Tax Reviewer

TAXATION I REVIEWER
A compilation of the Ateneo Bar Ops 1995 Reviewer, Araceli Habaradas Reviewer,
Jean Ferry Reviewer, and notes from the lectures of Atty. Gaudencio Mendoza S.Y. 2005-2006
GENERALPRINCIPLES
Whichisthebetterdescriptionoftaxation:TaxationisthepowertokeepaliveorTaxation
isthemeanstopayforacivilizedsociety?
Botharenotcompletedefinition.Thefirstoneseesitonlyfromthepointofviewofthe
governmentanditssurvival.Thesecondoneseesitasobligationofthetaxpayer.
Definitionoftaxation
Taxationisamodebywhichgovernmentsmakeexactionsforrevenueinordertosupporttheir
existenceandcarryouttheirlegitimateobjectives.
Howistaxationexercised?
Itisexercisedbylevy,thenassessmentandcollectionandthenpayment.LEVYistheactof
impositionbythelegislature.ASSESSMENTANDCOLLECTIONistheactofadministration
andimplementationofthetaxlawbytheexecutivethroughitsadministrativeagencies.
PAYMENTistheactofcompliancebythetaxpayer.
Congresspassesalawexemptingallminingcompaniesfromexcisetaxes.Isitstillaformof
taxation?
Yes,itisstillaformoftaxation.Taxationincludesthepowertograntexemptions.Theargument
thattaxationissupposedtoraiserevenuescanbeansweredbyarguingthatthegrantoftax
exemptionsaremadeinexchangeforadvantagesthatwouldindirectlyraiserevenuesforthe
governmentsuchasincreasedinvestmentsinthecountry,lessunemployment.Thus,tax
exemptionlawsinawaydoraiserevenues.
Theoryandbasisoftaxation
Thetheoryoftaxationisgovernmentalnecessityforwithoutit,governmentcanneitherexistnor
endure.Taxesarethelifebloodofthegovernment.Taxationisalsotheindispensablepricefor
civilizedsociety.(Symbioticrelationship/Reciprocalnatureoftaxation)
ThecaseofCommissionerv.Algue,explainedthetheoryandbasisoftaxation.TheCourtsaidthat
withouttaxes,theworkingsofthegovernmentwouldstop.Sothecitizenpays,theState
protects.Thecitizencontributes,theStategivesawellorderedsociety.Thatisthetheoryand
basisoftaxation.Thetheoryproceedsfromnecessity.Thetheory,thebasisofreciprocaldutyof
supportandbenefit.
Taxesproceeduponthetheorythattheexistenceofgovernmentisanecessity;thatitcannot
continuewithoutthemeanstopayitsexpenses;andthatforthosemeans,ithastherightto
compelallcitizensandpropertywithinitslimittocontribute.(NecessityTheory)
TheothertheoryrelatestothetheorythattheStatedemandsandreceivestaxesfromthesubjects
oftaxationwithinitsjurisdictionsothatitmaybeenabledtocarryitsmandateintoeffectand
performthefunctionsofgovernment,andthecitizenpaysfromhispropertytheproportion
demandedinorderthathemay,bymeansthereof,besecuredintheenjoymentofthebenefitsof
organizedsociety.(BenefitsProtectionTheory)
Scopeoftaxation
Taxationisunlimited,farreaching,plenary,comprehensiveandsupreme.Butisstillsubjection
toinherentandconstitutionallimitations.
Cecille 2C 05-06
Definition of Taxation
Theory and Basis of

Taxation
Scope of Taxation
Taxationissaidtobeaninherentpowerofsovereignty.Itmustbethereotherwiseno
governmentwouldexist.Butwhenwesaythatitinherestosovereignty,wearesimplyreferring
totheStateasasovereignunit.
Thatiswhywecannotusethisargumenttosaythatitinheresinlocalgovernmentunits.
Inthecaseoflocalgovernmentunits,youneedaconstitutionalorstatutorygrantoftaxing
power.Thisisbecauselocalgovernmentunitsarenotsovereignunits.Theyhavetohaveagrant
toenjoythepowertotax.
Explainpowertotaxisthepowertodestroy
Powertotaxmayincludethepowertodestroy.Thedoctrineseekstodescribeinanextreme,the
consequentialnatureoftaxationanditsresultingimplications:(a)thepowertotaxmustbe
exercisedwithcautiontominimizeinjurytotheproprietaryrightsoftaxpayerbut(b)ifthetaxis
lawfulandnotviolativeofanyoftheinherentandconstitutionallimitations,thefactalonethatit
maydestroyanactivityorobjectoftaxationwillnotentirelypermitthecourtstoaffordany
reliefand(c)asubjectorobjectthatmaynotbedestroyedbythetaxingauthoritymaynot
likewisebetaxed.Thus,ataxmaynotbeimposedontheexerciseofafundamentalrightsinceto
otherwisepermititwouldamounttodestroyingthatfundamentalright.Taxationisalways
relatedtothewelfareclauseandpolicepower.Thestatementthattaxationisanimplementof
policeiswillvalidaslongasitdoesnotgoagainsttheconstitutionallimitations.
Dowestillhavethedictumthatthepowertotaxisthepowertodestroy?
Presently,itisusedtodescribesimplytheextentthatthetaxingpowermaybeusedtoraise
revenues.Theextenttowhichthetaxingpowermaybeusedtofinancegovernment
requirements,totheextentthatitmayprohibit,discourageorevendestroyacertainbusiness.
Butaslongasthattaxationisanimplementofpolicepower,thenitisavalidact.
SohowdoyousummarizewhenyoureaskedIstherestillsuchadictum?
Ifthepowertotaxisexercisedwithinconstitutionalpowers,thenthepowertotaxmayinvolve
thepowertodestroy.
Ifthepowertotaxisnotexercisedwithintheconstitutionallimitations,thepowermaynever,
shouldnotandcannotinvolvethepowertodestroy.
AsearlyastheConcepcioncasein1936ortheChurchillcase,theCourtalreadystatedthatthe
powertotaxdoesnotinvolvethepowertodestroywhilethisCourtsits.TheCourtstatedthere
thatthepowertotaxcannotinjurepropertyrights,ifdoingsowouldviolatethebasicprinciples
ofjusticeandequity.
Howwillyoureconcilethedictumthatthepowertotaxisthepowertodestroywith
powertotaxisnotthepowertodestroywhiletheSupremeCourtsits?
Whenalegislativebodyhavingthepowertotaxacertainsubjectmatteractuallyimposessucha
burdensometaxaseffectuallytodestroytherighttoperformtheactortousetheproperty
subjecttotax,thevalidityoftheenactmentdependsuponthenatureandcharacteroftherightto
destroy.Ifsogreatanabuseismanifestedastodestroynaturalandfundamentalrightswhichno
freegovernmentcouldconsistentlyviolate,itisthedutyofthejudiciarytoholdsuchanact
unconstitutional.
PowertotaxisnotthepowertodestroywhiletheSupremeCourtsitsbecauseofthe
constitutionalrestraintsplacedonataxingpowerthatviolatesfundamentalrights.
Powerofjudicialreviewintaxation
Aslongasthelegislature,inimposingatax,doesnotviolateapplicableconstitutionallimitations
Cecille 2C 05-06
orrestrictions,thecourtshavenoconcernwiththewisdomorpolicyoftheexaction,thepolitical
orothercollateralmotivesbehindit,theamounttoberaise,orthepersons,propertyorother
privilegestobetaxes.
Definitionoftax
Taxistheenforcedandapportionedcontributionusuallyinmonetaryform,leviedbythe
lawmakingbodyonpersonsandpropertysubjecttoitsjurisdictionfortheprecisepurposeof
supportinggovernmentalneeds.
Essentialcharacteristicsoftax
1. Itisanenforcedcontribution.
Ataxisnotavoluntarypaymentordonationanditsimpositionisinnoway
dependentuponthewillorassent,open,orimplied,ofthepersontaxed.
Itsimplymeansthatthecitizenhasnochoice.Whenthegovernmentimposesatax,
thecitizenpays.Nobargain.Notamatterofcontractbutamatterofduty.
2. Itisgenerallypayableinmoney.
Universalpracticerequiresthattaxbepaidinmoney.However,thereisnolawthat
prohibitspaymentinkind.
Thisisalsoinlinewithoneoftheprinciplesofasoundtaxsystemwhichrequires
administrativefeasibility.
Thus,ifitispayableinkind,itwillnotbeillegalbutitwillbeunsound.
3. Itislaidbysomeruleofapportionment.
Ataxislaidbysomeruleofapportionmentaccordingtowhichpersonssharethe
publicburden.Itisordinarilybasedontheabilitytopay.
4. Itisleviedonpersons,propertyorbusiness,acts,transactions,rightsorprivileges.
Itisonlyapersonwhopaysthetax.Thepropertyisresortedtoforthepurposeof
ascertainingtheamountoftaxthatmustbepaidandofenforcingpaymentincase
ofdefaultofthetaxpayer.
Althoughitisleviedonpersonandproperty,itisactuallythepersonwhopaysthe
tax.Itisapersonalliability.
5. Itisleviedbythestatewhichhasjurisdictionoverthepersonorproperty.
Thisisnecessaryinorderthatthetaxcanbeenforced.Itcannotreachoverinto
anotherjurisdictiontoseizeuponpersonorpropertyforpurposesoftaxation.
6. Itisleviedbythelawmakingbodyofthestate.
ThepowertotaxisalegislativepowerwhichundertheConstitutiononlyCongress
canexercisethroughtheenactmentoftaxstatutes.Itisalsograntedtolocal
governmentssubjecttosuchguidelinesandlimitationsasmaybeprovidedbylaw.
7. Itisleviedforpublicpurposeorpurposes.
Revenuesderivedfromtaxescannotbeusedforpurelyprivatepurposesorforthe
exclusivebenefitofprivatepersons.
Whatdoyoumeanbyitisapersonalliability?
Itcannotbeshiftedtoanybodyelse.Exceptwhenyoutalkofindirecttaxesbuteveninthecase
ofindirecttaxes,thetaxliabilityistherewiththepersonsubjecttotax.Itistheburdenthatis
shifted.
