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T AXATION

I NCOME T AX

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GENERAL PRINCIPLESTaxation . An incidental and destructive power of the State, unlimited in itsrange, by which the sovereign raises revenue to defray government expensesby way of apportionment to those privileged to enjoy its benefits.Principles of a sound tax system

Fiscal adequacy. Sources should be sufficient to meet demand for

public expenditures Theoretical justice. Tax burden should be in proportion to taxpayers ability to pay

Administrative feasibility. Tax laws should be capable ofconvenient, just and effective implementation

Doctrine of Imprescriptibility of tax laws. In absence of a specific provision,tax laws shall not prescribe. They shall only be repealed by subsequent lawsStatute of limitations. Assessment of tax liability prescribes 3 years from thedate of filing of the return or from expiry of period prescribed to file such.Doctrine of equitable recoupment. Refers to a case where taxpayer hasclaim for refund but fails to file claim due to prescription. Taxpayer is allowedto credit refund to existing tax liability. Not allowed in the Philippines due tolifeblood theory.Doctrine of set-off. Applies when government and taxpayer are mutualcreditors and debtors of one another. Not allowed in the Philippines due tothe different nature of taxes and debts, and public policy is better served. Direct tax . Demanded from person intended to pay the tax.Indirect tax . Demanded from one person with the expectation that he canshift the burden to someone else.Final withholding tax . Constitutes final settlement of tax liability.Expanded withholding tax . Constitutes advance payment of tax liability.Nature of taxation

Necessary attribute of sovereignty Legislative in character. Power to:

o Determine Nature Object Extent Coverage Apportionment Situs

Methodo Grant exemptionso Provide remedies

Cannot be delegated. Except:o To local legislative bodieso To the Presidento When only in respect to administration or

implementation Subject to constitutional and inherent limitations

Stages of taxation (LAP)1. Levy. Enactment of law by Congress2. Assessment and collection. Implementation of the law3. Payment. Compliance by the taxpayer

THEORIES BEHIND TAXATIONLifeblood theory . The existence of the government is a necessity; it cannotexist without a means to pay its expenses; and for those means, the

government has the right to compel those under its jurisdiction to contributein the form of taxes.Benefits-protection theory . Every person who is able must contribute hisshare to the running of the government. For its part, the government is alsoexpected to respond in the form of tangible and intangible benefits.Expresses the symbiotic relationship between the taxpayer and government.Characteristics of taxes (PIPFALL)

Payable in money Imposed by the State with the principle of territoriality Personal to the taxpayer Forced charge Assessed in accordance with the rule of apportionment Levied by legislature Levied for public purpose

Purpose of taxation (R3PEP) Revenue Regulation Reduction of social inequality Promotion of general welfare Encourage economic growth through incentives and exemptions

ProtectionismGeneral rule : The Constitution does not prohibit double taxationExcept : When it amounts to direct duplicate taxation ; when both taxes areimposed: (JAPPSC)

Within the same jurisdiction By the same authority For the same purposes During the same period On the same subject matter Of the same kind or character

Usual methods to avoiding double taxation: Reciprocal exemption by law or treaty Allowing tax credit for foreign taxes Allowing deduction for foreign taxes Reduction of local tax rate

Tax pyramiding . Imposing a tax on a tax.Tax exemptions . A grant of immunity to particular persons from a tax uponproperty or excise, which they are generally obliged to pay. They aregenerally construed against the claimant since they are, in essence, aderogation of sovereignty.Tax laws . Statutes levying taxes are construed strictly against thegovernment, because burdens are not imposed, nor presumed to beimposed beyond what the statutes clearly import. Construction of a statuteby those administering it is not binding is not binding on their successors.Tax avoidance . Tax saving device within the means sanctioned by law, usedby the taxpayer in good faith and at arms length.Tax evasion . Scheme used outside of those lawful means, which subjects thetaxpayer to civil or criminal liability. Elements: (UBI)

Unlawful act or omission Bad faith Intent to pay less than what he legally owes

LIMITATIONSInherent . Those which exist despite the absence of an express provision ofthe Constitution. (PITED)

