TAX PART 1 compiled.pdf

PART 1 – Taxation Law Notes by: Justice Dimaampao

--------------------------------------------------------- Page 1 of 114 --------------------------------------------------------- retyped and compiled by: Calvan, Cayaban, Federio, Jumalon, Lacap, Macaraeg, Quinto, Tecson, Santos, Villanueva (May 2012)

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TAXATION Part 1 Justice JaparDimaampao

(page 1 missing)

j. Substituted Fuling of Income Tax Return

A. SCHEDULAR SYSTEM OF TAXATION and GLOBAL SYSTEM OF TAXATION:

1. TAN vs DEL ROSARIO - 237 SCRA 324

> Landmark case that was asked twice already in the Bar Exams

> The two recognized systems of income taxation:

a. SHEDULAR SYSTEM OF TAXATION

-> Is the system of taxation adopted in imposing taxes on the income of individual

Taxpayer

SC: The Schedular System of Taxation is the system employed where income tax treatment varies and made to depend on the kind or category of the taxable income of the taxpayer.

It is a system that provides for different tax rules or treatments. By making it depend on the kind or category of taxable income, it means that it classifies or

categorizes income 1997 Bar: discuss the meaning of Schedular Tax System. Possible modification: How does

the Tax Code impose tax on the income of individual TP?

These features are incorporated in the present tax code.

IMPORTANT CHARACTERISTICS OR FEATURES i. Income is classified or categorized

- Section 32 A gives 11 categories (actually 13) - Sec 32. Gross Income – (^). General Definition – Except when otherwise

provided in this title, gross income means all income derived from whatever

source, including but not l imited to the following items: 1. Compensation for services in whatever from paid, including but not

limited to fees, salaries, wages, commissions, and similar items;

These notes are meant to be shared to all who may benefit from it, provided, that THE USER SHALL NOT IN ANY MANNER WHATSOEVER DELETE, DIMINISH, OR OTHERWISE REFUSE TO GIVE CREDITS TO THE PEOPLE WHOM MADE THIS. Whoever does such ungrateful and dastardly acts shall most definitely suffer the consequences under the law of karma and no amount of prayer can save them from its effects. This was made

available through the collective efforts of the following UST bar examinees and friends: aaa lord V Marj nick g. tracy bryan louie levie henry leo rob dk julan rommel claudette dennis m.



2. Gross income derived from the conduct of trade or business, or the exercise of a profession;

3. Gains derived from dealings in property 4. Interests; 5. Rents; 6. Royalties;

7. Dividends; 8. Annuities 9. Prizes and Winnings; 10. Pensions; and

11. Partner’s distributive share from the income of the genera l partnership

ii . It provides for different tax rules or treatment

1. How are dividend income, royalties, prizes and winnings taxed? Correlate with Sec 24 and 25 where you will find the different tax rules and tax treatments that may apply

2. Do not memorize 24 and 25. Just try toi read

. Sec 24

. Sec 25

So, to answer the question, “ How does the tax code impose tax on income of

the individual taxpayer?’, Just state the 3 characteristics. The answer therefore is: the income of the individual taxpayer is taxed under the schedular system of taxation. Under this system, it operates as follows or has the following characteristics:

1. The income of the taxpayer is categorized or classified; 2. It is subject to different tax rules or treatment; and 3. The tax code imposes different tax rates on these different categories of

income

There are 3 basic rules / formula that you should remember here:

A. Where income is derived from the performance of services, Sec 35 applies. From gross compensation income is deducted personal and

additional exemptions. Also to be deducted under Sec 34(10) are premiums on hospitalization and heal; Insurance (2001 Bar). After such deductions, you arrive at Taxable Compensation Income

B. Where income of individual TP partakes of the nature of business income, different tax treatment applies. The formula is as follows: Gross Income from the conduct of trade or business or the exercise of the profession less allowable deductions under Sec 34.

Personal and additional exemptions may not be deducted as these are allowable only in compensation income.

C. Where income is derived solely from income subject to final tax, as in

dividends received from a domestic corporation, such is not included in gross income. The tax withheld will constitute a final settlement on the tax liability on that particular income.

. Fringe benefit is subject to final tax under 33A. The individual

TP is not report this as part of gross income because the tax

Withheld which is a final tax will serve or constitute a final



settlement on the on the tax liability on that particular

income.

. Other income subject to final tax – royalties, interest on bank

Deposits, prize and winnings.

iii . It imposes different tax rates

. Sec 24 and 25 provide for different tax rates which are known as

The progressive rates of income tax.

b. GLOBAL SYSTEM OF TAXATION

-> one adopted in imposing tax on income of corporate taxpayers

ROSARIO. The SC said “it is the system where the tax treatment views

indifferently the tax base, and generally brings in one (?) form a. categories of

Income of the taxpayer”.

. Indifferently views the tax code - means uniform tax rules or tax treatments

. generally brings in one form all categories of income of the taxpayer – means that

It does not classify or categorize income

Global system is really the opposite of Schedular Tax System

Secs. 27 & 28 are the 2 important provisions as far as Corporate Taxpayers are concerned.

These are classifications similar to 32A.

. In 32 A – it classifies income into 11 categories. Here in Secs. 27 & 28, the rules are

uniform as far as Domestic Corporations are concerned, subject to certain exceptions. Also, the rules are uniform as far as Non Resident Foreign Corporations are concerned. And also uniform as applied to NRFC

. Sec 27

. Sec 28

So, uniform corporate tax rules, subject to certain exceptions. No classification of income and also imposes a uniformed or fixed corporate rate of 35%. The 32% has been amended to 35% by RA 9337 (EVAT LAW) which took effect on July 1, 2005.

B. INCOME TAX SITUS: (Relevant Provision in Sec 23)

Sec. 23. General Principles of Income taxation in the Philippines. Except when otherwise

provided in this code.

A. A citizen of the Philippines residing therein is taxable on all income derived from

Sources within the Philippines;

B. A nonresident citizen is taxable only on income derived from sources within the

Philippines;

C. An individual citizen of the Philippines who is working and deriving income from

Abroad as an overseas contract worker is taxable only on income from sources

Within the Philippines. Provided, that a seaman who is a citizen of the Philippines



and who receives compensation for services rendered abroad as a member of the

the complement of a vessel engaged exclusively in international trade shall be

treated as an overseas contract worker;

D. An alien individual, whether a resident or not of the Philippines, is taxable only on

Income derived from sources within the Philippnes;

E. A domestic corporation is taxable only on all income derived from sources within

The Philippines; and

F. A foreign corporation, whether engaged or not in trade or business in the

Philippines, is taxable only on income derived from sources within the Philippines.

1996 Bar: Basis on imposing income tax (RPN): (Tan vs Del Rosario)

1. R – residence

2. P – place where the income was derived; and

3. N – nationality or citizenship

Residence:

Resident-Alien – can be taxed on his income derived from sources within

RFC – basis of the imposition of tax is the conduct of business in the Philippines

Place :

NRA – come can only be taxed from its income derived from sources within the

Philippines

NRFC – can be taxed from its income derived from sources within the

Philippines

Nationality:

- The place is not basis, it is the nationality. That’s why even the income

derived from sources without can be taxed.

- you know that Resident Citizen (RC) and Domestic Corporation) can be taxed

(Sec 23 (A&E) on income derived from sources within and without the

Philippines.

. please be reminded of the amendment because this has been the subject

of misleading 2002 bar Q: #1 regarding NRC and NRA. Take note of the

effectivity of RA 8424, Jan. 1, 1998.

. These rules in Sec 23 about NRC (that they can only be taxed on Income

Derived from sources within, and so is with Resident Alien, took effect on

Jan. 1, 1998

. therefore, if the income was derived in 1997, within and without, it is sub-



ject to tax.

Without of a seaman or NR Citizen. Severa l examinees answer the Q. under the new rule. This is

Not correct. What they have in mind is that the 1997 Comprehensive Tax Reform Act took effec t

In 1997. This is not correct. This RA 8424 took effec t on January 1, 1998.

. Please be reminded about this. That these individual taxpayers (Nonresident Citizen

and Resident Alien) have been the subject of the amendment introduced by RA 8424.

. they could only be taxed on their income derived from sources within and without

in 1997, or before 1998. But starting 1998, they could only be taxed on their

income derived from sources within the Philippines.

. the word used by the SC in describing the present income tax situs, and this is also

provided under the present tax code is “COMPREHENSIVE”. The SC said “we have

adopted a Comprehensive Income Tax situs” xxx “because we have practically

adopted all the possible criteria in imposing tax on income (residence, nationality or

citizenship, and place)”.

Q: Why is that the income derived by Resident Citizen from sources within and without is subject to

Tax? What is the rationale behind this? What is the basis for this?

CIR vs Lednicky (re: Partnership Theory) GRN L-18160 July 31, 1964:

Issue: Right of the Philippine Government to tax the income of resident from outside the

Philippines.

Held: the right of a government to tax emanates from its partnership in the production of income,

By providing the protection, resources, incentives, and proper climate for such production, the inter -

pretation given by the respondents to the revenue law provision in question operates, in its applica -

tion, to place a resident alien with only domestic sources of income in an equal, if not in a better,

position than one who has both domestic and foreign sources of income, a situation which is mani -

festly unfair and short of logic.

NOTE: This case was decided during the OLD Tax Code

Under the principle of Personal Jurisdiction, wherever you go, citizens in the Philippines, you are

Entitled to the protection of the Philippine Gov’t. This is in relation to Partnership theory between

The Taxpayer and the State-

- The State will provide protection but in return you have to pay taxes. The right of the Gov’t there-

fore, to impose taxes on income must be based on its capacity to extend protection. In other words,

If the Phil. Gov’t cannot provide protection, then it has no right to impose taxes. As simple as that.

This is the reason why the income derived by the Resident citizen from sources without can be

subject to Philippine income tax.



SUMMARY:

KIND OF TAXPAYER CRITERIA or INCOME TAX SITUS SOURCES of TAXABL E INCOME

RC Residence and Nationality Within and without

NRC Place Within

Residence

They can claim personal and additional exemptions and as well as deductions

Ws incomeithin

NRA Place

In certain cases, they are not

allowed to claim deductions

Within

DC Nationality Within and Without

SFC Residence Within

NRFC Place

They are not allowed to claim deductions

Within

C. DETERMINATIVE TEST OF WHETHER THE INCOME IS TAXABLE – Doctrine

Of Constructive Receipt of Income:

. This is cited in the case of Filipinas Fiber Corp. vs CIR. The SC said that it is not the actual

receipt of income but the right to rec eive that determines when to include an amount as

income in the gross income. This is the most important pronouncement of the SC in this case

which you should remember. This is consistent with the Doctrine of constructive receipt of

income.

FILIPINAS SYNTHETIC FIBER vs. CA - GRN – 118498 October 12, 1999

Under the accrual basis method of accounting, income is reportable when all the events have

Occurred that fix the taxpayer’s right to receive the income, and the amount can be

determined with reasonable accuracy. Thus, it is the right to receive income, and not the actual

receipt, that determines when to include the amount in gross income – whether then income is

taxable.

-> In title ii , there are specific rules regarding Constructive Realized Cash or Property

Dividends. The rule is provided in Rev. Reg. #2 Sec. ____ . It gives us 2 requisites:

1. The income or the amount must be credited to the account of the taxpayer



Or set apart or set aside for the taxpayer, and

2. It must be unconditional; that it is, not subject to any limitation or restrict-

Ion. The right to rec eive must not be subject to any contingent event

Examples:

a.) Dividend income perceived to be received from Domestic Corporation – it

is not required that the stockholder must actually receive the dividends be-

fore the 10% tax must be imposed. As long as it is set apart for the stock-

holder and the latter could demand the same without any limitation, the

10% tax may be imposed to the corporation

b.) As cited in Rev. Reg #2, the Partner’s Share in the Income of the Partner-

ship – it is not required that the share of such partner as actually received

or distributed. As long as the partner could demand the same without any

limitation or restriction, such share is already taxable.

. Class ic example using the word “credited” - interst income on Money Deposit

-> If you have money deposit in the bank that earns interest, such interest

Income is credited to your account. So, constructive receipt of income. An

Example of an income that is constructively in your hand, you have yet to

Receive the same, no actual receipt, but i t is already subject to 20% tax. The

20% Final Tax already applies because the 2 requisites are present (1) credi -

ted to your account and (2) you can withdraw the same anytime during the

taxable year without any limitations or restrictions.

Case: Limpian Investment vs. CIR (?) – What is the income considered as constructively rece-

ived here? It is the rentals deposited in court by the lessee as a result of the unjustified refusal

of the lessor to accept the same. The rentals were consigned in court. The rentals deposited in

court is considered as constructively received by the lessor because the lessor can withdraw the

same without any restriction. So, take note of this constructive receipt of income.

D. BASIS FOR THE COMPUTATION OF TAXABLE INCOME:

-> If you have not read Sec. 43, you cannot answer this.

Sec. 43. General Rule – the taxable income shall be computed upon the basis of the taxpayer’s

Annual accounting period (fiscal year or calendar year, as the case may be) xxx

-> If we try to analyze, it uses the words basis, than taxable income, then computed. It shall be

computed on the basis of what? Answer: your taxable income shall be based on either of these

accounting periods: 1) fiscal year period or 2) calendar year period



1990 Bar. There was a Q. on the distinction between these 2 accounting periods. The importance of

This Q. is that it tells us that there is a basis in the computation of the taxable income. These terms

Are defined in Sec. 22 P & Q.

Sec 22. Definitions -

(P) The term “taxable year” means the calendar year, or the fiscal year ending during

Such calendar year, upon which the net income is computed under this title. Xxx

(Q) the term “fiscal year” means an accounting period of twelve (12) months ending

on the last day of any month other than December.

-> You must know these terms because individual taxpayers can only adopt the calendar year

Period. Starting January 1 and as defined under Sec 22 Q. Fiscal Year Period is that Accounting

Period of 12 months ending on any month other than December. Therefore, Fiscal year Period

Can only be applied to corporate TP. Corporate TP have the option either to adopt the calendar

Year period or the fiscal year period.

. Correlate with Sec 77B. You’ll find therein that Corporate taxpayers have the option

To adopt calendar year period or fiscal year period. But in the case of individual tax -

payers, there is no choice but to adopt the calendar year period. So the taxable

period will cover only from Jan. 1 up to Dec. 31. You must master this so as to corre

late with Sec. 229

-> Under Sec 229, and you are Familiar with this Doctrine – the 2 year period

Shall commenc e to run from the fi l ing of the final adjustment corporate tax

Return;( __________ vs. CIR 205SCRA184). You ought to know whether the Cor -

poration adopted the fiscal or calendar period.

. There is no problem if the corp. has adopted the calendar period because it is April

15. What if it adopted the fiscal year period? When can you apply this 2 year period?

Sabe, “the 2 year period of fi ling the tax refund shall commence to run from the fi ling

Of the final adjustment corporate tax return”.

-> i f the corporation has adopted the fiscal year period, then it is not April 15. Sec.

77B says “on the 15th

day of the 4th

month, following the end of the taxable

period. So if the fiscal year ended on June 30, you count 4 months --- July, Aug.,

September, and October. On the 15th

day of the 4th

month following the end of

the fiscal year period. So that would be on October 15. So correlation

. It is really very important to correlate because questions will be asked on the appli -

cation of the 2 year period and the problem will state that the corporation has adop-

ted the fiscal year period. Take note of sec. 77B, it is not April 15.



E & F. NET INCOME TAXATION and GROSS INCOME TAXATION:

NET INCOME TAXATION (NIT) vs. GROSS INCOME TAXATION(GIT):

. NIT – one generally adopted under the present tax code. Bases are Secs. 34 & 35

-> Under Sec. 34 (Deduction from Gross Income) . NIT allows deductions. It also grants

Exemptions, basic and additional personal exemptions under sec. 35.

. GIT – can be applied or adopted under exceptional cases.

-> It is really correct to say that we have not adopted GIT

-> Sec. 25 B, C, D, and E, speak of gross income

-> Sec 25 B: the provision says “the income tax is imposed on the entire income”. That

Means that the basis is Gross income. The subsequent paragraphs (C,D, and E) consis -

Tently say or provide or use the word “gross income”.

. Who are these individual taxpayers whose income shall be taxed at gross , and therefore the

Method of taxation is GIT? NRA-NETB

-> The income of these individual taxpayers is taxed at Gross, therefore, the method or

System that apply to whom is GIT

. Who are these individual taxpayers who cannot claim any deductions/exemptions?

NRA-NETB

. As regards Corporate taxpayers:

-> Sec 28 B (1,2,3, & 4) provide for those corporations tax under GIT

-> Sec 28 B (1) – the 35% corporate income tax is imposed on Gross Income

(2) – the 25% corporate income tax shall be imposed on gross income on

Rentals

(3) – the 45% corporate income tax shall be imposed on gross income on

Rentals or charter fees

(4) – the 7.5% corporate income tax shall be imposed on gross income on

Rentals or fees.

. Corporations covered by Sec. 28B (1,2,3, &4) are nonresident foreign corporations. So,

Corporate taxpayers who cannot claim deductions are NRFC. The method of taxation applied

To these corporations is no doubt, GIT.

. Simply put NIT is the Rule. GIT is the exception to the rule. Exception in the sense that it

Applies only to these 2 kinds of taxpayer:

1. Individual – NRA NETB; and

2. Corporate – Nonresident foreign corporation

1997 Bar: Explain NIT

2000 Q. 10: Define Net or Taxable Income (the word taxation is not present here)



1983 Bar: Explain the meaning of GIT

1995 Q. #1: Define Gross income

--- the use of the word “taxation” really matters

. In 1995 Q.#1 – Define Gross income. 1 examinee answered: One where the tax is imposed at

gross. This is not really correct. This maybe partly correct if the Q. asked was that of 1963

Bar, because if we speak of GIT, that is really the method or system

. If the Q. is the Definition of Gross Income, then you really have to enumerate the items

Under Sec. 32. A.

GIT – is a method or system that allows no deduction; it grants no exemptions. In other words, the tax

base or the basis of the tax rate is Gross Income.I n other words, the tax base or the basis of the

tax rate is Gross Income.

NIT – not the same with Net Income or Taxable income. Sec. 31 (one sentence provision) defines Net or

Taxable Income. Do not confuse this with the concept of NIT because the word “taxation” con -

notes methods or system

. Sec 31 – Taxable Income Defined – The term “taxable income” means the pertinent items of

gross income specified in the tax code, less the deductions and/or personal and additional

exemptions, if any, authorized for such types of income by this code or other special laws

. So what then is Net Income Taxation? How does it operate? --- NIT allows deductions and

grants exemptions. The basis of the tax rate is taxable net income as defined under Sec. 31

. Probable Bar Q. here: What are the distinctions between GIT and NIT?

-> Answer:

1. As to the claim for deductions or exemptions: GIT – No exemptions/deductions; NIT

allows deductions and grants exemptions ;

2. As to the basis of the tax rate: GIT – Gross Income; NIT – Net Taxable Income

3. As to the applicability under the tax code:

GIT applies to 2 taxpayers: 1) NRA-NETB (Sec. 25 B, C, D, & E) NRFC (Sec. 28B

(1, 2, 3, & 4))

NIT applies to the following taxpayers: 1) RC; 2) NRC; 3) RA; 4) NRA-ETB; and

And Corporate 1) DC ; 2) RFC

. Q.: Are you in favor for the adoption of GIT? Congress is proposing a change from NIT to

GIT

-> This maybe a bonus Q. but your answer or opinion must be based on tax. Point out sig -

nificant advantages. There’s no such thing as perfect system because both have their

own disadvantages.

. As regards NIT, it allows deductions and grants exemptions. Therefore, the tax paid is less.

I think we can develop advantages on this



-> Try to recall these, as these are the characteristics or features of NIT.

1) To the taxpayers, they may consider this as fair, just and equitable system of tax-

ation. One or two sentences will suffice and you have to explain that. Favorable/

fair in the sense that taxpayers can claim those business connected expenses as

deductions, and taxpayers can also claim exemptions;

2) This brings us to the next advantage, as cited in Sec 2 (State Policy) of RA 8424. This

is one of the underlying purposes of the amendments. It says that “it provides for

equitable relief to a greater number of taxpayers in order to improve levels of dis -

posable income and increase economic activity.

. Equitable relief may refer to those allowable deductions under Sec. 34 and per-

sonal exemptions under Sec. 34. The effect of this is that it will increase the

levels of their disposable income. If taxpayers can claim these business related

expenses as deductions, they may fi le their income tax return religiously and

they may encouraged to engage in income producing activities. This is the amp-

lification of the provision under Sec 2 of RA 8424when it says increase economic

activity. That will be the effect of that grant of deductions and exemptions.

3) We can also cite as an advantage, that NIT minimizes fraud. In what sense?

. Through this tax audit examination of the taxpayer’s books of accounts. The

Taxpayer cannot just claim expenses not supported by receipts. BIR will check

Whether these expenses are indeed business connected or not. This is what we

Called “counter checking”. If you incurred expenses, make sure that it is suppor-

ted by rec eipts or is connected to business otherwise the BIR will disallow the

same. So it minimizes fraud in this context.

The result of this is that, if we have fair, just and equitable tax system, taxpayers will reli -

giously file their income tax return and fraud will be minimized. This will generate more

revenues to the Gov’t which is really the objective of every system of taxation.

. Q.: if you are against NIT (in effect you are for the adoption of GIT) what must be your reasons

Here?

-> Take note of the 2 salient features of GIT:

a) No deductions are allowed and no exemptions may be granted; and

b) The tax base is the gross income. Have these in mind.

-> Reasons:

1) The complaint of showbiz people under the present system is that, we have a compli -

cated system because there are so many requirements that must be complied with

and they could not just determine taxable income – services of CPA’s are still needed.



But here in GIT, since no deductions are allowed, this will simplify our income tax

system. In what sense? You can easily compute your income tax due or payable. Just

multiply your Gross income by the tax rate and that is the income tax due. It dispen-

ses with these several requirements on the claims for deductions. And this is consis -

tent with or in harmony with the sound fundamental principle of ADMINISTRATIVE

FEASIBILITY. GIT makes our system sound in the sense that it is capable of effective

enforcement or implementation.

2) So what would be the effect of this? If we have a simplified income tax system which

can be easily understood by common citizens, more will be religiously filing their

income tax returns because they can claim deductions. Because they can easily un-

derstand the system, they can easily file their tax returns without the assistance of

a CPA or tax experts.

3) The most important about GIT, as cited by the sponsor of the proposed Bill is that

It minimizes (we cannot use the word “eradicate” because this is next to M 13; it

Minimizes graft and corruption.

-> How do we explain this? The evil of NIT, is that there’s that abuse of discretion; mar-

gin of discretion on the part of the BIR examiner. They abuse it by collaborating with

the taxpayer and allow deductions not supported by receipts. This reduces the tax-

payer’s liability. Because of this margin of discretion, there’s that measure to the

effec t that this should not be the source of graft and corruption. So, no more deduc-

tions and no more exemptions must be allowed so that the BIR cannot make use of

the same. Here, it can no longer be the source of graft and corruption, so it minimizes

the same.

-> The result of this GIT is that,. It will generate more revenues to the Govt. which is really

the objective of every system of taxation.

. NIT vs GIT (As regards the objective of generating more revenues ):

1. In NIT, more revenues may be brought by these 3 factors:

a. favorable system

b. system that provide for equitablerelief

c. minimizes fraud

2. In GIT, more revenues may be brought by these 3 factors:

a. simplification

b. easy to understand system

c. minimization of graft and corruption

. You should also know the disadvantages of these 2 systems. In case of NIT, #1 disadvantage



Is that it really is vulnerable to graft and corruption because of the margin of discretion.

(BIR can allow or disallow the grant of discretion). #2 is that it is a complex or complicated

System. It is very complicated and there are so many requirements to be complied with.

-> the effec t of this graft and corruption is tax evasion

. The disadvantage of GIT is that there’s always tax evasion. In NIT, tax evasion may be

brought about by graft and corruption. In GIT, it is the employment of the fraudulent

methods; schemes or devices to understate Gross income. Also, if you are a businessman

cannot claim those business expenses as deductions, you may find the system as unfair. In

what sense? Even legitimate expenses cannot be classified as deductions.

. Sec. 24 A. you’ll find 32% progressive rate in 2000. If we will formally adopt this GIT, do

You think this tax rate will be retained?

-> If this will be retained, that would make the system unjust. These tax rate are quite high

up to 32% but it allows deductions, so there’s a balancing feature. But once we formally

adopt GIT, we cannot retain the same. We really have to reduce the rates to make this

sytem just. In my view, it must not exceed 10%. Eliminate deductions. No more Sec. 34,

but we have to reduce the rates.

. In my view, it should be modified income tax system. I’m not really in favor of pure Net

income or pure Gross income taxation. It should be modified income ta x system.

G. FILING OF INCOME TAX RETURN AND PAYMENT OF TAX:

. The system that we have adopted is PAY AS YOU FILE

-> In the case of individual Sec. 36 A (1) states that the tax shall be paid upon the fi ling of income tax

return

-> Sec. 36 A. Payment of Tax – (1) In general – the total amount of taxed imposed by this title shall be

Paid by the person subject thereto at the time the return is filed. X X X

-> In the case of Corporation, Sec. 77 C provides that Corporate taxpayers shall pay their corporate

Income tax upon the fi ling of corporate income tax return.

-> Sec. 77 C. Time of Payment of income tax – the income tax due on the corporate quarterly returns

And the final adjustment income tax returns computed in accordance with Sec. 75 and 76 shall

Be paid at the time of the declaration or the return is filed. X X X

. 2001 Q. #4. This will test the knowledge about the fi ling of tax return by a corporation. I will

modify : How often does a Domestic corporation file its Income Tax Return for income earned

during a single year. Explain the process. What must be the reason for such procedure?

Answer: LIFEBLOOD DOCTRINE --- Hehehehehefunds

-> Refer to secs. 75 and 76. Is it annually? No. How often, Once? No.



. Sec 75 explains the process. It says “every corporation shall file in duplicate a quarter -

ly summary declaration of its gross income and deductions on a cumulative basis for

the prec eding quarter or quarters, upon which the i ncome tax, as provided in Title.

collected and paid. X X X

-> So, four times, the word used is “Quarterly”. All Domestic Corporations file their incme tax

requires the filing of Final Adjustment Return (Sec. 76)

-> What are the words that you should say in your answer aside from Quarterly? You should say

in your answer, that under Sec 75, it requires the Quarterly declaration of gross

income and deductions. As regards the 4th

quarter, it rquires the fil ing the Final Adjus -

tment tax return.

-> Now, what do you think is the reason for the procedure? LIFEBLOOD. (hehehehe). If we allow

the Corporation to file their income tax returns annually, what would be the effect?

The effect is that the Govt would run out of funds before it can collect. That’s the

reason --- the timeliness of collection of corporate income tax because (lifeblood na)

taxes are the lifeblood of the Govt….hehehehe. There should be undue delay.

. What if it is an individual? How often does an individual taxpayer file his income tax return?

4X? Hehehe

-> Only Once (Annually) (Sec. 56)

-> what is the reason why individual taxpayers are only required to fi le their ITR Annual -

ly? Lifeblood na naman, hehehe…. Iba na cguro to. If we allow them to fi le their ITR

quarterly, sa tingin mo kaya? The BIR can check compliance with such? Millions of

individual taxpayers will be filing their ITR quarterly. The reason here is to make our

system capable of effective implementation or enforcement consistent with the

sound principle of Administrative Feasibility.

. This is modified by these 3 systems:

1. Creditable withholding tax system

2. Final withholding tax system

3. Substituted fi ling of ITR

H & I. CREDITABLE WITHHOLDING TAX SYSTEM:



. Medyo mahirap to. 1995 Bar – Q. on these: creditable Withholding tax system (CWTS) vs. Final

Withholding Tax System (FWTS):

- the common feature with these withholding systems is that there ’s a withholding agent

authorized by the Govt to deduct and withhold the tax

1) As to Income subject of the system

- classic example of this system is Compensation Income. The employer is the with-

holding agent, the employee is the recipient of the income. Under this system, the

employer will deduct and withhold the tax on that compensation Income. Remember

that the employee is required to include the income in his gross compensation in-

come.

- On the other hand, classic examples of Income subject to FWTS are dividends received

From Domestioc Corporation, Royalties, Prizes more than 10,000. Winnings and inte-

terest income on bond deposit. If you are the recipient of these, you are no longer re-

quired to include these incomes in your gross income.

- The word “final” connotes that the tax withheld will constitute as a final and

full settlement (FAFS for brevity) of the tax liability on that income

2) As to whether or not the Income should be reported as part of gross income:

- According to CWTS, since the income will not constitute as a FAFS of the tax liability on

that income, the recipient should report the said income in his gross income.

- This is provided for in Rev. Reg. 2-98. It is said therein under Sec 2-54, that an

income subject CWT must still be reported by the recipient as part of his gross

income.

