of such income. TAX ON RESIDENT FOREIGN CORPORATIONS
Tax on specific corporations
1. International Carrier 2 of Gross Philippine Billings 2. Offshore Banking Units - !0% of income derived from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, including any interest income derived from foreign currency loans granted to residents
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INCOME TAXATION
Any income of non-residents, whether individuals or corporations, from transactions with said offshore banking units shall be exempt from income tax 3. Tax on branch profits remittances 15% of total profits applied or earmarked for remittance without deduction for the tax component thereof. 4. Regional or area headquarters shall not be subject to income tax 5. Regional operating headquarters shall be subject to a tax of 10% of their taxable income. Gross Philippine Billings for International carriers Gross Philippine Billings refer to the amount of gross revenue derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document. Tickets revalidated, exchanged and/or endorsed to another international airline form part of the Gross Philippine Billings of the passenger boards a plane in a port or point in the Philippines. For a flight which originates from the Philippines, but transhipment of passenger takes place at any port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transhipment shall form part of the Gross Philippine Billing. Tax on branch profit remittances Any profit remitted by a branch to its head office shall be subject to a tax of 15% which shall be based on the total profits applied or earmarked for remittance without any deduction for the tax component thereof except those activities which are registered with the Philippine Economic Zone Authority. The following shall not be treated as branch profits unless the same are effectively connected with the conduct of its trade or business in the Philippines: 1. Interests 2. dividends 3. rents 4. royalties 5. remuneration for technical services 6. salaries 7. wages 8. premiums 9. annuities 10. emoluments 11. other fixed or determinable annual, periodic, or casual gains, profits, income and capital gains. of
Regional or area headquarters multinational companies
Regional or area headquarters shall not be subject to income tax. of
Regional operating headquarters multinational companies
Regional operating headquarters shall pay a tax of ten percent (10%) on their taxable income. by a
Tax on certain incomes received resident foreign corporation
Gross Philippine Billings for International Shipping Gross Philippine Billings means gross revenue whether for passenger, cargo or mail, originating from the Philippines up to final destination, regardless of the place of sale or payments of the passage or freight documents.
1. Interest from deposits and yield or any other monetary benefit from deposit substitutes, trust funds and similar arrangements and royalties. Interest income from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements and royalties derived from sources within the Philippines shall be subject to a final
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INCOME TAXATION
income tax at the rate of twenty percent (20%) of such interest. However, interest income derived by a resident foreign corporation from a depository bank under the expanded foreign currency deposit system shall be subject to a final income tax at the rate of seven and one-half percent (7 %) of such interest income. 2. Income derived under the expanded foreign currency deposit system This refers to income derived by a depositary bank under the expanded foreign currency deposit system from foreign currency transactions with local commercial banks including branches of foreign bank that many be authorized by the Bangko Sentral ng Pilipinas to transact business with foreign currency deposit system units and other depositary banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by such depositary banks under said expanded foreign currency deposit system to residents. A final income tax at the rate of ten percent (10%) is imposed on such income. 3. Intercorporate dividends Dividends received by a resident foreign corporation from a domestic corporation liable to tax under the NIRC shall not be subject to income tax. TAX ON NON-RESIDENT CORPORATION Taxation of a non-resident corporation, in general Rates of tax, in general 1997 35% 1998 34% 1999 33% FOREIGN 2000 32% However, the tax is imposed on gross income, not on taxable or net income. Such gross income may include interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains from the sale of shares of stock not traded in the stock exchange.
Taxation of certain non-resident foreign corporations 1. Non-resident cinematographic film owner, lessor or distributor 25% of gross income 2. Non-resident owner or lessor of vessels chartered by Philippine nationals 4 % of gross rentals, lease or charter fees 3. Non-resident owner or lessor of aircraft, machineries and other equipment 7 % of gross rentals or fees Non-resident cinematographic film owner, lessor or distributor A cinematographic film owner, lessor, or distributor shall pay a tax of twenty five percent (25%) of its gross income from all sources within the Philippines. vessel
Non-resident owner or lessor of chartered by Philippine nationals
A non-resident owner or lessor of vessels shall be subject to a tax of four and onehalf percent (4 %) of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations, as approved by the Maritime Industry Authority.
foreign
Non-resident owner or lessor of aircraft, machineries and other equipment Rentals, charters and other fees derived by a non-resident lessor of aircraft, machineries and other equipment shall be subject to a tax of seven and one-half percent (7 %) of gross rentals or fees.
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INCOME TAXATION
Tax on certain incomes received by a nonresident foreign corporation 1. Interest on foreign loans A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after 01 August 1986. 2. 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 by a non-resident foreign corporation from a domestic corporation, 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 non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to thirty two percent (32%) in the year 2000. This is the so-called tax sparing rule. 3. Capital gains from sale of shares of stock not traded in the stock exchange a. Not over P100,000 5% b. Over P100,000 10% E. THE RULES AS APPLIED TO PASSIVE INCOME Passive income 1. Passive income from Philippine sources subject to final tax. 2. Passive income from Philippine sources not subject to final tax. 3. Passive income from sources outside the Philippines. Passive income 1. 2. 3. 4. 5. Interest income Rentals/ leases Royalties Dividends Annuities and proceeds of life insurance/ other types of insurance 6. Prizes and winnings, awards, and rewards 7. Gifts, bequests, and devises
8. Other types of passive income a. Royalties, Prizes and Winnings 1. Exclusion from gross income a. Prizes, awards in sports competition sanctioned by national sports associations whether held in Philippines or abroad contemplates a particular competition, not a cumulative achievement (Ex. Sportsman of the year award does not qualify for exemption) b. Prizes and awards i. In recognition of religious, charitable scientific, educational, artistic literary or civic achievement but if only if: ii. Recipient was selected without any action oh his part iii. Recipient not required to render substantial future services as a condition of receiving the prize/award Example: Nobel prize award c. Rates of tax in certain passive income i. Royalties, except on books, as well as other literary works and musical compositions 20% ii. Royalties on books, literary works and musical compositions 10% iii. Prizes over P10,000 20% (Note: prizes less than P10,000 are included in the income tax of the individual subject to the scheduler rate) iv. Other winnings, except PCSO and Lotto, derived from sources within the Philippines 20% b. Interest Income from bank deposits and deposit substitutes 1. interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangement 20% final tax except non-
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INCOME TAXATION
resident alien not engaged in trade or business which is 25% 2. interest income received by an individual (except a nonresident individual)from a depositary bank under the expanded foreign currency deposit system 7.5% except non resident alien, non resident engaged in trade/business and non resident alien not engaged in trade and business 3. interest income from long term deposit or investment in the form of savings, common or individual trust fund, deposit substitutes, investment management accounts and other investments evidenced by certification in such form prescribed by the BSP all exempt except nonresident alien not engaged in trade/business which is subject to 25% 4. Interest income from long term deposit or investment evidenced by certificates prescribed by BSP: a) Exempt, if investment is held for more than 5 years b) If investment is preterminated, interest income on such investment shall be subject to the following rates: 20% - If pre-terminated in less than 3 years 12% - If pre-terminated after 3 years to less than 4 years 5%less than 5 c. Dividends Stock dividend As a rule stock dividends are not taxable. This is so, because there is no income here. It merely represents the transfer of surplus accounts to the capital account. Exception to the rule: Stock dividend may be subject to tax under the following exceptional cases: 1. If there is a change in the stockholders interest in the net assets of the corporation; If pre-terminated after 4 years to years
2. If it is one issued by another

