Income Taxation (Angelfire)

INCOME TAXATION
IN GENERAL
Income Tax
Income tax has been defined as a tax on all yearly profits arising
from property, profession, trade or business, or as a tax on a persons
income, emoluments, profits and the like.
It is generally regarded as an excise tax. It is not levied upon

persons, property, funds or profits but upon the right of a person to
receive income or profits.
Purposes of income taxation

1.
To provide large amounts of revenues.
2.
To offset regressive sales and consumption taxes.
3.
Together with estate tax, to mitigate the evils arising from the
inequalities in the distribution of income and wealth, which are
considered deterrents to social progress, by imposing a progressive
scheme of taxation.
Income
Income, in its broad sense, means all wealth which flows into the
taxpayer other than as a mere return on capital. [Section 36, Revenue
Regulations 2]
Income means accession to wealth, gain or flow of wealth.
Conwi v. CTA [213 SCRA 83]: Income may be defined as an amount

of money coming to a person or corporation within a specified time,
whether as payment for services, interest, or profit from investment.
Commissioner v. BOAC [149 SCRA 395]: Income means cash

received or its equivalent. It is the amount of money coming to a
person within a specific time. It is distinct from capital for, while the
latter is a fund, income is a flow. As used in our laws, income is flow of
wealth. The source of an income is the property, activity or service that
produces the income. For the source of income to be considered as

coming from the Philippines, it is sufficient that income is derived from
activity within the Philippines. IN BOACs case, the sale of tickets in the
Philippines is the activity that produces the income.
Fisher v. Trinidad [43 Phil 973]: Stock dividend is not an income. It

merely evidences the interest of the stockholder in the increased
capital of the corporation. An income may be defined as the amount of
money coming to a person or corporation within a specified time,
whether as payment for services, interest, or profit for investment. A
mere advance in the value of property of a person or corporation in no
sense constitutes the income specified in the revenue law. Such
advance constitutes and can be treated merely as an increase of
capital. An income means cash received or its equivalent. It does not
mean choses in action or unrealized increments in the value of the
property.
Income v. capital
Capital is a fund or property existing at one distinct point of time

while income denotes a flow of wealth during a definite period of time.
The essential difference between capital and income is that capital is

a fund or property existing at one distinct point of time; income is a
flow of services rendered by that capital by the payment of money
from it or any other benefit rendered by a fund of capital in relation to
such fund through a period of time. Capital is wealth, income is the
service of wealth. [Madrigal v. Rafferty, 38 Phil 414]
Capital is the tree while income is the fruit.
SOURCES
OF INCOME
What produces income?
The term source of income is not a place but the property, activity
or service that produced the income. In the case of income derived
from labor, it is the place where the labor is performed; in the case of
income derived from the use of capital, it is the place where the capital
is employed; and in the case of profits from the sale or exchange of
capital assets, it is the place where the sale or transaction occurs.
Commissioner v. BOAC: The source of an income is the property,

activity or service that produces the income. For the source of income
to be considered as coming from the Philippines, it is sufficient that
income is derived from activity within the Philippines. IN BOACs case,

the sale of tickets in the Philippines is the activity that produces the
income. The tickets exchanged hands here and payments for fares
were also made in Philippine currency. The site of the source of the
income is the Philippines and the flow of wealth proceeded from and
occurred in Philippine territory, enjoying the protection accorded by the
Philippine government. Thus, said flow of wealth should share the
burden of supporting the government.
Sources of income
1.
Sources within the Philippines
2.
Sources without the Philippines
3.
Sources partly within and partly without the Philippines
TAXABLE INCOME
Taxable income
The term taxable income means the pertinent items of gross

income specified in the NIRC, less the deductions and/or personal and
additional exemptions, if any, authorized by such types of income by
the NIRC or other special laws.
Requisites for income to be taxable

1.
There must be a gain or profit.
2.
The gain must be realized or received.
3.
The gain must not be excluded by law or treaty from taxation.
Gain must be realized or received
This implies that not all economic gains constitute taxable income.
Thus, a mere increase in the value of property is not income but
merely an unrealized increase in capital.
When is income considered received?

1.
actual receipt
2.
constructive receipt
Income constructively received
Income which is credited to the account of or set apart for a taxpayer

and which may be drawn upon by him at any time is subject to tax for
the year during which so credited or set apart, although not then
actually reduced to possession.
To constitute receipt in such a case, the income must be credited
to the taxpayer without any substantial limitation or restriction as to
the time or manner of payment or condition upon which payment is to
be made. [Section 52, Revenue Regulations 2]
Limpan Investment Company deemed to have constructively

received rental payments in 1957 when they were deposited in court
due to its refusal to receive them. [Limpan v. CIR, 17 SCRA 703]
Examples of constructive receipt

1.
Interest coupons which have matured and are payable, but have not
been cashed.
2.
Defaulted coupons are income for the year in which paid.
3.
Partners distributive share in the profits of a general professional

partnership is regarded as received by the partner, although not yet
distributed.
Are the following items income?
Found treasure - YES
Punitive damages - YES
Damages for breach of promise or alienation of affection - YES
Worthless debts subsequently collected - YES
Tax refund NO (but yes if the tax was previously allowed as a

deduction and subsequently refunded or credited, as benefit accrued
to the taxpayer; see discussion on tax as a deductible item)
Non-cash benefits - YES
Income from illegal sources - YES
Psychological benefits of work - NO
Give away prizes YES
Scholarships/fellowships YES
Stock dividends - NO
Tests to determine realization of income

1.
Severance test
2.
Substantial alteration of interest test
3.
Flow of wealth test
Severance test
As capital or investment is not income subject to tax, the gain or

profit derived from the exchange or transaction of said capital by the
taxpayer for his separate use, benefit and disposal is income subject to
tax.
Substantial alteration of interest test
Income is earned when there is a substantial alteration of the interest

of a taxpayer, i.e. increase in proportionate share of a stockholder in a
corporation.
Income to be returnable for taxation must be fully and completely

realized. Where there is no separation of gain or profit, or separation of
increase in value from capital, there is no income subject to tax.
Thus, stock dividends are not income subject to tax on the part of the
shareholder for he had the same proportionate interest in the assets of
the corporation as he had before, and the stockholder was no richer
and the corporation no poorer after the declaration of the dividend.
However, if the pre-existing proportionate interest of the
stockholder is substantially altered, the income is considered derived
to the extent of the benefit received.
Moreover, if as a result of an exchange of stocks, the person received

something of value which are essentially and fundamentally different
from what he had before the exchange, income is realized within the
meaning of the revenue law.
Flow of wealth test
The essential difference between capital and income is that capital is

a fund whereas income is the flow of wealth coming from such fund;
capital is the tree, income is the fruit. Income is the flow of wealth
other than as a mere return of capital.
CLASSES
OF INCOME
Kinds of taxable income or gain

1.
capital gain
2.
ordinary gain
a.
business income
b.
compensation income
c.
passive income
d.
other income from whatever source derived i.e. found treasure
Capital gains
Capital gains are gains or income from the sale or exchange of

capital assets. These include:
1.
Income from dealings in shares of stock of domestic corporation

whether or not through the stock exchange;
2.
Income from dealings in real property located in the Philippines;

and
3.
Income from dealings in other capital assets other than (a) and
(b).
Ordinary gains
Ordinary gains are gains or income from the sale or exchange of

property which are not capital assets.
Business income
1.
Income from trading, merchandising, manufacturing or mining
2.
Income from practice of profession
Note: The term trade or business includes the performance of the

functions of a public office. [Section 22(S), NIRC]
Passive income
1.
Passive income from Philippine sources subject to final tax
2.
Passive income from Philippine sources not subject to final tax
3.
Passive income from sources outside the Philippines
Passive income again

1.
Interest income
2.
Rentals/Leases
3.
Royalties
4.
Dividends
5.
Annuities and proceeds of life insurance/other types of insurance
6.
Prizes and winnings, awards, and rewards
7.
Gifts, bequests, and devises
8.
Other types of passive income
APPROACHES
IN INCOME
RECOGNITION
Approaches in income recognition

1.
schedular system
2.
global system
Schedular system
The schedular system is one where the income tax treatment varies
and is made to depend on the kind or category of taxable income of
the taxpayer.
Global system
The global system is one where the tax treatment views indifferently
the tax base and generally treats in common all categories of taxable
income of the taxpayer.
Schedular system v. global system

1.
Under the schedular treatment, there are different tax rates, while
under the global treatment, there is a unitary or single tax rate.
2.
Under the schedular treatment, there are different categories of

taxable income, while under the global treatment, there is no need for
classification as all taxpayers are subjected to a single rate.
3.
The schedular treatment is usually used in the income taxation of

individuals while the global treatment is usually applied to
corporations.
Approach used in the Philippines
Partly schedular and partly global. The schedular approach is used in

the taxation of individuals while the global approach is used in the
taxation of corporations.
CLASSES
OF INCOME
TAXPAYERS
Basis of classification of taxpayers

1.
corporations v. individuals
2.
nationality
3.
residence
Classes of income taxpayers

1.
Individuals
a.
Resident citizens
b.
Non-resident citizens
c.
Resident aliens
d.
Non-resident aliens
i)
engaged in trade or business in the Philippines, or
ii)
not engaged in trade or business in the Philippines
Note: A non-resident alien individual who shall come to the Philippines and
stay therein for an aggregate period of more than one hundred eighty
(180) days during any calendar year shall be deemed a non-resident
alien doing business in the Philippines. [Section 25(A)(1), NIRC]
2.
3.
Corporations
a.
Domestic corporations
b.
Resident foreign corporations
c.
Non-resident foreign corporations
Special
a.
Proprietary educational institutions and hospitals that are nonprofit
b.
Insurance companies
c.
General professional partnerships
d.
Estates and trusts
Note: Estates and trusts are treated as individual taxpayers.

Who is a non-resident citizen?
The term non-resident citizen means:

1.
A citizen of the Philippines who established to the satisfaction of

the Commissioner the fact of his physical presence abroad with a
definite intention to reside therein.
2.
A citizen of the Philippines who leaves the Philippines during the

taxable year to reside abroad, either as an immigrant or for
employment on a permanent basis.
3.
A citizen of the Philippines who works and derives income from

abroad and whose employment thereat requires him to be
physically present abroad most of the time during the taxable
year.
4.
A citizen who has been previously considered as a non-resident

citizen and who arrives in the Philippines at any time during the
taxable year to reside permanently in the Philippines.
Corporation
A corporation, as used in income taxation, includes partnerships, no

matter how created or organized, joint stock companies, joint accounts
(cuentas en participacion), and associations or insurance companies.
However, it does not include:

1.
a general professional partnership; and
2.
a joint venture or consortium formed for the purpose of

undertaking construction projects or engaging in petroleum, coal,
geothermal and other energy operations pursuant to an
operating or consortium agreement under a service contract with
the government.
Resident foreign corporation
The term applies to a foreign corporation engaged in trade or

business within the Philippines.
Non-resident foreign corporation
The term applies to a foreign corporation not engaged in trade of

business in the Philippines.
GENERAL
PROFESSIONAL PARTNERSHIP V.
PARTNERSHIP
ORDINARY
BUSINESS
General professional partnerships are partnerships formed by

persons for the sole purpose of exercising their common profession, no
part of the income of which is derived from engaging in any trade or
business. [Section 22(B), NIRC]
Persons engaging in business as partners in a general professional

partnership shall be liable for income tax only in their separate and
individual capacities. [Section 26, NIRC]
For purposes of computing the distributive share of the partners, the

net income of the partnership shall be computed in the same manner
as a corporation. [Section 26, NIRC]
Each partner shall report as gross income his distributive share,

actually or constructively received, in the net income of the
partnership. [Section 26, NIRC]
Income of a general professional partnership are deemed

constructively received by the partners. [Section 73(D), NIRC]
Ordinary business partnership
An ordinary business partnership is considered as a corporation and

is thus subject to tax as such.
Partners are considered stockholders and, therefore, profits

distributed to them by the partnership are considered as dividends.
Oa v. Commissioner, 45 SCRA 74 (1972): Unregistered partnership

Although the CFI already approved the project of partition of the estate
of Julia Buales among her surviving spouse, Lorenzo Ona, and her five
children, no attempt was made to divide the properties left by the decedent.
Instead, the properties remained under the management of Lorenzo Ona who
used said properties in business by leasing or selling them and investing the
income derived therefrom and the proceeds from the sales thereof in real
property and securities. The said incomes are recorded in the books of
account kept by Lorenzo Ona where the corresponding shares of the heirs in
the net income for the year are known.
Based on these facts, the Commissioner ruled that the heirs formed an
unregistered partnership which is thus subject to corporate income tax. The
Court of Tax Appeals and the Supreme Court affirmed.
For tax purposes, the co-ownership of inherited properties is

automatically converted into an unregistered partnership the moment the
said common properties and/or the incomes derived therefrom are used as a
common fund with intent to produce profits for the heirs in proportion to their
respective shares in the inheritance as determined in a project partition
either duly executed in an extrajudicial settlement or approved by the court
in the corresponding testate or intestate proceeding.
The reason is simple. From the moment of such partition, the heirs are
entitled already to their respective definite shares of the estate and the
incomes thereof, for each of them to manage and dispose of as exclusively
his own without the intervention of the other heirs, and, accordingly, he
becomes liable individually for all taxes in connection therewith. If after such
partition, he allows his share to be held in common with his co-heirs under a
single management to be used with the intent of making profit thereby in
proportion to his share, there can be no doubt that, even if no document or
instrument were executed, for the purpose, for tax purposes, at least, an
unregistered partnership is formed.
For purposes of the tax on corporations, the NIRC, includes
partnerships except general professional partnerships within the purview
of the term corporation.
Note: The income derived from inherited properties may be considered as
individual income of the respective heirs only so long as the
inheritance or estate is not distributed or, at least, partitioned, but the
moment their respective known shares are used as part of the common
assets of the heirs to be used in making profits, it is but proper that the
income of such shares be considered as part of the taxable income of
an unregistered partnership.
Gatchalian v. Collector, 102 Phil 140
Plaintiffs contributed money to buy a sweepstakes ticket which
subsequently won. The Supreme Court held that they formed an unregistered
partnership. Plaintiffs formed a partnership of a civil nature since each of
them contributed money to a common fund for the sole purpose of dividing
equally the prize which they win.
Pascual v. Commissioner
Petitioners bought two parcels of land in 1965, however, they did not
sell the same nor make any improvements thereon. In 1966, they bought
another three parcels of land. It was only in 1968 that they sold the two
parcels of land after which they did not make any additional or new
purchase. The remaining three parcels of land were sold in 1970.
Commissioner assessed them corporate income taxes on the ground that

petitioners established an unregistered partnership engaged in real estate
transactions.
The Supreme Court ruled that no unregistered partnership was formed.
The sharing of returns does not itself establish a partnership whether or not
the persons therein have a joint or common right or interest in the property.
There must be a clear intent to form a partnership, the existence of which
has the juridical personality different from the individual partners and the
freedom of each party to transfer or assign the whole property.
In this case, there was no showing of intent to form a partnership. The
transactions were isolated; therefore, the character of habituality peculiar to
business transactions engaged for the purpose of gain was not present.
The essential elements of a partnership are: (1) an agreement to
contribute money, property, or industry to a common fund; and (2) an intent
to divide the profits among the contracting parties.
Unregistered partnership v. co-ownership for tax purposes
If the activities of co-owners are limited to the preservation of the

property and the collection of the income therefrom, in which case,
each co-owner is taxed individually on his distributive share in the
income of the co-ownership.
If the co-owners invest the income in business for profit, they would
be constituting themselves into a partnership taxable as a corporation.
Joint venture, how created
A joint venture is created when two corporations, while registered

and operating separately, were placed under one sole management
which operated the business affairs of said companies as though they
constituted a single entity thereby obtaining substantial economy and
profits in the operation.
As stated, a joint venture is not taxed as a corporation, just like a

general professional partnership.
GENERAL PRINCIPLES
OF INCOME
TAXATION
IN THE
PHILIPPINES
General principles of income taxation in the Philippines
1.
A citizen of the Philippines residing therein is taxable on all income

derived from sources within and without the Philippines.
2.
A non-resident citizen is taxable only on income derived from sources

within the Philippines.
3.
An individual citizen of the Philippines who is working and deriving

income from abroad as an overseas contract worker is taxable only on
income from sources within the Philippines. Provided, that a seaman
who is a citizen of the Philippines and who receives compensation for
services rendered abroad as a member of the complement of a vessel
engaged exclusively in 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.
A domestic corporation is taxable on all income derived from sources

within and without the Philippines.
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.
SOME
RULES ON TAXATION OF THE VARIOUS TAXPAYERS
Who are taxed on their global income?

