Income Taxation Dimaampao

JUSTICE
JAPAR B. DI
DAYIL? APPRUALiH
TO
INCOME TAXATION
By
JAPAR B. DIMAAMPAO
Associate Justice, Court of Appeals
Professor of Law, Bar Reviewer
FOURTH EDITION
2011
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GOf4TENTS
Chapter 1
Salient Features of the Present Tax System
I. Individual Income System................................. 1
II. Corporate Income Taxation............................... 2
III. Common Features .................. 2
Chapter 2
Income and Requisites; Income Tax;
Nature and Functions
A. Definitions.......................................................... 4
(1.) Judicial Definitions ..................................... 4
(2.) Economist’s Definition................................ 4
B. Income, Capital, Revenue, Receipts;
Distinctions................................................. 5
C. Sources of Income ............................................ 5
D. Income Tax; Basis, Nature, Functions .............. 7
E. Requisites for Income to be Taxable ................ 8
(1.) Doctrine of Constructive Receipt
of Income ............................................ 9
F. Doctrines on Determination of Taxable Income 11
(1.) Claim of Right Doctrine.............................. 11
(2.) Severance test theory................................ 11
(3.) Control test................................................. 11
Chapter 3
Gross Income
A. General Statutory Definition.............................. 12
B. Broad Definition................................................. 13
(1.) Other tax implications of condonation
Formula: Gross Income; Net Income; 30
of indebtedness ........
Taxable Compensation Income; Income (2.) Other tax implications of premiums
Tax Due; paid by employer ....................... 30
Income Tax Payable .......... 13 a.) Convenience of the Employer
Gross Income Taxation and Net Income Rule 31
Taxation; Distinctions; Advantages and b.) De minimis benefits ..................... 32
Disadvantages ........ 14 E. Special Rules on Fringe Benefits .... 33
Exclusions from Gross Income ......................... 15 F. Doctrine of Cash Equivalent ............................. 38
A. Reasons for Exclusion ... 15 G. Allowable Deductions from Gross
B. Exclusions from Gross Income......................... 15 Compensation Income ............................... 38
(1.) Proceeds of life insurance ......................... 15 (1.) Personal exemptions ....... 38
(2.) Amount receiVed as return of premium ..... 16 (2.) Premium Payments on Health and/or
(3.) Gifts, bequests and devises ......... 17 Hospitalization Insurance........................... 43
(4.) Compensation for injuries or sickness....... 17 Business/Trade/Professional Income
(5.) Income exempt under treaty...................... 18 A. Income Covered
(6.) Retirement benefits, pensions, (1.) Income derived by self-employed
gratuities, etc. . 18 from trade or business (trading,
(7.) Miscellaneous items................................... 21 manufacturing, merchandising,
farming, and others) .......... 44
Chapter 4 (2.) Income derived by professionals ............... 45
(3.) Gross income of farmers include............... 46
Individual Income Taxation i.) Interest Income ................................. 46
A.
Classification of Individual Taxpayers ii.) Rental Income................................... 46
(1.) Resident citizen.......................................... 25 iii.) Dividend Income ............................... 48
(2.) Non-resident citizen ................................... 25 iv.) Passive Investment Income.............. 50
(3.) Resident alien ............................................ 25 (4.) Other Sources............................................ 51
(4.) Non-resident alien...................................... 27
(5.) Non-resident alien not engaged in Chapter 5
trade or business ................................ 27 Corporate Income Taxation
B.
General Principles; Sources of Income;
Tax Base .................................................... 27 A. Definition under the NIRC................................. 53
C Categories of Income........................................ 28 B. Major Groups of Corporation for Income
a. Definition ....... 28 Tax Purposes ............................................. 56
b. Basis/Test................................................... 29 (1.) Domestic Corporations ....... 56
c. Requisites for Taxability ............................. 29 (2.) Resident Foreign Corporations.................. 57
d. Forms of Compensation . 29 (3.) Non-resident Foreign Corporations ..... 60
XXÏ
C. Minimum Corporate Income Tax....................... 61 (1.) Distinctions: Deductions, Exclusions and
D. Improperly Accumulated Earnings Tax ............. 69 Personal Exemptions.......................... 92
E. Other Corporate Tax Rates............................... 73 Kinds of Allowable Deductions ... 92
(1.) Common Tax Rates ................................... 73 (1.) Itemized Deductions ..... 92
(2.) Domestic Corporations .............................. 73 (2.) Optional Standard Deduction..................... 93
(3.) Resident Foreign Corporations.................. 74 Kinds of Itemized Deductions ........................... 93
(4.) Non-resident Foreign Corporations ........... 75 C. Business Expenses........................................... 93
F. Tax Exempt Corporations Under the NIRC ...... 77 D. Interest Expenses 106
(1.) Labor, Agriculture or Horticultural .. Definition 106
Organization Not Organized E. Taxes ................................................................. 110
Principally for Profit............................. 77 Nature and Scope ............................................. 110
(2.) Mutual Savings Banks and Cooperative F. Losses ............................................................... 113
Banks .................................................. 77 (1.) Definition .................................................... 113
(3.) Fraternal Beneficiary Society, Order (2.) Kinds of Losses ................... 114
or Âssociation ..... . 78 (3.) Special Kinds of Losses ............. 115
(4.) Cemetery Companies ................................ 79 a.) Wagering losses 115
(5.} Religious, Charitable, Scientific, Athletic b.) Losses due to voluntary removal
or Cultural Corporations ...... of building incident to renewal
80
(6.) Business, Chamber of Commerce, or or replacement........................... 117
Board of Trade.................................... go c.) Loss of useful value of capital asset
(7.) Civic League ........................... ................ . 82 due to changes in business
(8.) Non-Stock, Non-Profit Educational condition..................................... 118
(4.) Casualty Losses......................................... 122
Institutions........................................... 3
(5.) Non-deduct bIe Losses 123
(9.) Government Educational Institution........... 85 G. Bad Debts .............. 126
(10.) Mutual Fire Insurance Companies
(1.) Definition ....... 126
and Like Organizations................ ....... 85 (2.) Requisites for deductibility......................... 126
(11.) Farmers, Fruit Growers' or Like
(3.) Measure of Bad Debts deductible ............. 129
Association.......................................... g6 H. Depreciation ........... 131
Tax-Exempt Corporations under (1.) Definition .. 131
Special Laws....................................... go (2.) Requisites for deductibility......................... 131
I. Depletion ............ 134
Chapter 6 (1.) Definition ........ 134
Allowable Deductions from Gross Income (2.) Theory and purpose of Depletion
allowance............................................ 134
A. Basic Principles............................ . .. .............. 91 (3.) Who are entitled......................................... 134
B. The Cohan Rule Principle.................... ............. 91 Essential factors......................................... 135
J. Charitable and Other Contributions .................. 136 Settled Case on the Tax Situs of Interest
(1.) Kinds .......................................................... 136 Income ....................................................... 150
(2.) Entitled ....................................................... 136 B. Capital Transactions.......................................... 153
(3.) Requisites for deductibility......................... 136
(4.) Contributions deductible in full................... 137 Chapter 9

(5.) Contribution subject to limitation................ 138 Income Tax Rules on Dealings in Property
(6.) Deductible under Special Laws ................. 139
K. Research and Development Expenditure ......... 139
(1.) In General .................................................. A. Capital Gains from Sale or Other Disposition
139
of Real Property
(2.) Limitations on Deduction .. 140
(1.) Individual Taxpayers ....................... 164
L. Employer’s Contribution to Pension Trust ........ 140
(2.) Corporate Taxpayers......................................166
(1.) Nature 140 Gains and Losses from Dealings
(2.) Requisites for Deductibility ........................ 140 in Property ..... . 166
(3.) There is no need of special permit from A. Concept..................................................................166
the BIR to put up a pension plan for B. Measure of Income or Loss...................................167
the benefit of employees .................... 141 C. Adjusted Basis or Cost of the Property Sold..........167
(4.) Treatment of Income from Pension Plan... 141 D. Settled Rules on Sale or Exchange......................169
(5.) Deductible payments to pension trusts ..... 141 E. Tax-exempt Sales or Exchanges..........................170
Optional Standard Deduction..................... 141 F. Gain recognized, loss not recognized Rule..........172
Special deductions allowed to Insurance
Companies.......................................... 142
Chapter 10
Items not deductible................................... 143
Taxpayers Required to File Income Tax Returns
Chapter 7
A. IndiViduals ................. 173
Estates and Trusts B. Corporations no matter How created or
A. Estate ................................................................ 146 organized including General Professional
B. Trust .................................................................. 147 Partnerships.....................................................175
(1.) Taxable Trust.............................................. 147 C. Estates and Trusts Engaged in Trade
(2.) Rules on Taxability..................................... XXÏV
147
C. Computation of Tax on Estate and Trust.......... 148
Chapter 8
Special Topics in Income Taxation
A. Determination of Source According to Kind
of Income ................................................... 149
or Business......................................................
APPE
NDICE
S
Appendix A — Revenue Regulations No. 9-98.............
Appendix B — Revenue Regulations No. 5-99............
Appendix C — Revenue Regulations No. 13-2000
.......................................................................................
XKV
Appendix D — Revenue Regulations No. 2-2001... 197
Appendix E — Revenue Regulations No. 25-2002... 204
Appendix F — Revenue Regulations No. 76-2003... 207
Appendix G — Revenue Regulations No. 12-2007 .. 211
Chapter 1
Appendix H — 2011 Bar Coverage for Taxation ....... 220
Appendix I — Bar Examination Questions
on Taxation.......,..............................................259 SALIENT FEATURES OF THE PRESENT
INCOME TAX SYSTEM
I. INDIVIDUAL INCOME TAXATION

A. Schedular Tax Treatment
1.It classifies income.
2. It provides different tax rules.
3. It imposes different tax rates.
B. Net Income Taxation
1. Resident citizen (RC)
2. Non-resident citizen (NRC)
3. Resident alien (RA)
4. Non-resident alien engaged in trade or busi-
ness (NRA-ETB)
C. Gross Income Taxation
Non-resident alien not engaged in trade or
business (NRA-NETB)
D. Income Tax Situs
1. Residence — RA, RC
2. Place — NRA, NRC
3. Citizenship — RC
E. Individual taxpayers (compensation earners) except
NRA-NETB are entitled to personal exemptions
xxvi 1
BASIC APPROACH TO INCOME TAXATION CHAPTER 1 3
SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM
II. CORPORATE INCOME TAXATION C. Final Withholding Tax System

A. Global Tax Treatment 1. Withholding agent (source) — withholds the
1. It generally provides for uniform rules. tax and remits the same to the BIR
2. It generally imposes uniform tax rate. 2. Tax withheld — final settlement of the tax li-
ability on the income covered
3. It does not generally classify income.
B. Net Income Taxation
1. Domestic Corporation (DC)
2. Resident Foreign Corporation (RFC)
C. Gross Income Taxation
Non-resident Foreign Corporation (NRFC)
D. Income Tax Situs
1. Residence — RFC
2. Place — NRFC
3. Nationality — DC
III. COMMON FEATURES

A. Pay as you File System
1. Individuals — upon filing of their income tax
returns
2. Corporations — upon filing of their quarterly
corporate income tax returns and final
adjustment corporate returns
B. Creditable Withholding Tax System
1. Withholding agent (source) — withholds the
tax and remits the same to the BIR
2. Tax withheld — creditable against income
tax due
CHAPTER 2 5
INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS
• it cannot be determined by reckoning cash receipts;

other income determining factors: inventories,
accounts receivable, property acquisition and
Chapter 2 accounts payable for expenses incurred.
INCOME AND REQUISITES; INCOME TAX; B. INCOME, CAPITAL, REVENUE, RECEIPTS;
NATURE AND FUNCTIONS DISTINC-
TIONS (1995 Bar)
Capital v. Income
Fund Flow
A. DEFINITIONS (1969 Bar)
Wealth Service of wealth
In a broad sense, income means all wealth that
flows into the taxpayer other than as a mere return Tree (property) Fruit (metaphorical
of capital. It includes the forms of income specifically language)
described as gains and profits including gains derived Gross receipt includes receipts which may con-
from the sale or other disposition of capital assets. stitute capital as well as income; therefore, broader in
scope. Income connotes a narrower concept limited
Judicial definitions only to gain derived from labor, capital or property,
• gain derived from capital, or from labor, or from both excluding non-income items such as the capital
capital and labor, including the gain derived from the inVested, cost of goods sold or those excluded by law
sale or exchange of capital assets (Fisher v. Trinidad, from income taxation.
43 Phil. 973; Eisner v. Macomber, 252 U.S. 189, 40 S. Revenue refers to all funds or income derived by
Ct. 189, 64 L. Ed. 521 1920). the government whether from tax or other sources.
• amount of money coming to a person or corporation Revenue is to the government as income is to private
within a specified time, whether as payment for persons or corporations.
services, interest or profit from investment (CONWI v.
CTA, 213 SCRA 83). C. SOURCES OF INCOME
• Property (capital)
Economist's definition
• Labor (service)
• money value of the net accretion to one’s economic
power between two points of time (R.M. Haig, The • Sale/Exchange of capital asset and activity
Federal Income Tax, Columbia University; Anderson, Source of income is any property, activity or
Taxation and the American Economy).
service
that produced the income (COM v. BOAC, 149 SCRA
395). It may also be in the form of proceeds from
sales of transport documents.
BASIC APPROACH TO INCOME TAXATION Bar).
Under the Tax Code, however, income derived

from whatever source forms part of the taxpayer’s
income. This includes the following:
(1.) Treasure found or punitive damages representing
profits lost;
(2.) Amount received by mistake (Javier v. CA, 199
SCRA 824; Javier v. Com, CTA Case No. 3393,
July 27, 1983).
If a foreign bank erroneously remitted U.S.$1
million instead of U.S.$1,000.00 and it appears
subsequently that the recipients spent the
difference of U.S. $999,000 on various purchases
of property both here and abroad of their own
material benefit, the said sum constitutes taxable
income.
It has been held that if a taxpayer receives
earnings under a claim of right without restrictions
as to its disposition, he has received income even
though it may still be claimed that he is not
entitled to retain the money and e\/en though he
may still be adjudged liable to restore its
equivalent. This is an exception to the rule that
income received through mistake is not taxable
as its receipt is offset by liability to the party
making the excessive payment (North American
Consolidated v. Burnet, 286 U.S. 417).
(3.) Cancellation of the taxpayer’s indebtedness.
(4.) Payment of usurious interest.
(5.) Illegal gains — gambling, theft, embezzlement,
extortion, fraud — income to embezzler if
forgiven by the owner.
(6.) Tax refund must be claimed as deduction from
gross income in the preceding year. It means that
the tax must be a deductible one (2005, 2003
CHAPTER 2 7 a) Protection theory. It dictates that when
INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS
the flow of wealth proceeded from, and
occurred
(7 ) tBad debt recovery — must be claimed as
deduction
- from gross income in the preceding year.It
assumes that the taxpayer has a net income,
not a net loss (2005, 2003 Bar).
D.
(1.) It is a tax on all yearly profits arising from
property, profession, trades or offices or as a tax
on a person’s income, emoluments, profits and
the like.
(2.) It is based on income, either gross or net,
realized in one taxable year.
(3.) Excise tax — it is not levied upon the person or
property but upon the right of a person to
receive income or profits.
(4.) Functions of income tax:
a.) to provide large amounts of revenues;
b.) to offset regressive sales and consumption
taxes;
c.) to mitigate the evils arising from the
inequalities in the distribution of income and
wealth which are considered deterrents to
social progress, by a progressive scheme of
taxation (Report of the Tax Commission of
the Phil., Vol. II; Madrigal V. Rafferty, 38
Phil. 414).
(5.) The basis of the right of the government to tax
income emanates from its partnership in the pro-
duction of income by providing the protection,
resources, incentive and proper climate for such
production (Com. v. Lednicky, 11 SCRA 603).
This is called the Partnership Theory which has
spawned the following principles:
8 BASIC APPROACH TO INCOME TAXATION CHAPTER 2 9
INCOME AND I2EQUISITES; INCOME TAX; NATURE AND FUNCTIONS
within, Philippine territory, enjoying the dez v. Commissioner of Internal Revenue,

protection accorded by the Philippine 29 SCRA 553).
government, the same, in consideration of
such protection should share the burden of c) But if the increase in the net worth of a
supporting the government [CIR v. BOAC, taxpayer is the result of the receipt by it of
149 SCRA 395, 407 (2009 Bar)]. unreported or unexplained taxable income,
the correction is taxable income.
b) Theory of favorable business climate.
Domes- tic corporations owe their corporate d.) Receipt includes constructive receipt.
existence and privilege to do business to the ’Y ’ Doctrine of Constructive Receipt oI
government. They also benefit from the
income — Income which is credited to the
efforts of the government to improve the
account of and set apart for a taxpayer and
financial market and to ensure a favorable
which may be drawn by him at any time is
business climate. It is therefore fair for the
government to require them to make a subject to tax for the year during which it
reasonable contribution to the public was so credited or set apart although not yet
expenses (CREBA v. Romulo, 614 SCRA then actually received or reduced to his
605, 622). possession. To constitute receipt in such
case, the income must be credited to the
ET REQUISITES FOR INCOME TO BE TAXABLE taxpayer without any substantial limitation or
condition upon which payment is to be
« » (1.) There must be gain or profit, whether in cash or its
made.
” equivalent.
Examples of Constructive Receipt:
(2.) The gain must be realized or received. This
implies that not all economic gains constitute i. Matured interest coupons due and de-
taxable income. mandable (convertible into cash);
a.) Mere increase in the value of property is not ii. Share in the profits of a partner in a
income (unrealized increase in capital). partnership;
b.) Increases in the taxpayer’s net worth are not Interest credited on savings bank
taxable increases in net worth if they are not deposit (Section 53, Re\/enue
Regulations No. 2);
the result of the receipt by it of unreported or ÎV. Dividends applied by the corporation
unexplained taxable income, but are shown against the indebtedness of a
to be merely the result of the correction of stockholder (Section 50, Revenue
errors Regulations No. 2);
in its entries in its books relating to its indebt- erroneously overstated or listed as
edness to certain creditors, which had been
outstanding when they had in fact been duly V. Rental payments refused by the lessor
paid (Fernan-
when the lessee tendered payment and
the latter made a judicial deposit of
the
10 BASIC APPROACH TO INCOME TAXATION required to be included in computing the taxable
income.
rental (Limpian Investment Corporation
v. Com., 17 SCRA 703).
vi. Amount credited to shareholders of a
building and loan association when such
credit passes without restriction to the
shareholder.
The Doctrine of Constructive
Receipt is designed to prevent the
taxpayer using the cash basis from
deferring or postpon- ing the actual
receipt of taxable income. Without the
rule, the taxpayer can con- veniently
select the year in which he will report
the income.
In Filipinas Synthetic Fiber Corpo-
ration v. CA [316 SCRA 480, 486], the
Supreme Court ruled that it is the right
to receive income, and not the actual re-
ceipt, that determines when to include
the amount in gross income.
For taxpayer using the accrual
method, the determinative question is,
when do the facts present themselves in
such a manner that the taxpayer must
recognize income? The accrual of
income is permitted when the all-
events test has been met. This test
requires: (1) fixing of a right to income to
pay; and (2) the availability of the
reasonable accurate determination of
such income. [Commissioner of Internal
Revenue v. lsabela Cultural Corporation,
515 SCRA 556, 564-565 (2010 Bar)].
The gain must not be excluded by law or treaty
from taxation. This means that not all income is
CHAPTER 2 11
INCOME AND REQUISITES; INCOME TAX; NATURE AND
FUNCTIONS
F. DOCTRINES ON DETERMINATION OF TAXABLE

INCOME
(1.)‹GIatm ofright'ddfitrine — illegally acquired
income constitutes realized gain (Rutkin v. U.S.,
343 U.S. 130). (2001 Bar)
(2.)Woar ce.test‹tfYeo try — separation from capital
of something which is of exchangeable value
(Eisner
v. Macomber, 252 U.S. 189).
(3.) Gontrof›test.— power to procure the payment of
income and enjoy the benefit thereof (Helvering
v. Horst, 311 U.S. 112).
CHAPTER 3 13
GROSS INCOME
B. BROAD DEFINITION
In a broad sense, gross income means income
less income which by statutory definition or
Chapter 3 otherwise, is exempt from the tax imposed by law.
Stated otherwise, gross income means all items of
GROSS INCOME income less exclusions.
A. GENERAL STATUTORY DEFINITION FORMULA: GROSS INCOME; NET INCOME; TAXABLE

COMPENSATION INCOME; INCOME TAX DUE;
In a narrow sense, gross income means all INCOME TAX PAYABLE
income derived from whatever source, including but
not limited
to the following: Gross Income = All income less ex-
(1.) Compensation for services in whatever form clusions
paid including but not limited to fees, salaries, (1980,1983 Bar)
wages, commissions and similar items; Net or Taxable Income —— Gross income less
(2.) Gross income derived from the conduct of trade allowable deductions
or business or the exercise of profession; (1977, 2000 Bar)
(3.) Gains derived from dealings in Taxable Compensation Income = Gross compensa-
property; (4.) Interests; tion less personal
and additional ex-
($.) Rents; emptions (Individual
(6.) Royalties; Taxpayers)
(7.) Dividends; 12 Income Tax Due
(8.) Annuities;
(9.) Prizes and
Income Tax Payable
winnings; (10.) Pensions;
and
(11.) Partner’s distributive share from the net income
of the general professional partnership.
= Taxable or net income multiplied by income tax rate
= Income Tax due less creditable withholding tax or
tax credit
44 BASIC APPROACH TO INCOME TAXATION
CHAPTER 3 15
GROSS INCOME
GROSS INCOME TAXATION AND NET INCOME

EXCLUSIONS FROM GROSS INCOME
TAXATION; DISTINCTIONS; ADVANTAGES
AND DISADVANTAGES
A. REASONS FOR EXCLUSION
(1.) The item of receipt does not fall within the
Gross Income Taxation Net Income Taxation definition of income for income tax purposes.
Allows no deductions Deductions are allowed
Grants no exemptions Exemptions are granted • Damages recovered in libel and slander suits
Tax base: Gross income Tax base: Net income • Damages recovered for alienation of affection
• Damages recovered for breach of promise to
Advantages of Gross Advantages of Net marry
Income Taxation Income Taxation
• Damages recovered for loss of life of spouse
Simplifies the income tax Fair and just due to grant
system of deductions • Damages recovered in annulment of
Does away with wastage of Tax audit minimizes fraud marriage (2.) A provision of the Tax Code or special
manpower and supplies
law exempts
Substantial reduction in cor- Provides equitable reliefs
it from income tax.
ruption and tax evasion in the form of deductions,
exercise of discretion to exemptions and tax credits B. EXCLUSIONS FROM GROSS INCOME
allow or disallow deductions
dispensed with (1.) Proceeds of life insurance (2007, 2005, 2003 Bar)
— received in a single sum or installments — not
taxable — Reason: indemnity rather than as gain
or profit. Insurance contract is a contract of
Disadvantages of Gross indemnity. Exception — interest payments shall
Disadvantages of Net
Income Taxation be included in
Income Taxation
No deductions and Vulnerable to corruption on
exemptions allowed account of margin of
discretion in the grant of However, prsceeds of life insurance where
deductions the beneficiari is/revocabIe is subject to estate
Susceptible of fraud in the Co nfusin g an d com plex tax. The exclusíon from fncórrie taxation applies
absence of general audit process of filing income tax regardless of who the beneficiary is, whether a
return family member, or other individual, corporation or
Taxpayers lose interest to Difficult/costly to administer partnership.
earn more thereby Exclusion applies to group insurance, death
lessening their purchasing
benefits under the Workmen’s Compensation Insur-
ance or under health or accident insurance
contract having the characteristics of life
insurance proceeds
CHAPTER 3 17
GROSS INCOME
by reason of death (El Oriente v. Posadas, 56

