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C o n t e n t s : Basic Concepts in Income TaxationGeneral Classification of Taxpayers

Tax on IndividualsTax on Corporations

Taxation of Fringe BenefitsTaxation of Partnerships

Tax on Estates and Trusts

Source of IncomeGross Income

Exclusions from Gross IncomeAllowable Deductions from Gross Income

Non-deductible ExpensesCapital Gains and Losses

Installment BasisReturns and Payments of Tax / Withholding Taxes

***

INCOME TAXATION

I. BASIC CONCEPTS IN INCOME TAXATION

Income Tax defined as a tax on all yearly profits arising from property, professions, trades or offices, oras tax on a persons income, emoluments, profits and the like. Income tax is a tax on the net income orthe entire income realized in one taxable year. It is levied upon corporate or individual incomes in excessof specified amounts, less certain deductions and/or specified exceptions in cases permitted by law.

N a t u r e o f i n co m e t a x

Income tax is a DIRECT TAX because the tax burden is borne by the incomerecipient upon whom the tax is imposed. It is a tax demanded from the veryperson who, it is intended or desired, should pay it, while indirect tax is a tax demandedin the first instance from one person in the expectation and intention that he can shift

the burden to someone else. Income tax is a PROGRESSIVE TAXsince the tax base increases as the tax rate

increases. It is founded on the ability to pay principle and is consistent with theConstitutional provision that Congress shall evolve a progressive tax system.

Income tax is generally regarded as an EXCISE TAX(privilege tax) and not a tax onpersons, property, funds or profits. It is really a tax on the right to earn incomebyan individual or entity for government needs

P u r p o s e ( s ) o f I n c om e Ta x : Fi s ca l / N o n - F i s ca l

The imposition of income tax is intended to:1. raise revenue to defray the expenses of the government;2. offset regressive sales and consumption taxes; and together with estate tax3. mitigate the evils arising from the inequalities of wealth by a progressive scheme of

taxation which places the burden on those best able to pay.

Income all wealth which flows to the taxpayer other than a mere return of capital. It is a flow ofservices rendered by that capital by the payment of money from it or any other benefit rendered by a fundof capital in relation to such fund through a period of time. It includes gain derived from the sale or otherdisposition of capital assets.

It is an amount of money coming to a person/corporation within a specified time, whether aspayment for services, interest or profit from investment. Unless otherwise specified, it means cash

or its equivalent. Income can also be thought of as a flow of the fruits of one's labor. (Conwi v.Court of Tax Appeals)

Income includes earnings, lawfully or unlawfully acquired, without consensual recognition, express

or implied, of an obligation to repay and without restriction as their disposition.


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D i f f e r e n t i a t e d f r om Ca p i t a l

The essential difference between capital and income is that capital is a fund; income is a flow. Afund of property existing at an instant of time is called capital. A flow of services rendered bythat capital by the payment of money from it or any other benefit rendered by a fund of capitalin relation to such fund through a period of time is called income. Capital is wealth, whileincome is the service of wealth. The Supreme Court of Georgia expresses the thought in thefollowing figurative language: "The fact is that property is a tree, income is the fruit; labor is a

tree, income the fruit; capital is a tree, income the fruit." A tax on income is not a tax onproperty. "Income," as here used, can be defined as "profits or gains." (Madrigal v. Rafferty)

I n c r e a s e i n P r o p e r t y V a l u e A mere increase in the value of property is NOTINCOME, but merely unrealized increase in capital. The increase in the value of property isalso known as appraisal surplus or revaluation increment.

Cl a s si f ic a t i o n o f I n c om e A c c o r d i n g t o S o u r c e

1. Income from sources within the Philippines2. Income from sources without the Philippines3. Income from sources partly within and partly without the Philippines

T a x a b i l it y o f I n c om e , Re q u i s i t e s

Income, gain or profit is subject to income tax, when the following requisites are present:a. there is income, gain or profitb. the income, gain or profit is received or realized during the taxable year

c. the income gain or profit is not exempt from income tax

T e s t s t o D e t e r m i n e R e al i za t i o n o f I n c om e f o r T a x Pu r p o s e s

Realization Test there is no taxable income until there is a separation from capital ofsomething of exchangeable value, thereby supplying the realization or transmutationwhich would result in the receipt of income.

Claim of right doctrine a taxable gain is conditioned upon the presence of a claim ofright to the alleged gain and the absence of a definite unconditional obligation to returnor repay that which would otherwise constitute a gain.

Corollary Doctrine Principle of Constructive Receipt of IncomeIncome which is credited to the account of or set apart for a taxpayer andwhich may be drawn upon by him at any time is subject to tax for the yearduring which so credited or set apart, although not then actually reduced topossession. To constitute receipt in such case, the income must be creditedto the taxpayer without any substantial limitation or restriction as to the

time or manner of payment or condition upon which payment is to bemade.

Economic benefit test any economic benefit to the employee that increases his networth, whatever may have been the mode by which it is effected, is taxable.

Cl a s si f i ca t i o n s o f I n c om e S u b j e c t t o P h i l ip p i n e I n c om e T a x 1. Compensation Income income which is derived from the rendering of services

under an employer-employee relationship.2. Professional Income fees derived from engaging in an endeavor requiring special

training as professional as a means of livelihood, which includes, but is not limited to,

the fees of CPAs, doctors, lawyers, engineers and the like.3. Business Income gains or profits derived from rendering services, selling

merchandise, manufacturing products, farming and long-term construction contracts4. Passive Income income in which the taxpayer merely waits for the amount to come

in. It includes, but is not limited to, interest income, royalty income, dividend income,winnings and prizes.

5. Capital Gain gain from dealings in capital assets


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II. GENERAL CLASSIFICATION OF TAXPAYERS

W h o i s a t a x p a y e r ?

Under Sec 22(N), a taxpayer is any person subject to [income] tax. Income taxpayers, with distinctionbased on the amount of income subject to tax, or the applicable tax rates, or both, are classified asfollows:

PrimaryClassification

Sub-Classification(s)

Residents of the PhilippinesCitizens ofthePhilippines

Not Residents of the Philippines

Residents of the Philippines

Engaged in Trade or Business in the PhilippinesAliens

NotResidentsof thePhilippines

Not Engaged in Trade or Business in the Philippines

Individual Employed by Regional or Area Headquarters and RegionalOperating Headquarters of Multinational Companies

Individual Employed by Offshore Banking Units

Individuals

Special

Classes ofIndividuals Individual Employed by a foreign service contractor or by a foreign service

subcontractor engaged in petroleum operations in the PhilippinesEstates and

Trusts

Domestic Corporations

Resident CorporationsForeignCorporations Non-resident Corporations

Proprietary educational institutions and non-profit hospitals

Domestic Depositary Bank (Foreign Currency Deposit Units)

Resident international carriers

Offshore Banking Units

Resident Depositary Bank (Foreign Currency Deposit Units)

Regional or Area Headquarters and Regional Operating Headquarters

of Multinational Companies

Non-resident cinematographic film owners, lessors or distributors

Non-resident owners or lessors of vessels chartered by Philippinenationals

Corporations

Special Classesof Corporations

Non-resident lessors of aircraft, machinery and other equipment

III. TAX ON INDIVIDUALS

A. Cl a s si f i ca t i o n s o f I n d i v i d u a l T a x p a y e r s1. Citizens

RESIDENT a citizen is deemed as a resident of the Philippines unless he qualifiesas a non-resident under Sec. 22E of the NIRC; taxable for income derived from allsources based on taxable (i.e., net) income

NON-RESIDENT- term"nonresident citizen"means a citizen of the Philippines who:(1) establishes to the satisfaction of the Commissioner the fact of his physical

presence abroadwith a definite intention to reside therein.(2) Leaves the Philippines during the taxable year to reside abroad, either as an

immigrantor for employmenton a permanent basis.


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(3) Works and derives income from abroad and whose employment thereatrequires him to be physically present abroad most of the time during thetaxable year.

(4) Has been previously considered as nonresident citizen and who arrives inthe Philippines at any time during the taxable year to reside permanently inthe Philippines shall likewise be treated as a non-resident citizen for thetaxable year in which he arrives in the Philippines with respect to his incomederived from sources abroad UNTIL the date of his arrival in the Philippines.