Congresspassesalawsubjectingallbicyclestotaxes.Noobjectionbutprovisionsays:taxes
paidwhenbicycleownerscanpay.Valid?
No.Itisnotavalidlaw.Taxationismandatoryandcompulsory.Itisnotamatterofbargainbut
amatteroflaw.
Congresspassesalaw:5%additionalrealpropertytaxbasedonvalueofproperty.5%setup
asloyaltyfundforgoodsoldiers.Taxpayercanpayinkind.Valid?
Theoretically,itisvalidbecausetheconstitutiondoesnotsaythattaxesmustbeinmoneyalone.
Cecille 2C 05-06
Definition of Tax
Characteristics of Tax
Butthismayviolatebasicprinciplesofasoundtaxsystem,specificallythatitbeadministratively
feasible.Itmaybehardtoknowtheexactvalueofthethingspaidastaxes.
Basicprinciplesofasoundtaxsystem
1. FiscalAdequacy
Itmustbeadequatetofinancegovernmentexpenditures.Itmustbesufficientto
meetgovernmentrequirements.InthecaseofChavezv.Ongpin,theCourtusedthis
theorytojustifytheimpositionofhighertaxes.
Thesourcesoftaxrevenueshouldcoincidewithandapproximatetheneedsof
governmentexpenditures.
TheChavezv.Ongpincaseinvolvedtheupwardadjustmentofcertainrealproperty
values.Therewasthisscheduleofrealpropertyvalueswhichadjustedtheexisting
realpropertyvalues.OneofthereasonsusedbytheCourttojustifytheincrease
wastheprincipleoffiscaladequacy.Wehavetohaveahightaxbaseinorderto
havegreaterrevenues.Inshort,theCourtusedthistheoryoffiscaladequacyto
justifytheimpositionofhighertaxes.
2. TheoreticalJustice
Itmeansthatthetaxburdenshouldbeinproportiontothetaxpayersabilitytopay.
Thetaxsystemshouldbefairtotheaveragetaxpayerandbaseduponhisabilityto
pay.
Inotherwords,taxationshouldbeuniformaswellasequitable.
ItmeansthathewhohasmoreinlifeshouldhavemoreintaxHewhohasmorein
lifeshouldbetaxedmore.
Thosewhoearnlessshouldpaylesstax.
3. AdministrativeFeasibility
Itmeansthattaxlawsshouldbecapableofconvenient,justandeffective
administration.
Thetaxsystemshouldbecapableofbeingpropertyandefficientlyadministeredby
thegovernmentandenforcedwiththeleaseinconveniencetothetaxpayer.
Itshouldbeeasytoimplement.
Thetaxpayershouldhavenodifficultyinunderstandingthetaxlaw.
Willthenonobservanceoftheseprinciplesrenderthetaximpositionsinvalid?
No.Itwillbeinvalidonlytotheextentthatspecificconstitutionalorstatutorylimitationsare
impaired.
Supposingthetaxmeasurefailstoproducetherevenuetargetbecauseitwasdifficultto
implementinthefirstplace.Wouldsuchtaxmeasurebeaninvalidtax?Whatistheremedy?
No.Itwillbeunsoundtaxbutnotillegal.Unsoundbutlegal.
Theremedywouldbetochange,torestructure,torefine,andtoredefine.
Ifsupposingataxlawviolatestheprinciplesofasoundtaxsystem,isthetaxlawinvalid?Is
thetaxlawillegal?
Itdepends.
Ifitsimplyviolatestheprincipleoffiscaladequacy,theprincipleofadministrativefeasibility,its
notinvalid.Simplyunsound.
Butifitviolatestheprincipleoftheoreticaljustice,itisinvalid.ThisisbecausetheConstitution
requiresthattaxationmustbeequitable.Ifitviolatestheoreticaljustice,thenitsimplymeansitis
inequitable.
IfyourecallinthecaseofReyesv.Almanzor,theCourtimpliedtheprinciplethatataxmeasure
Cecille 2C 05-06
Basic Principles of a
Sound Tax System
maybeinvalidifitviolatestheoreticaljusticebecauseitwillbeinequitable.
WhatwasthecaseofReyesv.Almanzor?
Inthatcase,thetaxpayers,JBLReyesetal.,ownedpropertiessomewhereinTondo,Manila.The
realpropertyvalueswerebeingadjustedandtoarriveattherealpropertyvaluesorthefair
marketvalue,thetaxingauthorityadoptedthecomparativesalesapproach.Thismeansthatthe
valuationshouldbebasedonthesaleofthepropertyorsimilarsalesofthepropertywithinthe
district.ThepropertiesofJBLetal.werepropertieswhichweresubjecttotherentalfeeslawand
therecouldbenoreadybuyersforthatpropertyandthereforethepropertiesincomegenerating
capacitywasseriouslydiminished.Asamatteroffact,inthatcase,itwasshownthattherentals
ofthepropertywerenotevensufficienttopaytherealpropertytax.
Theargumentwasthatifyouusethestandardbeingusedinotherpropertiesinthisclassof
propertieswhichhasadiminishedvalueyouareactuallysayingthatwe,thetaxpayersor
ownersofthepropertywhohavelesserabilitytopaybecauseofthekindofpropertywehave,
wouldbepayingthesametaxasthosewhohavemoreabilitytopaybecausetheyhaveproperty
whichhasmorevalueandcaneasilybesold.
Themoralofthestory:Donotviolatetheprincipleoftheoreticaljustice.Andifyouviolateit,it
willbeunconstitutional.Itmaybeunconstitutionalbecauseitviolatestheprovisionthat
providesthattaxmustbeequitable.
InthecaseofReyesv.Almanzor,theCourtdidnotexactlyputitthatway.Butifyouread
betweenthelines,thatwasthekindofargumentthatitwastryingtoconvey.
Cecille 2C 05-06
CLASSIFICATIONOFTAXES
1.
2.
3.
4.
5.
6.
Astosubjectmatterorobject:
a. Personal,pollorcapitationTaxofafixedamountimposedonpersonsresiding
withinaspecifiedterritory,whethercitizensornot,withoutregardtotheirproperty
ortheiroccupationorbusinessinwhichtheymaybeengaged
b. PropertyTaximposedonproperty,whetherrealorpersonal,inproportioneither
toitsvalue,orinaccordancewithsomeotherreasonablemethodsof
apportionment.
c. ExciseItisachargeimposedupontheperformanceofanact,theenjoymentofa
privilege,ortheengaginginanoccupation,profession,orbusiness.Itis
synonymouswithprivilegetax.
Astowhobearstheburden:
a. DirectTaxwhichisdemandedfromthepersonwhoalsoshoulderstheburdenof
thetax;ortaxforwhichthetaxpayerisdirectlyorprimarilyliableorwhichhe
cannotshifttoanother.
b. IndirectTaxeswhicharepaidbyonetaxpayerbutwhocanshifttheburdento
another.Theseareleviedupontransactionsoractivitiesbeforethesubjectmatter
reachtheconsumerstowhomtheburdenoftaxmayultimatelybechargedor
shifted.
Astodeterminationofamount:
a. SpecificTaxoffixedamountimposedbytheheadornumber,orbysome
standardofweightormeasurement;itrequiresnoassessmentotherthanalistingor
classificationoftheobjectstobetaxed.
b. AdvaloremTaxofafixedproportionofthevalueofthepropertywithrespect
towwhichthetaxisassessed;itrequirestheinterventionofassessorsorappraisers
toestimatethevalueofsuchpropertybeforetheamountduefromeachtaxpayer
canbedetermined.
Astopurpose:
a. General,fiscalorrevenueTaximposedforthegeneralpurposesofthe
government.
b. SpecialorregulatoryTaximposedforaspecialpurpose.
Astoscopeorauthorityimposingthetax:
a. NationalTaximposedbythenationalgovernment.
b. MunicipalorlocalTaximposedbymunicipalcorporationsorlocalgovernment
units.
Astograduationorrate:
a. ProportionalTaxbasedonafixedpercentageoftheamountoftheproperty,
receipts,orotherbasistobetaxed.
b. ProgressiveorgraduatedTaxtherateofwhichincreasesasthetaxbaseor
bracketincreases.Itisbasedontheprinciplethatonewhoearnsmoreshould
betaxedmore.
c. RegressiveTaxtherateofwhichdecreasesasthetaxbaseorbracketincreases.
Thelesserincomeyouhave,themoretaxyouput.Itmakesnodistinction
betweenwhohasmoreandwhohasless.
Cecille 2C 05-06
BASICDISTINCTIONS
Taxdistinguishedfromdebt
1. Adebtisgenerallybasedoncontract,expressorimplied,whileataxisbasedonlaw.A
taxisacontractualobligationwhileataxisalegalobligation.
2. Adebtisassignable,whileataxcannotgenerallybeassigned.
3. Adebtmaybepaidinkind,whileataxisgenerallypayableinmoney.
4. Adebtdrawsinterestwhenitissostipulatedorwhenthereisdefault,whileataxdoes
notdrawinterestonlywhendelinquent.
5. Adebtmaybethesubjectofsetofforcompensation,whileataxisgenerallynot.
6. Apersoncannotbeimprisonedfornonpaymentofdebt,whileimprisonmentisa
sanctionfornonpaymentoftax.
Cantaxesbesubjecttocompensation?
1962MambulaoLumbercaseheldtaxescannotbesubjecttosetoff
1963Garlitoscaseheldthatsetoffispossibleprovidedthatitmeetstherequisitesforlegal
compensation
1966GondacasequotedMambulaodoctrinewithoutmentioningGarlitoscase
1988FranciacaseheldnosetoffbutnomentionofGarlitoscase
1992Caltexcasesaidnotsetoff
1998PhilexcaseheldnosetoffbutnomentionofGarlitoscase
Istaxsubjecttosetoffgiventhepresentstateofjurisprudence?
TaxisnotsubjecttosetoffforthereasonsstateintheMambulao,Francia,andCaltexcases.