Amount other than amount paid by reason of
Phil. 147).
death. Excess of the amounts received over the
Transfer of insurance contract —— amount aggregate premiums or consideration paid is tax-
excludible should only be the amount or value of able. Hence, if a taxpayer took out a
actual consideration paid and the premiums paid P100,000.00 endowment policy in which he paid
later by the transferee. P80,000.00 as aggregate premiums and upon
maturity he received P100,000.00, only
Where the consideration and premiums paid
P20,000.00 is taxable.
exceed the proceeds, no amount is includible in
the gross income of the transferee. (3) Gifts, bequests and devises
Reason: Not a product of capital nor industry.
• other tax implications of life insurance
proceeds (2003 Bar) ° Gifts are subject to donor’s tax, whereas be-
quests and devises are subject 1o estate
a.) Included in the gross estate: tax (1994 Bar).
• Third person is revocably • But the income from such property is
designated as beneficiary; taxable. If the taxpayer inherits securities,
• Estate, executor or administrator is the value of such securities does not
designated as beneficiary, constitute income but the di\/idends and
revocable or irrevocable. interest paid on such securities are taxable.
b.) Excluded from the gross estate: (2007 • Principal paid under a marriage settlement
Bar) and alimony or allowance based on
separation agreement are considered as
gifts.
• Third person is irrevocably desig- Reas(4,)
nated as beneficiary; on
for
• Proceeds of group insurance.
the
(2.) Amount received as return ofpremium under life exclu
insurance, endowment or annuity contracts, sion:
either during the term or at the maturity of the Retur
contract. Cash surrender value of the policy is n of
also non- taxable. Return of premium means a capit
repayment of a part or the whole of the premiums al
paid (Com. v. Winslow, 113F [Ed.] 418).
Compensation for injuries or sickness (2003, 1995,
1986, 1967, 1964 Bar)
Reason: Compensatory; not gain/profit; adds
nothing to the individual (Lawkins v. Com., 6 B.T.A.
1032).
• Through accident or health insurance;
• Workmen’s Compensation;
• Damages received whether by suit or agreement
on account of such injuries or sickness;
° Damages recovered are taxable if the amount
represents loss of anticipated profits; not tax-
CHAPTER 3 19
GROSS INCOME
able if it representa a return of capital or

iii. At least 50 years of age at the time of
investment (BIR Ruling, September 8, the retirement;
1954).
iV. The benefit of exclusion shall be
If the recovery represents damages for lost
aVailed of only once. (Santos v. Servier
profits, it is taxable as ordinary income (36 Philippines,
T.C. 1173 [1961], Federal lncome Taxation, Inc., 572 SCRA 487, 499)
Third Edition, Rose and Chommie, p. 24). • Even if the member has attained 50
(2005 Bar) years of age with at least ten years
•
Disability benefits paid under life insurance of service, if the employee-member
are also excluded although the law refers is still on active employment with
to accidents and health insurance (Wong v. the company, any and all amounts
Wing Non, 18TC 205, December 18, 1949). distributed from the fund to the
private member over and above his
(5.) Income exempt under treaty. This is premised
on personal contributions shall be
our adherence to the generally accepted taxable to the said employee
of
principles international law. In this category, the recipient as wages were received
following items of income are tax exempt: before his retirement from the
• Income derived by the US Consular officials service of his employer (BIR Ruling
the Philippines in connection with such 97-86, April 4, 1986).
in
consular service (USPI Consular • An agreement to pay the taxes on
Convention). the retirement benefits as an
•
Income exempt under tax treaty with incentive to prospective retirees
and for them to avail of the optional
foreign
countries. retirement scheme is not contrary to
law or pub-
(6.) Retirement benefits, pensions, gratuities, etc. lic morals (International
(2000, 1999, Bar) Broadcasting Corporation v.
Amarilla, 505 SCRA
Retirement benefits received by officials and employees;
employees of private firms, individuals or Retiring official or employee who has
ii.
corporations. Requisites for exclusions: rendered at least 10 years of
i. Reasonable private plan maintained by service;
the employer duly approved by the BIR
for exclusive benefit of the members-
687, 702).
b.) Separation benefits due to death, sickness or
other physical disability or for any cause
beyond the control of the said official or em-
ployee.
• Any amount received from an employer as
a result of separation from service due to
sickness is exempt from all taxes (BIR
Ruling 1-87, January 9, 1987; Ruling 39-
87, February 10, 1987).
20 BASIC APPROACH TO INCOME TAXATION employer has already severed
• Separation benefits paid to retrenched

employees as a consequence of either
the sale of the entire business to
another corporation or the cessation of
the employer’s business are exempt
from income tax (BIR Ruling 130-87,
May 14, 1987).
° Benefits received as a result of voluntary
resignation are taxable (1984 Bar).
Rea- son: It is a cause within the
control of the said official or employee.
• The exemption holds regardless of the
employee’s age and length of service
(1999 Bar).
• The law does not require that the
exclusion be enjoyed once.
• Separation of employee due to
dissolution of a law firm is a cause
beyond the control of said employee
(BIR Ruling No. 73-85, May 20, 1985).
• Compulsory retirement cause beyond
the control of the employee (Request
for reconsideration ofAtty. Zialcita, 190
SCRA 851).
° Terminal leave pay is excluded from
gross income. Compulsory retirement
may be considered as a cause beyond
the control of the said official or
employee. Consequently, the amount
received by way of commutation of his
accumulated leave credits as a result
thereof falls within the enumerated
exclusion from gross income. It is not
considered compensation for services
rendered. Reason: It is paid when the
CHAPTER 3 21
GROSS INCOME
his connection with his employees and

who is no longer working (Ibid.) (1996,
1991 Bar).
c.) Social Security benefits, retirement gratuities
received by resident or non-resident citizens or
resident aliens from foreign government agen-
cies and other private or public institutions.
(2007 Bar)
Pensions received by retirees from foreign
sources (BIR Ruling 72-87, March 12, 1987).
d.) Benefits received from US Veterans Adminis-
tration (R.A. No. 360) by veterans residing in
the Philippines.
e.) Payment of benefits under the Social Security
System in accordance with the provisions of
R.A. No. 8282.
f.) Benefits received from the GSIS under R.A.
No. 8291 including retirement gratuity.
a.) Income received by foreign governments from

their investments in the Philippines. Reason:
To lessen the burden of foreign loans inasmuch
as the interest of these loans are, by contrac-
tual arrangement, borne by the domestic bor-
rowers. Foreign governments include financing
institutions owned, controlled and financed by
them and international or regional financing
institutions established by governments.
• To be exempt; the creditor must be the
foreign government or financing institu-
tions owned, controlled and established by
it.
22 BASIC APPROACH TO INCOME TAXATION operation of a market or an electric
power plant) — This is in recognition
of the principle of exemption from
° Mitsubishi Metal Corporation, a
taxation of government agencies or
Japanese Corporation, borrowed $20 entities.
million from the Import-Export Bank of
Japan (Ex- imbank), owned, controlled
and financed by the Japanese
government through a consortium of
Japanese banks. Mitsubi- shi used the
same amount in extending loan to
Atlas which agreed to sell copper
concentrates to the former.
RULING: Mitsubishi, not Eximbank,
is the sole creditor of Atlas in the
contract of loan, hence, the interest
income of Mitsubushi is subject to
income tax. Ex- imbank (not party in
interest) had nothing to do with the sale
of the copper concentrates. When
Mitsubishi obtained the loan of $20
million from Eximbank of Japan, said
amount ceased to be the property of the
bank and became the property of
Mitsubishi. Tax exemptions are
construed STRICTISSIMI JURIS (Com.
v. Mitsubishi Metal Corp., 181 SCRA
214).
• Income of foreign government from
operation in the Philippines of vessels
owned or chartered by it is taxable
(Opinion of the Secretary of Justice, 40
O.G. 785).
b.) Income derived by the Government of the
Philippines or any political subdivision from
any public utility or from the exercise of any
essential goVernmental function (e.g.,
income derived by a municipality from the
CHAPTER 3 23
GROSS INCOME
Prizes and awards under the following conditions

(2000 Bar):
i. Received in recognition of religious, charitable,
scientific, educational, artistic, literary or civic
achievement.
ii. Recipient was selected without any action on
his part to enter the contest or proceed- ing.
iii. Recipient is not required to render substantial
future services as a condition to receiving the
prize or award.
d.) Prizes and awards in sports competition granted to
athletes whether held in the Philippines or abroad and
sanctioned by their national sports associations
(1996 Bar).
e) 13th-month pay and other benefits:
i. Other benefits cover productivity incentives and
Christmas bonus;
ii. Tot a I e xcl u s io n sha II n ot exce ed
P30,000.00.
GSIS, SSS, Medicare and other contributions.
Gains from the sale or exchange of retirement of
bonds, debentures, or other certificate of
indebtedness with a maturity of more than five (5)
years.
h.) Gains from redemption of shares in Mutual Fund
Company.
• Tax-exempt income under special laws
i. Prizes received in charity, horse rac- ing,
sweepstakes from the Philippine
Charity Sweepstakes Office (R.A.

No. 1169).
ii. Salaries and stipend in dollars re- Chapter 4
ceived by non-Filipino citizens serv-
ing as staff of: INDIVIDUAL INCOME TAXATION
• International Rice Research
In- stitute (R.A. No. 2707);
A. CLASSIFICATION OF INDIVIDUAL TAXPAYERS
• Ford Foundation Grants (R.A.
No. 3538); (1.) Resident citizen (RC) — citizens of the Philippines
• Agricultural Department of the who are residing therein (Article IV, Constitution).
Southeast Asian Fisheries De- (2.) Non-resident citizen (NRC) — citizens of the Phil
velopment Center (SEAFDEC) ippines who are physically present abroad for ari
(P.D. No. 246); uninterrupted period covering an entire taxable
• Population Council of New year. NRC means one who establishes to the sat-
York (P.D. No. 246). isfaction of the BIR Commissioner the fact of his
physical presence abroad with definite intention to
lncome from bonds and securities: reside therein, either as:
• For sale in the international a.) Immigrant;
market (P.D. No. 81);
b.) Employee on a more or less permanent
• lssued by EPZA (P.D. No. 66).
basis;
c.) Contract workers whose contracts of employ-
iv. Income derived from the installment ment are renewed from time to time within or
sales of houses to their employees during the taxable year.
and workers or to low-income
groups in housing projects or NRC may be considered RC or NRC
income derived from rentals thereof depending upon his departure and arrival.
(P.D. Nos. 745 and 1217 — In this regard, NRC shall submit proof to the
Housing Program of the BIR to show his intention of leaving the
government). Philippines to reside permanently abroad or
to return to and reside in the Philippines for
this purpose.
(3.) Resident Alien (RA) — non-citizens who reside in
the Philippines
25
CHAPTER 4 27
INDIVIDUAL INCOME TAXATION
a.) He must be a resident not mere transient or

sojourner (whether he is a transient or not is period exceeding three months as
determined by his intention with regard to of and including December 31.
the length and nature of his stay). (4.) Non-Resident Alien (NRA) — neither citizen nor
b) Alien living in the Philippines and has no resident of the Philippines
definite intention (floating intention) as to a.) NRA-ETB — comes and stays in the Philip-
the time of return to his country or his stay in pines for an aggregate period of more than
the Philip- pines. 180 days during the calendar year (Section
c.) Those who come to the Philippines and 25 A[1], NIRC, as amended) (2000 Bar).
whose extended stay may be necessary to b.) ETB — includes the performance of personal
accomplish the purpose and to that end they services within the Philippines
may have the intention at any time to return
home, when their purpose of stay is c.) Foreign technician on a job contract for one
accomplished/completed. year
• BIR regulation provides no fixed or (5.) Non-Resident Alien Not Engaged in Trade or
definite criterion of determining Busi- ness — NRA-NETB. In general, his income
residency beyond stating that NRA must is taxed at 25% final tax based on gross or entire
have no residence in the Philippines. income. However, NRA-NETB is taxed at special
The difficulty however, arises where an rate of 15% if employed by the following:
alien lives in the Philip- pines, though he a.) Regional or area headquarters of multi-
does not maintain residence therein. national corporations;
Maintenance of residence is the test but
actual stay is a basic factor in b.) Offshore banking units established in the
determining residency. Therefore, the Phil- ippines;
following must be considered: c.) Petroleum service contractors or sub-
i. Maintenance of residence in the contractors.
Phil- ippines;
B. GENERAL PRINCIPLES: SOURCES OF INCOME;
Actual physical residence in the ' TAX BASE
Phil- ippines;
Sources of income Tax Base
iii. His temporary stay (with intention
to return) is on an extended stay;
iv. Co ns idered re sident a lien if he v. L es his residence if he
resides for more than one year; o stays outside the
s Philippines for a
continuous
RC within and without taxable income
NRC within taxable income
RA within taxable income
CHAPTER 4 29
NRA-ETB within
taxable income B. BASIS/TEST: Designation/name of the remuneration
NRA-NETB within
upon which it is paid and the manner of payment is
gross income
IM- MATERIAL. What is important is that it is derived
from
C. CATEGORIES OF lNCOIdE (1967, 1969, 1970 Bar) in kind.
Income of similar nature — proceeds from
property sharing; COLA, PERA, housing allowance,
CATEGORIES OF INCOME overtime pay, emergency pay, hazard pay, rice
Compensation income and clothing allowance, medical allowance,
grocery allowance.
Business income derived by self-employed
Professional income derived by
professionals
Passive investment income
’ Gains derived from dealings in property
COMPENSATIOFI INCOME
&. BEFINITION
All remuneration for services rendered by an em-
ployee for his employer unless specifca|y excluded
under the Tax Code (Revenue Regulations 2-98). It
includes salaries, wages, emoluments, honoraria,
bonuses, allowances (transportation, representation,
entertainment and the like), fringe benefits (monetary
and non-monetary fees) including director's fee,
taxable pensions and retirement pay and other
income of similar nature including compensation paid
employer-employee relationship.
• However, not every compensation income is includ-
ible under the term gross compensation income.
Compensation for services rendered by an inde-
pendent contractor does not fall under the legal
category of “gross compensation income.”
• Amounts paid either as advances or reimburse- ment
for transportation, representation and other bona fide
ordinary and necessary expenses incurred in the
performance of his duties — not taxable
compensation income. Only the excess, if any, over
actual expenses is taxable.
• Three years back wages shall be taxable to an il-
legally separated employee but not attorney’s fees
which are not subject to tax (BIR Ruling, 13 July
1992).
• Income derived by partner from professional part-
nership does not form part of the gross compensa-
tion income.
C. REQUISITES FOR TAXABILITY

(1.) Personal services actually rendered; (2.)
Payment is for such services rendered; (3.)
Payment is reasonable.
D. FORMS OF COMPENSATION
Form/Kind — Measure of income:
(1.) Cash or in money — Amount of money received.
CHAPTER 4 31
30 BASIC APPROACH TO INCOME TAXATION INDIVIDUAL INCOME TAXATION
eficiary designated is the family,

(2.) Property or in kind (Doctrine of Cash Equivalent)
executor, administrator or the estate of
— FMV.
the employee (2007, 2004 Bar);
(3.) Price is stipulated — FMV of the compensation in ii.Employer is not allowed to claim
the absence of contrary evidence.
premiums paid as deductible if he is
directly or indi-
(4.) Promissory notes or other e\/idence of employer:
indebtedness (not mere security) — Not i. Employer may claim the premiums as
Discounted: Face Value; Discounted: 1.) Year of deductible from gross income if the ben-
receipt — Discounted value; 2.) Maturity Date —
Difference between Face Value and Fair Market
Value
(5.) Cancellation or forgiveness of indebtedness
made in consideration of debtor’s services
rendered — amount of debt cancelled
• Other tax implications of condonation of
indebtedness:
i. If no consideration is given, it amounts
to taxable donation and therefore
subject to donor’s tax as far as the
creditor (donor) is concerned (1997
Bar);
ii. It amounts to taxable indirect dividend
if the creditor is a corporation and the
debtor is the stockholder.
Premiums paid by employer on the life
insurance policy of employee whose family,
executor, administrator or his estate is the
beneficiary — amount of the premium paid.
• Conversely, premiums are not taxable if the
beneficiary is the employer whether directly
or indirectly designated.
• Other tax implications of premiums paid by
rectly designated as beneficiary
(Section 36[A][4]) (1978 Bar).
(7.) Income tax paid by employer in consideration of
the employee’s services rendered — amount of
such tax paid
(8.) Personal services performed partly within and
partly without —apportion on the time basis
(9.) Tax exempt compensation income (benefits, privi-
leges, facilities and the like)
a.) Convenience of ffie Employer Rule (1995
Bar). It grants exemption to benefits which
are given for the excl si e benefit or onven
ence of the employer.
• If such quarters and other facilities
exceed the employee's needs, only a
ratable part of the value thereof as
employee would have spent therefor
constitutes taxable income. The
remainder is considered expense of the
employer (Collector v. Henderson, 1
SCRA 649).
• Lodging quarters furnished to an
employee by or on behalf of the
employer shall be excluded from
employee’s gross income if the living
quarter is situated within the business
premises of the employer and the
employee is required to accept such
lodging facility as a condition of his em-
ployment (Revenue Audit Memo. Order
No. 1-87, April 23, 1987).
• The value of meal furnished to an em- not more than P1,500.00; (2007 Bar;
ployee by or on behalf of his employer RR 5-2008)
shall be excluded from the employee’s V. Unifo rm an d clothing allowance not
gross income if the meals are furnished exceeding P4,000.00 per annum,' (RR
in the business premises of the 5-2008)
employer and the meals are for the Actual yearly medical benefits not
VÏ.
convenience of the employer (Ibid.). exceeding P10,000.00 per annum,
• Under Revenue Regulations 3-98, the t¡¡ Laundry allowance not exceeding
monetary value of housing unit or the P300.00 per month;
rental value thereof is tax exempt if the
Employee achievement awards, e.g., for
housing unit is situated within the busi-
length of service or safety achievement,
ness premises of the employer. In this
which must be in the form of tangible
case, the recipient must be a managerial
personal property other than cash or gift
or supervisory employee.
certificate, with an annual monetary
De minimis Benefits. These refer to value not exceeding P10,000.00
facilities or privileges furnished or offered by received by the employee under an
an employer to his employees that are of established written plan which does not
relatively small value and are offered or discriminate in favor of highly paid
furnished by employees;
ix.
the employer merely as a means of Gifts given during Christmas and major
promoting health, goodwill, contentment or anniversary celebrations not exceeding
efficiency of his employees. These include P5,000.00 per employee per annum',
only, pursuant to RR 5-2011, the following:
i. Monetized unused vacation leave sack of 50-kg. rice per month
credits of private employees not amounting to
exceeding ten
(10) days during the year;
ii. Monetized value of leave credits paid to
government officials and employees\
iii. Medical cash allowance to dependents
of employees not exceeding P750.00
per employee per semester or P125.00
per month;
iv. Rice subsidy of P1,500.00 or one (1)
ix. Flowers, fruits, books, or similar items
given to employees under special cir-
cumstances, e.g., on account of illness,
marriage, birth of a baby, etc.; and
x. Daily meal allowance for overtime work
not exceeding twenty-five percent (25%)
of the basic minimum wage.
E. SPECIAL RULES ON FRINGE BENEFITS
(1.) What is a fringe benefit?
Fringe benefits refer to goods, services, or
other benefits furnished or granted by an
employer,
CHAPTER 4 35
in cash or in kind, in addition to basic salaries, to are involuntarily separated from work are not
managerial or supervisory employees such as, subject to FBT;
but not limited to the following:
b.) Contributions of the employer for the
• Housing; benefit of the employee to retirement,
• Expense account; insurance and hospitalization benefit
plans;
• Vehicle of any kind;
c.) Benefits given to the rank and file, whether
• Household personnel, such as maid, driver granted under a collective bargaining agree-
and others; ment or not;
• Interest on loan at less than market rate d.) De minimis benefits (refer to Tax Exempt
(benchmark rate of 12%) to the extent of Com- pensation Income, item no. 9{bJ);
the difference between the market rate and
actual rate granted; e.) Benefits granted to employee as required
by the nature of, or necessary to the
• Membership fees, dues and other expenses trade, business or profession of the
borne by the employer for the employee in employer;
social and athletic clubs or other similar or-
ganizations; f.) Benefits granted for the convenience of the
employer.
• Expenses for foreign travel;
(3) Benefits which are considered necessary to
• Holiday and vacation expenses; the business of the employer, or are granted
• Educational assistance to the employee or for the convenience of the employer.
his dependents; and The following fringe benefits are not subject
• Life or health insurance and other non-life to FBT because they are given primarily for the
insurance premiums or similar amounts in convenience of the employer:
excess of what the law allows. a.) housing privilege of military officials of the
(2) Not all benefits given by an employer to his AFF’ located inside or near the military
employees are subject to FBT. camps;
The following benefits are not subject to FBT: b.) A housing unit which is situated inside or at
most 50 meters from the perimeter of the
a.) Fringe benefits which are authorized and ex- busi- ness premises;
empted from income tax under the Code or
under special law. For instance, separation c.) Temporary housing for an employee for 3
benefits which are given to employees who months or less;
d.) Expenses of the employee which are reim-
bursed by the employer if they are
supported by receipts in the name of the
employer and do
36 BASIC APPROACH TO INCOME TAXATION behalf of the employee.
not partake the nature of a personal

expense of the employee;
e.) Motor vehicles used for sales, freight,
delivery service and other non-personal
uses;
f.) The use of aircraft (including helicopters)
owned and maintained by the employer;
g.) Business expenses which are paid by the em-
ployer for the foreign travel of his employees
in connection with business meetings or con-
ventions. The expenses should be supported
by documents proving the actual
occurrences of the meetings/conventions, or
official com- munications from business
associates.
( Nature of Fringe Benefits Tax.
The Fringe Benefits Tax is a tax imposed on
fringe benefits which are granted or are paid by
an employer to an employee occupying a
managerial or supervisory position.
() Purpose of the FBT.
The FBT is a measure to ensure that an
income tax is paid on fringe benefits (FBs). If they
were given in cash, an income is automatically
withheld and collected by government. An
additional compensation which is given in non-
cash form is virtually untaxed. This situation has
caused inequity in the distribution of the tax
burden. The FBT can enhance the
progressiveness and fairness of the tax system.
Who should pay the FBT? (2003 Bar)

The FBT is a tax on the income of an
employee which is paid by the employer on
CHAPTER 4 37
The FBT is collected from the employer even

if the employer is a tax-exempt corporation, or an
instrumentality of the Philippine government.
(7.) Why is the FBT collected from the employer?
(2003 Bar)
Valuation of benefits is easier at the level of
the firm. The problem of allocating the benefits
among individual employees is avoided. Collection
of the FBT is also ensured because the FBT is
withheld at source and does not depend on the
self-declaration of the individual.
(8.) FBT is not an additional tax on the employer.
The FBT is not an additional tax on the em-
ployer. He can claim the fringe benefit and the
FBT as a deductible expense from his gross
income.
Benefits subject to the FBT.
The FBT is imposed on fringe benefits given
or furnished to managerial or supervisory
employees on or after January 1, 1998. Fringe
benefits granted to rank and file employees are
not subject to FBT.
(10.) Who are considered as managers? supervi-
sors? rank-and-fiIe‘7
“Managerial employees” refer to those who
are given powers or prerogatives to lay down and
execute management policies and/or to hire,
transfer, suspend, lay-off, recall, discharge,
assign or discipline employees.
“Supervisory employees” are those who ef-
fectively recommend such managerial actions if
the exercise of such authority is not merely
routinary or clerical in nature but requires the use
of independ- ent judgment.
38 BASIC APPROACH TO INCOME
CHAPTER 4 39
TAXATION
y"Rank-and-file employees” mean all

ployees who are holding neither em— ° They are intended to substitute for the
managerial supervisory position. nor disallowance of personal family or living
expenses.
DOCTRINE OF CASH EQUIVALENT
• Nature: Personal exemptions are the theoretical,
personal, living and family expenses of an
individual allowed to be deducted from the gross
or net income
It provides that any economic benefit to the em- expenses. According to the Supreme Court,
ployee whatever may have been the mode by which it the amount has been calculated to be
is effected is compensation income. In stock option, roughly equivalent to the minimum of
for instance, the difference between the FMV of the subsistence (Madrigal v.
shares at the time the option is exercised and the Rafferty, 38 Phil. 414).
option price constitutes additional compensation
income to the em- nln\/..e (Com. v. Smith, 324 U.S.
177; Com. v. Le Bue,
ALLOWABLE DEDUCTIONS FROM GROSS COM-

