taxation reviewer- dimaampao

8/20/2019 Taxation Reviewer- Dimaampao

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1) Income tax;

2) Estate and donor’s taxes;

3) Value-added tax;

4) Other percentage taxes;

5) Excise taxes;

6) Documentary stamp taxes; and7) Such other taxes as are or hereafter may be imposed and collected by

the Bureau of Internal Revenue

INCOME TAX

FEATURES OF OUR PRESENT INCOME TAXATION

Q. What are the features of our present income taxation in the light of R.A

8424?

A. We adopted the so-called “COMPREHENSIVE TAX SITUS

” – Comprehensivein the sense that we practically apply all possible rules of tax situs.

Criteria used: (Code: R. P. N.)

a)Residency of taxpayer;

Situations where we utilized residency as basis:

1) We tax the income of a resident alien derived from sources within the

Philippines.

2) We also tax the income from sources within of resident foreign

corporation in the Philippines.

b)Place/Source

Used as a basis in taxing the income of a non-resident alien individual. We

can only tax his income derived from sources within and in taxing the same, we

consider the place where the income is derived.

c)Nationality or Citizenship in the case of individual taxpayer

We used that as a basis in imposing tax on the income of a resident citizen.

Resident citizen may be taxed from his sources within and without. The source

of income here is immaterial what we consider is the nationality or citizenship

of the taxpayer.

Domestic corporation – we can tax its income derived from sources within and

without.

OnNon-resident citizen, they can only be taxed on their income derived from

the sources within – tax situs is the place /source of income.

Taxpayer Sources

1. RC I/O (Sec. 23 [A])

2. NRC I (Sec. 23 [B])

3. OCW I (Sec. 23 [C])

4. ALIEN

4.1 NRA-ETB

4.2 NRA-NETB

4.3 ALIEN ERA-MNC

4.4 ALIEN OBUs

I (Sec. 23 [D])

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4.5 ALIEN PSCS

5. Domestic Corp. I (Sec. 23 [E])

6. Foreign Corp-RFC/NRFC I (Sec. 23 [F])

1) Aresident citizen is taxable on all income derived from sources within

and without the Philippines.

2) Anon-resident citizen is taxable only on income derived from sources

within the Philippines.

3) Anoverseas contract worker is taxable only on income from sources

within the Philippines; aseaman who is a citizen of the Philippines and

who receives compensation for services rendered abroad as a member of

the complement of a vessel engaged exclusively in the international

trade shall be treated as an overseas contract worker.

4) An alien individual, whether a resident or not of the Philippines, is

taxable only on income derived from sources within the Philippines.

5) Adomestic corporation is taxable on all income derived from sources

within and without the Philippines; and

6] A foreign corporation, whether engaged or not in trade or business in

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

Philippines.

Income Taxation may be grouped into:

1) individual income taxation

2) corporate income taxation

Q.What are thebasic features of individual taxation?(S.P. F. E. M.)

A.

1) Individual income taxation adopted theSchedular system of taxation

Schedular Sy!e" o# $a%a!&o' – is a system employed where the income tax

treatment varies and made to depend on the kind or category of the taxpayer’s

taxable income(Tan vs. Del Rosario).

Characteristics of schedular system of taxation:

a) It gives or accords different tax treatment on the income of

individual taxpayer.

b) It classifies income.

Manifestations:(that under the individual taxation we adopted the

schedular system of taxation)C B P D* I R R D A P+ P P,

Under Sec. 32(a), income may be categorized as follows:

1) compensation income,

2) business income,

3) professional income,

4) income derived from dealings in property,

5) interest income,

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6) rent income,

7) royalties,

8) dividends,

9) annuities,

10)prizes,

11)winnings,12)pensions, and

13)partner’s distributive share from the net income of the general

professional partnership.

This is the manifestation that as far as individual income taxation,

the income is categorized.

2] Thetax rates are progressive in character. This is clear under Sec. 24 (a).

You will notice there that the tax base increases as the tax rate increases.

3] Modified gross income as regards compensation earner. Modified because

in determining the taxable compensation income, the only allowable deductions

are personal and additional exemption. You cannot deduct the allowable

deductions under Sec. 34 from gross compensation income.

But as regards those individual taxpayers that derived business, trade or

professional income, we adopted thenet income system. This is so because

under Sec. 34,allowable deductionsmay be claimed by individual taxpayers

who derived business trade and professional income.

4] We employ this “Pay as you File” system.

5] Under certain cases, we employ the “pay as you earn” system. This applies

to “income subject to withholding tax”.

Q. What are thebasic features of corporate income taxation?

A.

1] Global Concepthas been adopted. >>> Global system where the tax

treatment views indifferently the tax base and treats in common all categories

of taxable income of taxpayer (Tan vs. Del Rosario).

Characteristics of Global system of Taxation:

a)Uniform tax treatment – this is subject to diminishing corporate tax rates of

34% (Jan. 1, 1998), 33% (Jan. 1, 1999), 32% (Jan. 1, 2000). See Chapter IV,

Sec. 27).

b)Does not categorize income.

2] Corporate taxpayer, particularly domestic corporations are entitled to

deductions. So, insofar as domestic corporation and resident foreign

corporation is concerned, we adopted here the net income tax system.

New provisions under R.A. 8424: 10% tax on improperly

accumulated earnings of a corporate taxpayer.

3] Pay as you file system has also been employed.

Corporate taxpayer is allowed to adopt calendar or fiscal year

period. Corporate taxpayer files corporate income tax return

quarterly. And it also files the so-called FINAL ADJUSTED

RETURN.

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c. Both labor and capital

d. Sale of property

Example of income derived from capital >>> Interest Income

Example of income derived from labor >>> Compensation Income

Example of income derived from both capital and labor >>> Income of an

independent contractor. The independent contractor provides work force,

provides capital and derives income from such capital.

*In determining the profit from the sale of property, you should always be guided

by this formula:

Amount Received Or Realized LESS Cost of Property = PROFIT

TAXABLE INCOME – (the old term is Net Income) – means all pertinent items of

gross income specified in the Tax Codelessthe deductions and/or personal

and additional exemptions, if any, authorized for such types of income by this

Code or other special laws. (Sec. 31 of the TRA of 1997).

Shoter Version: All pertinent items of gross income less allowable deductions.

Q. What are the advantages/disadvantages of gross income taxation and net

income taxation?

Advantages of gross income taxation:1. It simplifies our income taxation. This is so because since no deductions are

allowed, it is very easy to tax the income. You don’t have to find out whether

deductions or expenses are legitimate or not because they are not deductible.

2. This will generate more revenue to the government.

3. It minimizes cost.

Disadvantages of gross income taxation:

1. As far as the taxpayer is concerned, this is inequitable because they cannot

claim the expenses, which are incurred in connection with his trade or business

or exercise of his profession.

2. And if this is the system, in all likelihood the taxpayers will lose interest to

earn more. It will in effect reduce the purchasing capacity of the taxpayer.

3. Since taxpayers cannot claim those legitimate expenses as deductions, they

may resort to fraudulent scheme that will minimize their tax ability and this

may be done through the understatement of income. So, in effect, this will

encourage tax evasion.

Advantages of net income taxation:

1. As far as the taxpayer is concerned, they will consider this as equitable and

just system.

2. This will minimize tax evasion because examiners will be employed to check whether expenses are correct or not.

3. The consequence of no. 2 is that this will generate more revenues.

Disadvantages of net income taxation:

1. vulnerable to graft and corruption

2. vulnerable to tax evasion

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3. will give rise to loss of revenues.

SOURCES/SITUS OF INCOME

An income may be an income from within or without the Philippines. Theother term for income within isLocal Income while income without is sometimes

calledGlobal Income or Universal Income.

In determining whether an income is an income within or without, you have to consider

the classification or kind of income.

CLASSIFICATION OF INCOME: C B P I R R D A P P P,

1. Compensation income from services

2. Income derived from business, trade or profession – in this regard, the

common forms of business are merchandising business, farming business,

mining business and manufacturing business.3. Income from sale or exchange of property (either real or personal property)

4. Interest Income

5. Rent Income

6. Royalties

7. Dividends, which may be received from domestic or foreign corporation

8. Annuities

9. Prizes and winnings

10. Pensions

11. Partner’s distributive share in the net income of general professional

partnership (Professional income of a partner)

* COMPENSATION INCOME

Tax Situs:Place where services are rendered. So, if services are rendered within

the Phils., that is a Local Income. If it is a payment for services rendered

outside the Phils., that is an income without.

RC – income from within and without are taxable.

NRC – only compensation income from sources within is taxable.

RA – same as NRC.

* BUSINESS INCOME M F,

a) Merchandising Business

b) Farming Business Tax Situs: Place where these

c) Mining Business business are undertaken.

d) Manufacturing Business

Tax Situs:

(1) if the goods are manufactured in the Phils. And sold within the phils. This is

considered asincome derived purely within.