corporation. This dividend stock. is called
Stock dividend vs. Dividend stock: Stock dividend is not taxable, while dividend stock is taxable 3. Redemption of stock dividend; 4. If the corporation had issued to a stockholder 2 different classes of shares of stock, any stock dividend that may be issued to such stockholder shall be taxable. A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. It shall be taxable only if subsequently cancelled and redeemed by the corporation. It is also taxable if it leads to a substantial alteration in the proportion of tax ownership in a corporation.
Dividends paid in property Dividends paid in securities or other property, in which the earnings of a corporation have been invested, are income to the recipients to the amount of the full market value of such property when receivable by individual stockholders. A dividend paid in a stock of another corporation is not a stock dividend, even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. [Section 251, Revenue Regulations 2]. Liquidating dividend Where a corporation distributes all its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporation, is a taxable income or deductible loss, as the case may be.
Disguised dividends These are payments which are equivalent to dividend distribution.
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INCOME TAXATION
date, the records revealed that he has a total shareholdings of 185,154 shares 50,495 of which are original issues and the balance of 134.659 shares as stock dividend declarations. Correspondingly, one-half of that shareholdings or 92,577 shares were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate. Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme under Section 367 of the 1954 U.S. Revenue Act. he IRS opined that the exchange is only a recapitalization scheme and not tax avoidance. Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727. In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue Code, for the year 1968 and the second quarter of 1969 based on the transactions of exchange 31 and redemption of stocks. The Bureau of Internal Revenue (BIR) made the corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree (P.D.) 23 which were amended by P.D.'s 67 and 157. Issue: whether the stock dividends of the Late Don are taxable and not covered by the tax amnesty. Held: Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of the U.S. Revenue Code of 1928. It laid down the general rule known as the proportionate test wherein stock dividends once issued form part of the capital and, thus, subject to income tax. Specifically, the general rule states that: A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.
In the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be a distribution of earnings or profits, the excessive payments will be treated as dividends. [Section 71, Revenue Regulation 2] 1.Cash and/or property dividends
10% final tax, by January 1, 2000, on the following: a) Cash and or property dividend actually or constructively received from a domestic corporation or from a joint stock company, insurance or mutual fund companies and regional operating headquarters of multinational companies. b) Share of an individual in the distributive net income after tax of a partnership except a general professional partnership of which he is a partner c) Share of an individual in the net income after tax of an association, joint account, or a joint venture or consortium taxable as a corporation of which he is a member or a coventurer 2.CIR vs CA and ANSCOR, GR no. 108576, January 20, 1999 Facts: Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR. Don Andres transferred some of his shares his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR. Both sons are foreigners. By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and December 20, 1963. On December 30, 1964 Don Andres died. As of that
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INCOME TAXATION
the Exception However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable. Although redemption and cancellation are generally considered capital transactions, as such. they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice. Having realized gain from that redemption, the income earner cannot escape income tax 3.Section 73. Distribution of dividends or Assets by Corporations. (A) Definition of Dividends. - The term 'dividends' when used in this Title means any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property. Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss, as the case may be. (B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it represents a distribution of earnings or profits. (C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. - Any distribution made to the shareholders or members of a corporation shall be deemed to have been made form the most recently accumulated profits or surplus, and shall constitute a part of the annual income of the distributee for the year in which received. (D) Net Income of a Partnership Deemed Constructively Received by Partners. - The taxable income declared by a partnership for a taxable year which is subject to tax under Section 27 (A) of this Code, after deducting the corporate income tax imposed therein, shall be deemed to have been actually or constructively received by the partners in the same taxable year and shall be taxed to them in their individual capacity, whether actually distributed or not. d.Capital Gains from Sale of Real Property 1. 6% final tax on gross selling price or current fair market value, whichever is higher 2. imposed upon capital gains presumed to have been realized from the sale, exchange, or other dispositions of real property located in the Philippines, including pacto de retro sales and other forms of conditional sales 3. law presumes a gain, hence even if the sale was at a loss (bought for 2M, sold for 1.5M), CGT will still be imposed on entire
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INCOME TAXATION
process of the disposition. Reason: the law does not talk about the net gain, it only considers gross selling price/FMV whichever is higher 4. refers to real property held as capital asset as opposed to ordinary asset(used in ordinary course of business) 5. Rules for disposition to government: a. taxpayer has option of treating the proceeds as taxable income (5-32% on net gain) or as capital gains (6% final tax on FMV/gross selling price) b. if second option is chosen it shall be based on actual consideration and not FMV since the former is usually lower than FMV (BIR ruling) c. if the disposition took nature of expropriation, transaction is not subject to CGT. Net gain (if any) will be treated as part of GI. Includes disposition by judicial order and other forms of forced disposition 6. Rule for Exchange FMV of the property exchanged/given up shall be basis of CGT. (ex. A exchanges property worth 2M for Bs property worth 4M; therefore CGT on A will be based on 2M and 4M for B.) 7. exception on principal residence a. gains presumed to have been realized from sale or disposition of principal residence, the proceeds of which is fully utilized in acquiring new principal residence within 18 months from disposition shall be exempt from CGT b. can be availed only once every 10 years c. if the new principal residence is cheaper than old (meaning there is no full utilization of the proceeds), the difference will be subject to CGT The above-mentioned tax rates apply to all individual taxpayers. d. exemption does not include exchange of principal residence for a new principal residence -> subject to rules on exchange above. e. Sales of shares of stock not listed or trated in the stock exchange CAPITAL GAIN DERIVED SHARES OF STOCK FROM SALE OF
Listed and traded through local stock exchange- this is not subject to income tax but subject to percentage tax of of 1% of the gross selling price.
Not listed and traded through local stock exchange- this is the one subject to income tax. Not over P100,000.00 Amount over P100,000.00 5% 10%
If the share of stock is not listed and traded through local stock exchange, the basis of the tax is net capital gain. So, you should first deduct the capital loss.
If listed and traded through local exchange, there is no deduction allowed because the basis of the tax rate of of 1% of the gross selling price.
Distribution of TREASURY STOCKS should be considered taxable since the stocks are not sourced from the unissued shares of the corporation and there being no transfer from surplus to capital. F. OTHER SOURCES OF NCOME - Cancellation of indebtedness Cancellation of indebtedness has the following tax consequences: a. It may account to taxable compensation income if the
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INCOME TAXATION
indebtedness has been cancelled in consideration of the services rendered. b. It may account to taxable gift or donation of the indebtedness has been cancelled without any consideration at all. c. If may amount to capital transaction if the creditor is a corporation and the debtor is stockholder. If creditor corporation condoned the indebtedness of the debtor stockholder, that may amount to taxable capital transaction. This is the form of direct dividend. Income from lease and leasehold improvements following are obligations which may be assumed by the lessee: [R.I.D.I.O.] a.1. Real property taxed on leased premises a.2. Obligation to pay insurance premium on the insured leased premises. a.3. If the lessor is a corp., the obligation to distribute Dividends to its stockholders a.4. Obligation to pay interest on the bonds issued by the lessor. a.5. Other obligations of the lessor which may be assumed by the lesee. of permanent improvements on leased premises. This may be reported through: b.1. Outright method at the time of permanent is completed, he may report that as additional rent income FMV of the building or permanent improvement b.2. Spread out method by allocating the depreciation among throughout the remaining term of the leased. c. Advanced rentals c.1. If in the nature of the prepaid rentals without restriction on the use of the amount, it is taxable. c.2. If it is in the nature of security deposit, it is taxable rent income if there is a violation of the term of the lease. c.3. If it is in the nature of a loan to the lessor, it is not taxable. C. Income from Installment Transactions
Operating lease An operating lease is a contract under which the asset is not wholly amortized during the primary period of the lease, and where the lessor does not rely solely on the rentals during the primary period for his profits, but looks for the recovery of the balance of his costs and for the rests of his profits from the sale or re-lease of the returned assets at the end of the primary lease period. Financial lease Also called full payout lease is a contract involving payment over an obligatory period (also called primary or basic period) of specified rental amounts for the use of a lessors property, sufficient in total to amortize the capital outlay of the lessor and to provide for the lessors borrowing costs and profists. Obligatory period is primary noncancellable period of the lease which in no case shall be less than 730 days. Lesee exercise choice over the asset. The following income: constitutes taxable rent
b. Value
1. The regular rent may be monthly, semiannually or annually. 2. Additional rent income which includes: a. Obligation of the lessor assumed by the lesee. The
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INCOME TAXATION
Baas vs. CA Facts: On February 20, 1976, petitioner, Bibiano V. Baas Jr. sold to Ayala Investment Corporation. AYALA issued one promissory note covering four equal annual installments. Each periodic payment of P461,754.00 pesos shall be payable starting on February 20, 1977, and every year thereafter, or until February 20, 1980. The same day, petitioner discounted the promissory note with AYALA, for its face value of P1,847,016.00. AYALA issued nine (9) checks to petitioner, all dated February 20, 1976, drawn against Bank of the Philippine Islands with the uniform amount of two hundred five thousand, two hundred twenty-four (P205,224.00) pesos. In his 1976 Income Tax Return, petitioner reported the P461,754 initial payment as income from disposition of capital asset.2 Selling Price of Land Less Initial Payment Unrealized Gain P2,308,770. 00 461,754.00 P1,847,016. 00
3
Revenue Director Mauro Calaguio authorized tax examiners to examine the books and records of petitioner for the year 1976. They discovered that petitioner had no outstanding receivable from the 1976 land sale to AYALA and concluded that the sale was cash and the entire profit should have been taxable in 1976 since the income was wholly derived in 1976. The examiners recommended deficiency tax assessment for two million, four hundred seventy-three thousand, six hundred seventythree (P2,473,673.00) pesos. However, after reviewing the examiners' report, Larin directed the revision of the audit report, with instruction to consider the land as capital asset. The tax due was only fifty (50%) percent of the total gain from sale of the property held by the taxpayer beyond twelve months pursuant to Section 345 of the 1977 National Internal Revenue Code (NIRC). The deficiency tax assessment was reduced to nine hundred thirty six thousand, five hundred ninetyeight pesos and fifty centavos (P936,598.50), inclusive of surcharges and penalties for the year 1976. respondent Larin sent a letter to petitioner informing of the income tax deficiency that must be settled him immediately but petitioner insisted that the sale of his land to AYALA was on installment. As a consequence, a criminal complaint was filed against petitioner for tax evasion. Issue: Whether respondent court erred in finding that petitioner's income from the sale of land in 1976 should be declared as a cash transaction in his tax return for the same year (because the buyer discounted the promissory note issued to the seller on future installment payments of the sale, on the same day of the sale); Decision: Sec. 43 of the 1977 NIRC states, Installment basis. (a) personal property. . . . Dealers in
1976 Declaration of Income on Disposition of Capital Asset subject to Tax: Initial Payment P461,754.0 0
Less: Cost of land and ( 76,547.90) other incidental Expenses Income Income subject to (P385,206. 10 x 50%) P385,206.1 0 tax P192,603.6 5
In the succeeding years, until 1979, petitioner reported a uniform income of two hundred thirty thousand, eight hundred seventy-seven (P230,877.00) pesos4 as gain from sale of capital asset. In his 1980 income tax amnesty return, petitioner also reported the same amount of P230,877.00 as the realized gain on disposition of capital asset for the year.
(b) Sales of realty and casual sales of personalty In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price
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INCOME TAXATION
exceeding one thousand pesos, or (2) of a sale or other disposition of real property if in either case the initial payments do not exceed twenty-five percentum of the selling price, the income may, under regulations prescribed by the Minister of Finance, be returned on the basis and in the manner above prescribed in this section. As used in this section the term "initial payment" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made. . . . (emphasis ours) Revenue Regulation No. 2, Section 175 provides, Sale of real property involving deferred payments. Under section 43 deferredpayment sales of real property include (1) agreements of purchase and sale which contemplate that a conveyance is not to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as to deferred payments. Such sales either under (a) or (b), fall into two classes when considered with respect to the terms of sale, as follows: (1) Sales of property on the installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made do not exceed 25 per cent of the selling price; (2) Deferred-payment sales not on the installment plan, that is sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made exceed 25 per cent of the selling price; In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject to the
mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the "selling price" but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or of the "total contract price," as those terms are used in section 43 of the Code, in sections 174 and 176 of these regulations, and in this section. The term "initial payments" does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years. Commissions and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the "initial payments," the "total contract price," or the "selling price." The term "initial payments" contemplates at least one other payment in addition to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no payment during the year, the income may not be returned on the installment basis. Income may not be returned on the installment basis where no payment in cash or property, other than evidences of indebtedness of the purchaser, is received during the first year, the purchaser having promised to make two or more payments, in later years. Petitioner asserts that Sec. 43 allows him to return as income in the taxable years involved, the respective installments as provided by the deed of sale between him and AYALA. Consequently, he religiously reported his yearly income from sale of capital asset, subject to tax, as follows: Year 1977 P461,754) 1978 1979 1980 (50% of P230,877. 00 230,877. 00 230,877. 00 230,877.
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00 Petitioner says that his tax declarations are acceptable modes of payment under Section 175 of the Revenue Regulations (RR) No. 2. The term "initial payment", he argues, does not include amounts received by the vendor which are part of the complete purchase price, still due and payable in subsequent years. Thus, the proceeds of the promissory notes, not yet due which he discounted to AYALA should not be included as income realized in 1976. Petitioner states that the original agreement in the Deed of Sale should not be affected by the subsequent discounting of the bill. On the other hand, respondents assert that taxation is a matter of substance and not of form. Returns are scrutinized to determine if transactions are what they are and not declared to evade taxes. Considering the progressive nature of our income taxation, when income is spread over several installment payments through the years, the taxable income goes down and the tax due correspondingly decreases. When payment is in lump sum the tax for the year proportionately increases. Ultimately, a declaration that a sale is on installment diminishes government taxes for the year of initial installment as against a declaration of cash sale where taxes to the government is larger. As a general rule, the whole profit accruing from a sale of property is taxable as income in the year the sale is made. But, if not all of the sale price is received during such year, and a statute provides that income shall be taxable in the year in which it is "received," the profit from an installment sale is to be apportioned between or among the years in which such installments are paid and received.13 Sec. 43 and Sec. 175 says that among the entities who may use the above-mentioned installment method is a seller of real property who disposes his property on installment, provided that the initial payment does not exceed 25% of the selling price. They also state what may be regarded as installment payment and what constitutes initial payment. Initial payment means the payment received in cash or property excluding evidences of indebtedness due and payable in subsequent years, like promissory notes or mortgages, given of the purchaser during the taxable year of sale. Initial payment does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years.14 Such disposition or discounting of receivable is material only as to the computation of the initial payment. If the initial payment is within 25% of total contract price, exclusive of the proceeds of discounted notes, the sale qualifies as an installment sale, otherwise it is a deferred sale.15 Although the proceed of a discounted promissory note is not considered part of the initial payment, it is still taxable income for the year it was converted into cash. The subsequent payments or liquidation of certificates of indebtedness is reported using the installment method in computing the proportionate income16 to be returned, during the respective year it was realized. Non-dealer sales of real or personal property may be reported as income under the installment method provided that the obligation is still outstanding at the close of that year. If the seller disposes the entire installment obligation by discounting the bill or the promissory note, he necessarily must report the balance of the income from the discounting not only income from the initial installment payment. Where an installment obligation is discounted at a bank or finance company, a taxable disposition results, even if the seller guarantees its payment, continues to collect on the installment obligation, or handles repossession of merchandise in case of default.17 This rule prevails in the United States.18 Since our income tax laws are of American origin,19 interpretations by American courts an our parallel tax laws have persuasive effect on the interpretation of these laws.20 Thus, by analogy, all the more would a taxable disposition result when the discounting of the promissory note is done by the seller himself. Clearly, the indebtedness of the buyer is discharged, while the seller acquires money for the settlement of his receivables. Logically then, the income should be reported at the time of the actual gain. For income tax purposes, income is an actual gain or an actual increase of wealth.21 Although the proceeds of a discounted promissory note is not considered initial payment, still it must be included as taxable income on the year it was converted to cash. When petitioner had the promissory notes covering the
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succeeding installment payments of the land issued by AYALA, discounted by AYALA itself, on the same day of the sale, he lost entitlement to report the sale as a sale on installment since, a taxable disposition resulted and petitioner was required by law to report in his returns the income derived from the discounting. What petitioner did is tantamount to an attempt to circumvent the rule on payment of income taxes gained from the sale of the land to AYALA for the year 1976 Long-term contracts For each married individual *P 50,000.00 Note: In case of married individuals where only one of the spouses is deriving gross income, only such spouse will be allowed to claim the personal exemption. Additional Exemptions: For each qualified dependent, an P25,000 additional exemption can be claimed but only up to 4 qualified dependents
The additional exemption can be claimed by the following: The husband who is deemed the head of the family unless he explicitly waives his right in favor of his wife The spouse who has custody of the child or children in case of legally separated spouses. Provided, that the total amount of additional exemptions that may be claimed by both shall not exceed the maximum additional exemptions allowed by the Tax Code. The individuals considered as Head of the Family supporting a qualified dependent
The term long term contract means building, installation or construction contracts covering a period in excess of one year. [Section 48, NIRC] of income from long-term
Treatment contracts
1. Percentage of completion basis 2. Completed contract basis Note: Section 48 of the NIRC provides that Persons whose gross income is derive in whole or in part from such (long term) contracts shall report such income upon the basis of percentage of completion. The return should be accompanied by a return certificate of architects or engineers showing the percentage of completion during the taxable year of the entire work performed under the contract. G. EXCLUSION LAWS BY REASON OF SPECIAL
The maximum amount of P 2,400 premium payments on health and/or hospitalization insurance can be claimed if: Family gross income yearly should not be more than P 250,000 For married individuals, the spouse claiming the additional exemptions for the qualified dependents shall be entitled to this deduction
DEDUCTIONS FROM GROSS INCOME