PENSATION INCOME
(1.) Personal exemptions:
a.) Basic Personal Exemption (R.A. No.
9504) Each married individual —
P50,000.00 Head of family — 50,000.00
Single or legally separated individual
with no dependents 50,000.00
b.) Additional exemption for qualified dependent
child — P25,000.00 but not in excess of four
(4) or P100,000 (R.A. No. 9504).
• Personal exemptions are arbitrary amounts (they
may not be fully adequate to cover all personal ex
penses) allowed in the nature of a deduction from
gross or net income, for personal, living or family
of an individual taxpayer (Pansacola v. CIR, 507 SCRA
81, 87).
• Basis: Principle that the burden of income taxation
should be adjusted according to one's capacity to
pay.
° Taxpayers entitled — a.)
Resident citizen
b.) Non-resident citizen c.)
Resident alien
d.) Non-resident alien engaged in trade or busi-
ness on the basis of reciprocity. The reciprocity
rule applies only to basic personal exemption.
The basic personal exemption that may be al-
lowed must not be more than the aforestated
amounts.
Conditions for the grant of basic personal
exemption to NRA-ETB:
• His foreign (mother) country has income tax
law;
• His foreign country allows personal ex-
emptions to citizens of the Philippines not
residing therein;
• File an accurate return of his income from all
sources within the Philippines on time;
• Amount allowable — not to exceed our
maximum allowable personal exemption.
• In the case of legally separated spouse, Series of 1961. However, Section 35

additional exemption may be claimed only by the
of the Tax Code excludes them from
spouse who has custody of the child or children. qualified dependents;
The total addi-
tional exemption claimed by both must not ii. Legally adopted child. There must be a
exceed four (4) or P100,000.00. judicial order by competent court, not
• Head of family means an unmarried or legally mere affidavit(BIR Ruling 572, 29
October
separated man or womag‘with one or both 1959).
parents ok ith one or more brothers or sisters or
d.) Senior’citizen.’Under Republic Act No. 7432
with one or
as implemented by ReVenue Regulations
more legitimate or ecognized illegitimate or
legally No.
adopted childreq*#ving and #epyndent upon means any resident citizen
with
him/her for chief support, where such brothers of the least sixty (60) years
or old,
are not more than twenty-one ‘ including those who have retired from both
years (21) and not gainfully government offices and private enterprises,
employed
or where such children, brothers or sisters, and has aJincome of not more than sixty
regardless of age are incapable of self-support thou-
because of sand pesos (P60,000.00) per annum subject
mental or physical defect. to reView by the National Economic and
Qualified dependents: Develop- ment Authority (NEDA) every three
(3) years.
a.) Parents (step parents, parents in- are • The term head of family includes an
law unmarried or legally separated man or
and
excluded) — Living with the taxpayer
woman who is the benefactor of a quali-
dependent on the taxpayer for chief support. fied senior citizen. Benefactor means
b.) Brothers and sisters (full or half blood): any person whether or not related to the
senior citizen who takes care of the
i. Living with and dependent upon the tax-
latter as a dependent.
payer for chief support;
ii. ui. Unmarried and not gainfully employed; ’
Not more years of age except if incapable of • "Living with" does not connote actual or physical
than self support because of physical or togetherness. It means that taxpayer exercised
twenty- mental defect. control based on some moral or legal obligation
one (21) and makes the taxpayer’s home as his principal
place of abode. Dependent must be a member of
Children (legitimate, recognized illegitimate the taxpayer’s family by blood relationship,
and legally adopted) — Same qualifications relationship by marriage, or by adoption
as brothers and sisters: (Section 11, Rev. Reg. No. 2, Stanley &
i. Stepchildren are qualified dependents Kilcullen).
under BIR Revenue Regulations 235, a.) Temporary absence from their common
residence brought about by force of
circumstances,
e.g., taxpayer may be away on business or to

• BIR Rulings:
earn livelihood, or dependent may be Taxpayer can still claim him or her as
boarding elsewhere in the pursuit of dependent for the
education. particular taxable year.
b.) Children of resident alien residing abroad are
not considered living with the taxpayer
(Section 11, Revenue Regulations No. 2).
• Chief support means principal or main support
not just partial support. It must be more than 50%
of the dependent's need pertaining to food,
clothing and shelter.
• Rules on change of status (1997 Bar)
a.) Death of the taxpayer — Estate may claim the
appropriate personal exemptions.
b.) Death of the dependent — Taxpayer is
still entitled to additional exemption.
c.) Additional dependent — Taxpayer is still enti- ’
tled to additional exemption.
d.) Dependent becoming more than twenty-one
(21) years of age — Taxpayer can still claim
him or her as dependent.
e.) Marriage of the taxpayer— Taxpayer is
entitled to full exemption for the particular
taxable year.
f.) Death of spouse — Surviving spouse may still
claim the full amount of thirty-two thousand
(P32,000.00) (2004 Bar).
• New rules under Section 35(C):
g.) Marriage of dependent — Taxpayer can still
claim him or her as dependent for the
particular taxable year.
h.) Gainful employment of dependent —
(a.) Non-resident Chinese stockholders of a local bank
are not entitled to personal exemptions granted in
accordance with the reciprocity provisions of the
Tax Code. Reason: The laws of China do not
grant similar exemptions to non- resident Filipinos
(BIR Ruling No. 164, series of 1961).
(b.) Where both husband and wife are employees, the
latter can claim additional exemptions for her two
minor children by her first marriage in their(oint/
income tax return (BIR Ruling No. 216, series of
1960).
(c.) A resident alien supporting his wife and children
living abroad is entitled to a personal exemption
corresponding to a married person provided that
proof of marriage is established to the satisfaction
of the BIR and he is not legally separated from
his wife. However, he is not allowed to claim an
additional exemption because without necessity,
the children con- tinuously make their home
abroad (BIR Ruling No. 371, series of 1958).
(d.) Only one exemption is allowed even if taxpayer
received accumulated pension corresponding to
six years (BIR Ruling No. 203, series of 1960).
(2.) Premium Payments on Health and/or Hospitali-
zation Insurance (2001 Bar).
Conditions:
a.) Claimant: spouse claiming the additional ex-
emption for dependents.
CHAPTER 4 45
TAXATION
b.) Amount allowed: P2,400.00 per annum or

P200.00 a month. Answer: Gross income means the total
c.) Limitation: family gross income must not be sales, less the cost of goods sold
more than P250,000.00 for the taxable year. plus any income from investments
and incidental operations
(Section 4B, Rev. Reg. No. 2).
BUSINESS/TRADE/PROFESSIONAL INCOME merchandising, or mining business,
how is the gross income computed?
A. INCOME COVERED
(1.) Income derived by self-employed from trade or
business (trading, manufacturing, merchandis-
ing, farming, and others).
• Self-employment income consists of the
earnings derived by the individual from
the practice of profession or conduct of
trade or business carried on by him as a
sole proprietor or by a partnership of
which he is a member.
Self-employed — means a perso n
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.
The term includes but is not limited to single
pro- prietorships engaged in trade or
business as manufacturers, traders, market
vendors, own-
ers of eateries and farmers as well as owner
! of service shops, brokers, agents and others

similarly situated.
• Business is any actiVity that entails the time,
attention and effort of an indiVidual or group
of individuals for livelihood or profit.
• In the case of manufacturing,
• How is income from long-term contracts (building
installations or construction contracts covering a
period of more than one [1] year) treated for income
tax purposes?
Answer:
• Percentage of completion basis gross income
already earned though not yet received, based on
estimates of architects or engineers duly certified by
them is reported in a taxable year and all deductions
relating to such for the taxable year, even if not yet
paid, are taken into account.
’ Completed contract basis — taxpayer reports his income
and deductions in the year the contract is finally
completed (Section 44, Revenue Regulations No. 2).
Income derived by professionals from the practice of

professions.
Professionals — refer to persons who derive their
income from the practice of their profession. The term
includes lawyers and other persons who are registered
with the PRC such as doctors, den- tists, CPA’s and
others similarly situated. It may also refer to one who
pursues an art and makes living therefrom such as artists,
athletes, and others similarly situated.
46 BASIC APPROACH TO INCOME TAXATION 47
CHAPTER 4
Gross income of farmers include: marks, patents and natural resources under
a.) Sale of livelihood and farm products lease.
received from the farm;
c.) Items considered likewise as rental income
b.) Value of merchandise and other property
received from such sales; • Obligations of lessor to 3rd parties as-
sumed by the lessee:
c.) Profit from the sale of livestock and other items
purchased; i. Real estate taxes on leased
premises;
d.) Gross income from all other sources, rent
received on crop shares, proceeds of Insurance premiums paid by lessee
income of growing crops. on p
¡¡j Dividends paid by lessee to stoCk-
INTEREST INCOME holders of lessor-corporation;
a.) Definition —amount of compensation paid ÏV. Interest paid by lessee to holder of
for the use of money or forbearance from bonds issued by lessor-corporation.
such
use. copyrights, trade-
b.) Includes such interest arising from indebted-
ness — business or non-business, legal or
illegal, usurious or not:
i. Interest on government securities —
taxable effective January 1, 1998;
ii. Interest on savings deposit, time
deposits and deposit substitutes
subject to 20% final tax.
RENTAL INCOME •
a.) Definition fixed sum either in cash or prop-
erty equivalent, to be paid at a definite period
for the use or enjoyment of a thing or right.
b.) Scope all rentals (including royalties) de-
rived from lease of property, whether used
in business or not, from real estate or
personal property; earnings from
• Value of permanent improvements made by
lessee on leased property that will be-
come the property of the lessor upon the
expiration of the lease. The lessor shall
report such an income under any of the
following methods (1995 Bar):
i. Outright method Fair Market Value of
the completed building or improvement
shall be reported as additional rent
income;
¡¡ Spread out method — Allocate the
depreciated value over the remaining
term of the lease contract.
d.) Are advance mentais taXable?
i. Prepaid rentals — taxable if so received
under a claim of right and without restric-
tion as to its use.
CHAPTER 4 49
TAXATION
Security deposit — not taxable. are nothing but an

However, it is taxable if the lessee enrichment through increase
violates any provision of the contract. in value of capital investment
¡¡¡. Loan not taxable. (Commis- sioner v. Court of
Appeals, 301 SCRA 152).
DIVIDEND INCOME Exceptions, however, are as
a.) Definition — corporate profit set aside, de- follows:
clared and distributed by the director of a ° Change in the stockholder’s equity,
corporation to be paid to stockholders on de- right/interest in the net assets of
mand or at a fixed time. Under the Tax Code,
the corporation;
any distribution made by a corporation to its
stockholders, whether in money or property ° Recipient is other than shareholder.
out of its earnings and profit accrued since 1 Stock dividend is taxable to
March 1913. usufructu- ary (Bachrach v. Siefert,
87 Phil. 483);
Kinds of Dividend
• Cancellation or redemption of
i. Cash dividend — paid in given sum of
shares of stock (Ibid.),
money.
ii. Property dividend — one paid by corpo- • Distribution of treasury stocks;
ration in securities (not its own stock) or • Dividends declared in the guise of
other property. treasury stock dividend to avoid the
effects of income taxation (Com-
¡¡¡ Stock dividend — one paid by a corpo-
thereof is not yet subject to income tax as they
ration with its own stock. It represents
transfer of surplus to capital account. It
may be of the same kind or different
from that on which it is issued.
As a general rule, stock dividends
are not taxable (2003 Bar).
Reason: They are considered unreal-
ized gain, and Cannot be
subjected to income tax
until that gain has been
realized. Mere issuance
missioner V.
Manning, 66
SCRA 14)
(1994 Bar);
•
Illustrati
on of
taxabilit
y/non-
taxabilit
y of
stock
dividen
d
Case Authorized Issued & Stock Taxable/Not

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

II Com & Pref. Common Preferred Not Taxable
III Com & Pref. Com & Pref. Common Taxable
IV Com & Pref. Com & Pref. Preferred Taxable
50 BASIC APPROACH TO INCOME TAXATION 51
CHAPTER 4
iV.
Scrip Dividend — one that is paid in the d.) Taxpayer is not required to file ITR if his or
V. form of promissory notes. her income consists solely of income subject
to final tax.
Indirect Dividend — one made through
the exercise of right or other means of e.) The tax withheld constitutes final settlement
payment, e.g., cancellation or of the tax liability on the income.
condonation of indebtedness.
f.) Examples of income subject to final tax (2001
Liquidating dividend — one resulting Bar):
from the distribution by a corporation of
• Interest income from bank deposit;
all its property or assets in complete
liquidation or dissolution. Taxable • Royalties;
income refers to • Dividend received from domestic
the excess of amount received over cost ' corporation by individual or non-
of the share surrendered.
resident foreign
Giver Recipient corporation (NRFC);
Taxable(tax rate)/Exempt
Domestic Domestic/RFC • Prizes amounting to more than P10,000.00;
tax exempt (2005 Bar)
Domestic RC, NRC, RA • Winnings (except sweepstakes and
10% — effective taxable lotto).
year 2000
• Partner’s share from the net income after
Domestic NRA — ETB 20°f« c.) The recipient is not required to
Domestic NRA — NETB 25% include the income in his gross
income. Neither is the taxpayer
Domestic NRFC 15% subject to allow- required to include it in the taxable
ance for tax credit income (CU v. PAL, 504 SCRA
90).
PASSIVE INVESTMENT INCOME ,
a.) It is an income subject to final withholding tax

(2001 Bar).
b.) The withholding agent withholds the tax and
remits the same to the BIR.
’
tax of business partnership, joint account,
joint venture or consortium. (4.) Other
Sources
a) Capital Gain from Sale of Shares of Stock
i. If not listed and traded through stock exchange:
• Net capital gain not over P100,000
— 5%;
• Any amount in excess of P100,000
— 10%.
ii. If listed and traded through local stock exchange
— 1/2% of 1% of Gross Selling Price. The tax is in
the nature of percentage tax not an income tax.
Acquisition and disposition of capital stock

which include sales and retirement of bonds.
Illegal gains — gambling, betting, lotteries,
extortion or fraud.
d)
Chapter 5
Recovery of damages — taxable — it repre-
sents lost profit/income. CORPORATE INCOME TAXATION
e)
Bad Debts recovery — taxable if it results in
reduction of the taxpayer's tax liability in the
previous year. “Tax benefit rule” or the “Doc- A. DEFINITION UNDER THE NIRC
trine of equitable benefit” applies in this
case. Corporation includes partners hips, no matter
how created or organized, joint stock companies, joint
• It must be claimed as a deduction from accounts, associations or insurance companies
the gross income in the preceding year. except:
The reduction results in a tax benefit. • Joint construction venture; (2007 Bar)
f)
Tax refund — taxable if it results in reduc- • General professional partnership;
tion of the taxpayer's liability in the preceding
year. This means that the tax refunded must • Joint venture for engaging in petroleum, coal,
be previously claimed as deduction from geo- thermal and other energy operations
gross income. Tax benefit rule likewise pursuant to a consortium agreement with the
applies. government.
(1.) Unregistered or registered partnership — taxable
provided that the following requisites concur:
a.) Agreement, oral or writing, to contribute
money, property or industry to a common
fund;
b.) Intention to divide the profits.
i. Two sisters purposely created a com-
mon fund without being registered for
the purpose of engaging in a series of
transactions for profit — taxable
unregistered partnership is created
(Evangelista v. Commissioner, 102 Phil.
140).
53
CHAPTER 5 55
CORPORATE INCOME TAXATION
Taxable partnership is formed where fif- (Article 1769, NCC) (Pascual and Dragon
teen (15) persons contributed money to v.
Commissioner, 166 SCRA 560).
purchase sweepstakes tickets for the
sole purpose of dividing among On 2 March 1973, Joe Obillos, Sr.
themselves the prize. transferred his rights under contract
with Orti- gas Co. to this four (4)
Two persons entered into agreement to children to enable them to build
operate cockpit under which one was to residences on the lots. TCTs were
contribute his services and the other to issued. Instead of building houses, the
provide the capital — taxable Obillos children sold them after one
partnership is formed (Rallos v. Rallos, 2 (1) year to Walled City Securities
Phil. 509). Corpora- tion and Olga Cruz Canda.
iv.
As a rule, co-ownership is tax-exempt. It The Supreme Court held that the Obillos
becomes taxable if it is converted into an children are co-owners. It is an isolated
unregistered partnership. Converted into act which shows no intention to form a
partnership if the properties and income partnership. It appears that they
are used as common fund with intention decided to sell it after they found it
to produce profits. If after partition, the expensive to build houses (Obillos, Sr.
shares of the heirs are held under a v. Commissioner, 139 SCRA 436).
single management for profit making, (2.) Joint accounts or joint ventures formed for
unregistered partnership is formed profits.
(1997 Bar) (Ona, et al. v. Commissioner,
45 SCRA 74). Joint Emergency Operation — (no legal per-
sonality) operates the business affairs of the two
V. Pascual and Dragon bought two (2) par- companies as though they constitute a single
cels of land from Bernardino and three entity thereby obtaining substantial economy and
(3) from Rogue. Thereafter, the first two profit in operation — taxable (Collector v.
(2) were sold to Meirenir Development Batangas Co., 54 OG 6724).
Corporation at a profit of P165,224.70
and the three (3) to Reyes and Samson (3.) Joint Stock Companies — generally classified as
for a profit of P60,000. They divided the a partnership possessing some of the
profits between the two (2) of them. characteristics of a corporation. They appear to
RUL- ING: There was no partnership be like corporations to the extent that they have
formed. The sharing of returns does not capital stock but when capital is divided or made
in itself establish a partnership whether transferable even without the consent of the co-
or not the persons sharing therein have partner, they partake of the nature of partnership
a joint or common right or interest in the (Brocki v. American Express Company, CA
property Michigan, 279F 2d 785, 787).
56 BASIC APPROACH TO INCOME TAXATION institution of its educational
purpose or function.
B. MAJOR GROUPS OF CORPORATION FOR • Related activities include income
INCOME derived from auxiliary activities —
TAX PURPOSES (Sources, tax base, tax rate) School owned
(1.) DOMESTIC CORPORATIONS
Source: Within and without
Tax base: Taxable income
Tax rate: 35% effective July 01, 2005; 30%
effec-
tive January 1, 2009 (R.A. No. 9337)
Special domestic corporations:

a.) Private Educational Institution —
• Subject to ten percent (10%) on their
taxable income provided that its gross
income from unrelated trade, business
or other activity does not exceed fifty
percent (50%) of the total income.
Conversely, it is subject to thirty-five
percent (35%) if its income from
unrelated trade or business exceeds fifty
percent (50%) of the total (gross)
income.
• Private educational Institution — is any
“private school” maintained and admin-
istered by private individuals or groups
issued a permit to operate by Secretary
of DECS in accordance with existing
laws and regulations.
• Unrelated trade, business, or other
activity
— the conduct of which is not
substantially related to the exercise or
performance by such educational
CHAPTER 5 57
canteen, cafeteria, dormitory and book-

store within the school premises (BIR
Ruling 237-87, 16 December 1987).
b.) Non-profit hospital
• Same rules as private educational institu-
tion.
• Unrelated trade, business, or other acf/vify
— the conduct of which is not substantially
related to the exercise or performance by
such hospital of its primary purpose or
function.
(2.) RESIDENT FOREIGN CORPORATIONS
Source: Within
Tax base: Taxable income
Tax rate: 35% effective July 01, 2005; 30% effec-
tive January 01, 2009 (R.A. No. 9337)
Special Resident Foreign Corporations:

a.) International Carriers — within — Gross Phil.
Billings — 2.5%;
b.) Offshore banking unit — within — Gross on-
shore income — 10%;
c.) Foreign currency deposit unit —within — Gross
onshore income — 10%.
Transacting business — means continuity of
commercial dealings and arrangements (Far East
Import-Export Corp. v. Nankai Kogyo Co., Ltd., Int’l.,
No. L-13525, 30 November 1962, 6 SCRA 725).
Gross Philippine Billings —— refers to the
amount of gross revenue realized from carriage of
persons, excess baggage, cargo and mail originat-
the general rule under Sec. 28(A)(1),
58 BASIC APPROACH-I TO INCOME TAXATION it would have used the appropriate
ing from the Philippines in a continuous and

uninterrupted flight, irrespective of the p/ace
of sale or issue and the p/ace of payment of he
ticket or passage document. (2005 Bar)
FOREIGN AIRLINE COMPANIES WITH -
OUT FLIGHTS STARTING FROM OR PASSING
THROUGH ANY POINT IN THE PHILIPPINES
—
An off-line airline having a branch office or a
sales agent in the Philippines which sells
passage documents for compensation or
commission to cover off- line flights of its principal
or head office, or for other
airlines covering flights originating from Philippine
ports or off-line f|ights, is not considered engaged
in business as an international air carrier in
the PhilippineS and is, therefore, not subject
to Gross Philippine Billings Tax provided for in
Section 28(A)[3J[aJ of the Code nor to the
three percent (3%) common carrier’s tax under
Sec- tion 118(A) of the same Code. (2005 Bar)
This provision is without prejudice to classifying
such taxpayer under a different category
pursuant to a separate provision of the same
Code (Rev. Reg. No. 15-2002).
International Air Carrier and
International Shipping — shall be taxed on
the basis of their Gross Philippine Billings.
Off-line international airline is subject to
corporate income tax
Sec. 28(A)(3)(a) of the 1997 NIRC does not,
in any categorical term, exempt all international
air carriers from the coverage of Sec. 28(A)(1) of
the 1997 NIRC. Certainly, had legislature’s
intentions been to completely exclude all
international air carriers from the application of
CHAPTER 5 59
language to do so; but the legislature did not. Thus, the

logical interpretation of such proVisions is that, if Sec. 28(A)
(3)(a) is applicable to a taxpayer, then the general rule under
Sec. 28(A)(1) would not apply. If, however, Sec. 28(A)(3)(a)
does not apply, a resident foreign corporation, whether an
international air carrier or not, would be liable for the tax
under Sec. 28(A)(1).
Clearly, no difference exists between British Overseas
Airways and South African Airways. The findings therein that
an off-line carrier is doing business in the Philippines and
that income from the sale of passage documents here is
Philippine- source income must be upheld.
The general rule is that resident foreign corporations
shall be liable for a 32% (now 30%) income tax on their
income from within the Philippines, except for resident
foreign corporations that are international carriers that derive
income “from carriage of persons, excess baggage, cargo
and mail originating from the Philippines” which shall be
taxed at 2 1/2% of their Gross Philippine Billings. South
African Airways, being an international carrier with no flights
originating from the Philippines, does not fall under the
exception. As such, petitioner must fall under the general
rule. This principle is embod- ied in the Latin maxim,
exception firmat regular in casibus non exceptis, which
means, a thing not being excepted must be regarded as
cOmfng within the purview of the general rule.
To reiterate, the correct interpretation of the above
provisions is that, if an international air carrier maintains
flights to and from the Philippines, it shall be taxed at the
rate of 2 1/2% of its Gross Philippines Billings, while
international air carriers
CHAPTER 5 61
that do not have flights to and from the c. MINIMUM CORPORATE INCOME TAX (Sections
Philippines but nonetheless earn income from 27[E], 28A[2] fmp/emenfe¢f by Revenue
other activities in the country will be taxed at the Regulations No. 9-98 as amended by Revenue
rate of 320/0 (now 30%) of such income. (see Regulations 12- 2007)
South African Airways
v. Commissioner of Internal Revenue, 612 SCRA (1) Concept and Rationale of the MCIT
665, 675-676, 678 (2010)]
The MCIT on domestic corporations is a new
(3.) NON-RESIDENT FOREIGN CORPORATIONS concept introduced by RA 8424 to the Philippine
taxation system. It came about as a result of the
Source: Within
perceived inadequacy of the self-assessment
Tax base: Gross income system in capturing the true income of
Tax rate: 35% effective July 01, 2005; 30% effec- corporations. It was devised as a relatively
tive January 01, 2009 (R.A. No. simple and effective revenue-raising instrument
9337) compared to the normal income tax which is
more difficult to control and enforce. It is a means
Special Non-Resident Foreign Corporations: to ensure that everyone will make some
a.) NR — lessor of cinematographic film —within minimum contribution to the support of the public
— JFOss income — 25% final tax; sector. x x x
b.) NR — owner or lessor of vessels Domestic corporations owe their corporate
chartered by Phil. Nationals — within — existence and their privilege to do business to the
Gross rental government. They also benefit from the efforts of
— 4.5% final tax; the
c.) NR — owner or lessor of aircraft, machinery Reederji Amsterdam v. COfTi., L-460229, 23 June
& equipment —within — Gross rental —7 1988, 162 SCRA
.50/ final tax. 487).
Two vessels of V. Reederji Amsterdam
called on Philippine ports twice to unload car-
goes for foreign destination. It has no office
in the Philippines. The fees were collected by
its husbanding agent, Royal International
Ocean Lines. The Supreme Court held that
the corporation is considered non-resident
foreign corporation. Casual activity as in
this case, does not amount to engaging in
trade or business in the Philippines (N.V.
g to ensure a favorable business climate. It
o is therefore fair for the government to
v require them to make a reasonable
e contribution to the public expenses.
r Congress intended to put a stop to
n the practice of corporations which, while
m having large turn-overs, report minimal or
e negative net income resulting in minimal
n or zero income taxes year in and year out,
t through under-declaration of income or
t over-deduction of expenses otherwise
o called tax shelters. x x x
i
m The primary purpose of any
p legitimate business is to earn a profit.
r Continued and repeated losses after
o operations of a corporation or con-
v
e
t
h
e
fi
n
a
n
c
i
a
l
m
a
r
k
e
t
a
n
d
62 BASIC APPROACH TO INCOME TAXATION [CREBA v. Romulo, 614 SCRA 605,
622-624 (2010 J1
sistent reports of minimal net income render its
financial statements and its tax payments
suspect. For sure, certain tax avoidance
schemes resorted to by corporations are allowed
in our jurisdiction. The MCIT serves to put a cap
on such tax shelters.
/\s a tax on gross income, it prevents tax evasion
and minimizes tax avoidance schemes achieved
through sophisticated and artful manipulations of
deductions and other stratagems. Since the tax
base was broader, the tax rate was lowered.
To further emphasize the corrective nature of
the MCIT, the following safeguards were incorpo-
rated into the law.
First, recognizing the birth pangs of
businesses and the reality of the need to recoup
initial major capital expenditures, the imposition
of the MCIT commences only on the fourth
taxable year immediately following the year in
which the corporation commenced its operations.
This grace period allows a new business to
stabilize first and make its ventures viable before
it is subjected to the MCIT.
Second, the law allows the carrying forward
of any excess of the MCIT paid over the normal
income tax which shall be credited against the
normal income tax for the three immediately
succeeding years.
Third, since certain businesses may be
incur- ring genuine repeated losses, the law
authorizes the Secretary of Financato suspend
the imposition of MCIT if a corporation suffers
losses due to prolonged labor dispute, force
majeure and legitimate business reverses.
CHAPTER 5 63
Purpose o/'MC/r (2001 Bar)