(2) Goods manufactured outside the Phils. and sold outside –income derived

purely without.

(3) Goods manufactured within the Phils. and sold outside the Phils. –income

partly within and partly without.

(4) Goods manufactured outside the Phils. and sold within the Phils. –income

partly within and partly without.

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* INCOME FROM SALE OR EXCHANGE OF PROPERTY

If it involves personal property, in determining the tax situs, we

have to consider the place of sale.

In the case of sale oftransport documents, tax situs is the place

where the transport document is sold (BOAC Case).

If it involvesreal property, the tax situs is the place or location of

the real property. So, if the property sold is situated within the

Phils., the income derived from such sale is considered as income

within.

* INTEREST INCOME

Tax Situs:RESIDENCE of the DEBTOR

Case: There was this contract regarding the construction of ocean-going

vessels. There was this issuance of letter of credit and the payment of

downpayment. All the elements of the transactions took place in Japan. The

payment was made in Japan. The letter of credit was executed in Japan. The

delivery was made in Japan. Thedebtor is a domestic corp.

Is the interest income on this loan evidenced by the letter of credit

taxable to the Japanese corp.?

HELD:NO, becausethe tax situs of interest income is not the activity but theresidence of the debtor. The place where the contract of loan is executed is

immaterial.

* RENT INCOME

Tax Situs:the PLACE of property subject of the contract of lease.

* ROYALTIES

Tax Situs:the PLACE where the intangible property is USED

* DIVIDEND

a.Received from domestic corp. – this is an income purely within.

b.Received from foreign corp. – consider the income of the foreign corp. in the

Phils. during the last preceding three (3) taxable years;

rules:

(1) Theincome is purely within if the income derived from the Phil. sources ismore than 85%

(2) It is purely without if the proportion of its Phil. income to the total income is

less than 60%

(3)There should be an allocation if it is more than 50% but not exceeding 85%

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* ANNUITIES

Tax Situs:the PLACE where the contract was made

* PRIZES AND WINNINGS

Prizes may be given on account of services rendered – in which

case, the tax situs is the place where the services were

rendered.

If these prizes are not given on account of services, the tax situs is

theplace where the same was given.

Tax situs of winnings is the place where the same was given.

*PENSION

Tax Situs:PLACE where this may be given on account of services rendered

*PROFESSIONAL INCOME OF PROFESISONAL PARTNERS

Tax Situs:PLACE where the exercise of profession is undertaken

GROSS INCOME

GROSS INCOME – means all income derived from whatever source, including

but not limited to the following:

INCLUSION: code: S$P-IRR-DAP-PS,

1. compensation for services

2. gross income from trade or business or the exercise of a profession

3. gains derived from dealings in property

4. Interests

5. Rents

6. Royalties

7. Dividends

8. Annuities

9. Prizes and winnings

10. Pensions and

11. Partner’s distributive share from the net income of the general professional

partnership(Sec. 3 of TR! of "##$)

EXCLUSIONS code: A/CIRM,

1. proceeds of life insurance policy

2. amount received by the insured as return of premium

3. gifts, bequests, devises or descent

4. compensation for injuries or sickness

5. income exempt under treaty6. retirement benefits, pensions, gratuities

and others:(F V R S S /)

a.retirement benefits received from foreign institution whether

public or private

b.veteran’s benefits

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c.retirement benefits received from private firms whether individual

or corporate

d.separation pay

e.SSS

f. GSIS

7. miscellaneous items:a.prizes and awards given in recognition of religious, charitable, scientific,

educational, artistic, literary, or civic achievements

CONDITIONS:

1.the recipient wasselected without any action on his part to enter the

contest or proceeding

2.the recipient isnot required to render substantial future services as a

condition to receiving the prize or award

b.income derived by the government or its political subdivisions from the

exercise of any essential governmental function or from any public utility

c.income derived from investment in the Philippines by foreign government orfinancing institutions

d.prizes and awards in sports competitions

e.gain derived from the redemption of shares of stock issued by the mutual

fund company

f. contributions to GSIS, SSS, PAG-IBIG, and union dues

g.benefits in the from of 13th month pay and other benefits

h.gain derived from the sale, exchange, retirement of bonds debentures or

other certificate of indebtedness with a maturity of more than five (5) years.

(Sec. 32 (b), TRA of 1997)

*ALLOWABLE DEDUCTIONS

1.Optional Standard Deduction – of ten percent (10%) of the Gross Income

available only to individual other than a non-resident alien provided he signifies

in his return his intention to elect OSD, otherwise, itemized deductions apply.

Election made shall be irrevocable for the taxable year (Sec. 34 L)

2.Itemized Deductions – under Sec. 34 A-K, and M

3.Personal and Additional Deductions/Exemptions under Sec. 35

* ITEMIZED DEDUCTIONScode: EI$-BDD-CRC,

1. expenses2. loses

3. interest

4. taxes

5. bad debts

6. depreciation

7. depletion of oil, gas wells and mines

8. charitable and other contributions

9. research and development

10. contribution to pension trust

* NON-DEDUCTIBLE ITEMS(Sec. 36 A)

1. Personal living or family expenses;

2. Amount paid for new buildings or permanent improvements, or betterment to

increase the value of any property or estate;

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3. Any amount expended in restoring property or in making good the

exhaustion thereof for which an allowance is or has been made; or

4. Premiums paid on any life insurance policy covering 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.

(Sec. 36 B) Losses from sales or exchanges of property directly or indirectly –

1. Between members of a family (brother, sister of half or full blood, spouse,

ascendant, lineal descendants);

2. Except in case of distributions in liquidation, between an individual and a

corporation – more than 50% in value of the outstanding stock of which is

owned directly, by or for such an individual; or

3. Except in case of distributions in liquidation, between two corporations –

more than 50% in value of the outstanding stock of each of which is owned,

directly or indirectly, by or for same individual, if either one of such corporationis a personal holding company or a foreign personal holding company; or

4. Between the grantor and a fiduciary of any trust; or

5. Between fiduciary of a trust and the fiduciary of another trust, if the same

person is a grantor with respect to each trust; or

6. Between a fiduciary of a trust and a beneficiary of such trust.

TAXABLE INDIVIDUALS

RESIDENT CITIZENS(RC)

Income fromwithin and without – taxable

NON-RESIDENT CITIZENS(NRC)

Income fromwithin

When an NRC returns to the Phils., his income may also be taxed as

Resident Citizen or Non-Resident Citizen.

Illustration: A, an OCW, arrived in the Phils. sometime in June 1998. He will be

taxed as a Non-Resident Citizen (NRC) as regards the income that he earned

which covers the period of January to June. Now as regards the income that he will derive upon his arrival from June to December, he will be taxed as Resident

Citizen (RC).

But if he is not in the Phils. from the period of January to December 1998, he

will be taxed as NRC for the said period.

If he will return to the Phils. and stay there from January t December 1999, he

will be taxed as RC for the same period.

* NRC must prove to the satisfaction of the BIR Commissioner the fact of physical

presence abroad with the intention to reside therein.

* When an NRC decides to return to the Phils., he must prove his intention to

reside here permanently.

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* Now NRC includes OVERSEAS CONTACT WORKERS (OCW), IMMIGRANTS, and

those who STAY OUTSIDE the Phils. by virtue of an employment.

RESIDENT ALIEN (RA)

1. An individual who is not a citizen of the Phils. but a resident of the Phils.

* Includes those who consider the Phils. as a second home. ***Transient tourist who just sojourn, their stay is merely temporary, thus

may not be considered as RA.

*If an alien stays in the Phils. for a period of more than one (1) year, he is

considered as RA.

SPECIAL NON-RESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS (NRA-NE$B)

* He must be an alien individual who is not residing in the Phils. and not

engaged in trade or business in the Phils.

*He is one whose stay in the Phis.is not more than 180 days

SPECIAL NON-RESIDENT NOT ENGAGED IN TRADE OR BUSINESS (SNRA-NE$B)

* Those employed by: (ROP)

1. Regional or Area Headquarters of Multinational corporations;

2. Offshore Banking Units;

3. Petroleum Service Contractors

NON-RESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS(NRA-E$B)

> considered as engaged in trade or business if his stay is more than 180 days

> We can no longer tax his income from sources without. We can only tax his

income from sources within.

ENTITLEMENT OF DEDUCTIONS

RC – entitled to deductions because the tax base is taxable income.

Gross Income

Less: Allowable deductions

=======================

Taxable Income

NRC – entitled to deductions because the tax base is taxable income.

RA – entitled to deductions because the tax base is taxable income.

NRA-TB – entitled to deductions because the tax base is gross income. Their

income is subject to 25% tax rate.