- On the other hand, the said Rev. Reg. 2-98 also provides that in the case of FWTS the

recipient may not report income as part of his gross income because the tax withheld

will constitute as a FAFS of the tax liability



3) As to the Effect of the Tax Withheld.

- The tax withheld under the CWTS can be claimed as tax credit or may be deducted

from the Income tax due or payable.

-> If you are compensation earner, and you have other sources of income. Let us assume that your income tax due is 150,000. The tax withheld by your

employer can be claimed as a tax credit. It may be credited against or deduc-

ted from your income tax due or payable. Say, if the tax withheld is 50,000,

deduct this to your income tax due or payable of 150,000, the final income

tax due is 100,000.

-> Again, Creditable implies that the tax withheld by the employer can be

claimed as a tax credit or may be deducted from income tax due or payable.

- On the other hand, in FWTS, the tax withheld cannot be claimed as a tax credit. The

Final Tax Withheld will constitute as a FAFS on the tax liability on said particular

income.

- For instance, the stockholder is not required to report as part of the gross

income the dividends received from a domestic corporation. The reason is

because the 10% tax withheld on the a mount will constitute as a FAFS of

the tax liability on the dividend income.

- Fringe Benefit under Sec. 33 A is subject to Final tax, therefore this is also

Governed by FWTS. This is another example of income subject to FWT

- 2003 Bar: Who is obliged to pay Fringe Benefit Tax? This Q. is not the about

delinition of FB but requires your knowledge about withholding tax. Rev.

Reg. 3 – 98 Sec. 2 (2) say that the employer is the one lega lly obliged to pay

the tax.

- Person legally obliged to pay the tax – is the one who in case of nonpayment

may be legally demanded to pay the tax. If the Final tax on FB will not be

paid, the BIR will not go after the employee but to the employER. This is the

same in the case of interest on bond deposit. In case of nonpayment,, the BIR

will not run after stockholder but to the corporation. The Corporation being

the withholding agent is the one legally obliged to pay the tax. The rule is that

“it is the withholding agent that is legally obliged to pay the tax

4) As to the Filing of Tax Return.



- In the case of CWTS, the compensation earner reports the income received as

part of his gross income. Necessarily, he has to file an ITR

- Whereas if the only source of income is subject to Final Tax, you need not fi le

An ITR

> These are provisions on individual whose sole income is one that is subject to Final tax (Sec.

51 A (2C)):

1. 25% final tax under Sec. 25 B – NRA-NETB

2. 15% final tax under Sec. 25 C, D, and E (Alien employed by Multinational

companies, offshore banking unit and petroleum service contractor or sub

contractor

> So they are NRA-NETB

> Bar Q.: Why are NRA-NETB not required to fi le ITR? This can be answered by 1 sentenc e. It

is because their income is already taxed as a Final tax.

> So as to the 2 Questions:

1) Who are these individual taxpayers who are not required to fi le ITR? NRA-NETB

2) Why are NRA-NETB not required to fi le ITR? Because they are subject to a Final Tax

rate. Final tax withheld will constitute as a FAFS of the tax l iability

> How about Corporate taxpayer?

- Sec. 52 A. It says ‘except! nonresident foreign corporation. The rule is that corporate

Taxpayers must file their ITR, except nonresident foreign corporations

- Why? The reason is sec. 28 B (1, 2, 3, 4)

Sec. 28 B – Tax on Nonresident Foreign Corporation

1. FC not engaged in trade or business – 35% FT

2. Nonresident Cinematographic Film owner – 25% FT

3. Nonresident O wner or Lessor of Vessel – 4.5% FT

4. Nonresident O wner or Lessor of Aircraft, Machineries – 7.5% FT

> These are all Nonresident Foreign Corporations. Apply the rule that they are not required

To fi le ITR because the tax withheld constitutes as a FAFS of the tax liability

Who are these individuals? Sec 25 BCDENRA not engaged in trade or business

57a

Why? These income tax rate is final tax accdg to 57A



J. SUBSTITUTED FILING OF INCOME TAX RETURN:

> Rev. Reg. 3-2002 (1, 2,. 3, 4). The effect of this system is that you are no longer required to

File ITR.

Requirements for one to avail of this system:

1. You must be a compensation earner. Meaning that your income is derived

derived solely on compensation. If you have other sources of income such as

business, trade or profession, you are still required to file an ITR;

2. You must have only 1 employer in the Philippines. So, if you have 2 or more

Employers, you are not allowed to avail of this system;

3. The tax withheld by the employer must be the same or equal to the tax due

Or payable after applying the tax rate.

- For example: tax due is 250,000. Make sure that the exact amount is

Is withheld by the employer. Otherwise, you will be required to file

ITR.

4. The employer must fi le an information return (BIR Form 1704) showing

Therein the income tax withheld on the compensation income.

> Rev. Reg. 3-2002 declares “that is tantamount to a substituted fi ling of ITR by the employees

Hence they are no longer required to fi le ITR”.

> Let us examine Sec. 51 A and B.

Rules lay down therein:

1. If your compensation income is not more than 60,000;

2. Only 1 Employer; and

3. Tax withheld is the same wi th the tax due.

- Then you are no longer required to fi le ITR. But if your compensation is more than

60,000even if you satisfy requirements 2 & 3, you are still required to file ITR

- These rules have been modified by Rev. Reg. 3-2002. Under 3-2002, it imposes no limi -

Tation as to the amount. What is important is that as long as the tax withheld is the

Same with the tax due, irrespective of the amount, this new system applies.

There is no more limitation

Only applies to individual earners, compensation earners

No more limitation. As long as the tax withheld is equalto the amount of tax due



- Is this not an impermissible encroachment on administrative prerogative because it is

a mere regulation? BIR has the power to promulgate regulations for the enforcement

of rules as part of its administrative functions . Nobody questioned this.

Frey

II. General Principles Of Income Taxiation

This is precisely the title of Sec23 – General Principles Of Income Taxiation In the Philippines Sec.23 Principles Of Income Taxiation In the Philippines. Except when otherwise provided in this code:

A. A citizen of the Philippines resicing therein is taxable on all income derived from the sources within the Philippines.

B. A nonresident citizen is taxable only on income derived from sources within the Philippines. C. An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker is taxable only on income from sources within the Philippines. Provided

that seaman who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker. D. An allien individual, wheather a resident or not of the Philippines is taxable only on income

derived from the sources within the Philippines. E. A domestic corporation is taxable only on all income derived from the sources within and without the Philippines; and

F. A foreign corporation, weather engaged or not in a trade on business in the Philippines is taxable only on income derived from the sources within the Philippines.

Sec23 classifies taxpayers into two: individual and corporal

Can only answer the Q: Can we tax the incomes derived from the sources w/n and w/o? Sec23 cannot answer the Q on wheather the taxpayer can claim dedductions, (which also a gener al principle or basic rule.) There’s a need to supplement the particular provision. That’s why under Secs.24 & 25, there are provisions that apply to individual taxpayers that answer the Q on wheather they can claim deductions.

As regards corporate taxpayers: Q on wheather they can claimdeductions cannot also be answered by Sec.23. We really need to refer to sec.27 & 28 which give us the tax rates and the base.

Bar Questions on general Prnciples 2000 Bar Q#8 , 2002 Q#1 & 1998 Q#2. Try to refer to these O because these are really questions

on thegeneral principles of Income taxation 2000 Q#8- the tenor of the Q was: How will this individual taxpayer, a NRA-NETB be taxed on his

income derived from the sources w/in an w/o? In 2000 bar our suggested answer incl udes not only there 2 sources. 1) wheather

income from w/in and w/o can be taxed and 2)regarding tax bases; wheather the taxpayers can claim deductions. 3) We also mentioned abou the applicable tax rates.

2002 Bar-The tenor of the q has been changed: What is the Rule of Income Taxation with respect to

the income of Mr. Sebastian, a NRC deriving income from sources w/in and w/o? 2002 Q#1 also requires these 3 basic principle.

The answer to these Q are the same ever. If the examiner changed the tenor of the O .

However, 1098 Q#2 can be surely answered by Sec.23 alone.This is Q on sources alone.

So when we speak of general principles, these are not l imited to sources alone under Sec.23 These

also include rules on tax base as well tax rates. There are really different ways on how to ask Q on General Principles. Provisions regarding General

Principles: Sec 23, 24, 25, 27 & 28



The tax code classifies the taxpayer as either individual or corporate. So this, General Principles may

be broken into 2: o General Principles of Individual Income Taxation and

o General Principles of Corporate Income Taxation

1. General Principles of Individual Income Taxation:

RESIDENT CITIZEN

How will the Income of RC be taxed? RC can be taxed on his income w/in and w/o (Sec.23 A) Can a RC claim deductions ? The income tax is imposed on the taxable income. That means that

RC can claim as deductions those expenses pold or incurred w/in ad w/o (Sec.24A(12) The taxable income of RC is subjected to 5.32%. It is known as the progressive tax rate schedul e.

NONRESIDENT CITIZEN

Can only be taxed on his income from sources w/in (Sec.23B,C) this has been the subject of an amendment. This is a new rule (Took effect on Jan.1, 1898). So that if the income w/in and w/o was derived in 1997. That income could be taxed under the old tax ccode. But beginning 1998, we can only tax his income derived from sources w/in.

Can he claim those expenses incurred within the period? Sec.23is not clear on this. This can be answered by Sec.24 A(1, b) it says that the income tax is based on the taxable income under Sec.31.meaning, Gross income less allowable deductions. But the allowable deductions are only

those expenses paid or incurred w/in the Philippines because he could only be taxed on his income derived from sources w/in.

This taxable income is subject to 5-32% progressive rate schedule. 2002 Q#1: Mr. Sebastian, a seaman received income in 1997 from sources w/in and w/o. What is

the rule with regard to the income of Mr. Sebastian in 1997? o Some answered this Q under the rule. This is not really correct. This should be answered

under the old tax code because the present tax code took effect only Jan.1, 1998.

RESIDENT ALIEN

Could be atxed only his income derived from the sources w/in.

Entitled to deduc tion (Sec.24 A(1,C)) because you can see therein the word “taxable income”. But the allowable duductions are only these expenses paid or incurred w/in the Philippines.

Subject to 5-32% progresive tax rate schedule.

NON-RESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS

How do you know that 2 NRA is engaged in trade or business? Determinative test is Sec.25A(1) it is considered engaged in trade or business if it’s aggregate satyed in the Philippines is more that

180 days. Sec.25 A(1) – X X X A nonresident alien individual who shall come to the Philippines and stay

therein for an aggregate period of more than one hundred eighty(180) days during any calendar

year shall be deemed a “nonresident alien business in the Philippines “ X X X o If it is exactly 130 days, then it is not engaged in trade or business because the law is

very clear. This must be strictly construed because of the tax benefit that may accrue to this alien individual.

What is that tax benefit? o If the alien is engaged in trade or business the tax benefit is not, he can claim deductions

because the tax base is taxable income under Sec.25 A(1). On the other hand, if he is not

engaged in trade or business, he is not entitled to this tax benefit because the tax base is gross income under Sec.25B.



o Refer to sec25, you will find therein the rule that “NRA-ETB” can claim basic personal exemption subject to reciprocity. This is another tax benefit that can be availed of by

NRA-ETB to the exclusion of NRA-NETB. 2000Q#8-Mr. Corpuz, A NRA was based in Hongkon. In 1999 he stayed in the Philippines for more

than 180 days. Q: How will the income of Mr.corpuz derived the sources within the Philippines and other countries be taxed?

o When it made mention about w/in and w/o then refer to Sec.23 O. NRA-ETB can only be taxed on his income derived fron the sources w/in the Philippines. The rule has act been changed. This is still the same under the old tax code.

Q: can he claim deductions?

o Yes, Sec.25A(2)- the income tax is imposed on the taxable income. Of course, only those expenses incurred w/in the Philippines could be deducted. The tax base is subject to 5-32% progressive rate.

Authoritative answer. You’ll know that the problem did not categorically state that he is engaged in trade or business. So you should start with this: having stayed in the Philippines more than 180 days. Mr. Corpuz, is engaged in trade or business. Under the tax code (You need not cite the provision). NRA-ETB shall be taxed under the following general rules/ principles:

A. Only his income derived from the sources w/in the Philippines can be taxed. We cannot tax the income derived from the other countries.

B. Indicate also the rule regarding deductions. Mr. Corpuz can also claim deductions

because the tax base is taxable income. These 2 will suffice. But you can add this. C. The taxable income is subject to the progressive tax rate schedule of 5.32%

Modifications: Supposed the examiner changed this to 9 months? o In aswering this problem, Art 13 of the NCC will come in handy- one month is equal to

30 days, no multiply 9 (months) with 30(days) = 270 days. Mr. Corpuz, is a NRA-ETB. What if it’s exactly months?

o The law says “more than 180 days” this is strictly contrued, so he is NRA -NETB. The rule says he cannot claim deductions.

How about if the problem is specified in that it indicates the Specific months, for example from April 15, 2004 to October. 15, 2004?

o Remember the “boxer rule”

April - 15 May - 31 June - 30 July - 31

August - 31 Sept - 30 Oct - 15

183 days= NRA-ETB

So, remember that the problem may categorically state more than 180 days or will state the

number of months or will indicate specific months. Remember the rules applicable in each of the

situation. NONRESIDENT ALIEN NOT ENGAGED IN TRADE OR BUSINESS:

Under sec.23 D, NRA-NETB can only be taxed on his income derived from the sources w/in (same with the old tax code)

Can he claim deductions? No. Under Sec. 25B the basis is entire income,meaning Gross income.

So, he cannot claim any deductions. This is the one that you should underscore. As regards tax rate, it is not 5-32% the tax rate is applicable to NRA-NETB is 25% FT. That means

that this is subject to Final withholding tax, and the tax withheld constitute as a FAFS of the tax liability on the income.



Questions regarding these 3 special NRA-NETB, have yet to be asked in the Bar: o Sec.25 C,D, E

C-Alien Individual Employed by Regional Area Headquarters and Regional Operating Headquarters of Multinational Companies

D-Alien Individual Employed by Banking Units E-Alien Individual Employed by Service Contractor and Subcontrac tor.

o They can only be taxed on their income derived from the sources w/in; they cannot claim deductions because tax base is Gross Income; and the tax rate has been reduced to 15%

Q: Mr. Corpuz stayed in the Philippines for more than 180 days. How will his income be taxed if

be was employed by Regional Headquarters of Multinational Company? Would you answer be the same as in the previous bar exam question?

o You have to change only the tax rate. As to the sources and tax base the rules are still

the same. SUMMARY: General Principle of Individual Income Taxation

Kinds of Individual TP Sources of Income TAX BASE (SEC 24 and 25) TAX RATE (SEC24 and 25(

RC Within and without Sec.24A-1(a)-TAXABLE

INCOME. Hence, he can claim deductions expenses paid within and without.

Progressive rate 5-32%

NRC Within (1-1-98) Sec.24A-1(D)-TAXABLE

INCOME. Hence, he can claim deductions expenses paid within.


RA Within (1-1-93) Sec.24A-1(C)-TAXABLE

INCOME. Hence, he can claim deductions expenses paid within.


NRA-ETB Within Sec.25A-1(a)-TAXABLE INCOME. Hence, he can claim deductions expenses paid within.


NRA-NETB Within Sec. –Gross Income. Henc e, No deductions or exemptions can be claimed.

25% Final Tax

Special NRA-NETB:

1. Alien individual employed by regional or Area HQ and regional

operating HQ of Multinational Co.-par .C 2. alien individual employed by ohshore

banking units- par D3. Alien Ind Employed by petronulnum service

contractor and subcontractor par E.

Within

Sec. 25C, D and E- Gross Income. Hence, No deductions or Exemptions can be claimed.

15% Final Tax



2. General Principles of Corporate Income Taxation:

Domestic Corporation (Sec23E): Taxable on its income derived from the sources w/in and w/o As to the tax base, refer to Sec.27 A. It says that the corporate rate is based on the taxable income. This

means that expenses paid or incurred w/in and w/o are deductible.

The taxable income w/in and w/o is subject to 35%(effec tive July.1 2005)

Resident foreign corporation (Sec.23F):

Taxable on its income derived from the sources w/in only As to the tax base, refer to Sec. 28 A (1). It says that the corporate saleis based on the taxable income.

This means that expenses paid or incurred w/in are deductible. The taxable income w/in is subject to 35% (effective July 1, 2005)

Nonresident foreign corporation (Sec23F):

Taxable on it’s income derived from the sources w/in only

As to the tax base, refer to Sec. 28B (1). It says that the corporate rate is based on Gross Income. The taxable income w/in is subject to 35% FT Just like NRA-NETB, there are also special kinds of corporate of corporation taxpayers, and this is yet to be

asked in the Bar.

[B] [2]- Nonresident cinematographic film owner lessor or distribution 25% FT

[B][3]-nonresident owner or lessor of vessels chartered by Philippine national -4.5%

[B][4]-nonresident owner or lessor of aircraft machineries and other equipment- 7.5%

1994 Bar. The secretary of finance upon the recommendation of the CIR issued BIR regulation using gross income as the tax base for corporation doing business in the Philippines. Q: It is BIR Regulation valid?

o It is not a valid BIR regulation for the simple reason that it runs counter to the provisions of the tax code. The SC in one case held that the requisites for the BIR regulations to be valid as are follows (CRUP):

Consistent or in harmony with the provision of the tax code or the law it seeks to

implement. Reasonable Useful and necessary and Pub products listed in the OG or in a newspaper of general circulation

Case: Misamis oriental association of coconut dealers vs. Sec. of Finance o The SC made a pronouncement in this case that BIR regulations are mere interpretative rules .

Therefore, it cannot go beyond the scope of the provision lay down in the tax code.

Another case: Auto incorporated vs. CIR 240 SCRA 368 o The SC said in this case that HIR regulation is designed or intended to carry out the provisions of

the tax code. It cannot supplant, modify the provisions of the tax code.

You need not cite the name of the case. It is enough to use the following words: “ It has been held that” or

“settled is the rule that” or “it is jurisprudentially settle that” BIR regulation is valid if it is in harmony or consistent with the provision of the tax code. The BIR regulation in question contravenes the provision of the tax code that the tax base for the corporation doing business in the Philippines is taxable income. It is



a mere interpretative rule intended to carry out the provisions of the tax code. It cannot alter, supplant or modify the provision of the tax code. The BIR regulation in question therefore, constitutes an

impermissible encroachment on legislative prerogative.

SUMMARY:

General Principles of Corporate Income Taxation

Kinds of corporate Sources of income (sec.23)

Tax base (Sec. 27&28) Tax rate (Sec. 27&28)

DC Within and without Sec.27A-TAXABLE INCOME Hence, can claim deductions experiences paid within and without.

35%

RFC Within Sec.28A(1)-TAXABLE INCOME hence, can claim deductions experiences

paid within

35%

HRFC-NETB Within Sec. 268(1)GROSS INCOME hence, NO deductions or exemptions

can be claimed.

35% FINAL TAX

Special:

NRFC-NETB

(Sec.28B2,3 and 4)

1.Par. B2- nonresident cinematographic film owner lessor or

distributor

Within

Sec. 28B(2)- GROSS INCOME. Hence, NO deductions or exemptions

can be claimed.

25%FINAL TAX

2. Par. B3- nonresident owner or lessor of vessels chartered by Philippine

nationals

Within Sec. 28B(3)-GROSS RENTALS, LEASE OR CHARTER FEES. Henc e, NO

deductions or exemptions can be claimed.

4.5%FINAL TAX

3. Par. B4-nonresident

owner or lesser of aircraft machineries and other equipment

Within Sec.28B(4) GROSS

RENTALS, CHARTER FEES AND OTHER FEES. Hence, NO deductions or exemptions can be

claimed.

7.5%FINAL TAX

SPECIFIC RULES:

NRA-ETB vs. NRA-NETB:

NRA-ETB NRA-NETB

As to the tax base Taxed on the basis of the his Taxed on the basis of his gross



taxable net income income

As to the right to claim deduction

As to the filling of the ITR

Can claim deductions

Required

Not allowed

Not required to fi le since he is subjected to final tax see Sec. 51-

A2© in relation to Sec.25B, C, D, and E

Q: When is a corporation considered as “doing business”

In Mentinolalum vs. Mangiliman, the SC said that it implies continuity of commercial transactions. It was

called in BOAC vs. CIR Doing business engaging in business, conducting business must imply continuity of commercial transactions. There’s OCT (Original Certificate of Title, hehehehehe)

o O- the activity is done in connection with it’s ordinary business in the Philippines

o C- there is a CONTINUITY of commercial transactions or dealings.

o T- trade or business

It must engaged in a business here in the Philippines it must be an ordinary one; and there must be continuity of the same.

In the case of ______ vs. CA it is intention to engage in a continued business in the Philippines. It is not the number it is not the frequency, but the intention to engage in a continued business in the Philippines, that determines whether the corporation is doing or engaging business.

If the corporation is not doing the business the tax effect is that it cannot claim any deductions because the tax base is Gross income.

In the case of individual it is easy because R is fixed, it says more than 180 days. But in the case of a corporation, the SC said that it depends upon the peculiar circumstances of the case. But in one case, the

SC said that it is really the intention to engage in a continued business.

RFC vs. NRFC:

RFC NRFC

As to the tax base Taxed on the basis of his taxable or net income

Taxed on the basis of his gross income

As to the right to claim deductions Can claim deductions Not allowed

As to the filling of the ITR Required to fi le it’s ITR Not required to fi le since it is subjected to final tax- see Sec52A in

relation to Sec.28B1, 2, 3, and 4

III. GROSS INCOME:

Sec.32 A must be memorized. There are 13 items here

Keywords: PBC PRP WPD PARI

o PBC- PROVINCIAL BOARD OF CANVASSERS



o PRP- PEOPLES REFORM PARTY

o WPD- POLICE

o PARI- PRIEST

Sec.32A-Except when otherwise provided GI means all income derived from whatever source including but not l imited to the following items:

-------------------Page 18: MISSING

Requisites for deductibility

a. It is a payment for services rendered

b. It must arise from EE-ER relationship

c. It must be reasonable, meaning that it represents the fair value of the services rendered.

o Example: ER pays 30,000for the services rendered by his secretary. Assume that of the 30000 only 20,000 represents the FV of the services rendered. The 10,000 is a manifestation of the love and affection of the ER to his EE being his sexytary. Q: how much can be deduc ted on the part of the ER?

o Apply the rule under Sec.34A (a)(1). It must be reasonable. It is very clear 20,000 can be claimed as a deduction as it is the only amount that represents the FV of the service rendered.

o Q: how much can be taxed as income on the part of the EE?

To the employee, the entire 30,000 is taxable:

20,000- Taxable as part of the compensation income

10,000- Sec.32 A taxable as it is considered as derived from whatever source.

So it forms part of the gross income.

o Life Insurance Premium

o As to taxability or nontaxability – Consider Sec. 32A(1) that is in whatever form paid. This may be taxed as compensation income because the premium is maintained by the employer under EE-ER

relationship. Also under Sec. 33 B(10) one of the taxable fringe benefit applies to insurance premiums. Here, it is subject to final tax.

o When you speak of taxability, that is the implication as far as the EE is concerned.

o As to deductibility ( it is far as the ER is concerned) Considered Sec.34 A (1) (a,1) this is the basis for that. It says “xxx is reasonable payment salaries, wages and other form of compensation for personal services rendered.” Life insurance premium is one of the other forms of compensation.

o Sec.36A (4) says that this life insurance premium is nondeductible. So, let us summarize 4

provisions in the tax code relative to this Life insurance premium. You will see how technical the rules are. That is, you really have to group related provisions that apply to this item.

o Beneficiaries that may be designated:

The heirs, family, executor or administrator of the estate

Employer

o Implications

To the employer it may be treated as an expense and the employee as income

o Q: as to assumption that the beneficiary is the heirs, family, executor or administrator of the estate: Can the employer claim deductions?



Under Sec.34 A(1) (a,1) the provisions say “other forms of compensation for personal services rendered”. So this includes life insurance premium paid by the employer under

ER-EE relationship. So, Yes!

Is the amount taxable to the employee?

Quality: bear in mind that there is a now rule- Sec. 33 8 (10) So,

It is taxable FB and therefore subject to Final tax if the insured employee is a supervisor or managerial EE.

If the insured EE is a rank and file EE that the time to apply Sec32A(1) when it says “in whatever form paid”. So, that may include life insurance premium. The employee here must be rank and file.

o Simoly but it is taxable to the employed but you should qualify:

It is subject to FT (Sec.33B(10)) if the insured EE is a supervisor or manager a nd

It is subject to compensation income subject to 5-32% progressive rate if the EE

is a rank and file.

o As to second the assumption that the employer is the beneficiary: can the employer claim it is a

deductible expense?

No, Why? Because upon the death of the EE the proceeds will go to the ER being the beneficiary. Shall we allow him to deduct the premiums paid? No because it is just a mere return of capital (of the proceeds paid by him) That’s the reason why in Sec.36A(4)

whether the EE is directly or indi rectly designated as beneficiary. Sec36 A(4)says. NONDEDUCTIBLE.

Is the amount taxable to the employee? This is not taxable to the employee for simple reason that his family will receive no benefit his estate will receive no benefit. The

proceeds will go to the employer if there’s no benefit received there’s nothing to tax. There’s no basis for imposing the same.

Summary of the tax treatment on the life insurance premium:

BENEFICIARY EMPLOYER EMPLOYEE

QUALIFY: If this employee is a:

The heirs family, executor of administrator of the estate.

The ER can deduct the amount of the premiums paid as a form of

business expense. –Sec34A(1)

a. Managerial or supervisor EE- if its subject to FINAL TAX (fringe benefit)

b.Rank-and-fileEE- it sis considered a COMPENSATION INCOME and is therefore subject to progressive

rate. 5-32%

Employer The ER cannot claim it is deductions or expenses because the Insurance

proceeds are but a mere return of capital. (Sec.36A((4))

NOT TAXABLE – since there was no benefit received by the EE or his

family.

TAX IMPLICATION OF CANCELLATION, CONDONATION OR FORGIVENESS OF INDEBTEDNESS:

Common sense



o This is a favorite bar Q. on forms of Compensation Income. If you try to read Secs. 32 -83, you’ll find no specific tax rules on this.

o The amount condoned may be considered as compensation income or a donation or a capital transaction depending on the circumstances of the case.

o Sec 32A says compensation in whatever form paid. We have already discussed one that is that life insurance premiums. The next i s cancellation or forgiveness of indebtedness.

TAX EFFECTS/ IMPLICATIONS/ INCIDENCES:

o Considered as compensation income of the EE/ Deductible to the ER:

Requisites

The cancellation or forgiveness must be in consideration based on account of

services rendered;

The creditor must be the ER, the debtor must be the EE;

The ER condoned or canceled the debt of the EE in consideration of the

services rendered

Effects if these requisites are present:

To the ER-creditor that may be claimed as a deductible expense because this is

really a form of compensation for services rendered (Sec34A(1)

To the EE-debtor it is a compensation income taxable (sec32A(1) in whatever

form paid.

As a taxable donation:

o If no consideration was given the obligation was simply condoned renounced by the creditor employer then that may account to a taxable donation. There is a donation in accordance with

Art 1270 of NCC: it says “if its is gratuitious in character, it shall be governed by the rules on donation. Also, under Rev.Reg.2- R says “if the cancellation or forgiveness was made w/o any consideration that may amount to donation.

o Effects:

If there’s a donation, the creditor becomes the donor. The debtor become sthe donee or the recipient of the literally

The creditor-donor is subject to donor’s tax

The deptor-doner is no longer subject to donee’s or inheritance tax as the same was abolished by PD 69 on Nov. 24, 1972

It is not also subject to income tax because Sec32B(3) says that donation/ gifts shall be excluded from gross income. So the debtor-donee is neither subject to donee’s or

income tax.

o 1997 Bar- an insolvent company has an outstanding obligation to its creditor for 100,000. Since the debtor could not pay its obligation, the creditor agreed to accept through dacion en pago document property valued at p30,000. Q1: what is the tax effect on the discharge of the unpaid

balance on the debtor-corporation? Explain.

The unpaid balance discharge here is 70,000 and the transaction referred to in the Q is the condonation of the unpaid balance.

The creditor having resolved no consideration as regards the 70,000 unpaid balance is liable to pay donor’s tax as the transaction given rise to a donation. The debtor becomes



the done the recipient of the liberality. He is not subject to donee’s tax as donee’s tax was abolished by PD 69. Neither is he subject to income tax, as a donation under

Sec32B(3) is excluded from gross income.

Q2 in so far as the creditor is concerned tax-wise, how is it affected as a result of that transaction?

The creditor becomes the donor-The one who canceled or renounced the obligation

without receiving any consideration. As donor, he is subject to donor’s tax.