Must be for a public purpose at inception International comity Territorial jurisdiction Exemption of government entities (except GOCC) Cannot be delegated. Except:

o To local legislative bodieso To the Presidento When only in respect to implementation

Constitutional Due process clause

o Substantive due process. Statute free from ambiguityo Procedural due process. Notice and hearing

Equal protection clause. Subject to reasonable classification:o Substantial distinctiono Germane to the purpose of the lawo Not limited to existing conditionso Apply equally to all members of such class

Uniform and equitable. All taxable articles of the same class shallbe taxed at the same rate

Non-impairment of contractual obligations. Levying statues thatalter relative rights of the parties with each other are prohibited.Unilateral tax exemptions may be revoked at will, but whenexemption is founded on valuable consideration, revocationconstitutes impairment.

Freedom of religion Freedom of the press

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Source rules : Interest: residence of the debtor Dividends: residence of the corporation paying Services: place of performance. If there is no accurate segregation

for compensation performed, the amount shall be determined onapportionment of time basis

International shipping lines and air carriers . Gross Philippine billingsmeans gross revenue from persons, cargo or mail originating from thePhilippines up to the final destination, regardless of the place of sale ofpassage or freight.In the case of transhipment, only the portion of the cost from thePhilippines to the point of transhipment. Sale of tickets in thePhilippines by an off-line carrier (those without any flight operations inthe country) is treated as income from whatever source. Rentals and royalties: location of the property or interest therein Sale of real property: location of real property Sale of personal property

o Produced within, sold without and vice versa: partlywithin, partly without

o Purchase within, sold without and vice versa: countrywhere sold

o Shares of stock of a domestic corporation: withinTests in determining income

Realization test . No income until there is a separation fromcapital of something of exchangeable value. The transmutationresults in the receipt of income.

Claim of right doctrine . A taxable gain is conditioned on thepresence of a claim of right to such gain and the absence of anunconditional obligation to return such.

Income from whatever source . All income not expressly excludedor exempted from taxable income, irrespective of voluntarinessand its source, is taxable.

Economic benefit test . Any economic benefit that increases networth, whatever the mode, is taxable.

COMPENSATION INCOME All remuneration for services performed under an employer-employee

relationship, unless expressly excluded by the law.Elements of an employer-employee relationship:

Power to select Payment of wages Power to dismiss Power to control

Items not considered compensation income: Agricultural labor paid entirely in the farms produce Domestic service in a private home Casual labor not in the course of employers trade Services for a foreign government or international organization

Fringe benefits . Any benefit furnished by an employer to an employee. Managerial and supervisory employees: fringe benefit tax is

withheld by employer, who is then liable to remit it and deductsuch as a business expense.

Rank-and-file: fringe benefits are treated as part of compensation

BUSINESS INCOMEContinuity of commercial dealings incidental to the pursuit of commercialgain. In the case of manufacturing, merchandising and mining, it means thetotal sales, less cost of goods sold, plus income from outside investments.Rental income is business income.Exchange of real property classified as ordinary assets is business income.

PROFESSIONAL INCOME Fees received by a professional in the practice of his profession, providedthere is no employer-employee relationship between him and his clients.

CAPITAL GAINSGeneral types of capital assets:

Shares of stock in a domestic corporationo If transferor is a dealer, shares are ordinary assets,

subject to income taxo If transferor is not a dealer, shares are capital assets:

If shares are listed and traded in the localstock exchange, exempt from income tax.Subject to stock transaction tax.

If shares are not listed, or listed but nottraded, subject to capital gains tax.

Note: Intracorporate dividend. Stock is transferred from onecorporation to another. Transaction not taxable.

Real property. Gain is determined by either selling price or zonalvalue of the property, whichever is higher

o If transferor is a dealer, property is ordinary asset,subject to income tax.

o If transferor is not a dealer: If used in trade or business, property is

ordinary asset, subject to income tax. If not used in trade or business, property is

capital asset, subject to capital gains tax.