A. CONCEPT OF ALLOWABLE DEDUCTIONS a) Deductions, Defined DEDUCTIONS items or amounts which the law allows to be deducted from gross income in order to arrive at the taxable income (2010 Beda Notes, page 66) Nature of Deductions (Valencia, Roxas, page 365)
RA 9504 -Income and withholding exemption for minimum wage earners Personal Exemptions:
tax
For single individual or married individual judicially decreed as legally separated with no qualified dependentsP 50,000.00 For head of familyP 50,000.00
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In general, deductions or allowable deductions are business expenses and losses incurred which the law allows to reduce gross business income to arrive at net income subject to tax. They are kind of legislative grace. They are not presumed but allowable only by specific provisions of law. They are construed strictly against the taxpayer.
d) Deductions, When Allowed INSTANCES WHEN ARE ALLOWED: DEDUCTIONS
b) Deductions vs. Exclusions

DEDUCTIONS 1. Amount which the law allows to be subtracted from the gross income in order to arrive at a net taxable income (NIRC) EXCLUSIONS 1. Flow of wealth not treated as part of gross income because exempted by tax treaty, statute or the Constitution (in the nature of tax exemptions) and those which do not come within the definition of income Can be availed by all kinds of taxpayer
1. Existence of a law authorizing the deductions taxpayer seeking the deduction must point some specific provision of the statute authorizing the deductions 2. Tax payer must be able to prove that he is entitled to such deductions
3.
Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income or for depreciation or amortization may be allowed as deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to BIR (Section 34(K), NIRC)
2.
Allowed only to businesses, corporations, institutions. Amounts spent or paid in the process of earning gross income
2.
e) Deductions vs. Tax Credit

3. Amounts earned or received by the taxpayer but do not form part of the gross income Used in computing GROSS INCOME DEDUCTIONS 1. Subtracted from the gross income to arrive at net taxable income TAX CREDIT 1. Deducted from taxable income to arrive at income tax payable
3.
4.
Used computing TAXABLE INCOME
in
4.
2. Diminishes income tax payable
2. Diminishes liability
tax
c) Deductions vs. Cost

DEDUCTIONS COST
i) CIR vs. Central Luzon Drug Corp, GR No. 159647, 15 April 2005 PANGANIBAN, J.: The 20 percent discount required by the law to be given to senior citizens is a tax credit, not merely a tax deduction from the gross income or gross sale of the establishment concerned. A tax credit
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is used by a private establishment only after the tax has been computed; a tax deduction, before the tax is computed. RA 7432 unconditionally grants a tax credit to all covered entities. Thus, the provisions of the revenue regulation that withdraw or modify such grant are void. Basic is the rule that administrative regulations cannot amend or revoke the law. Facts: Respondent is a domestic corporation primarily engaged in retailing of medicines and other pharmaceutical products. In 1996, it operated six (6) drugstores under the business name and style Mercury Drug. From January to December 1996, respondent granted twenty (20%) percent sales discount to qualified senior citizens on their purchases of medicines pursuant to Republic Act No. [R.A.] 7432 and its Implementing Rules and Regulations. For the said period, the amount totalled P904,769.00. On April 15, 1997, respondent filed its Annual Income Tax Return 1996 declaring that it incurred net losses from its operations. On January 16, 1998, respondent filed with petitioner a claim for tax refund/credit in the amount of P904,769.00 allegedly arising from the 20% sales discount granted by respondent to qualified senior citizens in compliance with [R.A.] 7432. Unable to obtain affirmative response from petitioner, respondent elevated its claim to the Court of Tax Appeals [(CTA or Tax Court)] via a Petition for Review. The Tax Court dismissed respondents Petition for lack of merit. CTA said: x x x, if no tax has been paid to the government, erroneously or illegally, or if no amount is due and collectible from the taxpayer, tax refund or tax credit is unavailing. Moreover, whether the recovery of the tax is made by means of a claim for refund or tax credit, before recovery is allowed[,] it must be first established that there was an actual collection and receipt by the government of the tax sought to be recovered. x x x. Prescinding from the above, it could logically be deduced that tax credit is premised on the existence of tax liability on the part of taxpayer. In other words, if there is no tax liability, tax credit is not available. The MR filed by the respondent was granted by the CTA. It then ordered petitioner to issue a Tax Credit Certificate in favor of Central Luzon Drug. The CA affirmed in toto the Resolution of the Court of Tax Appeals (CTA) in the reduced amount of P903,038.39. It reasoned that Republic Act No. (RA) 7432 required neither a tax liability nor a payment of taxes by private establishments prior to the availment of a tax credit. Moreover, such credit is not tantamount to an unintended benefit from the law, but rather a just compensation for the taking of private property for public use. Issue : Is the 20% sales discount a tax credit or a deduction from gross income or gross sales? Ruling: The 20% sales discount is a tax credit as expressly provided for by RA 7432. Tax Credit versus Tax Deduction
Tax credit generally refers to an amount

that is subtracted directly from ones total tax liability. It is an allowance against the tax itself or a deduction from what is owed by a taxpayer to the government. Examples of tax credits are withheld taxes, payments of estimated tax, and investment tax credits.
Tax deduction -- defined as a subtraction

from income for tax purposes, or an amount that is allowed by law to reduce income prior to [the] application of the tax rate to compute the amount of tax which is due. An example of a tax deduction is any of the allowable deductions
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enumerated in Section 34[20] of the Tax Code. Granting that there is a tax liability and respondent claims such cost as a tax credit, then the tax credit can easily be applied. If there is none, the credit cannot be used and will just have to be carried over and revalidated accordingly. If, however, the business continues to operate at a loss and no other taxes are due, thus compelling it to close shop, the credit can never be applied and will be lost altogether. Tax Credit Compensation Benefit Deemed Just
tax credit differs from a tax deduction. On the one hand, a tax credit reduces the tax due, including -- whenever applicable -- the income tax that is determined after applying the corresponding tax rates to taxable income.
A tax deduction, on the other, reduces