The other tax implication is declared by Rev.Reg#2 Sec. 50 that may amount to capital transactions. This may take the form of INDIRECT DISTRIBUTION of dividends by a corporation. Hence, the creditor here must a corporation and the debtor must be a stockholder. That must be

the situation.

o Under Sec43 of the corporation code (provision on declared dividends) dividends that may be declared may be in the form of cash, property, steel, liquidaled, script and

indirect dividends.

o Indirect dividends may arise when a corporation condoned or canceled the obligation of the stockholder.

o This is a form of a indirect dividends in the sense that it is made through the cancellation

or forgiveness of stockholder’s obligations.

o On the part of the stockholder, much amount condoned or canceled is a taxable income subject to 10%FT

o On the part of the corporation, this is considered as i nterest on capital

o Is this interest deductible? 1999 Bar 14 Q on wheather or not this interest is deductibleor not?

o De Leon is on the opinion that it depends upon the circumstances. He is of the view that

if the declaration of the dividends is dependent upon surplus profits there is no obligation to speak of, so it is not a deductible interest. On the other hand,if the declaration is not dependent upon surplus profits there is an obligation tos peak of, in case it is deductible interest.

o In our suggested answer in the 1999 bar, we did not qualify our answer because interest on preferred shares of stocks is considered as interest on capital. In your book, i did mention about this RMC 17-71, june 9, 1971 w/c differentiates the rule that interest on

capital and that may include interest on preferred shares of stock, is a non-deductible interest. So, we can apply this, that it may be treated as interest on capital. And it is now an absolute rule that interest on capital is 2 non-deductible interest. So, the corporation cannot claim this as a deductible interest. Since, it partakes the nature of dividend

through indirect and since dividend under the tax code if received by individual tax payer is subject to 10% 20% or 25% final tax depending on the kind of taxpayer receiving the same said indirect dividendsis therefore subject to the same rate if it is a dividend.

SUMMARY:

TAX IMPLICATION OR CONSEQUENCE OR INCIDENCE OR EFFECT OF CONDONATION



Rev.Rep2, sec50- must be made in corporation for services rendered on amount of an EE relationship

COMPENSATION INCOME DER is the creditor and the EE is the debtor

DER can be claim it as a deduction and the same is considered as a taxable compensation income on the

part of EE.

Article 1270 of the NCC- if the creditor condones the obligation of the debtor without rec eiving any

consideration. It is considered as a taxable donation because only the creditor’s liberality is the consideration involved.

TAXABLE DONATION Q: Does it mean that the donor and the donee will be

made to pay donor’s tax? A: NO. PD69 abolised donee’s and inheritance tax which became effective on Nov24, 1972

Q: is the amount donated/ condoned part of the donee gross income? A: NO Sec32B(3) provides that donations are excluded from GI.

When the debtor is the corporations and the creditor becomes a stockholder in exchange of the condonation of the debtor’s obligation.

CAPITAL TRANSACTION The amount condoned is subject to 10% FINAL TAX if

the corporation is DC.

The corporation(creditor) cannot claim the same as a

deducion. When corporation declare dividends. It can be considered as “interest on capital” Rev.Memo.Clrc 17-71 effective on July12, 1971 provides that interest

on capital-which includes stocks or dividend- are not deductible.

Favorite BAR Q” convenience of the employer rule o This is thejustification that may be used in quanting exemptions from income tax on

certain benefits that may be received under an ER-EE relationship. Housing privelege benefits

o You should consider the employee who may be recipient of this. o In Rev. Reg 3-98 there’s a provision on this and this applies to Managerial/Supervisory

Ees

o What are these housing benefits that are tax exempt and granted to the conveniece of the ER?

If the EE ia a renk and the fi le EE- the poverning rule is Rev. Administrative Meino Order(RAMO) 1-87



Before the amendment on some of the parts of Sec.33, it was RAMO 1-87 that applies to all employees.

In the light of the new provision code under Sec33 C (a new rule on fridge benefit) the rule under RAMO 1-87 has been modified. And this has been implemented by Rev.3-93.

Rev. Reg3-98 says, housing benefits that is exempt one that situated w/in the

business premises of the employer. The new rule included here is “including housing units that are situated w/in the 50 meter perimeter of the business odf the employer.RAMO 1-87 provides no provision to this effect. This Rev.Reg 3-98 will only apply to managerial employees.

So if the housing unit is outside the premises of the employer it may or may not be covered by the exemption. If it is within the 50 meter perimeter then covered bu the exemption otherwise it is not exempted.

2001 Bar house constructed w/in the premises of the employer and the employee is a manager. Yet to be asked (in the light of rev.Reg.3-98) Suppose the house is constructed outside?

Answer is YES, as long as it is within the 50m perimeter. If not no

longer covered by the exemption.

The trick of the Q is that, would your answer be the same if the

employee is a rank and file employee? Remember that rev.Reg.3-98) applies only to managerial/ supervisory employees.

As far as rank and file EE are concerned it is the rule: housing units

covered by the exemption are those situated within the business premises of the ER. RAMO 1-87 provides 2 conditions which are not

really found or covered by RR 3-98 o It must be situated w/in the business premises of the

employer.

o This must be given as condition of employment. If you read rev.Reg.3-98 1 imposes no condition. These requisites are

provided only in RAMO 1-87 and these requisits apply only to rank and file EE.

MEAL ALLOWANCE o Traditional rule is: as long as it is given within the business premises of the employer

and it is justified by the convenience of the employer, it is tax exempt.

o New rule: rev.Reg.10-2000 (Mcal allowance for overtime work) It says it is exempt provided that the meal allowance for overtime does not exceed 25% of the basic minumum wage and it applies only to managerial/supervisory employee because this is not provided under RAMO 1-87.

FRINGE BENEFIT (SEC33B) o BarQ watch out for this: compensation income (under Sec32A) (1))) vs. Fringe benefit

(Sec33) what are the notable distinctions between the two? The common features of these 2 is that both must be given under the ER-EE

relationship. Distinction:

As to the tax rate-compensation income is subject to FT

Whether to be reported as part of the gross income –compensation

income is to breported FB being subject to FT need not be reported as

part of the gross income. As to the tax withheld- compensation income is subject to creditable

withholding tax. FB is subject to FT.



o Define: Fringe benefit (FB) Sec 33 has 3 parographer: put A(imposition of tax rates) is the most difficult one (this is onlu proper for CPA board exam) you will not be asked to

compute but you might be asked to enumerate those tax exempt FB. In Par.A you must note that the tax base is the grossed-up monetary value: the

tax rule is a FT (32,25 or 15%) Multiply the 2 and the result would be the FB tax. o 2000Q#3: who is really obliged to pay FB tax?

It is the employer (Rev.Reg3-90) Sec.2.33(2) o Fringe benefit

May be in cash or in kind; it may be goods, services or other benefits. The giver/source must be yhe employer. So, the benefits are given under an ER-

EE ralationship. Recipient must be a managerial or supervisory employee

o Q: Suppose the recipient a rank and file employee?

There’s an author who is in the view that the benefits received by the rank and file employee is exempt from the income tax. Do not allow this.

Under Sec.33C it states the following FB are exempt from the tax imposed therein (1,2,3& 4) and the tax imposed on taxable FB is a FT.

The correct interpretation of this is that FB given to rank and file employee are not subject to FB Tax which is a final tax. But it does not mean that it is also exempt from the income tax. That can still be taxed as part of the gross

compensation income. The FB should be reported as part of the GROSS COMPENSATION INCOME.

Example: A mangerial employee’s basic salary is 75000/month. He received housing benefit the monetary value of which is 25000/month. How do we tax

this 75000 representing basic salary? Do not confused. It does no mean that all benefits/salaries received by

the managerial EE are subject to FT excluded from the imposition of FBT is the basic salary odf the managerial EE.

If you read Sec33B, it is not clear on this. But rev.Reg3-98 clarifies it says other

than basic salary. This is because basic salary is taxed as compensation income subject to 5-32%. It is only the housing benefit that is subject to FBT.

Take note of this because the Q may be framed like this: are ali salaries &wages

received by the managerial EE subject to FBT? No, you should exclude the basic salary because it is subject to 5-32% progressive rate.

o Taxable Fringe Benefit Sec33B

Means any good, servies and other benefit Lumished or granted by the employer In cash or in kind, given in addition on the basic salary Of an individual employer, except rank and file such as but not l imited to the

following: Keywords: HEV HIM HEEL

o Housing o Expense account

o Vehicle of any kkind o Household personal -maid, yaya,driver o Interest on loan at less than market rate 12% benchmark rate

to the extent of the difference between the market rate and

actual rate granted. o Membership fees, dues and other expenses berne by the

employer for the employee in social and athletic clubs or other similar organizations.



o Holiday and vacation expenses o Expenses for foreign travel

o Educational assistance to the EE or his dependents o Life or health insurance and other ren-life insurance

premiums or similar amounts in excess of the law allows. Item #5: the Actual rate of interest must be less than the market rate, according to rev.Reg.3 -98

market rate refers to 12% benchmark rate. o If the actual rate of interest is not less than 12% or 12% or more than 12% then theres

no more taxable FB. o Example: loan amounting to 300000 granted to managerial employee. Situation that

may arise. If the actual rate is 14%-then it does not result to taxable interest benefit Employer imposed 12%- sell it does not result to taxable interest benefit

0%-then it is taxable interest benefit 0%-also taxable interest benefit

o Rationale: rate is pag at 12%. So, it is possible that the employer will secure loan from other sources and he may only be made to pay the legal interest rate. By lowering the

rate to less than 12%theres that benefit that will accrue to the employee. SUMMARY OF LEGAL PROVISIONS OF TAX EXEMPT FB:

Under rev.Reg.3-98 3 tax exempt housing benefits 2 tax exempt educational benefit 3 tax exempt life insurance premium RAMO 1-87 1 tax exempt benefit (expenses for foreign travel)

SEC33C 4 not taxable FB

SEC.33b TAXABLE FB EXEMPTIONS, if any under ER 3-98

1. Military Housing

2. Temporary Housing Unit *(3 months or less stay in the

premises)

H-1 HOUSING 3.Business premises of the ER including housing unit within 50 meters from the perimeter of the business premise.

KEYWORD: M T B

E-2 EXPENSE ACCOUNT

V-3 VEHICLE OF ANY KIND Helicopters or aircrafts are exempled because they are

considered as business expenses of the employer.

H-4 HOUSEHOLD PERSONNEL

If the actual interest imposed is LESS THAN 12% the same is taxable. If it is exactly more than

12%. It is tax exempt.

Ex: loan of P500000 extended to



managerial employee at the rate of: a. 14%- not taxable b.12%-not taxable

c.6%-taxable d.0%-taxable

Reason: lowering of interest rate on loan gives benefit to the

employee (they get to save). So if the actual rate is less than 12%, the FB will be taxable to be extent of the difference between

the market rate and the actual rate.

A1-6 MEMBERSHIP BENEFIT

H-7 HOLIDAY AND VACATION EXPENSES

EXEMPT IF:

1. required by the nature of the employer’s trade, business or exercised professions.

E-6 EXPENSES FOR FOREIGN TRAVEL 2. paid or incurred in connection with the business conventions, migs or seminars, abroad;

3. All expenses are substantiated by receipts or documents.

4.There must be an official communication coming

from the business associates abroad:

Tax treatment of the cost of he airline Economy class: Exempt Business class: Exempt 1 class tickets-are exempled only up to 70%

5. Allowance exempt only up to 530000

EXEMPT IN 2 CASES

E-8 EDUCATIONAL BENEFIT-for the employee or

his dependent

1. scholarship grant in managerial or supervisory

employees-there must be a written agreement that the employee shall remain in the employ of the employer for a certain period of time and such a scholarship is required by the nature of the

employer’s business.

2. Scholarship grant to the dependents of an employee- the dependent must have passed the competitive exam conducted by the employer.

L-10 LIFE OR NON-LIFE INSURANCE PREMIUMS 3 Tax Exempt life insurance premiums: a. LIFE INSURANE PREMIUM ON GSIS



Sec 33 C-Fringe Benifits Not Taxables 1. Fringe Benefits which are authorized are exempted from under special laws;

2. Contributions of the employer for the benifit of the employee to retirement insurance and hospitalization benefit plans: 3. benifits given to the rack and file EE, whether granted urder a collective bargaining agreement or not and 4.De minimis benefits

The rec ent regulations is Rev. Reg 10-2009 These refers to facilities or privileges furnished by the employer to his employee that

Are of relatively small value and are offered or furnished by the employer merely as a means of promoting HEALTH, GOOD WILL, CONTENTMENT OR EFFICIENCY of his employees.

Des

TAX EXEMPT DE MINIMIS BENEFIT

REVENUE REGULATIONS 10-2000

MONETIZED VALUE OF UNUSED BENEFITS QUALIFY:

PRIVATE EMPLOYEES

Vacation leave- exempt up to 10 days

Sick Leave- always taxable

GOVERNMENT EMPLOYEES

VL and SL are always taxable regardless of the number of days

MEDICAL CASH BENEFIT OR ALLOWANCE GIVEN TO THE DEPENDENTS OF THE EMPLOYEE

P 125.00 per month or P725 per semester

RICE SUBSIDY P1000.00 per month or 1 sack of 50 kg per month- not more than P1,000

UNIFORM AND CLOTHING ALLOWANCE NOT to exceed P3,000 per annum

MEDICAL BENEFIT GRANTED TO EMPLOYEES NOT to exceed P10,000 per annum

LAUNDRY ALLOWANCE NOT to exceed P300.00 per month

EMPLOYEE’S ACHIEVEMANT AWARD ON ACCOUNT OF LENGTH OF SERVICE

Must be in the form of TANGIBLE PERSONAL PROPOERTY other than cash or gift certificates, NOT to exceed P10,000

GIFTS OR DONATIONS DURING XMAS AND MAJOR

ANNIVERSARY CELEBRATION

NOT to exceed P5,000.00 per employee per annum

With respect to Christmas Bonus, add 13th

month bonus to the Xmas bonus- the same must not exceed P30,000.00

B. LIFE INSURANE PREMIUM ON SSS D. LIFE INSURANE PREMIUM ON GROUP INSURANCE POLICY



FLOWERS, FRUITS, BOOKS AND SIMILAR ITEMS OF RELATIVELY SMALL VALUE

Reasonable value- depending on the ER’s capacity

MEAL ALLOWANCE FOR OVERTIME WORK NOT exceeding 25% of the Ee’s basic minimum wage- managerial and supervisory employees

Item No. 2- INCOME FROM BUSINESS OR TRADE OR EXERCISE OF PROFESSION

INCOME COVERED INCOME DERIVED FROM SELF- EMPLOYED FROM TRADE OR BUSINESS(TRADING, MANUFACTURING, MERCHANDISING, FARMING AND OTHERS) SELF- EMPLOYMENT INCOME (SEC 74) consists of earnings derived by the individual from:

From the practice of profession Conduct of trade or business carried on by him as a sole proprietor A partnership of which he is a member

SELF- EMPLOYED- a person engaged in trade or business or performs services for others for a fee and who derived personal income from such trade or business or from the performance of such services. INCOME DERIVED FROM PROFESSIONALS FROM THE PRACTICE OF PROFESSIONS

PROFESSIONALS- persons who derive their income from the practice of their profession- lawyers and other persons registered with the PRO. It may also refer to one who pursues an art and makes a living there from such as artists, athletes and others who are similarly situated.

NOTE: It is not material whether they have a business license or whether they are registered or if they are self- declared (so si MangKepweng taxable- joke ni Japs)

BUSINESS INCOME:

FORMULA OF GROSS INCOME

GROSS SALES 1,000,00.00

LESS: COST OF INVESTMENT

Cost of sale

Cost of goods

Sales allowance

Sales discount

530,000.00

GROSS BUSINEE INCOME 470,000.00

BUSINESS includes: one, which entails time, effort, and activity for purposes for purposes of LIVELIHOOD and

PROFIT

Q: Is income for “illegal business” taxable?

A: YES. It falls under the phrase “income from whatever source”- Section 32A

Q: Are expenses from illegal business deductible?

A: NO. By express provision of law, only legitimate expenses are deductible



Q: Suppose a Corporation A gave P100,000.00 to a customs official to process their license. Is the P100,000 taxable as income? May the Corporation deduct the same as business expense?

A: The P100,000.00 is taxable and should be included in the gross income of the customs official since it is income from whatever source. However, the same is not deductible since unlawful or illegitimate expenses are not deductible items form gross income (Sec. 34A)

Item No. 3- PROPERTY INCOME- GAINS DERIVED FROM DEALINGS IN PROPERTY:

You should know the provisions that amplify this. There are 2 provisions: Sec 39- there are 4 sets of rules that will apply to Gain from dealing in property Sec 40- there are also 4 sets of rules that will apply to Gain from dealings in property

So, in all there are 8 rules that apply to Gains from Dealing in Property or property income

Favorite Bar Q: Sec 39A (1)- Ordinary Asset vs. Capital Asset Q not yet asked: What is ordinary loss; Distinguish ordinary gain from ordinary loss Classification of Assets (Sec 39A (1) Ordinary Asset- defined by way of enumeration. There are four categories of Ordinary Asset (SOUR)

Capital Asset- defined by way of exclusion. Meaning, other than ordinary assets. What is not included in SOUR is considered as capital asset.

S-O-U-R

STOCK IN TRADE SUCH AS INVENTORIABLE ASSET. These are really assets that remain in the inventory of the taxpayer at the end of the taxable year. This includes raw materials, work- in process and finished goods. ORDINARY COURSE OF BUSINESS AND TRADE. So property primarily held for sale to customers may be

ordinary if it is held in the ordinary course of business or trade Example: A real estate dealer sold real properties. Such real properties being held in the ordinary course of trade or business is an ordinary asset. The gain derived from such sale is treated as Ordinary Income. Example- sale of land in a real property development business.

USED IN BUSINESS. Property used in business subject to depreciation. These are really depreciable assets. If these assets are not used in the trade or business, they are capital assets, and therefore the gains from such sale of assets are treated as Capital Income. Example Furniture and Fixture, Machineries Equipment-

these are really subject to depreciation, but these must be used in trade or business; otherwise, it would be classified as capital asset. REAL PROPERTY USED IN TRADE OR BUSINESS SUCH AS PARCELS OF LAND, MACHINERIES AND BUILDINGS. If these are not used in trade or business, then they are considered as Capital Assets. Real properties not

use in trade or business include residential house and lot. WHAT IS NOT INCLUDED IN THIS ENUMERATION IS AUTOMATICALLY CONSIDERED AS CAPITAL ASSET

Q: Are all properties used in trade or business by the taxpayer considered as ordinary assets?

No. Not all properties used in trade or business are considered as ordinary asset because they are only limited to SOUR. Assets which may be held in connection with the business but not included in SOUR may be considered as Capital Asset.

Examples: Accounts Receivable – these are held by the taxpayer in connection with the business. But since it is not included in the SOUR, the gain derived from sale of A/R is considered as Capital Income.

Investments in Stocks Sale of Goodwill – Goodwill may be sold and the gain from the sale of goodwill is a capital income.



You will note that in the provision, the definition of Capital Asset includes properties whether or not held by the taxpayer in connection with the trade or business. So, you cannot apply the business test because these are really

properties are held in connection with the business of the taxpayer and yet considered as capital asset. So capital assets cover not only properties not used in trade or business. It may also include properties used or hel d by the taxpayer in connection with his business. This is true in the case of A/R Investment in stocks & Goodwill.

But the definition of Ordinary Asset may refer only to properties used in trade or business. So it is safe to say that

Ordinary assets are limited only to those used in connection with his trade or business and capital assets may include all properties not used in trade or business including those assets which may be used in trade or business.

2003 Bar Distinguish Ordinary Asset from Capital Asset

Answer: In ordinary asset, you cannot use the word “includes” because that is not only really accurate.

The word “includes” may be used only in defining capital asset because the enumeration of Ordinary Assets is exclusive. So, you will sat that “Ordi nary asset may refer or is just limited to the following items: SOUR

On the other hand, Capital Asset (You can now use the word include) includes properties whether or not connected in trade or business, except or other than SOUR, because capital asset is defined by way of exclusion. So, you have to exclude SOUR.

Ordinary Asset Capital Asset

Refers to and is limited to the following

assets: Stocks in trade or business, properties in Ordinary course of business, those used in business and Real property used in trade or business

Includes property whether or not

connected with the trade or business of the TP other than Stocks in trade or business, those used in business and real property used in trade or business.

Q: Distinguish Ordinary Gain from Capital Gain Answer. Ordinary gain refers to the gain derived from the sale or exchange of ordinary asset whereas capital gain may include gain derived from the sale or exchange of capital assets. To elaborate on this, you may define it in this way: Ordinary gain is a gain derived from the sale or exchange of an asset such as

SOUR whereas capital gains refer to the sale or exchange of an asset whether or not used in trade or business except that of gain derived from the sale or exchange of the following asset: SOUR.

Ordinary Gain Capital Gain

Gain derived from the sale or exchange of ordinary assets such as stocks in trade or business, properties

in ordinary course of business those used in business and Rizal property used in trade or business.

Gain derived from the sale or exchange of capital assets or property whether or not connected with the

trade or business of the TP other than stocks in trade or business, properties in Ordinary course of business, those

used in business and real property used in trade or business

Q: Define Ordinary Income: Refer to Section 22(2).

The term “ordinary income” includes any gain from the sale or exchange of an ordinary asset. So, it made mention

of Section 39 A (1). Ordinary income is not only limited to that gain derived from the sale or exchange of an asset. Remember that there may be other business that may be the source of this ordinary income. But if the only source of income is sale or exchange of ordinary asset, that definition may be considered as is really defined i n that limited sense. Hence, you can use the word “includes” because there are other sources of this income.

Q: Define Ordinary Loss



This is a loss that may arise or may be sustained from the sale or exchange of an asset that is SOUR.

Q: Distinguish Ordinary Income from Ordinary Loss

Ordinary loss refers to that income that may be derived from the sale of an asset SOUR. On the other hand, ordinary loss is one that may be incurred from the sale or exchange of an asset considered SOUR.

ORDINARY INCOME

Includes the gain derived from the sale or exchange of ordinary asset

ORDINARY LOSS

Loss which may be sustained from the sale or exchange of an ordinary asset

Q: Capital Gain v. Capital Loss

Capital gain may include gain derived from the said or exchange of a n asset whether or not connected in trade or business except SOUR. On the other hand, Capital Loss is one that may be incurred from the sale or exchange of an asset whether or not used in the ordinary trade or business except SOUR.

CAPITAL GAIN

Includes gain derived from the sale or exchange of an asset, WON connected with trade or business, except SOUR

CAPITAL LOSS

Loss which may be sustained from the sale or exchange of an asset, WON connec ted with trade or business, except SOUR

Q: If an asset is considered ordinary, can it be converted to Capital Asset?

There’s really no rule that says Ordinary Asset is always an Ordinary Asset. There’s no rule to that effect because there are exceptional case that Ordinary Asset may become capital asset. Conversely , there’s no such rule that say that Capital Asset is always a Capital Asset. Capital asset, also under certain situation may be converted to Ordinary Asset.

TWO IMPORTANT CASES: SC laid down the criteria/ test on when ordinary asset may become Capital Ass et and vice- versa

TUASON VS. LINGAT, JR. 58 SCRA 170 – In this case, the SC mentioned 7 circumstances that may convert a Capital

Asset to Ordinary Asset

Area of the property Whether the property or land is divided into lots The improvements introduced must be valuable

Whether the lots are for sale If for sale, if they are for sale on If a broker was employed to manage or administer the sale

If the seller is engaged in the real estate business

All of these circumstances were present in this case. It turned out that the seller was really in the real

estate business; the property (78 h) was originally classified as Capital asset; it was subdivided into lots; improved; sold in installment; and the seller derived substantial income from such sale

Q: What is the really the importance in knowing whether the asset is OA or a CA?

o Bear in mind that capital transaction is accorded preferential tax treatment. Under Sec. 39 B, this holding period rule which reduces the taxable capital gains by 50% only applies to capital transactions. This is a form of tax avoidance. If you sell a capital asset, try to recall this provision. Don’t’ sell it within the 12 month period because if the sale is within that 12 month period, the

gain is 100% taxable. The tax avoidance scheme is that you sell after the lapse of the said holding period because the gain is taxable only up to 50%. You cannot apply this rule to sale of OA. This is



what the taxpayer is alleging in this case, that the asset is a CA so as to avail of the reduced tax rate.

o OA Converted to CA: Situation: A real estate dealer, business is buying and selling of real property. So this is

considered as OA. When will this OA become CA? What happened? The real estate dealer died. Upon the death, this property is transmitted to th e heirs

under the law on Succession. The heirs now are in possession of the property. Answer: It really depends upon the circumstances:

o If the heirs will continue the business, these properties will remain as OA.

o If the heirs will not continue the business , then these properties will

now converted to CA, so that if the heirs sell these properties, the gain is considered as Capital Gain.

Calasanzvs CIR 144 SCRA 664: In this case, the SC cited the circumstance “substantial or extensive improvements”.

How do you improve a parcel of land? You subdivide it; construction of concrete gutters (?) mapping, installation of lighting systems and drainage facilities. These are substantial improvements according to the SC. The SC in this case mentioned that it may become an Ordinary asset if the cost of the improvement is twice the cost of the property. In this case, the cost of property is 4,742.65: the cost of the improvement is 170,028.60, more than twice

the cost of the property.

There is really no fixed rule or formula that will determine whether an OA will be converted to CA or vice versa. Consider these circumstances. There are really the criteria or tests.

3 Rules that apply only to Capital Transactions: (Sec. 39 B, C, D)

Holding Period Rule (Sec. 39 B) Capital loss limitation (Sec 39 C) NELCO – Net Capital Loss Carry Over (Sec. 39 D)

2001 Bar-Q on the Distinction between NELCO (Sec. 39 D) and NOLCO (Sec. 34 D(3))

NELCO – Net Capital Loss Carry Over

NOLCO – Net Operating Loss Carry Over

3 Notable Distinctions

a. NELCO arises from capital transactions (meaning, involving capital assets): NOLCO arises from Ordinary transaction (may involve ordinary asset)

b. Sec. 39 B Categorically says “other than corporate”, so NELCO can only be availed of by individual

taxpayer. Under NOLCO (Sec 34 D(3)), there’s no similar provision Sec 34 D(3) admits of no distinction, so individual and corporate taxpayer may avail of this NOLCO.

c. NELCO may be carried over only in the next succeeding taxable year. On the other hand, NOLCO allows carry over only in the next succeeding taxable years or in the case of mining companies, 5

years.

If you will be asked, define tax avoidance? Distinguish the same from tax evasion 1996 Bar there’s a follow up Q. Give examples of tax avoidance. You can cite these as examples.

Holding period rule – this implies that the asset sold has been held by the taxpayer for a period of more

than 12 months; if the sale took place after the lapse of the said 12-month period then the gain is taxable only up to 50%

Will this rule apply to Ordinary Assets?

No the gain from the sale of OA is always 100% taxable. The gain derived from the sale of OA is 100% taxable. Immaterial of the holding period. This 50% can only be availed by individual taxpayer.



Q: An individual taxpayer, MR. A, sold his property considered as OA. He derived a gain amounting o 150,000. The property has been held for 2 year from the date of purchase.

Q#1: what is the tax treatment on the 150,000 capital gain?

Only 50% (70,000) is taxable

Q#2: What if the seller is a corporation?

The whole amount (150,000) is taxable. Sec. 39B says that “other than corporate taxpayers”, that

means that 100% taxable if capital gains is derived by corporate TP.

Capital Loss is deductible to the extent of Capital Grain

This means that you can only deduct capital loss from capital loss from capital gain. If there’s no capital gain, no deduction is allowed. The deductibility of capital loss is dependent upon the existence of capital gain.

Since you can only deduct capital l oss capital gain, then you cannot deduct capital loss from ordinary gain to allow such is to violate this rule (Sec 3 C)

2003 Bar the rationale behind the prohibition that capital loss cannot be deducted from Ordinary Gain

Answer: Under Sec. 34, there’s a rule on matching cost against revenue. This principle states that “Only ordinary

and necessary expenses (business connected expenses) are deductible from Gross income or Ordinary Income. These non-business connected expenses cannot be considered as deducti ble items. Capital loss is non-business connected expenses as it arises or can be sustained only from capital transactions. If we allow capital loss as a deduction from ordinary income, it will violate this rule that only ordinary and necessary expenses ar e deductible

from Gross income as required by the Principle of Matching cost against revenues.

SUMMARY:

CAPITAL TRANSACTIONS – 3 Special Rules

Sec. 39 B, C and D

TAXABLE CAPITAL GAINS:

RULE 1:

HOLDING PERIOD RULE – Sec. 39B

Applies only to INDIVIDUAL TP 100% subject to tax if capital asset sold after being held by the TP for a period of not more than

12 months. 50% If holding period is more than 12 months

NOTE: Gain from ORDINARY ASSETS is always taxable regardless of the holding period Ex. Individual TP sold a car which is not used in business for P100,000

Tax treatment o If the car was NOT held more than 12 months the whole of P100k is taxable. o If the car was held over 12 months, only P50k is taxable.