A non-resident citizen is taxable for income derived within the Philippinesbased on taxable (i.e., net) income

NOTES: The definition of a non-resident citizen should be cross-referred with Sec. 23 (c),

which provides that a citizen of the Philippines who is working and deriving incomefrom abroad as an OVERSEAS CONTRACT WORKER is taxable only on incomefrom sources w i t h in the Philippines.

NOTE FURTHER: A seaman who is a Filipino citizen and who receivescompensation for services rendered abroad as member of the complementof a vessel engaged exclusively in international trade is treated as anoverseas contract worker.

Length of stay is indicative of intention.A citizen of the Philippines who shallhave stayed outside the Philippines for 183 days or moreby the end of the year isa non-resident citizen. His presence abroad, however, need not be continuous.

2. Alien RESIDENT- an individual whose residence is within the Philippines and who is not a

citizen thereof. An alien actually present in the Philippines who is not a mere transientor sojourner is a resident of the Philippines for income tax purposes. A mere floatingintention indefinite as to time, to return to another country is not sufficient toconstitute him a transient. If he lives in the Philippines and has no definite intentionas to his stay, he is a resident. He is taxable for income derived within thePhilippines based on taxable (i.e., net) income

NON-RESIDENT- an individual whose residence is NOT in the Philippines and who isnot a citizen thereof.

Engaged in trade or business in the Philippines (NRAETB) - is taxable forincome derived within the Philippines based on taxable (i.e., net)income

Not engaged in trade or business in the Philippines (NRANETB) - is taxable

for income derived within the Philippines based on g r o s s income1

NOTES: What makes an alien a resident or non-resident alien is his i n t e n t i o n w i t h r e g a r d

t o t h e l e n g t h a n d n a t u r e o f h i s st a y . Thus:a. One who comes to the Philippines for a definite purpose which in its

very nature may be promptly accomplished is not a resident citizen.b. One who comes to the Philippines for a definite purpose which in its

very nature would require an extended stay, and to that end, makeshis home temporarily in the Philippines, becomes a resident, thoughit may be his intention at all times to return to his domicile abroad

when the purpose for which he came has been consummated orabandoned. (Sec. 5, RR 2-

Length of stay is indicative of intention. An alien who shall have stayed in thePhilippines for more than one year by the end of the taxable year is a residentalien.

1Notwithstanding the general classification of aliens into resident and non-resident for income tax purposes, note that there is a

special classification of aliens who are taxed differently. See subsection D (page 11).


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NOTE FURTHER: An alien who shall come to the Philippines and stay for anaggregate period of more than one hundred eighty days during acalendar year shall be considered a non-resident alien in business, or inthe practice of profession, in the Philippines. [Sec. 25(A)(1)] Thus, if analien stays in the Philippines for 180 days or less during the calendar year,he shall be deemed a non-resident alien not doing business in thePhilippines, regardless of whether he actually engages in trade or businesstherein. (Mamalateo)

B. T h r e e Ki n d s o f I n c o m e1. Capital Gains subject to Capital Gains Tax

A sale or exchange in asset gives rise to a gain or a loss on the sale. When the asset soldwas held as a capital asset, the gain or loss is called a capital gain or loss. When the assetsold was not held as a capital asset (in other words, as an ordinary asset), the gain or lossis called an ordinary gain or loss.

W ha t a r e c a p i t a l a s s e t s ? The NIRC defines a capital asset in a n e g a t i v e way.The law enumerates four categories of ordinary assets; hence, all assets (even ifused in trade or business) other than ordinary assets are capital assets. The FOURCATEGORIES OF ORDINARY ASSETSare as follows [Sec. 39]:

1. Stock in trade of the taxpayer, or other property of a kind which wouldproperly be included in an inventory of a taxpayer if on hand at the end ofthe taxable year (example: Raw Materials Inventory, Work in ProcessInventory, Office Supplies Inventory)

2. Property held by the taxpayer primarily for sale to customers in the ordinarycourse of his trade or business (example: Merchandise Inventory)

3. Property used in the trade or business which is subject to the allowance fordepreciation (example: Office Equipment)

4. Real property used in trade or business of the taxpayer (example: Buildingused as a factory)

Succinctly, a capital asset is an asset not used in business. When an asset heldis described as an investment, it is a capital asset. Examples of capital assets are:

residential house, personal art collection, family pleasure yacht.

A r e a l l s al e s / d i s p o s i t i o n s o f c a p i t a l a s s e t s s u b j e c t t o c a p i t a l g a i n s t a x ?

NO! Only two kinds of things held as capital assets are subject to the capital gainstax, as follows:

1. On sale, barter, exchange or other disposition of s h a r e s o f s t o c k o f a

d om e s t ic corporation n o t l i s t ed a n d t r a d e d t h r o u g h a l o ca l s t o ck

e x c h a n g e , held as a capital asset:On the net capital gain:

Not over P100,000 Final Tax of 5%On any amount in excess of P100,000 Final Tax of 10%

Key definitions

Net capital gain selling price less cost

Selling price consideration on the sale OR fair market

value of the shares of stock at the time of the sale,whichever is HIGHER

Cost original purchase price


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ILLUSTRATION: Mr. X sold directly to a buyer shares of stock of adomestic corporation held as a capital asset. The selling price wasP200,000 at the time when the fair market value of the shares soldwas P250,000, and the cost was P100,000.

Selling price P250,000Less: Cost 100,000

Capital Gain P150,000

On the First P100,000, at 5% P 5,000Excess over P100,000 (P50,000), at 10% 5,000

Total Capital Gains Tax P10,000

2. On sale, exchange, or other disposition of r e a l p r o p e r t y i n t h e Ph i l i p p i n e s ,held as a capital asset On the gross selling price, or the current fair market

value at the time of the sale, whichever is higher, a final tax of 6% The capital gains tax is applied on the gross selling price, or the

current fair market value at the time of the sale, whichever ishigher. Any gain or loss on the sale is immaterialbecause there isa conclusive presumption by law that the sale resulted in again.

ILLUSTRATION: Mr. N sold a land and building for P2,000,000when the fair market value was P1,900,000 and which had a cost

to him of P2,500,000, for a loss on the sale of P500,000. Thecapital gain tax is 6% of P2,000,000, or P120,000. The loss fromthe sale is immaterial.

EXCEPTION (i.e., NO NEED TO PAY CAPITAL GAINS TAX): Nocapital gains tax (CGT) if the following requirements are met:

a. There is a sale or disposition of their principal residence bynatural persons.

b. The proceeds of the sale are fully utilized in acquiring or

constructing a new principal residence within 18 calendarmonths from the date of sale or disposition.

c. The Commissioner shall have been duly notified by thetaxpayer within 30 days from the date of sale or dispositionthrough a prescribed return of his intention to avail of thetax exemption.

d. A deposit is made of the 6% capital gain tax otherwise due,in cash or managers check, in an interest-bearing accountwith an Authorized Agent Bank (AAB), under an EscrowAgreement between the taxpayer and the Bureau of InternalRevenue that the same shall be released to the taxpayerwhen the proceeds of the sale shall have been utilized asintended.

e. The tax exemption can only be availed of once every 10years

If there is no full utilization of the proceeds of sale or

disposition, the portion of the gain presumed to have beenrealized from the sale or disposition shall be subject to capitalgains tax (CGT). The GSP or FMV at the time of sale, whicheveris higher, shall be multiplied by a fraction which the unutilizedamount bears to the gross selling price in order to determine the

taxable portion.


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i.e.,Unutilized amount x (higher of ) GSP or FMV = Taxable portion

GSP

ALTERNATIVE TAXATION: In case of a sale or other dispositionof real property to the government or any of its politicalsubdivisions or agencies or to government-owned or controlledcorporations, the tax shall be EITHER the y e a r - e n d t a x of the

individual (i.e., capital gain to be included in the computation ofincome subject to schedular rates), OR the c a p i t a l g a i n t a x o f6 % , at the option of the taxpayer

W ha t i s t h e t a x i m p l i ca t i o n o f s a l e s / d i s p o s i t io n s o f c a p i t a l a ss e t s NOT

s u b j e c t t o c a p i t a l g a i n s t a x ? The net capital gain or loss is included in the

computation of net income subject to schedular rates (5% to 32%).