the income that is subject to tax in order to arrive at taxable income. To think of the former as the latter is to avoid, if not entirely confuse, the issue. A tax credit is used only after the tax has been computed; a tax deduction, before. By ordinary acceptation, a discount is an abatement or reduction made from the gross amount or value of anything. To be more precise, it is in business parlance a deduction or lowering of an amount of money; or a reduction from the full amount or value of something, especially a price. In business there are many kinds of discount, the most common of which is that affecting the income statement or financial report upon which the income tax is based. To stress, the effect of a sales discount on the income statement and income tax return of an establishment covered by RA 7432 is different from that resulting from the availment or use of its tax credit benefit. While the former is a deduction before, the latter is a deduction after, the income tax is computed. As mentioned earlier, a discount is not necessarily a sales discount, and a tax credit for a simple discount privilege should not be automatically treated like a sales discount. Where the law does not distinguish, we ought not to distinguish. When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed -- shall be treated as a reduction from any tax liability, plain and simple
Sections 2.i and 4 of RR 2-94 deny the exercise by the State of its power of eminent domain. Be it stressed that the privilege enjoyed by senior citizens does not come directly from the State, but rather from the private establishments concerned. Accordingly, the tax credit benefit granted to these establishments can be deemed as their just compensation for private property taken by the State for public use. SC affirmed Decision and Resolution of the Court of Appeals. ii) CIR vs. Central Luzon Drug Corp, GR No. 148512, 26 June 2006
AZCUNA, J.: FACTS: Central Luzon Drug Corporation has been a retailer of medicines and other Pharmaceutical products since December 19, 1994. In 1995, it opened three (3) drugstores as a franchisee under the business name and style of Mercury Drug. For the period January 1995 to December 1995, in conformity to the mandate of Sec. 4(a) of R.A. No. 7432 (Senior Citizens Act), petitioner granted a 20% discount on the sale of medicines to qualified senior citizens amounting to P219,778. Pursuant to Revenue Regulations No. 294[1] implementing R.A. No. 7432, which states that the discount given to senior citizens shall be deducted by the establishment from its gross sales for value-added tax and other percentage
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tax purposes, respondent deducted the total amount of P219,778 from its gross income for the taxable year 1995. For said taxable period, respondent reported a net loss of P20,963 in its corporate income tax return. As a consequence, respondent did not pay income tax for 1995. Subsequently, on December 27, 1996, claiming that according to Sec. 4(a) of R.A. No. 7432, the amount of P219,778 should be applied as a tax credit, respondent filed a claim for refund in the amount of P150,193, thus: Since the Commissioner of Internal Revenue was not able to decide the claim for refund on time,[2] respondent filed a Petition for Review with the Court of Tax Appeals (CTA) on March 18, 1998. The CTA dismissed the petition, declaring that even if the law treats the 20% sales discounts granted to senior citizens as a tax credit, the same cannot apply when there is no tax liability or the amount of the tax credit is greater than the tax due. In the latter case, the tax credit will only be to the extent of the tax liability. Also, no refund can be granted as no tax was erroneously, illegally and actually collected based on the provisions of Section 230, now Section 229, of the Tax Code. Furthermore, the law does not state that a refund can be claimed by the private establishment concerned as an alternative to the tax credit. Thus, respondent filed with the CA a Petition for Review. RULING: The CA and the CTA correctly ruled that based on the plain wording of the law discounts given under R.A. No. 7432 should be treated as tax credits, not deductions from income. The provision of RA 7432 explicitly employed the word tax credit. Nothing in the provision suggests for it to mean a deduction from gross sales. To construe it otherwise would be a departure from the clear mandate of the law. Accordingly, when the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed shall be treated as a reduction from any tax liability. The tax credit that is contemplated under the Act is a form of just compensation, not a remedy for taxes that were erroneously or illegally assessed and collected. In the same vein, prior payment of any tax liability is not a precondition before a taxable entity can benefit from the tax credit. The credit may be availed of upon payment of the tax due, if any. Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year. It must also be stressed that unlike in Sec. 229 of the Tax Code wherein the remedy of refund is available to the taxpayer, Sec. 4 of the law speaks only of a tax credit, not a refund. The tax credit benefit granted to the establishments can be deemed as their just compensation for private property taken by the State for public use. The privilege enjoyed by the senior citizens does not come directly from the State, but rather from the private establishments concerned. SC affirmed Appeals. Decision of the Court of
CA concluded that the 20% discount given to senior citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A. No. 7432 is considered just compensation and, as such, may be carried over to the next taxable period if there is no current tax liability. ISSUE: whether the 20% sales discount granted by respondent to qualified senior citizens may be claimed as a tax credit or as a deduction from gross sales.
iii)
Bicolandia Drug Corp vs. CIR GR No. 142299, 22 June 2006
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INCOME TAXATION
AZCUNA, J.: FACTS: Petitioner Bicolandia Drug Corporation is a domestic corporation principally engaged in the retail of pharmaceutical products. Petitioner has a drugstore located in Naga City under the name and business style of Mercury Drug. Pursuant to the provisions of R.A. No. 7432 (Senior Citizens Act), and Revenue Regulations No. 2-94, petitioner granted to qualified senior citizens a 20% sales discount on their purchase of medicines covering the period from July 19, 1993 to December 31, 1994. When petitioner filed its ITR 1993 and 1994, it claimed as a deduction from its gross income the respective amounts of P80,330 and P515,000 representing the 20% sales discount it granted to senior citizens. However, alleging error in the computation and claiming that the aforementioned 20% sales discount should have been treated as a tax credit pursuant to R.A. No. 7432 instead of a deduction from gross income, petitioner filed a claim for refund or credit of overpaid income tax for 1993 and 1994. Petitioner contended that Section 4 of R.A. No. 7432 provides in clear and unequivocal language that discounts granted to senior citizens may be claimed as a tax credit. Revenue Regulations No. 2-94, therefore, which is merely an implementing regulation cannot modify, alter or depart from the clear mandate of Section 4 of R.A. No. 7432, and, thus, is null and void for being inconsistent with the very statute it seeks to implement. The CIR, on the other hand, maintained that the aforesaid section providing for a 20% sales discount to senior citizens is a misnomer as it runs counter to the solemn duty of the government to collect taxes. The Commissioner likewise pointed out that the provision in question employs the word may, thereby implying that the availability of the remedy of tax credit is not absolute and mandatory and it does not confer an absolute right on the taxpayer to avail of the tax credit scheme if he so chooses. The Commissioner further stated that in statutory construction, the contemporaneous construction of a statute by executive officers of the government whose duty is to execute it is entitled to great respect and should ordinarily control in its interpretation. The CTA ruled that: Revenue Regulations No. 2-94 gave a new meaning to the phrase tax credit, interpreting it to mean that the 20% discount granted to qualified senior citizens is an amount deductible from the establishments gross sales, which is completely contradictory to the literal or widely accepted meaning of the said phrase, as an amount subtracted from an individuals or entitys tax liability to arrive at the total tax liability (Blacks Law Dictionary). In view of such apparent discrepancy in the interpretation of the term tax credit, the provisions of the law under R.A. 7432 should prevail over the subordinate regulation issued by the respondent under Revenue Regulation No. 2-94. x x x On the issue of whether or not petitioner is entitled to the claim for refund of its overpaid income taxes for the years 1993 and 1994 based on the evidence at hand, the CTA ordered CIR to ISSUE tax credit certificates in favor of petitioner [in] the amounts representing overpaid income tax for the years 1993 and 1994. On the other hand, the CIRs Motion for Reconsideration is DENIED for lack of merit. Consequently, the Commissioner filed a petition for review with the CA asking for the reversal of the CTA Decision and Resolution. However, CA denied such petition.
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INCOME TAXATION
Issue: The matter to be determined is the amount of tax credit that may be claimed by a taxable entity which grants a 20% sales discount to qualified senior citizens on their purchase of medicines. Is it the acquisition cost or the actual amount of discount? Ruling: Section 4(a) of R.A. No. 7432 states Facts: Respondent is a domestic corporation engaged in the retail of medicines and other pharmaceutical products. In 1997, it operated eight drugstores under the business name and style "Mercury Drug."6 Pursuant to the provisions of RA 7432 and Revenue Regulations No. (RR) 2-94 issued by the BIR, respondent granted 20% sales discount to qualified senior citizens on their purchases of medicines covering 1997 which totalled P2,798,508.00. Respondent filed its 1997 Corporate Annual ITR reflecting a nil income tax liability due to net loss incurred from business operations of P2,405,140.00. Respondent filed its 1997 ITR under protest. In March 1999, respondent filed with the petitioner a claim for refund or credit of overpaid income tax for the taxable year 1997 in the amount of P2,660,829.00. Respondent alleged that the overpaid tax was the result of the wrongful implementation of RA 7432. Respondent treated the 20% sales discount as a deduction from gross sales in compliance with RR 2-94 instead of treating it as a tax credit as provided under Section 4(a) of RA 7432. Petitioner contended that the construction given to a statute by a specialized administrative agency like the BIR is entitled to great respect and should be accorded great weight. When RA 7432 allowed senior citizens' discounts to be claimed as tax credit, it was silent as to the mechanics of availing the same. For clarification, the BIR issued RR 2-94 and defined the term "tax credit" as a deduction from the establishment's gross income and not from its tax liability in order to avoid an absurdity that is not intended by the law. 12 The Ruling of the Court of Tax Appeals The CTA rendered ordered petitioner to issue a tax credit certificate in the amount of P2,376,805.63 in favor of respondent. In a number of analogous cases, CTA has consistently ruled that the 20% senior citizens' discount should be treated as tax credit instead of a mere deduction from gross income. In quoting its previous decisions, the CTA ruled that RR 2-94 engraved a new meaning to the phrase "tax
that:
Sec. 4. Privileges for the Senior citizens. The senior citizens shall be entitled to the following: a) the grant of twenty percent (20%) discount from all establishments relative to utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit. The term "cost" in the above provision refers to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines. This amount shall be applied as a tax credit, and may be deducted from the tax liability of the entity concerned. If there is no current tax due or the establishment reports a net loss for the period, the credit may be carried over to the succeeding taxable year. This is in line with the interpretation of this Court in Commissioner of Internal Revenue v. Central Luzon Drug Corporation9 wherein it affirmed that R.A. No. 7432 allows private establishments to claim as tax credit the amount of discounts they grant to senior citizens. Accordingly, petitioners claim for refund must be denied. The law expressly provides that the discount given to senior citizens may be claimed as a tax credit, and not a refund.
iv)
CIR vs. Central Luzon Drug Corp, GR No. 159610, 12 June 2008 (in relation to RA 9257) CARPIO, J.:
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INCOME TAXATION
credit" as deductible from gross income which is a deviation from the plain intendment of the law. An administrative regulation must not contravene but should conform to the standards that the law prescribes. The CTA also ruled that respondent has properly substantiated its claim for tax credit by documentary evidence. However, based on the examination, the CTA deemed it proper to consider the lesser of two amounts. Aggrieved by the CTA's decision, petitioner elevated the case before the Court of Appeals. The Ruling of the Appellate Court The CA affirmed the CTA's decision in toto. The CA distinguished "tax credit" as an amount subtracted from a taxpayer's total tax liability to arrive at the tax due while a "tax deduction" reduces the taxpayer's taxable income upon which the tax liability is computed. "A credit differs from deduction in that the former is subtracted from tax while the latter is subtracted from income before the tax is computed."19 Hence, this petition. Issue: Whether the respondent may claim the 20% senior citizens' sales discount as a tax credit deductible from future income tax liabilities instead of a mere deduction from gross income or gross sales The Ruling of the Court The petition lacks merit. In two similar cases involving the same parties on the same issues, the Court has squarely ruled that the 20% senior citizens' discount required by RA 7432 may be claimed as a tax credit and not merely a tax deduction from gross sales or gross income. Under RA 7432, Congress granted the tax credit benefit to all covered establishments without conditions. The net loss incurred in a taxable year does not preclude the grant of tax credit because by its nature, the tax credit may still be deducted from a future, not a present, tax liability. However, the senior citizens' discount granted as a tax credit cannot be refunded. RA 7432 expressly allows private establishments to claim the amount of discounts they grant to senior citizens as tax credit. Section 4(a) of RA 7432 states: SECTION 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following: a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit; (Emphasis supplied) However, RR 2-94 interpreted the tax credit provision of RA 7432 in this wise: Sec. 2. DEFINITIONS. - For purposes of these regulations: xxx i. Tax Credit - refers to the amount representing 20% discount granted to a qualified senior citizen by all establishments relative to their utilization of transportation services, hotels and similar lodging establishments, restaurants, drugstores, recreation centers, theaters, cinema houses, concert halls, circuses, carnivals and other similar places of culture, leisure and amusement, which
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discount shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes. (Emphasis supplied). xxx Sec. 4. Recording/Bookkeeping Requirement for Private Establishments xxx The amount of 20% discount shall be deducted from the gross income for income tax purposes and from gross sales of the business enterprise concerned for purposes of the VAT and other percentage taxes. (Emphasis supplied) Tax credit is defined as a peso-for-peso reduction from a taxpayer's tax liability. It is a direct subtraction from the tax payable to the government. On the other hand, RR 2-94 treated the amount of senior citizens' discount as a tax deduction which is only a subtraction from gross income resulting to a lower taxable income. RR 2-94 treats the senior citizens' discount in the same manner as the allowable deductions provided in Section 34, Chapter VII of the National Internal Revenue Code. RR 2-94 affords merely a fractional reduction in the taxes payable to the government depending on the applicable tax rate. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court ruled that petitioner's definition in RR 2-94 of a tax credit is clearly erroneous. To deny the tax credit, despite the plain mandate of the law, is indefensible. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court declared, "When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount- when claimed shall be treated as a reduction from any tax liability, plain and simple." The tax credit may still be deducted from a future, not a present, tax liability. Petitioner-CIR alleged that respondent incurred a net loss from its business operations in 1997; hence, it did not pay any income tax. Since no tax payment was made, it follows that no tax credit can also be claimed because tax credits are usually applied against a tax liability. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court stressed that prior payment of tax liability is not a pre-condition before a taxable entity can avail of the tax credit. The Court declared, "Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year." It is irrefutable that under RA 7432, Congress has granted the tax credit benefit to all covered establishments without conditions. Therefore, neither a tax liability nor a prior tax payment is required for the existence or grant of a tax credit. Hence, respondent is entitled to claim the amount of P2,376,805.63 as tax credit despite incurring net loss from business operations for the taxable year 1997. The senior citizens' discount may be claimed as a tax credit and not a refund. Section 4(a) of RA 7432 expressly provides that private establishments may claim the cost as a tax credit. A tax credit can only be utilized as payment for future internal revenue tax liabilities of the taxpayer while a tax refund, issued as a check or a warrant, can be encashed. A tax refund can be availed of immediately while a tax credit can only be utilized if
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the taxpayer has existing or future tax liabilities. Hence, the senior citizens' discount may be claimed as a tax credit and not as a refund. RA 9257 now specifically provides that all covered establishments may claim the senior citizens' discount as tax deduction. On 26 February 2004, RA 9257, otherwise known as the "Expanded Senior Citizens Act of 2003," was signed into law and became effective on 21 March 2004.31 RA 9257 has amended RA 7432. Section 4(a) of RA 9257 reads: "Sec. 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following: (a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of services in hotels and similar lodging establishments, restaurants and recreation centers, and purchase of medicines in all establishments for the exclusive use or enjoyment of senior citizens, including funeral and burial services for the death of senior citizens; xxx The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of the discount shall be allowed as deduction from gross income for the same
taxable year that the discount is granted. Provided, further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended." (Emphasis supplied) Contrary to the provision in RA 7432 where the senior citizens' discount granted by all covered establishments can be claimed as tax credit, RA 9257 now specifically provides that this discount should be treated as tax deduction. With the effectivity of RA 9257 on 21 March 2004, there is now a new tax treatment for senior citizens' discount granted by all covered establishments. This discount should be considered as a deductible expense from gross income and no longer as tax credit. The present case, however, covers the taxable year 1997 and is thus governed by the old law, RA 7432. The Decision of the CA was AFFIRMED. B. KINDS OF ALLOWABLE DEDUCTIONS a) Optional Standard Deductions (OSD) b) Special Deductions c) Itemized Deductions (ID) SPECIAL DEDUCTIONS those which are allowed by law to specific taxpayers only. 1. Private Proprietary Educational Institutions (PPEI) [Section 34(A)(2)] - in addition to the expenses allowed as deduction, PPEI has the option to treat the amount utilized for the acquisition of depreciable assets for expansion of school facilities such as:
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a) Outright expense (the entire amount is deducted from gross income); or b) Capital asset and deduct only from the gross income an amount equivalent to its depreciation every year. 2. Insurance Companies (Section 37, NIRC) can deduct the following: a) Net additions required by law to be made within the year to reserve funds; AND b) Sums other than dividends paid within the year on policy and annuity contracts 3. Estates and Trusts (Section 61, NIRC) can deduct the following: a) Amount of income paid, credited or distributed to the heirs/ beneficiaries; AND b) Amount applied for the benefit of the grantor C. THE OPTIONAL STANDARD DEDUCTION (RA 9054, June 17, 2008) Earlier, only individual subject to tax under Section 24 of the NIRC (other than a non resident alien) may elect a standard deduction. However, the new RA 9504 (Act Amending among others Section 34 of the NIRC) allows OSD not only to individual taxpayer (other than a non-resident alien) but also to corporation subject to tax under Section 27(A) and 28 (A)(1) of the Tax Code. In lieu of the itemized allowable deductions, the OSD may be deducted from the gross income as follows: a) An individual other than a non resident alien OSD must not exceed 40% of his gross sales or gross receipts b) A corporation OSD is not exceeding 40% of its gross income
From its name itself, standard deduction is optional (Mamalateo, page 213). The taxpayer must signify in his return that he elects the OSD, otherwise he shall be considered as having availed of the itemized deductions. The Tax Code provides that once a taxpayer elected a deduction (either OSD or itemized) in his ITR, such election is irrevocable for the taxable year which the return is made [Section 34(L), NIRC]. Hence, the taxpayer can change to itemized deductions in succeeding years. (Mamalateo, page 213). Requites for the exercise of OSD: 1) Available to both corporations and individuals other than non-resident aliens 2) OSD is optional - taxpayer signifies in his return his intention to elect OSD otherwise he is considered as having availed of ID 3) Election is irrevocable for the year in which it is made 4) Amount is limited to 40% of taxpayers gross income or gross receipts 5) Proof of required. actual expenses is not
Illustration 1 (Individual Taxpayer): Mr. X, a practicing lawyer, received a total professional fee amounting to P600K during the taxable year. His related itemized deduction allowed amounted to P100K. Mr. X opted to deduct OSD in lieu of itemized deductions (ID).
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The net income of Atty. X before personal exemption would be:
Gross Receipts professional fee P600,000.00 Less: OSD (P600K x 40%) 240,000.00 Net Income before Personal P360,000.00
P5,000,000.00 Less: Cost of Sale 3,000,000.00 Gross Income 2,000,000.00 Less: OSD (P2M x 40%)800,000.00 Net Income
Exemption
NOTES: a) The following individuals may claim OSD in lieu of ID: 1. Resident Citizen 2. Non-resident Citizen 3. Resident Alien 4. Taxable Estates and Trusts
P1,200,000.00 NOTES: a) The following corporations may claim OSD in lieu of ID: 1. Domestic Corporations 2. Resident Foreign Corporations b) Components of GROSS INCOME FOR OSD Gross Income includes other income not subjected to final tax. Other income includes interest income earned from outside source as well as gain from sale of capital assets. The other should have been reported in the ITR and not subjected to final tax or CGT. Hence, the basis of the 40% OSD should include other taxable income not subjected to final tax.
b) Submission of supporting financial