RULE 2:

CAPITAL & LOSS LIMITATION – Sec. 39C

- Applies to INDIVIDUAL and CORPORATE taxpayers except, in the latter’s case. – banks and trust companies

RULES:

Ordinary loss is deductible to the extent of ordinary gain

Capital loss is deductible from capital gain

Capital loss IS NOT deductible from ordinary gain



Q: Reason why capital loss is NOT deductible from ordinary gain?

A: Sec. 34 (Allowable Deductions) follow the principle of matching of cost against revenue. Only

ordinary and necessary expenses are deductible from ordinary income. Capital loss is a non -business loss; if we deduct it from ordinary income then it would be violative of the principle.

Q: Can you deduct ordinary loss from capital gain?

A: YES, the NIRC provides no prohibition against it.

When capital loss is more than capital gain:

Capital gain P50,000.00

Capital loss P100,000.00

Net capital loss P50,000.00 – may be carried over to the succeeding taxable year BUT the loss must not be more

than the net income for the year it was incurred.

RULE 3 : NET CAPITAL LOSS CARRY OVER – Sec. 39 D

Applies only to INDIVIDUAL TP

GR: Expenses which includes losses may not be carried to the succeeding taxable year.

XPN: NET CAPITAL LOSS CARRY OVER – such loss (in an amount not on excess of the net income of such year) shall be treated in the succeeding taxable year as a LOSS from sale or exchange of capital assets held for not more than 12 months

NET CAPITAL LOSS CARRY OVER (Sec. 39D) NET OPERATING LOSS CARRY OVER (Sec. 34D(3))

- Arises from capital transactions which necessarily

involves capital assets

- other than corporate TP – Henc e, available only to INDIVIDUAL TP

May be carried over to the succeeding taxable year

(1year only)

-Arises from ordinary transactions which necessarily

involves ordinary assets

- may be availed of by BOTH individual and corporate TP

-Allows carryover of operating loss for 3 succeeding years, 5 years for mining companies

Rules to be remembered:

1. It is settled that OL is deductible for OG 2. It is also allowed to deduct CL form CG (Sec. 39 C)

a. Justice Vitug asked this Q: Can you deduct OL from CG? i. His opinion is that the tax code provides no prohibition. The prohibition only applies to

the deductibility of CL from OG, as the rule says “CL is deductible only from CG”. But the

tax code, Justice Vitug emphasized, provides no prohibition in deducting OL from CG, therefore, it is allowed.

3. In the case of Capital Loss Limitation – it applies to both individual and corporate taxpayer, except trust companies and banking institutions

4. NELCO – this only applies to individual taxpayers. Sec. 39 B says: other than corporate taxpayer”. So corporate taxpayers are not allowed to carry over Net capital losses.

a. The term Net Capital Loss is defined in Sec. 39A (3). It says “it is the excess of Capital Losses over Capital Gains:. It means that Capital Loss is more than Capital Gain

i. Example CG- 150,000 CL – 200,000 It says there can only be Net Capital Loss if the CL is more than the CG. In this

case, therefore, Net Capital Loss is 50,000. This is one that may be carried over as a deduction in the CG of the succeeding taxable year.



b) Net Capital Gain- excess of the CG over the CL. Just the opposite of Net Capital Loss c) The general Rule is that expenses must be paid and be claimed in the year the same is paid or

incurred. You cannot as a rule, carry over an expense a. Exception: Sec. 34 – Net Operating Losses – these can be carried over as a deduction

from the GI in the next succeeding taxable year. Thus when we speak of Capital Transactions, this is the Exception, Sec. 39 (D) – Net capital Loss can be carried over as a

deduction from the CG in the succeeding taxable year.

SALE OF REAL PROPERTY CLASSIFIED AS CAPITAL ASSET:

Sec. 27 D (5): A final tax is hereby imposed on the gain presumed to have been realized on

the sale, exchange or disposition of lands and/or buildings which are not actually used in the

business of a corporation and are treated as capital assets based on the GROSS SELLING PRICE or FMV, whichever is higher, of such lands and/or buildings.

Sec. 24 D: X X X a final tax is nearby imposed upon capital gains presumed to have been

realized on the sale, exchange or disposition of real property located in the Philippines,

classified as capital assets including pacto de retro sales and other forms of conditional sales X X X

Favorite Bar Q: Sec. 24 D; compare thi s to 27 D (5)

o Sec. 24 D applies to individual taxpayer while Sec. 27 D (5) applies to Domestic Corporation

o It is 27 D (5) that is yet to be asked in the Bar. Sec. 24 D was asked 3x already o These 2 provisions pertain to sale, exchange or other disposition of Real property

classified as Capital Asset. This is the transaction contemplated therein. Try compare these 2. It will help you establish distinctions between these 2

The tax rate is the some – 6%. The tax base is likewise the same – it is the higher amount between the Gross Selling Price and Zonal Value.

These are the distinction:

A. As to the taxpayer – Sec. 24 D applies to individual taxpayers; Sec 27 D (5) applies to Domestic Corporation:

B. In 24 D. It says Real Property. However the Real Property in 27 D(5) covers only land and building. In 24 D, it says Real Property while in 27 D (5). It is very specific that it covers only land and building.

1. You must have learned in Civil law that under certain conditions, (Art. 415 (5)), machinery may be considered as R/P. But since 27 D (5) limits this to land and building, this machinery which may be considered under 24 D as R/P, may not

be covered. 2. You have to refer to the definition of R/P for purposes of R/p tax. We can adopt

Art 415(5) and this has been cited by the SC. In several cases, since there is really no clear definition of R/ under the Tax Code. By analogy, we can apply

the definition under the Civil Code; In fact under RA 7160 Sec. 99 (M). It incorporates Machinery.

C. Another point of distinction – in Sec. 24 D (2), there is a tax avoidance scheme, whereas Sec. 27 D (5) provides no tax avoidance scheme. In other words, Domestic corporations cannot legally avoid the

payment of Capital Gain Tax on the Sale of Real Property classified as Capital Asset involving land and building.

1. We have extensively discussed the meaning of Capital Assets [C/A]/ Take note

that this applies to R/P (Expressia Unius Est Exclusio Alterius), so this does not include those considered as Ordinary Assets Real Property used in trade or business. So here in Sec. 27 D (5). It must be land and building not used in the trade or business, that’s why t is considered as capital Asset.



2. Let us emphasize these additional requisites as provided for in RR 17-2003. This was mentioned in your book:

a. This is 6% Capital Gains Tax can be legally avoided if the following requisites are present:

i . The proceeds of the sale of Principal Residence must be applied either to construct or purchase new principal

residence. It is very clear in Sec. 24 D (2) that the same must involve Principal Residence. Principal residence may include also the land which it is built as clarified in Rev. Reg. 30-99)

1. The trick of the problem is that: Suppose what was

sold was not in the nature of Principal residence. Then this tax avoidance scheme will not apply. It must be a sale of Principal Residence. We may call it

“own principal residence”; then ii . Observe the 30 days day notice to the BIR. That means that

within 30 days from the date of sale, you should notify the BIR for their recognition of this tax avoidance scheme. The

“date of sale” as construed under Rev. Reg. 17-2003 refers to the date when the deed of sale was notarized – It is the date of the Notarization of the Deed or Sale;

iii . Comply with the 18-month period. How do you comply wi th this?

1. Within 16 months from the date of sale, the construction or purchase of this residence must be

made. So, the construction of new principal residence or the purchase of the new principal residence must be made within 18 months from the date of the sale was notarized.

iv. There’s another limitation, the 10 year period. This can be availed of only once every 10 years.

v. Under this Rev. Reg., the 6% capital Gains Tax must be

deposited under an escrow account with the authorized agent bank.

1. You must be familiar with the term escrow because it is in the Corporation Law-shares held in escrow.

2. Here, the purpose is to ensure compliance with the requisites. Under this escrow agreement, there are certain limitations set by the authorized revenue district officer to the effect that if the seller can

comply with these requisites, then the seller can ask for the withdrawal of the same.

3. After the execution of escrow agreement, it is

required under Reg. 17-2003 that the seller and the buyer should file joint tax return wi th respect to this 6% Capital Gains Tax so as to comply with the fi ling of the so called ITR of this 6% Capital Gains Tax

vi. There is another rule under RR 17-2003: within 30 days after the lapse of the 18

th month period, the seller should submit

documents showing that he has comply with these requisites.

That he used the proceeds to construct or purchase new principal residence. If there’s: no compliance from the lapse of the 18

th month period, RR 17-2003 says that “the seller is

considered as a delinquent taxpayer as far as non-compliance



of this provision is concerned”. And he can be charged with appropriate penalty. This is cited in your book, and the 30 day

period from the lapse of 10th

month period really applies to the submission of certain documents showing compliance to this regulation.

So, if this will be asked again, you should stain these new requisites and the execution of escrow

agreement among the buyer, seller, and RDO and authorized agent bank.

So far, we have mentioned 3 tax avoidance scheme:

a. mentioned that Sec 39B – the holding period rule – is really a tax avoidance scheme because it reduces your taxable gain by 50%, and the permissible method to reduce the same is to sell the Capital Asset after 12 months from the date of sale;

b. We also discussed Sec 40 C (2). What is that tax avoidance scheme or legally permissible means?

i. The exchange of properties, shares of stocks or securities

must be made in accordance with the plan of Merger or Consolidation (M or C)

c. And this is the third. If you want to avoid the effect of the 6% Capital Gains Tax, comply with the requisites laid down under Sec. 24 D(2)

D. Another distinction between Sec 24 D and Sec 27 D(5) is when the buyer is the Gov’t political subdivision of the state, agency, instrumentality or GOCC.

You will not note that under Sec. 24 D, the seller has the option. There’s that option granted by law for

the seller (that is, individual taxpayers only) either to avail of the 6% Capital Gains Tax or the progressive tax rate of 5-32& under Sec. 24A. It is unfortunate that the BIR has yet to issue a Regulation to this effect

in applying the 6% there’s no doubt that the basis is either the SP or Zonal Value, whichever is higher. The cost is nondeductible. If you apply Sec. 24A, you will note that the tax rates are higher and the very purpose here is for the seller to avail of the reduced rate. So, is the cost deductible under Sec. 24 A?

If you read Sec. 24A which provides progressive rates, the tax base is taxable income. So an opinion must

be expressed that since the purpose of the law is to make the seller to avail of the reduced tax rate, he must be entitled to deduct the cost.

On the other hand, under Sec. 2D (5), there’s no option given to Domestic Corporation if the buyer I the

Gov’t political subdivision of the state, agency, instrumentality or GOCC.

SUMMARY:

CAPITAL GAINS TAX – 6% FINAL TAX

Applicability Applies to real property classified as capital asset

Tax Base GSP or the Zonal value of the property, whichever is higher

BIR ruling includes: Exchange of property and other disposition such as:

Assignments of real rights over real property

Pacto de retro sale

Conditional sale subject to a suspensive condition

If the buyer is the GOVERNMENT – option of the seller to apply the tax rates under 6% capital gains tax as provided in Sec. 24D of the NIRC

NOT applicable to corporate TP

Avoidance of 6% CGT



In cases of sale or exchange of principal residential house of the individual TP – see the requirements for

the tax avoidance

INDIVIDUAL CORPORATION

CG tax OF 6% UNDER Sec. 24D CG Tax of 6% under Sec. 27A (5)

A TAX AVOIDANCE SCHEME for individual TP – sec. 24 D (2)

Corporate TP cannot avail of any tax avoidance scheme

Applicable to individual taxpayers Applicable only to Domestic Corporations

Applicable to all real property classified as capital asset Only to land and building

OPTION of the tax rate applicable in case the government is the buyer – 5-32% or CG tax of 6%

No such option available

PRESUMED GAIN:

There is a term you should rememb er under Sec. 24 D & Sec. 27 D (5). The word there is “presumed

gains”. The CG Tax of 6% shall be imposed on the presumed gains. 2001 Q: A doctor by profession acquired a parcel of land in 1990 for 1 Million. He sold the same in 2000 at

8-00,000. It would appear that he had incurred an actual loss in the amount of 200,000 because he received the SP amounting to 800,000 (the problem did not state the Zonal Value so, we considered this

as the basis) and he previously acquired it at 1 Million, so he incurred a n actual loss of 100,000. The doctor argued that he should not be made to pay the tax because he derived no gain, I fact he incurred a loss is the contention of the doctor/seller tenable?

o The problem may be answered by thee provisions: o NO. Because the cost is a nondeductible item. If you are an ordinary citizen/taxpayer, you will

surely argue that how can I be made to pay the tax if I derived no gain and more so I incurred a loss? Not all tax payers are award of this Sec.24 D which fixed the tax base at GSP or Zonal value,

whichever is higher. The cost is nondeductible. The contention of the doctor is not tenable because the basis of the 6% CG tax is the amount received (the GSP which is presumed in this problem to be higher than the Zonal Value), so the cos t is disregarded.

Q#1. Can a taxpayer-seller be made to pay tax even if he derived no gain, for instance:

GSP (higher than the Zonal Value) 800,000 Cost 800,000 Gain -0-

Answer: Even if he derived no gain, since the basis is the higher between the GSP and Zonal Value, he can be made to pay the 6% CG tax

Q#2. Is there a situation where in a seller can be made to pay a tax even if he incurred a loss from such

transaction? o YES. He really incurred an actual loss of 200,000 but he still required to pay the 6% CG tax

because the cost is not allowed to be deduc ted (Actual Bar Question in 2001) o Note under Sec. 24 D the meaning of “other dispositions”. Sec. 24 D says “ sale or exchange”

(sale is defined in Art. 1459 NCC, and the exchange or barter in Art. 1638), and then, :other

dispositions”. If you read the subsequent provision, this covers also conditional sale such as pacto de retro sale.

Q#3: Would your answer be the same if the seller is a Domestic Corporation?

o Recall Sec 27 D (5) – that’s the 6% CH tax. Sec. 28 A applies to RFC while Sec 28 B applies to NFRC



o So, there is really no provision mentioned about this 6% CG tax in Sec. 28 (A & B ), as this 6% CG Tax is a rule on corporate income tax that applies solely to Domestic Corporations

o This is a capital transaction which is not covered by the rules which we discussed under Sec 39 (B, C, D)

Q: What are the capital transactions not covered by the Rules under Sec. 39 B, C & D (Holding period,

Capital loss limitation & NELCO) o Answer:

Capital involving the sale of Real property (of course, this must be a Capital Asset): this is subject to 6% CG Tax based on the higher between the GSP and the Zonal Value. So, Sec 39 (B, C, ) does not apply to all capital transactions

Another can be found in 4 Sections (Secs. 24, 25, 27, & 28): this means that this is a rule

that applicable to both individual and corporate taxpayer. If you asked: Is there a common rule that can be applied to both individual and

corporate taxpayer? o YES. It is a capital gain (which is really a capital transaction) derived

from the sale of shares of stock NOT listed and traded through local stock exchange. THE TAX RATES ARE 5% * 10%

Net CG not exceeding 100,000 – 5% In excess of 100,000 – 10%

Q: Suppose the shares of stocks are listed and traded through the local stock exchange, will your answer

be the same? o The examiner should not ask this Q because this is excluded from the coverage as this ia really a

percentage tax. You can find in Title V Sec.127: IF the shares of stocks are listed and traded through LSE, the tax applicable is not an income tax (that’s why the examiner should not ask this

Q) but a percentage tax, 1/3 of 1% of the GSP. But you must still answer the same even if the examiner inadvertently overlooks the coverage as we will recommended that the Q be a bonus one.

o Thus, these are the 2 capital transactions not covered by the Rules under Sec 39 (B, C &D)

ITEM #4: INTEREST INCOME:

If a Q will be asked on Internet income, it would be on whether it is taxable or tax exempt

There are only 5 items under the tax code which are exempt from Income tax as far as interest income is

concerned: o Interest income from bank deposit:

The recipient must be any of the following tax exempt recipients: Foreign Government

Financial Institutions (FI) controlled or financed by foreign gov’t

Regional or Int’l FI established by foreign gov’t

o Interest income on loan extended by any of these 3 o Interest income on Bonds, Debentures and other certificate of Indebtedness received by any of

these of 3.

The first 3 you’ll find in Sec. 32 B (7.3) o This has been the subject of amendment by RA 8124. It is an interest income on bond deposit

maintained under the expanded foreign currency deposit system. The rule has been changed

Under the old tax code irrespective of the recipient of this recipient of thei deposit – TAX EXEMPT

Under the present tax code (as amended by RA 5424) – it is only tax exempt if the recipient is a NONRESIDENT taxpayer whether individual or corporate. Thus, if the

depositor (the recipient of this deposit maintained under the expanded foreign currency deposit system) is a resident taxpayer, it is subject to 7.5% FT.

Under the old tax code, tax exempt; Now, 7 .5%



o Interest income from long term investment or deposit. You’ll find the meaning of this under Sec 22 F. It is regulated by the BSP & the term Is 5 yrs. Or more. If less than 5 yrs this is subject to the

diminishing rates. If we refer to Sec. 24 & 25, you’ll find therein a provision exempting interest from income tax. Is this

found in Sec. 27 & 28? o Note that Secs. 24 & 25 apply to individual taxpayers while Secs. 27 % 28 apply to corporate

taxpayers. There is really no similar provision that you’ll find in 27 % 28. So, the exemption

therefore, applies only to individual taxpayers; it does not appl y to corporate taxpayer. Q: The is the interest Income that is subject Final Tax?

o It must be an interest income on bond deposit. If it is an interest income on loans, assuming it is not tax exempt, then such interest income is subject to regular income tax , whether the deposit is Philippine or Foreign Currency Deposit. This is also one of the amendments introduce by RA

8424. o Before, it only applies to Philippine Currency. Now, the law makes no distinction, bond deposit

whether Phil. Deposit or not, is subject to Final tax

Hypothetical Q: a taxpayer derived income from a loan that he extended to a certain person. He has also

interest income from his bond deposit. Q#1. As regards his interest loan, what ois the treatment? o Subject to regular income tax since it is not subject to exemption

Q#2: As regards interest on bond deposit?

o It is subject to Final tax The tax treatment here is that interest income must be reported as part of his gross income but interest

bond deposit, since is subject to FT, it need be reported as part of the Gross income.

Regarding interest income on Gov’t Securities, don’t be misled. Under Sec. 32B, that item was deleted.

There is no item under 32 B regarding interest income on Gov’t securities. That’s why it is not included in the exemptions. Interest income on Gov’t securities, effective Jan. 1, 1998, is already taxable. This is no longer tax exempt as the item was deleted from the enumeration on the exclusion from Gross Income.

SUMMARY:

Interest TAX EXEMPT

NTEREST FROM BANK DEPOSITS – Sec. 32 B – 7(a)

INTEREST ON LOANS EXTENDED BY 1. Financial Governments

2. Financial Institutions controlled or financed oy FX govts, Regional or International FI established by FX

INTEREST INCOME ON BONDS or OTHER CERTIFFICATES OF INDEBTEDNESS ISSUED IN FAVOR OF

INTEREST INCOME ON BANK DEPOSITS MADE UNDER THE EXPANDED FX CURRENCY DEPOSIT

The recipient must be a by a NRTP – NRA or NRFC

If by a resident, its subject to 7.5 % FINAL TAX

INTEREST INCOME Sec. 22F – term of 5 years or more made in pursuance of CB regulations and in

denominations of P10,000 or more

Only INDIVIDUAL TPs are exempted

NOTE: As of January 1, 1998 INTEREST on GOVERNMENT SECURITIES are no longer tax exempt.

ITEM #5: RENT INCOME:

Fixed sum either in cash or property equivalent to be paid at a definite period for the use or enjoyment of

a thing or a right



SCOPE – ALL rentals derived from lease of property, whether used in business in business or not, from real

estate or personal property, earnings from copyrights, trademarks, patents and natural resources under lease.

Q: What is the difference in terms of tax treatment between Rent Income and Royalties

RENT ROYALTY

AS TO REPORTING Must be reported as part of gross income

Need not be reported since subject to FINAL TAX

AS TO TAX RATE Regular progressive rate of 5-35% FINAL TAX

2002Q#3: This is a Q designed by the examiner to test the knowledge of the examinees regarding the

difference between Royalties & Compensation Income

o Q. UVK-UK entered into a licensing agreement with UKV-Pils. UKV-UK authorized UKV-Phils to distribute computer software in the Philippines. UKV-Phils, thereafter entered into a licensing agreement with a bank in the Phils. In the contract, it was categorically stated that the licensing agreement with bank in the Phils and the bank did not involved the transfer of proprietary rights

over the assets. Thereafter, Royalty was paid by UKV-Phils to UKV-UK. How do you treat these payments made by the banks to UKV-Phils? Is it in the form of Royalty or compensation for the services rendered?

The key here is, since it does not involve the transfer of proprietary rights when

UKV-Phils. Entered into a licensing agreement, it rendered technical services to

the bank, then that partakers the nature of compensation for services renders. It is therefore subject to regular or normal tax (if this is in the nature of royalty, it is subject to FT.)

o Modification: Is the payment be subjected to FT? IF not, then why? (the words “if not” is a guide that pag hindi subject to FT, what would be then the appropriate treatment)

So, it should be treated as compensation for services rendered technical services to the bank although there’s a licensing agreement because it is authorized by UKV-UK.

If there was really no transfer of proprietary rights, that may be treated as compensation for services rendered, otherwise (that is, there was transfer of proprietary rights), that may be treated as Royalty

o ADVANCE RENTALS: Rev. Reg. #2 Sec. 49 provides Rules not found in Title II which states that: Rent Income is

not only limited to the ordinary rent but also to additional rent income. There is no rule under Title II regarding Additional income. What would you find in Sec.

32S (5) is only ordinary income. Additional rent Income may be grouped into 2 accor ding to Rev. Reg. #2 Sec. 49:

Obligations of lessons to 3rd

parties assumed by the lessee:

o Real estate taxes on the leased premises o Insurance premiums paid by the lessee

o Dividends paid by lessee to SH of lessee - corporation

Jana

ITEM # 5 : RENT INCOME:

Fixed sum either in cash or property equivalent to be paid at a definite period for the use or enjoyment of a thing of a right.

SCOPE – ALL rentals derived from lease of property, whether used in business or not, from real estate or personal property, earnings from copyrights, trademarks, patents and natural resources under lease.



Q: What is the difference in terms of tax treatment between Rent Income and Royaltics.

RENT

ROYALTY

AS TO REPORTING - must be reported as part of gross

Income

Need not be reported since subject to FINAL

TAX

AS TO TAX RATE - regular progressive rate of 5-35% FINAL TAX

2002Q#3: This is a Q designed by the examiner to test the knowledge of the examinees regarding the difference between Royalties & Compensation Income.

Q: UKV-UK entered into a licensing agreement with UKV-Phils. UKV-UK authorized UKV-Phils. To

distribute computer software in the Philippines. UKV-Phils. Thereafter entered into a licensing agreement with a bank in the Phils. In the contract, It was categorically stated that the licensing agreement entered into by UKV-Phils and the bank did not involved the transfer of proprietary rights over the assets. Thereafter, Royalty was part by UKV-Phils. to UKV-UK. How do you treat

these payments made by the banks to UKV-Phils? Is it in the form of Royalty or compensation for the services rendered?

- The key here is, since it does not involve the transfer of proprietary rights when UKV-Phils.

Entered into a licensing agreement, and it rendered technical services to the bank then that partakes the nature of compensation for services rendered. It is therefore subject to regular

or normal tax. (If this is in the nature of royalty it is subject to FY.)

Modification: Is the payment be subjected to FT? If not, then why? (the words “if not” is a guide

that pag hindi subject to FT, what would then be the appropriate treatment?)

- So, it should be treated as compensation for services rendered because it rendered technical

services to the bank although there’s a licensing agreement because i t is authorized by UKV-

UK.

- If there was really no transfer of proprietary rights, that may be treated as compensation for

services rendered, otherwise (that is, there was transfer of proprietary rights). That may be treated as Royalty.

ADVANCE RENTALS:

Rev. Reg #2 Sec. 49 provide Rules not found in Title II which states that: Rent Income is not only

limited to the ordinary rent but also to additional rent income.

There is no rule under Title II regarding Additional Income. What you can find in Sec. 32A(5) is

only ordinary income. Additional Rent Income may be grouped into 2 according to Rev. Reg. #2 Sec. 49:

1. Obligations of lessons to 3rd

parties assumed by the lessee:

Real estate taxes on the leased premises

Insurance premiums paid by lassee

Dividends paid by lessee to SH of lessor – corporation

Interest paid by lessee to holder of bonds issued by lessor-corporation:



2. Value of permanent improvements made by the lessee on leased property that will

become the property of the lessor upon the expiration of the lease.

VALUE OF PERMANENT IMPROVEMENT: A permanent improvement may arise in long term contract of lease. Under the long term contract of lease, which is

usually 20-30 yrs. The lessee can introduce improvements, such as building on the property. As far as taxation is concern, the value of the property may be taxed as additional rent income Under Rev. Reg #2 Sec. 49 it may be reported under either of the 2 recognized methods:

a. Spread-out method; and

b. Outsight method

There will be no computation. You will only be asked to state the methods which this value of permanent improvement may be reported as additional rent income.

In legal ethics. If you will be asked to draft Long term contract of lease, you

should not forget, say it is for the period of 30 years to Incorporate the usual stipulation that the lessee can introduce improvements on the premises and upon the expiration of the LT contract of lease the ownership of such

improvements on the premises shall be transferred to the lessor.

In Outright method – it is the FV of the permanent improvement upon the completion of the contract that should be reported as additional rent income.

In Spread-out method – (the technical term to be remembered as to what should be spread-out is “depreciated Value”. It is the depreciated value of the permanent upon the expiration of the contract of lease. You have to consider

the deprecated value of the permanent improvement upon the expiration of the contract and divide it by the remaining contract of lease. Every year, an aliquot part of the depreciated value should be reported as additional rent

Income in addition to the regular rent Income.

Ex. Term of the Contract of lease is 30 years. In the 5th

year, a building is constructed with a value of 25M: the remaining term of the lease therefore is

25 years. Every year, 1M is to be reported as additional rent Income (25M/25 yrs.) This 1M is the aliquot part of the 25M. You need not state the amount in your answer. As long as you can explain that an aliquot part of the depreciated value of the improvement should be reported.

ITEM #7: DIVIDEND INCOME:

> There are 8 provisions under Title II that deal with Dividend income:



1) Sec. 24 B (2) – RC,NRC & RA are subject to 10% FT on dividends received from Domestic

Corporation effective year 2000;

2) Sec. 25 A (2) – covers NRA-NETB. Tax is 20% FT on the dividends received from Domestic Corporation;

3) Sec. 25 B – NRA-NETB. Tax is 25% FT on the dividends received from Domestic Corporation.

4) Sec. 27 D(4) – Dividend received by a Domestic Corporation from another Domestic Corporation. It is tax exempt.

5) Sec. 28 A (7. D) – 2005 Bar – Recipient is RFC. Is that taxable? No. it is tax exempt:

6) Sec 23 B (5. B) – received by NRFC. This is subject to 15% FT and this is subject to tax credit

system:

7) Sec. 42 A (2) – the source is a FC. In the first 6 provisions. The source is DC.

Q: the giver is a FC. What is the tax treatment?

Answer: It is an Income derived from sources win if:

a) the Philippine Income of this FC In the last 3 preceding taxable years is at least 50% of its foreign income (income w/o). If it is less than 50%, that's not an income derived fr om sources with, so not taxable:

8) Sec. 73 B – It provides that stock dividend is not subject to tax. It is not subject to tax because it

is just a transfer from the surplus to the capital account.

SUMMARY:

TAX RULES ON DIVIDEND INCOME



> TAXABLE GAIN AND DEDUCTIBLE LOSS :

* Sec. 40 has 3 paragraphs:

Par. A) provides the basic rules on taxable gain and deductible loss:

B) provides the rules on the detennination of the cost or adjusted basis thereof; and

C) States 2 Rules:

1. “NO GAIN, NO LOSS” which means that if the gain is not taxable the loss is not deductible

2. “GAIN RECOGNIZED, LOSS NOT RECOGNIZED”

> Q. When you sell property how do you know whether you derive gain from such sale of exchange or you incur losses from such sale or exchange of an asses or capital?

* The rules are basic there’s taxable gain if the amount received or realized is more than the cost or adjustable basis.

* Example: You sold your property: the selling price (that’s the amount you received) is 500,000. This for example, you acquired it at 330,000. It is really the differenc e between the Selling Price and the cost. So, the

taxable gain is 200,000.

* Is there an exception to this rule, that as a rule the cost is deductible from the amount rec eived or realized?

GIVER OF DIVIDEND RECIPIENT BASIS TAX TREATMENT

DC RC

NRC

RA

Sec. 24B – 2 10% FINAL TAX

DC NRA – ETD Sec. 25A – 2 20% FINAL TAX

DC NRA- NETB Sec. 25B 25% FINAL TAX

DC DC Sec. 27D – 4 Tax exempt

DC RFC Sec. 20A – 7(d) Tax exempt

DC NRFC Sec. 28B – 5(b) 15% FINAL TAX – subject to the tax credit system for corporate income tax

INCOME FROM WITHIN IS

TAXABLE IF:

If the income from within is AT LEAST 50% of

its income from without. Otherwise It's not taxable.