The imposition of the MCIT is designed to forestall the
prevailing practice of corporations of over claiming
deductions in order to reduce their income tax payments.
(3.) /\/ature ofminimUm corporate income tax(MciT)
The MCIT is an estimate of the income tax that is
due from a firm. It is equal to two percent (2%) of the
gross income of a corporation at the close of each
taxable quarter.
Being a minimum income tax, a corporation should
pay the MCIT whenever its regular (normal) income tax is
lower than the MCIT, or when the firm reports a net Toss in
its tax return. Conversely, the regular income tax is paid
when it is higher than the MCIT.
MCIT is not an ar/cfitiona/ fax fo the regular or

normal income tax
At the end of the taxable quarter, the MCIT is
compared with the regular income tax which is due from a
corporation. If the regular income is higher than the MCIT,
then the corporation does not pay the MCIT.
Newly established firms, or those which are on their
first three years of operations are not covered by the
MCIT.
Coverage of the lviciT (2001 Bar)

The MCIT covers domestic and resident foreign
corporations which are subject to the regular income tax.
The term “regular income tax" refers to the regular income
tax rates under the Tax Code.
64 BASIC APPROACH TO INCOME TAXATION A corporation starts to be covered
by the MCIT on the fourth (4th) year of
its business operations.
The tax rate is 33% for 1999, 32% for 2000, 35%
effective July 01, 2005 and 30% effective
January 01, 2009. Thus, corporations which are
subject to a special corporate tax system do not
fall within the coverage of the MCIT. These are
as follows:
• Schools, hospitals, and income of Offshore
Banking Units (OBUs), and Foreign
Currency Deposit Unit (FCDU) from foreign
currency transactions;
• Regional operating headquarters;
The incomes of these corporations are
subject to a ten percent (10%) preferential
tax rate;
• Firms under a special income tax regime
such as those under the PEZA law and the
Bases Conversion Development Act;
• International carriers subject to tax at 2 1/2%
of their Gross Philippine Billings.
For corporations whose operations or activi-
ties are partly covered by the regular income tax
system and partly covered under a special
income tax system, the MCIT shall apply on
operations covered by the regular income tax
system.
For example, the MCIT does not cover an
activity of a firm which is registered with the
Board of Investments (BOI) and is granted an
income tax holiday. The MCIT shall cover its
other activities which are not covered by the BOI
tax incentives.
(b.) When does a corporation start to 6e cov'erec/
6y the MCIT? “
CHAPTER 5 65
The period of reckoning the start of its business operations

is the year when the corporation was registered with the
BIR. This rule will apply regardless of whether the
corporation is using the calendar year or fiscal year as its
taxable year (Manila Banking Corporation v. CIR, 499
SCRA 782, 788).
• Firms that were registered in 1994 and earlier years
are covered by the MCIT beginning Janu- ary 1, 1998.
Firms which were registered with the BIR in any
month in 1998 will be covered by the MCIT after the
lapse of three calendar years, i.e., 2002.
( Suspension of the payment of MCIT
The Secretary of Finance, upon the recom-
mendation of the BIR Commissioner, may suspend the
imposition of the MCIT on a corporation in any of the
following cases:
• Sustained losses from prolonged labor dispute;
• force majeure,
• Legitimate business reverses.
“Sustained losses from a prolonged labor
dispute”means losses arising from a strike staged by
employees which lasted for more than six (6) months within
a taxable period and which has caused the temporary
shutdown of business operations.
“Force majeure” means a cause due to an
irresistible force as by “Act of God” like lightning,
earthquake, storm, flood and other natural calami- ties.
This term would also include armed conflicts like war or
insurgency.
66 BASIC APPROACH TO INCOME TAXATION provide the
“Legitimate business reverses” shall include

substantial losses due to fire, robbery, theft or
embezzlement, or for other economic reason as
determined by the Secretary of Finance.
(8.) How is the MCIT compnterf*
The MCIT is equal to two percent (2o/ ) of
the gross income of the corporation at the end
of the taxable year.
¿< “Gross income” means gross sales less
sales returns, discounts and allowances and cost
of goods sold. It will also include all items of
gross income enumerated under Section 32(A) of
the Tax Code, as amended, except income
exempt from income tax and income subject to
final withholding tax.
Cost of goods sold include all business
expenses directly incurred to produce the
merchandise to bring them to their present
location and use.
For a trading or merchandising concern, cost
of goods sold means the invoice cost of goods
sold, plus import duties, freight in transporting the
goods to the place where the goods are actually
sold, including insurance while the goods are in
transit.
For a manufacturing concern, cost of goods
manufactured and sold means all costs of
production of finished goods such as raw
materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and
other costs incurred to bring the raw materials to
the factory or ware- house.
For sale of services, gross income means
gross receipts less sales returns, allowances,
discounts and cost of services which cover all
direct costs and expenses necessarily incurred to
CHAPTER 5 CORPORATE INCOME
TAXATION
services required by the customers and clients including:

° Salaries and employee benefits of personnel,
consultants and specialists directly rendering the
service;
° Cost of facilities directly utilized in providing the
service such as depreciation or rental of
equipment used;
• Cost of supplies.
Interest expense is not included as part of cost of
service, except in the case of banks and other financial
institutions.
The term “gross receipts” means amounts actually or
constructively received during the taxable year. However,
for taxpayers employing the accrual basis of accounting, it
means amounts earned as gross income.
(9.) When is the MCIT reported and paid?
The MCIT shall be paid in the same manner
prescribed for the payment of the normal corporate income
tax which is on a quarterly and on a yearly basis.
The taxpayer shall pay the MCIT whenever it is
greater than the regular or normal corporate income tax
which is imposed under Section 27(A) and Section 28(A)
(1) of the Code.
Thus, in the computation of the tax due for the taxable
quarter, if the computed quarterly MCIT is higher than the
quarterly normal income tax, the tax due to be paid for
such taxable quarter and the time of filing the quarterly
corporate income tax return shall be the MCIT which is two
percent (2%) of the gross income as of the end of the
taxable quarter.
Net amount of tax payable 75,000 100,000 35,000
The final comparison between the normal

income tax payable by the corporation and the
MCIT shall be made at the end of the taxable
year and the payable or excess payment in the
Annual Income Tax Return shall be computed
taking into consideration corporate income tax
payment made at the time of filing of quarterly
corporate income tax return whether this be
MCIT or normal tncome tax.
(10.) Can the company claim the MCIT it paid as a
deduction from gross income†
Since the MCIT is an estimate of the
normal income tax, it cannot be claimed as
deduction.
(11.) What is the carry-forward provision under the
MCIT?
Any excess of the MCIT over the normal in-
come tax may be carried forward on an annual
basis and be credited against the normal income
tax for the three immediately succeeding taxable
years.
Illustration:
2000 2001 2002

Normal income tax 50,000 60,000 100,000
MCIT 75,000 100,000 60,000
Amount of tax to be paid 75,000 100,000 100,000
Less: Excess MCIT
2000 — 25,000
2001 — 40,000 — — 65,000
CHAPTER 5 69
The taxpayer is required to pay the MCIT

whenever it is greater than the regular income tax.
Thus, in 2000, the taxpayer will pay MCIT of P75,000
since this is greater than the normal income tax of
P50,000.
In 2001, the taxpayer will pay MCIT of P100,000
because its MCIT in 2001 is still higher than the
regular income tax. The excess MCIT of P25,000 in
2000 (or the difference between the MCIT and the
regular income tax in 2000) anno \be used in this
instance.
In 2002, ,w.ho.yn the regular inco.m.„ e tax of
P100,000 isfhighqr'than the MCIT of P60,000, the
taxpayer is allowed to claim as credit the excess MCIT
of P25,000 and P40,000 for
2000 and 2001 respectively, or a total credit of
P65,000. Hence, the taxpayer will pay only P35,000
(P100,000 — P65,000).
IMPROPERLYACCUMULATED EARNINGS TAX (Sec-

tion 29 as Implemented by Rev. Reg. No. 2-2001)
(1.) Rafiona/e of improper/y accomo/afed earnings

tax of J0%
If the earnings and profits were distributed, the
shareholders would then be liable to income tax thereon,
whereas if the distribution were not made to them, they
would incur no tax in respect to the undistributed earnings
and profits of the corporation. Thus, a tax is being
imposed in the nature of a penalty to the corporation for
the improper accumulation of its earnings, and as a form
of deterrent to the avoidance of tax on shareholders who
are
70 BASIC APPROACH TO INCOME TAXATION ' accumulations taken from other
years;
supposed to pay dividends tax on the earnings b.) Earnings reserved for definite
distributed to them by the corporation. corporate expansion projects or
programs requiring consider-
(2.) What is the touchstone of the liability?
It is the purpose behind the accumulation of
the income and not the consequences of the
accumulation. Thus, if the failure to pay
dividends is due to some other causes, such as
the use of undistributed earnings and profits for
the reasonable needs of the business, such
purpose would not generally make the
accumulated or undistributed earnings subject to
the tax. However, if there is a determination that
a corporation has accumulated income beyond
the reasonable needs of the business, 10%
improperly accumulated earnings tax shall be
imposed.
(3.) Determination of reasonable needs of the busi-
ness
’
An accumulation of earnings or profits
(including undistributed earning or profits of
prior years) is reasonable if it is necessary for the
purpose of the business, considering all the
circumstances of the case. The term “reasonable
needs of the business” are hereby construed to
mean the immediate needs
of the business, including reasonably anticipated
needs.
(4.) What constitute accumulation of earnings for
the reasonable needs of the business?
a.) Allowance for the increase in the
accumulation of earnings up to 100% of the
paid-up capital of the corporation as of
Balance Sheet date, inclusive of
CHAPTER 5 71
able capital expenditure as approved by the Board of

Directors or equivalent body;
c) Earnings reserved for building, plants or equipment
acquisition as approved by the Board of
Directors or equivalent body;
d.) Earnings reserved for compliance with any loan covenant
or pre-existing obligation established under a legitimate
business agreement;
e) Earnings required by law or applicable regulations to
be retained by the corporation or in respect of which
there is legal prohibition
against its distribution;
f.) In the case of subsidiaries of foreign corporations in the
Philippines, all undistributed earnings intended or
reserved for investments within the Philippines as can
be proven by corporate records and/or relevant
documentary
evidence.
• To determine the ‘reasonable needs’ of the business
in order to justify an accumulation of earnings, the
Courts of the United States have invented the so-
called “Immediacy Test” which construed the words
‘reasonable needs of the business’ to mean the
immediate needs of the business, and it was
generally held that if the corporation did not prove
an immediate need for the accumulation of earnings
and profits, the accumulation was not for the
reasonable needs of the business, and the penalty
tax would apply [Mertens, Law of Federal Income
Taxation, Vol. 7, Chapter 39, p. 103]. (2010 Bar)
72 BASIC APPROACH TO INCOME TAXATION business are indicative of purpose to
avoid income tax upon shareholders:
(5.) Coverage of IAET
The 10% Improperly Accumulated Earnings
Tax (IAET) is imposed on improperly
accumulated taxable income earned starting
January 1, 1998 by domestic corporation as
defined under the Tax Code and which are
classified as closely held corporations.
(6-) What are closely-held corporations?

Closely-held corporations are those corpora-
tions at least fifty percent (50%) in value of the
outstanding capital stock or at least fifty percent
(50%) of the total combined voting power of all
classes of stock entitled to vote is owned directly
or indirectly by not more than twenty (20)
individuals.
(7.) Corporations not subject to IAET:

• Banks and other non-bank financial interme-
diaries;
• Insurance companies;
• Publicly-held corporations;
• Taxable partnerships;
• General professional partnerships;
• Non-taxable joint ventures;
° Enterprises duly registered with the
Philippine Economic Zone Authority (PEZA)
under R.A. No.7916, and enterprises
registered pursuant to the Bases
Conversion and Development Act of 1992
under R.A. No. 7227.
(8.) Prima Mac/e instances of accumulation of
profits beyond the reasonable needs of a
CHAPTER 5 73
• Investment of substantial earnings and profits of

the corporation in unrelated business or in stock
or securities of unrelated business;
° Investment in bonds and other long-term se-
curities;
• Accumulation of earnings in excess of 100% of
paid-up capital, not otherwise intended for the
reasonable needs of the business.
E. OTHERCORPORATETAXRATES
(1.) Common Tax Rates
a.) Capital gain from sale of share of stock.
i. If not listed and traded through stock ex-
change:
• Net capital gain not over P100,000
— 5%;
° Any amount in excess of P100,000
— 10%.
ii. If listed and traded through local stock
exchange — 1/2% of 1% of Gross Selling
Price (not income tax).
(2.) Domestic Corporations
a.) Corporations have the option to be taxed at fifteen
percent (15%) of gross income. In this regard, the
President may, upon the recommendation of the
Secretary of Finance, effective 1 January 2000,
allow corporations the option to be taxed at fifteen
percent (15%) of gross income, after the following
conditions have been satisfied:
i. A tax effort ratio of twenty percent (20%) of
Gross National Product (GNP);
CHAPTER 5 75
ii. A ratio of forty percent (40%) of income

tax collection to total tax revenues; • Tax base: Profits applied or ear-
A VAT tax effort of four percent (4%) of marked for remittance. This took ef-
GNP; and fect on 1 January 1998.
• Tax rate: 15% final tax.
iU. A 0.9 percent (0.9%) ratio of the Con- • Condition: Branch profits are
solidated Public Sector Financial effec- tively connected with the
Position (CPSFP) to GNP. conduct of its trade or business in
the Philippines (1999 Bar).
• The option to be taxed based on
gross income shall be available only • The diVidend income remitted to
to firms whose ratio of cost of sales Marubeni Corporation of Japan aris-
to gross sales or receipts from all ing from its equity investments in
sources does not exceed fifty-five Atlantic, Gulf and Pacific Company
percen’t (55%). of Manila is considered separate
• The election of the gross income and distinct income from the branch
tax option by the corporation shall office in the Philippines. There can
be ir- reVocable for three (3) be no other logical conclusion that
consecutive taxable years during the investment was made for
which the corporation is qualified purposes peculiarly germane to the
under the scheme. conduct of the corporate affairs of
Marubeni, Japan, but certainly not
• The term “gross income” derived of the branch in the Philippines
from business shall be equivalent to (Commissioner v. Marubeni, 177
gross sales less sales returns, dis- SCRA 500).
counts and allowances and cost of
goods sold. “Cost of goods sold” • Exempt profits remitted: Derived
shall include all business expenses from activities registered with the
directly incurred to produce the Philippine Economic Zone Authority
merchandise to bring them to their (PEZA).
present location and use. (4.) Non-Resident Foreign Corporations
b.) Interest on currency deposit and royalties (3.) Resident Foreign Corporations
derived from sources within the Philippines
a.) Branch Profit Remittance Tax
— 20% Final Tax.
a.) Interest on foreign loan — 20% Final Tax.
b.) Dividend received from domestic corporation.
This is known as the tax sparing credit rule
(Section 28 B 5[b], NIRC).
• Tax rate: 15% final tax.
76 BASIC APPROACH TO INCOME TAXATION been paid in the Phil-
ippines. There is no
statutory
• Condition : foreig n go\/ernment shall
allow a credit against the tax due from
the foreign corporation taxes deemed
to have been paid.
• Tax credit allowed: 20% effective July
1, 2005; 15% effective January 1, 2005
(R.A. No. 9337).
Issues:
• May a subsidiary corporation
(withholding agent) file an action for
refund?
Answer. Procter and Gamble Philip-
pines, subsidiary corporation
OF P & G-USA is properly re-
garded as a “taxpayer” within
the meaning of Section 309,
NIRC [now Section 22(N)J
and therefore, authorized to
file refund. Withholding agent
is tech- nically considered as
taxpayer. Reason: It is also
an agent of the taxpayer in
reporting such an income
(Com. v. Procter, 204 SCRA
377).
•
Does the phrase “deemed paid” tax
credit mean tax credit actually granted
by the foreign county.
Answer: The Tax Code merely
requires that the foreign
country (USA) shall aIIOw a
credit against the tax due
from Procter and Gamble-
USA for taxes deemed to have
CHAPTER 5 77
provision or revenue regulation

requiring “Actual Grant.”
Therefore, the phrase “deemed
paid”“tax credit” does not imply
tax credit actually granted by the
foreign government.
• Purpose of Tax Sparing Credit: To
encourage foreign investments and to
attract foreign invesfors.
F. TAX EXEMPT CORPORATIONS UNDER THE NIRC

(1.) Labor, Agriculture, or Horticultural Organization
Not Organized Principally for Profit
a.) Provincial fairs and like associations of a quasi-
public character designed to encourage devel-
opment of better agricultural and horticultural
products through a system of awards, prizes or
premiums and whose income derived from
gate receipts, entry fees, donations, etc. is
used exclusively to meet necessary expenses of
upkeep and operation are thus exempt.
b.) On the other hand, the holding of periodical race
meets by associations, the profits from which
inure to the benefit of their stockholder are not
tax-exempt. Similarly, corporations engaged in
growing agricultural or horticultural products or
raising livestock or similar products for profit are
subject to tax (Section 25, Rev. Reg. No. 2).
(2.) Mutual Savings Banks and Cooperative Banks a.)
Requisites for exemption:
i. No capital stock represented by shares;
78 BASIC APPROACH TO INCOME TAXATION tax exempt.
ii. Earnings, less only the expenses of

operating are distributable wholly
among the depositors (Section 26, Rev.
Reg. No. 2);
iii. Operated for mutual purposes and
without profit.
b.) Exemption applies to foreign as well as
domestic banks
c.) Not qualified as mutual savings bank if
deposits are made compulsory under
contracts between the bank and depositors
and is operated for speculation rather than
for savings (C.C. 262;
C.B. III-2, 248; Mateus, ibid., Vol. 6, p. 7).
(3.) Fraternal Beneficiary Society, Order orAssocia-
tion
a.) Requisites for exemption:
i. Operated under lodge system or for the
exclusive benefit of the members of a
society — they have parent and local
organizations which are active (Western
Funeral Benefit Association v. Hellmich,
2F, [2d] 367);
ii. Established system of payment to its
members or their dependents of life,
sick, accident, or other benefits (Section
27, Rev. Reg. No. 2);
iii. No part of the net income inures to the
benefit of the stockholders or members.
b.) A grand lodge established for the care of the
members, their dependents, and members of
an affiliated lodge unable to earn a livelihood
by reason of the infirmities of age was held
CHAPTER 5 79
c.) MUtual protective societies not operating under the

lodge system and traveler’s association providing for
fixed death benefits to the beneficiaries or members
are not tax exempt (Commercial Travelers Life and
Accident As- sociation v. Rodway, 235 Fed. 370).
(4.) Cemetery Companies
a.) Requisites I'or exemption:
i. Owned and operated exclusively for the benefit of
its owners;
ii. Not operated for profit.
b.) Any cemetery corporation chartered solely for burial
purposes and not permitted by its charter to engage in
any business not necessarily incident to that
purpose, is exempt from income, provided that no part
of its net earnings inures to the benefit of any private
shareholder or individual.
c.) Cemetery company which fulfills the other requirements
of the Statute may be exempt, even though it issues
preferred stock entitling the holders to dividend at a
fixed rate, provided that its articles of incorporation
require:
i. that the preferred stock shall be retired at par
as soon as the sufficient funds are realized
from sales; and
ii. that all funds not required for the payment of
dividends upon or for the retirement of preferred
stock shall be used by the company for the care
and improvement of the cemetery/property.
d.) Cemetery having a capital stock a.) Requîsites /°or exemption:

represented by shares, or which is
operated for profit or for the benefit of i. Association of persons having some
persons other than its members, does not common business interest;
come within the exempted class (Sec- tion ii. Limited its activities to work for such
29, Rev. Reg. No. 2). common interests;
(5.) Religious, Charitable, Scientific, Athletic or
Cultural Corporations ÏÏi. Not engaged in a reguTar business for
profÎt;
a.) Requisites l'or exemption:
No part of the net income inures to the
i. Organized and operated for one or benefit of any private stockholder or
more of the specified purposes; individual.
ii. No part of its net income must inure to (6.) Business, Chamber of Commerce, or
the benefit of private stockholders or Board of Trade
individuals.
b.) In the case of religious activities, income
from the conduct of strictly religious
activities, such as fees received for
administering baptismal, solemnizing
marriages, attending burials, holding
masses, and other like income is exempt
(Section 30, Rev. Reg. No. 2).
c) Charitable corporation includes association
for the relief of the families of clergymen,
even though the latter make contributions to
the fund established for this purpose, or for
furnishing the series of trained nurses to
persons unable to pay for them or for
aiding the general body of litigants by
improving the efficient administration of
justice (Ibid.).
d.) Scientific corporation includes an association
for the scientific study of law with a view to
improving its administration (Ibid.).
b.) Ceases to be tax exempt if it engages in a regular
business for profit even if it conducts business on a
cooperaf/ve basis or produces only sufficient income
to be self-assessing.
An association engaged in furnishing informa- tionto
prospective investors, to enable them to make sound
investment, is not exempt, sinco its members have no
common business interests even though all its
income is devoted to the purpose stated.
d.) A clearing house association, not organized for profit,
no part of the net income of which inures to the
benefit of any private shareholder or individual, is
exempt provided its activities are limited to the
exchange of checks and similar work for the
common benefit of its member.
e) An association of persons who are engaged in the
transportation business whether by land or water,
which is designed to promote the legitimate objects
of such business, and all of the income of which is
derived from membership fee dues and is expended
for office expenses is exempt (Section 31, Rev. Reg.
No. 2).
82 BASIC APPROACH TO INCOME TAXATION interests and well-being, as well
as to safeguard
f.) Makati Stock Exchange is not a business
league, chamber of commerce, or board of
trade within the purview of Section 30(f) of
the Tax Code, as amended, and must pay
income tax on its taxable income. Earnings
inure to the benefit of its members (BIR
Ruling No. 64-027).
(7.) Civic League
a.) Requisites for exemption:
i. Not organized for profit but operated
exclusively for purposes beneficial to
the community as a whole. In general,
organizations engaged in promoting the
welfare of mankind (Section 32, Rev.
Reg. No. 2);
Sworn affidavit with the BIR showing
the following:
Character of the league or
organization;
° Purpose for which it was organized;
° Actual activities;
• Sources of income and disposition
there;
• All facts relating to the operation
of the organization which affects its
right to exemption.
iii. The copy of articles of incorporation, by-
laws and financial statements should
be attached to the sworn affidavit (BIR
Ruling No. 21, January 23, 1961).
b.) Activities which consist in the doing of acts
and things designed to promote the best
CHAPTER 5 83
the community welfare, of the residents of the place

which is a contiguous community of property
owners and residents within an area, its source of
income coming from dues assessed against the
members on the basis of their relative holding in
said place, and no part of such income inures to the
benefit of any private stockholder or individual is
exempt from the payment of income (BIR Ruling, 31
March 1959).
c.) An association organized for maintaining sani- tation,
to afford community police protection, fire prevention
as well as the beautification and uniformity of the
surrounding premises of the occupants of a
subdivision is exempt from income tax (BIR Ruling
No. 520, series of 1959).
(8.) Non-Stock, Non-Profit Educational Institutions
(Revenue Memorandum Circular No. 76-2003)
a.) The exemption of non-stock, non-profit educational
institutions refers to internal revenue taxes imposed
by the National Government on all revenues and
assets used actually, directly and exclusively for
educational purposes (Paragraph 3, Section 4, Article
XIV of the Constitution).
b.) Furthermore, revenues derived from assets used in
the operation of cafeterias/canteens and bookstores
are exempt from taxation provided they are owned
and operated by the educational institution as
ancillary activities and the same are located within
the school premises.
c.) However, they shall be subject to internal revenue
taxes on income from trade, busi-
84 BASlCAPPROACH TO INCOME TAXATION CHAPTER 5 85
ness or other activity, the conduct of struction and/or improvement of school