1.
Resident citizens
2.
Domestic corporations
Who are taxed only on their income from sources within the
Philippines?
1.
Non-resident citizen
2.
Overseas contract workers
3.
Alien individual, whether a resident or not of the Philippines
4.
Foreign corporation, whether engaged or not in trade or business in

the Philippines
Who are taxed based only on their net income?
1.
Resident and non-resident citizens
2.
Resident alien and non-resident alien engaged in trade or business in

the Philippines
3.
Domestic corporation
4.
Who are taxed based on their gross income?

1.
Non-resident alien not engaged in trade or business in the Philippines
2.
Non-resident foreign corporation
TREATMENT
OF SOME SPECIAL ITEMS
Forgiveness of indebtedness
The cancellation and forgiveness of indebtedness may, dependent

upon the circumstances, amount to:
1.
a payment of income;
2.
a gift; or
3.
a capital transaction.
If, for example, an individual performs services for a creditor who, in

consideration thereof cancels the debt, income to that amount is
realized by the debtor as compensation for his service.
If, however, a creditor merely desires to benefit a debtor and without

any consideration thereof cancels the debt, the amount of the debt is a
gift from the creditor to the debtor and need not be included in the
latters gross income.
If a corporation to which a stockholder is indebted forgives the debt,

the transaction has the effect of payment of a dividend. [Section 50,
Revenue Regulations 2]
Recovery of amounts previously written of
Considered as income
GUIDE QUESTIONS
IN
DETERMINING TAXABLE INCOME
1.
Is there a gain or income?
2.
Is the gain or income taxable? Is it excluded or exempt?
3.
What type of income is it: income includible in the gross income,

passive income, capital gains, income derived from other source?
4.
To what class does the taxpayer belong: individual or corporate, citizen

or not or domestic or foreign, resident or not, engaged in trade or
business or not?
TAX ON INDIVIDUALS
PRELIMINARY
POINTS ON TAXATION OF INDIVIDUALS
How taxed?
An individual citizen, both resident and non-resident, and an

individual resident alien are taxed similarly.
A non-resident alien engaged in trade or business shall be subject to

the same income tax rates as a citizen and a resident alien.
Thus, only a non-resident alien who is not engaged in trade or

business is taxed differently from the other individual taxpayers.
On what income taxed?
A resident citizen is taxed on all income from sources within and

outside the Philippines. The tax base is net income.
A non-resident citizen is taxed only on income from sources within

the Philippines. The tax base is net income.
An alien, whether resident or not, is taxed only on income from

sources within the Philippines. However, the tax base for a resident
alien and non-resident alien engaged in trade or business is net income
while the tax base for a non-resident alien not engaged in trade or
business is gross income.
Types of income taxed
1.
Items of income included in the gross income
2.
Passive income
3.
Capital gains from sale of shares of stock not traded in the stock
exchange
4.
Capital gains from the sale or exchange of real property
TAX ON INDIVIDUAL CITIZEN (RESIDENT

INDIVIDUAL RESIDENT ALIEN
AND
NON-RESIDENT)
AND
Items of income included in the gross income
A schedular rate of five percent (5%) to P125,000 + 32% of excess

over P500,000.00 by 01 January 2000 is imposed on items of income of
an individual citizen and individual resident alien which are properly
includible in the gross income.
Rates of tax on certain passive income

1.
Interest from any currency bank deposit and yield or any other
monetary benefit from deposit substitutes and from trust funds and
similar arrangements 20%
2.
Royalties, except on books, as well as other literary works and musical

compositions 20%
3.
Royalties on books, literary works and musical compositions 10%
4.
Prizes over P10,000.00 20%
Note: Prizes less than P10,000.00 are included in the income tax of the
individual subject to the schedular rate of 5% up to P125,000 + 32% of
excess over P500,000.00)
5.
Other winnings, except PCSO and lotto, derived from sources within
the Philippines 20%
6.
Interest income derived by a resident individual (Note: non-resident

citizen not included) from a depository bank under the expanded
foreign currency deposit system 7.5%
7.
Interest income from long-term deposit or investment evidenced by

certificates prescribed by BSP
8.
a.
Exempt if investment is held for more than five years
b.
If investment is pre-terminated, interest income on such

investment shall be subject to the following rates:
20% -
if pre-terminated in less than 3 years
12% -
if pre-terminated after 3 years to less than 4 years
5%
if pre-terminated after 4 years to less than 5 years
Cash and/or property dividends

Ten percent (10%) final tax by 01 January 2000 on the following:
a.
Cash and or property dividend actually or constructively received

from a domestic corporation or from a joint stock company,
insurance or mutual fund companies and regional operating
headquarters of multinational companies
b.
Share of an individual in the distributable net income after tax of

a partnership except a general professional partnership of which
he is a partner
c.
Share of an individual in the net income after tax of an

association, joint account, or a joint venture or consortium
taxable as a corporation of which he is a member or a coventurer
Capital gains from the sale of shares of stock not traded in the
stock exchange
1.
Not over P100,000
2.
Over P100,000
5%
10%
Capital gains from the sale of real property
General rule: A final tax of six percent (6%) is imposed on the gross
selling price or current fair market value, whichever is higher, for every
sale or exchange of real property.
Optional: If the sale is made to the government or any of its political

subdivisions or agencies or to government-owned or-controlled
corporations, the taxpayer has the option to choose from the final tax
of six percent (6%) of gross selling price or fair market value,
whichever is higher, or the schedular tax rate of 5% up to P125,000 +
32% of excess over P500,000.
Exception: The sale or disposition of the principal residence of

natural persons is exempt from capital gains tax if certain conditions
are met.
Conditions for exemption of gain from sale or exchange of principal
residence:
1.
Proceeds are fully utilized in acquiring or constructing a new

principal residence within 18 months from the date of sale or
disposition;
2.
Historical cost or adjusted basis of the real property sold or

disposed shall be carried over to the new principal residence
built or acquired;
3.
Notice to the Commissioner of Internal Revenue shall be given

within thirty (30) days from the date of sale or disposition; and
4.
This exemption can only be availed of once every ten years.
If the proceeds of the sale were not fully utilized, the portion of
the gain presumed to have been realized from the sale or disposition
shall be subject to capital gains tax.
GSP or FMV, whichever is higher x Unutilized proceeds/GSP =
Taxable Portion
TAX
ON
NON-RESIDENT ALIEN INDIVIDUAL
Remuneration received by a non-resident alien as president of a

domestic company taxable in the Philippines (Ms. Juliane BaierNickel, as represented by Marina Q. Guzman v. CIR, CTA Case No.
5514 dated 4/29/99)
A consultant, president of a domestic company or person involved

with product development is subject to Philippine income taxation.
Any remuneration received would stem from her employment as
company president and thus, negates her allegation that she is just a
sales agent who receives commissions. While petitioner tried to show
that she stayed in the country for less than 180 days, her remuneration
in the form of commissions is still taxable in the Philippines since it is
borne by a permanent establishment in the Philippines.
Non-resident alien engaged in trade or business
A non-resident alien engaged in trade or business shall be subject to

the same income tax rates as a citizen and a resident alien.
Exception: Cash and/or property dividends received by a nonresident alien individual shall be subject to a final tax of 20%; for
citizens and resident aliens, the rate is 10% beginning in the year
2000.
Non-resident alien not engaged in trade or business
A non-resident alien individual not engaged in trade or business shall

pay a tax equivalent to 25% on all items of income, except for gain on
sale of shares of stock in any domestic corporation and real property
which shall be subject to the same rate applied to other individual
taxpayers.
Gain on sale of shares of stock:

1.
Not over P100,000 5%
2.
Over 100,000 10%
Capital gains tax on sale or disposition of property 6% of GSP or

FMV, whichever is higher.
OTHER INDIVIDUAL TAXPAYERS

1.
Alien individual employed by regional or area headquarters and

regional operating headquarters of multinational companies
2.
Alien individual employed by offshore banking units
3.
Alien individual employed by petroleum service contractor and

subcontractor
Note: The salaries, wages, annuities, compensation, remuneration and other

emoluments, such as honoraria and allowances received by these
individuals and their Filipino counterparts occupying the same position
as these alien individuals shall be subject to 15% tax.
All other income derived by these individuals shall be subject to
the same rate as that of other individual taxpayers.
Regional or area headquarters
A regional or area headquarter is a branch established in the

Philippines by multinational companies and which headquarters do not
earn or derive income from the Philippines and which act as
supervisory, communications and coordinating center for their
affiliates, subsidiaries, or branches in the Asia-Pacific region and other
foreign markets.
Regional operating headquarters
A regional operating headquarter shall mean a branch established in

the Philippines by multinational companies which are engaged in
certain specified services, i.e. general administration and planning,
business planning and coordination, sourcing and procurement of raw
materials and components, among others.
Taxation of OBU employees (BIR Ruling No. 147-98 dated October

16, 1998)
The 15% preferential tax rate shall apply only in cases where an alien
concurrently holds a position similar to that of the Filipino employee.
Thus, this preferential tax treatment shall not apply where the
counterpart expatriate is recalled to the head office or reassigned
elsewhere, whether temporarily or otherwise, and only Filipinos are the
ones so employed by an OBU for the time being or where the post
vacated by the expatriate is subsequently assumed by a Filipino to
replace the expatriate, as a result of which all top management posts
are now being occupied by Filipinos.
Filipino staf of the ADB subject to 15% preferential tax rate ( NO.
29-99 dated 3/11/99)
Filipino employees occupying managerial or technical positions as

those of aliens employed by the Asian Development Bank (ADB), which
is not only a regional or area headquarters in the Philippines but the
headquarters itself, are subject to the preferential tax rate of 15% on
their gross compensation income pursuant to Section 25 ( C ) of the
NIRC of 1997.
General professional partnerships are partnerships formed by

persons for the sole purpose of exercising their common profession, no
part of the income of which is derived from engaging in any trade or
business.
Persons engaging in business as partners in a general professional

partnership shall be liable for income tax only in their separate and
individual capacities.
Each partner shall report as gross income his distributive share,

actually or constructively received, in the net income of the
partnership.
The net income of the general professional partnership shall be

computed in the same manner as a corporation for purposes of
computing the distributive shares of the partners.
TAX ON CORPORATIONS
RATES
OF INCOME
TAX
ON
DOMESTIC CORPORATIONS
In General
Rate of tax, in general

1997
1998
1999
2000
35%
34%
33%
onwards 32%
Tax is imposed on taxable or net income.
Optional 15% tax on gross income
The President, upon the recommendation of the Secretary of Finance,

may, effective 01 January 2000, allow corporations the option to be
taxed at fifteen percent (15%) of gross income, provided certain
conditions are satisfied.
This is available to firms whose ratio of cost of sales to gross sales or

receipts from all sources does not exceed 55%.
Once elected by the corporation, option shall be irrevocable for the

three consecutive years.
Conditions to be satisfied to avail of the 15% optional corporate tax

1.
A tax effort ratio of twenty percent (20%) of Gross National Product
(GNP)
2.
A ratio of forty percent (40%) of income tax collection to total tax
revenues
3.
A VAT tax effort of four percent (4%) of GNP
4.
A 0.9 percent (0.9%) ratio of the Consolidated Public Sector Financial
Position to GNP
Some definitions for this purpose
Gross income derived from business shall be equivalent to gross

sales less sales returns, discounts and allowances and cost of goods
sold.
For taxpayers engaged in sale of services, gross income means

gross receipts less sales returns, allowances and discounts.
Cost of goods sold shall include all business expenses directly

incurred to produce the merchandise to bring them to their present
location and use.
Trading Concern
Cost of goods sold shall include the
invoice cost of the goods sold, plus
import duties, freight in transporting
the goods to the place where the
goods are actually sold, including
Manufacturing Concern
Cost of goods manufactured and sold
shall include all costs of production of
finished goods, such as raw materials
used, direct labor and manufacturing
overhead, freight cost, insurance and
insurance while the goods are in

transit.
other costs incurred to bring the raw

materials to the factory or
warehouse.
Tax rate for proprietary educational institutions and hospitals
10% on taxable income, except on certain passive incomes

The ordinary rate imposed on corporations shall apply to proprietary
educational institutions and hospitals when their gross income from
unrelated trade, business or other activity exceeds 50% of their total
gross income derived from all sources.
Unrelated trade, business or other activity
This means any trade, business or other activity, the conduct of

which is not substantially related to the exercise or performance by
such educational institution or hospital of its primary purpose or
function.
Proprietary educational institution
A proprietary educational institution is any private school maintained

and administered by private individuals or groups with an issued
permit to operate from the DECS, or CHED, or TESDA, as the case may
be.
GOCCs, agencies or instrumentalities
All corporations, agencies, or instrumentalities owned and controlled

by the government shall pay such rate of tax upon their taxable
income as are imposed upon corporations or associations engaged in a
similar business, industry, or activity.
Exceptions: GOCCs and instrumentalities not subject to tax are the:

1.
Government Service Insurance System (GSIS)
2.
Social Security System (SSS)
3.
Philippine Health Insurance Corporation (PHIC)
4.
Philippine Charity Sweepstakes Office (PCSO)
5.
Philippine Amusement and Gaming Corporation (PAGCOR)
Rates on certain passive income subject to final tax