FC Individual or corporate TP Sec. 42A – 2

STOCK DIVIDENDS Sec. 73B GENERALLY TAX EXEMPT



- Yes. It is clear in Sec. 24 B (1) that the basis of the tax rate of 6% Capital Gains tax is the higher amount between the Gross Selling Price and the Zonal Value

* Thus if you will be asked: It is the general rule that cost or adjusted basis is deductible from the Selling Price, is there an exception to this Rule? YES. What is that Sale? It is a sale of capital asset, and that must be r eal property. It is a sale of capital asset classified as real property.

* The general rule is, If there is a loss, that is the amount rec eived or realized is less than the cost or

adjusted basis, such loss is deductible. That means that, for example. The Selling Price (the amount received or realized) is 300,000. This property was previously acquired for 400,000, there’s a loss of 100,000. As a rule this is deductible. Exception to this is Sec. 24B(1).

> BASIS FOR DETERMINING GAIN or LOSS FROM SALE OR DISPOSITION OF PROPERTY:

* It is really Important to know the cost or adjusted basis because this will help you determine whether or not you incur gain or loss. What are the Rules on this? It depends upon the Mode of acquisition or purchase of

such property.

* Sec. 40 B enumerated all the possible modes of acquiring property.

Modes: 1. Purchases (Sales tax)

2. Succession or Inheritance (Estate tax)

3. Donation (Donees)

4. Acquired through Insufficient or Inadequate consideration ( montage?)

5. Property or shares of stocks acquired through the so called tax exempt transactions

If the property is acquired under the above modes, we call that “NO GAIN, NO LOSS”

transaction

The last 2 modes are the technical ones.

You sold property for 500,000; property was previously acquired through purchase.

- The basis therefore is the purchase price. Thus, if the Purchase price

is 300,000. Deduct is from 500,000. The gain therefore is 200,000

#2: the law says, it is the FMV of the property at the time of acquisition. What does that mean?

- In the law of succession, when the property was acquired through

inheritance, the right accrues upon the death of the

decedent/testator. For purposes of determining the amount refer to Sec. 88. How would you know the FMV of the property transmitted through succession? Sec. 88 says “it depends upon the nature of property, whether real or personal”.

- Correlate. The exam will not ask you to compute. Just remember :

the basis is the FMV at the time of death of the decedent that is the date of acquisition. If you sold property acquired through



inheritance, selling price is 500,000. Shat must be the cost or adjusted basis?

To answer this, determine how you acquire this property

which you sold for 500,000 you acquired it through inheritance. And since Sec. 40 B (2) says the cost or the adjusted basis is the FMV of the property. Then it is a matter of referring to the date of property to determine

the FMV. The schedule of FMV of the property is usuall y supplied by the executor or administrator. So, If according to the Schedule of FMV of property, the FMV at the time of death is 400,000 (date of death is very material). The

gain derived would be 100,000.

#3: The tax Code provides all the possible mode of acquiring properties. It is

possible that the property was acquired through Donation. Say, the property was donated to you by your friend. You are in dire of money so you subsequently sold the same for 500,000. How do you know whether you derived a gain or incurred a loss?

- The provision is quite long. It may be simplified as follows: a) It is

the same basis “in the hands of the donor”. In the case of inheritance above, it is the FMV of the property at the time of death of the testator. Here, it is the same basis in the hands of the donor. What you have to do is to inquire from the donor this basis in

acquiring the property. It is possible that the donor acquired it through purchase, so he can tell you the purchase price.

- The rule under his situation may change if it is acquired through

inheritance of insufficient consideration

- Example: B acquired property through Insufficient consideration

from A, B sold said property to C. SP=500,000. So the property was not acquired through purchase or inheritance. It was acquired by the seller for inadequate or insufficient consideration Imaginable. It is below or way below the FMV of the property.

- 1936 Bar – many examinees complained to the SC that taxation was

a killer subject because several Questions Involved computations. The example above was one of the Q. If this will be asked again, I think you will only be asked about the legal provisions: What may be the basis for the sale of the property acquired through

Insufficient or Inadequate consideration?

Answer it is the amount paid by the transferee who now

becomes, as far as the present sale is concerned, as the transferor:

Example: A had this property with a FMV of 500,000. He

sold it to B for 200,000. It was acquired by A for Inadequate or insufficient considerati on in money’s worth. Under ordinary transaction, A can sell that at a price not below the FMV but he sold it a price way below the FMV,

so it was sold for Inadequate or insufficient consideration. B to A in acquiring the property). Subsequently, B dispos ed



the same to C. What then is the basis for the sale of the property?

o It is the amount or consideration paid by the transferee (as far as the first transaction is concerned –A to B), now the transferor (as far as the present transaction is concerned which is the sale from 2 to

C). Since B paid 200,000 that is the amount or consideration as far as A is concerned. B is the transferee, now the present transferor. So, deduct 200,000 the gain derived is 300,000.

1994 Q#4 – Suppose the property was acquired through these exempt as provided for in Sec. 40 C(2). What are the situations covered therein?

- These are tax exempt exchanges of properties, shares of stocks or

securities when these are paid in accordance with the plan of merger of consolidation. According to Sec. 40 C92). All these exchanges made in accordance with the plan of M or C are tax exempt. This is not a subject

of subsequent sale. So if these properties, shares of stocks or securities were acquired pursuant to the plan of M or C, the gain der ived from this exchange is tax exempt.

- However, subsequently, these were sold.

o As regards the subsequent sale, that is the one that is subject to

tax.

Example: ABC Corp. entered into a contract of M or C with LMN corp. All

those exchanges of properties , shares of stocks and securities are tax exempt. But the subsequent disposition is already subject to tax. For instance those properties were subsequently sold by the Corp for 500,000. Remember that this was acquired through an exempt transaction. What would be the tax

treatment?

o Answer: Just take note of the legal provision under Sec. 40 C (5). It says in the same basis in the hands of the transferor. In UP law

Center suggested answer the basis is the original cost of the property or shares of stocks or securities, as the case may be. The basis shall be the original or historical cost of the property, shares of stock or securities.

SUMMARY OF THE RULES:

MODE OF ACQUISITION COST or ADJUSTED BASIS (tax base)



PURCHASE

Purchase price

Ex. Sell ing price P500,000

Cost of acquisition P300,000

Property Income P200,000

INHERITANCE or SUCCESSION

FMV at the time of death of the decedent or testator correlate with Sec. 88B.

Ex. Sell ing price P600,000

FMV P500,000

Property income P100,000

DONATION

FMV is the same basis in the hands of the donor

The amount paid by the transferee who is the transferor at the present sale

Ex. A’s house and lot’s FMV was P500,000 but A sold his house and lot to B for P200,000, thereafter B

sold the same to C for P500,000.

1. deduct P200,000 (SP of A to B) from P600,000 (SP of B to C) – P400,000 property income

TRANSFER FOR INSUFFICIENT CO NSIDERATIO N

PROPERTY OR SHARES OF STOCKS ACQUIRED

THROUGH THE SO CALLED TAX EXEMPT TRANSACTIONS

- The original or historical cost of the property or share

of stocks as the case may be.

Sec. 40C – TAX EXEMPT EXCHANGES:

NO GAIN NO LOSS RECOGNEZED:

The Rule is No Gain, No Loss recognized. This means that the gain if the gain is taxable or the transaction is tax exempt, the loss is not deductible. There are four transactions covered by this Rule:

1. Properties for Stocks

2. Stocks for Stocks



3. Securities for Stocks

These 3 transactions are exchanges purely in kind. Each of the transactions must be made in accordance with the plan of M or C

4. Exchange of property for corporate control —this is also a purely in kind exchanges. This is another form of Tax Avoidance

Sec. 40 C(6,b) – Supposed the exchange is not made in accordance with the plan of M or C as it is a transaction wherein say, ABC Corp. transferred all its property to LMN Corp. in exchange for shares of stock. No M or C was made is this transaction covered by the exemption?

o If you have not read Soc. 40C (6,b), you may answer that since it is not a M or C, then it is not exempt. This is not correct. The meaning of M or C a requisite under Sec. 40 C (2)

has been relaxed. According to Sec. 40 C (6 (2)). It is not only limited to the ordinary meaning of M or C. Under the Corporation Code (Secs. 76-87) this is not definitely covered. But the Tax Code says “It also covers the acquisition and

substantial transfer of all properties to another Corp. in exchange solely for shares or stocks”. So, it is considered as M or C in so far as the Tax Code, in concerned. So this

transaction is also covered by the exemptions. Therefore, If there is any gain the gain is tax exempt.

The trick in the Q Is: Would your answer be the same if the exchange is made

not in accordance with the plan of M or C. It is a transaction that involved the transfer of all assets of the corp. to another corp. in exchange solely for shares of stock.

o The answer would still be the same. It is still tax exempt.

o Another Tax Avoidance is, that transaction is also tax exempt not in accordance with the plan M or C, is the exchange for Corporate Control. That means that as a result of the

exchange of property for shares of stocks, the transferor/s has/have acquired corporate control.

o What do you mean by Corporate Control?

Sec. 40 C (6,C), It means that at least 51% ownership

of the Outstanding Capital. The provision says “one person alone, including others not exceeding 4”. How do you construe this?

This means that the transferor or may be 1

that is alone: or including others not exceeding 4 (that is 1 tranferor plus 1 other, 1+2 up to 1+4, or up to the maximum of 5).

To be exempted, the transferor must acquire at least 51% ownership of the outstanding capital stock.



SUMMARY:

PURELY IN KIND EXCHANGES REQUIREMENT FOR EXEMPTION

PROPERTY FOR STOCK

Must be in accordance with a plan for merger or consolidation

Ex. ABC Corp. pursuant to a plan of M or C, gave all its properties to LMV Corp. in exchange of stocks – such transaction is tax exempt BUT should LMN Corp. sell the sold properties to another person such sale

would be subjected to tax.

STOCK FOR STOCK Must be in accordance with a plan for merger or consolidation

SECURITY FOR STOCK Must be in accordance with a plan for merger or consolidation

PROPERTY FOR STOCK

Must result to corporation control of the transferee corporation – corporate control should be 51% or more, there may be more than 1 transferor but the same must not exceed 5 – whether the transferor is an individual or a corporate TP.

Ex. ABC Co. transferred all its property to XYZ Corp in exchange of shares of stock but there was no plan for M or C. Is the transfer

exempt from tax?

The concept of merger or consolidation under Sec. 4QC(2) has been relaxed. The concept is not limited to

the ordinary concept of M or C – it l ikewise covers if there’s no plan for M or C PROVIDED that the transferors would acquire control over the corpora tion –

shares of stock is 51% or more.

So, In the case at bar, If the shares of stock would be at least 51% the transaction is tax exempt, otherwise it’s

taxable.

TAXABLE GAIN DOES NO T ONLY ARISE FROM ORDINARY SALE. It is also derived from exchange of property for

stocks:

FMV of shares of stocks

Less: Cost of the Prop

Gain or Loss



GAIN RECOGNIZED, LOSS NOT RECOGNIZED :

Q: When does this occur?

o A: In the following circumstances:

1. When the transaction is NOT solely in kind – that if aside from the property, cash is also given in the transfer

- Thus, suppose cash is given as additional consideration? This means

that cash + property, securities or shares of stock. A different rule will apply. The Rule that will apply now is “GAIN RECOGNIZED, LOSS NOT RECOGNIZED”. How do you describe this transaction?

This is a transaction not solely in kind because it involves cash

or money as an additional consideration. The gain will now be subject to tax. So, don't give additional cash or money because it will now be governed by this Rule “GAIN

RECOGNIZED, LOSS NOT RECOGNIZED”.

2. Illegal transactions

- 2001 Bar il legal transaction Is governed by this rule because the illegal

gain is taxable but the il legal loss or expense is not deductible. We can

tax the illegal gain because of Sec. 32 B(l) “derived from any other source”, but the loss that may be sustained from illegal transaction is a non-deductible loss because only those losses that are legitimate ones actually sustained from legal transaction are deductible

3. Transactions between related TP

- Transactions between related taxpayers shall be governed by this rule.

If there’s a gain the gain is definitely taxable, but the expense or the loss is a non-deductible expense

- Group of Related Taxpayers (Sec. 36 B)

a. Members of the same fa mily

b. A Stockholder and a Corporation – 1man Corporation, that is

the corporation is own or controlled by a single individuals

c. Between 2 corporations – they are related in the sense that they are own and controlled by the same stockholders

d. Parties to a trust

1. Trustor

2. Trustee

3. Beneficiary

4. Fiduciary



4. Wash sale – one of the illegal trading devices

- The reason why it is an illegal trading device is because there’s really

no substantial change of beneficial ownership

- Q: 1. What may be the subject of wash sale?

It may be shares of stocks, securities, including stock options

- Q: 2. Who must be the seller of such shares of stocks, securities, or

stock options?

It must not be a dealer in securities

- Are these periods that must be observed?

YES. a) 30 days before the sale; and 2) 30 days after the sale. These 2 periods are really determinative of whether it is a wash sale or not

- What must be that event that must transpire or occur 30 days before

the sale or 30 days after the sale (this is the reason why this is called “61- day sale”)?

The event that must transpire is the purchase or acquisition

of identical or substantially the same stock or securities

- It is important to know whether it was a wash sale or not because if it

was a wash sale transaction, the gain is taxable and the loss is non-deductible (Sec. 38)

- Q: What must be the reason for this?

The rationale behind this is that , this is – mere artificial loss

and it is not actually sustained. In actual transaction, the seller can recover his loss by adding the amount of loss to the Selling Price Involving the sale of stocks or securities. The seller can recover this loss through the subsequent sale of the

same. In effect the loss can be recover. So there is really no loss actually Incurred of sustained as it is a mere artificial loss

STOCK DIVIDENDS:

Those are the 3 important cases that provide exceptions to the rule that stock dividend is tax

exempt:

1. CIR vs. ANSCOR – this pertains to the redemption of shares of stock

2. CIR vs. MANNING – this was 1994 Bar Q – this pertains to dividends declared in the guise of stock dividends

3. BACHARACH vs. SCHIFERT (87 Phil 403) – this pertains stock dividends received by the usufructuary



CIR vs. ANSCOR: The requisites of redemption of stock divi dends that may result to taxable

income according to this cases are:

a. There must be a redemption or cancellation

b. It must be of shares of stock involving stock dividends

c. The cancellation must result in distribution of taxable dividend or income

Sec. 73 B second sentence thereof made mentioned of these 3 requisites – “at such time and

in such manner that may result in the distribution or cancellation of taxable dividend”. These are really the criteria or tests.

According to the tax courts of US, consider the following:

a. the real or business purpose (?);

b. the redemption must be bonafide;

c. the lapse of time between the issuance and redemption

d. the net effect of the redemption of the shares of stockholders

ANSCOR CASE: The 2 purposes raised by the taxpayer. a) legitimate business purpose; and b) justification for the cancellation or redemption, were not considered by the SC. The case made mention about the Filipinization(?) of the Corp. and citizenship(?); and the reduction

of foreign exchange transactions These 2 were not a justification. The period of 2-3 years was not also considered. However, the net effect, the SC said, resulted in taxable income. Here 108,000 shares _______(?) the original 25,247.50 shares _______(?). It turned out the

corporation redeorned the original investment on the original 25,247.50 shares of stocks. The SC modified the decision of the CA on the amount representing the taxable income.

In Corporation law, shares of stock may be classified as redeemable upon

incorporation but it must be expressly provided for in the Articles of Incorporation as redeemable. If this will be redeemed by the Corporation, this is not the one referred in the exception. So, if the source is the original subscription or the Initial Investment, Sec. 73 B will not apply because is still capital. But if the source is additional shares of stock, that is, stock

dividends were declared and this are in the nature of redeemable shares, then this is the one contemplated by this Sec. 73 B.

The SG said, if these redeemable shares of stock are in the nature or form part of the original investment the redemption is not covered by Sec. 73 B the exception is not applicable. It must be the shares of stock declared as stock dividends and were classified as redeemable shares. The situation in this case is that the corporation declared stock

dividends classified as redeemable shares.

The rule regarding stock dividend is that it is tax exempt because there is just a transfer from surplus to capital account. There is No realized gain or profit. In this case, a

device could really be availed of by the corporation. If this stock dividend declared would be categorized as redeemable shares of stock, this would be the situation: under the Corp. Code this may be redeemed in cash. Once this will be redeemed the stockholder will receive cash.



There is now a flow of wealth according to SC. This is the reason why stock dividends declared in the nature of redeemable shares of stock is taxable.

In the language of the SC, it is really a constructive ploy or device to evade the effec t of taxation having in mind that the stock dividend is stock exempt but if it is classified as redeemable shares of stock once redeemed from the corp. the stockholders cannot allege

that stock dividend is tax exempt. You cannot apply the principle here because there is a flow of wealth. Here, there may arise a flow of wealth because the stockholder will now receive cash.

The reason of the exceptions that you’ll find in Sec. 77 B is that it is an Income constructively devised to avoid the effects of taxation. So, stock dividends , as a rule is tax exempt. But onc e it is in the nature of redeemable shares of stock, there being a flow of

wealth as the stockholder may receive cash, then that’s the time we can tax such stock dividends. _______(?)

CIR vs. MANNING: Disguised Dividends

In the case of, it is in this case that you’ll find the language “in the guise of stock dividends” . What does that mean? The board may declared dividends and treat the same as stock dividends, name it as stock dividends in the books. But the BIR may examine the books.

In this case, It was discovered that the stocks were declared not in accordance with the Corporation Code. It was not declared out of the unrestricted retained earnings of the corp . It was declared out of the Outstanding capital stock. So there was a violation on the basic requirement under the Corp. Code that dividends, Including stock dividends can only be declared

out of unrestricted retained earnings.

So as to evade the affects of taxation, stock dividend being tax exempt the Corporation,

in connivance with the stockholders treated such stock dividends. So it is a dividend in the guise of stock dividends as to avoid the payment of tax. This is taxable of course. This is taxable as there is no tax dividends legally declared under the Corporation Code.

BACHARACH vs. SCHIFERT: The Q here: Is the stock dividends received by the usufructuary tax

exempt or taxable?

This is taxable according to the SC, rejecting the opposite view tha t it is tax exempt. The

SC adopted the Pennsylvania Rule. The SC cited Art. 565 of the Civil Code. Under this Article “the usufructuary is entitled to the natural, industrial, and civil fruits of the thing in usufruct”. The



thing in usufruct here is shares of stock. As this is a thing is usufruct, the SC considered this an exception to the rule and held that the stock dividends received by the usufructuary are subject

to tax.

WHEN THERE IS A CHANGE IN THE STOCKHOLDERS INTEREST IN THE CORPORATION:

This is another exception to the rule.

Illustration: A, before the declaration of stock dividends had a 20% ownership of the Outstanding capital stock of the Corporation. If there’s no change pertaining to the percentage of ownership after the declaration of the stock dividends, then such stock dividends is tax exempt. But if there’s a change, and it must be an increase in the interest. If

this increase to 22%, it is considered as an exception to the rule.

OTHER SOURCES OF INCOME

CAPITAL GAIN FROM SALE OF SHARES OF STOCK

ACQUISITION & DISPOSITION OF CAPITAL STOCK WHICH INCLUDE SALES AND RETIREMENT OF

BONDS

ILLEGAL GAINS

o Gambling betting, extortion or fraud

RECOVERY OF DAMAGES

o Taxable only when it represents lost profit or income.

BAD DEBTS RECOVERY

o Taxable if it results in reduction of the TP’s tax liability in the previous year. TAX BENEFIT

RULE or DOCTRINE OF EQUITABLE BENEFIT applies in this case.

o It must be claimed as a deduction from the gross Income in the preceding year – the reduction results in a tax benefit.

TAX REFUND

o Taxable if it results in reduction of the TP’s l iability in the preceding year. This means

that the tax refunded must be previously claimed as deduction from gross income. The tax benefit rule also applies.

In the items mentioned under Sec. 32 A ( we said that there are 13), the following are subject to FT

1. Royalties:

2. Prizes – take note of the clarification.

Prices subject to 5-32%. It must be included in the Gross Income of the taxpayer;

3. Winnings except lotto and sweepstakes;

4. Interest

This is subject to FT if this is an interest income on bank deposit. If it is an interest on loan, then it is subject to regular tax;

5. Dividends are subject to FT under 2 cases:



a) When it is received by Individual taxpayers. We can simply say that when a dividend is received by an individual taxpayer from a Domestic Corporation, it is subject to

FT;

b) If the recipient is a NRFC. So, if it is received by a Domestic Corporation or a RFC, it is not a FT:

6. Share of a partner from the net Income after tax of a business or taxable partnership.

Try to compare this to item 11 of Sec. 32 A. under Sec. 32A (11), the source is general professional partnership.

Q: A is a partner in ABC Partnership, a business partnership. A received an income amounting to 150,000 representing his share in the income of the partnership.

1. How do you tax the 150,000 income received by A from ABC partnership?

Answer: Since the source is a taxable partnership, this is subject to FT and therefore the partner is not required to report this Income as part of his

gross Income

2. Would your answer be the same if ABC is a general professional partnership?

Answer: No. If it is received from a tax exempt partnership. Sec. 26last paragraph states that the professional partner shall report such share fr om

the professional partnership a part of his Gross Income. So Sec. 32 A (11). As the tax treatment In Sec. 26 will tell you should be reported as part of the Gross income of the professional partner. But in the case of a taxable

partnership, Sec. 24 states that the share of a partner if it is received from a “taxable partnership” (that is not a general professional partnership) shall be subject to FT. And the rule provides that the recipient of the same is not required to report that as part of his GI.

2001 Bar: If a cash dividend ( or property) is received by a RC or RA, this is subject to FT (Sec. 24. 10% FT). Q: What do you think is the reason why these dividends received by RC or RA are subject to 10% FT and not by 5-32% progressive rate?

Answer: The reason is to ensure the collection of tax on these dividends. If we subject these to 5-32%, which can only be done through the tilling of ITR, there is no assurance that the taxpayer will report those as part of his GI because he has

also other sources of Income. It is extremely difficult for the BIR to monitor compliance w/ this considering the number of stockholders.

By shirting the responsibility to remit the tax to the corporation, it is easy for

the BIR to check compliance because there are fewer withholding agents compared to the # of stockholders. By subjecting this to FT the Govt. is assured of revenues in the earliest possible time because these taxes are needed by the Govt. to carry out its legitimate objectives – LIFEBLOOD na naman hehehehehe….. this is really

favoured by the LIFEBLOOD DOCTRINE.

By the way, In the case of interest on deposits, it is the bank that is legally

obliged to withhold the tax.



SUMMARY:

ITEMS SUBJECT TO FINAL TAX

R ROYALTIES Always subject to final tax

P PRIZES DEPENDS:

P10,000 or less – If forms part of gross income – subject to S. 32% progressive rate

More than P10,000 – 20% FINAL TAX

W WINNINGS GR: Always subject to final tax

XPM: Sweeptakes and lotto winnings (exempted)

I INTEREST FROM BANK DEPOSITS

- Subject to FT whether in Philippine or FX currency

D

DIVIDENDS GIVEN TO AN

INDIVIDUAL TP

- Subject to FT BUT If the recipient is a DC or a RFC. It’s exempt

NOTE: Cash Dividends given by DC to RC. NRC and RA is subject to 10% FINAL TAX due to the following reasons:

1. To ensure collection on the cash dividends otherwise there would be no assurance that the TP will report it in his ITR

2. The BIR will have a hard time monitoring compliance since there are numerous SHs

3. Shifting the responsibility to the corporation as the withholding agent – easier collection since there are fewer Corps then SHs

4. Taxes are made available to the govt in the earliest time possible.

S

SHARE OF A PARTNER FROM THE NET INCOME OF A TAXABLE PARTNERSHIP

If the source is a TAXABLE PAT the share is subjected to a FT if

the source is a TAX EXEMPT PAT, according to the last paragraph of Sec. 26, it must be reported and included in the gross income of the TP.

Sec. 24B (2) and Sec. 25A (2) – JOINT PAT etc. are tax exempt



IV. EXCLUSIONS FROM GROSS INCOME: Sec. 32B

In a recent case, the SC held that exclusions are in the nature of Exemptions and therefore these should be strictly construed against the taxpayer and liberally in favour of the Govt. So, this give us this probable bar Q because in the Recent case of PLDT vs. Laguna. The SC distinguished Exclusions from Exemptions.

There are 2 Probable Bar Q here:

a) Exclusions vs. Exemptions; or

b) Exclusions vs. Allowable deductions (Sec. 34)

In this case of PLDT vs. Laguna (2005 case), for the first time the SC made distinctions between these 2, that’s why this is a probable bar Q.

1. Exclusions – refers to the removal of otherwise taxable items from the reach of taxation (this is the language of the US tax court as cited in the PLDT vs Laguna case):

Exemptions – refers to an immunity or privilege, fr eedom from change or burden to which other persons are subject to tax.

The court said, they are the same as to their effect or nature. That’s why the old rule that would apply to them is the principle of STRICTISSIMI JURIS : Exclusions and Exemptions must be strictly constructed against the taxpayer and liberally in favour of the Govt.

If that would not be asked, this would be the Q on this section – What are the distinctions between Exclusions from Gross Income (32 B) and allowable deductions from GI (Sec. 32)?

o According to Sec. 61 of Rev. Reg. #2:

Exclusions from Gross income refer to a flow of wealth to th e taxpayer which does not from part of the GI because of the following reasons:

1) It is excluded by applicable law:

2) Excluded by the tax code: or

3) Excluded by the Constitution

On the other hand, allowable deductions refer to amounts, which

the law allows to be deducted from GI in order to arrive at taxable or net Income

EM

IV. EXCLUSIONS FROM GROSS INCOME: Sec. 32B



In a recent case, the SC held that exclusions are in the nature of Exemptions and there strictly construed against the taxpayer and liberally in favor of the Govt. So, this gives us because in the Recent case of PLDT vs.

Laguna, the SC distinguished Exclusions from Exemptions.

There are 2 Probable Bar Q here:

a) Exclusions vs. Exemptions; or b) Exclusions vs. Allowable deductions (Sec. 34)

In this case of PLDT vs. Laguna (2005 case), for the first time the SC made distinctions between …that’s why this is a probable bar Q.

1. Exclusions – refers to the removal of otherwise taxable items from reach of taxation (this…language of the US tax court as cited in the PLDT vs Laguna case)

Exemptions – refers to an immunity or privilege, fr eedom from charge or burden to which other … are subject to tax.

The court said, they are the same as to their effect or nature. That’s why the old rule that would … the m is

the principle of STRICTISSIMI JURIS. Exclusions and Exemptions must be strictly construed against the taxpayer and liberally in favor of the Govt.

If that would not be asked, this would be the Q on this section – What are the distinctions …Exclusions from Gross Income (32B) and allowable deductions from GI (Sec 34)

According to Sec. 61 of Rev. Reg. #2 (?)

Exclusions from Gross Income refer to a flow of wealth to the taxpayer which does …part of the GI

because of the following reasons: 1) It is excluded by applicable laws; 2) Excluded by the tax code; or 3) Excluded by the Constitution.

On the other hand, allowable deductions refer to amounts, which the law …deducted from GI in order

to arrive at taxable or net income

2. Another point of distinction is that Exclusions may pertain to the computation (this is material) for

purposes of determining GI, whereas allowable deductions is important for purposes of determining net or taxable income and this must be deducted from GI to arrive at taxable income. I repeat, exclusions may be material for purposes of determining GI because you have to exclude it to arrive at GI.

3. Exclusions are something earned or received which do not form part of GI, while deductions are

something paid or incurred in earning GI.

Try to analyze the enumeration under Sec. 32 B. If you count, there may be 19 Exclusions from GI. The Enumeration is not exclusive because there are other items not mentioned in 32 B but should be excluded. For

instance, in Sec. 24 & 25, there is that tax exempt interest income which we have already cited and is not



included in Sec. 32 B. This is interest income on Long term deposit. This is not included in the exclusion under Sec. 32 B. You will find that in Secs. 24 & 25 –if the term is 5 years or more, the interest income is tax exempt.

Keyword: LAGCIRM

1. Life insurance proceeds 2. Amount received as return of premium

3. Gifts, bequests, devises & legacies 4. Compensation for injuries or sickness 5. Interest exempt under tax treaty 6. Retirement benefits, pensions, gratuities, etc. (favorite Bar Q)

7. Miscellaneous items

Under item 6, there are 6 exclusions (a-f) and under item7, there are 8 items there. So, 19 items all in

all

Favorite Bar Q: Life insurance proceeds, Compensation for injuries or sickness, Retirement benefits, pen sions, gratuities, etc., and on item 7, just focus on 2 items (prizes and awards)

Item #1. Life Insurance Proceeds:

Correlate this with Sec. 85E because there are 2 Q on this in the previous bar exams.

Sec. 85E –refers to the Rule regarding Exclusions or inclusions from Gross Estate of Life Insurance

Proceeds o When a beneficiary is designated, you ought to know whether it is revocable or irrevocable,

in which case you must really consider the rule under Sec. 11 of the Insurance Code.