However,whenthefact,pattern,andthecircumstancesofthecasewouldbeidenticaltothefact
patternandcircumstancesintheGarlitoscase,thentherecanbeasetoff.
SothegeneralruleisthattherecanbenosetoffunlesstheGarlitoscasewouldapply.Butforthe
Garlitoscasetoapply,theidentityoffactualcircumstancesshouldbereal,shouldbemorethan
striking.ThereshouldbecircumstancesobtainingintheGarlitoscasethatshouldalsobepresent
inacaseforsetofftoapply.ToapplytheGarlitoscase,theremustbeanactofappropriationby
thegovernmentoffundsforthepaymentofdebt.
Whenistaxconsideredadebt?
Firstsituationiswhentaxwasconsideredadebtforpurposesofdeductionongrossincome
underSection34oftheNIRC.
Thesecondsituationisthatundertaxlaw,collectionoftaxesisbeingenforcedbyjudicialaction.
Andthejudicialaction,insomeinstances,ispremisedonthefactthatthelawconsiderstaxas
indebtedness.Tobemorespecific,ifcustomslawwhenthegoodsarebroughtoutfromthe
customsjurisdictionandyoustillhaveanunpaidcustomsduty,thetaxlienisthere.
Whatisthereasonwhyyoucanenforceitbyjudicialaction?
Becausethetaxisconsideredasapersonalindebtednessoftheimporter.Soforpurposesjudicial
action,taxisconsideredadebt.
Taxdistinguishedfromlicensefee
Licenseorpermitfeeisachargeimposedunderthepolicepowerforpurposesofregulation.
Licenseisratherinthenatureofaspecialprivilege,ofpermissionorauthoritytodowhatis
withinitsterms.Itmakeslawfulanactwhichwouldotherwisebeunlawful.Alicensegranted
bytheStateisalwaysrevocable.
1. Licensefeeisthelegalcompensationorrewardofanofficerforspecificservices,while
Cecille 2C 05-06
Tax v. Debt
Tax v. License Fees
2.
3.
4.
5.
6.
7.
taxisanenforcedcontributionassessedbysovereignauthoritytodefraypublic
expenses.
Licensefeeisimposedforregulation,whiletaxisleviedforrevenue.
Licensefeeinvolvesanexerciseofpolicepower,whileataxinvolvestheexerciseof
taxingpower.
Theamountoflicensefessshouldbelimitedtothenecessaryexpensesofinspectionand
regulation,whilethereisgenerallynolimitontheamountoftaxthatmaybeimposed.
Licensefeeisimposedontherighttoexerciseaprivilege,whileataxisimposedalsoon
personsandproperty.
Failuretopayalicensefeemakestheactorbusinessillegalwhilefailuretopaydoesnot
necessarilymaketheactorbusinessillegal.
Taxescoverbothlegalandillegalbusinessesbecausetaxcoversincomefromwhatever
sourcederived.Whilealicensefeewouldnotapplytoillegalbusiness.Itonlyappliesto
legitimatebusiness.So,nonpaymentoflicensefeemayaffectthestatusofthebusiness
whilenonpaymentoftaxwouldnotaffectthestatusofthebusiness.
Whatisthemaindistinctionbetweenataxandafee?
InthecaseofProgressiveDevelopmentCorporation,theCourtheldthatforataxtobeatax,the
primarypurpose,oratleaseoneoftherealandsubstantialpurposesittoraiserevenue.Evenif
insodoingitregulatesbecauseinthecase,regulationwouldsimplybeincidental.Ifthepurpose
istoraiserevenue,itisatax.Iftheprimarypurposeistoregulate,itisafee.Evenifin
regulating,itraisesrevenue.
TheCourtsaidthataregulatoryfeeoralicensefeemusthavearelationshiptothebusiness
beingregulated.Asamatteroffact,theamountofthefeeshouldnotbemorethanthecostof
regulation,thecostofsupervisionoftheactivitybeingsubjecttothelicensefee.Ifthereissuch
relationshipthenitisafee.Ifthereisnosuchrelationshipwhichmeansthatthelicensefee
involvedismuchmorethanthecostofregulation,thenitbecomesataxbecauseinthatcase,itis
forrevenuenotforregulation.
Torepeat,iftheprimarypurposeistoraiserevenue,thenitisatax.Iftheprimarypurposeisto
regulate,itisafee.Evenifinsoregulatingitraisesrevenue.
Andthemainguidelinetodistinguishbetweenregulationandrevenueistheguidelinegivenby
theProgressiveDevelopmentcase.Theregulationaspectorthefactitbeingalicensefeeshouldbe
consideredinthelightoftherelationshipofthefeeimposedtotheactivitybeingregulated.The
costofregulationmustsimplybetheamountoftheimposition.Iftheamountofimposition
exceedsthecostofregulation,thenitisatax.
Xtaxpayerisexemptfromalltaxes.TheCityofManilapassesaninspectionfee.Xtaxpayeris
exemptfromalltaxesimposedonthebusinessofCopratradingandCoprastorage.
SupposingtheCityofManilaimposesaninspectionfeeofPhp5Kperannumoncoprabeing
storedinwarehouses.Canthetaxpayerarguethatitisexempt?
Itsexemptionisfromtaxes,whatisbeingimposedisafee.Inthiscase,Xcaninvokethe
progressivedoctrinethatitisfee.Thatsuchmeasureistaxbecauseoftheamountofimposition.
Therefore,Xisexemptfromtax.
Corporationisexemptfrompaymentofnationalandlocaltaxes.Corporationisengagedin
cattleraising.CityofBalengaimposesanannualinspectionfeeofPhp20K.WouldX
Corporationbeexemptfromsuchfee?
Feesarealwayslimitedtotheamountnecessaryfortheinspection.ItcanbearguedbyX
corporationthatPhp20Kistoomachtobeclassifiedasmerelyafee.Php20Kisinessenceatax.
Whiletaxcanbetheoreticallyunlimitedinamount,itisnotsowithlicensefees.Xcorporation
thenwouldbeexemptfromsuchfeeasthisamountedtotax.
Cecille 2C 05-06
Whatisaregulatorytax?
Itisataxthatraisesrevenuebutatthesametimeregulatesbutitprincipallyraisesrevenue.
Astoamount,howdoyoudistinguishtaxandfee?
Whenyoutalkoftaxes,thereisnolimitastotheamount.Aslongasthegovernmentneedsthe
money,itcanimposetax.Thisisbecauseofthelifebloodofgovernmentprinciple.Theoretically,
anyamountcanbeimposedontaxes.
Ontheotherhand,feesmustbelimitedtothecostofregulation,tothecostofsupervisionofthe
businessortheactivitybeingsubjecttolicensefees.Ifitismorethanthat,itisatax.Theonly
exceptioniswhenyouaretalkingofnonusefulbusinessornonusefuloccupation.Inthecaseof
nonusefulbusinessornonusefuloccupation,thetaxingauthoritycanimposeabiggerfee
withouttheimpositionbeingatax.Theruleisthefeemustberelatedtothecostofsupervision.
Butwhenyoutalkofnonusefulbusinessornonusefulactivity,theimpositionmayexceedthe
costofsupervision.Theimpositionmaybealargerfee,alargeramountwithoutbeingatax.This
isbecauseunderthegeneralwelfareclause,municipalcorporationsareauthorizedtoenact
ordinancestoprovideforthehealthandsafetyandtopromotethemorality,peaceandgeneral
welfareofitsinhabitants.(PhysicalTherapyOrganizationofthePhilippinesv.MunicipalBoardofthe
CityofManila)
Anotherdistinctionbetweentaxesandfeesisthattaxescoverbothlegalandillegalbusinesses.
Taxescanapplytothekidnappingentrepreneurs;taxescanapplytotherobberyexpertsbecause
taxcoversincomefromwhateversourcederived.Itcoversillegalbusiness,coversillegalincome
fortaxpurposes.Butalicensefeewouldnotapplytoillegalbusinesses.Itonlyappliesto
legitimatebusiness.
Also,nonpaymentoflicensefeemayaffectthestatusofthebusinesswhilenonpaymentoftax
wouldnotaffectthestatusofthebusiness.Nonpaymentofalicensefeeforabusinessmakes
thatbusinessillegal.However,nonpaymentofataxforabusinessdoesnotnecessarilymake
thatbusinessillegalalthoughthismightbeagroundforcriminalprosecutionagainsttheperson
orpersonsviolatingthelaw.
Whatisthesignificancebetweentaxversuslicensefeeargument?
Exemptionfromtaxdoesnotnecessarilyincludeexemptionfromfee.Feeexemptionwouldnot
includetaxexemption.
Also,inthecontextoflocaltaxation,thedistinctionbetweentaxversusfeeisimportantbecause
thetaxingpowerofthelocalgovernmentunitsislimited.Itcannotraisetaxesbyusingits
regulatorypowers.
Importanceofthedistinctions
1. Exemptionfromtaxesmaynotincludeexemptionfromlicensefee.
2. Thepowertoregulateasanexerciseofpolicepowerdoesnotincludethepowerto
imposefeesforrevenuepurpose.
3. Anexaction,however,maybeconsideredbothataxandalicensefee.Thisistrueinthe
caseofcarregistrationfeeswhichmayberegardedastaxesevenastheyalsoserveasan
instrumentofregulation.Ifthepurposeisprimarilyrevenue,orifrevenue,is,atleast,
oneoftherealandsubstantialpurposes,thentheexactionispropertycalledatax(PAL
v.Edu).
4. Thegeneralruleisthattheimpositionistaxifitsprimarypurposeistogenerate
revenue,andregulationismerelyincidental;butifregulationistheprimarypurpose,
thefactthatincidentallyrevenueisobtaineddoesnotmaketheimpositionatax
(ProgressiveDevelopmentCorp.v.QuezonCity).
Cecille 2C 05-06
Regulatory Tax
INTERPRETATIONANDCONSTRUCTIONOFTAXLAWS
Howdoyouinterprettaxlaws?