statements to tax return shall not be required if a qualified individual claims OSD (Valencia, Roxas, page 371, 2010). Simply stated, proof of actual expenses is not required to support claim of OSD (Mamalateo, page 213). c) OSD is based on gross sales during the taxable year if an individual employs the accrual basis of accounting of his income and deductions
d) Sales discounts, sales returns and

sales allowances should reduce the gross sales in computing OSD (based on the tax principle that lower amount of deduction will be allowed for income tax purposes) (Valencia, Roxas, page 371, 2010) Illustration 2 (Corporate Taxpayer): X Corportion reported a gross sales of P5M, cost of sales of P3M and itemized deductions of P500K. The Company opted to deduct OSD in lieu of itemized deductions. The net income Corporation would be: Sales of X
c) If taxpayer elects to offset his

losses against his profit from capital asset transaction, he may no longer claim OSD because OSD shall be in lieu of the itemized allowed deductions which evidently includes losses from sales or exchanges of capital assets (Valencia, Roxas, Income Taxation, page 372, 2010)
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INCOME TAXATION
2) Hospitalization Insurance, D. ITEMIZED DEDUCTIONS: KINDS, RULES AND REQUISITES Itemized Deductions specific business operating expenses allowed by the Tax Code to be deducted from the gross income it includes special deductions allowed to insurance companies generally, these require supporting documents to justify the reduction from gross income N/A o NOLCO o any item of incentive deduction allowable under any special law a. General Business Expenses expenses refer to all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or the exercise of a profession. i. The All-Events Test CIR v. Isabela Cultural Corporation (G.R. No. 172231 February 12, 2007) The CA sustained the deduction of the expenses for professional and security services from ICCs gross income. Requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: 1) the expense must be ordinary and necessary; 2) it must have been paid or incurred during the taxable year; 3) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and CONCEPTS,
OSD or ID of HUSBAND and WIFE For married individuals, the husband may choose OSD and the wife ID (or vice versa) to minimize their individual income tax. ILLUSTRATION: The husband and wife may compute separately their individual income tax based on their respective taxable income as follows:
Mr. X Gross receipts from business service Less: OSD (P400K x 40%) ID Income from business Add: Compensation Income Income before personal exemption P 400,000.0 0 160,000.0 0 P 240,000.0 0 300,000.0 0 P 540,000.0 0
Mrs. X P 600,000.0 0 400,000.0 0 P 200,00.00
P 200,00.00
NOTES: a) Compensation Income is not allowed to be reduced by OSD b) If any income of the husband and wife cannot be definitely identified as income exclusively earned or realized by either of the spouses the same shall be divided equally between them in order to determine their respective taxable income.
c) In the case of individual entitled to claim