which is not related to the exercise or buildings and facilities, acquisition of
performance by such educational equipment, books and the like) to be
institutions of their educational purposes funded out of the money deposited in
or functions (Sec. 2, Finance Department banks or placed in money markets, on
Order No. 137-. 87 as amended by Finance or before the 14th day of the fourth
Department Order No. 92-88) i.e., rental month following the end of its taxable
payment from their building/premises. year (Sec. 3, Finance Department Order
d.) Unlike non-stock, non-profit corporations, their No. 137-87).
interest income from currency bank deposits e.) Finally, the exemption does not cover with-
and yield from deposit substitute instruments holding taxes. As an educational institution,
used actually, directly and exclusively in pur- they are constituted as withholding agents
suance of their purposes as an educational
for the government required to withhold the
institution, are exempt from the 20% final tax
tax on compensation income of their
and 7 1/2% tax on interest income under the
employees, or the withholding tax on income
expanded foreig n currency deposit system
payments to persons subject to tax pursuant
imposed under Section 27(D)[1] of the Tax
to Section 57 of the Tax Code of 1997.
Code of 1997, subject to compliance with the
conditions that as a tax-exempt educational (9.) Government Educational Institution
institution, they shall on annual basis submit
a.) UP (Act No. 1870, as amended) is subject to
to the Revenue District Office concerned an
20% final tax. Other government educational
annual information return and duly audited
institutions are likewise subject thereto. Rea-
financial statement together with the
son: Income from properties, real or
following:
personal or from any of their activities
i. Certification from their depository banks conducted for profit, regardless of the
as to the amount of interest income disposition made of such income shall be
earned from passive investment not subject to tax (BIR Ruling 21-90, 28
subject to the 20% final withholding tax February 1990).
and 7 1/2% tax on interest income under
(10.) Mutual Fire Insurance Companies and Like Or-
the expanded foreign currency deposit
system imposed by Section 27(D)[1] of ganisations
the Tax Code of 1997; a.) Requisites f°or exemption:
ii. Certification of actual utilization of the i. Income is derived solely from assess-
said income; and ments, dues and fees collected from
members;
IÎÏ.
Board ii. Fees collected from
Resolution by members are for the sole
the school purpose of meeting its
admin- expenses.
istration on
proposed
projects (i.e.,
con-
CHAPTER 5 87
b.) Receipt which is a mere incident of the business

b.) Cooperative dairy companies which are en-
of the company does not prevent exemption.
gaged in collecting milk and disposing of it,
or the products thereof and distributing the
! Thus, receipt or the proceeds of the sale of
proceeds less necessary operating expenses
badges, office supplies, or equipment will not
among the members upon the basis of the
defeat the exemption. The same holds true
quantity of the milk or of butter fat in the
with the receipt of interest upon government
bonds. milk are exempt from the tax (Section 35,
Rev. Reg. No. 2).
c.) However, where such bonds are bought as If the proceeds of the business are
c.)
permanent investment, the receipt of
distributed in any other way other than on
interest destroys the exemption.
such proportionate basis, the company will
d.) Receipt of entrance fee (premium) does not be subject to tax (Ibid.).
render the company taxable.
d.) Farmers association is not tax exempt, if it
EXCEPTION: Issuing policies for deducts more than the necessary selling
stipulated cash premiums or requiring expenses incurred in accounting the
advance deposits to cover the cost of proceeds to the farmers (Ibid.).
insurance and maintaining investment from e) Cooperative associations acting as purchasing
which income is derived — no longer exempt agents are not expressly exempt from tax,
(Section 34, Rev. Reg. No. 2). but rebates made to purchases, whether or
e.) Advance assessment for the sole purpose not member of the association, in
of meeting losses and expenses tax proportion to their purchases may be
exempt (Ibid.). excluded from gross income, any profits
made from non-members and distributed to
(11.) Farmers, Fruit Growers’ or Like Association members in the guise of rebates are, of
course, subject to tax (Ibid.).
a.) /?eqt//sites for exemption:
f.) “Like associations” is construed as referring
i. Formed and organized as sales agent only to association whose actiVities are
for the purpose of marketing the
similar to farming and fm/f growing (Garden
product of its members;
House Co.
ii. No net income to the members; v. Com., 64 F [2d] 953). Credit Union
which is a non-stock corporation organized
and operated
iii. Proceeds of the sale shall be turned to them less necessary selling expenses on the basis of the
over quantity of produce finished by them.
f ivi- ties being
o confined to the
r members thereof, is
m exempt from income
u business and
t residence taxes (BIR
u Ruling No. 605, 13
a October 1958).
l
p
u
r
p
o
s
e
s
w
i
t
h
o
u
t
p
r
o
f
i
t
,
i
t
s
a
c
t
88 BASIC APPROACH TO INCOME TAXATION Section 4[3], 1987 Constitution).
COMMON REQUISITES:
a.) Not organized and operated principally for
profit;
b.) No part of the net income inures to the
benefit of any member or individual;
c.) No capital represented by shares of
stock; d.) Educational or instructive in
character.
Objectives: betterment of the conditions
engaged in such pursuits, the improvement
of the grade of their product and the
development of a higher degree of efficiency
in their respective occupations.
COMMON LIMITATIONS:
The income of whatever kind and character
of the foregoing organizations from any of their
properties, real or personal or from any of their
activities conducted for profit, regardless of the
disposition made of such income shall be subject
to tax (2002 Bar).
i. The income of such organizations which is
considered as income from their properties,
real or personal, generally consists of
income from corporate dividend, rentals
received from their properties, interests from
Philippine currency bank deposits or capital
loaned to other persons, income from
agricultural lands, owned by such
corporations, profits from the sale of
property, real or personal and other similar
income are taxable.
EXCEPTION: When earned by a non-stock,
non-profit educational institution (Article XIV,
CHAPTER 5 89
ii. Young Men’s Christian Association of the Philippines,

Inc. (YMCA) established as “a welfare educational and
charitable non-profit corporation” is subject to income
tax on the rental income derived from the lease of its
properties, real or personal, and is therefore not exempt
from income taxation, even if such income is exclusively
used for the accomplish- ment of its objectives. The
exemption claimed by the YMCA is expressly disallowed
by the very wording of the last paragraph of then
Section 26 (now last paragraph of Section
30) of the NIRC which mandates that income of exempt
organizations (such as the YMCA) from any of their
properties, real or personal, be subject to the tax
imposed by the same Code. Because the last paragraph
of said section unequivocally subjects to tax the rent
income of the YMCA from its real property, the Court is
duty-bound to abide strictly by its literal meaning and to
refrain from resorting to any conVoluted attempt at
construction (Commis- sioner of Internal Revenue v.
Court of Appeals, 298 SCRA 83).
• Tax exempt government-owned and controlled
corporations (GOCC) (Sec. 27[c] as amended by R.A.
No. 9337
i. Government Service Insurance System;
ii. Social Security System;
iii. Philippine Health Insurance Corporation;
iv. Philippine Charity Sweepstakes Office.
90 BASIC APF’ROACH TO INCOME TAXATION
Tax-exempt corporations under special laws

(1.) Cooperatives are exempted from taxes subject to
certain conditions under Republic Act No. 6938
(Rev. Memo. Circular 48-91). Chapter 6
(2.) Foundation created for scientific advancement is
exempt from tax under Section 24 of Republic Act ALLOWABLE DEDUCTIONS FROM
No. 2067. GROSS INCOME
A. BASIC PRINCIPLES:
(1.) The taxpayer must point to some specific
provisions of the statute authorizing the
deduction; and
(2.) He must be able to prove that he is entitled to the
deduction authorized or allowed (1955 Ph. Fed.
Tax Course, par. 1801; Atlas Consolidated
Mining v. Com., 102 SCRA 246).
• If a taxpayer fails to deduct certain expenses
for the taxable year, he cannot deduct them
from the income of the next or any
succeeding year (Section 76, Rev. Reg. No.
2).
° Not allowed to claim deductions (Tax base:
Gross Income):
i. NRA — NETB
ii. NRFC
B. THE COHAN RULE PRINCIPLE: If there is showing
that expenses haVe been incurred but the exact
amount thereof cannot be ascertained due to the
absence of documentary evidence, it is the duty of the
BIR to make an estimate of deduction that may be
allowed in computing the taxpayer’s taxable income
bearing heavily against the taxpayer whose
inexactitude is of his own
91
92 CHAPTER 6 93
BASIC APPROACH TO INCOME TAXATION
ALLOWABLE DEDUCTIONS FROM GROSS INCOME
making. A disallowance of 50% of the taxpayer’s j.) Pension trust contribution

claimed deduction is valid (Rev. Memo. Circular No.
23-2000). 2. Optional Standard Deduction (OSD)
Deductions Exclusions (2001 Bar)
amounts/items KINDS OF ITEMIZED DEDUCTIONS
V.
exempt from tax by C. BUSINESS EXPENSES
amounts deducted virtue of the Tax Code
from gross income to or special law Requisites for deductibility (1968 Bar)
arrive at net income
Personal Exemptions (1.) The expense must be ordinary and necessary.
(2001 Bar) There is no hard and fast rule on the matter.
Deductions V.
personal expenses • It depends upon particular facts such as, the
cover personal, type of business (custom), intention of the
business expenses living or family taxpayer, time, place and prevailing
represent cost of doing expenses circumstances. The Supreme Court has
business never attempted to define with precision the
only individual is
terms ordinary and necessary.
entitled
both individual and • However, Section 34(A)[1a] of the NIRC, as
corporate taxpayers amended by R.A. 8424, provides that
may claim expens-
KINDS OF ALLOWABLE DEDUCTIONS i.) Research and development expenditure
1. Itemized deductions
a.) Business
expenses b.)
Interest
c.) Taxes
d.) Losses
e.) Bad debts
f.) Depreciation
g.) Depletion
h.) Charitable and other contributions
es are considered “ordinary and necessary” if they are
directly attributable to development, management,
operation, and or conduct of the trade or business of
the taxpayer, or in the exercise of the taxpayer’s
profession.
Guiding principles:
Ordinary, when it is normal (common or usual) in relation
to the business of the taxpayer and the surrounding
circumstances. Need not be recurring, e.g., lawyer’s fee to
prosecute infringement suit. It is called ordinary in most
cases to distinguish it from a capital expenditure (1955
CCH Fed. Tax Course, par. 403).
Recapitafizationandreorganizationexpenses
are capital expenditure as well as cost of
94 BASIC APPROACH TO INCOME CHAPTER 6 95
TAXATION ALLOWABLE DEDUCTIONS FROM GROSS INCOME
obtaining stock subscription and promotion c) Mere holding of investments cannot be con-
expenses (Atlas Consolidated Mining and sidered engaging in business so that the
Development Corp. v. Com., 120 SCRA expenses in managing the investments are
246). not considered ordinary and necessary in
Necessary, where it is appropriate and helpful in the pursuit of a trade or business (Hospital
the development of the taxpayer’s business. It is De San Juan De Dios v. Com., G.R. No.
intended to realize a profit or to minimize a loss 311305, 10 May 1990).
(Visayan Cebu Terminal Co. v. Collector, CTACase , d.) Margin fees of P340,822.04 paid to the
No. 28, 29 June 1957). Central Bank by ESSO, a foreign corporation
• Ransom money paid to secure the return of doing business in the Philippines, on its profit
an individual is not deductible as it has remit- tances to its New York head office are
nothing to do with profit-making (Teodoro not ordinary and necessary expenses.
and De Leon, op. cit., pp. 64-65). REASON: The fees were paid not in the
production of income, but in the disposition
• Payment of the debts of bankrupt company
of said income after it had already been
to which the taxpayer was an officer to
earned. Hence, it is an expense properly
establish his credit is, according to U.S.
attributable to the head office and not in the
Supreme Court not ordinary (Welch v.
carrying on of its trade or business in the
Helvering, 290 U.S. 11 [1933]).
Philippines (ESSO Standard Eastern, Inc. v.
(2.) The expenses must be incurred in trade or Com., 175 SCRA 158-159).
business carried on by the taxpayer — This
means that the same is not incurred in the trade (3.) The expenses must be substantiated by proof
or business
of another. a.) It is incumbent upon the taxpayer to
a.) Stockholder’s expense in connection with the establish proximate relation (logical link or
acquisition of additional stock in order to sell nexus) between the expense and the
it to certain company executives in taxpayer's business (Atlas Consolidated
furtherance of a management incentive plan v. Com.,102 SCRA 246, 256).
of the company
not incurred in connection with the trade connected expenses (Collector v. Phil.
or business of the company (Stanly and Education Co., G.R. No. L-8505, 30 May
Kilcullen, pp. 63-64). 1953).
b.) Fees paid by the taxpayer to recover its lost
assets occasioned by the war and to
rehabilitate its business — business
b.) Receipts are the best proof. Burden of
proof lies upon the taxpayer. In certain
cases, this rule is relaxed.
Even if no records/receipts are available,
the oral testimony of a CPA, if not
contradicted by the government is sufficient
(Basilan Estates v. Com., G.R. No. L-22494, 5
September 1967).
96 BASIC APPROACH TO INCOME TAXATION • Applying the all-events test, the
Supreme Court ruled in the
recent case of CIR v. Isa-
(4.) The expenses must be reasonable
a.) Promotiona| expenses incurred or paid by
Phil. Sugar Estate Development Co. to
Algue Inc. amounting to P125,000.00 was
reasonable in the light of the efforts
exerted in inducing investors and prominent
businessman to venture in a experimental
enterprise (Vegetable Oil Investment
Corp.), and to invest in a new business
involving millions of pesos (Com. v. Algue,
158 SCRA 11).
(5.) Paid or incurred during the taxable year
a.) Cash basis method — deducts expenses in
the year in which they are paid.
b.) Accrual basis method recognizes expenses
in the year they accrue.
• The propriety of an accrual must be
judged by the facts that a taxpayer
knew, or could reasonably be
expected to have known, at the
closing of its books for the taxable
year. Accrual method of accounting
presents largely a question of fact;
such that the taxpayer bears the
burden of proof of establishing the
accrual of an item of deduction.
• The all-events test requires that the
liability be fixed, and the amount of
such liability be determined with
reasonable accuracy. The amount of
liability does not have to be determined
exactly; it must be determined with
reasonable accuracy (something less
than an exact or complete accurate
amount).
CHAPTER 6 97
bela Cultural Corporation [515 SCRA 566- 567],

that the professional fees of SGV & Co., for
auditing the financial statements of ICC for the
year 1985 cannot be 'validly claimed as
expense deductions in 1986. Reason: ICC
failed to present evidence showing that e\/en
with only “reasonable accuracy, it cannot
determine the professional fees which said
company could charge for its services.”
(6.) Expenses must not be against public policy, public
moral or law
a.) Fines and penalties —against public policy. b.)
Attorney’s fee incurred in defending civil action
based on illegal act — deductible provided it is
business connected.
c.) Even though the defense is unsuccessfu! —as long
as it is business connected — deductible.
d.) Entertainment expenses incurred by officer of a
corporation to entertain certain government officials
to discuss transactions/dealings at Manila Hotel —
against public policy (Nava v. Collector, CTA No.
568, 25 September 1961).
e) The purchase price of political influence to obtain or
hold public contracts; dollar allocations from the
Central Bank; import control licenses; payments in
excess of the maximum amount authorized by law
— against public policy. Reason: To permit a
violator to gain a tax advantage through deductions
would in effect lessen the degree of punishment
intended, or would frustrate the purpose and
effectiveness
TAXATION CHAPTER 6 99
of the public policy that has been violated employees,

(1955 PH Fed. Taxes, pars. 11, 1235, 11,
237).
f.) Bribe to obtain protection from arrest or
pros- ecution —against public policy.
(7.) If subject to withholding tax, proof of payment
to BIR must be shown
• Professional expenses — 10%
• Rent expense — 10% (Rev. Reg. No. 6-85,
2 May 1985)
KINDS OF BUSINESS EXPENSES

(1.) Compensation for personal services
Requisites:
a) Personal services actually rendered;
b) Compensation is for such services rendered;
c) Reasonable.
What are included in compensation for serv-
ices which are allowed as deductions from gross
income? (1968 Bar)
Answer: • wages, salaries, etc.;
• bonuses in good faith;
• commissions, professional fees,
vacation-leave pay, retirement
pay;
• management expenses;
• premiums and compensation for
injuries if not compensated for by
insurance or otherwise;
° contribution to pension trust
created for the benefit of the
including contribution under SSS Act;
• other forms of compensation for services
actually rendered.
Factors/tests which determine whether compensation

paid for services rendered is deductible or not
• Any amount paid in the form of compensation which
does not partake of the purchase price of services is
not deductible.
Example: 1) Ostensible salary paid by a corporation
may be treated as distribution of dividend upon stock.
This is likely to occur in the case of a cor-
poration having few stockholders, practically all of
whom drew salaries. Reasonable amount
— deductible from gross income; Excess over
reasonable amount — not deductible.
Example: 2) An ostensible salary may be in part
payment for property — Partnership sells out to a
corporation; the former partners agreeing to continue
in the service of the corporation. The salaries are not
merely for services but payment for the transfer of
their business (Sec- tion 70, Rev. Reg. No. 2;
Alhambra v. Collector 105, 106 Phil. 355).
The form or method of fixing compensation is not
decisive as to deductibility. Contingent compensation
may be deductible as long as it is not influenced by
any consideration other than securing fair and
advantageous terms (Reyes v. CTA No. 4, 30
September 1957).
CHAPTER 6 101
• Bonuses are deductible under the following

• Other forms of
conditions:
compensation: a.)
a.) Paid in good faith as additional
compensation for services rendered; Housing and meals;
b.) Courtesy discounts;
b.) Reasonable amount. To hold otherwise c.) Entertainment and gifts to company of-
would open the gate to rampant tax eva- ficers during Christmas and major anni-
sion (Kuenzle & Strife, Inc. v. Collector, versary, sports tournament and
106 Phil. 355); company picnics (Rev. Audit Memo
c) Order 1-87, 23 April 1987);
Not to exceed reasonable compensation
when added to stipulated salaries. d.) Legitimate expenses (salaries and
miscellaneous expenses) of an
Suggested tests: (Consider the date when illegitimate business are deductible
the contract for services was made, not at the
based on the theory that the income tax
date when the contract is questioned) is not a tax on gross income even if
a.) good faith; such income is earned from an illegal
business (I.T. 2581, 1942-2 Com Bell
b.) character of business;
88).
C.) salary policy of the
(2.) Travelling expenses — include transportation
corporation; d.) type and expenses and meals and lodging (Sections 65
extent of services; and 66, Rev. Reg. No. 2).
e.) employee’s qualification and contribution; Requisites for deductibility:

f.) g en eral eco nomic conditions (C.M. a.) Paid or incurred while “away from home.”
Hoskins & Co. v. com., L-24059, 28
No- vember 1969). i. Transportation expenses from main
office to branch, from branch office to
• Bonuses granted to corporate officers fcr the main office
successful sale of a piece of land effected — deductible.
through broker — no services rendered —
ii. Transportation expenses from office
not deductible as reasonable and necessary
expenses (Aguinaldo Industries Corp. v.
to home; home to office — not
deductible.
Com., L-29790, 25 February 1982).
iii. If a company car is utilized both for busi-
• It is immaterial whether bonuses are paid in ness and personal use — proportion to
cash or in kind or partly in cash and partly in
the use.
kind.
b.) Paid or incurred in the conduct of trade or
business.
ALLOWABLE DEDUCTIONS FROM GROSS
INCOME
c.) Reasonable and necessary expenses. expense. There

(3.) Representation and Entertainment expenses
Requisites for deductibility:
a.) Subject to the rule of substantiation receipt
or adequate records, amount of expense,
date and place of expense, purpose of
expense and professional or business
relationship of expense;
b.) Paid or incurred in the pursuit of trade or busi-
ness;
c.) Paid or incurred in the taxable year;
d.) Not contrary to law, morals and public policy;
e.) Reasonable.
Dues paid to social, athletic, or sporting
club or organization per officer; to
professional or business organization (Lions,
Kiwanis) — deductible.
Purchase of propriety shares and
playing rights — not deductible.
(4.) Advertising and Promotional Expenses
a.) Must be substantiated.
b.) All payments for the purchase of promotional
give-aways, contest prizes or similar material
must be properly receipted.
All payments for services such as radio
and TV time, print ads, advertising expense
must be subjected to withholding tax.
• There is yet to be a clear-cut criteria or
fixed test for determining the
reasonable- ness of an advertising
being no hard and fast rule on the matter, the right to a
deduction depends on a number of factors such as but
not limited to: the type and size of business in which the
taxpayer is engaged; the Volume and amount of its net
earnings; the nature of the expenditure itself; the intention
of the taxpayer and the general economic conditions. It
is the interplay of these, among other factors and properly
weighed, that will yield a proper evaluation.
Advertising is generally of two kinds:
(1) advertising to stimulate the current sale of
merchandise or use of services and (2) advertising
designed to stimulate the future sale of merchandise or
use of services. The second type involves expenditures
incurred, in whole or in part, to create or maintain some
form of goodwill for the taxpayer’s trade or business or for
the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising of the
first kind, then, except as to the question of the reasona-
bleness of amount, there is no doubt such expenditures
are deductible as business expenses. If, however, the
expenditures are for advertising of the second kind, then
normally they should be spread out over a reasonable
period of time.
The protection of brand franchise is analogous to the
maintenance of goodwill or title to one’s property. This
is a capital expenditure which should be spread out over
a reasonable period of time. Cor-
CHAPTER 6 105
104 BASIC APPROACH TO IhlCOME TAXATION ALLOWABLE DEDUCTIONS FROM GROSS INCOME
(7.) Repairs
porate taxpayer’s venture to protect its
brand franchise was tantamount to efforts Rules on deductibility
to establish a reputation. [Commissioner by this method (Section 67, Rev. Reg.
of Internal Revenue v. General Foods No. 2).
(Phils.), Inc., 401 SCRA 545 (2003)
2009
Bar]
• Expenses incurred or paid to promote
sale of capital stock for acquisition of
additional capital is not deductible from
taxable income. Efforts to establish
reputation are akin to acquisition of
capital assets and, therefore, expenses
related thereto are not business
expense but capital expenditures.
[Welch v. Helvering, 290 U.S. 111, 78 L
Ed. 212, 545 Ct. 8 (1933)]
(5.) Rent Expense (Rev. Reg. No. 8-90 dated 15 Oc-
tober 1990)
a.) Business property at least P500 5%.
b.) Non-business/residential property — at least
P10,000.00 5%.
(6.) Cost of material and supplies — deductible only
to the amount actually consumed or used in
operation.
Methods utilized to determine materials used:
a.) Actual consumption method (inventory meth-
od);
b.) Direct purchase method.
Taxpayer purchases materials but has
no record of consumption deductible
provided the net income is clearly reflected
a.) Incidental or ordinary repairs — keeps the asset in
its ordinary working condition (does not add
material value to the property or prolong its life as
distinguished from extra-ordinary repairs).
i. Expense for the maintenance and repair of
fishponds deductible — It keeps the fishponds
in an ordinary efficient operating condition
(Villegas v. Com., CTA case dated 7 October
1963).
ii. Repairs on the second floor of plant to
strengthen it and avoid danger of col-
lapse — deductible (Kerotest Mfg. Co.,
BTA Momo Op., 25 November 1941).
b.) Extraordinary repairs are not deductible
they are capital expenditures.
i. Expenses necessitated by radical changes
in design made during construction are not
deductible part of the cost of the project
(Dirscoll v. Com., 1477 [2d] 493).
ii. Expenses of repairs to walls and roof of a
building to prevent leakage deductible
(Buckland v. U.S.D.C. Com., 9 May 1946).
iii. Cost of demolishing building and erecting a
new one is a capital expenditure (Law of
Federal Income Taxation, Merters, Vol. 4, p.
372).
• Organization costs are amortized over
the life of the corporation.
TAXATION
• Private or proprietary educational institution • Interest paid for late payment of

may, at its option, elect either: donor’s tax is deductible (Com.
a) To deduct expenditure otherwise considered v. Prieto, L-13912, 30 September
as capital outlets of depreciable assets 1960).
incurred during the taxable year for the ° What are included in the
expansion of school facilities, or
term“indebtedness" interest of
b) Deduct allowance for depreciation therefrom. which is deductible? (1968 Bar)
D. INTEREST EXPENSES • Gifts when proven to be bona fide
!oans
(1.) Definition — amount which one has contracted
to pay for the use of borrowed money (Old • Taxes
Colony Bay Co., 284 U.S. 552) or amount of • Obligations of joint obligor
compensation paid for the use of money or
forbearance from such use. • Discount on notes issued to bank
for loan
b.) Incurred in connection with taxpayer’s trade
a.) There must be an indebtedness: or business
i. no indebtedness -— no deduction; c.) Indebtedness must be that of the taxpayer:
ii. Indebtedness — unconditional and i. Corporation was allowed interest deduc-
legally enforceable obligation for tion for payments made on loans
payment of a sum certain in money; obtained in its Corporate capacity, using
corporate
¡¡ Embraces not only contractual debts 18 SCRA 496);
but also interest accruing as a result of
delin- quency for payment of the tax.
However, penalties (civil or criminal)
ÏV. are excluded;
Distinction between taxes and debts
are, on account of their nature and in
certain cases, inconsequential (Sambrano
v. CTA, L-8652, 30 March 1957).
Correspondingly:
• Interest on delinquent tax liabilities
is deductible (Com. v. Palanca,
asset ciency on property
s as after transfer to
secur transferee (Arcale
ity, Realty Co., Inc., 35 TC
throu 256).
gh Interest on mortgage by
borro
legal or equitable owner
wed
not directly liable upon
funds
indebtedness (Section
were
8, Rev. Reg. No. 2).
subs
eque d.) The interest must have been
ntly stipulated in writing in
loane consonance with Ariicle
d to a 1956, New Civil Code which
stock provides that no interest
holde shall be
r.
ÏÏ.
I
n
t
e
r
e
s
t
o
n
i
n
c
o
m
e
t
a
x
d
e
fi
due unless it has been expressly stipulated in