2. Passive Income subject to Final TaxCertain passive income items from sources within the Philippines are subject to final tax.Final tax means tax withheld from source, and the amount received by the income earneris net of the tax already. The tax withheld by the income payor is remitted by him to theBureau of Internal Revenue. The income having been tax-paid already, it need not beincluded in the income tax return at the end of the year. These passive income items are asfollows:

Interest Income:o on any currency bank deposit, yield or any other monetary benefit from

deposit substitutes, trust funds and similar arrangements - 20% final tax

o under the expanded foreign currency deposit system (EFCDS) - 7.5% finaltax for residents, exempt if non-residents

o on long-term deposit or investment certificates (LTDIC) in banks (e.g.,savings, common or individual trust funds, deposit substitutes, investmentmanagement accounts and other investments, which have maturity of 5years or more) exempt

Should LTDIC holder pre-terminate LTDIC before the 5th year, a finaltax shall be imposed on the entire income based on the remainingmaturity:

4 years to less than 5 years - 5%

3 years to less than 4 years - 12%

less than 3 years - 20%

Dividendso cash and/or property dividends2actually or constructively received by an

individual from

a domestic corporation

a joint stock company insurance or mutual fund companies regional operating headquarters of multinational companies

o share of an individual in the distributable net income after tax of apartnership (except a general professional partnership) of which he is apartner

2 A stock dividend representing the transfer of surplus to capital account shall not be subject to tax . However, if a

corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution andcancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount sodistributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it represents adistribution of earnings or profits. (Sec. 73B, NIRC) [ In other words, stock dividends are generally not subject to tax as long asthere are no options in lieu of the shares of stock. On the other hand, a stock dividend constitutes income if it gives theshareholder an interest different from that which his former stockholdings represented .]


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o share of an individual member or co-venturer in the net income after tax ofan association, a joint account, or a joint venture or consortium taxable as acorporation

Rate 10% for residents (RC, RA) and non-resident citizens (NRC),

20% for non-resident aliens engaged in trade or business (NRAETB)

Royaltieso From books, literary works, and musical compositions 10%

o Other royalties 20%

Winnings, except Philippine Charity sweepstakes / lotto winnings 20%

Prizes exceeding P10,000 20%o Prize, differentiated from winnings A prize is the result of an effort made

(e.g., prize in a beauty contest), while winnings are the result of atransaction where the outcome depends upon chance (e.g., betting).

3. Other Income subject to Schedular Tax Rates3

Income which is neither capital gain with capital gain tax, nor passive income with final tax,is other income or residual income. On other income, the law prescribes a graduated tax.

Other income is what is included in the computations, and in the income tax return, at theend of the year (and at the end of the first three quarters of the year if the individual hadincome from business or practice of profession). It may be derived from:

1. Employer-employee relationship, which is called compensation income2. Business or profession

3. Sale or exchange of property which is not subject to the capital gain tax4. Incidental sources, such as interest or dividend, which is not subject to final tax

(i.e., dividend from a foreign corporation in case of resident citizens, rent income).

The tax rates on NETordinary or other income (schedular rates)4are as follows:

Income over But less than Tax Plus of Excessover

10,000 5%

10,000 30,000 500 10% 10,000

30,000 70,000 2,500 15% 30,000

70,000 140,000 8,500 20% 70,000140,000 250,000 22,500 25% 140,000

250,000 500,000 50,000 30% 250,000

500,000 125,000 32% 500,000

3 Schedular tax rates apply to all classes of individuals, with the exception of non-resident aliens not engaged in trade or

business. Should NRANETB earn other income, such is subject to a 25% final tax.4Pro-forma computation of income subject to schedular tax rates:

Gross Compensation Income P xxxLess: Personal Exemptions (xxx)

Health Insurance (if qualified) (xxx)Net Compensation Income P xxx

Add: NetBusiness Income xxxNetProfessional Income xxxOther Income (capital gains, rent, etc.) xxx

Net Income subject to schedular tax rates P xxxwhere Net Business Income and Net Professional Income are computed as follows:

Gross Business / Professional Income P xxxLess: Itemized Deductions [OR] Optional Standard Deduction (xxx)Net Business / Professional Income P xxx


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Rule for Married Individuals Married individuals, whether citizens, resident ornonresident aliens, who do not derive income purely from compensation, shall file areturn for the taxable year to include the income of both spouses. [Sec 51(D)] Theycompute the income tax separately on their respective incomes. The two taxes willbe added to arrive at a single income tax still due and refundable. Income which isclearly joint, or which cannot be identified as exclusively of one spouse, will bedivided equally. [Sec 24(A)]o EXCEPTIONto the one-return rule: Where it is impracticable for the spouses

to file one return, each spouse may file a separate return of income but thereturns so filed shall be consolidated by the Bureau for purposes ofverification for the taxable year. [Sec 51(D)]

C. D e d u c t io n s [ f r o m I n c o m e S u b j e ct t o S c h e d u l a r Ta x R a t e s ] , I n G en e r a lThe allowable deductions from the gross income of an individual taxpayer5are as follows:

1. Business Expenses and Expenses from Practice of Profession deductible onlyfrom business gross income and professional income, respectively but not fromcompensation income.6The expenses to be deducted may either be itemized deductionsOR the optional standard deduction.7

2. Special deduction for actual premium payments for health and/or hospitalizationinsurancetaken by an individual taxpayer provided that the following requisites are met:

a. The taxpayers family gross income does not exceed P250,000 in ataxable year.

b. The amount deductible should only be limited to P2,400 per family orP200 per month.

In the case of married taxpayers, only the spouse claiming the additionalexemption for dependents shall be entitled to this deduction.

3. Personal Exemptions are arbitrary amounts allowed by law to be deducted fromincome to cover personal, living, or family expenses of the taxpayer. These deductionsare allowed on the theory that the minimum requirements of subsistence of a taxpayer

should be free from tax. K i n d s :

1. Basic Personal Exemptions (BPE) varies according to the status oftaxpayer

Kind of Taxpayer Basic Personal Exemption

(BPE)Single individuals (includes widow/er) P20,000

Married individual who are

judicially decreed as legallyseparated, and

with no qualified dependents

P20,000

Head of Family P25,000

Eachmarried individual * P32,000

*BUT note Sec 35(A) - In the case of married individuals where onlyone of the spouses is deriving gross income, only such spouseshall be allowed the personal exemption.

5

Remember that non-resident aliens not engaged in trade or business are taxed on grossincome. They may not, therefore, availof these deductions.6Thus, the only deductions that may be claimed by individuals with compensation income only are personal exemptions and

premium payments on health and/or hospitalization insurance.7 See Allowable Deductions from Gross Income (p. 40) for the detailed discussion on itemized deductions and the optional

standard deduction.


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W ho i s a H e a d o f t h e F am i l y ? [Sec 35(A), NIRC]1. An unmarried or legally separated man or woman with

dependents who may be

one or both parents

one or more brothers or sisters, or

one or more legitimate, illegitimate or legally adoptedchildren

2. Such dependent must be living with AND dependent upon himfor chief support

Chief support principal or main support given regularlysuch that withdrawal will result in destitute life fordependent; includes situations where taxpayer is awayfrom home on business, or dependent is away at school

NOTE: Chief support means more than one-half of the

requirements for support. Hence, if two children contributeequal amounts to the support of a parent, neither of themqualify as head of the family.

3. Such brothers or sisters or children are not more than 21 years old unmarried and

not gainfully employed OR

regardless of age, are incapable of self-support because

of mental or physical defect.

2. Additional Exemptions (AE) depends on the number of qualifieddependent children

Am o u n t a l l o w e d a s a d e d u c t i o n P8,000 per dependent child, butnot to exceed four children

W h o m a y c la i m a d d i t i o n a l e x e m p t i o n s ?