Other types of assets. Holding period rules: (applicable only toindividual tax payers)

o Long-term. Held for more than 12 months. Only 50% oflong-term capital assets are subject to income tax.

o Short-term. Held for 12 months or less. 100% of short-term capital assets are subject to income tax.

INTEREST INCOMEInterests received are included in gross income, unless exempt from tax orsubject to final withholding tax

Interest income from Philippine currency deposits. Subject to localincome tax

Interest income on foreign currency deposits. Bank outsidePhilippines, deposit made by nonresident, alien, or foreigncorporation, not subject to local income tax. Otherwise, subject.

Interest income from traditional loans by local banks. Subject toincome tax. Exempt from withholding tax.

Discounts are treated in the same manner as interest income Interest income from long-term investments of individuals are

exempt. Long-term investments are those for 5 years and over.Pre-terminate, final income tax shall be imposed.

Interest income from long-term investments of corporations aretaxable.

Interest on foreign loans extended by nonresident foreigncorporations is subject to income tax.

DIVIDEND INCOMECorporate profit set aside, declared and ordered by the directors to be paidto stockholders on demand or at a fixed time. Until the dividend is declared,the profits belong to the corporation, not to the stockholders.Cash dividend . Disbursement to the stockholder of the corporationsaccumulated earnings.Stock dividend . Payable in reserve or additional stock of the corporation.Involves no disbursement, since stockholders do not receive an actualdividend, but only a certificate of stock.General rule : Stock dividends are exempt from income tax. They areconsidered unrealized gain, and as such cannot be considered income, butrather capital.Exception : If the dividend gives the stockholder an interest different fromwhat his former holdings represented, i.e. increase in interest.

ROYALTY INCOMEWhere a person pays royalty to another for the use of its intellectualproperty rights, considered passive income subject to final withholding tax

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OTHER INCOME FROM ANY SOURCE WHATSOEVERDiscloses the legislative intent to include all income not expressly exemptedby law, irrespective of the its voluntariness or the source.

PRIZES AND AWARDSPrizes and awards received within the Philippines are subject to final

withholding tax. Except if 10,000 or less.Prizes and awards for the recognition of religious, charitable, scientific,education, artistic, literary or civic achievement is excluded if the recipient:

Was selected without any action on his part Is not required to render substantial future service as a condition

Prizes and awards granted to athletes in sports competitions, whether heldwithin or without the Philippines, are exempt if sanctioned by their nationalsports associationsPrizes and awards received by professional athletes are no longer exempt asthey were earned in the exercise of their profession or occupation

EXCLUSIONS FROM GROSS INCOME (MAGPAIR)Refer to income not included because:

Represent a return of capital Subject to another kind of internal revenue tax Income that are expressly exempt from income tax by:

o Constitutiono Statuteo Treaty

Proceeds of life insurance . Because it is a contract of indemnity; it iscompensatory in natureAmounts received under life insurance, endowment or annuity . Only theexcess of the aggregate premiums and interest payments shall be subject toincome taxProperty acquired by gift, bequest, devise or decent . Because they aresubject to another kind of internal revenue taxAmounts received through accident and health insurance . CompensatoryIncome exempt under treatyRetirement, benefits, pensions and gratuities . Retirement benefits receivedin accordance with a reasonable private benefit plan is exempt if:

Retiree is not less than 50 years old

In the service of the same employer for at least 10 years Benefit availed of only onceSeparation pay for causes beyond the control of the employee. ExemptTerminal leave pay. Commutation of leave credits. ExemptRetirement benefits from foreign government agencies. ExemptMiscellaneous items

Income derived from Philippine investments by foreigngovernments, and financial institutions controlled and/orestablished by such

Income derived by the government from a public utility 13 th month pay and other gross benefits are exempt up to 30,000 GSIS, SSS, Pag-ibig and PhilHealth contributions

RETURN OF CAPITALSale of inventory of goods . Cost of goods manufactured (manufacturers) andcost of goods sold (dealers) are deductable from gross salesSale of stock in trade . Real estate and security dealers are required to deducttotal cost specifically identifiable to the real property or stocks soldSale of services . Since no inventory or stocks in trade, entire gross receiptsare treated as income

DEDUCTIONSExclusions vs. deductions . Exclusions refer to a flow of wealth not treated aspart of gross income, while deductions are amounts which the law allows tobe deducted to arrive at net income. Exclusions are amounts received, whiledeductions are amounts paid. Both are construed strictly against theclaimant.