Thegeneralruleisthattaxlawsmustbeconstruedreasonablytocarryoutthepurposeofthetax
law.Alltaxlawsshouldbeconstruedreasonablytocarryoutthepurpose,theintent,the
objectiveofthelaw.
Ifthetaxlawifclearandunambiguous,applythelawstrictly.Ifthereisnodoubtastowhois
beingtaxed,astohowmuchisbeingimposedasatax,thenitmustbeconstruedagainstthe
taxpayerandinfavorofthegovernment.Thereisnoneedforconstructionandinterpretation.
Ifthetaxlawisdoubtful,thatiswhenthemeaningofthetaxlaworifthetaxabilityofacertain
object,business,orsubjectisdoubtful,thenthelawmustbeconstruedstrictlyagainstthe
governmentandliberallyinfavorofthetaxpayer.
Wherethetaxpayerclaimsexemption,exemptionprovisionsareconstruedstrictlyagainsttheone
whoassertstheclaimofexemption.
Howdoyouinterprettaxrulesandregulations?
Thegeneralprincipleintheconstructionoftaxlawsappliestotheinterpretationoftaxrulesand
rulings.Theyshouldbereasonablyconstruedtocarryoutthepurposeofthetaxlawwhichis
beingimplementedbythetaxrules.
Tobevalid,thetaxrulesmustbeconsistentwiththeprovisionsofthetaxlawwhichtheyseekto
implement.Theymustberelatedtothepurposeofthetaxlaw.Theymustbereasonable
implementingrules.Andassuchimplementingrulesoftaxlaws,theymustbepublishedas
implementingrulesofexistingtaxlaws.
Whataretherequisitesforavalidtaxregulation?
1. Publication;
2. Itmustbegermanetothepublicpurposeembodiedinthegoverningstatute;and
3. Exercisedwithintheauthority.
Whatisthespecificruleonretroactivityoftaxrulesandrulings?
Section244oftheNIRCsaysthattaxrulesarepromulgatedbytheSecretaryofFinanceuponthe
recommendationoftheBIR.Butitalsosaysthattaxrulesandrulingsandanymodification,
reversalofthetaxrulesorrulingsshouldnotbeappliedretroactivelytotheprejudiceofthe
taxpayer.
However,itmaybegivenretroactiveeffectif,evenifprejudicialtothetaxpayer,inthethree
instances:
1. Whenthetaxpayerdeliberatelymisstatedoromittedfromhisreturncertainfactsor
documents;
2. Whenthetaxpayeroronthefactssubsequentlygatheredaredifferentfromthefactson
whichthetaxrulingswasbased;and
3. Whenthetaxpayerisinbadfaith.
Ifalawispassedwhichexemptsallpropertyownersfromrealpropertytax,isthatatax
exemption?
No.Becausealawthatexemptseverybodyisnotataxexemptionlaw.Taxexemption
presupposesthatsomebodypaysandsomebodydoesnotpay.
Cecille 2C 05-06
Interpretation of Tax
Laws
Rules and Regulations
Requisites for a Valid Tax

Regulation
Rule on Retroactivity
10
AIncorporatedsellscertaincommodities,salessubjecttosalestax.AInc.SellstoBInc.which
isexemptfromalltaxes,directorindirect.AInc.refusedtopaysalestaxarguingthatitwill
beanindirecttaxonBInc.sinceAInc.willsimplypassonthetaxtoBInc.
AInc.cannotvalidlyrefusetopaythesalestax.Itisrightlythesellersobligationtopaysuch
tax.HeretherewillbenoviolationoftheexemptiongrantedtoBInc.Itdoesnotstatethatthe
lawexpresslystatedthatBInc.wouldbeexemptedfromdirectandindirecttaxes.The
exemptionfromtaxmustbethere,mustbeexpresslyprovidedotherwiseitdefeatsthepurpose
ofexemptionfromtax.Iftheexempteeenjoysexpresslyexemptionfromdirectandindirect
taxes,thenitshouldbeexemptedfromsalestax.Ifexemptionisalltaxesthenitdoesnot
includeindirecttax.Onecannotbeexemptbymereimplication.
Whatisataxexemption?
Ataxexemptionmeansgrantingtocertaintaxpayersimmunityfromthepaymentoftax,while
subjectingotherstothepaymentoftax.Ifyouexempteverybody,youarenotexempting
anyone.
Whatisthebasisoftaxexemption?
Thebasisistheprinciplethatsaysthatthepowertotaxincludesthepowertoexempt.The
powertotaxincludesthepowertoselectthesubjectandtheobjectoftaxation.Thepowerto
selecttheobjectoftaxationincludesthepowertoexcludecertainobjectsfromtaxation.
Whataretheimplicationsofthetermstrictlyconstrued?
First,itmeansthattaxexemptionmustneverbepresumed.Itmustbeestablishedandprovedby
thetaxpayer.Thetaxpayermustpointtoacleargrant,toaspecificprovisionthatsupportshis
claimfortaxexemption.
Anotherimplicationisthattaxexemptionmustneverbepresumed.Thiswasshowninthecase
ofProvinceofAbrav.JudgeHernandowheretheissueinvolvestheexemptionofcertainreligious
propertiesfromtherealpropertytaxexemptionundertheConstitution.Inthiscase,thejudge
simplygrantedthetaxexemptionwithoutanyproofonthepartoftheexemptee.TheSupreme
Courtsaidthattheexempteemustthatitisentitledtotheexemptionandthatithascomplied
withtherequirementsoftheexemption.Inthatcase,itmustbeshownthatthereligious
propertyisbeingactually,directly,andexclusivelyused.
Anotherimplicationisthatthelawmustbelimitedtowhatitsays.Itmustbeconfinedtothe
statutorylanguage.Youcannotexpandthecoverageofthetaxexemptionbecausethatwouldbe
liberallyconstruingthetaxexemption.
Anotherimplicationofstrictlyconstruedmeansthatitshouldbepersonaltothegrantee,
personaltotheexemptee,orpersonaltothetaxbeneficiary.Iftheexemptionisgiventoa
corporation,itcannotbeenjoyedbythestockholder,evenifthestockholderowns99%ofthe
corporation.
WhatwasthecaseofGotamcoallabout?
ItinvolvedtheWHOwhichisataxexemptinstitution.Itisexemptfromalltaxes,director
indirecttaxes.Theorganizationwantedabuildingconstruction.Thecontractorconstructedthe
buildingbutpartofthecontractcostwasacontractorstax.SothecontractorbilledtheWHOthe
amountofconstructionpriceplusthetax.WHOsaysthatitwillviolateitsexemptionfromall
taxeswhichincludeindirecttaxes.TheCourtsaidinthiscasethatthecontractorshouldbe
exemptfromthecontractorstax.
Thiscasedoesnotviolatethepersonalnatureoftheexemptionbecausetheintentionwasreally
tobenefitthecontractee.Ifthecontractorwillbesubjecttocontractorstaxthatwillviolatethe
contracteestaxexemption.So,theimpositionshouldnotberecognizedasnegatingthetax
Cecille 2C 05-06
Tax Exemption
11
exemptionprivilegeofWHO.Inshort,ifwastobenefitthecontracteeitselfandthereforeitsstill
personaltothecontractee.
Istheexemptionondirecttaxincludesexemptiononindirecttax?
No.Thegrantofexemptionondirecttaxdoesnotincludeindirecttax.
Whenisliberalinterpretationproper?
1. Whenthetaxlawitselfsimplysaysorthetaxexemptinglawsaysitshouldbeoritcan
appliedretroactively;
2. WhenthetaxexemptionpertainstothetraditionalexempteesortheConstitutional
exemptees,whenittalksofreligious,charitableandeducationalexemptees;
Thereasonforthisthatreligious,charitableandeducationalinstitutionsare
performingfunctionswhichshouldbeperformedbythegovernment.Sinceitis
helpingthegovernmenttodowhatitshouldbedoinginthefirstplace,thena
liberalinterpretationoftheexemptionshouldbemade.
3. Whentheexemptionappliestogovernmentpoliticalsubdivisionandinstrumentality.
Whenitcomestogovernmentproperty,exemptionistherulewhiletaxationisthe
exception.
Thisimpliedthatwhenyouaretalkingofnongovernmentproperty,taxationisthe
rulewhileexemptionistheexception.
Supposingtaxexemptionsaregranted,aretheyrevocable?
Asageneralrule,taxexemptionsarerevocableunlesstherevocationwouldresultinthe
impairmentofacontract.However,thenonimpairmentclausecanonlybeinvokedwherethere
isataxexemptiongrantedwhereinthegovernmentisoneofthepartiesinthecontract.
Whataboutinthecaseoffranchises?
Ataxexemptiongrantedtoafranchisemayberevoked.Itwouldnotamounttoanimpairment
ofobligationofcontractsbecauseSection11,ArticleXIIofthe1987Constitutionspecifically
providesthatthefranchisecanbeimpaired.Thelegislaturecanimpairagranteesfranchisesince
afranchiseissubjecttoamendment,alterationorrepealbytheCongresswhenthepublicinterest
sorequires.
Aretaxexemptionstransferable?
Thegeneralruleisthattaxexemptionsarenottransferable.Theexemptioniswhenthelaw
providesexpresslythatitwouldbetransferable.
Applicationoftaxlaws
Thegeneralruleisthattaxlawsareprospectiveinoperations.Thereasonisthatthenatureand
amountofthetaxcouldnotbeforeseenandunderstoodbythetaxpayeratthetimethe
transactionwhichlawseekstotaxwascompleted.
Whileitisnotfavored,astatutemayneverthelessoperateretroactivelyprovideditisexpressly
declaredorisclearlythelegislativeintent.Butataxlawshouldnotbegivenretroactive
applicationwhenitwouldbeharshandoppressive,forinsuchcase,theconstitutionallimitation
ofdueprocesswouldbeviolatedaswheretheincreasementionedisalsomadetoapplyto
incomeearnedlongbeforetheenactmentofthelawthepropertaxonwhichhasalreadybeen
paid.
Cecille 2C 05-06
Exemptions
12
DOUBLETAXATION
Whatisdoubletaxation?