1. Married Individuals Additional exemptions are claimed by only

one spouse. Generally, the spouse who is the grosscompensation earner is the claimant of the additionalexemptions. Where the husband and wife are both compensationincome earners, the husband is the proper claimant of theadditional exemptions EXCEPT if there is an express waiver bythe husband in favor of his wife, as embodied in the withholdingexemption certificate. When the spouses have business and/or

professional income only, either may claim the additionalexemptions at the end of the year. The wife claims the additionalexemptions in the following instances:

i. husband has no incomeii. husband works abroad

2. Legally separated spouses Additional exemptions can beclaimed by the spouse with custody of the child or children (butthe total amount for the spouses shall not exceed the maximumof four). [Sec 35(B), NIRC]

W h o i s a d e p e n d e n t f o r p u r p o s e s o f a d d i t i on a l e x e m p t i o n s ? Alegitimate, illegitimate or legally adopted child chiefly dependent uponand living with the taxpayer:

1. not more than 21 years old, unmarried and not gainfullyemployed OR

2. regardless of age, is incapable of self-support because of mental

or physical defectNOTE: Only children may be considered dependent for purposesof additional exemptions. Compare with dependent for purposes ofbasic personal exemption.


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Wh o m a y c la i m p e r s o n a l e x e m p t i o n s ? Citizens (whether resident or non-resident) and resident aliensare allowed to avail of basic personal and additionalexemptions. Non-resident aliens engaged in trade or businessare entitled tobasic personal exemptions only by way of reciprocity, but not to additionalexemptions. [Sec. 35, NIRC]

Limit of BPE Allowed to NRAETB: An amount equal to the exemptionsallowed by the non-resident aliens country to Filipino citizens not residingtherein but deriving income therefrom, but not to exceed the amount fixed by

NIRC.[In other words, whichever is LOWER]

ILLUSTRATION OF RECIPROCITY PRINCIPLE:Personal Exemption for NRAETB

If taxpayer is

Foreign countryallows to non-

resident Filipinos

Personal

exemption in theNIRC

Personalexemption

allowed (LOWERamount)

Single P30,000 P20,000 P20,000

Head of theFamily

P18,000 P25,000 P18,000

Married P40, 000 P32,000 P32,000

Ch a n g e o f S t a t u s [Sec 35(C), NIRC]

1. If taxpayer marries during taxable year, taxpayer may claim the

corresponding BPE in full for such year (i.e., no need to pro-rate theexemption).

2. If taxpayer should have additional dependent(s) during taxable year,taxpayer may claim corresponding AE in fullfor such year.

3. If taxpayer dies during taxable year, his estate may still claim BPE and AE for

himself and his dependent(s) as if he died at the close of such year.4. If during the taxable year

a.spouse dies orb.any of the dependents dies or marries, turns 21 years old or becomes

gainfully employedtaxpayer may still claim same exemptions as if the spouse or any of thedependents died, or married, turned 21 years old or became gainfullyemployed at the close of such year.

Summary of Rules with respect to Change in Status:

Change in StatusCurrent

YearExemption

SucceedingYear

Exemption

Married P32,000 P32,000

Dies P32,000 -

Widowed with qualified dependentchildren

P32,000 P25,000

Widowed with qualified dependent nothis child

P32,000 P25,000

Widowed without dependents P32,000 P20,000

Legally separated with qualifieddependent children

P25,000 P25,000

Legally separated with qualifieddependent not his child

P25,000 P25,000

Legally separated without dependents P20,000 P20,000 Not legally separated (i.e., separation de

facto)P32,000 P32,000

Dependent Child (maximum of four)


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Change in StatusCurrent

YearExemption

SucceedingYear

Exemption

Born P8,000 P8,000

Reaches 21 years old (normal child) P8,000 -

Reaches 21 years old (abnormal andincapable of supporting himself)

P8,000 P8,000

Marries P8,000 -

Gainfully employed P8,000 - Dies P8,000 -

ILLUSTRATIONS: (Given: taxpayer in question is a resident citizen)

Change of Status Exemptions Reason

A taxpayer, married, hadliving with and dependentupon him for support at thebeginning of the year hisspouse, a legitimate child(minor, single, unemployed)and a brother, 24 years oldbut crippled. The taxpayer

died on March 20 of theyear.

P40,000 If a taxpayer died during theyear, his estate may claimthe personal exemptions as ifhe died at the end of theyear. Thus:Basic P32,000AE for child 8,000Total P40,000

A taxpayer was married,with a child, 7 years old atthe beginning of the year.The wife and the child diedin an accident on October 25of the year.

P40,000 A taxpayer whose spouseand/or dependent child diedduring the year may claimpersonal exemptions as if thedeath took place at the closeof the year. Thus:Basic P32,000AE for child 8,000Total P40,000

A taxpayer was married andhad a child, 3 years old atthe beginning of the year.On May 17 of the year,another child was born. His

wife died giving birth to thesecond child. The secondchild lives.

P48,000 A taxpayer whose spouse

died during the year mayclaim personal exemptions asif the death took place at theclose of the year. A taxpayer

who should have anadditional dependent duringthe year may claim the

additional exemption in fullfor such year. Thus:Basic P32,000AE for child 16,000Total P48,000

A taxpayer was married witha qualified dependent childat the beginning of the year.On April 1 of the year, thechild became gainfully

employed.

P40,000 If a dependent becamegainfully employed during theyear, the taxpayer may claimthe personal exemption as ifsuch dependent child became

gainfully employed at the endof the year. Thus:

Basic P32,000AE for child 8,000Total P40,000


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D. S p e c ia l Cl a s si f i ca t i o n o f I n d i v i d u a l s a n d Co r r e s p o n d i n g T a x T r e a t m e n t [Sec 25(C), (D),(E)]

1. Alien individuals employed by:a. Regional or Area Headquarters (RAHQ) and Regional Operating Headquarters (ROHQ)

established in the Philippines by multinational companies

o Multinational company, defined a foreign firm or entity engaged ininternational trade with affiliates or subsidiaries or branch offices in the Asia-Pacific Region and other foreign markets

b. Offshore Banking Units established in the Philippines

2. Alien individuals who are permanent residents of a foreign countrybut who are employedand assigned in the Philippines by a foreign service contractor or by a foreign servicesubcontractor engaged in petroleum operations in the Philippines

Tax Rate and Base - 15% of gross income received as salaries, wages, annuities,compensation, remuneration and other emoluments, such as honoraria and allowances

o The same tax treatment shall apply to Filipinos employed and occupying the samepositions as those of aliens employed by these multinational companies, offshorebanking units and petroleum service contractors and subcontractors.

Note that the coverage of the special classification (and the corresponding tax rate) islimited to income received as wages. Hence, any income earned from all other sourceswithin the Philippines by the alien employees shall be subject to the pertinent income tax

(example: sale of real property in the Philippines is subject to 6% capital gain tax, imposedon the gross selling price or fair market value of the property at the time of the sale,whichever is higher).


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E. S um m a r y o f T a x B a s e s a n d T a x R a t e sQU I CK GLANCE

RES I D ENT NON -RES I D ENT

CITIZEN ALIEN CITIZEN NRAETB NRANETBCATEGORY OF INCOME

All sourcesWithin thePhilippines

Within thePhilippines



GIW 25%Based on Taxable (i.e, Net) Income

Schedular Income Tax Rates (Sec. 24, NIRC)(i.e, 5% to 32%) Not

Applicable

1. Compensation / Business /Profession

2. Prizes of P10,000 or less

3. Proprietary, Educational / Hospital

4. Cinematographic Film and the likeGIW -25%

5. Interest from any currency bankdeposit , etc., Royalties (otherthan from books, literary worksand musical compositions),Winnings / Prizes (except prizesP10,000 and below)

GIW 20% Final Withholding Tax

6. Royalties from books, literaryworks, musical compositions GIW 10% Final Withholding Tax

7. Interest from long-term deposit orinvestment certificates, which have

a maturity of 5 years or more

EXEMPT; However:In case of pre-termination, with remaining maturity

of:4 years to less than 5 years 5% on entire income3 years to less than 4 years 12% on entire income

less than 3 years 20% on entire income

8. Cash / Property Dividends from adomestic corporation, etc., ORshare in the distributable netincome after tax of a partnership

(except a general professionalpartnership), etc.