Types of deduction Itemized deductions Optional standard deductions Special deductions

BUSINESS EXPENSES Conditions

Ordinary and necessaryo Ordinary. Normal in relation to the type of businesso Necessary. Appropriate or helpful for the development

of the businesso Expenses in connection with the creation of goodwill

are considered capital expenditures Incurred during the taxable year

o Satisfaction of the all events test: Fact of liability has been determined by

events which have already occurred Amount of liability is determined with

reasonable accuracy Incurred in the conduct of trade Supported by adequate receipts Not contrary to law, public policy or morals Tax required to be withheld is remitted

INTEREST Amount paid by the debtor for the use of money. Interest expense incurredin connection with the taxpayers trade shall be allowable deduction Interest expense on capital expenditure may, at the taxpayers option, be:

Treated as deduction in full in the year incurred; or Treated as a capital expenditure, in which case the taxpayer may

claim the periodic amortization as the deduction

Conditions Valid and existing indebtedness Indebtedness is that of the taxpayer Interest is legally due and stipulated Indebtedness is connected with the taxpayers business The arrangement must not be between related taxpayers Deduction of interest expense must not be expressly disallowed Amount of interest deducted must not exceed the limits set forth

by law (Interest arbitrage rule. See below)

TAXESGeneral rule : All national or local taxesExcept :

Philippines income tax Foreign income tax Estate a nd donors tax Special assessments on real property Electric energy consumption tax

Conditions Payment for taxes Taxes are imposed by law Taxes are not specifically excluded by law Incurred during the taxable year Incurred in the conduct of trade

Amt loaned * interest rate = interest expenseInterest income * 33% = - interest arbitrage

= deductable interest expense

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LOSSESClasses

Incurred in trade Incurred in any transaction entered into for profit, although not

connected with trade Casualty losses, although not connected with trade. Destruction

of property resulting from an identifiable event of sudden,unexpected or unusual nature

Conditions Loss must be that of the taxpayer Incurred within the taxable year Incurred in the conduct of trade Evidenced by a closed transaction Not claimed as a deduction for estate tax Not compensated by insurance In case of casualty loss, reported within 45 days

BAD DEBT Debt resulting from the worthlessness of amount due to the taxpayer. Inorder to be considered a bad debt, taxpayer should show that during thetaxable year of the deduction, a situation developed which it became evidentthat there remained no practical, but only vaguely theoretical, prospect thatthe debt would ever be paidTax benefit rule . Taxpayer is obliged to declare as taxable income therecovery of bad debts in the year collected to the extent of the tax benefitenjoyed by him when the bad debts were claimed as deduction

DEPRECIATIONGradual diminution in the useful value of tangible property resulting fromwear and tear and normal obsolescence, and the amortization of value ofintangible assets, the use of which is limited in duration. It cannot go beyondthe cost of acquisition and cannot be based on appraisal valueConditions

Allowance must be reasonable. Must be computed through:o Straight-line methodo Declining balance methodo Sum-of-years-digit methodo Other methods prescribed by the Secretary Property must be used in trade

Incurred within the taxable year

CHARITABLE CONTRIBUTIONSConditions

Made to the Philippine government or accredited domesticcorporation or association specified by law

Incurred within the taxable year Not exceed 10% (individual) or 5% (corporation) of taxable

income before charitable contributions Evidenced by receipts Based on acquisition cost

OPTIONAL STANDARD DEDUCTIONSMay be claimed in lieu of itemized deductionsConditions

Claimant must be a citizen or resident alien Intention to avail must be expressed in the tax return Such availment is irrevocable for the taxable year Limited to 40% of gross income Proof of expenses not required

NON-DEDUCTABLE EXPENSES Personal expenses Amount paid for permanent improvements Amount paid for restoration of property Premiums paid on life insurance Losses for exchanges of property between related parties

PERSONAL EXEMPTIONSBasic personal exemption . 50,000Additional exemption . Maximum of 4 dependent children. 25,000 each.