SNRA-NETB – subject to 15% tax rate on their income in the from of:

S - Salaries

0 - Honoraria

O - Other

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1 - Wages

E - Emoluments

R - Remuneration

EXCLUSION FROM GROSS INCOME

“PROCEEDS OF LIFE INSURANCE”

Subject to tax if :

1. the insurer and insuredagreed that the amount of the proceeds shall be

withheld by the insurer with the obligation to pay interest in the same,the

interest is the one subject to tax;

2. there istransferof the insurance policy;

Example:

A transferred to B his life insurance policy. The value of the policy is P1

M. B paid a consideration amounting to P300,000. B continued paying the

premiums after the transfer such that the premiums amounted to P200,000.

Upon the death of the insured, the P1 M may be received by the heirs.

Q. Is the full amount of P1 M exempt?

A. NO, only the consideration given and the total premiums paid may be

excluded. That is, P1 M less P500,000.

Problem:

A obtained a life insurance policy for B. B is the president of A’s

corporation. Corp. has an insurable interest in the life of its officers, so

premiums may be paid by the employer A. Upon the death of B, his designated

beneficiaries will receive the proceeds.

a.Is the amount representing the proceeds of the life insurance policy

taxable?

b.What about the premium paid by the employer A? Does this amount

form part of the gross compensation income?c.Does the amount representing the proceeds of life insurance policy from

part of the estate of the decedent?

Answers:

a.Let us first maketwo (2) assumptions. Let us assume that:

1.the beneficiary designated is the employer;

2.the beneficiary designated is the heir of the family of the insured.

The Tax Code however, makes no distinction. Regardless of the designated

beneficiary is the employer or the heirs, or the family of the insured proceeds of

life insurance policy should always be excluded.

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b.Premiums of life insurance policy paid by the employer may form part of

compensation income; hence,taxable if the beneficiary designated are the

heirs or the family or the employees.

It isnot taxable compensation income if the designated beneficiary is the

employer because that is just a mere return of capital.

c.Proceeds of life insurance policy may be excluded from the gross estate of

the decedent under the following cases:

1.if the beneficiary designated is a 3rd person and the designation is

irrevocable;

2.it is a proceed of a group insurance policy.

However, it is included in the gross estate of the decedent:

1.if the beneficiary designated in the estate, executor or

administrator of the estate or the family of heirs of the decedent;2.if the beneficiary designated is a 3rd person and the designation is

revocable [see Section 85 (e)]

As far as Sec. 85 (e) is concerned, an employer may be considered a 3rd person.

“AMOUNT RECEIVED BY INSURED AS RETURN OF PREMIUM”

Reason for Exclusion:It represents a mere return of capital.

Thesources of this return of premium:(.E.A.)

1. Life Insurance Policy2. Endowment contracts

3. Annuity contracts

---Whether the premiums are returned during or at the maturity of the term

mentioned in the contract or upon surrender of thee contract

Problem:

A took out an endowment policy amounting to P1 M. He paid premiums

amounting to P800,000. Upon the maturity of the policy, A received that P1M.

How much is the taxable amount?

Answer:

That is P1,000,000. – value of endowment policy

LESS: P 800,000. – representing amount of premium

===============================================

P 200,000. – taxable amount

*“GIFTS, BEQUESTS and DEVISES”

Rationale: What is contemplated here are donations which are purely gratuitous

in characterin order that it may be excluded.

Gifts are excluded because these are subject todonor’s tax. Bequests and devises are excluded because these may be subject

toestate tax.

What about remuneratory donations?Remuneratory donations are

subject to income tax.

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EXCEPTIONS to the Rule:>>> the income or fruit of such money given by

donation, bequests or devise, including the income of this gift, bequest or devise

in cases of transfer of divided interest.

*“COMPENSATION FOR INJURIES OR SICKNESS”

Reason for Exclusion: This is just anindemnification for the injuries or damages

suffered. This is compensatory in nature.

Thesources are:

1. The compensation may be paid by virtue of a suit;

2. It may be paid by virtue of health insurance, accident insurance or Workmen’s

Compensation Act

But as regards damages representing loss of anticipated income, this is the one

that is taxable.

If damages are in the nature of moral, exemplary, nominal, temperate, actual and

liquidated damages, as a rule, these may not be subject to tax.

Example:

If a person suffered injury as a result of a vehicular accident, and an

action is filed in court, the Court awards the following:

Moral - P100,000.

Exemplary - P100,000. Actual - P 60,000. (hospitalization expenses)

P 20,000. (repair of car)

P 60,000. (loss of income)

*** All damages awarded are tax-exempt except damages of representing loss of

income.

Question: Are damages awarded by the Court on account of breach of contract

taxable?

Answer: Qualify your answer. With regards to damages awarded on account of

loss of earnings of the contracting party, it is taxable.

“INCOME EXEMPT UNDER TREATY”

Reason for the Exclusion:Treaty has obligatory force of contract.

Exception: As may be provided for in the treaty.

*“RETIREMENT BENEFITS, PENSIONS, GRATUITIES AND OTHERS”

- VETERAN’S BENEFIT

* This may be given by the US Administration.

* Therecipient must be a resident veteran.

- BENEFITS GIVEN BY FOREIGN AGENCIES OR INSTITUTIONS WHETHER

PUBLIC OR PRIVATE

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Giver: Foreign government agencies or institutions whether public or private.

Recipient: Resident citizen, non-resident citizen or resident alien.

Observation:

Non-resident citizen should not be included in the enumeration since it is

already understood that we cannot tax his income from without. We can onlytax the income of non=-resident citizen derived from sources within.

The same is true with resident alien because we can only tax his income from

sources within.

The inclusion of NRC and RA in the enumeration are mere surplusage.

-RETIREMENT BENEFITS RECEIVED FROM PRIVATE FIRM WHETHER

INDIVIDUAL OR CORPORATE

Recipient: Private employees or official of such private firm.

REQUISITES:

1. The private employee or official must be at least 50 years of age at the time of

his requirement;

2. He must have rendered at least 10 years of service to the employer at the

time of the retirement;

3. There must be reasonable private benefit plan – established by the employer;

4. The reasonable private benefit plan must be approved by the BIR.

5. Reasonable private benefit plan may be in the nature of pension plan, profit

sharing plan, stock bonus plan, or gratuity;6. The employer must give contribution and no amount shall inure to the

benefit of a particular employee or official. This must be established for the

common benefit of the employees or officials;

7. This can be availed of ONCE.

* The subsequent retirement benefits received from another private employer is

no longer exempt but subject to tax.

* If the second employer is a government entity or institution, in which case,

that is exempt because the giver here is not a private firm. The limitation

applies only when the giver of the subsequent retirement benefits is another

private employer.

-PHYSICAL DISABILITY BENEFITS

* These include death benefit, sickness benefit and other disability benefit.

Sometimes, the term used is “separation pay”.

Giver: may either be public or private employer

*Sources of Separation Pay:

1. Death of an employee;2. Physical disability of an employee;

3. Any other cause beyond the control of the employee or official.

Example of no.3

a.Retrenchment of employees;

b.Installation of labor saving devises;

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c.Dissolution of law firm.

>Resignation of an employee is a cause within his control.

>But, involuntary resignation is beyond the control of the employee.

>The most important thing here is that the separation pay was given on

account of the above-mentioned sources.>There is no requirement as to age of the employee or official; there is also no

requirement as to the length of service of the employee or official.

>No requirement also as to the number of availment of benefits.

-AMOUNT OF THE ACCUMULATED SICK LEAVE AND VACATION LEAVE

CREDITS

The monetized value of these benefits may be subject to tax if these

will not form part of the terminal leave pay.

The monetized value of sick leave credit is always tax exempt, if it

forms part of the terminal leave pay. As regards UNUSED VACATION LEAVE CREDIT, this is exempt

only if the number of days is 10 days or less in excess of 10 days,

it is already subject to tax.

If theunused sick leave benefit is monetized, if the employer allow

such practice, and the same is given at the end of this year, it is

subject towithholding tax because in this case, it does not form

part of the terminal leave pay.

Reason for exemption of terminal leave pay:

The accumulated value of unused sick leave and vacation leave

credits included in the terminal leave pay is exempt from incometax because it is one received on account of a cause beyond the

control of the employee. This terminal leave pay is usually given

under a compulsory retirement. Compulsory retirement is a cause

beyond the control ofte employee.

*“MISCELLANEOUS ITEMS”

a.Prizes and Awards in Awards Competitions

REQUISITES:

1.Competition and tournament must be sanctioned or approved by

the National Sports Association;2. The competition and tournament must also be approved by the

Philippine Olympic Committee, whether local or international;

whether held in the Phils or outside.(if not accredited% &' ta)

b.Prizes and Awards made primarily in recognition of:(RCS-SAE)

Religious, Charitable, Civic Achievement, Scientific, Athletic, Literary,

Educational

Example: P1 M reward given to Mr. Advincula for his exemplary honesty.