GIW 10% Final Withholding TaxGIW 20%

GIW

25%

9. Interest (Expanded ForeignCurrency Deposit System)

GIW 7.5% FinalWithholding Tax

EXEMPT

10. Winnings on PhilippineSweepstakes / Lotto EXEMPT

11. Capital Gains on Sale of Shares(not traded in a domestic stockexchange)

Net Capital Gains within:Not Over P100,000 5% Final Tax

Amount in Excess of P100,000 10% Final Tax

12. Capital Gains on Sale of RealProperty in the Philippines Gross Selling Price or FMV, whichever is higher 6% Final Tax

13. Sale of Shares (traded in adomestic stock exchange)

of 1% of the Selling Price (Stock Transaction Tax)Note: Stock Transaction Tax is notan income tax, but a business

(percentage) tax

Legend: GIW Gross Income within the Philippines FMV Fair Market Value

C

apitalGains,subject

toCapitalGainsTax

PassiveIncomefromd

omesticsources,

subjecttoFinalTax

OtherIncome,subjectto

GraduatedTaxRates,excep

t

forNRANETB


15/97



15

IV. TAX ON CORPORATIONS

A. Co v e r a g e o f t h e t e r m Co r p o r a t i o n [Sec 22(B)] The term corporation includespartnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentasen participacion), associations, or insurance companies

It does NOTinclude:

1. general professional partnerships (partnerships formed by persons for the solepurpose of exercising their common profession, no part of the income of which isderived from engaging in any trade or business)

2. joint venture or consortium formed for the purpose of undertaking constructionprojects or engaging in petroleum, coal, geothermal and other energyoperationspursuant to an operating consortium agreement under a service contractwith the Government.8

B. C la s s i f i c a t i o n o f Co r p o r a t i o n s Ge n e r a l T y p e s

1. Domestic Corporation (DC)- one created or organized in the Philippines or underits laws [Sec 22(C)]

2. Foreign Corporation (FC) one that is not domestic [Sec 22(D)] Resident Foreign Corporation (RFC) - a foreign corporation engaged in

trade or business within the Philippines [Sec 22(H)]9

Non-resident foreign coporation (NRFC) - a foreign corporation notengaged in trade or business within the Philippines [Sec 22(I)]

Spe c i a l Ty p e s 1. Proprietary educational institutions and non-profit hospitals2. Domestic Depository Bank (Foreign Currency Deposit Units)3. Offshore Banking Units4. Resident Depository Bank (Foreign Currency Deposit Units)5. Resident international carrier

6. Non-resident owner or lessor of vessel7. Non-resident cinematographic film owner, lessor or distributor8. Non-resident lessor of aircraft, machinery and other equipment9. Regional/Area Headquarters & Regional Operating Headquarters of Multinational

companies

8In this case, the joint venture [as an entity] is not subject to income tax, but each member of the joint venture shall be taxable on

his/its share in the net income of the corporation. On the other hand, a joint venture constituted for purposes other than (2) above

is treated as a corporation and taxable as such.9The qualifier resident in the term resident foreign corporation should not be equated with the nationalityof the corporation. In

determining nationality, the control test is often invoked and applied, which considers corporate nationality by the nationality of itscontrolling shareholders or members. (Mamalateo, citing Winship v. Philippine Trust Co., 90 Phil 744) Thus, for income taxpurposes, a domestic corporation may be formed or organized by foreigners (as long as three of them are residents of thePhilippines as per the Corporation Code),provided that it is organized under the laws of the Philippines.


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C. S co p e o f T a x a t i o n

QU I CK GLANCE

Type of Corporation Sources of Taxable Income Allowed BusinessDeductions?

Domestic Corporation (DC) Within and without the Philippines Yes

Resident Foreign Corporation(RFC)

Within the Philippines Yes

Non-resident Foreign Corporation(NRFC)

Within the Philippines No*

* - Ergo, non-resident foreign corporations are taxed on GROSS INCOME.

NOTE: A good example of a resident foreign corporation is the Philippine branch of a foreigncorporation duly licensed by the Securities and Exchange Commission. The Philippine branch ismerely an extension of the foreign head office (i.e., non-resident foreign corporation); hence itdoes not have nor issue Philippine shares of stock. There is only one single entity to speak of.However, for income tax purposes, only the income of the Philippine branch from sources withinthe Philippines is subject to income tax, and the income of the Philippine branch as well as that ofthe foreign head office from sources outside the Philippines are exempt from Philippine income

tax.- NOTE FURTHER: Marubeni Corporation v. Commissioner (177 SCRA 500) clarified thesingle entity concept. As a GENERAL RULE, the head office of a foreign corporation isthe same juridical entity as its branch in the Philippines following the single entityconcept. The income from sources within the Philippines of the foreign head officeshall thus be taxable to the Philippine branch. BUTwhen the head office of a foreigncorporation independently and directly invested in a domestic corporation without thefunds passing through its Philippine branch, the taxpayerwith respect to the tax on thedividend income would be the non-resident foreign corporation itself and the dividendincome shall be subject to the tax similarly imposed on non-resident foreign corporations.

D. T a x o n D om e s t i c Co r p o r a t i o n sDomestic corporations are subject to any or some of the following:

Capital Gain Tax

Final Tax on Passive Income

Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR] Gross Income Tax(GIT) Improperly Accumulated Earnings Tax (IAET) [only if a domestic and closely-held

corporation]

1. Capital Gains subject to Capital Gains Taxa. On sale, barter, exchange or other disposition of s h a r e s o f s t o c k o f a d om e s t ic

corporation n o t l i s t ed a n d t r a d e d t h r o u g h a l o ca l s t o ck e x c h a n g e , held as acapital asset:

On the net capital gain:


[NOTE: Tax treatment is the same as that of individuals.]

b. On the s a l e , e x c h a n g e o r d i s p o s i t i o n o f l a n d s a n d / o r b u i l d i n g s which are not

actually used in the business of a corporation and are treated as capital assets Onthe gross selling price, or the current fair market value at the time of the sale,whichever is higher, a final tax of 6%

NOTE: Tax treatment is the same as that of individuals.


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17

The capital gains tax is applied on the gross selling price, or the current fairmarket value at the time of the sale, whichever is higher. Any gain or loss onthe sale is immaterialbecause there is a conclusive presumption by lawthat the sale resulted in a gain.

2. Passive Income Subject to Final Tax Interest Income:

o on any currency bank deposit, yield or any other monetary benefit from

deposit substitutes, trust funds and similar arrangements - 20%o under the expanded foreign currency deposit system (EFCDS) - 7.5%

Dividends received from another domestic corporation (IntercompanyDividend) - EXEMPT

Royalties (any kind) 20%

3. Income subject to Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR]Gross Income Tax (GIT) NORMAL CORPORATE INCOME TAX RATE 32%

10of net taxable incomeTax formula for normal tax:

Gross Income (ALL income items EXCEPT passive income subject

to final tax and capital gain with capital gain tax) Pxxx

Less: Allowable deductions for expenses and lossesxxx

Taxable Income subject to normal tax Pxxx

MINIMUM CORPORATE INCOME TAX (MCIT) 2% of MCIT Gross IncomeWhat is MCIT gross income? Gross sales less sales returns, discounts andallowances and cost of goods sold. Cost of goods sold includes all businessexpenses DIRECTLYincurred to produce the merchandise to bring them to theirpresent location and use. [Sec. 27(E)(4)]

MCIT gross income differentiated from the normal tax gross incomethelatter would include other incidentalincome items, such as rent income,interest, gain on sale of assets, certain tax refunds, etc.

10 Starting July 1, 2005, the normal corporate income tax rate for domestic corporations is 35%. (RA 9337, May 24, 2005)

However, the 2006 Bar Examinations will (most likely)only cover laws promulgated up to 31December 2004. For purposes of theBar, therefore, the 32% normal corporate income tax rate is (most likely) still applicable. Anyway, FYI lang


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e.g.,

Normal Tax Computation MCIT Computation

Sales revenue Pxxx

Less: Sales Discounts (xxx)

Sales Allowances (xxx)

Net Sales Pxxx

Less: Cost of Goods Sold (xxx)

Gross Income from Sales Pxxx

Add Incidental Income:

Rent Income xxx

Interest Income xxx

N o r m a l T a x G r o ss I n c o m e P x x x

Less: Allowable deductions (xxx)

Net Taxable Income Pxxx

Sales Revenue Pxxx

Less: Sales Discounts (xxx)

Sales Allowances (xxx)

Net Sales Pxxx

Less: Cost of Goods Sold (xxx)

MCI T G r o ss I n c o m e P x x x

Less: Operating Expenses (xxx)

Net Operating Income Pxxx

Add Incidental Income:

Rent Income xxx

Interest Income xxx

Gain on Sale of Property xxx

Net Income Pxxx

When is the MCIT computed? beginning on the fourth taxable yearimmediately following the year in which such corporation commenced its businessoperations

W h a t a m o u n t o f i n c o m e t a x i s p ai d b y t h e c o r p o r at i o n t o t h e B I R ? Whichever is HIGHERbetween the normal tax and the minimum corporate incometax.