Not more than 21 years old or any age if incapable of self-support Unmarried Not gainfully employed

Living with the taxpayerDeductions vs. personal exemptions . Deductions are expenses incurred inthe conduct of trade, while personal exemptions are arbitrary amounts forpersonal expenses. Deductions can be claimed by all taxpayers, whilepersonal exemptions can only be claimed by individualsStatus-at-the-end-of-the-year rule . Whatever the taxpayers status at theend of the calendar year shall be used for purposes of determining hispersonal and additional exemptions. Change of status generally benefits, butdoes not prejudice the taxpayer.

TAX BASES AND RATESTax bases can be grouped into:

Compensation, business, professional income, capital gains notsubject to final tax, passive income not subject to final tax, andother income

Capital gains subject to final tax Passive income subject to final tax

INDIVIDUALS Tax bracket Tax rateNot over 10,000 5%10,001 30,000 500+ 10% excess 10,00030,001 70,000 2,500 + 15% excess 30,00070,001 140,000 8,500 + 20% excess 70,000140,001 250,000 22,500 + 25% excess 140,000250,001 500,000 50,000 + 30% excess 250,000Over 500,000 125,000 + 32% excess 500,000

DOMESTIC CORPORATIONS General rule : 30% of taxable income (normal corporate income tax) or 2% ofgross income (MCIT, imposable on the 4 th year of operation)

Except : Non-profit hospital and educational institutions, 10% of taxableincome. Provided that gross income from unrelated trade does not exceed50% of total gross incomePurpose of the MCIT

Prevent over-claiming of deductions Ensure minimum contribution to support the government

Grounds for valid suspension of MCIT Force majeure Prolonged labor dispute

RESIDENT FOREIGN CORPORATIONS 30% of taxable income on sources withinPreferential tax rate for resident foreign corporations

International carriers. 2.5% of GPB Offshore banking units. 10% of income derived from transactions

with Philippine residents Regional headquarters. 10% of taxable income sourced withinPreferential tax rate for non-resident foreign corporations

Cinematographic film owner. 25% of gross income sourced within Lessor of vessels chartered by Filipinos. 4.5% of gross rentals Lessor of aircraft, machines or other equipment. 7.5% of gross

rentals Interest income on foreign loans. 20% final withholding tax Dividends received from domestic corporations. 15% final

withholding tax Net capital gains realized by non-resident foreign corporation

from disposition of stock in a domestic corporation. Finalwithholding tax of:

o 5% of net capital gains, if not over 100,000o 10% of net capital gains, if over 100,000

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GAINS FROM SALE OF PROPERTYExcess of the amount realized over the basis or adjusted basis.Amount realized shall be the sum of money received plus the fair marketvalue (other than money) receivedBasis shall be:

Acquisition cost

Fair market value as of date of acquisition If acquired by gift, the basis shall be the same as the lastpreceding owner by whom it was not acquired by gift. For loss, ifbasis is greater than fair market value, latter shall prevail

Acquired for less than adequate consideration, acquisition costpaid by the transferee

Adjusted basis shall be the original cost plus amounts spent for improvementTransfer for inadequate consideration . Is deemed as a gift. Except: Whensold for a bona fide business purpose. What is important is the showing ofdonative intent on the part of the sellerNature of property

If ordinary asset, use either individual or corporate tax rate If capital asset, 6% of actual consideration or fair market value,

whichever is higher

ORDINARY AND CAPITAL ASSETSOrdinary assets . Include:

Stock in trade, included in inventory Property held by taxpayer for sale Property used in trade, subject to depreciation Real property used in trade

Capital assets . All elseLoss limitation rule . A capital loss can only be deducted from capital gainsbut never from an ordinary gain.