OSD, allowable deductions shall mean aforesaid OSD plus deductions of premium payments (if applicable) on: 1) Health insurance, and/or
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INCOME TAXATION
it must be supported by receipts, records or other pertinent papers. Requisites for All-events test 1) the right to income or liability be fixed; and 2) the amount of such income or liability be determined with reasonable accuracy. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." 1) "Reasonable accuracy"implies something less than an exact or completely accurate amount. Held: The disallowance of the expense deduction of ICC for professional and security services is declared valid only insofar as the expenses for the professional fees of SGV & Co. and of the law firm. 1) ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. 2) ICC, in the exercise of due diligence could have inquired into the amount of the obligation to the firm. 3) ICC owes familiarity with the rates charged by their long time legal consultant. Capital Expenditure v. Ordinary Expenditure Capital Expenditure payments made in cash or cash equivalents over a period of more than one year. are used to acquire assets or improve the useful life of existing assets. Ordinary Expenditure
4)
iii.
iv.
commonly incurred in the trade or business of the taxpayer with a useful life of not more than one year. Rule re: Proprietary Educational Institutions deduct expenditures otherwise considered as capital outlays o capital outlays- same as capital expenditures deduct allowance for depreciation Reasonableness Test
expenses
ii.
CIR v. General Foods, Inc. (G.R. No. 143672 April 24, 2003) Issue: WON the subject media advertising expense for "Tang" incurred by respondent corporation was an ordinary and necessary expense fully deductible under the NIRC. Held: NO! o If the advertising is designed to stimulate the future sale of merchandise or use of services, it is not deductible as an ordinary and necessary expense. Rationale"it has not been established that the item being claimed as deduction is excessive." o There is yet to be a clearcut criteria or fixed test for determining the reasonableness of an advertising expense. o There being no hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: 1) the type and size of business in which the taxpayer is engaged; 2) the volume and amount of its net earnings; 3) the nature of the expenditure itself; 4) the intention of the taxpayer and the general economic conditions.
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vi. CM
24059 Hoskins v. CIR (G.R. No. LNovember 28, 1969) Issue: WON payment by the taxpayer to its controlling stockholder of 50% of its supervision fees or the amount of P99,977.91 is a deductible ordinary and necessary expense and should be treated as a distribution of earnings and profits of the taxpayer. Held: NO! o For income tax purposes the employer cannot legally claim such bonuses as deductible expenses unless they are shown to be reasonable. o CM Hoskins is bound to pay the income tax imposed by law on corporations and may not legally be permitted, by way of corporate resolutions authorizing payment of inordinately large commissions and fees to its controlling stockholder, to dilute and diminish its corresponding corporate tax liability. Representation Expenses these are entertainment, amusement and recreation expenses incurred or paid during the year that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer Requisites: 1) It must be substantiated with sufficient evidence such as receipts and or adequate records; 2) It must be limited to the ceiling requirement as provided in Rev. Reg. 10-2002 of net sales for taxpayers engaged in sale of goods/properties; or 1% of the net revenue for taxpayers engaged in sale of services, including exercise of profession and use or lease of properties. Substantiation Rule and Cohan Rule Substantiation Rule All deductions from gross income must be substantiated with sufficient evidence, and as official receipts and other adequate records. Cohan Rule Where it is certain from the evidence adduced that the taxpayer did incur expenses but the actual amount thereof has not established, the Commissioner should make a close approximate thereof.
Gancayco v. CIR (G.R. No. L-13325
v.
April 20, 1961) Issue: WON the sum of P16,860.31 is due from Gancayco as deficiency income tax for 1949 hinges on the validity of his claim for deduction of two (2) items, namely: (a) for farming expenses, P27,459.00; and (b) for representation expenses, P8,933.45. Held: Partly YES, Partly NO! o Gancayco's claim for representation expenses aggregated P31,753.97, of which P22,820.52 was allowed, and P8,933.45 disallowed. o Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or vouchers of the expenditures in question, petitioner could not specify the items constituting the same, or when or on whom or on what they were incurred.
b. Bad Debts debts due to the taxpayer which are actually ascertained to be worthless and charged off within the taxable year. Requisites:
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1) There must be a valid and
subsisting debt; 2) The debt must be actually ascertained to be worthless and uncollectible during the taxable year; If a taxpayer incurred indebtedness and interest expense connected with his trade or business during the taxable year and also earned interest income which had been subjected to final withholding tax, the amount of interest expense shall be subject to the limitation as provided for by law. It was stressed that the law did not require that there be a tax arbitrage in order that the limitation on the deduction of the interest expense can be applied. RR No. 13-00 itself specifically provides that the limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer. REVENUE REGULATIONS NO. 13-2000 issued Decem ber 29, 2000 implements the provisions of Section 34(B) of the Tax Code of 1997 relative to the requirements for the deductibility of interest expense from the gross income of a corporation or an individual engaged in trade, business or in the practice of profession. o In general, subject to certain limitations, the following are the requisites for the deductibility of interest expense from gross income: 1) there must be an indebtedness; 2) there should be an interest expense paid or incurred upon such indebtedness; 3) the indebtedness must be that of the taxpayer;
3) The debt must be charged off

during the taxable year; and 4) The debt must be connected with the trade, business or profession of the taxpayer, and not sustained in a transaction entered into between related taxpayers. i. Tax Benefit Rule GR: the recovery of amounts deducted in previous years from gross income become taxable income XPN: to the extent thereof the deduction did not result in any benefit to the taxpayer Otherwise stated, if the recovery of bad debts resulted in a tax benefit to the taxpayer, that is taxable. If it did not result in any tax benefit to the taxpayer, that is not taxable. c. Interests i. Requisites: 1) This must be paid or incurred DURING the taxable year. 2) This must be paid or incurred in connection with the trade, business or profession of the taxpayer 3) There must be an obligation which is valid and subsisting. 4) There must be an agreement in writing to pay interest. ii. Tax Arbitrage Scheme
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INCOME TAXATION
4) the indebtedness must be connected with the taxpayer's trade, business or exercise of profession; 5) the interest expense must have been paid or incurred during the taxable year; 6) the interest must have been stipulated in writing; 7) the interest must be legally due; 8) the interest payment arrangement must not be between related taxpayers 9) the interest must not be incurred to finance petroleum operations; and 10) in case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure. iii. On Capital Expenditure At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure. iv. Rules re: deductibility Taxpayer is not entitled to both: o deduction from gross income; and o increased basis for determining gain or loss and the allowable depreciation charge. interest on unclaimed salaries of the employeesnot deductible interest charged to the capital of the taxpayer- not deductible interest on preferred stock- not deductible; XPN- if it is not
dependent upon corporate profits or earnings INTEREST ON GOVT SECURITIES is now taxable.
v. Interest on Tax Delinquencies
For interest to be allowed as

deduction from gross income, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. The term indebtedness has been defined as an unconditional and legally enforceable obligation for the payment of money. Within the meaning of that definition, a tax may be considered as an indebtedness. Hence, interest paid for late payment of the donors tax in deductible from gross income. The interest on deficiency donors tax is deductible. The SC explained that taxes here are considered obligations or indebtedness. And it ruled that we have to relax the distinction between tax and ordinary obligation in this respect. Interest on deficiency income tax can also be claimed as deductible interest expense because taxes here are considered ordinary obligations.
d. Taxes i. Requisites:
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1. It must be paid or incurred within the taxable year; 2. It must be paid or incurred in connection with the taxpayers profession, trade or business; and 3. The tax must be imposed directly upon the taxpayer ii. Deductible Taxes 1. Import duties
2. Local Business taxes