ILLUSTRATION: E Co., a domestic trading corporation, in its fourth yearof operations had a gross profit from sales of P300,000 and net taxableincome of P100,000. How much was the income tax paid by thecorporation for the year?

MCIT (P300,000 x 2%)P6,000

Normal income tax (P100,000 x 32%)P32,000

Income Tax to be paid for the year (whichever is higher) P32,000

Ex c e s s MCI T ca r r y - f o r w a r d

Any excess of the minimum corporate income tax over the normal income tax shallbe carried forward and credited against the NORMAL TAXfor the three (3)immediately succeeding taxable years. [Sec. 27(E)(2)] In the year to which carriedforward, the normal tax should be higher than the MCIT.


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ILLUSTRATION: A domestic corporation had the following data oncomputations of the normal tax (NT) and the minimum corporate incometax (MCIT) for five years.

Year 4 Year 5 Year 6 Year 7 Year 8

MCIT 80,000 50,000 30,000 40,000 35,000

NT 20,000 30,000 40,000 20,000 70,000

The excess MCIT over NT carry-forward is shown below:

Year 4 Year 5 Year 6 Year 7 Year 8

MCIT 80,000 50,000 30,000 40,000 35,000

NT 20,000 30,000 40,000 20,000 70,000

NT ishigher

40,000 70,000

Less: MCIT

carry-forward -

(40,000) (20,000)

(20,000)

From Year4

FromYear 5

From Year7

Tax Due 80,000 50,000 - 40,000 30,000

Arrow pointing downward means that the normal tax is higher sothat there can be an excess MCIT carry-forward against it.

While only P40,000 out of P60,000 excess MCIT in Year 4 wasused in Year 6, the unused P20,000 cannot be used in Year 8

because Year 8 was beyond three years from Year 4.

R e li e f f r om M CI T The Secretary of Financeis authorized to suspend theimposition of the minimum corporate income tax on any corporation which suffers

LOSSES:

on account of p r o l o n g e d l a b o r d i s p u t e (losses from a strike staged byemployees that lasts for more than 6 months and caused the temporaryshutdown of operations), or

because of f o r c e m a j e u r e (acts of God and other calamity; includes

armed conflicts like war or insurgency), or because of l e g i t i m a t e b u s i n e s s r e v e r s e s (substantial losses due to

fire, robbery, theft or other economic reasons).

> >

>


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20

GROSS INCOME TAX (GIT) The President, upon the recommendation of theSecretary of Finance, may allow domestic corporations the option to be taxed atfifteen percent (15%) of gross income, after the following conditions have beensatisfied:

Tax effort ratio 20% of GNP

Ratio of IT collection to total tax revenue 40%

VAT tax effort 4% of GNPRatio of Consolidated Public Sector Financial Position(CPSFP) to GNP

0.9%

Ratio of the Corporations Cost of Sales to Gross Sales Does not exceed55%

The election of the gross income tax option by the corporation shall be

irrevocable for three (3) consecutive taxable years during which thecorporation is qualified under the scheme.

Computation of GIT Gross Income Gross sales less sales returns, discountsand allowances and cost of goods sold. Cost of goods sold shall include allbusiness expenses directly incurred to produce the merchandise to bring

them to their present location and use. [Sec. 27(A)]

4. Improperly Accumulated Earnings Tax (IAET) [Sec. 29, as implemented by RR 2-2001

which prescribes rules governing the imposition of IAET]A. Rule There is imposed for each taxable year, in addition to other taxes, a tax equal

to 10% of the improperly accumulated taxable income of domestic andclosely-held corporations formed or availed of for the purpose of avoiding theincome tax with respect to its shareholders or the shareholders of any othercorporation, by permitting the earnings and profits of the corporation to accumulate

instead of dividing them among or distributing themto the shareholders.

B. Rationale If the earnings and profits were distributed, the shareholders wouldthen be liable to income tax; if the distribution were not made to them, they wouldincur no tax in respect to the undistributed earnings and profits of the corporation. Itis a tax in the nature of a PENALTY to the corporation for the improperaccumulation of its earnings, and a DETERRENT to the avoidance of tax uponshareholderswho are supposed to pay dividends tax on the earnings distributed tothem.

C. Exception The use of undistributed earnings and profits for the r e a s o n a b l en e e d s o f t h e b u s i n e s s would not generally make the accumulated or undistributedearnings subject to the tax. What is meant by r e a s o n a b l e n e e d s o f t h e b u s i n e s s

is determined by the IMMEDIACY TEST. Immediacy Test- It states that the r e a s o n a b l e n e e d s o f t h e b u s i n e s s are

the1) i m m e d i a t e needsof the business; and2) r e a s o n a b l y a n t i c i p a t e d needs.

How to prove the r e a s o n a b l e n e e d s o f t h e b u s i n e s s The corporationshould prove that there is1) an immediate need for the accumulation of the earnings and profits; or2) a direct correlation of anticipated needsto such accumulation of profits.

D. Composition: The following constitute accumulation of earnings for the r e a s o n a b l e needsof the business: (ILL ABE)

1) ALLOWANCEfor the increase in the accumulation of earnings up to 100% ofthe paid-up capitalof the corporation as of Balance Sheet date, inclusive ofaccumulations taken from other years;


21/97



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2) Earnings reserved for definite corporate EXPANSION projects or programsrequiring considerable capital expenditure as approved by the Board ofDirectors or equivalent body;

3) Earnings reserved for BUILDING, PLANT or EQUIPMENT ACQUISITIONas approved by the Board of Directors or equivalent body;

4) Earnings reserved for compliance with any LOAN COVENANTor pre-existingobligation established under a legitimate business agreement;

5) Earnings required by LAW or applicable regulations to be retained by the

corporation or in respect of which there is legal prohibition against itsdistribution;

6) In the case of subsidiaries of foreign corporations in the Philippines, allundistributed earnings intended or reserved for INVESTMENTS WITHINTHE PHILIPPINESas can be proven by corporate records and/or relevantdocumentary evidence.

E. Covered Corporations Only domestic and closely-held corporations are liablefor IAET.

1. Closely-held corporationsare those:a) at least 50%in value of the outstanding capital stock; orb) at least 50% of the total combined voting power of all classes of

stock entitled to vote

is owned directly or indirectly by or for n o t m o r e t h an 2 0i n d i v i d u a l s . Domestic corporations not falling under the aforesaid

definition are, therefore, publicly-held corporations.

2. To d e t e r m i n e w h e t h e r t h e c o r p o r a t i o n i s cl o se l y h e l d c o r p o r a t io n ,insofar as such determination is based on stock ownership, the following

RULESshall be applied:a. St o c k N o t O w n e d b y I n d i v i d u a ls . - Stock owned directly or

indirectly by or for a corporation, partnership, estate or trust shall beconsidered as being owned proportionately by its shareholders,

partners or beneficiaries.b. Fam i ly a n d P a r t n e r s h i p O w n e r s h i p . - An individual shall be

considered as owning the stock owned, directly or indirectly, by orfor his family, or by or for his partner. For purposes of thisparagraph, the family of an individual includes his brothers orsisters (whether by whole or half-blood), spouse, ancestors andlineal descendants.

c. Op t i o n t o A c q u i r e S t o c k s . - If any person has an option to acquirestock, such stock shall be considered as owned by such person. Forpurposes of this paragraph, an option to acquire such an option andeach one of a series of option shall be considered as an option toacquire such stock.

d. Co n s t r u c t i v e Ow n e r s h i p a s Ac t u a l Ow n e r s h i p . - Stockconstructively owned by reason of the application ofparagraph (1) or(3) hereof shall, for purposes of applying paragraph (1) or (2), betreated as actually ownedby such person; but stock constructivelyowned by the individual by reason of the application ofparagraph (2)

hereof shall NOT be treated as owned by himfor purposes of againapplying such paragraph in order to make another the constructiveowner of such stock.