This may be excluded from his gross income because it is given inrecognition of civic achievement. He was(1) selected without any action on

his part to enter a contest or proceeding; and(2) he is not required to render

substantial future services as a condition to receiving the award.

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c.Income derived from public utility or from the exercise of essential

government function by the Government or political subdivisions of

the Phils.

Recipient:Government or its Political Subdivision

*Government of the Republic of the Phils or Government of the Phils vs. National

Government

Government of the Republic of the Phils. is synonymous with Government of

the Phils.

Government of the Phils. or government of the Phils. – refers to the

government corporate entity through which the functions of the government are

exercised throughout the Phils., including save as the contrary appears from

the context, the various arms through which political authority is made

effective in the Phils., whether pertaining to the autonomous regions, cities,provinces, municipalities, barangays or other forms of local government. These

autonomous regions, provincial, city, municipal or barangay subdivisions are

the political subdivisions.

National government - refers to the entire machinery of the central

government. This includes the three (3) major departments of the government:

the Executive, the Legislative and the Judiciary(actan *e+u International !irort !uthority vs. arcos, Set. "", "##-).

It is clear thatgovernment-owned and controlled corporations is within the contemplation of the term “national government”.

We need this distinctions because the particular item of exclusion

emphasizes the fact that political subdivisions of the State form

part of the Government of the Phils.

You must have noticed that there is no provision regarding

government-owned and controlled corporations. Also, there are no

provisions on agencies or instrumentalities of the government. The

item or income here is exempt if the recipient is either the

Government of the Republic of the Phils. or the provincial

subdivisions of the State such as provinces, cities, etc.

*Income derived by a government-owned and controlled corporation, agency or

instrumentality of the government may be subject to tax.

*Government-owned and controlled corporations are now subject to corporate

income tax,except:

a.SSS

b.GSIS

c.Phil. Health Insurance Corp.

d.PCSO

e.PAGCOR

Situation: A municipality derived income from holding a fiesta.

Rule: The rule is settled that holding a town fiesta is considered a proprietary

function. Therefore, said income is subject to tax.

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Situation: A municipality derived income from the operation of public market,

electric power plant and other public utilities.

Rule: That income is tax exempt.

d.Income derived from investment in the Phils. (1) by foreign

government or (2) financing institutions, owned, controlled or

financed by foreign government, regional or (3) international

financing institutions established by foreign government

REQUISITES:

1.Recipient must be:

a.foreign government;

b.financing institution owned, financed or controlled by foreign

government;

c.regional financing institution, international financing institution

established by foreign government;2.It must be an income derived from investment in the Phils.

Sources of such income:

--- It may be in the nature of bonds. So, foreign government here may be

considered the creditor – possible income here is theinterest of bonds. Now,

loans may be extended – possible income here isinterest on loans.

--- If a foreign government or financing institution made a deposit in a bank, Phil.

currency deposit – the income here is the nature ofinterest income.

--- If a foreign government made an investment in a domestic corporation. It may

be considered a stockholder. And a stockhlder is entitled to dividend. Hence, the

dividend income received from domestic corporation istax exempt.

** If the recipient of such dividend is aresident foreign corporation that is

alsotax exempt. It is only subject to tax if the recipient of such dividend is a

non-resident foreign corporation.

Case: EXIMBANK, which is a consortium of Japanese banks, extended a loan in

the amount of S20M to Mitsubishi Metal Corp., a Japanese corporation. Thesame amount was extended by Mitsubishi as a loan to Atlas Corp., a domestic

corporation.

The contract entered into between Mitsubishi Metal Corp. is denominated

as “contract of loan and sale”. It is a contract of loan because Mitsubishi would

lend Atlas S20M. It is a contract of sale because under the contract Atlas bound

itself to sell the concentrates (this is a mining corp.) that may be produced by

the concentrator machine/equipment purchased through the use of the S20M

for a period of 15 years.

This being a contract of loan, Mitsubishi is entitled to interest on loan.

ISSUE: Whether or not such interest on loan is subject to Phil. income tax

ARGUMENTS: Mitsubishi contended that this is not taxable because:

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1. The source of S20M is a tax exempt entity (EXIMBANK is a financing

institution controlled and financed by a foreign government); and

2. Mitsubishi is an agent of EXIMBANK, a tax exempt entity.

HELD: There was no evidence to the effect that Mitsubishi is an agent of

EXIMBANK. It is a mere allegation that has not been proven.

In a contract of loan, once the loan is consummated, the amount

becomes exclusive property of the borrower. It is no longer considered the

money of EXIMBANK. Hence, the interest of such loan should be subject to tax.

The lender is not a tax exempt entity. The creditor here is Mitsubishi and

it is not a tax exempt entity. Such being the case, tax exemption must be strictly

construed against the taxpayer and liberally in favor of the government. When

you claim exemption, you should prove it clear and categorical terms.

* The problem may be modified by the examiner. The examiner may clearly state

the Mitsubishi is an agent of EXIMBANK. The answer is, the interest on loan is

tax exempt. Mitsubishi then is considered as an extension of EXIMBANK. It is

as if the lender is EXIMBANK.

e.13th month Pay and Benefits

* This applies both to private and public employees.

* Total exclusion should not exceed P30,000 subject to increase by the

Secretary of Finance upon the recommendation of the BIR Commissioner.

f.Contributions to GSIS, SSS, MEDICARE, PAG-IBIG, and union dues

* This is a surplusage. Even if this is not mentioned, we cannot tax that.

g.Sale, exchange, retirement of bonds, debentures and other

certificates of indebtedness with a maturity of more than FIVE (5)

YEARS

- If maturity is less than 5 years, taxable.

Rule: Interest on bonds

1. issued by C.B - exempt

2. if issued by corp.- not exempt

Rule: Redemptions of share in mutual funds:

- only those gains derived from redemption of shares issued by a mutual fund

company are exempt

- it must emanate from a mutual fund

- If the term is not more than 5 years (5 years or less), the gain derived from the

sale, exchange and retirement of the same, may be subject to tax.

Illustration:

If you are a creditor, you may sell these bonds, debentures or certificates

of indebtedness to another.Hindi mo na mahintay ang maturity kasi long term.If

there is a gain on the sale of the same, it would be a tax exempt provided that

the bonds, etc., have a maturity or term of more than 5 years.

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Retirement of bonds, debenture, etc. ---Nagbayad na ‘yung debtor. There

may be gain derived from the same, such as interest. This time, since the gain

is in the nature of interest, it is subject to tax. But, the gain derived from the

sale, exchange or retirement with a term of more than 5 years, is tax exempt.

This is because exemptions are strictly construed against the taxpayer and

liberally in favor of the government. Interests on bonds, debentures, etc. aretaxable, the provision is clear. It only covers sale/exchange/retirement of bonds,

debentures and other certificate of indebtedness with a maturity of five years.

Strict interpretation of tax exemption.

TYPES/ CLASSIFICATION OF INCOME

1. COMPENSATION INCOME – an income derived under an employee-

employer relationship.

This may include the following: (1EBB-DROP)

Wages,Emoluments,Bonuses,Benefits,Director’s fee, TaxableRetirement

Benefits,Other items of income of similar nature, TaxablePensions

*Retirement benefits may be subject to tax, if it does not comply with the

provision of Sec. 32 (b) par. 6 sub.par a.

* Pensions may be subject to tax, if it is given not in accordance with the

conditions laid down under that exclusion provision.

*Other items of income of similar nature may include:(C0AMP)

Clothing allowance, Hospitalization allowance, Allowances for Food, Medical

allowance, Share from the Profit sharing plan of the employee

*TESTS TO DETERMINE WHETHER AN INCOME IS COMPENSATION or NOT:

Find out whether it is received under an employer-employee

relationship.

Any payment received under an employer-employee relationship is

compensation income.

*TESTS TO DETERMINE THERE EXISTS AN EMPLOYER-EMPLOYEE RELATIONSHIP: (AC-DC)

1. Appointment (selection and hiring)

2. Compensation

3. Dismissal power

4. Control test

N.B. : The name or designation of income is immaterial. The basis of the income

is immaterial and the manner by which it is paid, is also not important. As long

as it is given under an employer-employee relationship, then that is compensation

income.

CANCELLATION OF INDEBTEDNESS – Considered as compensation income is

the indebtedness had been cancelled in consideration of the services rendered.

***Share of the employee from the PROFIT SHARING PLAN of the employer-

Compensation income received in consideration of services rendered.

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TAX LIABILITY OF THE EMPLOYEE PAID BY THE EMPLOYER –

Compensation income if paid under an employer-employee relationship in

consideration of services rendered.

PREMIUMS PAID BY THE EMPLOYER ON THE INSURANCE POLICY OF THE

EMPLOYEE – Compensation income if the beneficiary designated is the family

of heirs of the employee.

***The basis of the income is immaterial. Even if it is paid in piece work, fixed

rate or percentage basis as long as it is paid under an employer-employee

relationship.