Doubletaxationmeanstaxingforthesametaxperiodthesameactivityoractivitytwice,whenit
shouldbetaxedbutonce,forthesamepurposeandwiththesamekindofcharacteroftax.
Whenisdoubletaxationpermissiveorimpermissive?
Asageneralrule,doubletaxationisnotavaliddefense,butyoucanarguethedefenseof
oppressivenessandinequalityoftax,asagainsttheconstitutionalrequirementofuniformityin
taxation.Indoubletaxation,indirectduplicateispermissivewhiledirectduplicateisprohibited.
Whatarethetwoconceptsofdoubletaxation?
First,theconceptofdirectduplicatetaxationanditmeanstaxingtwiceforthesamepurpose,for
thesameyear,forthesamesubjectbythesametaxingauthority.Itwasstatedinthecaseof
Villanuevav.CityofIloilothatdirectduplicatetaxationmeansthatthesamepropertyistaxed
twicewhenitshouldbetaxedonlyonce;andthatbothtaxesareimposedonthesameproperty
orsubjectmatterforthesamepurpose,bythesameState,Governmentortaxingauthority
withinthesamejurisdictionortaxingdistrictduringthesametaxingperiodandcoveringthe
samekindorcharacteroftax.
Second,theconceptofindirectduplicatetaxationwhichexistsifanyoftheelementsofdirect
duplicatetaxationisnotpresent.Intheabsenceoftheelementsofdirectduplicatetaxation,
doubleimpositionsleviedonaparticularsubjectoftaxationmaybejustified.
WhatdoestheSupremeCourtmeanwhenitsaysdoubletaxationisnotprohibitedgiven
thesetwoconcepts?
Injurisprudence,theSCheldthatthereisnoconstitutionalprohibitionagainstdoubletaxation.
Itissomethingnotfavoredbutisneverthelesspermissive.Thereis,however,animplied
constitutionalprohibitionagainstdoubletaxation.Butthisimpliedprohibitionappliessimplyto
directduplicatetaxation.
Whatisthatimpliedprohibition?
Thatconstitutionalprovisionwhichsaystaxationmustbeequitable.
Ifthereisdirectduplicatetaxation,itiseasilyopentoobjectionongroundsofbeingharsh,
oppressiveandbeinginequitableandthereforethatobjectionwhichispremisedoninequitable
taxationmaybesustained.Itmayalsobeobjectionablebasedonuniformityoftaxation.
WhatdowemeannowwhentheSupremeCourtsaysthereisnoprohibitionagainstdouble
taxation?
Itmeansthereisnoprohibitionagainstindirectduplicatetaxation.
Agoodexampleofindirectduplicatetaxationisrealpropertytaxedbothlocallyandnationally.
Realpropertyissubjecttorealpropertytax,atthesametime,itisusedasabasisforyour
communitytax.
Meaningoftaxevasion
Itistheusebythetaxpayerofillegalorfraudulentmeanstodefeatorlessenthepaymentofa
tax.Itisalsoknownastaxdodging.
Factorsintaxevasion
1. Theendtobeachieved;
2. Theaccompanyingstateofmindwhichisdescribedasbeingevil,inbadfaith,willfulor
deliberateandnotaccidental;and
Cecille 2C 05-06
Definition of Double
Taxation
Direct Duplicate Taxation

v. Indirect Duplicate
Taxation
Tax Evasion
13
3. Acourseofaction(orfailureofaction)whichisunlawful.
Meaningoftaxavoidance
Itistheusebythetaxpayeroflegallypermissiblealternativetaxratesormethodsofassessing
taxablepropertyorincome,inordertoavoidorreducetaxliability.Itisalsoknownastax
minimization.
Distinctionbetweentaxevasionandtaxavoidance
Taxavoidanceisthetaxsavingdevicewithinthemeanssanctionedbylaw.Thismethodshould
beusedbythetaxpayeringoodfaithandatarmssanctionedbylaw.Taxevasionisascheme
usedoutsideofthoselawfulmeansandwhenavailedof,itusuallysubjectsthetaxpayerto
furtheroradditionalcivilorcriminalliabilities.Ataxevaderbreaksthelaw,thetaxavoider
sidestepsit.
Tax Avoidance
Tax Evasion v. Tax

Avoidance
Cecille 2C 05-06
14
INHERENTLIMITATIONSONTHEPOWEROFTAXATION
Whatarethelimitationsonthepoweroftaxation?
Althoughthepowertotaxisunlimited,comprehensiveandplenary,thispoweris,however,
subjecttoinherentandconstitutionallimitations.
Whataretheinherentlimitations?
1. Ataxmustbeleviedonlyforpublicpurpose.
2. Prohibitionagainstthedelegationoflegislativepower.Thus,thetaxmustbelegislative
incharacter.
3. Thepowertotaxislimitedtotheterritorialjurisdictionofthetaxingstate.Thisisthe
principleofterritoriality.
4. Internationalcomity.
5. Exemptionofgovernmentagencies.
Whatispublicpurpose?
Asitstands,publicpurposeissynonymouswithgovernmentalpurpose.Aslongasthetaxis
designedtocarryoutanyofthegovernmentsobjectivesoranyofitsspecificactivity,itisfora
publicpurpose.
Aslongasthetaxisdesignedforarecognizedpublicneedorconcernitisforapublicpurpose.
Whatarethetestsfordeterminingthepublicpurposeinatax?
Onetestiswhetherthethingtobefurtheredbytheappropriationofpublicrevenueissomething
whichisthedutyoftheState,asagovernment,toprovide.
Anothertestiswhethertheproceedsofthetaxwilldirectlypromotethewelfareofthe
communityinequalmeasure.
SupposingCongresspassesalawincreasingpropertytaxesbyof1%toformriceexporters
fund,tostrengthenandprotectthelocalriceindustry.ThereisanNGOwhichrepresentsall
riceexportersandallriceplantersandmillers.ThepurposeoftheNGOistoassisttherice
industryinallitsvariousaspects.ThefundcollectedwasreleasedtothisNGO.Isthetaxlaw
valid?Doesithaveapublicpurpose?
No.Whenyougivetaxesdirectlytoaprivateentity,accordingtoLutzv.Araneta,youare
favoringaprivatepersonandyouhavenopublicpurpose.Thepublicpurposeistobeachieved
bytheStategovernment.InLutz,thetaxwasforthebenefitofthemembersofthesugar
industry.TheSCheldthatthefundwasbeingcollectedbythegovernment,forthegovernment
itselftostrengthenandrehabilitatethesugarindustry.
SupposingCongresspassesalawimposinganadditional1%realproperty.Taxpropertyisto
setasideafundforpublicschoolteachers.Parentsofchildreninprivateschoolsarguethat
thistaxdoesnotbenefitthem.Istherestillapublicpurpose?Ifthereare102privateschools
inamunicipalityandonly3arepublicschools?
Thereisstillapublicpurpose.Thepublicpurposeofthetaxisnotremovedbythefactthatnot
allarebenefitedfromsuchtaxlaw.Publicpurposedoesnotrequirethateachandeverytaxpayer
bepersonallybenefitedfromthepaymentofthetax.Itissufficientthatultimatelyyouhavea
betterorganizedsociety.Moreover,thesinglingoutofaparticularsectorofsocietyforeither
taxationorexemptionwouldstillnotviolatethepublicpurposerequirement.Thisargumentis
bolsteredbytheprinciplethatthepowertoexemptinvolvesthepowertoselecttheobjectof
taxation(whototaxandnottotax).
InLutzcase,theSCcameoutwithapowerstatement,withregardtotaxation,theLegislatureis
notrequiredtoadoptapolicyofallornone.ThisisbecauseCongresshasthepowertoselect.
Cecille 2C 05-06
Inherent Limitations
Public Purpose
Tests in Determining
Public Purpose
15
Thepublicpurposerequirementwillnotbeviolateifthetaxproceedsgotosomesectorswhich
areinneedofit.Foraslongastheproceedsaredevotedtoamatterofpublicconcern,thenthe
requirementismet.
InthecaseofLutzv.Araneta,theadministratoroftheLedesmaestateobjectedtothecreationof
theSugarStabilizationFundonthegroundthatthelawwhichcreatedthefundisbeingsetto
benefitthesugarworkersonly.TheCourtsaidthattheyarenotbeingbenefiteddirectlyorbeing
singledoutasbeneficiary.Whatisbeingbenefitedistheentiresugarindustrywhichisan
activityimpressedwithpublicinterest.
Whatifthetaxcarryanelementofspecialbenefittospecificindividuals,willitstillbevalid?
Yes.Aslongasthatspecialbenefitissimplyincidental,thatfactwouldnotdiminishthenature
ofthetaxbeingforapublicpurpose.
Supposingtheobjectionisgroundedonthefactthatitisnotforapublicpurposebecause
whileitfavorsoneindustryitdiscriminatesagainstanotherindustry?Lawforrice
stabilizationfundbutevidenceprovesitprejudicescornfarmers.Valid?
Yes,itmaystillbeheldvalid.Publicpurposeisnotdestroyedbythefactthatthetaxlawmay
notbebeneficialtoonegroup.Thereisavalidpublicconcern.Theclassificationisanexerciseof
thepowertoselect.Theinequitywhichmayariseviolatesnoconstitutionalprohibition.
InTiov.VidegramRegulatoryBoard,therewasastatementinlawwhichsaysthatthelawshall
protectthemovieindustrywhileittaxesthevideogramindustry.TheCourttheresaidthereis
therecognizedpublicconcerntoprotectthevideoindustryfrompiracyandfromdiminutionof
intellectualpropertyrights.Inprotectingthemovieindustry,thelawdoesnot,however,
diminishthepublicconcerntoprotectthevideoindustryfrompiracyandfromdiminutionof
intellectualpropertyrights.
Thefactthatonesectorisbenefitedandintheprocessanothersectorisbeinginaway
prejudicedwouldnotdiminishthepubliccharacterofthetax.