3. Occupation taxes 4. Privilege and license taxes 5. Excise taxes 6. Documentary stamp taxes 7. Automobile registration fees 8. Community Tax 9. Municipal Tax iii. Non-deductible Taxes 1. Philippine income tax 2. Foreign income tax, if claimed as tax credit 3. Estate and donors taxes 4. Value-added tax 5. Taxes not related to business, trade, or profession 6. Other items related to tax such as: (1) special assessment tax (2) surcharges (3) compromise penalty Interest on delinquent taxes can be deducted as interest expense at its full amount. e. Depreciation gradual diminution in the useful value of tangible property used in trade, business or profession resulting from exhaustion, wear and tear, and obsolescence also applied to amortization of the value of intangible assets, the use of which in trade or business is definitely limited in duration Requisites:
1. The allowance for depreciation must be reasonable. 2. It must be for property used in the trade, business, or profession. 3. It must be charged off during the taxable year. 4. The asset must have a limited useful life. 5. The depreciable asset must be located in the Philippines if a taxpayer is a nonresident alien or a foreign corporation. i. Properties subject to depreciation 1) Depreciation of Properties Used in Petroleum Operations - An allowance for depreciation in respect of all properties DIRECTLY related to production of petroleum shall be allowed under the straightline or declining-balance method of depreciation at the option of the service contractor. - However, if the service contractor initially elects the declining-balance method, it may shift to the straightline method. - The useful life of properties used in or related to production of petroleum shall be ten (10) years or such shorter life as may be permitted by the Commissioner. - Properties NOT USED DIRECTLY in the production of petroleum shall be depreciated under the straightline method on the basis of an estimated useful life of 5 years. 2) Depreciation of Properties Used in Mining Operations - An allowance for depreciation in respect of all properties used in mining operations other than petroleum operations, shall be computed as follows: a. At the normal rate of depreciation if the expected life is ten (10) years or less; or b. Depreciated over any number of years between five (5) years and the expected life IF more than ten (10) years, - Provided, That the contractor notifies the Commissioner at the beginning Page 48
INCOME TAXATION
of the depreciation period which depreciation rate allowed will be used. Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business (NRAETB) or Resident Foreign Corporations (RFC) A reasonable allowance for the deterioration of property arising out of its use or employment or its non-use in the business, trade or profession shall be permitted only when such property is located in the Philippines. cost of the property and the rate then only applied to the resulting balance. 3. Sum of the year digit method application of a changing fraction to the taxpayers cost basis for the property, reduced by the estimated residual salvage value. 4. Unit of work or unit of production method A provision is made for equal depreciation per unit of use regardless of the lapse of time. 5. Job basis method The allowance is computed as being equal to the difference between the cost of depreciation of the asset purchased for a particular job, and the salvage value at the end of the job. 6. Retirement method The cost of the property retired each year is credited to the capital asset account and less net salvage value actual or estimated. Charged to expense in lieu of an annual provision for depreciation deductions. 7. Such other methods as may be allowed by the Sec. of Finance upon recommendation by the Commissioner. f. Depletion exhaustion of natural resources such as oil and gas wells and mines as a result of production or severance from such mines or wells Determination of amount of depletion In determining the amount of allowable depletion cost, the following three factors are essential, namely: 1. The basis for the cost of the property; 2. The estimated total recoverable units in the property; and 3. The number of units recovered during the taxable year in question. [Consolidated Mines V. CTA 58 SCRA 618]
Deduction for obsolescence If the whole or any portion of the physical property is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its natural life, so that depreciation deductions alone would be insufficient to return the cost at the end of its economiv terms of usefulness, reasonable deduction for obsolescence, in addition to depreciation, may be allowed. Property held for life In case of property held by one person for life with remainder to another person, the deduction, shall be computed as if the life tenant were the absolute owner of the property and, shall be computed as such to the life tenant. In case of property held in trust Allowable deductions shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each. ii. Allowable Modes of Depreciation 1. The straight line method Equal depreciation per unit of time, regardless of use or production output of the property. 2. Declining balance method Amount of depreciation is subtracted annually from the
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INCOME TAXATION
Basis, means the amount of the taxpayers capital or investment in the property which he is entitled to recover tax-free during the period he is removing mineral in the deposit. Intangible cost in petroleum operations This refers to any cost incurred in petroleum operations which in itself has no salvage value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum. Depletion and Depreciation Both are predicated upon the same basic premise of avoiding tax on capital. However, depletion is based upon the concept of the exhaustion of a natural resource, whereas, depreciation is based upon the concept of exhaustion of the property, not otherwise a natural resource, used in trade or business or held for the production of income. Thus, depletion and depreciation are made applicable to different types of assets. g. Losses implies an unintentional parting with something of value Requisites: 1. The loss must be incurred in the trade, business or profession of the taxpayer. 2. It must be actually sustained and charged off within the taxable year. 3. It must be evidenced by a closed and completed transaction. Completed Transaction this means that the loss must be fixed by identifiable event. Example: If it is a loss sustained from sale, the event that may identify or complete the transaction is the consummation of the contract of sale. Suppose it is in the nature of casualty losses like fire? The fire destroyed your property in 1995, no payment has been made because the insurer and the insured were still under negotiation. It was only in 1997 that they agreed on the amount. The amount agrees upon is P100,000. The taxpayer may claim that casualty losses only in 1997 when payment was actually made. This is the event that will complete the transaction. 4. It must not be compensated for by insurance or other forms of indemnity. 5. If it is a casualty loss, the taxpayer has filed a sworn declaration of loss within 45 days after the date of the discovery of the casualty or robbery, theft, or embezzlement. Some recognized losses 1. Ordinary losses/business losses sustained in the course of trade, business or profession 2. Casualty losses 3. Capital losses involved are capital assets. 4. Securities becoming worthless 5. Losses from wash sales of stock or securities 6. Wagering losses Note: Capital losses and securities becoming worthless are governed by rules on loss from the sale or exchange of capital assets. Casualty loss This must be reported to the BIR earlier than 30 days but not later than 45 days following the date of loss. Loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.
Loss limitation rule for capital losses Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges.
Securities becoming worthless
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INCOME TAXATION
1. Securities become worthless during the taxable year 2. Securities are capital assets 3. Losses are considered as losses from the sale or exchange, on the last day of such taxable year, of capital assets. Net operating loss It means the excess of allowable deduction over gross income of the business in a taxable year. ordinary course of the business of such dealer. WASH SALE A wash sale occurs where it appears that within a period beginning thirty (30) days before the date of the sale or disposition of shares of stock or securities and ending thirty (30) days after such date, the taxpayer has acquired (by purchase or exchange) or has entered into a contract or option to so acquire, substantially identical stock or securities.
NET OPERATING LOSS CARRY-OVER (NOLCO) NOLCO shall be carried over as a deduction from the gross income for the next three (3) consecutive taxable years immediately following the year of loss. Such loss shall be allowed as a deduction if it had not been previously offset as deduction from gross income. However, any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction NOLCO shall be allowed only if there has been no substantial change in the ownership of the business or enterprise. There is no substantial change when: 1. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or 2. Not less than 75% of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons. Losses form securities wash sales of stock or
Wagering losses Losses from wagering shall be allowed only to the extent of gains form such transactions. The amount that is deductible must not exceed the gains
Abandonment losses In the event a contract area where petroleum operations are undertaken is partially or wholly abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as a deduction. In case a producing well is subsequently abandoned, the unamortized costs thereof, as well as the undepreciated costs of equipment directly used therein, shall be allowed as a deduction in the year such well, equipment or facility is abandonment by the contracto. of or
SPECIAL LOSSES include the following: a. loss arising from voluntary removal buildings as an incident to renewal replacement
No deduction for loss shall be allowed for wash sales unless the claim is made by a dealer in stock or securities and with respect to a transaction made in the
Problem: Supposed the taxpayer had a building constructed on a parcel of land. He owned this as well as the building erected thereon. He had business and his business was conducted within the premises. Then, he decided to remove such building as to construct a new building for new business.
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INCOME TAXATION
Is the cost of demolition to give way to a new building deductible loss? YES. Suppose A purchased that parcel of land of B and included in that sale was that of the building. A demolish this building in order to construct a new building. Is the cost of demolition deductible insofar as A is concerned? NO. That can only be claimed as deductions if the one demolishing the same is the taxpayer. The moment that is sold to another claim that as deductible loss. The treatment here is, the cost of demolition should be capitalized in the selling price. Exception:A may claim that as deductible loss if this was demolished by value of a court order because the govt considered this as a fire hazard, loss of useful value of property or capital asset. PICOP VS CA December 1, 1995 Issue: Whether Picop is entitled to deductions against income of net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and Decision: (1) On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred, assigned and conveyed to Picop as the surviving corporation. The entire subscribed and outstanding capital stock of RPPM and RMC would be exchanged for 2,891,476 fully paid up Class "A" common stock of Picop (with a par value of P10.00) and 149,848 shares of preferred stock of Picop (with a par value of P10.00), to be issued by Picop, the result being that Picop would wholly own both RPPM and RMC while the stockholders of RPPM and RMC would join the ranks of Picop's shareholders. In addition, Picop paid off the obligations of RPPM to the Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing 6,824,034 shares of preferred stock (with a par value of P10.00) to the DBP. The merger agreement was approved in 1977 by the creditors and stockholders of Picop, RPPM and RMC and by the Securities and
Exchange Commission. Thereupon, on 30 November 1977, apparently the effective date of merger, RPPM and RMC were dissolved. The Board of Investments approved the merger agreement on 12 January 1978. (2) In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. RPPM far from benefiting from the tax incentive granted by the BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the much larger group of Picop's stockholders. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM. Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same registered operations which earlier had sustained losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result. Indeed, that result makes nonsense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186. It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before merger effective date, RPPM had over preceding years accumulated losses in the total amount of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00 of RPPM's accumulated losses as a deduction against Picop's 1977 gross income.
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INCOME TAXATION
Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding shares of RMC stock to San Miguel Corporation for the sum of P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186. h. Charitable Contributions Kinds of charitable contributions 1. Ordinary or those which are subject to limitations as to the amount deductible from gross income. 2. Special or those which are deductible in full from gross income. Requisite for contributions deductibility of charitable compliance with agreements, treaties or commitments entered into by the Philippines or in pursuance of special laws. 3. Donations to accredited non-governmental organizations. * These are fully deductible if the contributions are given to the following: [F. A. G.] 1. Government or its political subdivisions, agencies or instrumentalities, for the purpose of undertaking priority projects of the government; These priority projects include: [S.H.E.] a. Sports development, science and invention b. Health and human settlement c. 2. 3. Educational and economic development and
Foreign government or institution international civic organizations; Accredited NGO
1. The contribution must actually be paid, or made payable to the Philippine government or any political subdivision thereof, or any domestic corporation or association specified by the NIRC. 2. No part of the net income of the beneficiary must inure to the benefit of any private stockholder or individual. 3. It must be made within the taxable year. 4. It must not exceed 10% in case of an individual, and 5% in case of a corporation, of the taxpayers taxable income (except when the donation is deductible in full) to be determined without the benefit of the contribution. 5. It must be evidenced by adequate records or receipts. Contributions deductible in full 1. Donations to the Philippine Government or to any of its political subdivisions according to a national priority plan determined by the NEDA. 2. Donations to foreign institutions or international organizations which are fully deductible in pursuance of or in
N.G.O. means non-profit domestic corporation which are formed and organized for any of the following purposes: [C.H.E.R.S.] a. Research b . c. d . e. Health Education Charitable, cultural, character building Sports development and social welfare
The amount of charitable contribution that may be claimed as deduction may be: 1. In the case of individual taxpayer: - Not more than 10% of the net income before charitable contribution 2. In the case of corporate taxpayer: - Not more than 5% of the net income before the charitable contribution IF the recipient of such contribution is any of the following DC formed or organized for: [R.E.C.S.]
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INCOME TAXATION
1 . 2 . 3 . 4 . Religious purpose and rehabilitation of veterans Educational purpose like educational corporations which are not qualified as NGO Charitable, cultural purpose Scientific, sports welfare purpose development an social 3. Administrative expenses shall, in no case, exceed thirty percent (30%) of the total expense. 4. The assets, in the event of dissolution, would be distributed to another non-profit domestic corporation organized for a similar purpose, or to the state for public purpose, or would be distributed by a court to another organization. Utilization 1. Any amount of cash or kind (including administrative expenses) paid or utilized to accomplish one or more purposes for which the accredited non-governmental organization was created or organized. 2. Any amount paid to acquire an asset used (or held for use) directly in carrying out one or more purposes for which the accredited non-governmental organization was created or organized. Proof of deductions Contributions or gifts shall be allowable deductions only if verified under the rules and regulations prescribed by the Sec. of Finance. i. Pension Trusts
10% or 5% of the net income before charitable contribution Example: If an individual taxpayer has a gross income of P100,000 and the allowable deduction, except charitable contribution, is P50,000. The Charitable contribution is P5,000. Deduction first P50,000 from P100,000 and the result is P50,000. This P50,000 is the basis of that 10% or 5% of net income before charitable contribution. So, 10% of the P50,000 is P5,000. Hence, the actual contribution of P5,000 may be fully claimed as deduction. But let us say, the amount of charitable contribution is P10,000. So, he can only deduct P5,000 as charitable contribution, and not the actual amount of P10,000 because the law imposes a limitation that the amount that may be claimed as deduction must not be more than 10% of net income before charitable contribution. Non-governmental organization It means corporation: a non-profit domestic
Requisites for the deductibility of payments to pension trusts 1. The employer must have established a pension or retirement plan to provide for the payment of reasonable pensions to his employees. 2. The pension plan is reasonable and sound. 3. it must be funded by the employer. 4. the amount contributed must no longer be subject to the control or disposition of the employer. 5. the payment has not been allowed as deduction. 6. the deduction is apportioned in equal parts over a period of ten (10) consecutive
1. Organized and operated exclusively for scientific, research, educational, character-building, and youth and sports development, health, social welfare, cultural or charitable purposes, or any combination thereof, where no part of the net income of which inures to the benefit of any private individual.
2. Utilizes the contribution directly for the