In 1983 Bar: There are 3Q on this:

a) Whether the proceeds received by the beneficiary may be excluded from GI. So it’s a Q on the

Exclusion from GI; b) Whether this should form part of the Gross Estate.

We have already discussed the tax Implications of Life Insurance Premium. When the life insurance policy

is obtained by the employer for his employee, premiums may be paid by the ER. And we have already extensively discussed the rule/tax implications of life insurance premium. Just incorporate the rules that we have simplified .

Tax implications:

a) Life insurance premium, may be taxable or not taxable to the employee; or b) As regards the employer, it may be a deductible or non-deductible expense

For these tax implications, you must know the beneficiary designated in the life insurance policy, and we have 2 assumptions:

1. Beneficiary is the heir, estate, executor, or administrator



2. Beneficiary designated is a 3rd

person, which may include the employer

Under assumption #1. This should always be excluded from the GI of the recipient whether irrevocably or revocably designated.

Under assumption #2 –some examinees answered that, since it’s a 3rd

person, that should be subject to

tax. That is not correct. The provision says “any beneficiary”. There is really no profit or gain here. This just represents indemnification and the insured has the right to designate the beneficiary. So it is always excluded from the GI of the recipient irrespective of the beneficiary designated in the life insurance policy.

Section 32. Gross Income. -

(B) Exclusions from Gross Income. - The following items shall not be included in gross income and shall be exempt from taxation under this title:

(1) Life Insurance. - The proceeds of l ife 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.

Section 85. Gross Estate. –

(E) Proceeds of Life Insuran ce. - To the extent of the amount receivable by the estate of the deceased, his executor, or administrator, as insurance under policies taken out by the decedent upon his own life, irrespective of whether

or not the insured retained the power of revocation, or to the extent of the amount receivable by any beneficiary designated in the policy of insurance, except when it is expressly stipulated that the designation of the beneficiary is irrevocable.

RULES under Sec. 85 E:

A) Included and therefore subject to estate tax under 2 cases: 1. If the beneficiary designated in the life insurance policy is the heirs, estate, executor or administrator of

the estate. “Whether the designation is revocable or irrevocable, always included if the beneficiary is the

estate, executor or administrator of the estate. 2. If a third person (including the employer) is revocably designated as beneficiary. If a 3

rd person is

designated as beneficiary, the rule says “excluded from gross estate.”

B) Excluded and therefore Not subject to Estate tax under 2 cases: 1. If 3

rd person is irrevocably designated as beneficiary

You see now the possible confusion. The designation of the beneficiary is IMMATERIAL if the one designated as beneficiary is the heirs, estate, executor or administrator of the estate. This is ALWAYS INCLUDED.

But if the one designated is a 3rd

person, you ought to know or check whether the designation is

revocable or irrevocable. If the designation or this 3rd

person as beneficiary is REVOCABLE, you have to INCLUDE that, therefore subject to estate tax. If this 3

rd person is IRREVOCABLY designated, EXCLUDED

from the Gross Estate and therefore not subject to estate tax.



2. If it partakes of a nature of Group Insurance policy

I mentioned about Sec. 11 of the Insurance Code. Under the Old Insurance Code, the rule was that designation is irrevocable. However, the rule now is REVOCABLE, unless that right is waived. Under Sec. 11 of the Insurance Code “there is only irrevocable designation of the beneficiary if the life insurance policy expressly so provides.” If it is silent, then it is presumed that the designation is revocable. So in A#2, it shall be included in the

Gross Estate subject to Estate tax. But if a 3rd

person is designated as beneficiary and the policy is silent, you may consider the designation revocable.

RULES ON PREMIUMS

In Life insurance, premiums are paid. We say the the following tax implications: To the employee, it may

be a taxable income, and to the employer, that may be an expense.

1. Under the assumption that is the heirs, estate, executor or administrator of the estate who received

the premium as beneficiary, it is taxable to the employee. It is taxable to the employee and the rules

are:

a. Under 32 A, taxable as compensation income if the employee is a rank and file employee.

b. Under 32 B (m) taxable as Fringe Benefit if the insured employee is a managerial or supervisory

employee

Q. Can it be claimed as an expense by the employer?

Yes. It is a deductible expense (32 A (1, a(I)) as other forms of compensation for personal services

rendered.

2. Under the assumption a 3rd person was the one designated (and this may include the employer) It is

NOT PAYABLE on the part of the employee there being no benefit accruing to the family of heirs.

To the employer designated as beneficiary, the proceeds he received upon the death of the EE just yo

represent a mere return of capital. This being the case, the employer should not be allowed to claim the

life insurance premium paid as a deductible expense.

SUMMARY RULES ON LIFE INSURANCE POLICY:

Example: A l ife insurance was obtained by an employer for his EE. The estate of the EE was designated as the beneficiary. During the lifetime of the EE, premiums were paid by the ER.

Q#1: Upon the death of the EE, the proceeds shall go to the beneficiary designated in the Policy. Will that form

part of the GI of the beneficiary?

Answer: NO. For purposes of exclusion, since Sec. 32 B (I) make no distinction as regards beneficiary, the proceeds of life insurance policy are always excluded from the Gross Income of any recipient or beneficiary of the



same. It is excluded whether the beneficiary is the employer or the heirs, estate, executor, or administrator of the estate.

Q#2: Will that be included in the Gross Estate of the dec edent EE? Is that subject to Estate Tax?

Answer: Qualify: Under Sec. 85 E: “if the beneficiary is the heirs, estate, executor or administrator of the estate, it should always be INCLUDED in the Gross Estate whether the designation is revocabl e or irrevocable. This will

form part of the Gross Estate.

If the beneficiary is a 3rd

person, Sec. 85 E makes a qualification. If a 3rd

person is the designated beneficiary, it is INCLUDED if the designation is revocable. It is EXCLUDED from the Gross Estate and therefor tax

exempt if the designation of the 3rd

person is irrevocable.

Q#3: Are premiums paid by the ER on the policy:

a. Deductible expense to the ER?

Answer: YES. [NB: there is a written note, “Depends.”] It is a deductible expense on the part of the ER if the designated beneficiary is the heirs, estate, executor or administrator of the estate. If the one designated as a beneficiary is the employer (considered as 3

rd person) that is not a deductible expense.

b. Taxable compensation income to the EE?

Answer: YES. It is taxable compensation income to the employee if the designated beneficiary is the heirs, estate,

executor or administrator of the estate. Since the beneficiary designated is the estate of the EE, then it is taxable. If the beneficiary designated is a 3

rd person (that includes the employer), it is not taxable since it is just a mere return

of capital.

SUMMARY

TAX TREATMENT OF LIFE INSURANCE PROCEEDS

EFFECTS

BENEFICIARY DESIGNATED

HEIRS, EXECUTOR OR ADMINISTRATOR

EMPLOYER

EXCLUSION FROM THE GROSS INCOME

EXCLUDED from the gross income of the beneficiary

(revocable or irrevocable) – it represents a compensation for the loss of life, hence a mere return of capital

EXCLUDED from the gross income of the employer – no

realization of profit and express exclusion by law

WON INCLUDED or EXCLUDED IN THE GROSS ESTATE

INCLUDED – whether the

designation is revocable or irrevocable (Sec 85 E)

Considered a 3rd

person

QUALIFY

IRREVOCABLE – EXCLUDED



REVOCAVLE – INCLUDED

PREMIUMS PAID

TAXABLE to the EMPLOYEE during his lifetime – Sec 33B-10:

MANAGERIAL or SUPERVISORY

employee (32 B (m)) – taxable as fringe benefits

RANK & FILE (32 A) – taxable as compensation income

DEDUCTIBLE EXPENSE to the

employer

NOT TAXABLE on the part of the employee – there being no benefit accruing to the heirs

NONDEDUCTIBLE EXPENSE to the employer as the same just represent a mere return on

capital

Item #2. Amounts received as Return of Premium:

This is self-explanatory in the sense that, the same as that of Life Insurance Proceeds, these are not included or mentioned under Sec 32 on Exclusions, but still it is excluded because this really does not qualify as an income. It is just a return of capital. Return of premium means a repayment of a part of the whole of the premiums

paid.

Item #3. Donations:

There are 2 kinds of Donations: Donation Inter Vivos and Donation Mortis Causa.

Distinctions:

1. Donations Inter Vivos – the giver is the donor

Donation Mortis Causa – the giver is the testator or decedent

2. Donation Inter Vivos – the recipient is the done

Donation Mortis Causa – recepients are the heirs or beneficiary

Q: If a donation inter vivos is given, what are the tax implications?

Sec 32 B (3) laid down just one of the tax implications.

As far as the donor is concerned – subject to donor’s tax

As far as the donee is concerned –



1. Not subject to donee’s tax as donee’s tax was abolished by PD 69 (favorite # of my good friend Prof. Sandoval. Prof. Portfolio)

2. This is not also subject to income tax because the same, according to Sec 32 B (3) is excluded from Gross Income

Q: Tax implications of Donation Mortis Causa

As far as the testator is concerned – subject to estate tax

As far as the done (heirs of the decedent or beneficiary) –

1. Not subject to donee’s tax as donee’s tax was abolished by PD 69 2. This is not also subject to income tax because the same, according to Sec 32 B (3) excluded

from Gross Income

1994 Q#2b: Are donations inter vivos and mortis causa subject to Estate Tax?

Answer: It is donation mortis causa that is subject to Estate Tax. Donations inter vivos are subject to donor’s tax.

Q: What about the implication in so far as the done is concerned?

Answer: At present, the right to receive donations is not subj ect to any tax.

SUMMARY:

TAX TREATMENT or IMPLICATION

MODE OF DONATION GIVER RECIPIENT

INTER VIVOS

Donor is subject to donor’s tax Donee is NOT subject to donee’s tax since Donee’s Tax has been

abolished by PD 69

The same is not subject to

income tax since donations are expressly excluded from the gross income by the NIRC (Sec 32 B)

MORTIS CAUSA

The estate of the testator is

subject to Estate Tax

Heir/s NOT subject to inheritance

tax since inheritance tax has been abolished by PD 69

NOT subject to income since the

same are expressly excluded from the gross income by the NIRC (Sec 32 B 3)

Item #4. Compensation for Injuries or Sickness:



In 2003 Q#5: Examinees were asked whether the following is subject to income tax:

a. Hospitalization expenses

b. Cost of repair of damaged vehicle; and c. Moral and Exemplary damages

Q: X, while driving home from his office, was seriously injured when his automobile was bumped from

behind by a bus driven by a reckless driver. As a result, he had to pay P200,000 to his docto r and P10,000

to the hospital where he was confined for treatment. He fi led a suit against the bus driver and the bus company and was awarded and paid actual damages of 300,000 (for his doctor and hospitalization bill), P100,000 by way of moral damages for what he had to pay for his attorney for bringing the case to court. Which, if any of the awards are taxable as income to X and which are not? Explain

Answer:

a. Hospitalization expenses – this is tax exempt because this represents compensation for

injuries sustained (this is the one covered by Sec 32 B 94)

b. Cost of repair of damaged vehicle – not taxable. There is really no income here. So, compensation for the amount spent for the repair of the car is not subject to tax.

c. Moral and Exemplary damages – Prof. Domondon advanced the view that moral damages and exemplary damages are taxable (he may have changed his view because when we answered this in the UPLC, we unanimously suggested that moral and exemplary damages

are tax exempt). He made mention about the definition of Gross Income under Sec 32 A “derived from whatever source.” He pointed out that there are really no clear exemptions from Gross Income and there are really no clear exemptions from Income under Title II.

The Committee in taxation in UPLC always answer this Q as not subject to tax. Under the NCC Art 2197 (you must master this) & 2229 (Exemplary damages) you should know the grounds for recovery of damages. There are 9 grounds under 2217 (you should memorize this article):

1. mental anguish 2. serious anxiety 3. wounded feeling

4. besmirched reputation 5. physical suffering 6. social humiliation 7. moral shock

8. fright 9. similar injury

The enumeration is not really exclusive because there are other grounds in the subsequent sections

If we tax moral damages, you can just imagine the effect, taxing any of the 9 grounds for which moral damages are awarded. There is really no gain or profit realized, how can we tax that? We shall not tax that, otherwise, we are in effec t taxing the grounds for which moral damages may be awarded. The is the same as in the case of exemplary

damages under 2229. Under 2229, there are 2 grounds mentioned there: 1) by way of example; and 2) as



deterrent for the commission of similar offense. If we tax that, we are in effect taxing the grounds laid down under Art 2229.

The correct answer is, and it is a unanimous decision of the members of the Committee in Taxation of UPLC – it should not be subject to tax.

Q: What about the award representing loss income or earnings or profit? He was hospitalized & wasn’t

able to earn his 2 months salary amounting to, let us say P30,000. This P30,000 is included in the judgment rendered by the court. Is this subject to tax or excluded from Gross Income?

Answer: What is clear here is that it is compensation for injuries or sickness that is not taxable. There is

an opinion expressed by 1 author that it should not be taxed because it is the result of that injury or hospitalization. I mentioned this in my book (as revised, p. 17) citing that opinion of tax experts of US. It is there in 1961 that the opinion is that this award representing loss income or profit is the one taxable. So, all damages that

may be included in the judgment of the court are tax exempt EXCEPT that amount representing loss of income. That is the one that is taxable.

Item #6. Retirement Benefits, Pensions, Gratuities, etc.:

You should try to distinguish Paragraph (a) from paragraph (b). Par (a) refers to tax exempt retirement

benefits, pensions, gratuities, etc. Par (b) is popularly known as separation pay.

Item (a) refers to that retirement benefits received from private firm, whether corporate or individual.

The Tax Code is strict on this, in that it provides 4 requisites for exemption or exclusion. But if you try to

refer to item (b), there is only 1 requisite for exemption, that is, if it is received beyond the control of the employee or official.

In Par (a) there are 4 requisites for exemption:

1. There must be BIR approved retirement plan (RA 4917); 2. The retiring employee or offi cial must be at least 50 years of age; 3. The retiring employee or official must have rendered at least 10 years of service 4. This can be availed of only once. Subsequent retirement that may be received from a private

employer is no longer tax exempt.

Compare the provisions:

In Par (b) the source of payment in the case of separation pay is immaterial. So, even if it is paid under the approved BIR retirement plan or not, exempted. Also, Par (b) does not require a certain age to avail of the

exemption, even if the employed is below 50 years of age. There’s also no requirement on the length of service. Even if he rendered only 1 or 2 yrs, if this benefits or pay is received on account or by reason beyond the control of the EE or official, it is tax exempt.

Examples of causes beyond the control of the EE or official:

a. death;



b. physical disability; c. sickness or illness

1996 Bar. An employee died and his surviving spouse received P100,000 separation pay benefits from the

ER. Is this amount subject to tax?

Others answered this Q in this way: taxable because under Sec 32 A “Gross income means all income

from whatever source.”

This Q is covered by item #6 (Sec 32 B 6 (b)). This is a tax exempt separation pay and should be excluded from the Gross Income of the surviving spouse.

So don’t always refer to Sec 32 A “derived from whatever source.” Consider also Sec 32 B. Sec 32 A is modified by Sec 32 B. Yes, it is derived from whatever source but there are items that are excluded from Gross

Income under 32 B and a retirement benefit is one of them.

Availed of only once –

Illustration: Assume that A, received from his 1st

employer 500,000. The employee is 50 yrs old, at least 10 yrs of service. Payment was made under a BIR approved retirement plan. He got employed in another ER and after rendering 10 yrs of service he retired from employer #2 and received P300,000.

“Can only be availed of once” means that the subsequent retirement benefit rec eived from private firm is no longer tax exempt. It is the first retirement benefit that is covered by the provision. So the P300,000 received from the subsequent ER is already subject to tax.

Karen

Suppose the subsequent ER is a Gov’t. Say, the employee was employed by a Government owned and controlled corporation (GOCC). Would your answer be the same? No. All benefit he received, according to RA 3231 (Revised GSIS Law), are tax exempt, including retirement gratuity. So, this limitation applies only to retirement benefit received from a subsequent private employer. It does not apply to subsequent public employee as the benefits are still exempt; not subject to tax under RA 8291

1999 Q#10: A Co., a Philippine Corporation has two divisions – manufacturing and construction. Due to the economic situation, it had to close its construction division and lay-off the employee in that division. A Co. has a retirement plan approved by the BIR, which requires a minimum of 50 years of age and 10 years of service in the same employer at the time of retirement. There are two groups of employees to be laid off:



a) Employees who are at least 50 years of age and has at least 10 years of service at the time of termination of employment

b) Employees who do not meet either the age or length of service A Co. plans to give the following

For category (A) employees – the benefits under the BIR approved plan plus an ex gratia payment of one month for every year of service. For category (B) employees – one month for every year of service For both categories, the cash equivalent of unused vacation and sick leave benefits. A Co. seeks your advice as to whether or not it will subject any of these payments to Withholding Tax. Explain your advice. SUGGESTED ANSWER: For category A employees, all the benefits received on account of their separation are not subject to income tax, hence no withholding tax shall be imposed. The benefits received under the BIR approved plan upon meeting the service requirement and age requirement are explicitly excluded from gross income. The ex gratia payment also qualifies as an exclusion from Gross Income being in the nature of benefit received on account of separation due to causes beyond the employee’s control. (Sec. 32B) The cash equivalent of unused vacation and sick leave credits qualifies as part of separation benefits excluded from gross income. For category B employees, all the benefits received by them will also be exempt from income tax, hence not subject to withholding tax. These are benefits received on account of separation due to causes beyond the employee’s control, which are specifically excluded from gross income (Sec. 32N). JAP’s ANSWER: Majority of the examinees qualifies their answer based on age & length of service; others also answering regarding the monetized unused sick leave credits. They mentioned about the 10 day rule and answered that sick leave credits are taxable. That is not correct. Answer: All of these benefits are NOT taxable. Why? They overlooked the second sentence due to economic situation. This is considered as a cause beyond the control of the employee or official. So, when the benefit or separation pay received from the employer is brought about by causes beyond the control of the employee, that is tax exempt. Disregard the source. So, don’t just take note of the benefits stated in the problem. Remember also the rule on separation pay. It must be one received on account of cause beyond the control of the employee or official. Separation pay as a result of voluntary resignation – this is subject to tax as the cause is not beyond the control of the employee or official.

In 1 Bar exam: A gov’t employee received benefits from GSIS. He deposited the amount received

& it earned interests. Q: Is the benefit representing GSIS benefit taxable? No. It is tax exempt. But as regards interest on this benefit, that is the one that is subject to tax. This is the same also with SSS benefits. If the amount received is deposited in a bank & it earned interest, such interest is subject to 20% FT. So, do not apply in this case the rule that “accessory follows the principal” because of the rule that exemptions must be strictly construed against the taxpayer and liberally in favour of the government.



SUMMARY: ITEMS INCLUDED CONDITIONS OR PARTICULARS

RETIREMENT BENEFIT FROM A PRIVATE RETIREMENT PLAN

REQUISITES: keyword – FORT a) Retiring official must be AT LEAST 50 years of age b) Approved or availed on ONCE c) REASONABLE private benefit plan approved by the BIR d) 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 private member over and above his personal contributions shall be taxable. If he has a 2nd employer and he has received benefits from the GSIS, the shall be tax exempt.

SEPARATION PAY The benefit shall be tax exempt, whether his employer is a private firm or the government provided the pay is given on account of:

a) Death b) Sickness c) Other physical disability d) For any cause beyond the control of the official or

employee Cessation of business operation due to continued losses Dissolution of the corporation Other authorized causes under the Labor Code Compulsory retirement Terminal leave pay

SOCIAL SECURITY BENEFITS, RETIREMENT GRATUITIES AND OTHER SIMILAR BENEFITS

Received by RC, NRC and RA from foreign government agencies and other private or public institutions

BENEFITS FROM US Veterans Administration – by veterans residing in the Philippines

SSS – RA 8282 Tax exempt GSIS – RA 8291 Tax exempt

COMMUTATION OR MONETIZED VALUE OF LEAVE PAY

VL SL If it forms part of TERMINAL LEAVE PAY Not taxable Not taxable

If given during the taxable year but NOT retirement to

RR – 10 – 2000

Government employees Tax exempt Tax exempt

Rank-and-file Exempt up to 10 days Unused - taxable



Item #7 Miscellaneous Items: I am confident that 1 or 2 on this item will be asked in the coming bar! 4 most important items: Paragraph a, b, c & d Par. (a) refers to investments in the Phils. By any of these:

1. Foreign government 2. Financing institutions controlled or financed by the foreign government 3. Regional or international financing institutions established by the foreign government

****SOME PAGES MISSING HERE***

(B) 7b. Income derived by the Government or its Political Subdivisions – income derived from any public utility or from the exercise of any essential governmental functions accruing to the Government of the Phils. Or to any political subdivision thereof.

Sec. 27. Rates of Income Tax on Domestic Corporations –

(C)Government owned and controlled corporations, agencies or instrumentalities – “the provisions of existing special or general laws to the contrary notwithstanding, all corporations, agencies or instrumentalities owned or controlled by the Government EXCEPT the GSIS, SSS, PHIC, PCSO and the PAGCOR, shall pay such rate of tax upon their taxable income as are imposed by this Section upon corporations or associations engaged in a similar business, industry or activity.”

There are 2 requisites for the exemption:

a) Source – it is an income derived from the exercise of essential governmental functions. If it is derived from the exercise of proprietary function, that is subject to tax, and apply the principle Strictissimi Juris

b) Recipient – must be any of the following: a. Government of the Phils. Or Republic of the Phils. b. Political Subdivision of the State (LGU)

It does not say national Government. It says Gov’t of the Phils. Thus, in Mactan Cebu International Airport Authority vs Marcos (261 SCRA 667) the SC extensively discussed the distinction between “Gov’t of the Phils.” And “National Gov’t”. The SC said these are different. Gov’t of the Phils is synonymous with Republic of the Phils but it is different from national gov’t. Gov’t of the Phils refers to instrumentality to which the political authority is exercised throughout the Phils. This may include autonomous regions and LGU. LGU is within the contemplation of the gov’t of the Phils or RP. 1999 Bar, there was a Q regarding GOCC. Do government-owned-and-controlled corporations form

part of the Gov’t of the Phils (RP) or national gov’t? It is believed that GOCC are within the contemplation of national gov’t, so that if the income is

received by the GOCC, since it is not covered by this (2nd requirement), even if it is an income derived from the exercise of essential Governmental functions, that may be subject to tax. But this is qualified by Sec27C, as amended by RA 9337. Under Sec27C, as amended, it grants exemptions to 4 GOCCs:

1. GSIS 2. SSS



3. PHIC 4. PCSO

PAGCOR is no longer a tax exempt GOCC. This is an amendment introduced by RA 9337 which took effect July 1, 2005. So, even if the recipient is not an LGU, as it is a GOCC, exemption is granted to the 4 GOCCs under Sec27C. PAGCOR was deleted from the list.

Take note of Paragraph C & D (favourite bar Q). Par (C) Prizes and Awards:

Sec. 32. Exclusions from Gross Income –

(B) 7c. Prizes and Awards – Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievements, but only if:

a) The recipient was selected without any action on his part to enter the contest or reseeding, and

b) The recipient is not required to render substantial future services as a condition to receiving the prize or award

The Tax Code is strict with regard to Paragraph C. There are 3 requisites in Par.C, while in Par.D, there is only 1, sanctioned by their respective sports association, Phil Olympic Committee (RA 7549) 3 requisites for exemption under Par. C:

1. Prize must be received in recognition with SCRALEC (scientific, charitable, religious, artistic, literary, educational or civic achievement);

2. No action on his part to enter the contest or proceedings; 3. Unconditional receipt of such prize – meaning that the recipient is not required to render

substantial future services as a condition to receiving the prize or award

2000 Q#10: Jose Miranda, a young artist and a designer, received a prize of 100,000 for winning in the on-the-spot peace contest sponsored by a local Lions Club. Shall the reward be included in the gross income of the recipient for tax purposes? Explain.

a) Answer: Yes. It is in recognition of his artistic achievement but since he performed an act – he qualified as a contestant – we pointed out that in the absence of the 3 requisites, the 100,000 received must be subject to tax. Exemptions must be strictly construed against the taxpayer.

Par. (d) – Prizes and Awards in Sports Competition

Sec. 32. Exclusions from Gross Income – (B) 7d. 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 Phils or abroad and sanctioned by their national sports association.

Sec. 32 B 7d provides only 1 of the Rules under RA 7549. RA 7549 (which is the one you will find in 32 B 7d) provides that the recipient is exempt from income tax; it is excluded from Gross Income.



There are other Rules which are not incorporated in the Tax Code; the other Rule is the donor or contributor of the award is not subject from donor’s tax. If your read Sec. 101 A (3) (Note this as this is a favourite Q under donor’s tax), this particular contribution or donation is not covered, but it is still exempt. The donor or contributor is exempt from donor’s tax, not under the tax code but by virtue of RA 7549.

Q: Is the contribution a deductible contribution? a) According to RA 7549, it is a deductible contribution. But if you read Sec. 34H

(exemptions), it enumerates all those deductible contributions, and this is not one of them.

b) To reiterate, it is deductible not under the provisions of the Tax Code but because of RA 7549. It is RA 7549 that is the source of the Rule that the donor of the award is exempt from donor’s tax. It is also the law that allows the contribution as deductible from the Gross income of the donor or contributor.

1990 Q# 10: Onyoc, an amateur boxer, won in a boxing competition sponsored by the Gold Cup Boxing Council, a sports association duly accredited by the Philippine Boxing Association. Onyoc received the amount of P500,000 as his prize which was donated by Ayala Land Corporation. The BIR tried to collect, income tax on the amount received by Onyoc and donor’s tax from Ayala Land Corporation, which taxes, Onyoc and Ayala Land refuse to pay. Decide.

a) Answer: The prize will not constitute a taxable income to Onyoc, hence the BIR is not correct in imposing the income tax. RA 7549 explicitly provides that “All prizes and awards granted to athletes in local and international sports tournaments and competitions held in the Philippines or abroad and sanctioned by thei r respective national sports associations shall be exempt from income tax.”

b) Neither is the BIR correct in collecting the donor’s tax from Ayala Corporation. The law is clear when it categorically stated “that the donor’s tax of said prizes and awards shall be exempt from the payment of the donor’s tax.

But this Q may be asked also: How about the amount of the contributions? Can that be claimed as deductible contributions?

a) Under RA 7549, YES. (You must state the # of the law to impress the examiner… 75 – grade you must obtain; 49 – avoid this, mortal sin!)

So to summarize, in paragraph d, the following are exempted: 1. The recipient of the award – exempt from income tax 2. Contributor/donor of the award – exempt from donor’s tax 3. Contributor/donor is allowed to claim the same as deductible contribution. This is based

on RA 7549 and not on the Tax Code.

Under the Old Tax Code, the following items were EXCLUDED from Gross income a) Informer’s reward

Under the Present Tax Code (as amended by RA 8424 Sec. 282), this informer’s reward is now subject to 10% FT (effective January 1, 1998)

b) Interest in income on Gov’t securities



This has been deleted from the enumeration under the Present Tax Code. This means that it is now taxable.

c) Interest income from bank deposit maintained under the Expanded Foreign Currency Deposit System Under the Old Tax Code, it made no distinction, irrespective of the recipient or depositor, tax exempt. Under the Present Tax Code, if it is received by Resident Taxpayer t is now subject to 7.5% FT. It is exempt only if the recipient is a non-resident taxpayer (individual or corporate).

SUMMARY ON MISCELLANEOUS ITEMS: INCOME DERIVED BY FOREIGN GOVERNMENT FROM THEIR INVESTMENTS IN THE PHILS

INCLUDES: a) Foreign government b) Financing institutions controlled by FX government c) Intl or regional FI established by FX gov’t

Reason: To lessen the burden of foreign loans in as much as the interest of these loans are, by contractual arrangement, borne by domestic borrowers COVERS THE FF INCOME GIVEN BY (a-c): INTEREST INCOME

1. From bank 2. On loan granted 3. On certificate of indebtedness on banks issued in ___ 4. Dividend income received from DC – stock investment income

INCOME DERIVED BY THE GOV’T OR ITS POLITICAL SUBDIVISIONS

To be exempted it must be derived from GOVERNMENTAL FUNCTIONS XPN: Proprietary Income of the ff are tax exempt:

1. GSIS 2. SSS 3. PHIC 4. PCSO Note: PAGCOR is no longer tax exempt – RA 9337 Expanded VAT

PRIZES AND AWARDS REQUISITES: 1. received in recognition with SCRALEC (scientific, charitable,

religious, artistic, literary, educational or civic achievement); 2. Recipient was selected without any action on his part to enter

the contest or proceeding; 3. Recipient is not required to render substantial future services

as a condition of receiving the prize

PRIZES AND AWARDS IN SPORTS CCOMPETITIONS

Under RA 7549, the venue is immaterial BUT the sports competition must be sanctioned by the Philippine Sports Competition. TAX TREATMENT:

Exempt from income tax



Donor or contributor is exempt from donor’s tax under RA 7549

He may claim the same as a deduction in addition to those available under Sec. 34H

13th MONTH AND OTHER BENEFITS

Total exclusion shall not exceed P50,000

GAINS FROM SALE OF BOND, DEBENTURES OR OTHER CERTIFICATE OF INDEBTEDNESS

Maturity of more than 5 years

GAINS FROM REDEMPTION OF SHARES IN MUTUAL FUND

Hanz

V. CORPORATE INCOME TAX

These are the provisions that apply to corporate taxpayers:

1. Under Sec 22B – you’ll find therein the definition of Corporate taxpayers, the meaning of corporation for purposes of income tax;

2. Sec 27, 28 and 29 – these provisions lay down different corporation rules

3. Sec 30 enumerates 11 tax exempt corporations 4. Sec 34, allowable deductions from GI of Corporate Taxpayers 5.

Tax Exempt corporations: Sec 22B enumerates 3 tax exempt ass ociations or entities. Add those tax exemptions

GOCC under Section 27 C, as amended by RA 9337. As amended, there are 4 tax exempt GOCC. Also add Sec 30 (11 items). So, all in all, there are 18 tax exempt corporations.