InCaltexv.CommissiononAudit,theobjectionwasgroundedonthefactthatthetaxproceedsare
beingplacedinaspecialfund,theOilStabilizationFund.Theirargumentwasthatthemere
conceptofspecialfundreferstoaspecialgroup,aspecialindividualandthatitmaynotbefora
publicpurpose.Theyarguedthatitshouldaccruetothegeneralfundbecausepublicfunds
belongtothegeneralfundandnotthespecialfund.TheSCsaidthecharacterofspecialfundis
thatisshouldbeusedforaspecificpurposeandthatspecificpurposeisstillapublicpurpose.
Thegovernmentprogramorobjectiveremains.
Aroadwithinaprivatesubdivisionisbeingusedbythepublic.Ifagovernmenttractor
maintainstheroadwithasphalt,wouldthisviolatethepublicpurposeprinciple
Yes,sinceyouaredirectlybenefitingaprivateperson.
Whatifthisroadisgoingtobedonatedtothegovernment?
Thiswouldstillbeinviolationofthepublicpurposerequirement,sincewhentheimprovements
weremade,theroadwasstillprivate.
ThisisthecaseofPascualv.SecretaryofPublicWorks.TheSCsaidthatthefactthatitwasdonated
afterdoesnotcurethedefectthatthetaxwasnotforapublicpurposeatthetimethetaxlawwas
passed.
Thiscaseisimportantasitpointedoutthatthepublicpurposemustexistatthetimeofthe
enactmentofthetaxmeasureorlegislation.
Cecille 2C 05-06
16
Whatdoyoumeanbylegislativeincharacter?
Itmeansthattaxationisapurelylegislativeact.Nootherofficialorexecutiveofficercanexercise
thetaxingpoweroftheState.Theruleisthatitcannotbedelegatedunlessexpresslyauthorized
bytheConstitution.
Whatisincludedinthatlegislativepowertotaxwhichcannotbedelegated?
1. Thedeterminationofthekindornatureofthetax;
2. Theobjectorpurposeofthetax;
3. Theextent,amount,orrateofthetax;
4. Thesubjectorcoverageoftax;and
5. Thesitusoftaxation.
CanBIRexercisethesamekindofdiscretionintheimpositionoftaxes?
No.TheBIRisonlytaxedwiththeassessmentandcollectionoftaxesdulylevied.Itcannotgo
beyondwhatthelegislativepowerprovidesregardingtaxes.However,theBIRmayissue
rulingsandformulaterulesandregulationsbutthesecannotgobeyondorexceedthetaxing
statute.
Whatarethetworecognizedexceptionstotheruleonnondelegationofpowertotax?
1. PresidentialTaxingPowers
UndertheConstitutionalFlexibilityClause(Section29(2)Art.VI),theCongress,
maybylaw,authorizethePresidenttofixwithinspecifiedlimits,andsubjectto
suchlimitationsandrestrictionasitmayimpose,tariffrates,importandexport
quotas,tonnageandwharfagedues,andotherdutiesandimportswithinthe
frameworkofthenationaldevelopmentprogramofthegovernment.Thisis
implementedundertheTariffsandCustomsCode(Section401).
2. DelegationtoLocalGovernments
ByexpressprovisionoftheConstitution,localgovernmentsmaycreatetheirown
sourcesofrevenues.ThisprovisionisstronglyimplementedintheLocal
GovernmentCodeunderthechaptersonlocaltaxesandrealpropertytaxation.
**Someauthorswouldputdelegationtoadministrativebodesasanotherexception.But
actually,thisisnotanexceptionsincewhatisbeingdelegatedisnotthepowertotaxbutthe
administrativedetailstoimplementwhatthelawhassaid(ex.RevenueRegulationsissued
bytheDept.ofFinanceandtheBIR).
Whyisthereaneedtodelegatethetaxingpowerstolocalgovernmentswhentheyarealso
partofthegovernmentofthePhilippines?Isntthepowertotaxaninherentpowerofthe
State,whichthelocalgovernmentsareapartof?
Thepowertotaxisvestedinthesovereignentity.Localgovernmentsarenotsovereignentities.
TheyaremerecreaturesoftheState,therefore,delegationmustbemade,otherwiseitwould
violatetheprincipleoftaxationbeingessentiallylegislativeincharacter.
WhatisthePrincipleofTerritoriality?
Itmeansthatthepowertotaxislimitedtotheterritorialjurisdictionofthetaxingstate.The
taxingpowerofastatedoesnotextendbeyonditsterritoriallimitsbutwithinwhichsuchlimits,
itmaytaxpersons,property,income,orbusiness.Thebasicreasonforthisisthatbeyondthe
territoryofthetaxingstate,thetaxingstatenolongerextendsprotection,thereforethereisno
basisfortaxation.
WhodeterminesthesitusorplaceoftaxationwhichiswhatisimpliedintheTerritorial
Principle?
Itisthelegislaturewhichfixestheplaceoftaxationbyconsideringseveralcriteria,allofwhich
recognizestherelations,privityorconnectionofthethingbeingtaxedtothetaxingpower.
Cecille 2C 05-06
Legislative in Character
Exceptions to the Rule on

Non-Delegation of Power
to Tax
Territoriality Principle
17
Whataretheuniversallyemployedcriteria?
1. citizenship;
2. residence;
3. locationofproperty;
4. sourceofincome;and
5. placeorexerciseoftheprivilege.
Otherfactorstoconsiderarethekindorclassificationofthetaxbeingleviedandthepossible
protectionandbenefitthatmayaccruetoboththegovernmentandtothetaxpayer.
Whatisthesitusrulebeingusedfortaxationofpersons?
Itmaybetheresidence/domicileorcitizenshipofthepersonbeingtaxed.
Whatisthesitusruleintaxationofproperty?
Itisthelocationoftheproperty.Ifapropertyislocatedinataxingstate,thattaxingstatehasa
righttotaxthepropertybecauseofthelocation.
Howabouttangiblepersonalproperty?
Themodernruleisthatitistaxableinthestatewhereitisphysicallylocatedalthoughthe
ownerresidesinanotherjurisdiction.TheCivilCodeprovidesrealpropertyaswellaspersonal
propertyissubjecttothelawofthecountrywhereitissituated.
Howaboutintangiblepersonalproperty?
Thegeneralruleisthatitistaxableinthedomicileoftheowners.Thisinaccordancewiththe
principleofmobiliasequunturpersonamthesitusofthepersonalpropertyisthedomicileofthe
owner.Theexceptioniswherethisrulewouldbeinconsistentwithanexpressstatute.
Whataretheexceptions?
Whentheintangiblehasacquiredbusinessoractualsituselsewhere.Inthiscase,thetaxsitus
wouldbetheplacewheretheintangiblehasacquiredbusinesssitus.Thatwouldbetheplace
wherethetaxingjurisdictioncanimposethetax.
InthecaseofMeralcov.Yatco,MeralcoobtainedfireinsurancewithtwoNewYorkbased
insurers.TheinsurancecontractwasexecutedinNewYorkbutthepropertiesweresituatedin
thePhilippines.Thegovernmentimposeda1%taxontheinsurancepremium.Theobjectionof
theinsurerswasthatitshouldnotbetaxedbecausethecontractwasexecutedoutsidethe
Philippinesandhence,theinsurerswerebeyondtheterritorialjurisdictionofthePhilippines.
Thatthetaxbeingimposedwouldbeineffectataxontheinsurerswhowouldbepayingthetax.
TheCourtheldthatwhiletheargumentistrueinthegeneralrule,inthiscase,thesubjectbeing
taxedhasacquiredactualsitusinthePhilippines.Thisissobecausethepropertyissituatedin
thePhilippines,theinsuredisinthePhilippinesandtherearecertainelementsofthecontract
whichwouldbeimplementedinthePhilippines.Therefore,thePhilippinesisextending
protectiontothatpropertytothebenefitoftheforeigninsurers.ThatalonegrantsthePhilippine
taxingjurisdictiontherighttoimposethetaxbecausethesubjectofthetaxhasacquiredactual
situshereinthePhilippines.
IntheWellsFargocase,itinvolvestheimpositionoftheinheritancetax.TheladyresidentofLos
Angeles,CaliforniadiedandpartofherestatewasabundleofsharesintheBenguet
ConsolidatedMininghereinthePhilippines.ThePhilippinegovernmenttriedtoimposean
inheritancetaxontheshares.Itwasopposedonthegroundthattheseshareswereintangibles
andarepersonalpropertyandtherefore,thegeneralprincipleshouldapply.
TheCourtsaid,yes,asageneralrulethatistherulebutinthiscase,thesharesofstockshas
acquiredabusinesssitusinthePhilippinesbecausethesharesofstocksaresharesofadomestic
Cecille 2C 05-06
Criteria in Determining
Situs
Actual Business Situs

Rule
18
entityenjoyingtheprotectionofthePhilippinejurisdiction.
ThissitusruleshavealreadybeenincorporatedintheNIRCunderSection104whichprovides
thatshares,obligationsandbondsissuedbydomesticcorporationsareconsideredordeemed
withinthePhilippines.
Also,underSection42,whenthesaleinvolvesthesharesofstocksofadomesticcorporation,it
shallbesubjecttotaxhereregardlessofwhereverthesalewasmade.
InthecaseoffireinsurancepropertysituatedinthePhilippines,aretheinsurancepremiums
paidthereontaxableasagainsttheinsurereventhoughthefireinsurancecontractwas
executedoutsidethePhilippines,andtheinsurancepolicyisdeliveredtotheinsuredtherein?
TheSupremeCourtruledinMeralcov.YatcothatsaidpremiumaretaxableinthePhilippines
becausethePhilippineGovernmentmustgetsomethinginreturnfortheprotectionitgivesto
theinsuredpropertyinthePhilippines,andbyreasonofsuchprotection,theinsurerisbenefited
thereby.
UnderSection104ofthe1997NIRC,whataretheintangiblepropertiesconsideredas
propertieswithasitusinthePhilippines?