1.
Interest from deposits and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements
20%
2.
Royalties 20%
3.
Interest income derived from a depository bank under the expanded

foreign currency deposit system 7 %
4.
exchange
5.
a.
b.
Over P100,000 10%
Tax on income derived by a depository bank under the expanded

foreign currency deposit system from foreign currency transactions
10%
Note: This is different from the interest income. This pertains to the
income derived by a depository bank itself.
Note: Any income of non-residents, whether individuals or
corporations, from transactions with depository banks under the
expanded system is exempt from income tax.
6.
Intercorporate dividends exempt
7.
Capital gains realized from the sale, exchange or disposition of lands

and/or buildings 6%
Sale of corporate real property that has ceased to be used in trade

or business subject to 6% capital gains tax ( No. 21-99 dated
2/25/99)
A final tax of 6% is imposed on the gains presumed to have been

realized in the sale, exchange or disposition of lands and/or buildings
which are not actively used in the business of a corporation and which
are treated as capital assets based on the gross selling price or fair
market value, whichever is higher. However, since in the instant case
the taxpayer claimed a depreciation deduction when the building and
other improvements were not used in trade or business, the taxpayer
must file and amend its income tax return and pay the deficiency
income tax, if any, plus surcharge and interest, based on its adjusted
taxable income resulting from the disallowance of the depreciation
deduction.
MINIMUM CORPORATE INCOME TAX

Minimum corporate income tax
A minimum corporate income tax of two percent (2%) of the gross

income as of the end of the taxable year is hereby imposed on a
corporation subject to income tax, beginning on the fourth taxable
year immediately following the year in which such corporation
commenced its business operations, when the minimum income tax is
greater than the regular corporate income tax for the taxable year.
Carry forward of excess minimum tax
Any excess of the minimum corporate income tax over the normal
income tax shall be carried forward and credited against the normal
income tax payable for the next three years immediately succeeding
the taxable year in which the minimum corporate income tax was paid.
Relief from the minimum corporate income tax under certain

conditions
The Secretary of Finance may suspend the imposition of the

minimum corporate income tax on any corporation which suffers losses
on account of prolonged labor dispute, or because of force majeure, or
because of legitimate business reverses.
Meaning of gross income and cost of goods sold under minimum

corporate income tax compared with meaning of gross income and
cost of goods sold under Section 27(A)
Gross Income
Cost of goods sold
Cost of goods sold for a
trading or merchandising
concern
Section 27(A)
Section 27(E) MCIT
equivalent to gross sales less sales returns,
discounts and allowances and cost of goods sold.
shall include all business expenses directly
incurred to produce the merchandise to bring
them to their present location and use.
shall include the invoice cost of the goods sold,
plus import duties, freight in transporting the
goods to the place where the goods are actually
sold, including insurance while the goods are in
Cost of goods
manufactured and sold
for a manufacturing
concern
Gross Income for
taxpayers engaged in
sale of service
Cost of services
transit.
shall include all costs of production of finished
goods, such as raw materials used, direct labor
and manufacturing overhead, freight cost,
insurance and other costs incurred to bring the
raw materials to the factory or warehouse.
gross receipts less
gross receipts less sales
sales returns,
returns, allowances and
allowances and
discounts and cost of
discounts.
services
All direct costs and
expenses necessarily
incurred to provide the
services required by the
customers and clients
including (A) salaries and
employee benefits of
personnel, consultants
and specialists directly
rendering the service
and (B) cost of facilities
directly utilized in
providing the service
such as depreciation or
rental of equipment used
and cost of supplies.
For banks, it includes
interest expense.
Note: Definition of gross income for taxpayers engaged in the sale of service
includes cost of services in MCIT but not in the case of the optional
15% tax on gross income [Section 27(A), NIRC].
TAX
ON
RESIDENT FOREIGN CORPORATIONS
A resident foreign corporation is one organized, authorized, or

existing under the laws of any foreign country, engaged in trade or
business within the Philippines.
Income tax rate, in general
Rates of tax, in general

1997
1998
1999
2001
35%
34%
33%
onwards 32%
Tax is imposed on taxable or net income.
Optional: 15% of Gross Income
The option to be taxed at fifteen percent (15%) on gross income shall

also be available to resident foreign corporations, subject to the same
conditions.
Available to firms whose ratio of cost of sales to gross sales or

receipts from all sources does not exceed 55%.
Once elected by the corporation, option shall be irrevocable for the

three consecutive years.
Minimum corporate income tax on resident foreign corporations
TAX
All conditions of the MCIT on domestic corporations also apply to

resident foreign corporations.
RATES ON SPECIFIC RESIDENT FOREIGN CORPORATIONS
1.
International Carrier 2 % of Gross Philippine Billings
2.
Offshore Banking Units 10% of income derived from foreign currency

transactions with local commercial banks, including branches of foreign
banks that may be authorized by the BSP to transact business with
offshore banking units, including any interest income derived from
foreign currency loans granted to residents
Any income of non-residents, whether individuals or
corporations, from transactions with said offshore banking units shall
be exempt from income tax.
3.
Tax on Branch Profits Remittances 15% of total profits applied or

earmarked for remittance without deduction for the tax component
thereof
4.
Regional or area headquarters shall not be subject to income tax
5.
Regional operating headquarters shall be subject to a tax of 10% of

their taxable income
Gross Philippine Billings for international air carrier
Gross Philippine Billings refers to the amount of gross revenue

derived from carriage of persons, excess baggage, cargo and mail
originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of
payment of the ticket or passage document.
Tickets revalidated, exchanged and/or endorsed to another

international airline form part of the Gross Philippine Billings if the
passenger boards a plane in a port or point in the Philippines.
For a flight which originates from the Philippines, but transshipment

of passenger takes place at any port outside the Philippines on another
airline, only the aliquot portion of the cost of the ticket corresponding
to the leg flown from the Philippines to the point of transshipment shall
form part of the Gross Philippine Billing.
Gross Philippine Billings for international shipping
Gross Philippine Billings means gross revenue whether for

passenger, cargo or mail originating from the Philippines up to final
destination, regardless of the place of sale or payments of the passage
or freight documents.
Tax on branch profits remittances
Any profit remitted by a branch to its head office shall be subject to a

tax of fifteen percent (15%) which shall be based on the total profits
applied or earmarked for remittance without any deduction for the tax
component thereof (except those activities which are registered with
the Philippine Economic Zone Authority).
The following shall not be treated as branch profits unless the same
are effectively connected with the conduct of its trade or business in
the Philippines:
1.
interests
2.
dividends
3.
rents
4.
royalties
5.
remuneration for technical services
6.
salaries
7.
wages
8.
premiums
9.
annuities
10.
emoluments
11.
other fixed or determinable annual, periodic or casual gains,

profits, income and capital gains
In Marubeni v. Commissioner, Marubeni-Japan invested directly in

AG & P Manila. Since Marubeni has a branch in the Philippines, AG & P
withheld 15% as branch profits remittance tax from the cash dividends.
SC held that the dividends remitted were not subject to the 15%
branch profit remittance tax as they were not income earned by a
Philippine branch of Marubeni-Japan.
In the 15% remittance tax, the law specifies its own tax base to be
on the profit remitted abroad. There is absolutely nothing equivocal
or uncertain about the language of the provision. The tax is imposed
on the amount sent abroad, and the law calls for nothing further.
[Bank of America NT v. Court of Appeals, 234 SCRA 302]
Marubeni v. Commissioner, 177 SCRA 500
Marubeni Corporation is a resident foreign corporation.

A resident foreign corporation is one that is incorporated under
the laws of a foreign country and is engaged in trade or business in the
Philippines. Marubeni Corporation is a foreign corporation duly
organized under the laws of Japan and it is duly licensed to engage in
business under Philippine laws. Marubeni Corporation maintains a
branch office to carry out its business in the country.
The equity investments of MC in AG&P are investments of the mother

corporation and not of its branch office.
The investment was in the name of the Marubeni Corporation

and therefore, the stockholder in AG&P is the mother corporation,
Marubeni Corporation, and not its branch office in the Philippines.
Marubeni Corporation, therefore, and not its branch office, is liable for
taxes on dividends earned on its investments.
Branch profit remittance does not include dividends on investments

received from other domestic corporations.
Only profits remitted abroad by a branch office to its head office
which are effectively connected with its trade or business in the
Philippines are subject to the 15% profit remittance tax.
To be effectively connected, it is not necessary that the income
be derived from the actual operation of taxpayer-corporations trade or
business; it is sufficient that the income arises from the business
activity in which the corporation is engaged.
The dividends received by Marubeni from AG&P are not income
arising from the business activity in which Marubeni is involved.
Accordingly, said dividends if remitted abroad, are not considered
branch profits for purposes of the 15% profit remittance tax.
Note: Test of whether remittance of profit by a branch to its head
office comes under the purview of the profit remittance tax, the branch
itself should have made the remittance. In this case, it was not
Marubenis branch in the Philippines, but the investee corporation,
AG&P, which directly remitted the dividends to Marubeni of Japan.
Also, only the branch office is the authorized withholding agent
for the profit remittance tax. AG&P, being an investee of Marubeni,
erred in withholding the profit remittance tax from the dividends it
remitted to Marubeni.
Interest received by a foreign corporation from Philippine sources

not efectively connected with the conduct of its business not
considered branch profits. (Hongkong-Shanghai Hotels, Ltd. v. CIR,
CTA Case No. 5243 dated 4/29/99)
Interest received by a foreign corporation during each taxable year

from all sources within the Philippines is not considered branch profits
except when the same is effectively connected with the conduct of its
business. In the instant case, the interest income from bank
placements is not effectively connected with the business of hotel
management, thus, it is excluded form profits subject to the 15%

branch profit remittance tax.
Regional or area headquarters of multinational companies
Regional or area headquarters shall not be subject to income tax.
Regional operating headquarters of multinational companies
Regional operating headquarters shall pay a tax of ten percent (10%)

on their taxable income.
Tax on certain incomes received by a resident foreign corporation

1.
Interest from deposits and yield or any other monetary benefit from
deposit substitutes, trust funds and similar arrangements and royalties
Interest income from any currency bank deposit and yield or any
other monetary benefit from deposit substitutes and from trust funds
and similar arrangements and royalties derived from sources within the
Philippines shall be subject to a final income tax at the rate of twenty
percent (20%) of such interest.
However, interest income derived by a resident foreign
corporation from a depositary bank under the expanded foreign
currency deposit system shall be subject to a final income tax at the
rate of seven and one-half percent (71/2%) of such interest income.
2.
Income derived under the expanded foreign currency deposit system

This refers to income derived by a depositary bank under the
expanded foreign currency deposit system from foreign currency
transactions with local commercial banks including branches of foreign
banks that may be authorized by the Bangko Sentral ng Pilipinas to
transact business with foreign currency deposit system units and other
depositary banks under the expanded foreign currency deposit system,
including interest income from foreign currency loans granted by such
depositary banks under said expanded foreign currency deposit system
to residents.
A final income tax at the rate of ten percent (10%) is imposed on
such income.
3.
4.
exchange
a.
b.
Over P100,000 10%
Intercorporate dividends
Dividends received by a resident foreign corporation from a
domestic corporation liable to tax under the NIRC shall not be subject
to income tax.
TAX
ON
NON-RESIDENT FOREIGN CORPORATION
Taxation of a non-resident foreign corporation, in general
Rates of tax, in general

1997
1998
1999
2000
35%
34%
33%
32%
However, the tax is imposed on gross income, not on taxable or net

income.
Such gross income may include interests, dividends, rents, royalties,

salaries, premiums (except reinsurance premiums), annuities,
emoluments or other fixed or determinable annual, periodic or casual
gains, profits and income, and capital gains, except capital gains from
the sale of shares of stock not traded in the stock exchange.
Taxation of certain non-resident foreign corporations

1.
Non-resident cinematographic film owner, lessor or distributor 25%

of gross income
2.
Non-resident owner or lessor of vessels chartered by Philippine

nationals 4% of gross rentals, lease or charter fees
3.
Non-resident owner or lessor of aircraft, machineries and other

equipment 7% of gross rentals or fees
Non-resident cinematographic film owner, lessor or distributor
A cinematographic film owner, lessor, or distributor shall pay a tax of

twenty five percent (25%) of its gross income from all sources within
the Philippines.
Non-resident owner or lessor of vessels chartered by Philippine

nationals
A non-resident owner or lessor of vessels shall be subject to a tax of

four and one-half percent (4% ) of gross rentals, lease or charter fees
from leases or charters to Filipino citizens or corporations, as approved
by the Maritime Industry Authority.
Non-resident owner or lessor of aircraft, machineries and other

equipment
Rentals, charters and other fees derived by a non-resident lessor of

aircraft, machineries and other equipment shall be subject to a tax of
seven and one-half percent (7%) of gross rentals or fees.
Tax on certain incomes received by a non-resident foreign

corporation
1.
Interest on foreign loans

A final withholding tax at the rate of twenty percent (20%) is
hereby imposed on the amount of interest on foreign loans contracted
on or after 01 August 1986.
2.
Intercorporate dividends
A final withholding tax at the rate of fifteen percent (15%) is
hereby imposed on the amount of cash and/or property dividends
received by a non-resident foreign corporation from a domestic
corporation, subject to the condition that the country in which the nonresident foreign corporation is domiciled shall allow a credit against the
tax due from the non-resident foreign corporation taxes deemed to
have been paid in the Philippines equivalent to thirty two percent
(32%) in the year 2000.
This is the so-called tax sparing rule.
3.
exchange
a.
b.
Over P100,000 10%
Tax sparing rule
Involves intercorporate dividends received by a non-resident

foreign corporation from a domestic corporation
Only 15% final withholding tax on cash and/or property dividends is

imposed
Provided the country in which the non-resident foreign corporation is

domiciled shall allow a credit against the tax due from the non-resident
foreign corporation taxes deemed to have been paid in the Philippines,
which is 32% by 2000 [Sec. 28, (B) (5) (b)]
TAX
ON IMPROPERLY
ACCUMULATED EARNINGS
Imposition of the tax
In addition to the other income taxes, there is hereby imposed for

each taxable year on the improperly accumulated taxable income of
each corporation an improperly accumulated earnings tax equal to ten
percent (10%) of the improperly accumulated taxable income. [Section
29, NIRC]
Corporations subject to improperly accumulated earnings tax
The improperly accumulated earnings tax shall apply to every

corporation formed or availed for the purpose of avoiding the income
tax with respect to shareholders or the shareholders of any other
corporation, by permitting earnings and profits to accumulate instead
of being divided or distributed.
Exceptions to improperly accumulated earnings tax
The improperly accumulated earnings tax shall not apply to:

1.
Publicly-held corporations
2.
Banks and other non-bank financial intermediaries
3.
Insurance companies
Evidence of purpose to avoid income tax
Prima Facie Evidence: The fact that any corporation is a mere

holding company or investment company shall be prima facie evidence
of a purpose to avoid the tax upon its shareholders or members.
Evidence Determinative of Purpose: The fact that the earnings or

profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the purpose
to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove to the
contrary.
The term reasonable needs of the business includes the reasonably

anticipated needs of the business.
Computation of improperly accumulated taxable income
Taxable income adjusted by:

1.
Income exempt from tax;
2.
Income excluded from gross income;
3.
Income subject to final tax; and
4.
Amount of net operating loss carry-over deducted;
And reduced by the sum of:

1.
Dividends actually or constructively paid; and
2.
Income tax paid for the taxable year.
Coverage
For corporations using the calendar basis, the accumulated earnings

tax shall not apply on improperly accumulated income as of 31
December 1997.
For corporations adopting the fiscal year accounting period, the

improperly accumulated income not subject to this tax shall be
reckoned as of the end of the month comprising the 12-month period
of fiscal year 1997-1998.
EXEMPTION
OF CERTAIN ORGANIZATIONS
Exemption from tax on corporations
The following organizations shall not be taxed in respect to income

received by them as such:
1.
Labor, agricultural or horticultural organization not organized

principally for profit;
2.
Mutual savings bank not having a capital stock represented by

shares, and cooperative bank without capital stock organized
and operated for mutual purposes and without profit;
3.
A beneficiary society, order or association, operating for the

exclusive benefit of the members such as a fraternal organization
operating under the lodge system, or a mutual aid association or
a non-stock corporation organized by employees providing for
the payment of life, sickness, accident, or other benefits
exclusively to the members of such society, order, or association,
or non-stock corporation or their dependents;
4.
Cemetery company owned and operated exclusively for the

benefit of its members;
5.
Non-stock corporation or association organized and operated

exclusively for religious, charitable, scientific, athletic, or cultural
purposes, or for the rehabilitation of veterans, no part of its net
income or asset shall belong to or inure to the benefit of any
member, organizers, officer or any specific person;
6.
Business league, chamber of commerce, or board of trade not

organized for profit and no part of the net income of which inures
to the benefit of any private stockholder or individual;
7.
Civic league or organization not organized for profit but operated

exclusively for the promotion of social welfare;
8.
A non-stock, non-profit educational institution;
9.
Government educational institution;
10.
Farmers or other mutual typhoon or fire insurance company,

mutual ditch or irrigation company, mutual or cooperative
telephone company, or like organization of a purely local
character, the income of which consists solely of assessments,
dues, and fees collected from members for the sole purpose of
meetings its expenses; and
11.
Farmers, fruit growers, or like association organized and

operated as a sales agent for the purpose of marketing the
products of its members and turning back to them the proceeds
of sales, less the necessary selling expenses on the basis of the
quantity of products finished by them. [Section 30, NIRC]
Income by exempted corporations which are not exempted
Notwithstanding the provisions in the preceding paragraphs, the

income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal, or from any of their
activities conducted for profit regardless of the disposition made of
such income, shall be subject to tax imposed under this
Code. [2nd pargraph, Section 30, NIRC]
Thus, the following income of the exempted organizations shall not

be exempted:
1.
Income of whatever kind and character from any of their

properties, real or personal
2.
Income from any of their activities conducted for profit
See Commissioner v. CA re. YMCA case in General Principles of

Taxation
Commissioner v. CA, CTA & Ateneo de Manila University, 271 SCRA

605
In conducting researches and studies of social organizations and

cultural values thru its IPC, is Ateneo performing the work of an independent
contractor and thus taxable for the contractors tax?
NO. An academic institution conducting researches pursuant to its
commitments to education and ultimately to public service cannot be
considered as an independent contractor when it accepts sponsorships for its
research activities from international organizations, private foundations and
government agencies.
The research activity of the IPC is done in pursuance of maintaining
Ateneo's university status and not in the course of an independent business
of selling such research with profit in mind.
It is error to apply the principles of tax exemption without first applying
the well-settled doctrine of strict interpretation in the imposition of taxes it
is obviously both illogical and impractical to determine who are exempted
without first determining who are covered by a provision of the NIRC.
Hornbook doctrine in the interpretation of tax laws:
Statute will not be construed as imposing a tax unless it does so
clearly, expressly, and unambiguously. A tax cannot be imposed without
clear and express words for that purpose. Accordingly, the general rule of
requiring adherence to the letter in construing statutes applies with peculiar
strictness to tax laws and the provisions of a taxing act are not to be
extended by implication.
GROSS INCOME
Gross income
Gross income means all income derived from whatever source,

including (but not limited to) the following items:
1.
Compensation for services in whatever form paid, including, but

not limited to, fees, salaries, wages, commissions, and similar
items;
2.
Gross income derived from the conduct of trade or business or

the exercise of a profession;
3.
Gains derived from dealings in property;
4.
Interests;
5.
Rents;
6.
Royalties;
7.
Dividends;
8.
Annuities;
9.
Prizes and winnings;
10.
Pensions; and
11.
Partners distributive share from the net income of the general

professional partnership.
COMPENSATION
FOR
SERVICES
Compensation for services
This means all remuneration for services performed by an employee

for his employer under an employer-employee relationship.
Compensation paid in kind
Compensation may be paid in money or in some medium other than

money.
Living quarters or meals
If a person receives a salary as a remuneration for services rendered

and, in addition thereto, living quarters or meals are provided, the
value to such person of the quarters and meals so furnished shall be
added to the remuneration paid for the purpose of determining the
amount of compensation subject to withholding.
However, if living quarters or meals are furnished to an employee for

the convenience of the employer, the value thereof need not be
included as part of compensation income. [Section 2.78.1, Revenue

Regulations 2-98]
Facilities and privileges of a relatively small value
Facilities are not considered as compensation subject to withholding

if such facilities or privileges are of relatively small value and are
offered or furnished by the employer merely as a means of promoting
the health, goodwill, contentment, or efficiency of his employees.
[Section 2.78.1, Revenue Regulations 2-98]
Tips and gratuities
Tips or gratuities paid directly to an employee by a customer of the

employer which are not accounted for by the employee to the
employer are considered as taxable income but not subject to
withholding.
Fixed or variable transportation, representation and other

allowances
In general, fixed or variable transportation, representation and other

allowances which are received by a public officer or employee or officer
or employee of a private entity, in addition to the regular
compensation fixed for his position or office, is compensation subject
to withholding.
Any amount paid specifically, either as advancements or

reimbursements, for traveling, representation and other bona
fide ordinary and necessary expenses incurred or reasonably expected
to be incurred by the employee in the performance of his duties are
not compensation subject to withholding, if the following conditions are
satisfied:
1.
It is for ordinary and necessary traveling and representation or

entertainment expenses paid or incurred by the employee in the
pursuit of the trade, business or profession; and
2.
The employee is required to account or liquidate for the

foregoing expenses in accordance with the specific requirements
of substantiation for each category of expenses. The excess of
actual expenses over advances made shall constitute taxable
income if such amount is not returned to the employer.
Vacation and sick leave allowances
Amounts of vacation allowances or leave credits which are paid to an

employee constitutes compensation. Thus, the salary of an employee
on vacation or on sick leave, which are paid notwithstanding his
absence from work constitutes compensation.
However, the monetized value of unutilized leave credits of ten (10)

days or less which were paid to the employee during the year are not
subject to income tax.
IMPOSITION
OF
FRINGE BENEFIT TAX
Imposition of fringe benefit tax
A final tax of 32% effective 01 January 2000 is imposed on the

grossed-up monetary value of fringe benefit furnished or granted to
the employee, except rank and file, by the employer, whether an
individual or a corporation.
The fringe benefit tax is paid by the employer.

Grossed-up monetary value is acquired by dividing the actual
monetary value of the fringe benefit by 68% effective 01 January 2000.
Fringe benefit
Fringe benefit means 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 employees, 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 and others;
5.
Interest on loan at less than market rate to the extent of the

difference between the market rate and 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.
Fringe benefits which are not subject to FBT

1.
Fringe benefits which are authorized and exempted from tax under
special laws.
2.
Contributions of the employer for the benefit of the employee to

retirement, insurance and hospitalization benefit plans.
3.
Benefits given to the rank and file employees, whether granted under
a collective bargaining agreement or not.
4.
De minimis benefits.
5.
Fringe benefit is required by the nature of, or necessary to the trade,

business or profession of the employer.
6.
It is for the convenience or advantage of the employer.
Convenience of the employer rule
Under this rule, allowances furnished to the employee for, and as a

necessary incident to, the performance of his duties are not taxable.
Thus, the value of meals and living quarters given to a driver who is
available any hour of the day when needed by his doctor-employer is
not considered income of the said driver.
De minimis benefits
These are facilities or privileges furnished or offered by an employer

to his employees that are of relatively small value and are offered or
furnished by the employer merely as a means of promoting the health,
goodwill, contentment, or efficiency of his employee.
GROSS
INCOME FROM THE CONDUCT OF TRADE OR BUSINESS
Performance of the functions of a public office
The term trade or business includes the performance of the functions

of a public office. [Section 22(S), NIRC]
INTEREST INCOME
Sources of interest income
1.
interest on bank deposit/deposit substitutes/trust fund and similar

arrangement
2.
interest from lending/interest income from bonds
3.
interest on uncollected salary
4.
interest on foreign bonds/government bonds
5.
interest on treasury bills
6.
interest earned from deposits maintained under the foreign currency

deposit system
7.
interest income of pawnshop operators
Interest income earned by non-stock, non-profit educational

institutions
Interest income shall be exempt only when used directly and

exclusively for educational purposes. To substantiate this claim, the
institution must submit an annual information return and duly audited
financial statement. A certification of actual utilization and the Board
resolution on the proposed project to be funded out of the money
deposited in banks must also be submitted. [Department of Finance
Order 149-95]
RENTALS
Operating lease
An operating lease is a contract under which the asset is not wholly

amortized during the primary period of the lease, and where the lessor
does not rely solely on the rentals during the primary period for his
profits, but looks for the recovery of the balance of his costs and for
the rests of his profits from the sale or re-lease of the returned assets
at the end of the primary lease period.
Finance lease
Also called full payout lease is a contract involving payment over

an obligatory period (also called primary or basic period) of specified
rental amounts for the use of a lessors property, sufficient in total to
amortize the capital outlay of the lessor and to provide for the lessors
borrowing costs and profits.
Obligatory period is primary non-cancelable period of the lease which

in no case shall be less than 730 days.
Lessee exercises choice over the asset.
DIVIDEND INCOME
Dividends
Dividends means any distribution made by a corporation to its

shareholders out of its earnings on profits and payable to its
shareholders, whether in money or in other property.
Kinds of dividend income

1.
Cash dividend
2.
Stock dividend/stock rights
3.
Property dividend
4.
Liquidating dividend
Stock dividend
A stock dividend representing the transfer of surplus to capital

account shall not be subject to tax.
It shall be taxable only if subsequently cancelled and redeemed by

the corporation.
It is also taxable if it leads to a substantial alteration in the

proportion of tax ownership in a corporation.
When redemption of stock dividends by a corporation is essentially

equivalent to a distribution of taxable dividends (CIR v. CA, et. al. ,
G.R. No. 108576 dated 1/20/99)
If the source of the redeemed shares is the original capital

subscriptions upon establishment of the corporation or from initial
capital investment in an existing enterprise, its redemption to the
concurrent value of acquisition would not be income but a mere return
of capital. On the other hand, if the redeemed shares are from stock
dividend declarations, the proceeds of the redemption is additional
wealth, for it is not merely a return of capital, and thus, deemed as
taxable dividends.
Dividends paid in property
Dividends paid in securities or other property, in which the earnings

of a corporation have been invested, are income to the recipients to
the amount of the full market value of such property when receivable
by individual stockholders.
A dividend paid in stock of another corporation is not a stock

dividend, even though the stock distributed was acquired through the
transfer by the corporation declaring the dividends of property to the
corporation the stock of which is distributed as a dividend. [Section
251, Revenue Regulations 2]
Liquidating dividend
Where a corporation distributes all its assets in complete liquidation

or dissolution, the gain realized or loss sustained by the stockholder,
whether individual or corporation, is a taxable income or deductible
loss, as the case may be.
Disguised dividends
These are payments which are equivalent to dividend distribution.
In the case of excessive payments by corporations, if such payments

correspond or bear a close relationship to stockholdings, and are found
to be a distribution of earnings or profits, the excessive payments will

be treated as dividends. [Section 71, Revenue Regulation 2]
EXCLUSION
Exclusion
Exclusion refers to income received or earned but is not taxable as

income because it is exempted by law or by treaty. Such tax-free
income is not to be included in the income tax return unless
information regarding it is specifically called for.
Exclusions from gross income

1.
Proceeds from life insurance
2.
Amount received by insured as return of premium
3.
Gifts, bequests and devises
4.
Compensation for injuries or sickness
5.
Income exempt under treaty
6.
Retirement benefits, pensions, gratuities, etc.
7.
Income derived by foreign government
8.
Income derived by the Philippine Government or its political

subdivisions
9.
Prizes and awards made primarily in recognition of religious,

charitable, scientific, educational, artistic, literary or civic achievement
10.
Prizes and awards in sports competitions sanctioned by the national

sports associations
11.
13th month pay and other benefits not exceeding P30,000.00
12.
GSIS, SSS, Medicare and other contributions
13.
Gains from the sale of bonds, debentures or other certificate of

indebtedness
14.
Gains from redemption of shares in mutual fund
Retirement benefits, pensions, gratuities, etc.
Such exclusions include:

1.
Retirement benefits under RA No. 7641 or a reasonable private

benefit plan
2.
Amount received by an official or employee or by his heirs from

the employer due to separation from the service because of
death, sickness or other physical disability or for any cause
beyond the control of the official or employee
3.
Social security benefits, retirement gratuities, pensions and

other similar benefits received by resident or non-resident
citizens or resident aliens from foreign government agencies and
other institutions, private or public
4.
Payment of benefits to a resident person under the United States

Veterans Administration
5.
Benefits received from or enjoyed under the Social Security

System
6.
Benefits received from the Government Service Insurance

System, including retirement gratuity received by government
officials and employees
Requisites for exclusion of retirement benefits