writing. (6.) Interest on indebtedness paid in adVance through
discount or otherwise (cash basis). Deductible in
e.) Paid or accrued within the taxable year.
the year the indebtedness was paid, not when
Cash basis deductible in the year it interest was paid in advance.
is actually paid.
(7.) Interest between related taxpayers.
Accrual basis — deductible in the year it
a.) Members of a family — brothers and sisters
is accrued even if not actually paid.
(full or half), spouse, ancestors and lineal
Deductible interest expenses descendants.
b.) Indi\/iduaI and corporate — individual owns
a.) Interest on taxes. Reason: Taxes for this pur- directly or indirectly more than 50% of the
pose are indebtedness. Fines, penalties and outstanding stock.
surcharges on taxes are not deductible.
c.) Between corporations — more than 50% of
b.) Interest paid by corporation on scrip dividends. the outstanding stock both owned directly or
c.) Interest on deposits paid by authorized indirectly by the same individual.
bank of the Central Bank. d.) Grantor and fiduciary (trustee) of any trust.
d.) Interest paid by legal or equitable owner on e.) Fiduciary and another fiduciary — the same
mortgage of real property. grantor.
Some non-deductible interest expenses f.) Fiduciary and beneficiary or such trust.
(1.) Interest on preferred stock which is considered • Theoretical interest is not deductible as
interest on capital by virtue of RMC 17-71 dated it is merely computed or calculated. It
does not arise from interest bearing
12 July 1971 (1999 Bar).
obligation (PICOP v. CA, 250 SCRA
(2.) Interest on undrawn salaries and bonuses 434).
(Keunzle & Streiff, Inc. v. Collector, 106 Phil.
• Optional treatment of interest expense
355).
on capital expenditure. At the option of
(3.) Interest on capital for cost keeping. Reason: the taxpayer, interest expense on a
No indebtedness. capital expenditure incurred to acquire
(4.) Interest paid where parties provide no stipulation property used in trade, business or
to pay interest in writing. exercise of a profession may be allowed
as a: (1) deduction in full in the year
(5.) Interest on indebtedness if incurred to finance pe- when incurred, the provisions of Section
troleum exploration. 36 (A)[2] and [3] of the Tax Code of
1997 to the contrary notwithstanding; or may
be treated as a (2)
d.) Special assessment
110 BASIC APPROACH TO INCOME TAXATION tax;
e.) Taxes paid for commodity not connected
capital expenditure for which the with
taxpayer may claim only as a deduction the taxpayer's business:
the periodic amortization of such
expenditure (Section 34(B)(3] as
implemented by Rev. Reg. No. 13-
2000).
° Arbitrage rule on deductible interest.
The percentage by which the taxpayer's
otherwise allowable deduction for inter-
est expense shall be reduced, has
been increased from 38% to 42% of
the interest income subjected to final
tax effective July 1, 2005. It shall be
reduced to 33%
effective January 1, 2009 (Section
34(B], as amended by R.A. No.
9337).
E. TAXES
(1.) NATURE AND SCOPE — All taxes, whether
national or local, paid or accrued, within the
taxable year in connection with the
taxpayer’s trade or business, except:
a.) Philippine income tax;
b.) Income, war profit, and excess profit taxes
imposed by the authority of any foreign
country provided the taxpayer chooses to
take a tax credit (If a taxpayer is qualified to
take a tax credit for income, war profits and
excess profits taxes paid or accrued to a
foreign country such taxes, when not taken
as tax credit, may be claimed as deductions
from gross income);
c) Estate and donor’s tax;
CHAPTER 6
ALLOWABLE DEDUCTIONS FROM GROSS INC ONCE
• No deductions are allowed for amoui.!S

representing: (1) interest; (2) surcharges;
and (3) fines or penalties incident to dc.-
linquency (Par. 2, Section 80, ReV. Reg.
No. 2).
• Postage is not a tax. Automobile registra-
tion fees are not considered taxes (Section
80, Rev. Reg. 2).
• Under Section 4(a), R.A. No. 9257
(Expanded Senior Citizens Act), the twenty
percent (20%) discount granted to senior
citizens shall be allowed as tax deduction
from gross income for the same taxable
year that the discount is granted.

(1.) Paid or incurred within the taxable year;
(2.) Paid or incurred in connection with taxpayer’s busi-
ness;
(3.) Deductible only by the person upon whom the tax
is imposed by law (VAT is deductible only by seller).
EXCEPTIONS:
a.) Taxes of shareholder upon his interest as such
and paid by the corporation without reimburse-
ment from him can be claimed by the corpora-
tion as deduction.
b.) A corporation paying the tax for the holder of its
bond or other obligations containing a tax-free
covenant clause cannot claim deduction for
such taxes paid by it pursuant to such covenant
(Sec. 80, Rev. Reg. No. 2).
CHAPTER 6 113
When may deduction for taxes be claimed?
Answer: Year paid or
incurred in general. the taxpayer’s taxable income from
However, in the case of contingent tax liability, sources without the Philippines bears
the obligation to deduct arises only when the to his entire taxable income for the
liability is finally determined.
same taxable year.
Tax Credit — amount allowed by law to
reduce the Philippine income tax due on account Tax Deduction v. Tax Credit
of income, war profit tax, excess profit tax, paid Deductible from gross in- Deductible from Phil.
or accrued to a foreign country. come income tax
Only domestic corporations are entitled to
avail of the tax credit. Sources: Deductible taxes Sources: Foreign income
such as business tax, war-profits and excess
Reason/Purpo se: excise tax, percentage tax profit tax
To lessen the harshness
of taxation in cases where an income is subject and other business-
to
connected taxes
both foreign tax and Philippine income tax. •
Tax deduction reduces taxable income while
• The taxpayer has the option either to claim tax credit reduces the taxpayer’s liability
foreign income taxes paid as deduction from (CIR
gross income or tax credit against the Philip- v. Bicolandia Drug Corporation, 496 SCRA 176,
pine income taX. If claimed as tax credit, it is 182).
no longer deductible from gross income.
Administrative conditions for a Ilowance of
• If claimed as tax credit, the allowable tax credit for foreign taxes:
credit is subject to the following limitations: (1.) The taxpayer must signify in his income tax
a.) The amount of the credit with respect return his desire to claim tax credit;
to
(2.) The return must be accompanied by the ap-
the tax paid or incurred to any country propriate form prescribed by the BIR Commis-
shall not exceed the same proportion of
the tax against which such credit is sioner, signed and sworn, carefully filled up
and containing the information required.
taken, which the taxpayer’s taxable
income from sources within such country If credit is sought for taxes already paid, receipt for
bears to his entire taxable income for the payment must be attached.
same taxable year; and
F. LOSSES
b.) The total amount of the credit shall not
(1.) DEFINITION
exceed the same proportion of the tax
against which such credit is taken, which The term implies an unintentional parting with
something of value. It is used in the income tax law
114 BASIC APPROACI-I TO INCOME
CHAPTER 6 115
TAXATION
INCOME
in a very broad sense

to comprehend all losses is due to a fluctuation in the market price
which are not general
or natural to the ordinary or to other similar cause, the amount of
loss is not
course of business and are not covered under some deductible until it is disposed of(Sec. 99,
other heading SUCh as bad debts, inventory Rev. Reg. No. 2).
losses; depreciation, etc. (1955 CCH Test Tax
Course, Par. 598). b.) Must be claimed in the year the
worthlessness occurs. The law requires
Treatment of losses depends that it must be considered as a loss from
upon: a.) Class of taxpayers; the sale or exchange of capital assets on
the last day of the taxable year in which it
b.) Nature of losses. occurred.
(2.) KINDS OF LOSSES: e.) Losses from short sale of property.
a.) Ordinary losses those incurred in trade f.) Losses due to failure to exercise privilege
or
business.
or option to buy or sell property.
b.) Those incurred in any transaction entered
g.) Abandonment losses (oil exploration).
for profit though not connected with the
trade, business. i.) All accumulated exploration and develop-
ment expenditures pertaining to partially
or fully abandoned petroleum operations
C.) Casualty Losses those incurred by property shall be allowed as deduction. In all
cases,
connected With the trade or business, if the notices of abandonment shall be filed
with
loss arises from fire, storm, shipwreck, or the BIR.
other casualties or from robbery, theft or
embezzlement. ii.) Subsequently abandoned producing well
— the unarmortized costs and undepre-
d.) Capital deductible only to the extent ciated costs of equipment directly used
losses of shall be allowed as deduction. If the well
capital gains:
° Losses from sale or exchange of capital 7wo important requisites:
assets;
a.) It becomes worthless upon the happening
• Losses resulting from securities becoming of an identifiable event which evidences
WOrthless which are capital assets. destruction of value. However, when the
decline in value is reentered and production resumed, or
if such equipment or facility is restored
into service — the costs shall be
included as part of the gross income
and shall be amortized or depreciated,
as the case may be.
(3.) SPECIAL KINDS OF LOSSES:
a.) Wagering losses deductible only to the
extent of gain or winning:
CHAPTER 6 117
116 BASIC APPROACH TO INCOME TAXATION ALLOWABLE DEDUCTIONS FROM GROSS INCOME
cannot be off-
Illustrations:
Gambling winning — 1,000.00
Gambling loss — 500.00
Deductible loss — 500.00
Gambling winning 500.00
Gambling loss — 1,000.00
Deductible Toss — 500.00
Gambling winning 0
Gambling loss — 1,000.00
Deductible loss 0
i. Thus, a taxpayer whose gambling
transactions resulted in losses of P500
and gains of P400 in another gambling
game, would be obliged to report the
gain of P400 in order to obtain a
deduction of the loss for P500. The
excess of the loss over the gain is not
deductible. On the other hand, the
excess of the gain over loss is taxab|e
(Humprey v. Com., 35 AFTR, 1572;
Fran- cis M. Cronon, 33 BTA 668).
ii. The cost of the unsold tickets of a
sweepstakes agent constitutes his
investment in a wagering transaction.
Losses he may incur therefrom can be
allowed as deduction only up to the
extent of the gains realized. But, R.A.
No. 1169 exempts sweepstakes
winnings from taxation, it follows that no
losses incurred therefrom can be
allowed as deductions from gross
income (BIR Ruling No. 62-006, 26
January 1962). Losses from an illegal
transaction are not deductible and they
set against gains from a legal
transaction (Section 96, Rev. Reg. No.
2).
b.) Losses due to voluntary removal of building
incident to renewal or replacement (1968
Bar).
Tax Code does not provide for the
deductibility of losses arising from voluntary
removal of old building, or scrapping of
machinery or equipment. Rev. Reg. No. 2,
Section 87 granted the deductibility of losses
sustained if building, machinery or equipment
is old, and the demolition or scrapping thereof
is made incident to removals or
replacements. This presupposes that the
building is already existing on the lot owned
by the taxpayer before the demolition.
With respect to the building existing at
the time of purchase of the lot upon which the
said building is erected, the rules are the
following:
i.) When a taxpayer buys a real estate upon
which a building is built, the cost to build
another building and the cost of removal
of the old building is not deductible. The
value of the real estate, exclusive of old
improvements, being presumably equal
to the purchase price of the land and
building plus the cost of removing the
useless building.
ii.) However, if the removal of the building
was required by the authorities because
the building was a fire hazard, the value
of the building and the cost of its removal
will be deductible as losses (Com. v.
Prescilla Estate, Inc., et a/., 11 SCRA
130).
TAXATION
INCOME
c.) Loss of useful value of capital asset due to Foreign Corporations — Losses actually sus-
changes in business condition. tained:
i.) When taxpayer discontinues the business a.) In business or trade conducted in the Philip-
or discards such assets permanently pines;
from use in such business, he may
claim as deduction the actual loss b.) In transaction entered into for profit in the Phil-
sustained. In determining the amount ippines;
of loss, adjustment must be made, c.) Not compensated for by insurance or
however, for improvements, otherwise.
depreciation and salvage v-alue of the Requisites /'or deductibility (In general):
property. This is an exception to the rule
requiring a sale or other disposition of a.) The loss claimed as deduction must be
property in order to establish a loss that of a taxpayer.
(Sec- tion 98, Rev. Reg. No. 2). i. The taxpayer must prove that the loss
Proof required to establish loss of useful was suffered by said taxpayer.
value (Unforeseen causes): • Where a taxpayer operates two
° Increase in the cost or change in phases of industry, one exempt
the manufacture of any product; from income tax pursuant to R.A.
No. 901 and the other taxable,
° New legislation directly makes the losses sustained in the tax-exempt
continued profitable use of the operation cannot be deducted from
property impossible. income of the taxable industry
Non-deductible loss due to loss of (Marcelo Steel Corp. v. Collector,
useful value: G.R. No. L-12401, 31 October
1960).
• Useful life of property terminates
solely as a result of those gradual • If the taxpayer is engaged in
processes for which depreciation is several businesses such that its
authorized; gross income arises from
operations of two or more
• Inventories (Section 98, Rev. Reg. businesses, loss sustained in one
No. 2). line of business cannot be claimed
Domestic Corporations A!I losses actually as a deduction or be offset from the
sustained and charged off within the taxable year income of its other line of
and not compensated for by insurance. businesses (BIR Ruling No. 123-87,
4 May 1987).
• If a taxpayer derived income from
manufacturing and at the same time
INCOME
farming, but its farming expenses transaction until

exceeded its farming income, the
taxpayer cannot offset its net loss
from farming against its
manufacturing income (BIR Ruling
No. 31-84, 9 February 1994).
b.) The loss must have been sustained during
the taxable year.
A taxpayer is not allowed to defer the
deduction to some other time other than the
year in which the loss was actually sustained
(Com. v. Asturias Sugar Central, Inc., G.R.
No. L-15013, 31 August 1961)
• Warlosses due to enemy attacks and
sustained subsequent to 6 December
1941, but not later than 1 July 1942 —
deductible in the year when the
taxpayer was advised by the War
Damage Commission (Philippine Sugar
Estate Development Company v.
Posadas, 68 Phil. 216).
c.) Loss evidenced by a closed and completed
transaction.
i. The phrase “closed and completed
transaction” means that the loss is
fixed by an identifiable event occurring in
the taxable year in which, under the
surrounding facts and circumstances,
the basis of an immediate recoupment is
not present (Louisville Trust Co. v.
Glenn, 25 AFTR 464). Consequently,
where the fact would
indicate substantial basis for
recoupment and reasonably recognized
as such, the matter is not a closed
the receipt of the recoupment fixed
the amount of the net loss (Section 96,
Re'v. Reg. No. 2).
There should be an identifiable
cause which fixed the loss.
ii. Loss from sale. Consumption of the sale
is the identifiable event which fixes the
loss.
iii. Building, worth P500, 000.00, insured
for P500,000.00; burned in the year
2000. The insurer refused to
acknowledge its Iiability; action was
brought in court by the insured. In the
year 2001, the parties agreed to com-
promise the case — P400,000.00. Loss
deductible (P500,000.00 — 400,000.00)
- P100,000.00 in the year 2001 when
the insurance recovery is definitely es-
tablished and not 2000. Closed and
completed transaction — final
settlement and determination of the
insurance recovery, event which took
place in 2001 (1955 PH Fed. Tax
Course, par. 2207).
d.) Loss not compensated by insurance or other-
wise.
i. Not indemnified by insurance or other
forms of indemnification.
ii. Insurance or otherwise. Otherwise
means in other ways — refers to
compensation due under a title
analogous or similar to insurance
(ejusdem generis; noscitur a sociis)
inasmuch as the latter is a contract
establishing a legal obligation, namely:
law, contract, quasi-contract, torts or
crime.
TAXATION CHAPTER6 123
ALLOWABLE DEDUC1ONS FROM GROSS INCOME
Included — insurance created by

c.) Proof of the elements of the loss claimed,
operation of law s\ ch as the War
such as the actual nature and occurrence of
Damage Corporation Act of the United
the event and the amount of the loss.
States (Com. v. Asturias Sugar Central,
Inc., G.R. No. L-15013, 31 August i.) Casualty loss — documentary proof of
1961). costs, photograph showing extent of
damage, condition or value of the
Excluded (lncome Tax Law) —
property after it was repaired, restored
hope, or even moral certainty, proposed
or replaced.
legislation — authorizing payment of an
indemnity, not due either the general ii.) Robbery, theft or embezzlement losses
principles of law, or under any particular — amount of loss. Police report is
statute — would eventually be approved necessary although not conclusive proof
(Cu Unjieng Sons, Inc. v. BTA, G.R. No. of the loss arising therefrom.
L-6296, 29 September 1956).
(5.) NON-DEDUCTIBLE LOSSES
(4.) CASUALTY LOSSES (fire, storms, robbery, theft
(1.) Losses in dealings between related
or embezzlement)
taxpayers (except in case of distribution in
Requisites for deductibility (Rev. Reg. No. 12-77) liquidation)
a.) Sworn declaration of loss must be filed with a.) Members of a family. Family means
the BIR. taxpayer’s brothers and sisters
i.) Nature of the event piving rise to loss (whether by whole or by half blood),
and time of its occurrence; spouse, ancestors and lineal
descendants.
i. Loss on a bonafide sale to a son-in-
law of the taxpayer’s brother — de-
ii.) Description of the damaged property and ductible.
its location;
ii. Prohibition applies to indirect sale
iii.) Items needed to compute the loss such or exchange. Consequently, if the
as cost or other basis of the property, taxpayer seeks to deduct a net
depreciation allowed if any, value of the operating loss, the prohibition does
property before and after the event, cost not apply (Anyder Sons Co. v.
of repair; Comm., G. AFTR 2d. 875).
iv.) Amount of insurance or other b.) Between an individual and
compensation received or receivable.
corporation. More than 50% of the
o utstanding stock
b.) Filed through the nearest RDO within 45 days of the corporation is owned directly or
after the date of the occurrence. indirectly by the individual.
CHAPTER 6 125
124 BASIC APPROACH TO INCOME ALLOWABLE DEDUCTIONS FROM GROSS INCOME
TAXATION
of stocks or securities;
c.) Between two corporations:
d.) Not limited to situations where
i. One or both of the corporations is a the replacement is acquired
personal holding company by purchase. It also
preceding the date of the sale or
exchange;
ii. More than 50% in value of the stock
of each corporation is owned
directly or indirectly by the same
indvidual;
iii. HoweVer, the limitation does not
apply where the indiVidual owning
more than 50% of the stock of the
purchasing corporation owned
less than 50% of the stock of the
selling corporation (Shelder Land
Co., 42 BTA 498).
d.) Between parties to a trust:
i. Grantor and fiduciary (trustee);
ii. Fiduciary of a trust and fiduciary of
another trust — the same grantor;
iii. Fiduciary and
beneficiary. (2.) Losses on wash sale
(61-day sale)
Points to be considered:
a.) Taxpayer must have bought or sold
stocks or securities;
b.) Substantially identical stock or securities
are acquired within a period beginning
30 days before the date of sale and
ending 30 days after such date;
c.) There must have been sale or disposition
applies to acquisition through a taxable
exchange and the making of an option contract;
e.) The seller is not dealer in securities.
Reasons for non-deductibility of loss from wash
sale:
i. Prevent deduction of losses on sales of
stock or securities that were replaced by
substantially identical stocks or
securities.
ii. Loss is added to the cost of the sub-
sequently acquired securities/stock. Hence,
a mere artificial loss.
(3.) Loss due to removal of building if purchased (not
existing and not incident to renewal)
• Net operating loss carry over (NOLCO)
i. Applies to individual and corporate.
ii. Can be carried over in the next three
consecutive taxable years.
iii. Taxpayer is not exempt from income tax.
iv. No substantial change in the ownership of
the business or enterprise in that not less
than 75% in nominal value of the
outstanding issued shares or paid up
capital of the corporation is held by or on
behalf of the same person.
V. Mines other than oil and gas wells may
carry over net operating losses as
deduction in the next five years.
G. BAD DEBTS
(1.) DEFINITION i.) Worthlessness is not determined by an
Debts due to the taxpayer which are actually inflexible formula but upon the exercise
ascertained to be worthless and charged off of sound business judgment. Mere
uncer- tainty of collection or
within the taxable year.
investigation that the debtor is in an
(2.) REQUISITES FOR DEDUCTIBILITY: unsatisfactory financial condition and
a.) Existence of a valid debt and subsisting that the collection of the debt is doubtful
debt (lepal and factual). will not suffice. All pertinent facts and
evidence must be considered. The
i.) A debt is valid if there exists the relation- burden of proof to show worthlessness
ship of a debtor and creditor. It is not is on the taxpayer.
necessary that the debt shall be due in
the sense that it is then collectible. It Illustration: If the creditor could show
must be an outstanding obligation, that during the years he at-
which if not due at the time, will certainly tempted to collect the
become due at some future date debt, the debtor had
(Budsboro Steel Foundry & Machine Co. property the title of which
v. U.S., 12 AFTR 1948). was in dispute but which
would enable him to pay
his debts when the
¡¡ ) Where the debt, however, is subject to title was cleared, the credi-
a contingency and such contingency did tor would be entitled to
not occur, there is no valid subsisting defer the deduction on the
debt (Evans Clark, 18TC 780). ground that there was no
genuine ascertainment of
iii. Repayment of the debt is essential for worthlessness.
) the existence of the debt. Understanding
that the payment of the alleged debt Factors affecting the worthlessness of a
would never be demanded — there is debt (2004 Bar):
no debt within the contemplation of the ii.a. Bankruptcy or insolvency of the
law. debtor;
Exception: Even if the debt be uncollect-
ible from its inception, it is the right of b.) ts must be
the endorser or guarantor to deduct D actually
payment which he is required to make e ascertained to
upon default of the primary debtor. b be worthless.
ii.b. li.C ii.d. Insufficienc
y of the
ii.e.
collateral;
Statute of
limitation;
Death of
the debtor
leaving no
assets;
Injury of the
debtor
making it
impossible
for him to
earn a
Ii'ving
(Section
CHAPTER 6 129
102, Rev. Reg. No. 2; 1955 CCH Non-resident Foreig n Corporation