Sec 22B – Definition of Corporation for purposes of Income Tax – Corporation includes partnership[ no matter how created or organized. There are 6 cases cited by the SC on this and there is also a BIR Ruling on this.

“No matter how created or organized”

EVANGELISTA v. COLLECTOR (104 Phil 42): According to the SC, the phrase simply means that coporations may be formed or organized in writing, orally or in a public instrument. It requires no particular form under which

a partnership may be formed and organized.

RALOS v. RALLOS: 2 persons made a contribution to a common fund for the purpose of engaging in a profit oriented business. So, there was a contribution to a common fund. Remember that under the law on

Partnership, a partnership is formed or created or organized if these 2 requisites concur:

1. Contribution to a common fund, and 2. Intention to divide the profit among themselves

In this case, they have the intention to divide the profits among themselves. These persons, according to its SC

formed a taxable unregistered business.



GATCHALIAN v. COLLECTOR: 15 persons made a contribution to a common fund to buy a sweepstakes ticket and agreed to divide the winnings among themselves. The SC held that there was a partnership formed.

REYES v. COLLECTOR (1960 case) Father & son purchased a building and put up a business. They agreed to divide the profit. Then an administrator was appointed. The SC said that there was a partnership created. These father and son formed a taxable unregistered partnership.

ONA v. CIR (45 SCRA 74 Favorite Bar Q; 1972 case asked 1997 bar): As a rule, co-ownership is tax-exempt because the co-owners formed the co-ownership not for profit but for common enjoyment. One of the causes that give rise to co-ownership is inheritance. The heirs are considered co-owners and in trial stage, they cannot be considered as

unregistered taxable partnership. Here in Ona, after partition, the co-owners made a contribution to a common fund out of their inherited properties. The allow one of them to administer the properties and the survivin g spouse made use of these funds and made investments in business that produced income. The SC said, the co -ownership

was converted into a taxable unregistered partnership because:

a) The heirs made a contribution to a common fund; and b) There was an intention to divide the profits among themselves.

Co-ownership may be converted into unregistered taxable partnership once the heirs made a contribution to a common fund with the intention to divide the profit among them. The SC held that the circumstance of the c ase would reveal that there was an intention to divide the profits among themselves because they authorize the

surviving spouse to administer the property and make use of these to invest in a profitable business.

Cases which are yet to be asked in the BAR:

OBILLOS, Sr. v. CIR (139 SCRA 436) – OBILLOS DOCTRINE: Obillos, Sr. entered into a contract with Ortigas Corpo. The agreement stipulates that the parcels of land be dividend into residential houses. But the children found the construction as expensive so they decided to sell the parcels of land. The BIR claimed that they formed a Partnership, “No matter how it created”.

The SC said there was no partnership created because it was just an isolated transaction. From the very beginning, the children never intended to form a partnership. There was really no intention to divide the profits

among themselves.

PASCUAL v. CIR (166 SCRA 306, 1988 case): The SC ruled that there was no taxable unregistered partnership formed or organized. Pascual acquired 5 parcels of land. They said these parcels of land for a profit. The BIR

claimed that there was a partnership formed. The SC ruled that there was no partnership formed or organized. The SC cited Art. 1769 B of the NCC, these are the tests to determine the existenc e on a partnership – it says “mere sharing of gross returns does not of itself establish partnership”. Here, they shared in the gross returns, not in the net profit. There was that absence of intention to divide the profits among themselves.

These to my mind, are the probable bar Qs. Ona case was already asked but it may be asked again. Obillos and Pascual are the most probable Q.



BIR Ruling 87-102 (April 8, 1987)

If the heirs who inherited a property, an appointment in this case, whereby income is deri ved on such property, continue to engage in the business (rental) and with intent to divide the rentals among themselves, then they shall be taxed as a taxable unregistered partnership.

TAX EXEMPT:

Sec 22B – 3 tax exempt entities or associations:

1. General Professional Partnership

2. Joint venture for the purposes of undertaking construction projects 3. Joint consortium for the purpose of engaging in petroleum and other energy operations

Sec 27 C – 4 tax exempt GOCC’s

4. GSIS 5. SSS 6. PHIC

7. PCSO

Sec 30 – 11 tax exempt corporations:

8. Labor horticultural organization not principally formed or organized for profit; 9. Mutual savings bank not for profit but organized for mutual purposes; 10. Beneficiary society or fraternal society/ it is organized for the benefit of the members; 11. Non-profit cemetery formed or organized for the benefit of the members;

12. Non-stock corporations which must be organized or organized or formed for gain or profit; 13. Business League, Board of Trade or Chamber of Commerce, formed or organized for the promotion of

collective business interest (Manila Stock Exchange is not qualified under this particular exemption); 14. Civic league formed or organized for the promotion of the general welfare of the people;

15. Non-stock, non-profit educational institution; 16. Government education institution; 17. Farmers cooperatives;

18. Fruit Growers Association

You need not memorize these. What is important is that you are familiar with the characteristics or features of these tax exempt corporations.

Q: Why are these corporations tax exempt? Tax reasons are: 1) They are not really organized for profits. They may be organized for charitable, educational, religious, philanthropic and other purposes. These are really non -stock corporations; 2) No part of the income of these corporations inures to the benefit of a particular member or

individual.

But memorize the last paragraph of Sec 33. This may be asked again:



Sec 30 last paragraph: “Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from

any of their activities conducted for profit regardless of the disposition made of such income, shall be subject to tax imposed under this Code”.

2002 Q #6: XYZ Foundation is a non-stock non-profit association duly organized for religious, charitable and social

welfare purposes. Last January 3, 2000, it sold a portion of its lots used for religious purposes and util ized the entire proceeds for the construction of a building to house its free Day and Night Care Center and to support its religious, charitable and social welfare projects, the Foundation leased the 300 square meter area of the second and third floors of the building for use as a boarding house. The foundation also operates a canteen and a gift shop

within the premises, all the income from which is used actually, directly and exclusively for the purposes for which the Foundation was organized.

A. Considering the constitutional provision granting tax exemption to Non-stock corporations such as those formed exclusively for religious, charitable and social welfare purposes, explain the meaning of the last paragraph of said Sec 30 of the Tax Code which states that “income of whatever kind and character of the foregoing organizations from any of their properties, real or personal or form any of their activities

conducted for profit regardless of the disposition made of such income shall be subject to tax imposed under this Code”.

B. Is the income derived a by XYZ Foundation from the sale of a portion of its lot, rentals from its boarding house and the operation of its canteen and gift shop subject to tax? Explain.

SUGGESTED ANSWER:

A. The exemption contemplated in the Constitution covers real estate tax on real properties actually , directly and exclusively used for religious, charitable and social welfare purposes. It does not cover exemption from the imposition of the income tax which is within the context of Sec 30 of the Tax Code. As a rule,

non-stock, non-profit corporations organized for religious, charitable and social welfare purposes are exempt from income tax on their income derived by them as such. However, if these religious, charitable and social welfare corporations derived income from their properties or any of their a ctivities conducted

for profit, the income tax shall be imposed on said items of income irrespective of their disposition. 9Sec 30 YMCA v. CIR)

COMMENT: Since this was asked already, the possible problem may be based on that case of CIR v. YMCA, which is

a case wherein the SC construed the meaning of the last paragraph of Sec 30.

When it says “NOTWITHSTANDING”, it implies that these 11 tax exempt corporations are not totally exempt from corporate income tax because their income derived from their properties, real or personal,

regardless of the use of the same is subject to tax because their income derived from activities conducted for profit irrespective of the use of the same is subject to tax. They are not totally exempt from their corporate income tax because they can be taxed on their income derived from the sale of their properties, real or personal. They can be

taxed on their income derived from the lease of their properties, real or personal. They can be taxed on the interest income from bank deposi t. With more reason, income derived from businesses. YMCA falls under paragraph E, “non-stock corporations, non-stock associations charitable, religious and educational organizations.”



CIR v. YMCA (298 SCRA 83)

4 arguments of YMCA in claiming that it is a tax-exempt corporation or association:

1. It invoked the constitutional exemption under Art VI Sec 28, par 3, it says that religious, educational and charitable institutions are exempt from taxation;

2. YMCA, under Art 14 Sec 4 (3), claimed that it is a NSNP educational institution, therefore exempt

from tax; 3. YMCA argued that it could not be taxed because it did not engage in a business 4. Such an amount shall never be used for business or for gain. It shall be used to carry out its non -profit

purposes which are religious, educational and charitable purposes

RULING:

1. Art VI Sec. 28 (3) applies only to property. The tax subject matter of the case is an income tax and not

property tax. 2. YMCA is not qualified as a NSNP educational institution. The SC scrutinized the pr ovisions of the Ar ticles of

Incorporation and By Laws of YMCA and ruled that it did not possess the features of NSNP educational institution.

3. Yes it did not engaged in a business. The leasing of such property cannot be considered as business. It is an isolated transaction. But this is where the provision in Sec 30 last paragraph saying “from any of their activities conducted for profit”, came into play.

` The SC construed that “whether for profit or act, that income derived from the sole of real propertt, lease of real property including personal property is subject to tax. So this is now settled that such phrase “for Profit” does not equally this provision. But the basis of this, the SC

said: “yes, that may be considered as isolated transaction, yes, we bel ieve that YMCA is not engaged in a business, but the law says “from any of their properties, real or personal.” It is immaterial whether such transaction is for business or not, as even isolated transaction is covered by this.

TRANSACTIONS COVERED

a) Income derived from the sale of real or personal properties received by any of Corp. under Section 30;

b) Income derived from the exchange of real or personal property even for isolated transaction;

c) Income derived from the lease of personal or real property or in other words, income derived from dealings in property. Recall Sec. 32 A(3) – one of the items that will form part of the GI is gain derived from dealings in property. Hence, it made mention of Real or Personal property as the source whatever the transaction – be it in the nature of sale,

exchange or lease of property.

So, 1) the income derived from the sale of real and personal property of any of these corporations under Section

30 is subject to tax; 2)the income derived from the exchange of real or personal property of any of these corporations under Section 30 is subject to tax; 3) the rent income from real or personal property of any of these corporation under Sec 30, is subject to tax; 4) as well as interest income from bank deposits is subject to 20 FT.



The SC said in this case that if YMCA derived income from deposits in the bank, that interest income is subject to 20%FT. Can it argue that the interest income shall be used to carry out its educational, religious, and charitable

purposes? No. it brings us to the argument.

4. That it being a religious educational charitable institution, the income (rent income) shall be used in

furtherance of its purpose. It is clear in the last paragraph of Section 30, “regardless of the disposition made on such income”. Disposition also means use. So, even if this income (rent income or income derived from sale or exchange or exchange of real or personal property or interest in bank deposits) shall be used in furtherance of non-profit purposes, that is not an argument b ecause the tax code categorically

says “regardless of the disposition; irrespective of use, that income is subject to tax.

Q: What about NSNP educational institutions, is this covered by the last paragraph of Sec. 30 (par H)?

There is constitutional infirmity. Don’t apply the last paragraph of Sec 30. What should be applied

in so far as NSNP educational institution is concerned is Art 14 Sec 4(3) of the Constitution. It says “as long as the revenue income shall be “ACTUALLY, DIRECTLY AND EXCLUSIVELY” used for educational purpose, EXEMPT. But here in Sec 30, even if such income is actually, directly, and exclusively used for educational purpose, it is still subject to tax.

This constitutional exemption must prevail over Sec 30. Sec 30 last par.must be amend ed to apply to NSNP educational institution.

Q: A government educational institution received interest from its bank deposits a. Is this subject to 20% FT?

YES, the last paragraph of Sec 30 squarely applies to a govt educational institutions. Govt educational institutions cannot argue that it shall be used for educational purpose.

b. Would your answer be the same if the educational institution is an NSNP education institution?

The answer would not be the same because as long as there is proof that the interest income shall be actually, directly, and exclusively used for educational purpose that is exempt from the 20% FT.

In par E it covers non-stock corporations. It includes charitable and religious institutions. YMCA falls under this. It is a charitable and religious corporation based on it By-laws. So, the last paragraph of Section 30 squarely applies to it.

Q. Is the interest income rec eived by YMCA subject to 20% FT? YES. It is a charitable and religious institution but it is not considered a NSNP educational institution.

Educational institutions are favourite Bar Q. You should know the Rules on these (Rules under Title II Exemptions from property taxation; tax treatment on donations that may be given to these educational institution – inter vivos or mortis causa)

Classifications of educational institutions:

1. Private educational institution 2. Government educational institution

3. Non-stock, non-profit (NSNP) educational institution



There may be 4 Q on these educational institutions:

Q1. Are these educational institutions subject to income tax? (be guided by Section 30)

Answer: As regards private educational – section 27 B imposes 10% preferential corporate rate of 35% as amended

July 1, 2005. The 10% preferential corporate rate applies if the income from unrelated trade, business or activity is NOT MORE THAN 50% of its total income. It means that if it is more than 50% of its total income, apply the 35% corporate rate.

As regards NSNP educational institution – Under Art 14. Section 4 (3) of the Constitution, it is exempt from income tax, property tax and customs duties. The constitutional exemption from income tax is reiterated under Section 30 (H).

Q2. What is the importance of knowing whether it is a constitutional exemption or a statutory exemption? If a l aw is pass by Congress withdrawing this exemption (Section 30 I), is that a valid law? YES. The power to grant an exemption carries with it the power to withdraw the same.

Would that be the same if the withdrawal pertains in NSNP institution?

That is UNCONSTITUTIONAL. The exemption is by virtue of a constitutional provision. Tes, the power to grant an

exemption carries with it the power to withdraw the same but it cannot withdraw Section 30(H) because it is just a reiteration of a Constitutional provision. It is the Constitution that grants the exemption.

Q3. Are donations inter vivos given to these educational institutions subject to donor’s tax? (Sec 101 A (b))?

Answer: Private educational institutions are not one of those mentioned under Section 101 A(3) . What it

mentioned there is Non-Stock corporation, that may include NSNP educational institution and government educational institution formed or organized as non-profit educational institution.

When this was asked in the bar exams, we suggested that the examinee should state these requisites for the

exemption from donor’s tax:

a. The done must be a NSNP educational institution b. The institution must be governed by the Board of Trustees

c. The Trustees received no compensation; d. The donation shall be used or devoted to the accomplishment of purposes stated in the Articles of

Incorporation e. Not more than 30% of the amount shall be used for administrative purposes

If the Government educational institution and NSNP educational institution possess these requisites/characteristics, the donor is not subject to donor’s tax with respect to donation inter vivos; given to these Government educational institution and NSNP educational institution

Q4. Is donation mortis causa made in favour of these educational institutions subject to Estate ta? (Section 87 (d)?



ANSWER: Yes. Under Section 87, the institutions covered are:

a) Transfers made in favour of social welfare organizations

b) Given to charitable institutions c) Cultural institutions

So, educational institution is not one of them. Since it does not cover educational institution, by the principle of

strictissimi juris, any donation mortis causa given to private educational institution, government educational institution and NSNP educational institution subject to tax.

SUMMARY

EDUCATIONAL

INSTITUTION

SUBJECT TO:

INCOME TAX PROPERTY TAX DONOR’S TAX ESTATE TAX

PRIVATE 10% preferential corporate rate if the income from unrealised

business is more than 50% of the total income; if not more

than 50% than normal corporate rate of 35%

Exempt provided actually, directly and exclusively used for

educational purpose

Donor is subejt to tax Sec 101 A (3) does not include private

educational institution

Donation is subject to Esate tax as Sec 87 does not include

educational institutions

GOVERNMENT Exempt Exempt provided actually, directly and exclusively used for

educational purpose

Donor exempt provided that:

a. The

donee/government educational institution is organized as non-

profit educational institution;

b. The institution must

be governed by the Board of Trustees;

c. The Trustees received no

compensation d. The donation shall be

used or devoted to the accomplishment

of purposes stated in the Articles of Incorporation

Not more than 30% of the amount shall be used for administration

Donation is subject to Estate tax as Sec 87 does not include

educational institutions



purposes

NSNP Exempt Exempt provided

actually, directly and exclusively used for educational purpose

Donor exempt

provided that:

e. The donee is organized as non-

stock non-profit educational institution;

f. The institution must

be governed by the Board of Trustees;

g. The Trustees received no

compensation h. The donation shall be

used or devoted to

the accomplishment of purposes stated in the Articles of Incorporation

i. Not more than 30% of the amount shall be used for administration

purposes

Donation is subject

to Estate tax as Section 87 does not include educational

institutions

TAX TREATMENT ON CORPORATIONS

TAX RATE GOVERNING PROVISIONS

MCIT 2% on Gross Income Sec 27B and 28A (2)

BPRT 15 of profits applied or earmarked for remittance

Sec 28A (5)

TAX SPARING CREDIT 15% Sec 28B 5B

IAS 10% Sec 29

BPRT – Marubeni v. CIR (177 SCA 500)

TAX SPARING CREDIT (Sec 285) (???)

Cases are: Protector and Gamble Phils. V. CIR (160 SCRA 560)

Wander Phils. V. CIR (160 SCRA 573)

Protector and Gamble Phils. V. CIR (204 SCRA 377)

You should also be aware of the modification on the BOAC Doctrine



Illustration:

2000 2001 2002 Normal Income Tax 60,000 100,000 100,000

MCIT 200,000 50,000 60,000

Tax payable (higher between MCIT & normal tax)

200,000 100,000 100,000

LESS: excess MCIT over normal Distribute the 150,000 (200,000- 50,000) excess MCIT for the next 3 succeeding TAXABLE year.

100,000 50,000

NET AMOUNT of TAX PAYABLE 200,000 -0- 50,000

2. Another equitable provision is that MCIT applies only after 4 years from the commencement of the

corporate business and not in the first year of operation. If you apply this in the 1sy year of corporate

existence- the year of adjustment of corporation-that would be unjust. (Sec. 27 E) The law assumes that

corporations are already financially stable on its 4th year of operation.

3. This may be suspended under equitable exceptional circumstances (Sec. 27 E (3)):

a. Suspended in the sense that upon the cessation of this cause. MCIT shall automatically be applied.

b. Prolonged labor dispute experienced by the corporation.

Equity dictates MCIT must be suspended. This is clarified by RR 9-98. What is meant by prolonged labor

dispute that will justify the suspension of this MCIT? The must be brought about by a labor strike and

have lasted for than 6months and it must result in the shutdown of the business operations.

c. Force Majeure

(This is construed under RR9-98 to include FILES (Flood, Insurgency, Lightning, Earthquake, and Strom)

d. Financial business reverse/lossess brought about by FERT (Fire, Embezzlement, Robbery, Theft)

2 Corporations covered by MCIT

a. Domestic Corporations (Sec.27 E); and

b. Resident Foreign Corporations (Sec. 25 A2)

4 Tax Exempt Domestic Corporations from MCIT under RR 9-98

a. Private or proprietary educational institutions;

b. Non-profit hospital;

c. Depositary bank that operates under the Expanded Foreign Currency Deposit System

d. Enterprises or firms registered with:

1. PEZA pursuant to RA 7960

2. registered with Basic Conversion Development Authority

Resident Foreign Corporations not subject to MCIT

a. regional headquarters of multinational corporations doing business in the Phils.



b. those engaged in offshore banking activities

c. international carriers which may include international airlines and international shopping or vessel

d. enterprises or firms registered with


2. Registered with Basic Conversion Development Authority

2001 Q# 9b: I a corporation which is exempted from MCIT automatically exempted from the regular

corporate income tax? Explain your answer.

Answer: No. Corporations may be exempted from MCIT but are still subject to corporate income tax.

The MCIT is a proxy for the normal corporate income tax, not the regular corporate income tax paid by a

corporation. For instance:

a. Private or proprietary educational institution-exempt from MCIT automatically exempted from the

regular corporate income tax of 10% under Sec. 27 B depending on its dominant income

b. Non-profit hospital – exempt from MCIT but subject to 10% or 35% as the case may be exempt from

MCIT but subject to 10% FT

d. Enterprises or firms registered with:


2. Registered with Basic Conversion Development Authority

Exempt from MCIT but subject to 6% special corporate rate

Improperly Accumulated Earnings Tax of 10% (new provision-has yet to be asked in the Bar)

Q: Explain the rationale of this new corporate rule imposing what is known as IAET

Sec. 2 RR 2-2001- Don’t just try to memorize this. Understand the implication so that you can easily

recall the provision.

Answer: In a domestic corp., if dividends are declared and distributed to stockholders, the stockholders

are subject to the 10% tax on these dividends. The source of these dividends is earnings (Sec. 43 says

unrestricted R/E). Let us say, the corporation improperly accumulates the corporate earnings. It

withheld the declaration of dividends. The effect of this is that the Govt. was deprived of the right to

impose tax on the dividends. Improperly accumulated earnings means that the corporation is not

justified under the circumstances.

As clarified by RR 2-2001 Prima facie Instances of IAE includes the following:

1. Based on 2nd par. Of Sec. 43 of the Corporation Code- stock corporations are prohibited from retaining

surplus profits in excess of 100% of its paid in capital. If there’s a violation of this, RR 2-2002 says that

this may give rise to IAE. This is a classic case wherein the 10% may be imposed;

2. When substantial earnings and profits of the corporation were invested in unrelated trade business or

activity of the corporation;



3. When such corporation made an investment in bonds and other long-term securities.

This is a good Q in the Bar- What are the 3 instances that may give rise to prima facie evidence of IAE.

On the other hand, when is it proper to accumulate earnings in excess of 100% of paid in capital?

Sec.43 Corporation Code & RR 2-2001:

1. When justified by definite corporate expansion projects or programs approved by the BOD; or

2. When the corporation is prohibited under any loan agreement with any FI or creditor, whether local

or foreign from declaring dividends without its/his consent and such consent has not yet been secured;

or

3. When it can be clearly shown that such retention is necessary under special circumstances obtaining

in the corporation, such as when there is a need for special reserve for probable contingencies.

4. To purchase land or building approved by the BOC.

Note: There are 6 cases under RR 2-2001 but these 4 are notable ones.

Sec. 29. Imposition of Improperly Accumulated Earnings Tax

B (2) Exceptions – The IAET as provided for under this Section shall not apply to

a. Publicly-held corporations;

b. Banks and other non-bank financial intermediaries; and

c. Insurance companies.

Since corporation covered are closely held corporations not covered are the following:

Under Sec. 29- 3 (BPI):

1. Publicly held corporations;

2. Banks and other non-bank financial intermediaries; and

3. Insurance companies.

In RR 2-2002, there are additional exempt corporations in addition to the the 3 mentioned in Sec. 29:

4. Taxable partnership

5. General Professional Partnership

6. Non-taxable joint ventures

7. Enterprises duly registered pursuant to the Bases Conversion and Development Act of 1992 under RA

7227.

These are the 8 corporations or entities which are not covered by the 10% tax on Improperly

Accumulated Earnings.

What was asked in the 2001 Bar is tax exempt corporations from MCIT. If this will be the trend the Q

may be corporations which are not subject to the 10% IAE (Sec. 29)

Branch Profit Remittance Tax of 15% (Sec. 28 A (5))



2 amendments were introduced by RA 8424. These amendments refer to the basis and the enterprise

not subject to 15% FT.

Sec. 28 A- Tax on Resident Foreign Corporations—

Tax on Branch Profit Remittance- “Any profit remitted by branch to its head office shall be

subject to a tax of 15% which shall be based on this 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. Xxx Provided, that interests, dividends, xxx received by a

foreign corporation during each taxable year from all sources wihin the Philippines shall not be treated

as branch profits unless the same are effectively connected with the conduct of its trade or business in

the Philippines.

Questions that must be answered:

1. What constitutes branch profits subject to 15% Ft?

2. What is the tax base of the 15 FT?

3. What are the tax exempt branch profits?

Q#1 MARUBENI CORP vs. CIR (177 SCRA 500) 1999 Q #9:

HK Co. is Hongkong company, which has a duly licensed Phil. Branch, engaged in tradition activities in

the Phils. HK Co. also invested directly in 40% of the shares of stock of A Co., a Phil. Corporation. These

shares are booked in the Head office of HK Co. and are not reflected as assets of the Phil. Branch. In

1998, A Co. declared dividends to its stockholders. Before remitting the dividends to HK Co. A Co. seeks

your advice as to whether it will subject the remittance to WT. No need to discuss WT rates, if

applicable. Focus your discussion on what is the issue.

SUGGESTED ANSWER:

I will advise A Co. to withhold and remit the withholding tax on dividends. While the general rule is that

a foreign corporation is the same juridical entity as its branch office in the Phils. when, however, the

corporation transacts business in the Philippines directly and independently of its branch, the taxpayer

would be the foreign corporation itself and subject to the dividend tax similarly imposed on non-

resident foreign corporation. The dividends attributable to the Home Office would not qualify as

dividends earned by a resident foreign corporation which is exempt from tax.

JAPS ANSWER:

Branch Profits are gains or profits which are effectively connected with the trade or business in the Phils.

That is exactly the last provision of Sec. 28 A. The case of Marubeni Corp. involves a direct investment by

the mother corporation (Marubeni Japan) in the Philippines corporation. It received income for such

direct investment. Marubeni Japan claimed that that should form part of the branch profit subject to

this 15% FT.



RULING: It should not form part of the branch profits because such investment has no connection with

the trade or business conducted in the Philippines.

With this ruling of the SC, we can now say that to be considered as effectively connected with the trade

or business in the Philippines. It must be one that is made by the branch office. If the investment is

directly made by the mother corporation, the income or profit derived therefrom cannot be considered

as branch profit subject to this 15% FT. Don’t be misled if in the problem the mother corporation

invoked that “under the principal-agent relationship theory, that may be considered as branch profit or

profit of the branch office. Principal-agent relationship was rejected by the SC. You cannot apply that

theory which dictates that the profit of the mother corporation is considered as profit of the agent and

vice versa. It is not applicable because there is a clear provision under the Tax Code. This has not been

amended. That is. It must be effectively connected with the conduct of trade or business in the

Philippines. It may be considered as branch profit if that investment is made through the branch office.

Q: What is the basis of this 15% FT?

There are 2 decisions of the SC: City Bank case and Chartered Bank case. The Sc based its rulings on the

old provisions because these 2 cases were promulgated before the effectivity of RA 8424. The SC said

that the 15% branch profit remittance tax should be based on profits actually remitted. This is no longer

the rule. With the effectivity of RA 8424 amending that particular provision, the basis now is it is no

longer the amount actually remitted it is the amount applied or earmarked for remittance. So, in the

problem, it is possible that the amount applied or earmarked for remittance is %M. Amount actually

remitted is 4M. This is the old rule which is deemed repealed by Sec. 28 A5.

Q#3. Tax exempt branch profits- profits earned or derived by firms or enterprises registered under

Philippine Economic Zone Authority. Under the old Tax Code, it was Export Processing Zone Authority.

But now, it under PEZA.

Carlos

TAPSI PART I

Tax Sparing Credit: (Sec. 28B5b):

What is the situation contemplated therein?

* Q#1: NRFC rec eived a dividend from a Domestic Corporation. So, the income subject matter of that provision is dividend income. Is that taxable? YES, that is taxable.

If it is taxable, is it subject to corporate FT or regular corporate rate?

- The tax rate is in the nature of a FT (I t is mentioned in Sec. 28B5b, and it made mention of Sec. 57A – this is the rule on Final Withholding tax – there are 26 items in Sec. 57A and this is one of them). This means that this 15% corporate income tax is a FT. Since it is a FT, the source (w/c is the domestic corporation) is

considered as the withholding agent of the government. And applying the Rule under RR 2 -98, as withholding agent, it is one legally obliged to pay the tax.



* Q#2: Why is it that the corporate rate has been reduced to 15%? The SC in the case of Proctor & Gamble Phils.

said that the purpose of the tax code is to attract/encourage foreign investment. If we reduce the tax rate from 35% to 15%, is there a tax saved or spared?