REQUISITES FOR TAXABILITY OF COMPENSATION INCOME ARE: (SPR)

1. There must be services, rendered under an employer-employee relationship.

2. If payment must be for that services rendered.3. It must be reasonable. The compensation for services rendered must be

reasonable.

Purpose why only a reasonable amount may be taxed as compensation

income:

Take note on the part of the employer, he can claim such compensation

for services as deduction. Now, only the amount that is reasonable under the

circumstances can be claimed as deduction. So, if the amount or the value of

the services rendered is P10,000 but the employee received P15,000. As far as

the employer is concerned, he can only claim the reasonable amount ofP10,000. In the case of an employee, he can consider P10,000 as compensation

income. The excess of P5,000 may be treated as other income.

***Not all payments for services rendered are considered compensation income.

Only those paid under the employer-employee relationship.

THE FOLLOWING ARE NOT COMPENSATION INCOME:(P I)

1. Compensation for services rendered byindependent service contractor. This

may be treated as trade or business income.

2. Income derived by professionals from the practice of profession underprofessional partnership. This is treated as professional income.

***Fringe benefit is considered as compensation income. This is governed

by Sec. 33, TRA 1997. This is compensation income in the sense that this is

received under an employer-employee relatioship.

DOCTRINE OF CASH EQUIVALENT

- you may be paid in cash or in property/kind

- equivalent value of property is taxable

* DIFFERENT FORMS OF COMPENSATION INCOME:

1. Property/Kind – Fair Market Value(FMV) of the property.If there is a price

stipulated, it is the price stipulated that will be followed in the absence of

contrary evidence.

2. Promissory Note or other evidence of Indebtedness -

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a.If it is not discounted, it is the face value of the promissory note.

b.If it is discounted, it is the fair discounted value of the promissory

note.

3. Stock – FMV of that shares of stock

4. Cancellation of Indebtedness – Cancellation of indebtedness has the

following tax consequences:

a.It may amount to taxable compensation income if the

indebtedness has been cancelled in consideration of the

services rendered.

b.It may amount totaxable gift or donation if the indebtedness

has been cancelled without any consideration at all. This is not

subject to income tax but may amount to taxable gift ordonation.

c.It may amount to capital transaction if the creditor is a

corporation and the debtor is a stockholder.If creditor

corporation condoned the indebtedness of the debtor stockholder,

that may amount to taxable capital transaction. This is the

form of direct dividend. Now, property dividend is subject to tax

rates of 6%, 8% and 10%.Dividend received from domestic

corporation is now subject to tax.

5. Tax liability of the Employee paid by the employer in

consideration of services rendered – amount of tax liability

6. Premiums paid by the employer on the life insurance policy of

the employee.

a.It is a taxable compensation income if the beneficiary designated

are the heirs of the employee or his family.

b.It is not a taxable compensation income if the beneficiary

designated is the employer because it is just a mere return of

capital.

If the designation of the employer as beneficiary is indirect (e.g.: It is

the creditor of the employer that is designated as beneficiary), that is still

not taxable compensation income.

Example of Indirect designation of the employer as a beneficiary:

a.Beneficiary is the wife of the President of a close corporation.

b.If the employer may secure a loan from he insurance policy.

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Premiums will be taxed under Sec. 33 par.b no.10. it is stated there: “Life

or health insurance and other non-life insurance premiums or similar

amounts in excess of what the law allows.

*If the payment was received by the employee when he was no longer

connected with his employer, it is still considered compensation income.

What is important here is that it must be received during the existence of

the employer-employee relationship. Employees may be dismissed by the

employer, and they may file complaint for illegal dismissal against the

employer. Judgment was rendered by the arbiter in favor of the employee.

All the wages supposed to be paid (e.g. backwages) can be taxed as

compensation income. What about attorney’s fees? That is exempt.

FRINGE BENEFITS: code(0EV-0IM-E0E)

FRINGE BENEFIT – Any good, service, or other benefit furnished or granted in

cash or in kind by an employer to an individual employee(except rank and file

employee) such as but not limited to the following:

1. Housing;

2. Expense account;

3 Vehicle of any kind;

4. Household personnel such as maid, driver, others;

5. Interest on loan at less than market rate to the extent of the difference between the market rate and the actual rate granted;

6. Membership fees, dues and other expenses borne by the employer for

the employee in social and athletic clubs or other similar

organizations;

7. Expenses for foreign travel;

8. Holiday and vacation expenses;

9. Educational assistance to the employee or his dependents; and

10. Life or health insurance and other non-life insurance premiums or

similar amounts in excess of what the law allows.(if contribution-

exempt)

* Hou!"# $%%o&$"ce '$ e e*e'+, ro' ,$* ! ,e %!/!"# 0u$r,er $re:

a.Provided with the premises of the employer.

b.It must be made as a condition of employment.

If said requisites are not present, housing allowance may be taxed

as fringe benefits.

* Me$% $%%o&$"ce '$ e e*e'+, ro' ,$* ! it is provided within the premises of the

employer.

* Pr!/!%e#e or +urc$e 1!cou", $re ,$* e*e'+, ! it does not exceed ½ of the basic

monthly salary of the employee.If it is more than ½, the excess may be as fringe

bene

2 Me1!c$% or o+!,$% $%%o&$"ce c%o,!"# $%%o&$"ce r!ce $%%o&$"ce '$ e e*e'+, ro' ,$* !

,e o%%o&!"# re0u!!,e $re +ree",:

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1. It must be of relatively small value (reasonable amount). (RSV)

2. It must be given for the following purposes: (CHEG)

a. To promote Contentment

b. To promote Health

c. To promote Efficiency

d. To promote Goodwill

* Tax Exempt fringe benefits: (RF DM C E% ECR)

1. Benefits given to the rank and file employees, whether granted under a

collective bargaining agreement or not.

2. “De minimis benefits” – means of small amount. These are benefits relatively

of small amount.

3. Contributions of the employer for the benefit of the employee to retirement,

insurance and hospitalization benefits plans.

4. Fringe benefits which are authorized or exempted from tax under special

laws.

5. Those given for the convenience of the employer, including those which are

required by the nature of the trade, business or profession of the employer

(Employer’s Convenience Rule)

De minimis benefits (of relatively small value) – limited to facilities or privileges

furnished or offered by employer to his employees merely as a means of

promoting health, goodwill, contentment, or efficiency of employees, such as:

a. Monetized unused vacation leave credits not exceeding ten (10) days

during the year;

b. Medical cash allowance to dependents of employees not exceeding P750

per semester of P125 per month;

c. Rice subsidy of P350 per month;

d. Uniforms;

e. Medical benefits

f. Laundry allowance of P150 per month;

g. Employee achievement awards, for length of service of safety achievementin the form of tangible personal property other than cash gift certificate,

with an annual monetary value not exceeding ½ month of the basic

salary of employee receiving the award under an established written plan

which does not discriminate in favor of highly paid employees;

h. Christmas and major anniversary celebrations for employees and their

guests;

i. Company picnics and sports tournaments in the Philippines and are

participated in exclusively by employees; and

j. Flowers, fruits, books or similar items given to employees under special

circumstances on account of illness, marriage, birth of a baby, etc.

*Principle of Employer’s Convenience Rule:

- fringe benefits may be exempt/not subject to tax if these are given

for the benefit or advantage of the employer.

Te o%%o&!"# $re ,e +o!%e r!"#e e"e!, &!c '$ e e*e'+, u"1er ,e E'+%oer4

Co"/e"!e"ce Ru%e: (0 V 0 M $)

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a.Housing benefit

b.Vehicle

c.Household personnel

d.Membership in a social or athletic club or similar organization

e.Traveling expense benefit

*Housing benefit – in determining whether the same is exempt under the

employer’s convenience rule, you have to consider the peculiar nature of the

special needs of the employer. Re0u!!,e or e*e'+,!o":

1. It must be made as acondition for employment;

2. It must be provided within the premises of the employer

*** This may apply to a supervisor of a plant or a company.

*If the housing or living quarters are provided outside the premises of theemployer, even if that is for the convenience of the employer, this is only exempt

up to 50% of the amount. So, 50% taxable, 50% exempt.

*Vehicle – Exempt but depends upon the peculiar nature of the special needs

of the business of the employer.

Example: LBC or DHL business

*Household personnel such as maid, driver and others – Exempt, but

depends upon the peculiar nature of the business of the employer.

*Membership in a social club, etc. – Peculiar nature requirement.

*Traveling expense benefit – Peculiar nature requirement.Example: Employer

sent his employees abroad to attend a particular seminar to improve their

technical know-how.

BAR QUESTION: A is a driver of Congressman Magtanggol and he received a

monthly salary of P5,000 and living quarter allowance of P2,500.

a. Whether the P2,500 living quarter allowance is excluded or subject to

tax?

b. Assuming the employer is an obstetrician would your answer be the

same?