BIR Ruling 025-02 The ownership of a domestic corporation forpurposes of determining whether it is a closely held corporation or apublicly held corporation is ultimately traced to the individual

shareholders of the parent company. Where at least 50% of theoutstanding capital stock or at least 50% of the total combined votingpower of all classes of stock entitled to vote in a corporation is owned


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directly or indirectly by at least 21 or more individuals, the corporation isconsidered as publicly held corporation.

F. Exempt Corporations: The IAET shall not apply to the following corporations: (BIG-PEN-T)

1. Banks and other non-bank financial intermediaries;2. Insurance companies;3. Publicly-held corporations;

4. Taxable partnerships;5. General professional partnerships;6. Non- taxable joint ventures; and7. Enterprises that are registered:

a. with the Philippine Economic Zone Authority (PEZA) under R.A.7916;

b. pursuant to the Bases Conversion and Development Act of 1992

under R.A. 7227; andc. under special economic zones declared by law which enjoy payment

of special tax rate on their registered operations or activities in lieuof other taxes, national or local.

Words in regular letters are found in Sec. 29(B)(2) of the NIRC. Words initalics are additions made by the revenue regulation to consolidate Sec. 29 withother pertinent laws.

G. ComputationYears taxable income: P XX

Add: Income exempt from tax XXIncome excluded from gross income XXIncome subject to final tax XXAmount of net operating loss carry-over(NOLCO)deducted XX

Total P XXLess: Income tax paid/payable for the taxable year XX

Dividends actually or constructively paid/issued fromthe applicable years taxable income XX

Amount reserved for the reasonable needs of thebusiness emanating from the covered yearstaxable income XX

Improperly Accumulated Taxable Income P XX

Multiplied by IAET rate x 10%Improperly Accumulated Earnings Tax (IAET) P XX

Words in regular letters are in the statutory formula. Words in italics areadditions made by the revenue regulation.

H. Limitation The profit that has been subjected to IAET shall no longer be subjectedto IAET in later years even if not declared as dividend. However, profits which havebeen subjected to IAET, when declared as dividends, shall be subject to tax on

dividends except in those instances where the recipient is not subject thereto.

I. Declaration of Dividends from earnings For purposes of determining the sourceof earnings or profits declared or distributed from accumulated income, the dividendsshall be deemed to have been paid out of the most recently accumulatedprofits or surplus and shall constitute a part of the annual income of thedistributee for the year in which received pursuant to Section 73(C) of the Code.But, where the dividends or portion of the said dividends declared forms part of theaccumulated earnings as of December 31, 1997, or emanates from theaccumulated income of a particular year and is therefore an exemption to theproceeding statement, such fact must be supported by a duly executed Board


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Resolution to that effect.

J. Period for Payment of Dividend/IAET The dividends must be declared and paidor issued not later than one year following the close of the taxable year ,otherwise, the IAET, if any, should be paid within fifteen (15) days thereafter.

K. Determination of Purpose to Avoid Income Tax1) The fact that a corporation is a m e r e h o l d i n g co m p a n y o r in v e s t m e n t

c o m p a n y shall be p r i m a f a ci e evidence of a purpose to avoid the taxuponits shareholders or members

A "holding or investment company" is a corporation havingpractically no activities except holding property, and collecting theincome therefrom or investing the same; and

2) where the earnings or profits of a corporation are permitted to accumulatebeyond the reasonable needs of the business.

PRI MA F ACI E INSTANCES of accumulation of profits beyond thereasonable needs of a business (and therefore, indicative of purposeto avoid income tax upon shareholders) (UBE)

1) Investment of substantial earnings and profits of thecorporation in UNRELATED BUSINESS or in stock orsecurities of unrelated business;

2) Investment in BONDS and other long-term securities;

and3) Accumulation of earnings IN EXCESS OF 100% OF PAID-

UP CAPITAL, not otherwise intended for the reasonableneeds of the business.

The controlling intention of the taxpayer is that which ismanifested at the time of accumulation. A speculative andindefinite purpose will not suffice. The mere recognition of afuture problem or the discussion of possible and alternative

solutions is not sufficient. D e f in i t e n e ss o f p l a n / s c o u p l e dw i t h a ct i o n / s t ak e n t o w a r d s it s co n s um m a t i o n is

e s s e n t i a l .

ONE LAST NOTE ON THE APPLICABILITY OF TAX RATES OF DOMESTIC CORPORATIONS : Allcorporations, agencies, or instrumentalities owned or controlled by the GOVERNMENT aretaxable and shall pay such rate of tax upon their taxable income as are imposed on

domestic corporations engaged in a similar business, industry, or activity.EXCEPTIONS (i.e, not taxable):

o Government Service Insurance System (GSIS),

o Social Security System (SSS),

o Philippine Health Insurance Corporation (PHIC),

o Philippine Charity Sweepstakes Office (PCSO) and

o the Philippine Amusement and Gaming Corporation (PAGCOR)11

E. T a x o n R e s i d e n t F o r e i g n C o r p o r a t i o n sResident foreign corporations are subject to any or some of the following:

Capital Gain Tax Final Tax on Passive Income

Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR] Gross Income Tax(GIT)

Branch Profit Remittance Tax

11The tax exemption of PAGCOR was withdrawn by RA 9337 (May 24, 2005). However, the 2006 Bar Examinations will (most

likely)only cover laws promulgated up to 31 December 2004. For purposes of the Bar, therefore, PAGCOR is (most likely) stilltax exempt.


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1. Capital Gains subject to Capital Gains Tax On sale, barter, exchange or otherdisposition of s h a r e s o f s t o c k o f a d om e s t ic corporation n o t l i s t e d a n d t r a d e dt h r o u g h a l o c a l st o c k e x c h a n g e , held as a capital asset:

On the net capital gain:Not over P100,000 Final Tax of 5%On any amount in excess of P100,000 Final Tax of 10%

NOTE:

Tax treatment is the same as that of individuals and domestic corporations.

There is no corresponding provision for resident foreign corporations regardingcapital gain tax on the sale of real property held as a capital asset. Hence, the nettaxable income from the sale of real property realized by the resident foreigncorporation shall be subject to the normal corporate income tax.

2. Passive Income Subject to Final Tax Interest Income:

o on any currency bank deposit, yield or any other monetary benefit fromdeposit substitutes, trust funds and similar arrangements - 20%

o under the expanded foreign currency deposit system (EFCDS) - 7.5%

Dividends received from a domestic corporation (Intercompany Dividend) -EXEMPT

Royalties (any kind) 20%

3. Income subject to Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR]Gross Income Tax (GIT)The discussion with respect to this topic (income subject tonormal tax, MCIT, or GIT) under the subheading of domestic corporations is equallyapplicable to resident foreign corporations, both as to concepts and computations, exceptthat RFCs are taxed only on income from sources within the Philippines.

NORMAL CORPORATE INCOME TAX RATE 32%12of net taxable income fromsources within the Philippines

MINIMUM CORPORATE INCOME TAX (MCIT) 2% of MCIT Gross Income fromsources within the Philippines. The MCIT is imposed on RFCs under the same

conditions as domestic corporations. [Sec. 28(A)(2)]

GROSS INCOME TAX (GIT) The President, upon the recommendation of theSecretary of Finance, may allow resident foreign corporations the option to be taxedat fifteen percent (15%) of gross income within the Philippines, under the same

conditions as domestic corporations. [Sec. 28(A)(1)]

4. Branch Profit Remittance Tax[Sec. 28(A)(5)] Taxable transaction any profit remitted by a branch to its head office

Tax Rate and Base 15% based on the total profits applied or earmarked forremittance without any deduction for the tax component

Non-taxable activitiesactivities which are registered with the Philippine EconomicZone Authority

Income NOT TREATED AS BRANCH PROFITSunless effectively connected with theconduct of trade or business in the Philippines:

i. Interests, dividends, rents, royalties, including remuneration for technicalservices

12Starting July 1, 2005, the normal corporate income tax rate for resident foreign corporations is 35%. (RA 9337, May 24, 2005)

Again, it is unlikely that the 2006 Bar would cover RA 9337 which was passed in 2005.