1. franchisewhichmustbeexercisedinthePhilippines;
2. shares,obligationsorbondsissuedbyanycorporationorsociedadanonimaorganizedor
constitutedinthePhilippinesinaccordancewithitslaws;
3. shares,obligationsorbondsissuedbyanyforeigncorporation85%ofthebusinessof
whichislocatedinthePhilippines;
4. shares,obligationsorbondsissuedbyanyforeigncorporationifsuchshares,
obligations,bondshaveacquiredabusinesssitusinthePhilippines;and
5. sharesorrightsinanypartnership,businessorindustryestablishedinthePhilippines.
Whatisthesitusruleintaxationofincome?
Thecitizenship,residencesandsourceofincomeareconsidered.
Howaboutintransfersofproperty?
Thecitizenship,residence,andlocationofpropertyareconsidered.Sowhenwetalkoftransfer
bydeathorgift,thecountryinwhichthedecedentordonorisaresidentorcitizenhasarightto
taxthepropertyortheactoftransmittingbydeathorbygift.Also,thecountrywherethe
propertyislocatedhastheauthoritytotaxthegivingofthatproperty.
Howaboutinbusinessoroccupation?
Thecriteriabeingusedaretheplacewheretheactisperformed,theplacewherethebusinessis
engagedinortheplacewheretheoccupationortheprofessionisbeingexercised.
SupposingX,Filipino,hasrealandpersonalpropertiesinthePhilippineswhichyield
income.XleftfortheUSandtherehealsoacquiredrealandpersonalpropertiesyielding
income.HethenleftforCanadawherehepermanentlyresided.InCanada,healsoacquired
realandpersonalpropertiesyieldingincome.
AsregardsthepropertieslocatedintheUnitedStatesandCanada,theycannotbereachedbythe
PhilippinetaxlawsasitisoutsideofthePhilippines.IncomefromtheUSandCanada,however
maybereachedduetoFilipinocitizenship.
SupposingY,anAmericancitizen,isaresidentofthePhilippineswhohasrealandpersonal
propertiesinthePhilippines.Notethataresidentaliencanonlyacquirerealpropertyinthe
PhilippinesifheusedtobeaFilipinocitizenwhohadrealproperty,privatelands,beforehe
acquiredforeigncitizenship.Notealsothatrealpropertyrefersnotonlytolandbutitalso
referstobuildings,improvementsandequipmentattachedtotheland.Yalsohasrealand
Cecille 2C 05-06
19
personalpropertiesyieldingincomeintheUS.HehasalsobusinessinCanada,owningreal
andpersonalpropertiesthere.
AsregardsthepropertieslocatedandtheincomeearnedinthePhilippines,theymaybetaxedin
thePhilippinesbecausetheyarelocatedandearnedinthePhilippines.Furthermore,Yisa
residentofthePhilippines,thoughhemaybeanAmericancitizen.
AsregardsthepropertieslocatedintheUSandCanada,theycannotbereachedbyPhilippine
taxlawsasitisoutsideofthePhilippines.IncomefromtheUSandCanada,however,maybe
reachedbecauseYisaFilipinoresident.
SupposingZ,anonresidentalien,droppedbyinthePhilippinesandboughtacondominium
unityieldingincome.HeisaUScitizenwherehehasrealandpersonalpropertiesyielding
income.HeisnowaresidentofCanadahavingrealandpersonalpropertiesyieldingincome
there.
AsregardsthepropertieslocatedandtheincomeearnedinthePhilippines,theymaybetaxedin
thePhilippinesbecausetheyarelocatedandearnedinthePhilippines.
AsregardsthepropertiesandtheincomeearnedintheUSandCanada,theycannotbereached
byPhilippinetaxlawsasitisoutsideofthePhilippines.Furthermore,Zisneitheracitizennora
residentofthePhilippines.Thatisthereasonwhy,inourincometaxation,nonresidentaliens
aretaxedonlyforincomewithin.
SupposingAhassharesofstocksinSanMiguelandFilEstateandheisnowinCanada.
Therehesoldthesharesofstocksandearnsanincome.Canthesaleortransferoftheshares
besubjecttoPhilippinetaxation?
Yes,becauseofthebusinesssitusrule.Thestocksaredeemedtobewithinbecausetheyare
stocksofadomesticcorporationreceivingprotectionfromthePhilippinetaxingjurisdiction.
Althoughtheyarelocatedabroad,personallycarriedbyAandstuckinhisvaultinCanada,still
thebusinesssituswillapply.
SummaryoftheSitusRule
RealProperty
Location
TangiblePersonalProperty
Location
Mobiliarule
IntangiblePersonalProperty
(exception:actualorbusiness
situs)
Income
Citizenship
Residence
SourceofIncome
TransferofProperty
Citizenship
Residence
LocationofProperty
Businessoroccupation
Wheretheactisperformed
Wherebusinessisengaged
Whereoccupation/professionisexercised
Section23oftheNationalInternalRevenueCodeprovidesthatexceptwhenotherwiseprovided:
(A) AcitizenofthePhilippinesresidingthereinistaxableonallincomederivedfrom
sourceswithinandwithoutthePhilippines;
(B) Anonresidentcitizenistaxableonlyonincomederivedfromsourceswithinthe
Philippines;
(C) AnindividualcitizenofthePhilippineswhoisworkingandderivingincomefrom
abroadasanoverseascontractworkeristaxableonlyonincomefromsources
withinthePhilippines;Provided,thataseamanwhoiscitizenofthePhilippinesand
Cecille 2C 05-06
Summary of Situs Rule
20
whoreceivescompensationforservicesrenderedabroadasamemberofthe
complementofavesselengagedexclusivelyininternationaltradeshallbetreatedas
anoverseascontractworker;
(D) Analienindividual,whetheraresidentornotofthePhilippines,istaxableonlyon
incomederivedfromsourceswithinthePhilippines.
(E) Adomesticcorporationistaxableonallincomederivedfromsourceswithinand
withoutthePhilippines;and
(F) Aforeigncorporation,whetherengagedornotintradeorbusinessinthe
Philippines,istaxableonlyonincomederivedfromsourceswithinthePhilippines.
CaseNo.1(NonresidentFilipino)
FilipinowithrealandpersonalpropertiesinthePhilippineswhichyieldincome.
LeftfortheUSwhereheacquiredrealandpersonalpropertiesyieldingincome.
WenttoCanadawherehepermanentlyresided.Healsoacquiredrealandpersonalproperties
yieldingincome.
***NotethatanonresidentcitizenistaxableonlyonincomederivedfromsourceswithinthePhilippines.
Transactions/Properties
UnderSection23of
(UndertheSitusRule)
NIRC
PropertiesinthePhilippines (location)
IncomeearnedinpropertiesinthePhilippines
(citizenship,sourceofincome)
PropertiesintheU.S.andCanada (location)
IncomefromU.S.andCanada (citizenship)
Examples
CaseNo.2(ResidentAlien)
American,aresidentofthePhilippines.
HasrealandpersonalpropertiesinthePhilippines.
HasrealandpersonalpropertiesyieldingincomeintheUS.
HasbusinessinCanadaandownsrealandpersonalpropertiesthere.
***NotethataresidentaliencanonlyacquirerealpropertyinthePhilippinesifheusedtobeaFilipino
citizenwhohadrealproperty,privatelands,beforeheacquiredforeigncitizenship.
***Notealsothatrealpropertyrefersnotonlytolandbutitalsoreferstobuildings,improvementsand
equipmentattachedtotheland.
***Analien,whetherresidentornotofthePhilippines,istaxableonlyonincomederivedfromsources
UnderSection23of
(UndertheSitusRule)
NIRC
IncomeearnedinpropertiesinthePhilippines
(sourceofincome,residence)
IncomefromU.S.andCanada (residence)
Cecille 2C 05-06
21
CaseNo.3(NonResidentAlien)
CitizenofUS.
DroppedbythePhilippinesandboughtacondounityieldingincome.
HasrealandpersonalpropertiesyieldingincomeintheUS.
ResidentofCanadawherehehasrealandpersonalpropertiesyieldingincomethere.
***Analien,residentornot,istaxableonlyonincomederivedfromsourceswithinthePhilippines.
UnderSection23of
(UndertheSitusRule)
NIRC
IncomeearnedinpropertiesinthePhilippines (source
ofincome)
IncomefromU.S.andCanada (residence,citizenship)
CaseNo.4
Filipinocitizen.
ResidentofthePhilippines.
HaspropertiesinthePhilippines,U.S.,andCanada.
Propertiesinthe
PropertiesintheUS
Propertiesin
Philippines
Canada
Realpropertyearning
Realproperty
Realproperty
income
Personalproperty
Personalproperty
Personalproperty
dependsiftangible
dependsiftangibleor
orintangible
intangible
Business
StocksinPLDT
Business
Businessincome
Stocksin3MUSA
Gainsfromtransactions
ofstocks
CaseNo.5
Filipinocitizen.
ResidinginthePhilippines.
HaspropertiesinthePhilippinesandintheU.S.
Transactions/Propertiesinthe
Transactions/PropertiesintheU.S.
Philippines
CallCenter
Consultantofacallcenter
(citizenship)
Realpropertyincome
Realpropertyincome
Realpropertytax
Personalproperty
Personalproperty
Cars (location)
Jewelry (location)
SharesofstocksinPLDT (thing
BoughtPLDTsharesofstocksinthe
followstheprincipal)
U.S. (actualbusinesssitusrule)
SharesofstocksinAmericaOnline
SharesofstocksinAmericaOnline
(thingfollowstheprincipal)
Butifitinvolvesgainsfrom
transactions (citizenship)
PNBNewYorkdepositearninginterest
PNBNewYorkdepositearninginterest
income (citizenship,residence)
income
Cecille 2C 05-06
22
CaseNo.6
Filipinocitizen.
Nonresident.
***NotethatanonresidentcitizenistaxableonlyonincomederivedfromsourceswithinthePhilippines.
Transactions/PropertiesinthePhilippines
UnderSection23of
(UndertheSitusRule)
NIRC
Businessincome
Realpropertyincome
Personalproperty
Cars (location)
Jewelry (location)
GainsfromtransactiononsharesofstocksinPLDT
GainsfromtransactiononsharesofstocksinAmerica
Online(transactionwasmadeinthePhilippines)
PNBNewYorkdepositearninginterestincome
(citizenship)
CaseNo.7
Nonresidentalien.