TAX-FREE EXCHANGESNo gain or loss in the following circumstances

Merger or consolidationo Corp A, property > Corp B, stocko Shareholder A, stock > Corp B, stocko Security holder A, securities > Corp B, stock or

securities Property transferred to corporation in exchange for stock, whichas a result of such exchange maximum of 5 persons gain controlof the corporation

Sale of principal residenceDwelling house, including land where situated, where husband and wife oran unmarried individual, and members of his family reside. Character ofpermanency must be present; individual intends to return to the dwelling,whenever he is absentWhere ownership of land and house belongs to a different person, onlyhouse shall be treated as principal residenceWhere owned by several co-owners and actually used as principal residenceby one or more, property shall be treated as principal residence of co-owner/s actually using the same to the extent of their shareWhen exempt from capital gains tax:

Proceeds of the sale of principal residence are fully utilized in theacquisition of new principal residence within 18 months

Commissioner is duly notified within 30 days of taxpayersintention to avail of the exemption

Tax exemption can be availed only once every 10 years

ACCOUNTING METHODS AND PERIODSThere is no uniform method of accounting prescribed for all taxpayers.Taxpayer may adopt such methods as are in his judgment best suited to hispurpose. If the method that clearly reflects his income, it is to be followedwith respect. In case of conflict, tax code prevails over generally acceptedaccounting principles

Cash receipts and disbursements method . Income is realizedupon actual or constructive receipt, and expenses are deductibleonly upon actual payment thereof, regardless of the period inwhich service is rendered or expense is incurred

Accrual method . Income is accounted for in the period it isearned, regardless if received or not; expenses are accounted forin the period they are incurred, regardless if paid or not

o Income is recognized when the requirements for therealization principle are met:

Earning process is complete Exchange has taken place

o All events test is followed for expenses Fact of liability has been determined by

events which have already occurred Amount of liability is determined with

reasonable accuracy

Installment method . Appropriate when collections of incomeextend over long periods of time and there is a strong possibilitythat full collection may not be made. As customers payinstallments, seller recognizes profit in proportion to thecollection during the year

Percentage of completion method . Applicable in the case ofbuilding , installation or construction contract covering a period inexcess of 1 year. Gross income reported upon basis of percentageof completion of contract. Basis:

o Cost incurred compared with estimated total o Work performed compared with estimated total

Crop year basisGeneral rule : All income received during the year shall be includedcomputation of gross incomeIncome which is credited or set aside for the taxpayer and may be drawn at

any time is deemed received during the year it was creditedExcept : Under permitted accounting methods, such amounts are to beproperly accounted for during a different periodGeneral rule : Deductions must be taken for the year in which they were paidor incurredExcept : Under permitted accounting methods, such amounts are to beproperly accounted for during a different period

FILING OF RETURNSExemption from income tax does not mean an exemption from filing ITRIndividuals deriving purely compensation income . Exempt from filing ITR if,substituted filing of tax returns are filed by the employer:

Employee receives purely compensation income From only one employer Tax due is equal to tax withheld

Individual deriving purely trade, business or professional income or mixed

income . Must file quarterly ITR and annual ITRDomestic corporation and resident foreign corporation . Must file quarterlycorporate ITR and annual corporate ITRComputation for quarterly and annual ITR made on a cumulative basis

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WITHHOLDING TAXESMethod of collecting income tax in advance of the income of the recipient.The amount withheld constitutes a full and final payment of the income taxdue from the recipient. The liability for the payment of tax withheld liessolely on the withholding agent.Since it is considered as advance payment, it follows that all persons exempt

from income tax are also exempt from withholding taxCreditable withholding tax . Taxes withheld are intended to equal or at leastapproximated the tax due. Recipient is still required to file ITR, report theincome, and pay the difference between tax withheld and tax due.Withholding agent . In application of the territoriality principle, must beresident of the Philippines

In general, any juridical person An individual, payments made in connection with trade All government offices and GOCCs

Bases for withholding tax Based on gross income, for expanded withholding tax Based on gross selling price or fair market value, whichever is

higher, for creditable withholding tax