ANSWER:

a.That should be subject to tax.

b.It should be excluded. Reason: Convenience of the employer’s rule.

2. GROSS INCOME FROM BUSINESS, TRADE OR PROFESSION

BUSINESS – Any activity that entails time, attention, effort for purposes of

livelihood or profit.

As regards construction business, the taxpayer here must be an

independent contractor. He may report his income under the

percentage of completion method or under the so-called completed

contract method.

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PROFESSIONAL INCOME – The recipient of the same must be professionals.

How about those who claim that they are professionals but are not

registered in the P. R. C., can they still be tax as such?

Yes, irrespective of whether they are licensed or not because of the

rule that gross income derived from whatever source.

3. PASSIVE INCOME

PASSIVE INCOME – This is the income that is subject to final tax.

Income subject to final tax are the following: (code:RPD-1IDS)

1. Royalties

2. Prizes

3. Winnings

4. Interests on bank deposit, deposit substitutes, trust funds and

other similar arrangements.

5. Dividend received from domestic corporation, mutual fund insurance

company, regional headquarters of multi-national corporation and

other corporation.

6. Share a partner in the net income after tax of a taxable partnership,

joint account, joint venture or concessions.

*** Do "o, !"c%u1e +$!/e !"co'e !" ,e !"co'e o our u!"e or +roe!o" or !" our

co'+e"$,!o" !"co'e. This is so because when you receive this income, the tax

had already been imposed and deducted.

RC, NRC, RA NRA-ETB NRA-NETB

ROYALTIES 20% except in

the case of

literary works,

books and

musical

compositions

which are

subject to 10%

final tax

Same as RC,

NRC, RA

25%

PRIZES

exceeding

P10,000.00

If it is

P10,000.00 or

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less, it is NOT

subject to final

tax but the same

must be included

in other income(e.g.

compensation,

business,

professional)

20% 20% 25%

WINNINGS

except PCSO &

Lotto

20% 20% 25%

INTERESTS ON

BANK

DEPOSITS, etc.

20% 20%

25%

DIVIDENDS

RECEIVED

from domestic

corp., etc.

Subject to

increasing rates

of 6% if received

in 1998; 8% in

1999; and 10%

in 2000.

20% 25%

SHARE OF A

PARTNER in

the net income

after a tax of a

taxable

partnership,

etc.

- do-

6, 8 & 10

20% 25%

Question: How do you treat that share of a professional partner from the net

income of a general-professional partnership?

Answer: This should be taxed at the rate provided under Sec.24, that is, 5% to34%.

Bu, $ re#$r1 ,e $re o $ +$r,"er !" ,e "e, !"co'e $,er ,$* o $ ,$*$%e or

u!"e +$r,"er!+, that is one which is subject to final tax.

PRIZES – may be exempt if given in sports competition and if given primary in

recognition of scientific, artistic, literary, educational, religious, charitable, or

civic achievement.

INTEREST Ru%e

1. If it is an interest on foreign currency deposit system, it is exempt.

If the recipient is non-resident individual (NRC, NRA-ETB, NRA-NETB).

2. If the recipient is a resident individual (RC, RA), that is subject to 7.5 %.

3. Interest income is also exempt if it is an interest income on a long- term

deposit or long-term investment (this must have a term of not less than 5

years).

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I ,e ,er' ! %e ,$" 5 e$r !, ! uec, ,o ,e o%%o&!"# r$,e:

1.4 years to less than 5 years 5%

2.3 years to less than 4 years 12%

3. Less than 3 years 20%

DIVIDEND RECEIVED FROM DOMESTIC CORPORATION

1. This is exempt from tax if the recipient is a foreign government, financing

institution, regional financing institution, international financing

institution established by foreign government [see Sec.32 (B) (7) (a)].

2. It is also exempt if the recipient of such dividend is another domestic

corporation or resident foreign corporation [see Sec. 28(A)(7)(d)]

CAPITAL GAIN DERIVED FROM SALE OF SHARES OF STOCK

L!,e1 $"1 ,r$1e1 ,rou# %oc$% ,oc7 e*c$"#e 8 this is not subject to

income tax but subject to percentage tax of ½ of 1% of the gross

selling price.

No, %!,e1 $"1 ,r$1e1 ,rou# %oc$% ,oc7 e*c$"#e – this is the one

subject to income tax.

Not over P100,000.00 5%

Amount Over P100,000.00 10%

If the share of stock is not listed and traded through local stock

exchange, the basis of the tax is net capital gain. So, you should

first deduct the capital loss.

If listed and traded through local exchange, there is no deduction

allowed because the basis of the tax rate of ½ of 1% of the gross

selling price.

The above-mentioned tax rates apply to all individual taxpayers.

* CAPITAL GAIN DERIVED FROM THE SALE OF REAL PROPERTY

- The real property involved must be considered CAPITAL ASSET.

- The tax on capital gain derived from the sale of real property is 6% of the

gross selling price or zonal value which ever is higher.

*CAPITAL ASSET – property held by the taxpayer whether or not connected in

his trade or business except:(code: SO2R)

1. Stock in trade or other property of any kind which would be includedin the inventory of the taxpayer if on hand at the end of the taxable

year.

2. Property primarily held for sale to customers in the Ordinary course

of trade or business.

3. Property Used in trade or business subject to depreciation

4. Real property used in trade or business.

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2. Additional rent income which includes:

a.O%!#$,!o" o ,e %eor $u'e1 ,e %eee The following are obligations

which may be assumed by the lessee:R.I.D.I.O.,

a.1. Real property taxed on leased premises

a.2. Obligation to pay insurance premium on the insured leasedpremises

a.3. If the lessor is a corp., the obligation to distribute Dividends to its

stockholders

a.4. Obligation to pay interest on the bonds issued by the lessor.

a.5 Other obligations of the lessor which may be assumed by the

lessee.

b.


32/103

STOCK DIVIDEND–$ $ ru%e "o, ,$*$%e. This is so because there is no income

here. It merely represents the transfer of surplus account to the capital

account.

EXCEPTIONS to the Rule:

S,oc7 1!/!1e"1 '$ e uec, ,o ,$* u"1er ,e o%%o&!"# e*ce+,!o"$% c$e: C OR D,1. If there is a Change in the stockholders interest in the net assets of the

corp;

2. If it is one issued by Other corp. We call that “1!/!1e"1 ,oc7 ”

S,oc7 1!/!1e"1 /. 1!/!1e"1 ,oc7 – Stock dividend as a rule is not taxable

whereas dividend in stock is taxable.

3. Redemption of stock dividend;

4. If the corp. issues Different shares of stock. If the corp. issues two

different classes of shares of stock, the dividend that may be declared

thereafter is taxable.

Example:

Ou,,$"1!"# ,oc7 S,oc7 1!/!1e"1 T$*$%e

1. Preferred Common NT

2. Common Preferred NT

3. Preferred Preferred NT

4. Common Common NT

5. Preferred/Common Preferred T

6. Preferred/Common Common T

D!#u!e1 1!/!1e"1 8 treasury stock dividend declared out of the outstanding

capital stock, the purpose of which is to avoid the effect of taxation

(Commissioner vs. Manning).

It is one which is made to appear as stock dividend when the truth of the

matter is that it is a dividend which is illegally declared, such a case, since the

purpose is to evade taxation, it is taxable.

Remember,,re$ur $re o ,oc7 $re "o, e",!,%e1 ,o 1!/!1e"1.

ALLOWABLE DEDUCTIONS (SEC. 34)

A re#$r1 !"1!/!1u$% ,$*+$er ,e o%%o&!"# '$ c%$!' $%%o&$%e 1e1uc,!o":

1. RC

2. NRC, only those expenses incurred in the Phils. because here, we

cannot tax his income derived from sources without.

3. RA, only those expenses incurred in the Phils.

4. NRA-ETB, but only those expenses incurred in the Phils.

5. PP (Professional Partners under Sec. 26)

E*ce+,!o":

1. IT earning CI – EE, ER REL

2. NRA-NTB

3. Aliens employed

A. RMC

B. OBU

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33/103

C. PSC

4. NRFC A re#$r1 cor+or$,e ,$*+$er ,e o%%o&!"# $re e",!,%e1 ,o c%$!' $%%o&$%e

1e1uc,!o":

1. DC, which includes private educational institutions, non-profit hospital,

government-owned and controlled corps.2. RFC

ITEMIZED DEDUCTIONS: [EI.$BDDCRC,

1. Expenses 6. Depreciation

2. Interests 7. Depletion of oil, gas, wells and mines

3. Taxes 8. Charitable contributions

4. Losses 9. Research & Development

5. Bad debts 10. Contribution to Pension Trust

* In the case ofindividual taxpayers, they may avail of theoptional standard

deduction of 10% of gross income

* Corporate taxpayers are not allowed to claim 10% optional standard

deductions.

* All individual taxpayers except the NRA individual may claim this optional

standard deductions.