Fed. Tax Course, par. 502); — not entitled.
ii.f. Meager amount involved; d.) Debt arises from business or trade.
ii.g. Improbability of success of judicial e.) Does not arise from transactions between
collection; related taxpayers.
ii.h. Destruction by fire of original in- f.) Additionally, before a debt can be ascer-
voices evidencing the tained to be worthless, the taxpayer
indebtedness (Goodwill must aISo show that it is indeed
International Rubber Co. uncollectible in the future.
v. Collector, CTA Case No. 468, 8 Furthermore, there are steps outlined
June 1963).
c.) Debt must be charged off within the year and Resident Foreign Corporations only
of worthlessness. business debts.
A taxpayer may not defer deduction
to a later year of a bad debt. If the charge
off is made in a later year, the deduction
will be disallowed (Collector v. Goodrich
International Rubber Co., 21 SCRA 1336,
1314).
Loss from theft or embezzlement
i. Deductible in the year in which it was
sustained.
ii. No means of determining the actual
date of embezzlement year of discovery
(Boston Consolidated Gas Co. v.
Comm., 126F [2d] 437).
iii. Modified by the application of the bad
debt theory which holds that since the
embezzlement of funds creates a
debtor- creditor relationship the loss is
deductible as BAD DEBT in the year
when the right of recovery become
worthless.
Deductible bad debts of Domestic
to be undertaken by the taxpayer to prove
that he exerted efforts to collect the debts,
Viz: (1) sending of statements of accounts;
(2) sending of collection letters; (3) giving
the aCCoMnt to a lawyer for collection;
and
(4) filing a collection case in court (PRC v.
Commissioner, 256 SCRA 667).
• In the case of banks, they shall submit a
Bangko Sentral ng Pifi pinas/Monetary
Board written approval of the writing off
of the indebtedness from the bank’s
books of accounts at the end of the
taxable year (Rev. Reg. No. 25-2002).
• As regards insurance or surety
company, writing off of a receivable
from the books and cla inned as bad
debts deduction requires declaration of
closure due to insolvency or for any
such similar reason by the Insurance
Commissioner. (Ibid).
(3.) I\MEASURE OF BAD DEBTS DEDUCTIBLE
a.) Generally the entire amount of the bad debt.
b.) Not necessarily so in the following
instances:
CHAPTER 6 131
Unpaid wages paid in promissory note

of P50,000.00 or the amount absolved if
— amount deductible is the \/aIue of the
the debtor is insolvent.
note and not the amount of the unpaid
salary or wages; viii. Unpaid wages, salaries, rents and other
similar income, deductible in full
ii. Distribution of the decedent’s assets provided the same is returned as
— only the difference between income.
creditor’s claim and property
received from the estate; H. DEPRECIATION
iii. Account receivable becoming worthless (1.) DEFINITION (1996 Bar)
in the hands of the purchaser — only
the amount which represents the Gradual diminution in the useful (service)
purchase price and not the face value of value of tangible property used in trade,
the note. profession or business resulting from exhaustion,
wear and tear, and obsolescence. It applies also
to the amortiza-
ÏV. Foreclosure of mortgages: tion of the value of intangible assets, the use of
which in trade or business is definitely limited in
iv.a. OnIy the difference between the
duration (Basilan Estates, Inc. v. Com., 21 SCRA
debt and the proceeds of the sale
17, 5 September 1967).
is generally deductible as bad
debts; Necessity of depreciation allowance ——
certain property used in the business gradually
iv.b. If no foreclosure occurs and the ap- proaches a point where its usefulness is
debtor surrenders the property to exhausted. By using the property, a gradual sale
the creditor — difference between is made of it, and the depreciation change is the
the basis of the debt and FMV of measure of the cost which has been sold (Ibid.).
the property is deductible (Section
(2.) REQUISITES FOR DEDUCTIBILITY:
103, Rev. Reg. No. 2).
v. If creditor buys the mortgaged property
and credits the debt with the purchase a.) The allowance for depreciation must be rea-
price even if such price is less than the sonable (Bacolod-Murcia Milling Co., Inc. v.
indebtedness — no deductible bad debt, Com., CTA Case No. 1402, 31 October
the security taking the place of the debt. 1969).
Depreciation is a question of fact and is
not
VÎÏ.
VÏi.
Debt measured by theoretical
partially yardstick. Reasona- bleness ofa
secured claim depends upon the
by a conditions known to exist at the
mortgag end of the period for which the
e is return is made (Section 109,
deducti Rev. Reg. No. 2). It must be in
ble only accordance with a reasonable
to the consistent plan.
extent
not
covered
by
mortgag
e.
A debt,
say for
P100,0
00,
compro
mised
for
P50,00
0.00 is
deducti
ble to
the
extent
132 eASIC APPROACH TO INCOME TAXATION
CHAPTER 6 133
The Tax Code, provides for the use of
the following methods of depreciation, viz: e.) Building and furnitures for personal
i. Straight line method; use; f.) lntangibles — use is unlimited;

ii. Declining balance method; g.) Personal effects and clothing.
iii. Sum of the years digit method; c.) Bodies of minerals subject to depletion;
iv. Any other method which may be pre- d.) Automobiles or transportation
scribed by the Secretary of Finance equipment for personal use
upon recommendation of the BIR (residence);
CommiSSiOn- er. The BIR and the
taxpayer may agree in writing on the
useful life of the property to be
depreciated. The agreed rate may be
modified if justified by facts or cirCUM-
stances. The change shall not be
effective before the taxable year on
which notice in writing by registered
mail or certified mail
is sent by the party initiating.
b.) lt must be for property used in trade or
business or profession (depreciable
assets).
Depreciable assets:
a.) Tangible property used in trade or business
— allowance;
b.) Intangible property like patent, copy rights and
franchises (Section 107, Rev. Reg. No. 2)
—
amortization.
Non-depreciabl e assets:
a.) Inventories or stock;
b.) Land and improvements;
Property kept in repair — subject to de-
preciation
Properties and costumes used exclusively in business
such as theatrical business, may be subject to
depreciation (Section 106, Rev. Reg. No. 2).
Rules on the depreciation of properties used in
petroleum operation:
(1.) Depreciation is allowed — straight line or declining
balance method at the option ofthe service contrac- ter;
(2.) Shift from declining to straight line is allowed;
(3.) Useful life of properties used — ten (10) years or
such shorter life as may be permitted by the BIR;
(4.) Properties not used indirectly in petroleum operation 5
years.
Depreciation deduction is not allowed:
(1.) Property amortized to its scrap value and no longer in
use (Section 108, ReV. Reg. No. 2);
(2.) Beyond the capital investment in the assets being
depreciated (Gutierrez v. Com., L 19587, 20 May
1965), otherwise some profit will be made. These
deductions are privileges not matter of right.
In the case of NRA and RFC — only properties
located in the Philippines.
In the case of property held by one person for life with
remainder to another person (usufruct or feidi-
commissary substitution — life tenant mav r:Iaim
CHAPTER 6 135
134 BASIC APPROACH TO INCOME TAXATION ALLOWABLE DEDUCTIONS FROM GROSS INCOME
(2.) Charged off within the taxable year.

the deduction as if he were the absolute owner of
the property. (3.) Allowance for depletion is computed in
Property held in trust — apportion between or accordance with the cost depletion method.
among the beneficiaries and trustees in accordance
Essential Factors:
with the trust instrument.
a.) Basis of the property;
1. DEPLETION
b.) Estimated total recoverable units in the
(1.) DEFINITION property;
It is the exhaustion of natural resources like c.) Number of units recovered during the taxable
mines and oil and gas wells as a result of a year.
production or severance from such mines or (4.) Depletion deductible:
wells (1965 CCH Fed. Tax Course, par. 1201).
a.) Domestic Corp. — oil, gas wells or mines lo-
(2.) THEORY AND PURPOSE OF DEPLETION AL- cated within and without;
LOWANCE as the product of the mine is sold, a
b.) Resident Corp. — gas wells and mines
gradual sale is being made of the taxpayer’s
located in the Philippines.
capital interest in the property. The purpose is,
then, to enable him to recover that capital interest (5.) May the taxpayer deduct exploration and
free of income tax at its cost or on some other development expenditures paid or incurred
basis. durinp the taxable year?
(3.) WHO ARE ENTITLED only persons having an YES. At taxpayer's option, he may deduct
economic interest in a mineral land or oil or gas exploration and development expenditures
wells. To acquire an economic interest, the (mines) provided that it shall not exceed 25% of
taxpayer must have a capital investment in the the taxable income from mining operations
property and not mere economic disadvantage. computed without the benefit of any tax
The taxpayer must have acquired at least, by incentives under existing laws.
investment, any interest in oil or gas, or mineral
NO. With respect to improvements of property
in place, and services, by any form of legal
subject to allowance for depreciation
relationship, income derived from the extraction
(expenditure) and those paid or incurred for the
of the oil, gas or mineral to which he must look for
exploration and development of oil and gas
a return of his capital (Gen. Cir. No. V-332, 6
January 1961).
Requisites for deduc assets
Depreciation
(1.) Depletible asset — natural resources mines,
gas and oil wells. Depreciable
v. Depletion Natural resources
J. CHARITABLE AND OTHER CONTRIBUTIONS the taxpayer of

(1.) KINDS:
(a.) Ordinary subject to
limitation; (b.) Special deductible
in full.
(2.) ENTITLED:
a.) Corporate taxpayer except NRFC 5% of the
Net Income before Charitable Contribution;
b.) Individual taxpayer except NRA-NETB
10% of the Net Income before Charitable
Contribu- tion.
(3.) REQUISITES FOR DEDUCTIBILITY
a.) Contribution or gift must be actually paid
during the taxable year.
Requirements/conditions (to be stated in the
return):
i. Name and address of organization;
ii. Approximate date and amount of the gift;
iii. If not in money, FMV of the gift;
iv. Signed by the responsible officer of the
corporation.
Question May the deduction of
contribution be allowed even in the
absence of supporting receipts?
Answer YES. Attachment of receipts for
contribution to the return is merely an admin-
istrative device for the convenience and
facility of the BIR in verifying the income tax
return and the requirement cannot deprive
his right to prove his contribution in accordance with
the rules of evidence (Ramirez v. Com., CTA Case No.
544, 14 September 1959).
b.) Must be given to the organization specified by Tax Code
or special law.
c.) The net income of the institution must not inure to the
benefit of any member or individual.
(4.) CONTRIBUTIONS DEDUCTIBLE IN FULL
a.) Donations to the government or political subdivision
including fully-owned government corporation to be
used exclusively in undertaking priority activities in:
i. education;
ii. health;
iii. youth and sports development;
iv. human settlement;
v. science and culture;
vi. economic development.
b.) Donations to international organizations or foreign
institutions in compliance with agree- ments or treaties.
c.) Donations to accredited non-go\/ernment organizations
(NGO).
i. Exclusively for:
a. scientific;
b. research;
c. character building;
d. youth and sports de\velopment;
BASIC AF‘PROACH TO INCOME CHAPTER 6 139
TAXATION
vi. rehabilitation of veteran;

e. health;
vii. social welfare.
f. social welfare;
g. cultural;
(6.) DEDUCTIBLE UNDER SPECIAL LAWS (IN
h. charitable;
FULL) a.) IBP (P.D. 1810)
i. any combination thereof.
b.) Development Academy of the Philippines
ii. Utilized not later than 15th day of the (P.D.
3rd month following the close of its 205)
taxable year.
c.) Agricultural Department of Southeast Asian
Administrative expense must not exceed Fisheries Development Center (P.D. 292)
30% of total expenses.
d.) National Social Action Council (P.D.
Upon dissolution, assets must be dis-
294) e.) Task Force on Human
tributed to another non-profit domestic
corporation or to the state. Settlement
f.) National Museum, Library & Archives (P.D.
(5.) CONTRIBUTION SUBJECT TO LIMITATION (5% 373)
or 10% of Net Income before Charitable Contri-
bution) g.) Ministry of Youth & Sports Development (P.D.
604)
a.) Not in accordance with priority plan.
h.) Social Welfare, Cultural & Charitable
b.) Conditions are not complied with. Institution (P.D. 507)
c.) Donation to the government of the Philippines i.) Museum of Philippine Costumes (P.D.
or political subdivision exclusive for public
purposes. 1388) j.) lntramuros Administration (P.D.
d.) Donations to domestic corporations organized 1616)
exclusively for: k.) Lungsod ng Kabataan (P.D. 1631)
i. religious”, • Contributions /o /n/emafiona/ Lions Club
ii. charitable; not Deductible (BIR Ruling, 16 July
1955).
iii. scientific;
iv. cultural; K. RESEARCH AND DEVELOPMENT EXPENDITURE
v. educational; (1.) IN GENERAL — A taxpayer may treat research
or development expenditures which are paid or
incurred by him during the taxable year in
connection with his trade, business or profession
as ordinary and necessary expenses which are
not chargeable to capital account. The
expenditures so treated shall
be allowed as deduction during the taxable year

when paid or incurred. (3.) There is no need of special permit from the
BIR to put up a pension plan for the benefit of
(2.) LIMITATIONS ON DEDUCTION — The following employees. However, the provision of Section
expenditures are not deductible: 118 of Rev. Rep. No. 2 must be complied with
a.) Any expenditure for the acquisition or (BIR Ruling, 26 July 1956).
improvement of land, or for the (4.) TREATMENT OF INCOME FROM PENSION
improvement of property to be used in PLAN
connection with research and
a.) Not taxable to the employee (BIR Ruling, 20
development of a character which is November 1956).
subject to depreciation; and
b.) In case any portion of the funds is reverted
b.) Any expenditure paid or incurred for the pur- back to the employer, said fund forms part
pose of ascertaining the existence, location, of the income of the employer during the
extent, or quality of any deposit of ore or taxable year of reversion (BIR Ruling, 3
other mineral, including oil or gas. April 1959).
L. EMPLOYER’S CONTRIBUTION TO PENSION TRUST (5.) DEDUCTIBLE PAYMENTS TO PENSION
TRUSTS
(1.) NATURE — applicable only to the employer on
account of its contribution to a private pension a.) Employer’s current Iiability —amount contrib-
plan for the benefit of its employee. Purely uted during the taxable year — ordinary and
business in character. necessary expenses.
b.) Employer’s Iiability for past services — one-
(2.) REQUISITES FOR DEDUCTIBILITY: tenth (1/10) of the reasonable amount paid
a.) Employer must have established a pension or by the employer to cover pension liability ap-
retirement plan for the payment of plicable to the preceding 10 years —
reasonable pension to its employees; payment to pension trust.
b.) Pension plan is reasonable and actuarially OPTIONAL STANDARD DEDUCTION (OSD)
sound (Section 118, Rev. Reg. No. 2); as amended by R.A. No. 9504
c.) Funded by the employer (employer a.) IndiVidual Taxpayers Entitled: Resident
contributes cash); Citizen (RC), Non-resident Citizen
d.) Amount contributed must no longer be subject (NRC), Resident Alien (RA).
to control of the employer; b.) Individual Taxpayers Not Entitled: Non-
e.) Payment has not yet been allowed as deduc- Resident alien whether engaged in trade
tion. or business (NRA ETB & NRA-NETB).
c.) Corporate Taxpayers Entitled: Domestic
Corporation (DC) and Resident Foreign
Corporation (RFC).
CHAPTER 6 143
d.) Limitation: 40% of: a.) Portion of the premium deposits returned
to the policy holders;
d.1) Gross income — DC and RFC
b.) Portion of the premium deposits retained for
d.2) Gross sales or receipts — RC,
payment of losses, expenses and
NRC, RA
reinsurance reserve.
e.) Option/Election. Taxpayer entitled must
signify his intention in his income tax (4.) Assessment insurance (domestic or foreign).
return which shall be irrevocable for the a.) Amount actually deposited with officers of the
taxable year for which the return is government of the Philippines pursuant to
made. (2009 Bar) law as addition to guarantee or reserve
funds.
SPECIAL DEDUCTIONS ALLOWED TO
INSURANCE COMPANIES ITEMS NOT DEDUCTIBLE
(1.) Non-life insurance (domestic or foreign doing (1.) Items not deductible:
business in the Philippine). a.) Personal, living or family expenses.
a.) Net additions, if any, required by law to be
Reason: Non-business expenses.
made within the year to reserve funds;
b.) Sums other than dividends paid within the b.) Amounts paid out for new buildings or for per-
year on policy and annuity contracts
manent improvements, or betterment made
to increase the value of any property or
provided that the released reserve be treated estate.
as income for the year released.
(2.) Mutual marine insurance companies (Gross Exception: Intangible drilling and
income from gross premiums less reinsurance): development cost incurred in petroleum
operations.
a.) Amounts repaid to policy holders on account
of premiums previously paid by them; Reason: Capital expenditure — that results
in obtaining benefits of a permanent nature
b.) Interest paid upon those amounts between
such as land, buildings, and machinery
the date of ascertainment and the date of (Encyclope- dia Dictionary of Business, p.
its payment.
127).
(3.) Mutual insurance (other than mutual marine and
mutual life) — mutual fire and mutual employer’s Examples of Capital Expenditures (Rev.
liability and mutual workmen*s compensation and Reg. No. 2):
mutual casualty insurance companies: i. Cost of defending or perfecting title to
property;
ii. Architects fee — part of the cost of building;
iii. Commissions paid in selling securities Reason/Purpose:

— part of the cost;
iv. Expenses of the administrator of the between related taxpayers.
estate Attorney’s fee and Executor’s
commission charge to the corpus of
the estate;
v. Corporate expenses for reorganization
such as incorporation fees, attorney*s
fee and accountant charge —amortize.
c)
Amount expended in restoring property or in
making good the exhaustion thereof for
which an allowance has been made.
Reason: Capital Expenditure
d.) Premiums paid on a life insurance policy cov-
ering the life of any officer or employee, or of
any person financially interested in any trade
or business carried on by the taxpayer,
individual or corporate, when the taxpayer is
directly or indirectly a beneficiary under such
policy.
i. Premiums paid by a family corporation
on the life insurance policy covering the
life of its president where the wife is the
beneficiary — Not deductible, corpora-
tion being indirectly beneficiary under the
policy (BIR Ruling, 1 0 November 1 960).
ii. Premiums paid by a corporation on life
insurance policies covering the lives of
two executives naming each other
beneficiary deductible because the
corporation is not directly and indirectly
the beneficiary of the policies (BIR
Ruling, 27 May 1953).
e) Losses from sales or exchanges of property
i. Members of the same Family — to pre-
vent avoidance of income tax by means of
purported or simulated sale or exchange.
Others —the law presumes that the transactions
are devoid of free bargain between the seller and
the buyer. It is immaterial whether the sale or
exchange is bonafide or not (Lake Irrigation Co.,
Inc. v. Com., 128F [2], 418).
CHAPTER 7
ESTATES AND TRUSTS 147
146
Chapter 7
ESTATES AND TRUSTS
A. ESTATE — refers to the mass of properties left by a

deceased person.
(1.) Taxable estate entity — estate under
administration or judicial settlement.
(2.) Hence, if not under judicial testamentary or
intestate proceedings, it is not taxable entity.
The income thereof is taxable directly to the heir
or beneficiary.
(3.) Subject to income tax in the same manner as
individuals. Its own status is dependent on
the status of the decedent immediately prior to
his death.
a.) Personal exemption — P20,000.00
i. If the taxpayer should die during the tax-
able year, his estate may still claim the
personal and additional exemptions for
himself.
Distribution to the heirs during the
taxable year is deductible from estate
income which distributed share would
then form part of the recipient heirs’
respective income. Where no such
distribution to the heirs is made during
the taxable year that the income is
earned, which is then subject to income
tax payment by the estate, the
subsequent distribution thereof
after tax, is no longer taxable on the part of its
recipient (BIR Ruling No. 233-86, 7 November
1986).
B. TRUST — right to the property, whether real or personal,
held by one person for the benefit of another
(1.) 7axa6/e trusts:
a.) Trust, the income of which is to be accumu-
lated;
b.) Trust, in which the fiduciary may, at his discre-
tion, either distribute or accumulate the income.
(2.) Rules on taxability:
a.) Taxable to the beneficiary — income of the trust for
the taxable year which is to be distributed to the
beneficiaries;
b.) Taxable to trustee or fiduciary — income of the trust
which is to be accumulated or held for future
distribution, whether consisting of ordinary income
or gain from sale of assets included in the “corpus”
of the estate (revocable trust).
Exceptions:
i. Revocable trust — taxable to grantor or
trustee;
ii. Income is held for the benefit of the grantor
— taxable to the grantor.
“The income of the trust shal! be included in comput-
ing the taxable income of the grantor where the power to
revest title to any part of the corpus of the trust is vested:
(1.) In the grantor, either alone or in conjunction with any
person not having a substantial adverse inter-
est in the disposition of the corpus or the income

therefrom; or
(2.) In any person not having a substantial adverse in- Chapter 8
terest in the disposition of the corpus or the
income therefrom." SPECIAL TOPICS IN INCOME TAXATION
C. COMPUTATION OF TAX ON ESTATE AND
TRUST (1.) Allowable deductions same as A. DETERMINATION OF SOURCE ACCORDING TO
KIND OF INCOME
individual.
Kinds of Income Source (Tax Situs)
(2.) Special deductions.
1.) Service or compensa- Place of performance of
a.) Personal exemption — P20,000.00. tion income service
b.) Amount of income which is to be 2.) Rent Location of property (real
distributed currently to the beneficiaries. or personal)
c.) Amount of income collected by a guardian of 3.) Royalties Place of use of intangibles
an infant which is to be held or distributed as (copyright, patent,
the court may direct. However, the amount design trade- mark,
so allowed as deduction shall be included in etc.) Place of sale
computing the net income of the heir, 4.) Merchandising
legatee or beneficiary. Place of sale
5.) Gain on sale of per-
Trust administered in foreign country — sonal property
deductions in (a) (b) and (c) are not Location of property
allowed. 6.) Gain on sale of real
property
Formula: Location of the mines
7) Mining income
Consolidated gross income — Pxxxx Place of farming activities
8.) Farming income
Less: Consolidated deduction — xxxx Income within the Philip-
9.) Gain on sale of pines
Consolidated net income Pxxxx domestic stock
Residence of the debtor
Less: Personal exemption P20,000 — xxxx 10.) Interest
Taxable income of several trusts Pxxxx
Apply 5-32% (year 2000)
Tax due Pxxxx 149
CHAPTER 8 151
SPECIAL TOPICS IN INCOME
TAXATION
Tax situs of three possible sources of income

interest paid even in Tokyo by NDC to the ship
Income from labor (services) — the place where
builders is considered as income from the Philippines
the labor is done;
(NDC v. Com., 151 SCRA 472).
Income from capital — the place where the capital (11.) Gain on sale of transport document — Place of
is employed; activity that produces income
Income from the sale of capital assets — the The source of an income is the property,
place where the sale is made. activity or service that produced the income. For
to be considered as coming from the
[8 Mertens, Law of Federal lncome Taxation, Sec- the income
tion 45.27 (1957)] Philippines, it is sufficient that the income is
derived from activity within the Philippines. In
Settled Case on the Tax Situs of Interest Income Commissioner v. BOAC, 149 SCRA 395, the sale
(1989 Bar) of tickets in the Philippines
is the activity that produced the income. The
tickets
exchanged hands here and payments for fares
FACTS: National Development Corporation (NDC) income from the Philippines. The law does
entered into contracts in Tokyo with Japanese not speak of the activity which gave rise to
building companies for the construction of 12 ocean- the obligation, but solely of the residence of
going vessels. Initial payments were in cash and the obligor. NDC is undoubtedly resident of
irrevocable letters of credit. The balance was secured the Philippines. Hence,
by promissory notes guaranteed by the Republic of
the Philippines. The vessels were completed and
delivered to the NDC in Tokyo. The promissory notes
and interest therein were paid by NDC.
ISSUE: Is interest on the promissory notes to be
treated income from the Philippines considering that
all the elements of the main transaction, i.e.,
construction and delivery of Vessels, were all
performed in Japan?
HELD: The interest is considered income from the
Phil- ippines. According to Section 36 [now Section
42A(1)] of the NIRC as amended, xxx interest on
bonds or other interest bearing obligations of
residents, corporate or otherwise, is considered
were also made here in the Philippine currency. The flow
of wealth proceeded from and, occurred within Philippine
territory, enjoying the protection accorded by the Philippine
government. In consideration of such protection, the flow of
wealth should share the burden of supporting the
government.
The absence of flight operations to and from the
Philippines is not determinative ofthe source of income or
the Situs of income taxation. Admittedly, BOAC was an
off-line international airline at the time pertinent to thÏS
case. The test of taxability is the “source” and the source of
an income is that activity (sale of airline tickets) which
U
produced the income. nfortunately, the passage
documents were sold in the Philippines and the revenue
therefrom was derived from a business activity regularly
pursued within the Philippines xxx. The word “source” con-
veys one essential idea, that of origin, and the origin
of the income herein is the Philippines (Ibid.).
However, Rev. Reg. No. 15-2002, implement- ing
Section 28A(3), provides that in computing for
CHAPTER 8 153
“Gross Philippine Billings,” there shall be TAXATION
included the total amount of gross revenue
derived from c.) Foreign corporation
passage of persons, excess baggage, cargo If for the 3-year period preceding the
and/or mail, originating from the Philippines in a declaration of such dividend, the ratio of such
continuous and uninterrupted flight, irrespective corporation's Philippine income to the world
of the place of sale or issue and the place of (total) income was:
payment of the passage documents. (2005 a) Less than 50% — Entirely without
Bar)
b) 50% tO 85% — Proportionate
(12.) Manufacturing
c) More than 850/ — Entirely within (Phil.)
a.) Produced in whole within and sold within —
lncome purely within FORMULA (PROPORTIONATE — 50% TO 85%)
Phil. Gross lncome
b.) Produced in whole without and sold without X Dividend received = Income
— Income purely without
c.) Produced within and sold without Income Entire Gross within (Phil.)
lncome
partly within and Income partly without (13.) Dividend income
d.) Produced without and sold within Income from:
partly within and Income partly without
a.) Domestic corporation — Income within (Phil.)
From the income partly within and partly
without, income purely within is derived as
follows:
Net Income x Value of property within

Pxxxx
2 Value of property
within and
without
Add:
Net Income x Gross sales within
Pxxxx
2 Gross sales within
and without
Income purely within =
B. CAPITAL TRANSACTIONS (2003, 1998 Bar)
(1.) Definition of Capital asset. The NIRC (Section
39)
defines capital assets by exclusion. There is no
concrète definition. The term “capital asset” means
property held by the taxpayer (whether or not con-
nected with his trade or business), but does not
include the following (thèse are ordinary assets).
a.) Stock in trade of the taxpayer or otherproperty
of a kind which would properly be included in
the inventory if on hand at the close of the
taxable year (raw materials, work in process,
finished goods, supplies);
b.) Property held by the taxpayer primarily for sale
to customers in the ordinary course of trade
or business.
Requisites:
i. Property must be held primarily for sale.
ii. Property must be held for sale to custom-
ers.
CHAPTER 8 155
SPECIAL TOPICS IN INCOME TAXATION
• A sale by dealer in securities is an