1.
It must be received under RA 7641 or in accordance with a reasonable

private benefit plan maintained by the employer.
2.
Retiring employee or official has been in the service of the same

employer for at least ten (10) years and is not less than fifty (50) years
of age at the time of his retirement.
3.
Benefits granted under the provision shall be availed of by an official

or employee only once.
Reasonable private benefit plan
It means a pension, gratuity, stock bonus or profit sharing plan

maintained by an employer for the benefit of some or all of his officials
or employees, or both, for the purpose of distributing to such officials
and employees the earnings and principal of the fund thus
accumulated, and wherein it is provided in said plan that at no time
shall any part of the corpus or income of the fund be used for, or be
diverted to, any purpose other than for the exclusive benefit of the said
officials and employees.
Separation pay and amounts received due to involuntary separation
Any amount received by an official or employee or by his heirs from

the employer due to death, sickness or other physical disability or for
any cause beyond the control of the said official or employee is
excluded from gross income.
Cause beyond the control of the employee
The phrase for any cause beyond the control of the said official or
employee connotes involuntariness on the part of the official or
employee. The separation from the service of the official or employee
must not be asked for or initiated by him. [Section 2.78.1, Revenue
Regulation 2-98] The separation was not of his own making.
Terminal leave pay
Commutation of leave credits or terminal leave pay are given not

only at the same time but also for the same policy considerations
governing retirement benefits. Thus, not being part of the gross salary
or income but a retirement benefit, terminal pay is not subject to
income tax. [Commissioner v. Court of Appeals, 203 SCRA 72]
Terminal leave pay is exempt from income tax. [Zialcita case, 190
SCRA 851]
Income derived by a foreign government
Income derived from investments in the Philippines in loans, stocks,

bonds or other domestic securities, or from interest on deposits in
banks in the Philippines by:
1.
foreign governments;
2.
financing institutions owned, controlled, or enjoying refinancing

from foreign governments; and
3.
international or regional financial institutions established by

foreign governments.
Income by the Philippine government
1.
Income derived from any public utility or from the exercise of any
essential governmental function
2.
Accruing to the Government or to any political subdivision thereof.
Prizes and awards in recognition of religious, charitable, scientific,

educational, artistic, literary or civic achievement
1.
Made primarily in recognition of religious, charitable, scientific,

educational, artistic, literary or civic achievement.
2.
The recipient was selected without any action on his part to enter the
contest or proceeding.
3.
The recipient is not required to render substantial future services as a

condition to receiving the prize or award.
Prizes and awards in sports competitions

1.
Prizes and awards must be granted to athletes in local and

international sports competitions and tournaments.
2.
Sports competition or tournament held either in the Philippines or

abroad.
3.
Sports competition or tournament must be sanctioned by their natural

sports associations.
DEDUCTIONS
IN GENERAL
Deductions
Deductions are items or amounts which the law allows to be

deducted under certain conditions from gross income in order to arrive
at taxable income.
Deduction v. exemption
Deduction is an amount allowed by law to be subtracted from gross

income to arrive at taxable income. Exemption from taxation is the
grant of immunity to particular persons or corporations or to persons or

corporations of a particular class from a tax which others generally
within the same taxing district are obliged to pay.
Deduction v. exclusion
Deduction is an amount allowed by law to be subtracted from gross

income to arrive at taxable income. Exclusion refers to income
received or earned but is not taxable as income because exempted by
law or by treaty. Such tax-free income is not to be included in the
income tax return unless information regarding it is specifically called
for. [Section 61, Revenue Regulation 2]
Basic principles governing deductions

1.
The taxpayer seeking a deduction must point to some specific

provisions of the statute authorizing the deduction; and
2.
He must be able to prove that he is entitled to the deduction

authorized or allowed.
Kinds of deductions
1.
Itemized deduction which is available to individual and corporate

taxpayers
2.
Optional standard deduction which is available to individual taxpayers

only, except a non-resident alien
3.
Special deductions which is available, in addition to the itemized

deductions, to certain corporations, i.e. insurance companies and
proprietary educational corporations
Time within which to claim deduction

1.
As a rule, if a taxpayer does not, within any year, deduct certain of his
expenses, losses, interests, taxes, or other charges, he cannot deduct
them from the income of the next or any succeeding year.
2.
If he keeps his books on the cash receipts basis, the expenses are
deductible in the year they are paid.
3.
If on the accrual basis, then in the year they are incurred, whether
paid or not.
Who may not avail of deductions from gross income?

1.
Citizens and resident aliens whose income is purely compensation

income.
They are allowed personal and additional exemptions and
deduction for premium payments on health and hospitalization
insurance.
2.
Non-resident aliens not engaged in trade or business in the Philippines
3.
Non-resident foreign corporations
Deductions from gross income

1.
Expenses
2.
Interest
3.
Taxes
4.
Losses
5.
Bad debts
6.
Depreciation
7.
Depletion of oil and gas wells and mines
8.
Charitable and other contributions
9.
Research and development
10.
Pension trusts
11.
Premium payments on health and/or hospitalization insurance of an

individual taxpayer
Some rules on deduction
A corporation may avail only of the deductions from (1) to (10);

premium payments on health and/or hospitalization insurance is
deductible only by an individual taxpayer.
A corporation may avail only of the itemized deductions; an

individual, except a non-resident alien, may elect the itemized
deductions or the optional standard deduction.
Thus, the optional standard deduction is not available to

corporations.
An individual earning purely compensation income is not allowed

itemized deductions, except premium payments on health and/or
hospitalization insurance. In addition, he is also granted personal and
additional exemptions.
An individual, who earns income other than purely compensation

income, is allowed personal and additional exemptions in addition to
the itemized deductions or the optional standard deduction.
Two kinds of deduction available to individuals, except a nonresident alien

1.
Itemized deductions
2.
Optional standard deduction
Note: Optional standard deduction is not available to corporations.
ORDINARY
AND
NECESSARY BUSINESS EXPENSES
Business expense v. capital expenses
Business expenses refer to all the ordinary and necessary expenses

paid or incurred during the taxable year in carrying on or which are
directly attributable to the development, management, operation
and/or conduct of the trade, business or the exercise of a profession.
Capital expenses are expenditures for extraordinary repairs which

are capitalized and subject to depreciation. These are expenses which
tend to increase the value or prolong the life of the taxpayers
property.
Ordinary and necessary expenses
An expense is ordinary when it is commonly incurred in the trade or

business of the taxpayer as distinguished from capital expenditures.
The payments, however, need not be normal or habitual in the sense
that the taxpayer will have to make them often. The payment may be
unique or non-recurring to the particular taxpayer affected.
An expense is necessary when it is appropriate and helpful to the

taxpayers business or if it is intended to realize a profit or to minimize
a loss.
Requisites for deductibility of business expense

1.
The expenses must be ordinary and necessary.
2.
It must be paid or incurred during the taxable year.
3.
It must be paid or incurred in carrying on any trade or business or

profession.
4.
It must be reasonable in amount.
5.
It must be substantiated by sufficient evidence such as official receipts

and other official records.
6.
It must not be against law, morals, public policy or public order.
Substantiation requirement for business expense
Taxpayer need to substantiate with sufficient evidence, such as

official receipts or other adequate records:
1.
the amount of the expense being deducted; and
2.
the direct connection or relation of the expense being deducted

to the development, management, operation and/or conduct of
the trade, business or profession of the taxpayer.
What are included in business expenses?
Business expenses include:

1.
Salaries, wages and other forms of compensation for personal

services actually rendered, including the grossed-up monetary
value of fringe benefit granted provided the fringe benefit tax
has been paid.
2.
Travel expenses, here and abroad, while away from home.
3.
Rentals and/or other payments of property to which the taxpayer

has not taken or is not taking title or in which he has no equity
other than that of a lessee, user or possessor.
4.
Entertainment, amusement and recreation expenses.
Requisites for deductibility of compensation payments

1.
The payments are reasonable.
2.
They are, in fact, payments for personal services actually rendered.

[Section 70, Revenue Regulation 2]
Treatment of excessive compensation
In the case of excessive payments by corporations, if such payments

correspond or bear a close relationship to stockholdings, and are found
to be distribution of earnings or profits, the excessive payments will be
treated as dividends. [Section 71, Revenue Regulations 2]
If such payments constitute payment for property, they should be

treated by the payor as capital expenditure and by the recipient as
part of the purchase price. [Section 71, Revenue Regulations 2]
Requisites for deductibility of bonuses to employees

1.
The bonuses are made in good faith.
2.
They are given for personal services actually rendered.
3.
They do not exceed a reasonable compensation for the services

rendered, when added to the stipulated salaries, measured by the
amount and quality of services performed in relation to the taxpayers
business. [Section 72, Revenue Regulations 2]
In Kuenzle v. CIR [28 SCRA 365] and C.M. Hoskins v. CIR [30
SCRA 434], the Supreme Court disallowed deductions for bonuses
given to the top officers of the involved corporations for being
unreasonable.
Pensions and compensation for injuries
Amounts paid for pensions to retired employees or to their families or

others dependent upon them, or on account of injuries received by the
employee, and lump sum amounts paid or accrued as compensation
for injuries are proper deductions as ordinary and necessary expenses.
Such deductions are limited to the amount not compensated for by
insurance or otherwise.
Rules on repairs
Expenses for repairs are deductible if such repairs are incidental or

ordinary, that is, made to keep the property used in the trade or
business of the taxpayer in an ordinarily efficient operating condition.
Repairs in the nature of replacement to the extent that they arrest

deterioration and prolong the life of the property are capital
expenditures and should be debited against the corresponding
allowance for depreciation. [Section 68, Revenue Regulations 2]
Travel expenses
Travel expenses include transportation expenses and meals and

lodging of an employee paid for by the employer. [Section 66, Revenue
Regulations 2]
Requisites for deductibility of travel expenses

1.
The expenses must be reasonable and necessary.
2.
They must be incurred or paid while away from home.
3.
They must be paid or incurred in the conduct of trade or business.
Tax home
Tax home is the principal place of business, when referring to away

from home.
Rental expense
A reasonable allowance for rentals and/or other payments which are

required as a condition for the continued use or possession, for
purposes of the trade, business or property to which the taxpayer has
not taken or is not taking title or in which he has no equity other than
that of a lessee, user or possessor is deductible from the gross income.
Where a leasehold is acquired for business purposes for a specified

sum, the purchaser may take as a deduction in his return an adequate
part of such sum each year, based on the number of years the lease
has to run.
Taxes paid by a tenant to or for a landlord for business property are

additional rent and constitute a deductible rent to the tenant and
taxable income to the landlord; the amount of tax being deductible by
the latter.
The cost borne by the lessee in erecting buildings or making

permanent improvements on ground of which he is a lessee is held to
be a capital investment and not deductible as a business expense.
Requisites for rental expense

1.
Required as a condition for continued use or possession
2.
For purposes of the trade, business or profession
3.
Taxpayer has not taken or is not taking title to the property or has no
equity other than that of a lessee, user or possessor
Entertainment, amusement and recreation expense

1.
Reasonable in amount
2.
Incurred during the taxable period
3.
Directly connected to the development, management, and operation

of the trade, business, or profession of the taxpayer, or that are
directly related to or in furtherance of the conduct of his or its trade,
business or profession
4.
Not to exceed such ceiling as the Secretary of Finance may, by rules

and regulations, prescribe
5.
Any expense incurred for entertainment, amusement or recreation

which is contrary to law, morals, public policy, or public order shall in
no case be allowed as a deduction
Option to private educational institutions
In addition to the allowable deductions, a private educational

institution may, at its option, elect either:
1.
To deduct expenditures otherwise considered as capital outlays

of depreciable assets incurred during the taxable year for the
expansion of school facilities; or
2.
To deduct allowance for depreciation thereof.
Treatment of other expenses

1.
Advertising expense
Not deductible business expense. Efforts to establish reputation
are akin to acquisition of capital assets and, therefore, expenses
related thereto are not business expense but capital expenditures.
2.
Promotional expenses
Same as advertising expense
3.
Litigation expenses
Litigation expenses that are incurred in the defense or protection
of title are capital in nature and not deductible.
In Gutierrez v. CIR [14 SCRA 34], it was held that litigation
expenses defrayed by a taxpayer to collect apartment rentals and to
eject delinquent tenants are ordinary and necessary expenses in
pursuing his business.
INTEREST EXPENSE
Interest
The amount of interest paid or incurred within a taxable year on

indebtedness in connection with the taxpayers profession, trade or
business shall be allowed as deduction from gross income.
Back-to-back interest
The taxpayers allowable deduction for interest expense shall be

reduced by an amount equal to 38% by 01 January 2000 of the interest
income earned by him which has been subjected to a final tax.
Interest which cannot be deducted
1.
Interest is paid in advance through discount or otherwise by an

individual taxpayer reporting income on the cash basis. Such interest
shall be allowed as a deduction in the year the indebtedness is paid.
2.
Interest between related taxpayers.
3.
If the indebtedness is incurred to finance petroleum exploration.
Requisites for deductibility of interest expense

1.
There must be an indebtedness incurred by the taxpayer in connection

with the taxpayers trade, business or profession.
2.
The interest must have been paid or incurred within the taxable year.
3.
The interest must have been stipulated in writing.
Optional treatment of interest expense
At the option of the taxpayer, interest incurred to acquire property

used in trade, business or exercise of a profession may be allowed as a
deduction or treated as a capital expenditure.
Delinquency interest on tax payment deductible
For interest to be allowed as deduction from gross income, it must be

shown that there be an indebtedness, that there should be interest
upon it, and that what is claimed as an interest deduction should have
been paid or accrued within the year. The term indebtedness has
been defined as an unconditional and legally enforceable obligation for
the payment of money. Within the meaning of that definition, a tax
may be considered as an indebtedness. Hence, interest paid for late
payment of the donors tax is deductible from gross income.
[Commissioner v. Prieto, 109 Phil 592]
TAXES
What taxes are deductible?
As a general rule, all taxes, national or local, paid or incurred with the
taxable year in connection with the taxpayers trade, business or
profession are deductible from gross income.
Taxes means taxes proper and, therefore, no deductions are allowed

for amounts representing interest, surcharges and fines or penalties
incident to delinquency.
What taxes are not deductible from gross income?