* I,e'!=e1 1e1uc,!o" '$ $++% ,o cor+or$,e ,$*+$er $ &e%% $ !"1!/!1u$% ,$*+$er.

* FUNDAMENTAL PRINCIPLE IN DEDUCTIONS

1. The taxpayer must prove that there is law authorizing deductions.2. The taxpayer must prove that he is entitled to deductions.

***NRFC are not entitled to claim deductions.

1. EXPENSES

ORDINARY & NECESSARY EXPENSES

When we speak of ORDINARY, this simply refers to the expenses which are

normal, usual or common to the business, trade or profession of the taxpayer.

This may not be recurring.

Example: if an action is filed in court, it is but normal to hire the services of a

lawyer. So, the taxpayer has to pay attorney’s fees. It is an ordinary expense

under this circumstances.

NECESSARY- It is one which is useful and appropriate in the conduct of the

taxpayer’s trade or profession.

ORDINARY & NECESSARY EXPENSES

-are those which are incurred or paid in the development, operation

management of the business, trade or profession of the taxpayer.

EXTRA-ORDINARY EXPENSES – No, De1uc,!%e. These are amortized or in lieu of

the same, you may claim that so-called allowance for depreciation. And if it

involves intangible asset, the word used is AMORTIZATION.

There is no hard and fast rule. An expense may be ordinary insofar

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as a particular taxpayer is concerned and it may not be an ordinary

as regards another taxpayer.

Example:

If you have business here in Manila and you also have business in Tawi-

tawi, what is the expense that you may incur in Tawi-tawi which you may notpossibly incur in Manila?

In Tawi-tawi, you may need people to guard your business. But here in

Manila, you may need not because of our new President-elect.

KINDS OF ORDINARY & NECESSARY EXPENSESC.A.R.$.E.R.S.,

1. Compensation for services rendered

2. Advertising & promotional expenses

3.Rent expenses

4. Travelling expenses5. Entertainment expenses

6. Repairs & maintenance expenses

7. Supplies and materials

COMMON RE>;ISITES 9OR DED;CTIBILITY o ,ee or1!"$r ? "ece$r e*+e"e:

D.I.R.,

a. Must be paid or incurred DURING the taxable year.

If you incur expenses in 1997, you cannot carry this over to 1998.

expenses incurred during a particular year must be claimed as

deductions during this year when the same were incurred.

“PAID” – to signify the fact that the taxpayer uses the CASH

BASIS. Under the CASH BASIS, an expense is recognized

when it is PAID.

“INCURRED” – implies that the taxpayer employs the ACCRUAL

BASIS. Under the ACCRUAL BASIS, income is recognized

when earned regardless of the receipt of the same and

the expense is recognized when incurred.

b. Must be paid or incurred in connection with the trade, business or profession of the taxpayer.

c. Must be proven by RECEIPTS.

SPECIAL REQUISITES FOR DEDUCTIBILITY OF THESE ORDINARY &

NECESSARY EXPENSES:

1. COMPENSATION FOR SERVICES RENDERED

This must bereasonable, meaning, this must not be ostensible.

Case 1: Partnership was sold to a corp. and it was agreed that the

partners will serve the corp. and make it appear that they render services. So,

compensation for services was ostensibly made by the corp.

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Held: These is a mere ostensible salary or payment for services not

actually rendered because that amount really forms part of the properties

purchased by the corp.

Case 2: Corporate officers succeeded in selling the property of the corp.

So, profit was derived therefrom. Bonuses were given to these corporate officers.

Held: The rule is settled. Bonuses must be given in good faith. There

must be services rendered because bonuses are additional compensation. In

this particular case, there was really no services rendered because that sale

was made through a broker. The corp. made it appear that it was through the

efforts of these corporate officers that brought about a successful sale of

property.

Bonuses must be given in good faith and in determining whether bonuses

will form part of the compensation for services rendered, you have to consider the(1) nature of the business, (2) the financial capacity of the taxpayer and (3) the

extent of the services rendered.

2. ADVERTISING AND PROMOTIONAL EXPENSES

- It must bereasonable.

Case:Sugar Dev’t. Corp paid P125,000.00 to Algue Corp. representing

promotional expenses.

Held: This is reasonable under the circumstances because the particular budget subject for promotion involves million of pesos. And under that

circumstances, the P125,000.00 is reasonable as this may coincide with the

efforts exerted considering that the taxpayer has no venture in that

experimental project to establish that vegetables of investment company and

this involves millions of pesos.

3. RENT EXPENSE

a. The taxpayer mustNOT be the owner of the property or he has no

equitable title over the property.

b. This issubject to withholding tax.

You cannot claim that the taxessupposed to be withheld have not been paid or remitted to BIR.

4. TRAVELLING EXPENSES

- This must beincurred or paid while “away from home”.

-“Home” does not refer to your residence but to the station assignment or post.

Example: From home office to branch office, the traveling expenses incurred

are deductible. And this includes not only the transporatiotion expenses but

also meal allowance and hotel accommodations.

5. ENTERTAINMENT EXPENSES

- Thismust not be contrary to law, morals, good customs, public policy or public

order.

- Hence,bribes, kickbacks, and similar payments are not deductible.

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THEORETICAL INTEREST – an interest which is computed or calculated, not

paid or incurred, for the purposes of determining the opportunity cost of

investing in a business. This does not arise from legally demandable interest-

bearing obligation. This isnot a deductible interest.

Question 3: What about interest on preferred stock, is this deductible?

Answer:

As a rule,!",ere, o" +reerre1 ,oc7 ! "o, 1e1uc,!%e, because there is no

obligation to speak of. It is in effect an interest on dividend. The reason why it is

not deductible is that the payment is dependent upon the profits of the corp. It

will only be paid if the corp. earn profits. And would not be paid of the corp.

incurs losses.

B;T ! !, ! "o, 1e+e"1e", u+o" cor+or$,e +ro!, or e$r"!"# ,$, ! 1e1uc,!%e. If ispayable on a particular on a particular date or maturity without regard to the

corporate profits, it is deductible.

The Supreme Court mentions TWO (2) FACTORS:

1. not dependent upon corporate profits; and

2. agreement as to the date or term within which payment will be made.

INTEREST ON O


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a.members of the same family which includes:

a.1. spouses

a.2. brothers and sisters

a.3. descendants and ascendants

b.between two (2) corporations owned or controlled by one individual. He

must have a controlling interest over these two corporations. OR, ifone corp. is considered as personal holding company of another corp.

c.between a corp. and an individual; that individual owns or controls

more than 50% of the outstanding capital stock of the such corp.

d. parties to a trust;

d.1. grant or fiduciary

d.2. fiduciary of one trust and fiduciary of another trust but there

is only one grantor

d.3. beneficiary and fiduciary

*Your knowledge of related taxpayers is also important in determining whether losses are deductible or not.If losses were incurred or paid in

connections with the transactions between these related taxpayers, these

are not deductible.

Question: How much interest expense is deductible?

Answer: The interest that may be claimed as deductions shall be reduced

by:

a. 41% - Beginning January 1, 1998

b. 39% - Beginning January 1, 1999

c. 38% - Beginning January 1, 2000 of the income subject

to final tax.

EXAMPLE OF INCOME SUBJECT TO FINAL TAX:

1. interest on bank deposit

2. interest on deposit maintained under the foreign currency deposit system

So, if the interest income on bank deposit amounted to P100,000.00. And the

total interest expense incurred or paid by the taxpayer is P200,000.00. If this is

incurred in 1998, 41% of P100,000.00 is P41,000.00. That P200,000.00 interest

expense incurred or paid, should be reduced to P41% of that P100,000.00 toarrive at P159,000.00 which is the interest that may be claimed as deduction.

P200,000.00

- 41,000.00

-----------------------

P159,000.00

The rule has been established that TAXES are NOT ORDINARY

OBLIGATIONS. But theSupreme Court in two (2) cases relaxed the distinction

between taxes and ordinary obligations.

1. The!",ere, o" 1e!c!e"c 1o"or4 ,$* ! 1e1uc,!%e. The SC explained that taxes

here are considered obligations or indebtedness. And it ruled that we have

to relax the distinction between tax and ordinary obligation in this respect.

2. I",ere, o" 1e!c!e"c !"co'e ,$* c$" $%o e c%$!'e1 $ 1e1uc,!%e !",ere, e*+e"e

because taxes here are considered ordinary obligations.

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3. TAXES

REQUISITES FOR DEDUCTIBILITY:

1. This must be paid or incurred during the taxable year.

2. This must be taxes paid or incurred in connection with the trade, business or

profession of the taxpayer.