Yes. As described by the SC, this is known as the Tax Sparing Credit. So this implies that there is a tax saved.

Try to analyze, 35% would have been the applicable corporate income tax but Sec.28B5b reduced it to 15%. So the tax saved percentage wise, is 20%.

* Q#3: What is the condition for the imposition of this 15% reduced corporate rate?

A condition sine qua non to the imposition of reduced corporate rate is that the foreign government, in the language of Sec. 285b “shall allow tax credit on taxes deemed paid in the Philippines by this foreign corporation.”

* Q#4: When it says “shall allow tax credit on taxes deemed paid in the Philippines” what does that mean? Will these corporations be obliged to present clear and convincing proof of the amount actually granted as tax Credit?

This now brings us to the 2 cases decided by the SC on the same date (April 15, 1980):

1. Procter & Gamble Phils. vs. CIR (160 SCRA 560)

2. Wander Phils. vs. CIR (160 SCRA 573)

These 2 cases were decided on the same date but were in conflict with each other (the jurisprudence has yet to be asked in the bar).

In the Procter case, according to Justice Paras of the 2nd

Division, there should be proof of the amount actually

granted as tax credit. However, in the Wander case decided by the 3rd

Division of the SC, did not make any ruling to that effect. It can be inferred from the WANDER case that proof as to the actual amount granted as a tax credit need not be necessary.

Prevailing Doctrine laid down in the MR of the Procter case (204SCRA 377)

On Dec. 02, 1991, acting on the MR fi led by Procter & Gamble, SC En Bank ruled that “the Tax Code does

not acquire actual grant”. It says “Shall allow”, it did not say “Actual grant”. The SC is absolutely correct in its ruling that since the Tax Code does not require actual grant, proof of the amount granted as tax credit by the foreign Govt. is enough. According to the SC, this is an old provision, except for the tax base. This provision is the same as the old tax code. And there is really no BIR Ruling requiring actual grant.

So, the prevail ing view is “No proof of the actual amount granted as tax credit” “What is only required is to prove that the foreign Govt allows such tax credit.”

Q. How do you prove if the foreign Govt allows tax credit?



Refer to the Revenue Code of the foreign Govt. In fact, in the Procter case, there is a provision in the U.S. Revenue Code allowing tax credit to these American corporations.

Twice asked in the BAR” Whether or not the withholding agent (subsidiary corp., in this case Procter Phils.) has the legal personality to file written claim for refund.

In the Procter case, the 2nd

division of the SC said” It is the mother corporation that has a legal personality to file the written claim for refund because the mother corporation is the one considered as the taxpayer. Since withholding agent is not considered as taxpayer, it has no legal personality to file a claim for refund.”

But in the Wander case, the 3

rd division said “Withholding agent has the legal personality to file a

written claim for refund.

This issue was also resolved by the SC en banc in the MR of the Procter case on Dec. 2, 1991. The

SC en banc ruled that the withholding agent is not only an agent of the Govt; it also an agent of the taxpayer. Since it is an agent of the taxpayer, it is technically considered as a taxpayer. As

such, it has legal personality to file a written claim for refund. (The SC cited the case of Phil. Life Insurance vs. CIR: SCRA 15). “It is an agent of the Govt for the collection of taxes and it is an agent of the taxpayer for the fi ling and payment of income tax

SUMMARY:

PROCTOR & GAMBLE vs. CIR – WANDER PHILIPPINES vs. CIR PROCTOR & GAMBLE vs. CIR April 15, 1988 April 15, 1988 MR – Dec 2 1991

WHETHER THE WITHHOLDING AGENT OF THE MOTHER CORPORATION MAY

FILE FOR A WRITTEN CALIM FOR REFUND

NO personality to file an action for refund because only the mother

corporation can file the same since it is the TP.

YES, since the agent is an agent of the TP and likewise an agent of the

government. It is an agent of the mother corporation since it is the one responsible for the reporting of such, an income – CONTROLLING

DOCTRINE

YES – Under sec. 222, in case of failure to remit the tax withheld the

agent shall be liable for the same.

PROOF NEEDED TO AVAIL OF THE TAX CREDIT

There must be proof of the actual amount of the tax credit by the FY

Actual proof is not required

Sustained Wander ruling – the law didn’t: mention “actual” – the

amount actually allowed need not



government . be proved, it would suffice that under the Tax Code of the FX /Govt,

it allows its corporation to claim tax credit for the taxes paid in FY governments.

BOAC DOCTRINE (take note of the modification as to tax situs)

Doctrine #1. Sources of income – it reiterates the settled rule that the sources of income are P.A.S

(Property, Ac tivity and Service). Recall the technical definition? Income is a gain derived from CAPITAL, LABOR or BOTH labor and capital (Fischer vs. Trinidad(?). In BOAC case, it just changed the terms: from

capital to property, labor to services; but activity is added. This is now brings us to the 2nd

doctrine.

Doctrine #2, When can you say that an income is derived from sources within? It is also in this case that

the SC enunciated the rule that “An income is considered as income WITHIN when the source of such

income is undertaken within the Philippines”. In the BOAC case, what is the determinative test of that income considered within? It is an Income derived from sources within when the source of the same is made or conducted or undertaken in the Philippines. So, it is considered income WITHIN if: the property from which the income is derived is situated in the Philippines; or the activity from which such income is

derived is undertaken in the Philippines; or if the service is performed within the Philippines. That’s the meaning of that.

Doctrine #3. Stale-Partnership Theory – The Philippines has the right to tax the same because it enjoys the

protection of the Philippine Govt. It can be taxed if the particular subject of taxation enjoys the

protection of the Philippine Govt. If that subject of taxation does not enjoy the protec tion of the Phil. Govt. (Theory of Protection reiterated in the BOAC case), we cannot tax that. So, in the BOAC case, the SC said that an income derived from the sale of transport documents (airline tickets) can be taxed because

such activity enjoys the protection of the Phil. Govt. This now brings us to the tax situs of sale transport document.

In BOAC case, the tax situs is the place of sale or place of payment. This has been changed or

modified by SEC. 28 A (3). The composition of Gross Phi. Billings or the determinative test of those revenues that would constitute Gross Philippine Billings has been changed by RA 8424.

Under the BOAC case, it is the place of sale or payment

Now, it is the origin of passengers, baggage, cargoes and the like.

This in effect changed the tax situs under Sec. 42A (6) – it speaks of sale of personal property and this may include sale of transport document or intangible personal property. In Sc. 42a (6), the tax situs is the place of sale. This is modified by SEC 23 A (3), that is, if the subject of sale is a transport document then consider the origin of the passengers, baggage or cargoes. As amended by RA 8424. Gross

Philippine Billings may now consist of revenue that may be derived from the transport of passengers, cargoes and the like, irrespective of the place of sale or payment.



RR 15-2000 now declares that off-line international airlines cannot be taxed on the income derive from the sale of transport documents where the passengers and cargos do not originate from the

Phils.

1994Q#15: An off l ine international airline sold transport documents (airline ti ckets) ir, the Phils. to his clients and officers. Can this off line international airline be taxed from income derived from the

sale of transport documents?

Under the BOAC case, YES because while it is true that it rendered no service, no property in th e Philippine from which income may be derived; there was that ACTIVITY. There was such activity

undertaken in the Philippines. The SC said that the activity refers to the sale of transport document. Since these transport documents are sold in the Phili ppines, payment is made in the Philippines, the flow of wealth therefore, occurred within the Philippines.

The rule now has been changed. We can no longer tax this. The origin of the passengers,

baggage or cargoes must be here in the Philippines.

VI. ALLOWABLE DEDUCTIONS & PERSONAL AND ADDITIONAL EXEMPTIONS:

The TP must point to some specific provisions of the statute authorizing the deduction and he must be

able to prove that he is entitled to the deduction authorized or allowed.

If a TP fails to deduct certain expenses for the taxable year, he cannot deduct them from the income of the next year or any succeeding year.

The following are not allowable to claim deductions – their tax base is GROSS INCOME

a. NRA – NETB

b. NRFC

EXCLUSION FROM GROSS INCOME

Section 326

Refers to a flow of wealth which doesn’t form part of the gross income because they are excluded by the TC or by special laws or the Constitution material to arrive at gross income – exclude such items to arrive at gross

income

something earned or received which do not form part of gross income.

ALLOWABLE DEDUCTIONS

Section 34

Refers to amounts which the law allows as deductions from gross income in order to arrive at net income or taxable income.

necessary to arrive at net or taxable income

something paid or incurred in earning gross income



As to nature

As to purpose

As to claimant

As to amount

As to kinds of deductions or exemptions

ALLOWABLE DEDUCTIONS

In the nature of business expenses

Is to recover or recoup the cost of doing business

may be claimed by individual and corporate TPs

Except: 1) NRA-NETB (Sec. 25B, basis us GI)

2) NRFC (Sec. 28 B1, basis of 35% is GI)

The actual expenses paid or incurred in the conduct

of trade, business or profession

Under /sec. 34 are classified into:

1) Itemized deductions

2) Optional Standard Deductions of 10% of GI

PERSONAL EXEMPTIONS

In the nature of personal, living or family expenses

To recover the personal living and

family expenses paid or incurred during the taxable year

Are granted only to individual TP

except NRA-NETB

Arbitrary amounts granted to

approximate the personal expenses that may be incurred by individual TP

Exemption may be classified info:

1) Basic personal exemption

2) Addt’l personal exemption PEX for every qualified dependent,

legitimate, recognized illegitimate child or children not more than 4.

Sec. 35D – Rule on reciprocity regarding NRA-ETB

It only applies to basic personal exemptions and should not exceed our maximum basic personal

exemption:

For married individual = 32,000

Head of the family = 25,000

Single = 20,000

Q: A. A non-resident foreigner was doing business here in the Philippines. He is married and has 2 minor children

Check if the country of the foreigner allows basic personal exemption to the citizens of the Phils.

If no personal exemptions is granted by his govt. we cannot grant him any personal exemption.



But if his gov’t allows basic personal exemption to Filipino citizens, we can grant him basic personal exemption but th e amount must not exceed our maxim basis personal exemption.

Example: his country allows 25k basic personal exemption to married Filipinos. Then he is also

entitled to 25k basic personal exemption here in the Phils. If his country allows 40k as basic personal exemption to married Filipinos in his country, he is only entitled to a basic personal exemption of 32k as the amount is the maximum basic personal exemption granted by our

country to a married person.

The foreigner cannot claim additional exemption as regards his 2 minor children as the rule on

reciprocity applies only to basic personal exemptions.

OSD of 10% GI vs. Itemized deductions :

CLASSIFICATIONS OF DEDUCTIONS

As to proof

As to claimant

ITEMIZED

substantiated by receipts or documents

claimed by individual and corporate TP

OPTIONAL STANDARD

requires no proof of expenses or

incurred because allowable deductions is 10% of GI or Gross receipts

claimed only by 3 individual TP: a. RC b. NRC

c. RA

Q: Suppose your friend asks you about these 2 deductions, would you advise him to avail of itemized

deductions or OSD of 10%?

Answer: It depends upon the circumstances of the case. If your friend has receipts or documents

which may substantiate all the expenses, it’s better to ava il of the itemized deduction because he

can claim more deductions. On the other hand, if he has no receipts to substantiate the expenses incurred, he should avail of the 10% OSD. No proof or receipts are required to avail of the 10% OSD.

ALLOWABLE DEDUCTIONS FROM GROSS INCOME: Section 34

Business expense

Interest expense

Taxes

Losses

Bad debts

Depreciation



Depletion of oil and gases wells and mines

Charitable and other contribution

Research and development

Pension trust

Additional requirements for deducti bility of certain payments

Optional standard deduction

Premium payments on health and/or hospitalization insurance of an individual TP

COMMON REQUISITE OF DEDUCTIONS:

Must be incurred in the exercise of the TP’s the trade or business

Incurred during the taxable year EXCEPT losses which may be turned over

Must be substantiated by receipts

Must be reasonable

Must not be contrary to law, public, morals or public policy

Favorite Bar Questions:

A) Sec. 34 A (1) – Ordinary and Necessary expense

B) Sec. 34 B – Interest expense

C) Sec. 34 C – Taxes (re: Tax Benefit rule; asked 2003 Bar; Q was modified in 2005 Bar)

D) Sec. 34 D – Losses

E) Sec. 34 E – Bad Debt Expense

Tax Benefit Rule: (Sec. 34 C (taxes) and 34 E (bad debts):

What is the provision under the Tax Code which enunciates the Tax Benefit Rule? This applies to two

provisions under Sec.34, paragraphs C and E. there is that common provision on income tax benefit.

Paragraph C provides; “shall be included in the gross income in the year of receipt to the extent of the

income tax benefit of said deduction”. So, this is refers to tax refund.

Paragraph E deals with recovery of bad debts. The provision says: “shall be included in the gross income in the year of recovery to the extent of the tax benefit of said deduction”

These are the provisions on “Tax Benefit Rule”. it applies to 2 cases:

1. Tax refund



2. Recovery of bad debts written off

Tax refund:

“shall be included in the C in the year of receipt to the extent of the income tax benefit of said deduction” --- it talks about deduction, so it means that what is involved is a deductible tax. This must be a deductible tax and must be actually claimed as deductions. That is precisely the tax benefit --- it is one that may reduce the taxable income. Stated otherwise, that ma y only reduce the taxable income if it is a deductible

tax.

Example: 2003 taxable year:

Net income before tax 150,000 Less: Local business tax (50,000) Taxable Income 100,000

In 2004, the Local business tax of 50,000 was recovered through a r efund because it turned out that the

taxpayer is tax exempt. This 50,000 tax refund is subject to tax because applying the tax benefit rule, it

was claimed as deduction and therefore it reduces taxable income by 50,000. It reduced your taxable income by 50,000.

However, if the taxpayer receives no tax benefit, the recovery of such tax refund may not result to taxable

income. Example is when the tax refunded is a non-deductible tax. If a tax refunded is a non-deductible tax, it is not subject to income tax in the year of recovery because it did not result in a tax benefit as it did not reduce the taxable income of the taxpayer for the simple reason that it is not a deductible item.

So you ought to know what are non-deductible taxes because if the tax refunded is a non-deductible tax, common sense will tell you it never reduced the taxable income in the preceding year. There is no tax benefit, so there is nothing to tax. In short. It is not taxable.

TAXES:

Sec. 34 C-Non-deductible taxes (S-I-D-E):

1. Special assessment;

2. Income tax;

3. Donor’s Tax;

4. Estate Tax

These taxes if refunded, will not result in a taxable gain because the taxpayer received no tax

benefit

Deductible Taxes:



1. VAT;

2. Percentage Taxes;

3. Excise Taxes;

4. Documentary stamp taxes;

5. Local business taxes

Take Note: Only Local taxes are included in the coverage of the exam!!!

NON-DEDUCTIBLE TAXES

S – Special assessment tax

I – Income tax

D – Donor’s tax

E – Estate tax

NOT taxable and does not form of the gross income

DEDUCTIBLE TAXES

E – Excise tax

V – Value added tax

P – Percentage tax

D – Documentary Stamp tax

L – Local business tax

Taxable if tax refunded was a deductible tax, hence

forms part of the gross income in the year of receipt

Recovery of Bad Debts Written Off:

Same principle as that of refund applies – “to the extent of the income tax of said deduction”. It

presupposes that the bad debt was claimed as a deduction; that it was actually claimed as a deduction.

Example: 2003 taxable year:

Net income before write off o f worthless accounts 150,000



Less: Bad Debts Written off (50,000) Taxable income after BDWO 100,000

In 2004, this 50,000 was recovered by the creditor. Will this result in taxable gain?

Applying the Tax benefit rule, yes, because such taxpayer received tax benefit. By claiming

the 50,000 as deduction from the net income, it reduced the taxable income by 50,000. It

follows that if such amount was not claimed as a deduction, it will never result in a taxable income.

Suppose: Net loss (150,000)

BDWO ( 50,000)

Total net loss (200,000)

The 50,000 was subsequently recovered in 2004. Is that subject to tax?

That is not taxable because the taxpayer received no tax benefit since it was never claimed as a deduction. According to RR 5-99, the recovery of bad debts written off is a mere return of capital. The reason is simple: it was never claimed as deduction because the taxpayer has no net income in the preceding taxable year. There is

nothing to reduce.

2000 Q#8: a) What is meant by the tax benefit rule? b) Give an illustration of the application of the tax benefit rule.

SUGGESTED ANSWER:

a) TAX BENEFIT RULE states that the taxpayer is obliged to declare as taxable income subsequently recovery of bad debts in the year they were collected to the extent of the tax benefit enjoyed by the taxpayer when the bad debts were written off and claimed as a deduction from income. It also applies to taxes previously deducted from gross income but which were subsequently

refunded or credited. The taxpayer is also required to report as taxable income the subsequent tax refund or tax credit granted to the extent of the tax benefit the taxpayer enjoyed when such taxes were previously claimed as deduction from income.

b) X Company has a business connected receivable amounting to 100,000 from Y who was declared bankrupt by a competent court. Despite earnest efforts to collect the same, Y was not able to pay, prompting X company to write-off the entire l iability. During the year of write-off, the entire

amount was claimed as a deduction for income tax purposes reducing the taxable net income of X Company to only P1M. Three years later, Y voluntarily paid his obligation previously written -off to X Company. In the year of recovery, the entire amount constitutes part of the gross income of X Company because it was able to get full tax benefit three years earlier.

JAPS ANSWER:



Citing 2 cases, tax benefit rule applies to:

1. Tax Refund. It is subject to tax if the tax refunded is a deductible tax;

2. Recovery of bad debts written off. It is subject to tax if the amount recovered was claimed as a deduction from gross income in the preceding year

2005Q#2: Are the following taxable:

a) Tax refund

b) Recovery of bad debts

Answer: You really have to qualify your answer.

In letter (a) it may be taxable depending on the nature of the tax refunded, whether it is a deductible or non-deductible tax. If it is non-deductible, then it is not taxable as there is no benefit on the part of the one claiming the refund.

In letter (b) you must qualify and cite RR 5-99 if the problem states that there was a net loss in

the prec eding taxable year. It was just a return of capital, so not taxable.

BUSINESS EXPENSE:

Considered as ordinary or necessary expenses. They are directly attributable to the development management operation and/or conduct of the trade or business of the TP or in the exercise of his profession.

The enumeration of ordinary and necessary expenses under Sec. 34 A is not complete. Other reasonable

business expenses are:

Compensation for personal services rendered-ex. Life insurance premium paid by the

employer

Traveling expenses – meal and lodging

Representation

Entertainment

Advertising or promotional expenses

Rent

Repairs and maintenance – must be ordinary or incidental

Q: How do you know whether or not an expense is ordinary or necessary?



ANSWER: D-O-M: An expense is ordinary and necessary if it is paid or incurred in connection with

the DEVELOPMENT, OPERATION, or MANAGEMENT of the business or exercise of profession.

This is a new provision. Under the old tax code, there was no determinative test because as

explained by the Sc in several cases, ordinary and necessary cannot be defined with

completeness

Promotional Expenses:

CIR vs. ALGUE (158 SCRA 9):

o Q: Is the P125,000 promotional expenses considered reasonable?

o The word “reasonable” is a question of fact. It is a relative term and will depend upon the circumstances of the case and the nature of the business of the taxpayer. According to

the SC, the 125,000 promotional expense is reasonable under the circumstances. It is reasonable because the experimental project involves millions of pesos. P125,000 is unreasonable if your business is a mere sari -sari store.

ESSO STANDARD DOCTRINE:

The doctrine enunciated her e is that “an expense is deductible if it is paid or incurred in the

production of income”. It is not deductible if it is paid or incurred after the production of income or disposition of income.

The case is about whether the margin fee paid to the Central Bank is a deductible expense. The SC said that it is not deductible because this was paid or incurred not in the production of

income. It was paid or incurred after the disposition of income.

INTEREST EXPENSE:

Amount of compensation paid for the use of money or forbearance from such use. They are deductible under the following conditions:

o There must be a valid and subsisting indebtedness

o It must be an interest bearing obligation – see art. 1956

o Obligation incurred or paid in connection with the business or trade or the exercise of one’s profession

o Must be proven or substantiated by receipts or documents

Just focus on non-deductible interest!!!

PICOP vs. CIR (yet to be asked in the Bar) – a case regarding non-deductible interest

Q: Is theoretical interest deductible?



There are 2 reasons why theoretical interest is non-deductible (citing RR 2 Sec. 79):

1. It is not paid or incurred. Here, the interest is merely computed or calculated (iniisip pa lang);

2. It lacks the essential requisite for the deduc tibili ty of interest expense – it must arise from interest bearing obligation. The SC said, this does not arise from interest

bearing obligation.

MANO A MANO: PACQUIAO vs. LARIOS – unanimous decision

Interest on Capital: (non-deductible interest):

1994Q#14: a Co., a Philippine corporation, issued preferred shares of stock with the

following features:

1. Non voting;

2. Preferred and cumulative dividends at the rate of 10% per annum, whether or

not in any period the amount is covered by earnings or projects;

3. In the event of dissolution of the issuer, holders of preferred stock shall be paid in full or ratably as the assets of the issuer may permit before any distribution

shall be made to common stockholders; and

4. The issuer has the option to redeem the preferred stock.

A Co. declared dividends on the preferred stock and claimed the dividends as interests deductible from its gross income for income tax purposes. The BIR disallowed the deduction. A Co. maintains that the preferred shares with their features are really debt and therefore the dividends are really interests. Decide

SUGGESTED ANSWER:

The dividends are not deductible from gross income. Preferred shares shall be considered capital regardless of the conditions under which such shares are issued and therefore, dividends paid thereon are not considered “interest” which are allowed to be deducted from the gross income of the corporation (RMC #17-71, July 12, 1971)

JAPS ANSWER:

The Q here is: Is the interest on preferred shares of stocks deductible? De L eon qualifies his answer.



Yes if the payment of dividends is not dependent upon surplus profits.

No if the payment of dividends is dependent upon surplus profits.

We do not qualify. Under RMC 17-71, it is clear here that interest on capital, which may include interest on

preferred shares of stocks, is a non-deductible interest. It makes no qualification.

BAD DEBT EXPENSE:

Under Sec. 34 E: RR1 5-99 (as amended by RR 25-2002) and PRC vs. CIR (256 SCRA 57), these are the requisites for the valid deduction of bad debts written off:

there must be an existing, valid and enforceable obligation;

this must be connected with the business, trade or exercise of profession by the taxpayer;

this must not arise from transactions between related taxpayers under Sec . 36 B:

between FAMILY MEMBERS

between an INDIVIDUAL and a CORPORATION, more than 50% of the OCS is owned by such individual

3) EXCEPT IN LIQUIDATION

between two (2) corporations

c. same exception as the foregoing

between GRANTOR and FIDUCIARY of any trust

between FIDUCIARY OF A TRUST and A FIDUCIARY OF ANOTHER TRUST if the same person is a GRANTOR with respect to each trust

between a fiduciary of a trust and a beneficiary of such trust

it must be charged or written off from the books of the taxpayer;

→ Under RR 5-99, there must be an actual charged off or written off of such amount, mere

recording will not suffice. The implication is that: only those taxpayers who have books of accounts can claim these particular expenses as deductions;

it must be ascertained to be worthless and uncollectible as of the end of the taxable year;

PRC vs. CIR – it must be uncollectible in the near future (not just at the end of the taxable year;

there must be no slim chance on collecting the same)

Test or factors that are determinative of worthlessness of a debt or obligation (p. 119-120 of the book) – based on American Jurisprudence:

3) Consider whether the obligation has already prescribed (Application of Statute of Limitation – once it is already prescribed, it is already an exercise of futility);

4) The amount should also be considered, it may be collected but if the cost of collecting the same is more than the amount to be collected, it is impractical to be collect such amount;

5) Injury that may sustained by the debtor. For example, nahospital ang debtor, walang panggastos, wag mo na lang singilin, maawa ka naman);

6) Death of the debtor leaving no property (galang natin ang patay)



7) Bankruptcy/solvency of the debtor;

8) Insufficiency of collateral;

9) Destruction of documentary evidence or receipts which will prove the payment – if there’s no evidence to prove that the debtor incurred obligation;

10) Under RR as amended by 25-3002:

The CIR is authorized to waive that required evidence regarding the determination of

worthlessness of an account. It made mentioned of the financial incapacity or condition of the debtor ;

It also mentioned the insufficiency of collateral;

Referral of debtor/defendant lawyer (?) (the lawyer must execute and affidavit to the

effec t of that fi ling of the case on court would be unsuccessful (di ko maintindihan sinasabi ni japs dito)

World Cup muna ako --- Germany vs. Italy eh. Talo team ko.. last two minutes na lang before mag penalty, naka

score pa Italy…France na nga lang ako

EXEMPTIONS:

In Sec. 35 there are important provisions there:

Master the definition of head of the family; the Q on senior citizen has never been asked in the

Bar (marami tayo dito niyan, Dimayuga, Aligada, Alcantara)

Sec. 35 C

→Head of the family – 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 – l iving with and dependent upon him or her for their chief support; and where such brothers or sisters or children are 1) not more than 21 years of age, 2)

unmarried, and 3) not gainfully employed, or 4) where such children, brothers, or sisters, regardless of age are incapable of support because of mental or physical defect (last paragraph Sec 35 A)

→ RA 7432, as amended by RA 9257: Senior citizens shall be treated as dependents provided for in the NIRC and as such, individual taxpayers caring for them, be they relatives or not, shall be accorded the privileges granted by the Code insofar as having dependents are concerned.

Example, 60 years old resident citizen of the Philippines. Even if he is receiving income,

if the gross income is not more than 60,000, this senior citizen can be considered as a dependent.

Take note that relationship is not requisi te.

→ Sec. 35 C – there are 2 new rules hero. Master this. This was asked in 2004. I told them don’t forget this Sec. 35 C (yung natutulog, di nasagot to). This refers to change of status.

→ Q in 2004 Bar: Ram married Liza in January 2003. Liza died in November 2003. For purposes of filing his income tax return, what would Ram declare as status?

Single

Married

Head of the family

None of the above



This may be answered by Sec . 35 C has 3 paragraphs:

1st

Paragraph: * If the taxpayer marries or should have additi onal dependent(s) during the taxable year, the taxpayer may claim the corresponding additional exemptions, as the case may be, in full for such year. Par. 1 covers 2 situations:

Marriage of the taxpayer during taxable year

> Example. You have developed an unexplained feeling with your seatmate. So you agreed to get married after the Bar (December 31, 2006). You made it sure that the marriage will be solemnized

before the midnight of December 31. Even if you will be considered married for only 1 hour, you can claim 32,000 basic personal exemptions as married individual. as long as the

marriage is within the taxable year. Additional dependent

> Example. Masipag si Mister. Punong puno si Mrs. May anak ng isa, nanganak pa si Mrs. Twice in the same year. Can you claim

this 2 children as dependents?Yes.

2nd

Paragraph: *if the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions for himself and his dependent(s) as if he died at

the close of such year.

3rd

Paragraph: *If the spouse or any of the dependents dies or if any of such dependents marries, becomes 21 years old or becomes gainfully employed during the taxable year, the taxpayer may still claim the same exemptions as if the spouse or any of the

dependents died or as if such dependents married, became 21 years old or became gainfully employed at the close of such year.

2 new rules under this paragraph:

5. marriage of an dependent during the taxable year

> Old Tax Code – he could no longer be claimed as dependent >New Tax Code – taxpayer can still claim this as dependent (P8K)

6. gainfully employment of the dependent during the taxable year

>Old Tax Code – he could no longer be claimed as dependent >New Tax Code – the taxpayer is entitled to claim that dependent. As such he can claim the P8K as additional personal exemption

NRA-NETB is not entitled to claim personal exemption

NRA-ETB – Sec. 35 D requires the reciprocity rule. The foreign Government of the NRA-ETB must also grant exemption to Filipino citizen doing business therein. If no exemption is granted, we cannot grant exemption to this NRA-ETB. That rule in reciprocity applies only to basic personal exemption. So even if the foreign government grants additional personal exemption to citizens doing business ther ein, we

cannot grant additional personal exemption because it is clear. In Section 35 C, basic personal exemption, that means additional basic exemptions are excluded.

Q: Who can claim the additional personal exemption of P8K in the case of married individuals?

The additional exemption for dependents shall be claimed by only one of the spouses in the case of married individuals. (2

nd par. Section 35 B). The husband shall be the proper claimant for qualified

dependent children (last par. Section 2.79 (l) (1) (b), and the 1st

sentence Section 2.79.1 A 5 of 2-98)

Instances when the wife shall claim full additional exemptions for qualified dependent children:



6. Husband is unemployed

7. The husband waives his right to claim the exemptions of children (waiver should be for all children)

Husband is a member of RAMBO – Report Again kay Misis Bawal Oras (Alcantara is member of this)

or a member of BBB – Bantay Bata Brigade

8. Husband is a non-resident citizen deriving income from foreign sources.

Documents

TAX PART 1 compiled.pdf