1.
Philippine income tax
2.
Income taxes imposed by the authority of any foreign country but

deduction is allowed only in the case of a taxpayer who is entitled to
tax credit for taxes of foreign countries but does not avail of the same
3.
Estate and donors taxes
4.
Special assessments or levies assessed against local benefits of a kind

tending to increase the value of the property assessed
Tax subsequently refunded or credited
Taxes previously allowed as deductions, when refunded or credited,

shall be included as part of gross income in the year of receipt to the
extent of the income tax benefit of said deduction.
Limitations on deductions for non-resident alien engaged in trade or

business and resident foreign corporation
In the case of a non-resident alien individual engaged in trade or

business in the Philippines and a resident foreign corporation,
deductions for taxes shall be allowed only if and to the extent that they
are connected with income from sources within the Philippines.
Tax credit
Tax credit refers to the taxpayers right to deduct from the income
tax due the amount of tax he has paid to a foreign country subject to
limitations.
Tax deduction v. tax credit
In the former, the taxes are deducted from the gross income in
computing the net income, while in the latter, the taxes are deducted
from Philippine income tax itself.
In the former, all taxes as a general rule, are allowed as deductions

with some exemptions (enumerated above), while in the latter, only
foreign income taxes may be claimed as credits against Philippine
income tax.
Proof of credits
The credits shall be allowed only if the taxpayer establishes to the

satisfaction of the Commissioner the following:
1.
The total amount of income from sources without the Philippines;
2.
The amount of income derived from each country, the tax paid
or incurred to which is claimed as a credit; and
3.
All other information necessary for the verification and

computation of such credits.
Credit against tax for taxes of foreign countries
Credit may be claimed by a citizen, domestic corporation, members

of general professional partnerships, and beneficiaries of estates and
trusts.
An alien individual and a foreign corporation are not allowed to claim

credits against the tax for taxes of foreign countries.
Limitations on credit
The amount of the credit taken shall be subject to each of the

following limitations:
1.
The amount of the credit in respect to the tax paid or incurred to any
country shall not exceed the same proportion of the tax against which
such credit is taken, which the taxpayers taxable income from sources
within such country bears to his entire taxable income for the same
taxable year; and
2.
The total amount of the credit shall not exceed the same proportion of
the tax against which such credit is taken, which the taxpayers
taxable income from sources without the Philippines taxable under this
Title bears to his entire taxable income for the same taxable year.
LOSSES
Losses
The term implies an unintentional parting with something of value.
It is used in the income tax law in a very broad sense to comprehend

all losses which are not general or natural to the ordinary course of
business.
Requisites for deductibility of loss

1.
The loss must be incurred in the trade, business or profession of the

taxpayer.
2.
It must be actually sustained and charged off within the taxable year.
3.
It must be evidenced by a closed and completed transaction.
4.
It must not be compensated for by insurance or other forms of

indemnity.
5.
If it is a casualty loss, the taxpayer has filed a sworn declaration of loss

within 45 days after the date of the discovery of the casualty or
robbery, theft, or embezzlement.
Some recognized losses

1.
Ordinary losses/business losses
2.
Casualty losses
3.
Capital losses
4.
Securities becoming worthless
5.
Losses from wash sales or stock or securities
6.
Wagering losses
7.
Abandonment losses
Note: Capital losses and securities becoming worthless are governed by

rules on loss from the sale or exchange of capital assets.
Casualty loss
Loss arises from fires, storms, shipwreck, or other casualties, or from

robbery, theft or embezzlement.
Loss limitation rule for capital losses
Losses from sales or exchanges of capital assets shall be allowed

only to the extent of the gains from such sales or exchanges.
Securities becoming worthless

1.
Securities become worthless during the taxable year
2.
Securities are capital assets
3.
Losses are considered as losses from the sale or exchange, on the last
day of such taxable year, of capital assets
Net operating loss
It means the excess of allowable deduction over gross income of the

business in a taxable year.
Net operating loss carry-over (NOLCO)
NOLCO shall be carried over as a deduction from the gross income

for the next three (3) consecutive taxable years immediately following
the year of loss.
Such loss shall be allowed as a deduction if it had not been

previously offset as deduction from gross income.
However, any net loss incurred in a taxable year during which the
taxpayer was exempt from income tax shall not be allowed as a
deduction.
NOLCO shall be allowed only if there has been no substantial change

in the ownership of the business or enterprise.
There is no substantial change when:

1.
Not less than 75% in nominal value of outstanding issued shares,

if the business is in the name of a corporation, is held by or on
behalf of the same persons; or
2.
Not less than 75% of the paid up capital of the corporation, if

the business is in the name of a corporation, is held by or on
behalf of the same persons.
Losses from wash sales of stock or securities
No deduction for loss shall be allowed for wash sales unless the claim
is made by a dealer in stock or securities and with respect to a
transaction made in the ordinary course of the business of such dealer.
Wash sale
A wash sale occurs where it appears that within a period beginning

thirty (30) days before the date of the sale or disposition of shares of
stock or securities and ending thirty (30) days after such date, the
taxpayer has acquired (by purchase or exchange) or has entered into a
contract or option to so acquire, substantially identical stock or
securities.
Wagering losses
Losses from wagering shall be allowed only to the extent of gains

from such transactions.
Abandonment losses
In the event a contract area where petroleum operations are

undertaken is partially or wholly abandoned, all accumulated
exploration and development expenditures pertaining thereto shall be
allowed as a deduction.
In case a producing well is subsequently abandoned, the

unamortized costs thereof, as well as the undepreciated costs of
equipment directly used therein, shall be allowed as a deduction in the
year such well, equipment or facilitiy is abandoned by the contractor.
BAD DEBTS
Bad Debts
Bad debts are debts due to the taxpayer which are actually
ascertained to be worthless and charged off within the taxable year.
Requisites for deductibility of bad debts

1.
There must be a valid and subsisting debt.
2.
The debt must be actually ascertained to be worthless and

uncollectible during the taxable year.
3.
The debt must be charged off during the taxable year.
4.
The debt must be connected with the trade, business or profession of

the taxpayer, and not sustained in a transaction entered into between
related taxpayers.
Diligent eforts to collect
In addition to the four requisites, the taxpayer must show that the
debt is indeed uncollectible even in the future.
Furthermore, there are steps outlined to be undertaken by the

taxpayer to prove that he exerted diligent efforts to collect the
debts, via: a) sending of statement of accounts; b) sending of
collection letters; c) giving the account to a lawyer for collection; and
d) filing a collection case in court. [Philippine Refining Co. v. Court
of Appeals, 256 SCRA 667]
Equitable doctrine of tax benefit
This doctrine holds that a recovery of bad debt previously deducted

from gross income constitutes taxable income if in the year the
account was written off, the deduction resulted in a tax benefit, that is,
in the reduction of taxable income of the taxpayer.
DEPRECIATION
Depreciation
Depreciation is the gradual diminution in the useful value of tangible

property used in trade, business or profession resulting form
exhaustion, wear and tear, and obsolescence.
The term is also applied to amortization of the value of intangible

assets, the use of which in trade or business is definitely limited in
duration.
The income tax law does not authorize the depreciation of an asset
beyond its acquisition cost. Hence, a deduction over and above the
cost cannot be claimed and allowed. [Basilan v. CIR, 21 SCRA 17]
Depreciation is a question of fact
Depreciation is a question of fact and is not measured by theoretical

yardstick, but should be determined by a consideration of actual facts.
[Limpan v. CIR, 17 SCRA 703]
Requisites for deductibility of depreciation

1.
The allowance for depreciation must be reasonable.
2.
It must be for property used in the trade, business or profession.
3.
It must be charged off during the taxable year.
4.
A statement on the allowance must be attached to the return.
Deduction for obsolescence
If the whole or any portion of physical property is clearly shown by

the taxpayer as being affected by economic conditions that will result
in its being abandoned at a future date prior to the end of its natural
life, so that depreciation deductions alone would be insufficient to
return the cost at the end of its economic terms of usefulness, a
reasonable deduction for obsolescence, in addition to depreciation,
may be allowed.
Property held for life
In the case of property held by one person for life with remainder to
another person, the deduction shall be computed as if the life tenant
were the absolute owner of the property and shall be allowed to the life
tenant.
In case of property held in trust
Allowable deductions shall be apportioned between the income

beneficiaries and the trustees in accordance with the pertinent
provisions of the instrument creating the trust, or in the absence of

such provisions, on the basis of the trust income allowable to each.
Certain methods in computing depreciation
1.
The straight line method
2.
Declining balance method
3.
Sum-of-the-year-digit method.
4.
Any other method which may be prescribed by the Secretary of

Finance upon recommendation of the Commissioner.
Agreement as to useful life on which depreciation rate is based
Where the taxpayer and the Commissioner have entered into an

agreement in writing specifically dealing with the useful life and rate of
depreciation of any property, the rate so agreed upon shall be binding
on both the taxpayer and the National Government in the absence of
facts and circumstances not taken into consideration during the
adoption of such agreement. The responsibility of establishing the
existence of such facts and circumstances shall rest with the party
initiating the modification.
Where the taxpayer has adopted such useful life and depreciation
rate for any depreciable asset and claimed the depreciation expenses
as deduction from his gross income without any written objection on
the part of the Commissioner or his duly authorized representative, the
aforesaid useful life and depreciation rate so adopted by the taxpayer
shall be considered binding.
Depreciation of patent or copyright
In computing a depreciation allowance in the case of a patent or

copyright, the capital sum to be replaced is the cost or other basis of
the patent or copyright.
The allowance should be computed by an apportionment of the cost

or other basis of the patent or copyright over the life of the patent or
copyright since its grant, or since its acquisition by the taxpayer, or
since March 1, 1913, as the case may be.
DEPLETION
OF OIL AND GAS WELLS AND MINES
Depletion of Oil and Gas Wells and Mines
Depletion is the exhaustion of natural resources like mines and oil

and gas wells as a result of production or severance from such mines
or wells.
Determination of amount of depletion cost
In determining the amount of depletion cost allowable, the following

three factors are essential, namely:
1.
the basis of the property;
2.
the estimated total recoverable units in the property; and
3.
the number of units recovered during the taxable year in

question. [Consolidated Mines v. CTA, 58 SCRA 618]
Basis means the amount of the taxpayers capital or investment in

the property which he is entitled to recover tax-free during the period
he is removing the mineral in the deposit.
Intangible cost in petroleum operations
This refers to any cost incurred in petroleum operations which in

itself has no salvage value and which is incidental to and necessary for
the drilling of wells and preparation of wells for the production of
petroleum.
Depletion v. depreciation
Both are predicated on the same basic premise of avoiding a tax on

capital.
However, depletion is based upon the concept of the exhaustion of a

natural resource whereas depreciation is based upon the concept of
the exhaustion of the property, not otherwise a natural resource, used
in a trade or business or held for the production of income. Thus,
depletion and depreciation are made applicable to different types of
assets.
CHARITABLE
AND
OTHER CONTRIBUTIONS
Kinds of Charitable Contributions
1.
Ordinary or those which are subject to limitations as to the amount

deductible from gross income.
2.
Special or those which are deductible in full from gross income.
Requisite for deductibility of charitable contributions

1.
The contribution must actually be paid or made to the Philippine

government or any political subdivision thereof or to any of the
domestic corporations or associations specified by the NIRC.
2.
No part of the net income of the beneficiary must inure to the benefit
of any private stockholder or individual.
3.
It must be made within the taxable year.
4.
It must not exceed 10% in the case of an individual and 5% in the case
of a corporation of the taxpayers taxable income (except where the
donation is deductible in full) to be determined without the benefit of
the contribution.
5.
It must be evidenced by adequate records or receipts.
Contributions deductible in full

1.
Donations to the Philippine government or to any of its political

subdivisions according to a national priority plan determined by NEDA.
2.
Donations to foreign institutions or international organizations which

are fully deductible in pursuance of or in compliance with agreements,
treaties or commitments entered into by the Philippines or in
pursuance of special laws.
3.
Donation to accredited non-governmental organization.
Non-government organization
It means a non-profit domestic corporation:

1.
Organized and operated exclusively for scientific, research,

educational, character-building and youth and sports
development, health, social welfare, cultural or charitable
purposes, or a combination thereof, no part of the net income of
which inures to the benefit of any private individual.
2.
Utilizes the contribution directly for the active conduct of the

activities constituting the purpose or function for which it is
organized and operated not later than the 15th day of the their
month after the close of the accredited NGOs taxable year in
which the contribution were received.
3.
Administrative expense shall, in no case, exceed thirty percent

(30%) of the total expenses.
4.
The assets, in the event of dissolution, would be distributed to

another non-profit domestic corporation organized for similar
purpose, or to the State for public purpose, or would be
distributed by a court to another organization.
Utilization
Utilization means:
1.
Any amount in cash or kind (including administrative expenses) paid or

utilized to accomplish one or more purposes for which the accredited
non-governmental organization was created or organized.
2.
Any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more purposes for which the accredited nongovernmental organization was created or organized.
Proof of deductions
Contributions or gifts shall be allowable as deductions only if verified

under the rules and regulations prescribed by the Secretary of Finance.
RESEARCH
AND
DEVELOPMENT
Research and development
A taxpayer may treat research or development expenditures which

are paid or incurred by him during the taxable year in connection with
his trade, business or profession as ordinary and necessary expenses
which are not chargeable to capital account. The expenditures so
treated shall be allowed as deduction during the taxable year when
paid or incurred.
Amortization of certain research and development expenditures
Taxpayer may also elect to treat the following research and

development expenditures as deferred expenses:
1.
Paid or incurred by the taxpayer in connection with his trade,

business or profession;
2.
Not treated as expenses; and
3.
Chargeable to capital account but not chargeable to property of

a character which is subject to depreciation or depletion.
Research and development expenses deductions shall not apply to:

1.
Any expenditure for the acquisition or improvement of land, or for the

improvement of property to be used in connection with research and
development of a character which is subject to depreciation or
depletion.
2.
Any expenditure paid or incurred for the purpose of ascertaining the

existence, location, extent or quality of any deposit of ore or other
mineral, including oil or gas.
PENSION TRUSTS
Requisites for deductibility of payments to pension trusts
1.
The employer must have established a pension or retirement plan to

provide for the payment of reasonable pensions to his employees.
2.
The pension plan is reasonable and actuarially sound.
3.
It must be funded by the employer.
4.
The amount contributed must no longer be subject to the control or

disposition of the employer.
5.
The payment has not yet been allowed as a deduction.
6.
The deduction is apportioned in equal parts over a period of ten (10)

consecutive years beginning with the year in which the transfer or
payment is made.
ADDITIONAL
REQUIREMENT FOR DEDUCTIBILITY OF CERTAIN PAYMENTS
Additional requirement for deductibility of certain payments
Any amount paid or payable which is otherwise deductible from, or

taken into account in computing gross income or for which
depreciation or amortization may be allowed, shall be allowed as a
deduction only if it is shown that the tax required to be deducted and
withheld therefrom has been paid to the Bureau of Internal Revenue.
Limitations or ceilings on itemized deductions
The Secretary of Finance may prescribe limitations or ceilings for any

of the itemized deductions from (1) to (10). This can be done through
rules and regulations issued by the Secretary upon the
recommendation of the Commissioner and after a public hearing has
been held for such purpose.
The Secretary shall, for purposes of determining such ceilings or

limitations, consider the following factors:
1.
Adequacy of the prescribed limits on the actual expenditure

requirements of each particular industry; and
2.
Effects of inflation on expenditure levels.
OPTIONAL STANDARD DEDUCTION

Optional Standard Deduction
An individual subject to tax, other than a non-resident alien, may

elect a standard deduction in an amount not exceeding ten percent
(10%) of his gross income in lieu of itemized deductions.
Unless the taxpayer signifies in his return his intention to elect the
optional standard deduction, he shall be considered as having availed
himself of the itemized deductions.
Such election when made in the return shall be irrevocable for the
taxable year for which the return is made.
An individual who is entitled to and claimed for the optional standard

deduction shall not be required to submit with his tax return such
financial statements otherwise required in the NIRC.
DEDUCTIONS ALLOWED ONLY TO INDIVIDUAL TAXPAYERS

Deductions allowed only to individual taxpayers
1.
Personal exemption
2.
Additional exception
3.
Premium payments on health and/or hospitalization insurance
Personal exemptions
Personal exemptions are arbitrary amounts allowed, in the nature of

a deduction from taxable income, for personal, living or family
expenses of an individual taxpayer. They are considered to be the
equivalent of the minimum of subsistence of the taxpayer.
Who are allowed personal exceptions?