***Taxes that may be claimed as deductions may be national or local taxes.

THE FOLLOWING ARE NON-DEDUCTIBLE TAXES S.I.N.E,1. SPECIAL ASSESSMENT – tax imposed on the improvement of a parcel of

land

2. INCOME TAX – This includes foreign income tax. In this regard, the so-

called foreign income tax may be claimed as a deduction from gross

income or this may be claimed as tax credit against Phil. income tax. In

the event that he claims that as tax credit, he can no longer claim the

same as deduction.

3. Taxes which areNOT CONNECTED WITH THE TRADE, BUSINESS OR

PROFESSION OF THE TAXPAYER

4. ESTATE TAX, DONOR’S TAX (see also discussion on tax benefit rule)

TAX AS DEDUCTIONS vs. TAX CREDIT

► Taxes as deductions may be claimed as deductions from gross income.

► Tax credit is a deduction from Phil. income tax.

► Tax as deduction includes those taxes which are paid or incurred in

connection with the trade, business or profession of the taxpayer. However,

the sources of a tax credit is foreign income tax paid, war profit tax, excess

profit tax paid to the foreign country.

► The foreign income tax paid to the foreign country is not always the

amount that may be claimed as tax credit because under the limitation

provided under the Tax Code, it must not be more than the ratio of foreign

income to the total income multiplied by the Phil. income tax.

► Taxes are deductible only by the person upon whom the tax is imposed

Except:

1. Share holder

2. corporate bonds - tax free Covenant clause

The following are entitled to claim tax credit:

1.RC 2. DC

4. LOSSES

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CLASSIFICATION OF LOSSES [O. C. W. – C. S.]

1.ORDINARY LOSSES – losses sustained in the course of trade,

business or profession of the taxpayer.

2.CAPITAL LOSSES – the assets that must be involved there must be

capital assets

Capital Losses include the following:

a. Loss arising from failure to exercise privilege to sell or buy property

b.Worthless securities

c. Abandonment losses in the case of natural resources

d. Loss from wash sale

3.WAGERING OR GAMBLING LOSSES – the amount that is deductible

must not exceed the gains.

E*$'+%e: The winnings amounted to P1,000.00 Loss is P500. This loss is

deductible.

If the winning is P500 and if the loss is P1,000. The amount deductible is

only P500 because the amount must not exceed the gains.

If there is no winnings and loss is P500. Deduction losses here is ZERO.

4.CASUALTY LOSSES – this must be reported to the BIR earlier than 30

days but not later than 45 days following the date of the loss.

Casualty losses include:a. Fire

b. Storm

c. shipwreck

d. Other casualty losses

e. Robbery

f. Embezzlement

g. Theft

5.SPECIAL LOSSES –!"c%u1e ,e o%%o&!"#

a.loss arising from voluntary removal of buildings as an incident to renewal or

replacement

Problem:

Supposed the taxpayer had a building constructed on a parcel of land.

He owned this as well as the building erected thereon. He had

business and his business was conducted within the premises. Then,

he decided to remove such building as to construct a new building for

new business.

Is the cost of demolition to give way to a new building deductible loss?

YES.

Suppose A purchased that parcel of land of B and included in that

sale was that of the building. A demolish this building in order to

construct a new building. Is the cost of demolition deductible insofar

as A is concerned?

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NO. That can only be claimed as deductions if the one demolishing the

same is the taxpayer. The moment that is sold to another claim that as

deductible loss. The treatment here is, the cost of demolition should

be capitalized in the selling price.

Exception:A may claim that as deductible loss if this was demolished

by value of a court order because the gov’t considered this as a fire

hazard, loss of useful value of property or capital asset.

THE COMMON REQUISITES for DEDUCTIBILITY OF LOSSES are:

1. Losses must be actually/sustained and not mere anticipated losses;

2. Must not be compensated by insurance;

--- If it is partly compensated, only the amount not compensated by

insurance is deductible.

3. Must be evidenced by a completed transaction.

Completed Transaction –this means that the loss must be fixed by

identifiable event.

Example: If it is a loss sustained from sale, the event that may identify

or complete the transaction is the consummation of the contract of sale.

Suppose it is in the nature of casualty losses like fire?

The fire destroyed your property in 1995, no payment has been made

because the insurer and the insured were still under negotiation. It was

only in 1997 that they agreed on the amount. The amount agrees upon is

P100,000. The taxpayer may claim that casualty losses only in 1997 when

payment was actually made. This is the event that will complete the

transaction.

5. BAD DEBTS

REQUISITES FOR DEDUCTIBLITY: C2 1 $BP VS 2,

1.Must becharged off and uncollectible within the taxable year;

2. Must be ascertained to beworthless

3.Mustarise from trade, business or profession of the taxpayer;

4.Must bevalid and subsisting indebtedness;

5.Must beuncollectible in the near future.

HOW TO PROVE THE WORTHLESSNESS OF OBLIGATION:

According to the Supreme Court, the following STEPS must be complied:

1. There must be a statement of account sent to the debtor;

2. A collection letter;

3. If he failed to pay, refer the case to a lawyer;

4. If lawyer may send a demand letter to the debtor;

5. If the debtor still fails to pay the same, file an action in court for

collection.

In proving that the debtor is insolvent of bankrupt, mere allegation of the

same is not enough. You should prove that the debtor is indeed

bankrupt or insolvent. So, you maysecure a copy of that decision by the

SEC or other agency as the case may be, declaring the debtor as

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bankrupt or insolvent. And then there must be a demand letter sent to

him.In case the debtor was robbed, there must be a police report to that

effect.

Thedebtor may be a NRFC, so you may argue that he may not be sued

here. According to the Supreme Court, as a rule that is not an excuse. You shouldstill send a demand letter to that NRFC. In other words,there

must be diligent efforts to collect the indebtedness and to prove that in the

near future such obligation is no longer collectible.

*** If the recovery of bad debts, resulted in a tax benefit to the taxpayer, that

is taxable.If it did not result in any tax benefit to the taxpayer, that is not

taxable.(TAX BENEFIT RULE)

N.B. Read the case ofPhil. Refining Company vs. Commissioner, a 1989 case.

6. DEPRECIATION

The idea here is not to recover profit, but to recover the cost of property

invested in business. When the properties are used in trade, business or

profession of the taxpayer, the law considers or recognizes the gradual loss or

sale of property.

DEPRECIATION refers to the gradual diminution of the useful value ofthe property used in trade, business or profession of the taxpayer,

arising from wear and tear or natural obsolence.

REQUISITES FOR DEDUCTIBILITY: 2 P R A C ,

1. The property must beused in trade, business or professionof the taxpayer;

2. There must bedepreciable properties.

The"o"-1e+rec!$%e +ro+er,!e $re

a. Personal property not used in trade, business or profession of thetaxpayer;

b. Inventoriable stock and securities

c. Land

d. Mining and other natural resources

3. Theallowance for depreciation must be reasonable

4. Themethod in computing the allowance for depreciation must bein

accordance with the method prescribed by the Sec. of Finance upon the

recommendation of the BIR Commissioner.

T! +recr!e1 'e,o1 !"c%u1e:a. Declining balance method

b. Sum of the years digit method

c. Straight line method

d. Any other method as may be prescribed by the Sec. of Finance upon

the recommendation of the BIR Commissioner

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5. This must becharged off during the taxable year.

7. DEPLETION –"$,ur$% reource

► This involves natural resources such as oil, gas wells and mines. These are

non-replaceable assets.

► Therequisites for deductibility are the same as that of depreciationexcept

that the properties involved are natural resources

► The idea here is not for profit but to recover the cost of investment through

this allowance for depletion.

8. CHARITABLE AND OTHER CONTRIBUTIONS

*Tee $re u%% 1e1uc,!%e ! ,e co",r!u,!o" $re #!/e" ,o ,e o%%o&!"#: F. A. /.,

1. Government or its political subdivisions, agencies or instrumentalities, for

the purpose of undertaking priority projects of the government;Tee +r!or!, +roec, !"c%u1e: S.0.E.,

a. Sports development, science and invention

b. Health and human settlement

c. Educational and economic development

2. Foreign government or institution and international civic organizations;

3. Accredited NGO

N.G.O. means non-profit domestic corporation which are formed and

organized for any of the following purposes:C.0.E.R.S.,

a. Research

b. Health

c. Education

d. Charitable, cultural, character building

e. Sports development and social welfare

Te $'ou", o c$r!,$%e co",r!u,!o" ,$, '$ e c%$!'e1 $ 1e1uc,!o" '$ e:

1. In the case of individual taxpayer:

- Not more than 10% of the net income before charitable contribution

2.In the case of corporate taxpayer:

- Not more than 5% of the net income before the charitable contribution

► I9 ,e rec!+!e", o uc co",r!u,!o" ! $" o ,e o%%o&!"# DC or'e1 or or#$"!=e1 or :

[R.E.C.S.]

1.Religious purpose and rehabilitation of veterans

2.Educational purpose like educational corporations which are not qualifiedas NGO

3.Charitable, cultural purpose

4.Scientific, sports

taxation reviewer- dimaampao

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