active conduct of the activities constituting the purpose or function for which it is organized and operated not later than the 15th day of the month after the close of accredited NGOs taxable year in which the contribution were received.
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INCOME TAXATION
years beginning with the year in which the transfer or payment was made. Contribution to pension trust may refer to the current year or past years. CURRENT YEAR- this is considered as ordinary & necessary expenses Employer may also make a contribution to the pension plan in regard to the services rendered for the past 10 years. j. Research and Development Costs . year. In other words, P200.00 a month. The P2,400.00 is the maximum amount that may be claimed as deductions. The family must have an income of not more than P250,000.00 a year. The claimant must be the spouse claiming the additional exemption.
b . c.
Premiums on life insurance policy is also included here because it is included under the health insurance policy. * If taxpayer has no compensation income, these deductions may be claimed against the gross income of his business, trade, or profession. PERSONAL EXEMPTIONS Personal exemptions are arbitrary amounts allowed, in the nature of a deduction from taxable income, for personal, living or family expenses of an individual taxpayer. They are considered to be the equivalent of the minimum of subsistence of the taxpayer.
A taxpayer may treat research and development expenditures which are paid or incurred by him during the taxable year in connection with his trade, business or profession, as ordinary expenses 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. This may not be claimed as deduction if the amount is: 1. Spent for the acquisition or improvements of land or for the improvement or development of natural resources, or a character which is subject to depreciation and depletion. 2. Paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any natural resources like deposits of ore or other minerals including oil or gas. D. Other Forms of Deductions DECUCTIONS ALLOWED ONLY TO INDIVIDUAL TAXPAYERS Deductions allowed only to individual taxpayers 1. Personal exemption 2. Additional exception 3. Premium payments on health and/or hospitalisation insurance if the taxpayer has no compensation income, this can be claimed as deduction from gross income from business, trade or profession. Premiums on health and hospital insurance Limitations: a It must not be more than P2,400.00 a
Who are allowed personal exemptions? 1. Citizens 2. Resident aliens 3. Non-resident aliens engaged in trade or business in the Philippines under certain conditions 4. Estates and trusts, which are treated for purposes of personal exemptions, as a single individual Amount of personal exemptions citizens and resident aliens allowed to
P20,000 single person or a married person judicially decreed as legally separated from his or her spouse with no qualified dependents. Applies also to estates under judicial settlement and irrecoverable trusts. P25,000 head of the family P32,000 married person
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INCOME TAXATION
Note: Only the spouse deriving taxable income can claim the P32,000 personal exemption; if both have taxable income, each can claim P32,000 exemption. Head of the family It means an unmarried or legally separated man or woman with one or both parents, or with one or more brothers or sisters, or with one or more legitimate, recognized natural or legally adopted children living with and dependent upon him or her for their chief support. Such brothers or sisters or children should be not more than 21 years old, unmarried and not gainfully employed, or where such children, brothers or sisters, regardless or are, are capable of self-support because of mental or physical defect. A head of family is an individual who actually supports and maintains in one household one ore more individuals, who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation.
The term family includes an unmarried or legally separated person with:
1. one or both parents; 2. one or more brothers or sisters; or 3. one ore more legitimate, recognized natural, or legally adopted children living with and dependent upon him or her for their chief support. Additional exemption A married person or a head of a family may claim an additional exemption of P8,000 for each dependent, not exceeding four (4). The additional exemption shall be claimed by only one of the spouses in the case of married individuals. In the case of legally separated spouses, it may be claimed only by the spouse who has custody of the child or children.
Dependent Refers only to the legitimate, illegitimate or legally adopted child of the taxpayer The child is:
Note: Consider discrepancy between definition of head of family and dependent i.e. children. To be a head of a family, one or more legitimate, recognized natural or legally adopted children must live with and depend on an unmarried or legally separated man or woman. A dependent, on the other hand, may be a legitimate, illegitimate or legally adopted child. terms. Both, however, define or qualify different
1. living with the taxpayer; 2. chiefly dependent upon the taxpayer for support; 3. not more than 21 years of age; 4. not married; and 5. not gainfully employed or, even though over 21 years old, incapable of self support because of mental or physical defect. Change of status Taxpayer marries dependents or have additional
Living with
The term living with the person giving support does necessarily mean actual and physical dwelling together at all times and under all circumstances.
Family
Taxpayer dies during the taxable year
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INCOME TAXATION
If the spouse or any of the dependents dies or if any of such dependent marries, becomes 21 years old, or becomes gainfully employed Personal Exemption taxpayers, including estate entitled. only individual and trust, are
In case of estate and trust Php20,000.00 R.C . N.R.C . R.A. NRA-NTB /subject to the rule on reciprocit y. But it must not exceed the maximu m allowable personal exemptio n. X Rule on reciprocit y does not apply. NRANETB
Note: As a general rule, interpret in favour of taxpayer. Presumed that the change of status transpired at the end of the taxable year. PERSONAL EXEMPTIONS TO NON-RESIDENT ALIEN INDIVIDUAL Only personal exemption Non-resident alien individual engaged in trade or business Entitled only to personal exemption Amount allowed is limited to exemptions granted to Filipino citizens who are not residents in the aliens domicile country but not to exceed the amount allowed to citizens or residents of the Philippines in the NIRC. Personal Exempti on
/ withi n
/ withi n
Addition al Exempti on
/ withi n
/ withi n
KINDS OF PERSONAL EXEMPTION: 1. Basic personal exemption: a. b. c. single or legally without dependent; head of the family; each married individual if both of them are earning Compensation income (in case only one of the spouses is deriving gross income, only such spouse shall be allowed the personal exemptions) separated Php20,000. 00 Php25,000. 00 Php32,000. 00 2 .
Legend: / - available; X not available Head of the family unmarried man or woman legally separated man or woman who has the following qualified dependents: 1 . Parents One or both parents. Must be living with the taxpayer and dependent upon the taxpayer for chief support. Parents must be natural parents.
2. Additional exemption - This only applies to qualified dependent child and children such as legitimate and illegitimate children. Php8,000.00 for every qualified dependent child but not to exceed 4
Brothers or sister To be qualified they must be: a. Living with the taxpayer; b. Dependent upon the taxpayer for chief support; c. Unmarried; d. Not gainfully employed. e. No more than 21 years old except if physically or mentally incapacitated; must be brothers or sisters by blood one is enough
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INCOME TAXATION
3 . Children Must be legitimate , illegitimate, legally adopted or stepchildren Conditions: a. Living with the taxpayer; b. Dependent upon the taxpayer for chief support; c. Unmarried; d. Not gainfully employed; e. Not more than 21 years old except if physically or mentally incapacitated. There is a provision in the Tax Code, which is not so clear. For purposes of head of the family, in the case of natural children or child, there is that word acknowledged or recognized. For purposes of the definition of head of the family, it is clear that to qualify as dependent, the natural child or legitimate child must be acknowledged or recognized by the taxpayer. But in the definition of the dependent, dependent means legitimate, illegitimate or legally adopted child or children. There is no word acknowledged or recognized. Was this deliberately omitted by our Congressmen? Does this imply that since they have so may illegitimate children, they may not be required to acknowledge or recognize them and they can claim this illegitimate child as their dependent? This is not clear. If we will try to interpret the law literally, there is no need of any recognition on the part of the taxpayer. Is this really the intention of law? No. The intention of the law has always been to recognize this illegitimate child and this is one way of compelling the taxpayers to recognize this child. The President of the Republic of the Phils. cannot issue an executive order to increase the basic personal exemption because the provision under the Old Tax Code authorizing the President to increase the personal and additional exemption upon the recommendation of the Sec. of Finance has been removed or deleted by RA 8424. Now, you can only increase the amount of personal and additional exemption by legislative enactment.
Dependent is considered living with the taxpayer even if the former or the latter are not physically together if that is brought about by force of circumstances. Example if one of the parents will have to undergo by-pass operation in the U.S. Chief Support means more than 50% of the needs of the dependents are provided by the taxpayer. Problem: If the child or the brother/sister got married and then he has found to be physically or mentally incapacitated, so bumalik si tatay at dependent sa tatay for chief support, can he qualify as dependent? Answer: No, physical or mental defect applies only to age requirement. Once the child or brother/sister got married, he is automatically disqualified as dependent. CHANGE OF STATUS: 1. Death of spouse during the taxable year; 2. Death of dependent during the taxable year; 3. Death of the taxpayer during the taxable year; estate of the taxpayer may claim the basic personal exemption; 4. Additional dependent during the taxable year; 5. Taxpayer got married during the taxable year; 6. Gainful employment of the dependent during the taxable year 7. Dependent became more than 21 years old during the taxable year. Even if the above-mentioned change of status happened during the taxable year, the taxpayer may still claim the basic personal exemption because it is as if the change of status happened at the end of the taxable year.
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INCOME TAXATION REVIEWER

Mariano Marcos State University- College of Law 2011

1. Income is a flow of service rendered by

Non- compensation income any

3 categories of taxable income:

Non taxable income those excluded

Income tax tax on all yearly profits

Types of income tax: Personal income tax on individuals

Madrigal Vs Rafferty 38 Phil 414

Revenue Distinguished from income:

TESTS APPLIED IN DETERMINING EXISTENCE OF INCOME

1. Severance test income is recognized

2. Realization test no taxable income until

5. Claim of Right Doctrine a taxable gain is

6. Income from Whatever Source Income sources whether legal or illegal

b. Constructive (sec 26) an income is

THE PHILIPPINE INCOME TAX SYSTEM 1. Types of Income Tax Systems

a. Schedular System- Different types of

b. Global System The taxpayer is

Subtract (-) allowable deductions =

c. Semi-schedular or semi Global tax

3. Features of Income tax law:

Resident citizen on his worldwide income

An alien was subject to Philippine income

Nonresident citizen only on his sources

It includes compensation for labor or

If the obligor or debtor (corporation or

(3) Gifts, Bequests, and Devises.

(4) Compensation for Injuries or Sickness.

(5) Income Exempt under Treaty. Page 10

Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen

Social security benefits; retirement

Rank and file

General professional partnerships

Non-Resident Alien Not Engaged in Trade or Business

Tax rate for proprietary institutions and hospitals

Tax on specific corporations

Regional or area headquarters multinational companies

Regional or area headquarters shall not be subject to income tax. of

Regional operating headquarters multinational companies

Tax on certain incomes received resident foreign corporation

Non-resident owner or lessor of chartered by Philippine nationals

2. If it is one issued by another

DEDUCTIONS FROM GROSS INCOME

d) Deductions, When Allowed INSTANCES WHEN ARE ALLOWED: DEDUCTIONS

b) Deductions vs. Exclusions

e) Deductions vs. Tax Credit

Used computing TAXABLE INCOME

2. Diminishes income tax payable

c) Deductions vs. Cost

Tax credit generally refers to an amount

Tax deduction -- defined as a subtraction

A tax deduction, on the other, reduces

Bicolandia Drug Corp vs. CIR GR No. 142299, 22 June 2006

b) Submission of supporting financial

d) Sales discounts, sales returns and

c) If taxpayer elects to offset his

Mrs. X P 600,000.0 0 400,000.0 0 P 200,00.00

c) In the case of individual entitled to claim

Gancayco v. CIR (G.R. No. L-13325

3) The debt must be charged off

v. Interest on Tax Delinquencies