• Account receivable;
ordinary transaction (BIR Ruling, 27
February 1954). • Securities held as
investments;
iii. Property must be sold in fhe ordinary
• Goodwill.
course of taxpayer’s trade or business. Reason: Not included in the four
• Trade of business — that which oc- catego- ries of ordinary assets.
cupies the time, attention, and labor ii. Sale of a business to a corporation Or-
cf men for the purpose of livelihood dinary and capital assets. Consider the
or profit (Flint v. Storne Tracy assets involved in the sale.
Company, 220 U.S. 107, 31 S. Ct.
342, 55 L. Ed. 389; Kackler v.
iii. Sale of partner’s interest in a
Commissioner, 133F [2d] 509). partnership capital asset.
• “Ordinary course“ indicates signifi- Reason: Not included in the category of
cance of the transaction and, there- ordinary assets
fore, excluded are those sales iV. Car used in trade or business and for
which are effected by the taxpayer personal purpose —
merely incidentally or accidentally • One half of the value — ordinary
to his business. Hence, isolated asset used in business.
transactions would not be in the
ordinary course of trade of business • One half of the value — capital asset
(Alfonso Zobel vs. Com., CTA Case — not used in business.
No. 622, 29 April
1961)
(2) The statutory definition of capital assets is
c.) Property used in trade or business of a char- negative in nature. If the asset is not among the
acter vrh/ch is subject to the allowance for exceptions, it is a capital asset; conversely,
depreciation. assets falling within the exceptions are ordinary
i. Depreciable personal properties such as assets. And necessarily, any gain resulting from
furnitures, equipment, and machineries the sale or exchange of an asset is a capital gain
used in trade or business. or an ordinary gain depending on the kind of
asset involved in the transaction.
d.) Rea/ property used in trade or business of the
taxpayer. However, there is no rigid rule or fixed
formula by which it can be determined with
i. Properties used or connected with trade finality whether property sold by a taxpayer was
or business which are considered held primarily for sale to customers in the
capital assets:
ordinary course of his trade or business or whether it
was sold as a capital as-
CHAPTER 8 157
TAXATION
set. Although severaf factors oF indices have d.) If conducted throu gh a supervision over the
been recognized as helpful guides in making a agent;
determination, none of thèse is decisive;
neither is the presence nor the absence of e.) Extent and nature of the taxpayer’s efforts
thèse factors conclusive. Each case must in the to sell (Smith v. Dunn, 224 F. [2d] 353, 47
last analysis rest upon its own peculiar facts A.F.T.R 1419; Tuazon v. Lingad, 58 SCRA
and circumstances. [Calasanz v. CIR, 144 170; Blake
SCRA 664, 669-670 (1986)] v. Ravanagh, 107 R. 179).
(5.) Guidelines in determining whether a
Also a property initially c\assified as a
capital asset may thereafter be treated as an particular real property is a capital asset or
ordinary asset if a combination of the factors ordinary asset (Rev. Reg. No. 7-2003).
indubitably tend to show that the activity was in a.) Taxpayers engaged in I/ie real estate busi-
furtherance of or in the course of the taxpayer’s ness. — Real property shall be classified
trade or business. Thus, a sale of inherited real with respect to taxpayers engaged in the real
property usually gives capital gain or loss even estate business as follows:
though the property has to be subdivided or
improved or both to make it salable. However, if i. Rea/ Estate Dealer. — All real properties
the inherited property is substantially improved acquired by the real estate dealer shall
be considered as ordinary assets.
or very activefy sold or both it may be treated
as held primarily for sale to customers in the Rea/ Estate Developer. — AII real
ordinary course of the heir’s business. [34 Am properties acquiFed by the real estate
Jur 2d., p. 92] developer, whether developed or
(3.) Construction and interpretation of capital assets undeveloped as of the time of
— The general rule ! as been laid down that the acquisition, and all real properties
which are held by the real estate
codal definition of a capital asset must be
developer primarily for sale or for lease
narrowly construed while the exclusions from
such definitions must be interpreted broadly to customers in the ordinary course of
(Tuazon v. Lingad, 58 SCRA 176). his trade or business or which would
properly be included in the inventory of
(4.) Factors/tests determinative of capital or ordinari the taxpayer if on hand at the close of
asset: the taxable year and all real properties
a.) Nature and character of the taxpayer’s title used in the trade or business, whether
in the form of land, building, or other
to the property;
improvements,
shall be considered as ordinary assets.
b.) Reason, purpose and interest of r equisition, as
well as its period of duration; ¡¡¡
Real Estate Lessor. — AII real
c.) Taxpayer's vocation, extent of activities; properties ofthe real estate lessor,
whether land and/ or improvements,
which are for lease/rent
158 BASIC APPROACH TO INCOIVIE TAXATION
CHAPTER 8
SPECIAL TOPICS IN INCOME 159
TAXATION
or being offered for lease/rent, or other-
wise for use or being used in the trade nally registered to be engaged in the real
business, a// real properties
or business shall likewise be considered estate ol“tginaÍly
as ordinary assets. acquired by it shall continue to be treated as
ordinary assets.
iv. Taxpayers habitually engaged in fhe Treatment ofabandonecf and idfe real
e.)
real estate business. — All real proper- rop-
erties.
ties acquired in the course of trade or part
of the
business by a taxpayer habitually taxpayer engaged in
engaged in the sale of real estate shall
be considered as ordinary assets.
b.) Taxpayer not engae e iFt the real esfafe Which a I estate business,
dnsiness. — In the case of a taxpayer not were later on bandoned and became
ídle,
engaged in the real estate business, real Shall continue to be treated as
properties, whether land, building, or other ordinary assets.
improvements, which are used or being used f.) Treatment of rea/property subject of invol-
or have been previously used in the trade or unta transfer. In the case of involuntari
business of the taxpayer shall be considered fFansfers of properties, inc/uding
as ordinary assets. or foreclo sure sale, the
expropriation
c) Taxpayer changing business from rea/ es- inVoluntariness of such safe shalI have no
tale business to non-real esfafe business. effect on the classifiCàtion of such real
— In the case of a taxpayer who changed its property in the hands of the invo/- untary
real estate business to a non-real estate seller, either as capital
asset, aS the case mayasset or ordinary
busi- be.
ness, or who amended its Articles of Incorpora- Rules on capital gains and /osses. Two
tion from a real estate business to a non-real conditions must concur: a) There
MUSt be a
estate business, such as a holding company, sale or exchange, and b) what is
SOld or ex-
manufacturing company, trading company, change is à C£IpitaI asset.
etc., the change of business or amendment
of the primary purpose of the business shall (6.j Special Rules on Capital T
ransactio ns
not result in the re-classification of real
property held by it from ordinary asset to INDIVIDUAL CORPORATE
capital asset. a.) HOLDING PERIOD / x
d.) Taxpayers originally registered to de en- RULE
gaged in the reat estate Business but failed to snóseqoent/y oj
Perate. — In the case of subsequent non- b.) LOSS L/MiTATlON / except
operation by taxpayers origi- RULE tFUSt company
and bank
CHAPTER 8 161
160 BASIC APPROACH TO INCOIVIE SPECIAL TOPICS IN INCOME
TAXATION TAXATION
d.) Ordinary loss is deductible from capital

c.) NET CAPITAL LOSS gain. Net capital gain — excess of capital
/ CARRY OVER gain over capital loss.
Percentage of gain or loss recognized Net capital loss — excess of capital loss o'ver
capital gain.
1000/ if the asset was held for not more than 12
months
months
50% if the asset was held for more than 12
Holding period — the length of time the asset
was held by the taxpayer. It covers the period
from the
date of acquisition of the assets to the
date of sale.
!n computing the period, the day on which the
property was acquired is excluded, the day on
which it was disposed of is included (1955 PH
Fed. Tax
Course, Par. 1604).
“ Loss limitation rule — capital losses are allowed
only to the extent of capital gains. Therefore,
capital losses are not deductible from ordinary
Reason: To ensure the matching of costs
gains.
against revenues consistent with the rule that only
business expenses are deductible from gross
income. Capital loss is not a business expense
(2003 Bar).
Seft/ed rules:
a.) Ordinary loss is deductible from ordinary
gain;
b.) Capital loss is deductible from capital
gain; capital loss is not deductible from
c.)
ordinary
gain;
”“ Net capital loss (carry over) — shall be treated in
the succeeding taxable year as loss from the sale
or exchange of capita! asset held for not more
than 12 months.
Limitation — not in excess of the taxable (net)
income in the preceding year or the lower amount
between the net income and the capital loss.
• The foregoing rules are not applicable to sale
of shares of stock & real property.
(7) Special capital transactions
a.) Short sale. A transaction in which a speculator
sells securities which he does not own in an-
ticipation of a decline in its price. It represents
a debt contracted in goods rather than cash.
Should the price of the securities decline, the
seller makes profit. If the price goes up, he
incurs the loss
b.) Securities becoming worthless.
Requisites:
i. Ascertained to be worthless and charged off
within the taxable year;
ii. Worthlessness occurred during the tax-
able year;
iii. Deductible on the last day of the taxable
year.
• If the loss is due to fluctuation of price
in market, the loss is not deductible
until finally disposed of.
c.) Failure to exercise privileges or option to buy or
sell property. A sale of the option itself under
allowable covenants would constitute
CFIAPTER 8
SPECIAL TOPJCS IN INCOME TAXATION
sale or exchange of a capital assets. In fine,
the law considers an option or privilege as the Amount received from corp. xxx
—
P
capital asset itself and the failure to exercise Less: Cost of shares surrendere d
xxx
the same as transaction. If the option is not Capital gain or loss I
exercised, it is deemed to have been sold or X X
exchanged as of the day the option expires. g.) An equity investment iS a Capital, not ordina
d.) Retirement of bonds. Amounts received by asset of the investor the sale or exchan
ge
the holder upon retirement of bonds, deben- of
Which results in either a capital gain
or a
capital Bankin g Co
tures, notes or certificates or other evidence BOSS (China rporation v. CA, 236
of indebtedness issued by any corporation SCRA 178, 181).
(including those issued by a government or (8.) Expense s of acquisitio n
political subdivision thereof) with interest and diS {gosition of
Cä@itaÏ assets
cou-
pons or in registered form, shall be a.) ExpenSes OU aCC|uisi(ion (purchase)
considered as amounts received in should be
Capitalized together with the cost of
exchange therefrom. acqUiSition;
b.) Expenses of disposition (sale) such as com-
e) Readjustment of interest in a tax-exempt /TliSSion and other selling expenses
partnership (Section 142, Rev. Reg. No. 2). considere d as reduction from th ShOUld
be eseWng
Where a partner retires from a tax-exempt prite.
(9.) Exemption of capital gain from
partnership, or the partnership is dissolved,
the partner
realizes gain or suffers a loss determined as income tax —tax
avoidance (both indiVidual and corporation)
follows:
for
a.} Under the Investment lncentives Act,
tal gain realized from the sale the capi-
Price received for his interest of Capita| asset
in the — P xxx shall be exempt from income tax under the
partnership
Less: Cost of interest following conditions:
partnership Investment in new issues of Capital stock
Pxxx i.
Add: Share in any undistributed Of BOI registered enterprise within six

partnership net income since months from the date the ga ns were
becoming partner xxx ized; re
Capital gain or loss ii.
Sale and investmen t of the proceed s
should be registered with the BOI and
BIR.
f.) Receipt of liquidating dividend. If the stock was iii.
Investme nt must not be disposed of:
held as a capital asset, gain or loss is deter- • 3 years — pioneer industry;
mined as follows:
• 5 years — non-pioneer industry.
CHAPTER 9 165
INCOME TAX RULES ON DEALINGS IN
PROPERTY
• Principal residence shall refer to the

dwelling house, including the land on
which it is situated, where the husband
Chapter 9 and wife or an unmarried individual,
INCOME TAX RULES ON DEALINGS whether or not qualified as head of
family, and members of his family
IN PROPERTY reside. Actual occupancy of such
principal residence shall not be
considered interrupted or abandoned by
A. CAPITAL GAINS FROM SALE OR OTHER reason of the individual’s temporary
DISPOSI- TION OF REAL PROPERTY absence therefrom due to travel or
studies or work abroad or such other
TRANSACT!ONCOVERED similar circumstances. Such principal
Sale, exchange or other disposition of real residence must be characterized by per-
property located in the Philippines classified as capital
manency in that it must be the dwelling
assets,
including pacto de refro sales and other forms house to which, whenever absent, the
of con-
said individual intends to return (Rev.
ditional sales. Reg. No. 13-99).
(1.) INDlViouAr vAxPAYERS (Section 24[D]) ii. BIR should be notified of the intention
a.) Final tax rate: 6% to avail of the exemption within thirty
Gross Selling Price or zonal value (30) days from the date of sale or
b.) Basis:
(cur- disposition;
rent fair market value), whiGhever is
higher.
iii. Acquisition or construction of new
e.) Taxpayer covered: Citizen or resident alien. principal residence must be made within
eighteen
(18) months from the date of sale or
d.) Option: Apply the tax rates under Section 24(A) disposition;
— 5% to 32% if thG buyer is the government
or any of its political subdivisions or agencies iv. The tax exemption can only be availed
Or government-owne d or -cOntrolled of once every ten (10) years;
corporations.
e.) Payment: Thirty (30) days after the v. The buyer/transferee must withhold from
the seller and deduct from the selling
sale. f.) Tax aVOidance scheme:
price the 6% capital gains tax which
i. The proceeds of the sale must be fully must be deposited in cash or manager's
check with
utilized in acquiring or constructing a new an Authorized Agent Bank (AAB) under
principal residence; an ESCROW Agreement between the
Rev- enue District Officer, the seller,
164 transferee and the AAB.
INCOME TAX RULES ON DEALINGS IN PROPERTY
Definition of ESCROW Agreement — refers to Answer:

a scroll, writing or deed, delivered by the is included in gross income derived from
grantor, promisor or obligor into the hands of a dealings in property?
third person, to be held by the latter until the
happening of a contingency or performance of
a condition, and then by him deliVered to the
grantee, promisee or obligee (Rev. Reg. No.
17-2003).
vi. After depositing the 60/o capital gains tax, the
buyer/ transferee and the seller shall jointly file,
within 30 days from the date of the sale or
disposition of the principal residence, the Final
Capital Gains Tax Return (Ibid.).
(2.) CORPORATE TAXPAYERS
a.) Only domestic corporation is subject to 6%
of the gross selling price or zonal value
(fair market value) whichever is higher
(Section 27[D] [5]).
b.) Real property: lands and/or buildings which
are not actually used in the business.
c.) Payment: thirty (30) days following the sale
or disposition.
GAINS AND LOSSES FROM

DEALINGS IN PROPERTY
A. CONCEPT
Include all gains or losses derived from the
disposition of property (real, personal or mixed) for
MONEY in case of SALE, or for PROPERTY in
case of EXCHANGE, or from a combination of both
sale and exchange.
• Under the legal definition of gross income, what
• It includes all income derived from the
disposition of property whether real or
personal, or mixed, for money (sale) or for other
property (exchange) or for a combination of
both, which results in gain (loss) because of
the difference between the taxpayer’s
investment in what the disposed of and the
value in what he received (1955 PH Fed.
Handbook, par. 1401).
B. MEASURE OF INCOME OR LOSS
Selling Price P xxx
Less: Cost xxx
Gain (loss) P xxx
Two conditions:
(1.) The property received in exchange is
essentially different from the property
disposed of;
(2.) The property received has a market value
(Section 140, Rev. Reg. No. 2).
C. ADJUSTED BASIS OR COST OF THE

PROPERTY SOLD. It depends primarily on the
manner in which the taxpayer acquired the
property.
(1.) By purchase:
a.) acquired before 1 March 1913— FMV on
such date;
b.) acquired on or after 1 March 1913 — Cost
plus expenses of acquisition (Section 136,
Rev. Reg. No. 2).
(2.) Included in the inventory — its latest inventory
value (Section 36, Rev. Reg. No. 2).
TAXATION INCOME TAX RULES ON DEALINGS IN PROPERTY
(3.) By devise, bequest or inheritance — FMV or The same basis as it would be in the
value of such property at the time of the hands of transferor increased by the amount of
acquisition — death of the decedent (Section the gain recognized to the transferor on the
139, Rev. Reg. No. 2). transfer.
D. SETTLED RULES ON SALE OR EXCHANGE
(4.) By gift the same basis as if it would be in the (8.) Property transferred in the hands of the
hands of the donor or the last preceding owner transferee if exchange is one where the
by whom it was acquired by gift, except that if gain, if any, but not the loss is to be
such basis is greater than the fair market value recognized.
of the
property at the time of the gift, then for the
purpose of determining the loss, the basis shall
be such fair market value.
(5) Acquired (other than capital assets) for less
than an adequate consideration in money or
money’s
worth —amount paid by the transferee.
(6.) Stock or security property received if the
exchange is one where gain or loss may be
recognized — The same as the basis of the
stock, or security or property given in
exchange.
(7.) Stock or security received if the exchange is
one where the gain, if any, but not the loss is
to be
recognized
Basis of the property, stock or security given in
exchange
Less: Cash and FMV of property given in ex-
change
Add: Dividend and/or gain recognized
Basis of stock or security received
(1.) Distribution in complete liquidation has been held to be
an “exchange” for the purpose of determining whether or
not gain or loss has been realized or sustained within
the provisions pertinent (Helvering
v. Chester N. Weaver Co., 305 U.S. 293).
(2.) Conveyance of property in consideration of the
transferee's assumption of accrued taxes for which
the transferor was personally liable, as a compromise
of the tax liability on other realty, has been construed
to be a sale or exchange within the meaning of the
law (Philipps v. Com., 112 F [2d] 721; C.L. Gransder
& Co. v. Com., 117 [2d] 80).
(3.) The words “sales or exchanges” have been inter-
preted quite liberally. Thus, forced sales such as
foreclosure sales and tax sale, have been held to be
embraced within the meaning of the law (Helvering v.
Hommel, 311 U.S. 504).
(4.) A sale or exchange will ordinarily be held to occur on the
date the transfer of title over the asset is effected or
when ownership is terminated in the hands of the
transferor. In other words, it is the consummation
thereof not the perfection of the contract that is
generally taken into account (American Fork & Hoe Co.,
T.C. Memo Op. Dkt. 108334, 22 September 1943;
U.S. Industrial Alcohol Co. v. Helvering, 137 F. [2d]
511).
(5.) In condemnation proceedings, the sale occurs at the time
of taking of the property rather than when the
170 BASIC APPROACH TO INCOME TAXATION SoHo i I-U u 1/1
INCOME TAX RULES ON DEALINGS IN PROPERTY
proceeds of the judgment are received • The term merger or

(Kieselback v. Com., 317 U.S. 399, 87 L. Ed. 3ñ8, consolidation shall be
63 S. Ct. understood to mean: i.) The
303). It is essential that the right of condemnation ordinary merger or
be legally recognized. consolidation, or ii.) the
E. TAX-EXEMPT SALES OR EXCHANGES “NO GAIN,

NO LOSS RECOGNIZED” (Section 40(C)[2]) Ex-
ceptions to the rule that the entire amount of gain or
loss shall be recognized:
(1.) Between corporation which are parties to the
merger or consolidation (PROPERTY FOR
STOCK).
— A corporation which is a party to a merger or
consolidation exchanges property solely for
stock in a corporation which is a party to the
merger or consolidation.
(2.) Between a stockholder of a corporation party to a
merger or consolidation and the other party
corporation (STOCK FOR STOCK).
— A shareholder exchanges stock in a
corporation which is a party to the merger or
consolidation, solely for the stock of another
corporation also a party to the merger or
consolidation.
(3.) Between a security holder of a corporation party
to the merger or consolidation and the other
corporation (SECURITIES FOR SECURITIES OR
STOCK).
— A security holder of a corporation which is a
party to the merger or consolidation
exchanges his securities in such corporation
solely for stock or securities in another
corporation, a party to the merger or
consolidation.
acquisition by one corporation of all or
substantially all the properties of another
corporation solely for stock.
(4.) Transfer or exchange of property for stock resulting in
acquisition of corporate control (PROPERTY FOR
STOCK).
— No gain or loss shall be recognized if property is
transferred to a corporation by a person in exchange
for stock in such corporation of which as a result of
such exchange said person, alone or together with
other, not exceeding fourper- sons, gains control of
said corporation. Stocks issued for services shall not
be considered as issued in return of property.
However, the BIR ruled that the law would apply even
when the exchangor or exchangors already had control
of the corporation at the time of the exchange (BIR
Rulings Nos. 04987, 27 February 1987;
06087, 9 March 19987; 09887, 6 April 1987).
• The term control shall mean ownership of stocks
in a corporation possessing at least fifty-one
percent (51%) of the total voting power of all
classes of stocks entitled to vote.
In the foregoing cases, if the taxpayer receives
stocks (or securities) and, as a part of the
consideration, another party to the exchange
assumes a Iiability of the taxpayer, or acquires
from the taxpayer property subject to a Iiability,
then such assumption or acquisition shall not be
treated as money/or property, and it shall not
prevent the exchange from being exempt.
F. "GAtN RECOGNIZED, LOSS NOT RECOGNIZED

RULE" APPLIES TO THE FOLLOWING TRANSAC-
TIONS:
Transactions not solely in kind (Exchanged of prop- Chapter 10
erty, stocks or securities plus cash or money);
TAXPAYERS REQUIRED TO FILE INCOME
(2.) Illegal transactions (2001 BaF);
TAX RETURNS
(3.) Transaction between related taxpayers:
a.) Members of a family;
A. INDIVIDUALS
b.) Gorporation and individual — Individual (1.) Resident citizens receiving income from sources
owned more than fifty percent (50%) of the within or outside the Philippines:
outstand-
a.) Individuals deriving compensation income
c) ing capital stock of the corporation; from 2 or more employers, concurrently or
Two (2) corporations — more than fifty percent succes- sively at anytime during the taxable
(50%) of the outstanding capital stock is owned year;
by the same individual; b.) Employees deriving compensation income
d.) Parties to a trust trustor, trustee, beneficiary regardless of the amount, whether from a
and fiduciary’. single or several employers during the
(4. wash sale transaction (61-day sale). calendar year, the income tax of which has
not been withheld correctly (i.e., tax due is
• Purchase of substantially identical stock or
not equal to the tax withheld) resulting to
securities beginning thirty (30) days before
collectible or refundable return;
the date of sale and ending thirty (30) days
thereafter. Employees whose monthly gross compensa-
• Seller must not be a dealer in securities or tion income does not exceed P5,000 or the
stock. statutory minimum wage, whichever is
higher, and opted for non-withholding of tax
• It covers acquisition through a taxable ex- on said income;
change and the making of an option
contract. d.) Individuals deriving other non-business, non-
professional related income in addition to
compensation income not otherwise subject
to a final tax;
173

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JUSTICE

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(4.) Contributions deductible in full................... 137 Chapter 9

I. INDIVIDUAL INCOME TAXATION

II. CORPORATE INCOME TAXATION C. Final Withholding Tax System

III. COMMON FEATURES

• it cannot be determined by reckoning cash receipts;

Under the Tax Code, however, income derived

within, Philippine territory, enjoying the dez v. Commissioner of Internal Revenue,

F. DOCTRINES ON DETERMINATION OF TAXABLE

A. GENERAL STATUTORY DEFINITION FORMULA: GROSS INCOME; NET INCOME; TAXABLE

GROSS INCOME TAXATION AND NET INCOME

by reason of death (El Oriente v. Posadas, 56

able if it representa a return of capital or

• Separation benefits paid to retrenched

his connection with his employees and

a.) Income received by foreign governments from

Prizes and awards under the following condi- tions

Charity Sweepstakes Office (R.A.

a.) He must be a resident not mere transient or

’ Gains derived from dealings in property

C. REQUISITES FOR TAXABILITY

eficiary designated is the family,

not partake the nature of a personal

Who should pay the FBT? (2003 Bar)

The FBT is collected from the employer even

y"Rank-and-file employees” mean all

ALLOWABLE DEDUCTIONS FROM GROSS COM-

• In the case of legally separated spouse, Series of 1961. However, Section 35

e.g., taxpayer may be away on business or to

b.) Amount allowed: P2,400.00 per annum or

! of service shops, brokers, agents and others

Income derived by professionals from the prac- tice of

Security deposit — not taxable. are nothing but an

Case Authorized Issued & Stock Taxable/Not

I Common Common Common Not Taxable

a.) It is an income subject to final withholding tax

Acquisition and disposition of capital stock

Special domestic corporations:

canteen, cafeteria, dormitory and book-

Special Resident Foreign Corporations:

ing from the Philippines in a continuous and

language to do so; but the legislature did not. Thus, the

Purpose o/'MC/r (2001 Bar)

MCIT is not an ar/cfitiona/ fax fo the regular or

Coverage of the lviciT (2001 Bar)

The period of reckoning the start of its business operations

“Legitimate business reverses” shall include

services required by the customers and clients including:

The final comparison between the normal

2000 2001 2002

The taxpayer is required to pay the MCIT

IMPROPERLYACCUMULATED EARNINGS TAX (Sec-

(1.) Rafiona/e of improper/y accomo/afed earnings

able capital expenditure as approved by the Board of

(6-) What are closely-held corporations?

(7.) Corporations not subject to IAET:

• Investment of substantial earnings and profits of

ii. A ratio of forty percent (40%) of income