1.
Citizens
2.
Resident aliens
3.
Non-resident aliens engaged in trade or business in the Philippines

under certain conditions
4.
Estates and trusts, which are treated for purposes of personal

exemptions, as a single individual
Amount of personal exemptions allowed to citizens and resident

aliens
P20,000
P25,000
head of a family
P32,000
married person
single person or a married person judicially

decreed as legally separated from his or her spouse
with no qualified dependents
Note: Only the spouse deriving taxable income can claim the P32,000
personal exemption; if both have taxable income, each can claim
P32,000 exemption.
Head of the family
It means an unmarried or legally separated man or woman with one

or both parents, or with one or more brothers or sisters, or with one or
more legitimate, recognized natural or legally adopted children living
with and dependent upon him or her for their chief support.
Such brothers or sisters or children should be not more than 21 years

old, unmarried and not gainfully employed, or where such children,
brothers or sisters, regardless of age, are incapable of self-support
because of mental or physical defect.
A head of family is an individual who actually supports and maintains

in one household one or more individuals, who are closely connected
with him by blood relationship, relationship by marriage, or by
adoption, and whose right to exercise family control and provide for
these dependent individuals is based upon some moral or legal
obligation.
Note: Consider discrepancy between definition of head of

family and dependent i.e. children.
To be a head of a family, one or more legitimate, recognized
natural, or legally adopted children must live with and depend on
an unmarried or legally separated man or woman.
A dependent, on the other hand, may be a legitimate,
illegitimate or legally adopted child.
Both, however, define or qualify different terms.
Living with
The term living with the person giving support does not necessarily
mean actual and physical dwelling together at all times and under all
circumstances.
Family
The term family includes an unmarried or legally separated person

with:
1.
one or both parents;
2.
one or more brothers or sisters; or
3.
one or more legitimate, recognized natural, or legally adopted

children living with and dependent upon him or her for their chief
support.
Additional exemption
A married person or a head of a family may claim an additional

exemption of P8,000 for each dependent, not exceeding four (4).
The additional exemption shall be claimed by only one of the spouses

in the case of married individuals.
In the case of legally separated spouses, it may be claimed only by

the spouse who has custody of the child or children.
Dependent
Refers only to the legitimate, illegitimate or legally adopted child of

the taxpayer
The child is:

1.
living with the taxpayer;
2.
chiefly dependent upon the taxpayer for support;
3.
not more than 21 years of age;
4.
not married; and
5.
not gainfully employed or, even though over 21 years old,

incapable of self support because of mental or physical defect.
Change of status
Taxpayer marries or have additional dependents
Taxpayer dies during the taxable year
If the spouse or any of the dependents dies or if any of such

dependent marries, becomes 21 years old, or becomes gainfully
employed
Note: As a general rule, interpret in favor of taxpayer
Personal exemptions to non-resident alien individual
Non-resident alien individual engaged in trade or business
Entitled only to personal exemption
Amount allowed is limited to exemptions granted to Filipino citizens

who are not residents in the aliens domicile country but not to
exceed the amount allowed to citizens or residents of the Philippines in
the NIRC.
Premium payment on health and/or hospitalization insurance of an

individual taxpayer
Premium payments should not exceed P2,400 per family or P200 a

month for a taxable year
Family has a gross income of not more than P250,000 for the taxable
year
In the case of married taxpayers, only the spouse claiming the

additional exemption for dependents shall be entitled to this deduction.
ITEMS NOT DEDUCTIBLE

Items not deductible
1.
Personal, living or family expenses
2.
Capital expenditures
3.
a.
Any amount paid out for new buildings or for permanent

improvements, or betterments made to increase the value of any
property or estate
b.
Any amount expended in restoring property or in making good

the exhaustion thereof for which an allowance is or has been
made
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, individually or corporate, when
the taxpayer is directly or indirectly a beneficiary under such policy

[Section 36, NIRC]
4.
Losses between related taxpayers.
5.
Losses on wash sales
6.
Illegal expense i.e. bribes, kickbacks, and other similar payments

[Section 34(A)(1)(c), NIRC]
Capital expenditures
1.
Any amount paid out for new buildings or for permanent

improvements, or betterments made to increase the value of any
property or estate
2.
Any amount expended in restoring property or in making good the

exhaustion thereof for which an allowance is or has been made
3.
Cost of defending or perfecting title to property constitutes a part of

the cost of the property and is not a deductible expense
4.
The amount expended for architects services is part of the cost of the
building
5.
Expenses of the administration of an estate such as court costs,

attorneys fees, and executors commissions are chargeable against
the corpus of the estate and are not allowable deductions
6.
In case of a corporation, expenses for organization, such as

incorporation fees, attorneys fees and accountants charges are
ordinarily capital expenditures, but where such expenditures are
limited to purely incidental expenses, a taxpayer may charge such
items against income in the year in which they are incurred. [Section
120, Revenue Regulations 2]
Life or health insurance and other non-life insurance premiums or

similar amounts in excess of what the law allows
General rule: The cost of life or health insurance and other non-life
insurance premiums borne by the employer for his employee shall be
treated as taxable fringe benefit.
Exceptions
1.
Contribution of the employer for the benefit of the employee

pursuant to the provisions of existing law, i.e. SSS, GSIS, among
others.
2.
The cost of premiums borne by the employer for the group

insurance of his employees. [Revenue Regulations 3-98]
Related taxpayers
1.
Between members of a family (which shall include only his brothers

and sisters, spouse, ancestors and lineal descendants)
2.
Between an individual and a corporation more than 50% in value of

the outstanding stock of which is owned, directly or indirectly, by or for
such individual except in the case of distributions in liquidation
3.
Between two corporations more than 50% in value of the outstanding

stock of each of which is owned, directly or indirectly by or for the
same individual
4.
Between the grantor and the fiduciary of a trust
5.
Between the fiduciary of a trust and the fiduciary of another trust if the
same person is a grantor with respect to each trust
6.
Between the fiduciary of a trust and a beneficiary of such trust

[Section 36(B), NIRC]
Relevant points regarding related taxpayers

1.
Payment of interest is not deductible.
2.
Bad debts are not deductible.
3.
Losses from sales or exchanges of property are not deductible.
CAPITAL GAINS AND LOSSES

Ordinary asset
1.
Stock in trade of the taxpayer or other property of a kind which would

properly be included in the inventory of the taxpayer if on hand at the
close of the taxable year.
2.
Property held by the taxpayer primarily for sale to customers in the

ordinary course of his trade or business.
3.
Property used in the trade or business, of a character which is subject

to the allowance for depreciation.
4.
Real property used in the trade or business of the taxpayer.
Capital asset
Property held by the taxpayer, whether or not connected with his

trade or business, which is not an ordinary asset.
Ordinary gain or income
Ordinary income or gain includes any gain from the sale or exchange
of property which is not a capital asset.
Capital gain or income
Capital gain or income is any gain from the sale or exchange of a

capital asset.
Net capital gain
Net capital gain means the excess of the gains from sales or
exchanges of capital assets over the losses from such sales or
exchanges.
Net capital loss
Net capital loss means the excess of the losses from sales or
exchanges of capital assets over the gains from such sales or
exchanges.
Three rules on the recognition of capital gains and losses

1.
Holding rule
2.
Loss limitation rule
3.
Net capital loss carry-over rule
Note: The holding and net capital loss carry-over rules apply only to
individual taxpayers and not to corporate taxpayers.
Percentage taken into account or holding rule
In the case of an individual taxpayer, only the following

percentages of the gain or loss recognized upon the sale or exchange
of a capital asset shall be taken into account in computing net capital
gain, net capital loss, and net income:
100% 50% -
if the capital asset has been held for not more than 12
months
if the capital asset has been held for more than 12 months
Loss limitation rule
Losses from sales or exchanges of capital assets shall be allowed

only to the extent of the gains from such sales or exchanges.
Net capital loss carry-over
If any taxpayer, other than a corporation, sustains in any taxable

year a net capital loss, such loss (in an amount not in excess of the net
income for such year) shall be treated in the succeeding taxable year
as a loss from the sale or exchange of a capital asset held for not more
than 12 months.
Gains and losses from short sales, etc.
Gains or losses from short sales of property shall be considered as

gains or loses from sales or exchanges of capital assets.
Gains or losses attributable to the failure to exercise privileges or

options to buy or sell property shall be considered as capital gains or
losses.
General rule on the recognition of gain or loss upon the sale or

exchange of property
The general rule is that the entire amount of the gain or loss, as the
case may be, shall be recognized, i.e. taxable or deductible.
Exceptions
1.
2.
Transactions where gains and losses are not recognized

a.
Exchange of property where the property received is not

substantially different from the property disposed of. [Section
140, Reg. No. 2]
b.
Exchange of property solely in kind in pursuance of corporate

mergers and consolidations.
c.
Exchange by a person of his property for stocks in a corporation

as a result of which said person, alone or together with others
not exceeding four persons, gains control of said corporation.
Transactions where gain is recognized but not the loss

a.
Transactions between related taxpayers
b.
Illegal transactions
c.
Exchanges of property, not solely in kind, in pursuance of

corporate mergers and consolidations
Merger or consolidation
Merger or consolidation shall be understood to mean the (a) ordinary

merger or consolidation or (b) the acquisition by one corporation of all
or substantially all the properties of another corporation solely for
stock.
Such merger or consolidation must be undertaken for a bona

fide business purpose and not solely for the purpose of escaping the
burden of taxation.
SOURCES OF TAXATION
Source of income
The term source of income is not a place but the property, activity
or service that produces the income. [Commissioner v. BOAC]
Dissent of Justice Feliciano in Commissioner v BOAC
The source of income relates not to the physical sourcing of a flow of

money or the physical situs of payment but rather to the property,
activity or service which produced the income. Where a contract for
rendition of services is involved, the applicable source rule may be
simply stated as follows: The income is sourced in the place where the
service contracted for is rendered.
Sources of taxation
1.
Income from sources within the Philippines
2.
Income from sources without the Philippines
3.
Income from sources partly within and partly without the Philippines
Gross income from sources within the Philippines
The following items of gross income shall be treated as gross income

from sources within the Philippines:
1.
Interests derived from sources within the Philippines, and

interests on bonds, notes or other interest-bearing obligations of
residents, corporate or otherwise.
2.
Dividends received from a domestic corporation and from a

foreign corporation, unless less than 50% of the gross income of
such foreign corporation for the three-year period ending with
the close of its taxable year preceding the declaration of such
dividends was derived from sources within the Philippines.
3.
Compensation for labor or personal services performed in the

Philippines.
4.
Rentals and royalties from property located in the Philippines.
5.
Gains, profits and income from the sale of real property located
in the Philippines.
6.
Gains, profits and income from the sale of personal property if

sold within the Philippines. [Section 42(A), NIRC]
Interest income
The residence of the obligor who pays the interest, rather than the
physical location of the securities, bonds or notes or the place of
payment, is the determining factor of the source of interest income.

[National Development Corporation v. Commissioner, 151 SCRA
472]
Gross income from sources without the Philippines
Just the exact opposite of the items of gross income from sources
within the Philippines. [Section 42(B), NIRC]
Income from sources partly within and partly without the

Philippines
Gains, profits and income from the sale of personal property

produced by the taxpayer within and sold without the Philippines, or
produced by the taxpayer without and sold within the Philippines shall
be treated as derived partly from sources within and partly from
sources without the Philippines. [Section 42(E), NIRC]
Purchase or sale of personal property
Gains, profits and income derived from the purchase of personal

property within and its sale without the Philippines, or from the
purchase of personal property without and its sale within the
Philippines shall be treated as derived entirely from sources within the
country in which sold. [Section 42(E), NIRC]
Gain from sale of shares of stock of a domestic corporation
Gain from the sale of shares of stock in a domestic corporation shall

be treated as derived entirely from sources within the Philippines
regardless of where the said shares are sold.
The transfer by a non-resident alien or a foreign corporation to

anyone of any share of stock issued by a domestic corporation shall
not be effected or made in its book unless:
1.
The transferor has filed with the Commissioner a bond

conditioned upon the future payment by him of any income tax
that may be due on the gains derived from such transfer; or
2.
The Commissioner has certified that the taxes, if any, imposed

and due on the gain realized from such sale or transfer have
been paid. [Section 42(E), NIRC]
ACCOUNTING PERIODS AND METHODS OF ACCOUNTING

Methods of accounting
General Rule: The taxable income shall be computed upon the

basis of the taxpayers annual accounting period in accordance with
the method of accounting regularly employed in keeping the books of
such taxpayer.
Exception: Computations shall be made in accordance with such

method as in the opinion of the Commissioner clearly reflects the
income:
a.
If no such method of accounting has been so employed; or
b.
If the method employed does not clearly reflect the income.

[Section 43, NIRC]
Taxable year
Taxable year means the calendar year, or the fiscal year ending
during such calendar year, upon the basis of which the net income is
computed.
Accounting periods
1.
Calendar year - January 1 to December 31
2.
Fiscal year an accounting period of twelve (12) months ending on the

last day of any month other than December.
When calendar year used?

1.
If the taxpayer chooses the calendar year
2.
If the taxpayer has no annual accounting period
3.
If the taxpayer does not keep books
2.
If the taxpayer is an individual
When Commissioner is authorized to terminate taxable period

1.
When a taxpayer retires from business subject to tax
2.
When he intends to leave the Philippines
3.
When he removes his property from the Philippines
4.
When he hides or conceals his property
5.
When he performs any act tending to obstruct the proceedings for the
collection of the tax for the past or current quarter or year
6.
When he renders the collection of the tax totally or partly ineffective
Methods of accounting
1.
Cash Basis
Income, profits and gains earned by taxpayer are not included in
gross income until received.
Expenses are not deducted until paid within the taxable year.
2.
Accrual Method
Income, gains and profits are included in the gross income when
earned, whether received or not.
Expenses are allowed as deductions when incurred, although not
yet paid.
3.
Mixed/Hybrid
Combination of the cash and accrual method.
4.
Any other method which clearly reflects the income
Cash v. accrual method of accounting
Gains, profits and income are to be included in the gross income for
the taxable year in which they are received by the taxpayer, unless
they are included when they accrue to him in accordance with the
approved method of accounting followed by him.
Tax accounting v. financial accounting
While taxable income is based on the method of accounting used by

the taxpayer, it will always differ from accounting income. This is so
because of a fundamental difference in the ends the two concepts
serve. Accounting attempts to match cost against revenue. Tax law is
aimed at collecting revenue. It is quick to treat an item as income,
slow to recognize deductions as losses. Thus, tax law will not
recognized deductions for contingent future losses except in very
limited situations. Good accounting, on the other hand, requires their
recognition. [Consolidated Mines v. CTA, 58 SCRA 618]
Long-term contracts
The term long term contracts means building, installation or

construction contracts covering a period in excess of one year. [Section
48, NIRC]
Treatment of income from long-term contracts

1.
Percentage of completion basis
2.
Completed contract basis
Note: Section 48 of the NIRC provides that Persons whose gross income is
derive in whole or in part from such (long term) contracts shall report
such income upon the basis of percentage of completion.
The return should be accompanied by a return certificate of
architects or engineers showing the percentage of completion during
the taxable year of the entire work performed under the contract.
Sales of dealers in personal property
A person who regularly sells or otherwise disposes of personal

property on the installment plan may return as income therefrom in
any taxable year that proportion of the installment payments actually
received in that year, which the gross profit realized or to be realized
when payment is completed, bears to the total contract price. [Section
49, NIRC]
Treatment of sales of realty and casual sales of personalty
These include:
1.
Casual sale or other casual disposition of personal property

(other than property included in the inventory at the close of the
taxable year) for a price exceeding P1000; and
2.
Sale or other disposition of real property.
Treated either on installment basis or deferred sales basis.
Installment basis selling price.
Deferred sales basis - if the initial payments exceed 25% of the

selling price [Section 49, NIRC and Section 175, Revenue Regulations
2]
if the initial payments do not exceed 25% of the
Initial payments
These include the payments received in cash or property other than

evidences of indebtedness of the purchaser during the taxable period
in which the sale or other disposition is made.
The term initial payments contemplates at least one other

payment in addition to the initial payment. [Section 175, Revenue
Regulations 2]
Termination of leasehold
Lessor who acquires building or improvements made by the lessee

after the termination of the lease has two options in reporting said
income:
1.
Lessor may report as income at the time when such buildings or

improvements are completed the fair market value of such
buildings or improvements; or
2.
Lessor may spread over the life of the lease the estimated
depreciated value of such buildings or improvements at the
termination of the lease and report as income for each of the
lease an adequate part thereof. [Section 49, Revenue
Regulations 2]
Allocation of income and deductions
In the case of two or more organizations, trades or businesses

(whether or not incorporated and whether or not organized in the
Philippines) owned or controlled, directly or indirectly, by the same

interests, the Commissioner is authorized to distribute, apportion or
allocate gross income or deductions between or among such
organization, trade or business, if he determines that such distribution,
apportionment or allocation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any such organization, trade or
business. [Section 50, NIRC]
RETURNS AND PAYMENT OF TAX

INDIVIDUAL INCOME TAX RETURNS
Who are required to file individual returns?
1.
Every Filipino citizen residing in the Philippines
2.
Every Filipino citizen residing outside the Philippines, on his income

from sources within the Philippines
3.
Every alien residing in the Philippines, on income derived from sources

within the Philippines
4.
Every non-resident alien engaged in trade or business or in the

exercise of a profession in the Philippines
Who are not required to file individual returns?