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ii. salaries, wages premiums, annuities, emolumentsiii. other fixed or determinable annual, periodic or casual gains, profits,

incomeiv. capital gains received during each taxable year from all sources within

the Philippines

NOTES:

- The branch profit remittance tax is imposed whether the head office of the foreigncorporation is located in a tax treaty country, in a tax haven or other non-treatycountry.

- The branch profit remittance tax is imposed only on the profits remitted by aPhilippine branch to the head office of a foreigncorporation. Should the branch of adomesticcorporation remit profits to its head office, the transaction is notsubject tothe branch profit remittance tax.

F. T a x o n N o n r e s i d e n t Fo r e i g n C o r p o r a t i o n sNon-resident foreign corporations are subject to any or some of the following:

Capital Gain Tax

Final Tax on Passive Income

Final Tax on [Other] Gross Income from sources within the Philippines

1. Capital Gains subject to Capital Gains Tax On sale, barter, exchange or otherdisposition of s h a r e s o f s t o c k o f a d om e s t ic corporation n o t l i s t e d a n d t r a d e d

t h r o u g h a l o c a l st o c k e x c h a n g e , held as a capital asset:On the net capital gain:


NOTE:

Tax treatment is the same as that of individuals and domestic/resident foreign

corporations. There is no corresponding provision for non-resident foreign corporations regarding

capital gain tax on the sale of real property held as a capital asset. Hence, the grossincome from the sale of real property realized by the non-resident foreigncorporation shall be subject to a 32% final tax imposed on gross income fromsources within the Philippines.

2. Passive Income Subject to Final Tax Interest

o on foreign loans contracted on or after August 1, 1986 20%

o under the expanded foreign currency deposit system (EFCDS) - EXEMPT

Dividends (cash and/or property) received from a domestic corporation(Intercorporate Dividend) 15%, AS LONG AS the country in which thenonresident foreign corporation is domiciled allows a tax credit for taxesdeemed paidin the Philippines equivalent to 17%

13

- 17% represents the difference between the regular income tax of 32% oncorporations and the 15% tax on dividends

- If the country within which the NRFC is domiciled does NOT allow a tax credit, afinal withholding tax at the rate of 32% is imposed on the dividends receivedfrom a domestic corporation. [In other words, the dividends are subject to thethird kind of tax: Final Tax on [Other] Gross Income from sources within the

Philippines.]

13NOTE: Salient amendment made by RA 9337: The tax credit must now be equivalent to 20%, since the new income tax rate

for non-resident corporations is 35% (such that 35% - 20% = 15%). Again, for purposes of the Bar, (chances are) the applicabletax credit rate is 17%.


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3. Final Tax on [Other] Gross Income from sources within the Philippines 32% ofthe gross income14 received from all sources within the Philippines, such as interests,dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities,emoluments or other fixed or determinable annual, periodic or casual gains, profits andincome, and capital gains EXCEPT capital gains resulting from the sale of shares of stock ofa domestic corporation not listed and traded through a local stock exchange, held as acapital asset.

G. S p e c ia l T y p e s o f Co r p o r a t i o n sA. Special Type of Domestic Corporations

1. Proprietary Educational Institutions and Hospitals (Non-profit) Tax Rate and Base 10% on net income (except on income subject to

capital gains tax and passive income subject to final tax) within and without

the Philippines CAVEAT: If gross income from unrelated tradeor business or other activity

exceeds 50% of total gross income derived from all sources, the tax rateof 32% shall be imposed on the entire taxable income.

- Unrelated trade, business or other activityany trade, business orother activity, the conduct of which is not substantially related to theexercise or performance by such educational institution or hospital ofits primary purpose or function.

- Proprietary educational institution any private school maintained

and administered by private individuals or groups with an issuedpermit to operate from the DECS, CHED or TESDA.

2. Depository Banks (Foreign Currency Deposit Units)[Sec. 27(D)(3) as amended by RA9294 (2004)]

Coverage of the Rule ONLY income derived by a depository bank under theexpanded foreign currency deposit system from foreign currency transactions

with:- nonresidents,- offshore banking units in the Philippines,- local commercial banks including branches of foreign banks that may

be authorized by the Bangko Sentral ng Pilipinas (BSP) to transactbusiness with foreign currency deposit system units and

- other depository banks under the expanded foreign currency depositsystem

Tax Rate: Exempt from all taxes, e x c e p t net income from suchtransactions as may be specified by the Secretary of Finance, uponrecommendation by the Monetary Board to be subject to the regularincome tax payable by banks

- EXCEPTION: Interest income from foreign currency loans grantedby such depository banks under said expanded system to residentsother than offshore units in the Philippines or other depository banksunder the expanded system shall be subject to a final tax at the rateof 10%.

B. Special Types of Resident Foreign Corporations1. International Carriers

Tax Rate and Base 2.5% on Gross Philippine Billings (GPB)What is GPB?

- In the case of International Air Carriers, GPB refers to the amount

of:

14Now 35% of gross income, by virtue of RA 9337. Same comment as notes 10, 11, 12, 13. (nakakapagod na).


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gross revenue derived from carriage of persons, excessbaggage, cargo and mail originating from the Philippines in acontinuous and uninterrupted flight, irrespective of the placeof sale or issue and the place of payment of the ticket orpassage document

gross revenue from tickets revalidated, exchanged and/orindorsed to another international airline if the passengerboards a plane in a port or point in the Philippines

for flights which originate from the Philippines, buttransshipment of passenger takes place at any port outsidethe Philippines on another airline, the gross revenueconsisting of only the aliquot portion of the cost of the ticketcorresponding to the leg flown from the Philippines to thepoint of transshipment

- In the case of International Shipping, GPB means:

gross revenue whether for passenger, cargo or mailoriginating from the Philippines up to final destination,regardless of the place of sale or payments of the passage orfreight documents.

2. Offshore Banking Units authorized by the Bangko Sentral ng Pilipinas (BSP) [Sec.28(A)(4) as amended by RA 9294 (2004)]

Coverage of the Rule ONLY income derived by offshore banking units from

foreign currency transactions with:- nonresidents,- other offshore banking units- local commercial banks including branches of foreign banks that may

be authorized by the Bangko Sentral ng Pilipinas (BSP) to transactbusiness with offshore banking units

Tax Rate: Exempt from all taxes, e x c e p t net income from suchtransactions as may be specified by the Secretary of Finance, uponrecommendation by the Monetary Board to be subject to the regularincome tax payable by banks

- EXCEPTION: Interest income derived from foreign currency loansgranted to residents other than offshore banking units or localcommercial banks, including local branches of foreign banks thatmay be authorized by the BSP to transact business with offshorebanking units, shall be subject only to a final tax at the rate of 10%.

3. Resident Depository Bank (Foreign Currency Deposit Units) [Sec. 28(D)(7)(b) asamended by RA 9294 (2004)]

Coverage of the Rule ONLY income derived by a depository bank under theexpanded foreign currency deposit system from foreign currency transactionswith:

- nonresidents,

- offshore banking units in the Philippines,

- local commercial banks including branches of foreign banks that maybe authorized by the Bangko Sentral ng Pilipinas (BSP) to transactbusiness with foreign currency deposit system units and

- other depository banks under the expanded foreign currency deposit

system Tax Rate: Exempt from all taxes, e x c e p t net income from such

transactions as may be specified by the Secretary of Finance, uponrecommendation by the Monetary Board to be subject to the regularincome tax payable by banks

- EXCEPTION: Interest income from foreign currency loans grantedby such depository banks under said expanded system to residentsother than offshore units in the Philippines or other depository banks


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under the expanded system shall be subject to a final tax at the rateof 10%.

4. Regional or Area Headquarters and Regional Operating Headquarters of MultinationalCompanies

Regional or area headquarters not subject to income tax

- Regional or area headquarters a branch established in thePhilippines by multinational companies and which headquarters do

not earn or derive income from the Philippines and which act assupervisory, communications and coordinating center for theiraffiliates, subsidiaries, or branches in the Asia-Pacific Region andother foreign markets.

Regional operating headquarters 10% of their taxable income- a branch established in the Philippines by multinational companies

which are engaged in any of the follow

Documents

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