1.
An individual whose gross income does not exceed his total personal
and additional exemptions.
However, a Filipino citizen and any alien individual engaged in
business or practice of profession within the Philippines shall file an
income tax return, regardless of the amount of gross income.
2.
An individual with respect to pure compensation income derived from

sources within the Philippines, the income tax on which has been
correctly withheld.
However, an individual deriving compensation concurrently from
two or more employees at any time during the taxable year shall file
an income tax return.
Further, an individual whose pure compensation income derived

from sources within the Philippines exceeds P60,000 shall also file an
income tax return.
3.
An individual whose sole income has been subjected to a final

withholding tax.
4.
An individual who is exempt from income tax pursuant to the NIRC and
other laws, general or special.
Where to file
1.
Authorized agent bank
2.
Revenue District Officer
3.
Collection agent
4.
Duly authorized Treasurer of the city or municipality in which such

person has his legal residence or principal place of business in the
Philippines
5.
Office of the Commissioner if there be no legal residence or place of

business in the Philippines
When to file
On or before April 15 of each year covering income from the

preceding taxable year
Thirty (30) days from each transaction and a final consolidated return
on or before April 15 covering all stock transactions of the preceding
year in case of sale or exchange of shares of stock not traded through
a local stock exchange
Thirty (30) days following each sale or other disposition in case of

sale or disposition of real property
Husband and wife
Married individuals, whether citizens, resident or non-resident aliens,

who do not derive income purely from compensation, shall file a return
for the taxable year to include the income of both spouses.
However, if it is impracticable for the spouses to file one return, each

spouse may file a separate return of income but the returns so filed
shall be consolidated by the BIR for purposes of verification for the
taxable year.
Return of parent to include income of children
The income of unmarried minors derived from property received from

a living parent shall be included in the return of the parent, except:
1.
When the donors tax has been paid on such property; or
2.
When the transfer of such property is exempt from donors tax.
SELF-EMPLOYED INDIVIDUALS
Declaration of income tax for individuals
Every individual subject to income tax, who is receiving selfemployment income, whether it constitutes the sole source of his
income or in combination with salaries, wages and other fixed or
determinable income, shall make and file a declaration of his estimated
income for the current taxable year on or before April 15 of the same
taxable year.
Non-resident Filipino citizens with respect to income from without the

Philippines and non-resident aliens not engaged in trade or business in
the Philippines are not required to render a declaration of estimate
income tax.
Self-employment income
Self employment income consists of the earnings derived by the

individual from the practice of profession or conduct of trade or
business carried on by him as a sole proprietor or by a partnership of
which he is a member.
Return and payment of estimate income tax by individuals
The amount of estimated income shall be paid in four (4)

installments.
Estimated tax
Estimated tax means the amount which the individual declared as

income tax in his final adjusted and annual income tax return for the
preceding taxable year minus the sum of the credits allowed against
the said tax.
If, during the current taxable year, the taxpayer reasonably expects
to pay a bigger income tax, he shall file an amended declaration during
any interval of installment payment dates.
CORPORATE
RETURNS
Corporation returns
Every corporation subject to income tax, except foreign corporations

not engaged in trade or business in the Philippines, shall render, in
duplicate, a true and accurate:
1.
Quarterly income tax return; and
2.
Final or adjustment return.
The return shall be filed by the president, vice president or other

principal officer, and shall be sworn to by such officer and by the
treasurer or assistant treasurer.
A corporation may employ either the calendar year or fiscal year as

basis for filing its annual income tax return.
Every corporation deriving capital gains from the sale or exchange of

shares of stock not traded through a local stock exchange shall file a
return within thirty (30) days after each transaction and a final
consolidated return of all transactions during the taxable year on or
before the fifteenth (15th) day of the fourth month following the close of
the taxable year.
Declaration of quarterly corporate income tax
Every corporation shall file in duplicate a quarterly summary

declaration of its gross income and deductions on a cumulative basis
for the preceding quarter or quarters upon which the income tax shall
be levied, collected and paid.
The tax computed shall be decreased by the amount of tax

previously paid or assessed during the preceding quarters and shall be
paid not later than sixty (60) days from the close of each of the first
three (3) quarters of the taxable year, whether calendar or fiscal year.
Final adjustment return
Every corporation liable for tax shall file a final adjustment return
covering the total taxable income for the preceding calendar or fiscal
year.
If the sum of the quarterly tax payments made during the said
taxable year is not equal to the total tax due on the entire taxable
income of that year, the corporation shall either:
1.
Pay the balance of tax still due; or
2.
Carry over the excess credit; or
3.
Be credited or refunded with the excess amount paid, as the

case may be.
Carrying-over or crediting of excess to succeeding quarters
In case the corporation is entitled to a tax credit or refund of the

excess estimated quarterly income taxes paid, the excess amount
shown on its final adjustment return may be carried over and credited
against the estimated quarterly income tax liabilities for the taxable
quarters of the succeeding taxable years.
But this is not automatic. Need to apply for crediting of such excess
or tax credit to succeeding quarters.
PAYMENT
AND ASSESSMENT OF INCOME
TAX
Payment of tax, in general
The total amount of tax shall be paid by the person subject thereto at
the time the return is filed.
Installment payment
A taxpayer, other than a corporation, may opt to pay the tax in two
equal installments when the tax due is in excess of two thousand pesos
(P2,000).
In such cases, the first installment shall be paid at the time the
return is filed and the second installment on or before July 15 following
the close of the calendar year.
Payment of capital gains tax
It shall be paid on the date the return prescribed therefor is filed by

the person liable thereto.
In case the taxpayer elects and is qualified to report the gain by

installments, the tax due from each installment payment shall be paid
within thirty (30) days from the receipt of such payments.
Assessment and payment of deficiency tax
After the return is filed, the Commissioner shall examine it and

assess the correct amount of tax.
The tax or deficiency income tax so discovered shall be paid upon

notice and demand from the Commissioner.
Deficiency
The term deficiency means:

1.
The amount by which the tax imposed by this Title exceeds the
amount shown as the tax by the taxpayer upon his return.
However, the amount so shown on the return shall be
increased by the amount previously assessed (or collected
without assessment) as a deficiency, and decreased by the
amount previously abated, credited, returned or otherwise repaid
in respect of such tax; or
2.
If no amount is shown as the tax by the taxpayer upon his

return, or if no return is made by the taxpayer, then the amount
by which the tax exceeds the amounts previously assessed (or
collected without assessment) as a deficiency.
However, such amounts previously assessed or collected
without assessment shall first be decreased by the amounts
previously abated, credited, returned or otherwise repaid in
respect of such tax.
WITHHOLDING
OF
TAX
AT
SOURCE
Two kinds of withholding

1.
Withholding of final tax on certain incomes
2.
Withholding of creditable tax at source
Fund withheld held in trust by withholding agent
The taxes deducted and withheld by the withholding agent shall be

held as a special fund in trust for the government until paid to the
collecting officers.
All taxes withheld pursuant to the NIRC and its implementing rules
and regulations are hereby considered trust funds and shall be
maintained in a separate account and not commingled with any other
funds of the withholding agent.
ESTATES AND TRUSTS

Taxation of estates and trusts
Income tax imposed upon individuals shall also apply to the income
of estates or of any kind of property held in trust.
The tax shall be computed upon taxable income of the estate or trust
and shall be paid by the fiduciary.
What are the income of the estates or trusts which are included for
taxation?
1.
Income accumulated in trust for the benefit of unborn or unascertained

person or persons with contingent interests, and income accumulated
or held for future distribution under the terms of the will or trust.
2.
Income which is to be distributed currently by the fiduciary to the

beneficiaries, and income collected by a guardian of an infant which is
to be held or distributed as the court may direct.
3.
Income received by estates of deceased persons during the period of

administration or settlement of the estate.
4.
Income which, in the discretion of the fiduciary, may be either

distributed to the beneficiaries or accumulated.
Exception from taxation of estates or trusts
Employees trust which forms part of a pension, stock bonus or profitsharing plan of an employer for the benefit of some or all of his
employees shall be exempt from income tax:
1.
If contributions are made to the trust by such employer, or

employees, or both, for the purpose of distributing to such
employees the earnings and the principal of the fund
accumulated by the trust in accordance with such plan; and
2.
If under the trust instrument, it is impossible, at any time prior to

the satisfaction of all liabilities with respect to employees under
the trust, for any part of the corpus or income to be used for or
diverted to purposes other than for the exclusive benefit of the
employees.
However, any amount actually distributed to any employee or

distributee shall be taxable to him in the year in which so distributed to
the extent that it exceeds the amount contributed by such employee or
distributee.
Taxable income of estates or trusts
The taxable income of the estate or trust shall be computed in the

same manner and on the same basis as in the case of an individual.
However, there shall be allowed as a deduction in computing the

taxable income of the estate or trust the amount of the income of the
estate or trust for the taxable year which is to be distributed currently
by the fiduciary to the beneficiaries, and the amount of the income
collected by a guardian of an infant which is to be held or distributed
as the court may direct, but the amount so allowed as a deduction
shall be included in computing the taxable income of the beneficiaries,
whether distributed or not.
In the case of income received by estates of deceased persons

during the period of administration or settlement of the estate, and in
the case of income which, in the discretion of the fiduciary, may be
either distributed to the beneficiary or accumulated, there shall be
allowed as an additional deduction in computing the taxable income of
the estate or trust the amount of the income of the estate or trust for
its taxable year, which is properly paid or credited during such year to
any legatee, heir or beneficiary, but the amount so allowed as a
deduction shall be included in computing the taxable income of the
legatee, heir or beneficiary.
The deductions allowed above shall not be allowed in case of a trust

administered in a foreign country.
Exemption allowed to estates and trusts
There shall be allowed an exemption of twenty thousand pesos

(P20,000) from the income of the estate or trust.
Fiduciary returns
Guardians, trustees, executors, administrators, receivers,

conservators and all persons or corporations acting in any fiduciary
capacity shall render a return of the income of the persons, trust or
estate for whom or which they act, and be subject to all the provisions
of this Title, which apply to individuals in case such person, estate or
trust has a gross income of twenty thousand pesos (P20,000) or over
during the taxable year.
Such fiduciary or person filing the return for him or it, shall take oath
that he has sufficient knowledge of the affairs of such person, trust or
estate to enable him to make such return and that the same is, to the
best of his knowledge and belief, true and correct, and be subject to all
the provisions of this Title which apply to individuals.
Fiduciaries indemnified against claims for taxes paid
Trustees, executors, administrators and other fiduciaries are

indemnified against the claims or demands of every beneficiary for all
payments of taxes which they shall be required to make under the
provisions of this Title, and they shall have credit for the amount of
such payments against the beneficiary or principal in any accounting
which they make as such trustees or other fiduciaries.

Income Taxation (Angelfire)

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What are the different types of income according to the document?

What are the different types of income according to the document?

What is the difference between capital and income?

What is the difference between capital and income?

INCOME TAXATION

It is generally regarded as an excise tax. It is not levied upon

Purposes of income taxation

To provide large amounts of revenues.

To offset regressive sales and consumption taxes.

Conwi v. CTA [213 SCRA 83]: Income may be defined as an amount

Commissioner v. BOAC [149 SCRA 395]: Income means cash

produces the income. For the source of income to be considered as

Fisher v. Trinidad [43 Phil 973]: Stock dividend is not an income. It

Capital is a fund or property existing at one distinct point of time

The essential difference between capital and income is that capital is

Capital is the tree while income is the fruit.

What produces income?

Commissioner v. BOAC: The source of an income is the property,

income is derived from activity within the Philippines. IN BOACs case,

Sources within the Philippines

Sources without the Philippines

Sources partly within and partly without the Philippines

The term taxable income means the pertinent items of gross

Requisites for income to be taxable

There must be a gain or profit.

The gain must be realized or received.

The gain must not be excluded by law or treaty from taxation.

Gain must be realized or received

When is income considered received?

Income constructively received

Income which is credited to the account of or set apart for a taxpayer

Limpan Investment Company deemed to have constructively

Examples of constructive receipt

Defaulted coupons are income for the year in which paid.

Partners distributive share in the profits of a general professional

Are the following items income?

Found treasure - YES

Punitive damages - YES

Damages for breach of promise or alienation of affection - YES

Worthless debts subsequently collected - YES

Tax refund NO (but yes if the tax was previously allowed as a

Income from illegal sources - YES

Psychological benefits of work - NO

Give away prizes YES

Tests to determine realization of income

Substantial alteration of interest test

Flow of wealth test

As capital or investment is not income subject to tax, the gain or

Substantial alteration of interest test

Income is earned when there is a substantial alteration of the interest

Income to be returnable for taxation must be fully and completely

Moreover, if as a result of an exchange of stocks, the person received

Flow of wealth test

The essential difference between capital and income is that capital is

Kinds of taxable income or gain

other income from whatever source derived i.e. found treasure

Capital gains are gains or income from the sale or exchange of

Income from dealings in shares of stock of domestic corporation

Income from dealings in real property located in the Philippines;