HaspropertiesinthePhilippines.
Transactions/PropertiesinthePhilippines(UndertheSitusRuleandSection23
ofNIRC)
Businessincome (source)
Realpropertyincome
Personalproperty
Cars (location)
Jewelry (location)
GainsfromtransactioninthePhilippinesonsharesofstocksinAmericaOnline
IfsoldinAmericathroughhislawyer
CaseNo.8
ResidentalienwhohaspropertiesintheU.S.
Transactions/PropertiesintheU.S.(UndertheSitusRule) UnderSection23of
NIRC
BusinessincomeintheU.S. (residence)
Realpropertytax
Realpropertyincome
Personalproperty
Cars (location)
Jewelry (location)
(residence)
GainsfromtransactiononsharesofstocksinAmericaOnline

(residence)
(actualbusiness
situsrule)
Cecille 2C 05-06
23
Howisinternationalcourtesyorcomityalimitation?
ThroughtheconstitutionalprovisionthatthePhilippinesadoptsthegenerallyaccepted
principlesofinternationallawaspartofthelawoftheland.Underinternationalcomity,the
propertyofaforeignstateorgovernmentmaynotbetaxedbyanother.
Oneoftheprinciplesisthesovereignequalityofthestates.IfthePhilippinegovernmenttaxes
thepropertyoftheU.S.governmenthere,itwouldmeanthatthePhilippinegovernmentismore
equalthattheU.S.government.ItwouldmeanthattheUSisinferiortothePhilippinesbecause
thePhilippinescantaxtheUSgovernment.
Whatarethegroundsuponwhichtheprincipleofinternationalcomityisbased?
1. Thesovereignequalityamongstatesunderinternationallawbyvirtueofwhichonestate
cannotexercisesovereignpowersoveranother;
2. Theusageamongstatesthatwhenoneenterstheterritoryofanother,thereisanimplied
understandingthattheformerdoesnotintendtodegradeitsdignitybyplacingitself
underthejurisdictionofthelatter;and
3. Theruleofinternationallawthataforeigngovernmentmaynotbesuedwithoutitsconsent
sothatitisuselesstoassessthetaxsinceanywayitcannotbecollected.
Whyisnontaxationofgovernmententitiesconsideredalimitation?
Becausethepurposeoftaxationistoraiserevenuesandtofinancegovernment.Howcanyou
raiserevenueswhenyoutaxgovernmentitself?Iftaxationofgovernmentisallowed,itwouldin
effectdefeatthepurposeoftaxation.
Byjurisprudence,thenontaxationofgovernmententitiesaresimplyappliedtogovernment
agenciesexercisingsovereignfunctions.
Thegovernment,however,cantaxitselfaslongasthereisastatutoryauthoritytodosoand
whenthereisnoexpressprovisionagainstsuchact.Thegovernmentisnotsimplyexercising
sovereignfunctions,ithasalsootherfunctionswhichmaybesubjectedtotax.
Cecille 2C 05-06
International Comity
Non-Taxation of
Government Entities
24
CONSTITUTIONALLIMITATIONSONTHEPOWEROFTAXATION
Whataretheconstitutionallimitationsonthepoweroftaxation?
1. dueprocessoflaw;
2. equalprotectionofthelaws;
3. ruleofuniformityandequityintaxation;
4. noimprisonmentfornonpaymentofapolltax;
5. nonimpairmentoftheobligationofcontracts;
6. freedomofspeechandofthepress;
7. noninfringementofreligiousfreedom;
8. noappropriationforreligiouspurposes;
9. exemptionofreligious,charitable,andeducationalentities,nonprofitcemeteries,and
churchesfrompropertytaxation;
10. exemptionofnonstock,nonprofiteducationinstitutionsfromtaxation;
11. concurrencebyamajorityofallthemembersofCongressforthepassageofalaw
grantingtaxexemption;
12. thepowerofthePresidenttovetoanyparticularitemoritemsinarevenueortariffbill;
and
13. nonimpairmentofthejurisdictionoftheSupremeCourtintaxcases.
WhatistheDueProcessClause?
TheConstitutionprovidesthatnopersonshallbedeprivedoflifelibertyorpropertywithout
dueprocessoflaw.
Itdoesnotsaythatnooneshallbetaxedwithoutdueprocessoflawbutbecausetaxationaffects
propertyandpropertyrights,theDueProcessClausemustcomeintoplay.
Howdoesdueprocesslimittaxation?
Thedueprocessclausesimplygivesyouthestandardbywhichalltypesoflegislationshallbe
measuredagainst,includingtaxlaws.
Thebasicconceptofdueprocessisthatanygovernmentactorlawmustbereasonable,
substantivelyorprocedurally.
Substantivedueprocessmeansitshouldnotbeharsh,oppressive,andconfiscatory.
Proceduraldueprocessmeanstheremustbetherightoropportunitytobeheard.
Taxlawsmustbereasonable.Ifataxlawisharsh,oppressive,andconfiscatoryinitsoperation
orimplementation,thenitisormaybeviolativeofthedueprocessclause.Ifataxlawdeniesthe
rightoftaxpayertobeheardortheopportunitytoheard,thenitviolatesthedueprocessclause.
SupposingCongresspassesaCronyTaxLawwhichtaxesillgottenwealthacquiredfrom1965
to1985.Assumingthattheonlyissueisthatsinceitisretroactive,itisviolativeoftheDue
ProcessClause.WillretroactivityofthetaxlawviolatetheDueProcessClause?
No,unlesstheretroactivitycouldbeestablishedasharshandoppressiveinitsoperation.
ThatwastherulingintheFernandezEstatecase.
Inthatcase,theFernandezcoupleengagedincertainbusinessduringtheJapaneseoccupation
andtheyearnedprofitsduringthattime.Afterthewar,theWarProfitsTaxLawwaspassed.
ThelawtaxesprofitsearnedduringtheJapaneseoccupation.Theobjectionwasthatitviolates
dueprocessasitisretroactivebecauseittaxesincomeearnedbeforethepassageoftheWar
ProfitsTaxLaw.TheSupremeCourtheldthatmereretroactivitydoesnotviolatetheDue
Cecille 2C 05-06
Due Process
25
ProcessClauseaslongastheretroactivityisnotharshoroppressive.
Inassessmentcase,whenataxpayerisbeingaskedtopayacertaintaxliabilityandthe
taxpayerarguesthathehasnotreceivedthenoticeofassessment.Ifthegovernmentinsists
thatthetaxpayerpaysthetaxliabilitywithoutprovingthereceiptofthetaxassessment,
wouldthatbeviolativeoftheDueProcessClause?
Yes.TheNIRCgivesthetaxpayerarighttodisputetheassessmentuponthereceiptofthetax
assessment.Ifthereisnoshowingofthereceiptofthenoticeofassessmentandthegovernment
stillinsiststhatthetaxbepaid,thatwouldbeviolativeofdueprocess.
IsataxpayertheonlyonewhocaninvoketheDueProcessclauseforprotection?
No.InProvinceofAbrav.JudgeHernando,thegovernmentthereinvokedtheDueProcessClause.
ThetaxpayersarguedthatasarepresentativeoftheChurchandsincethepropertyinquestion
areChurchproperties,thepropertiesareexemptconstitutionallyfromthepaymentofthe
propertytax.Withouthearingthesideofthegovernment,theJudgeaccededtothepositionof
theChurch.
TheSupremeCourtsaidthatthatisaviolationofdueprocessbecausethepropertiesmustbe
showntobeusedforreligiouspurposes.Thatwasnotshownandthegovernmentwasnotgiven
therighttoshowthatitwasactuallybeingusedforreligiouspurposes,itappearingthatno
courthearingwasconductedthereon.
IntheTolentinocase(ValueAddedTaxcase),theSupremeCourtsaidtheharshness,the
arbitrarinessandtheconfiscatorynatureofataxlawtoshowthatitviolatesdueprocessmustbe
establishedbysufficientfacts.Ifthetaxpayerallegesarbitrariness,thatmustbeshownbythe
facts,notbyspeculationsortheories.Ifthetaxisallegedtobeharshorconfiscatory,itmustbe
shownhowitisharshorconfiscatory.
ItisonthisscorethattheSupremeCourtdismissedtheargumentofKilosbayanthattheValue
AddedTaxwasharsh,oppressive,andconfiscatorybecauseallKilosbayandidwastopresent
positionpaperswhichdidnotestablishfactsonwhichtobasetheirallegationofharshness,
oppressiveness,andunjustnessoftheoperationofthetax.
WhatdoestheConstitutionrequirewithregardtouniformity?
TheConstitutionprovidesthattheruleoftaxationshallbeuniformandequitable.Thisisthe
UniformityClause.
WhatistheEqualProtectionClause?
TheConstitutionprovidesthatnopersonshallbedeniedtheequalprotectionofthelaws.
HowdotheUniformityandEqualProtectionClausesintheConstitutionoperateasa
limitationonthepowertotax?
TheSupremeCourt,inChurchillv.Concepcion,heldthatuniformitymeansallpropertiesbelong
tothesameclassshallbetaxedatthesamerate.Itdoesnotmeanthatallkindsoftaxable
properties,incomeprivileges,andfranchisesshallbesubjecttothesametax.Itsimplymeans
sameproperty,sameclass,sametax.
Ontheotherhand,equalitymeansallpersonssubjecttolegislationaretreatedalikeunderlike
circumstancesandconditionsbothinprivilegesconferredandliabilitiesimposed.
Uniformityandequalitymaybereducedtoonesimilarstandardorconcept.
Inthecontextoftaxationbothclausessimplymeansallsimilarsubjectsoftaxationundersimilar
circumstancesshallbegivensimilartaxtreatment.
Cecille 2C 05-06
Uniformity
Equal Protection
26

ThisconceptisexpoundedbytheSupremeCourtintheSisonv.AnchetacaseandtheTanv.Del
RosariocasewheretheconstitutionalityoftheSimplifiedNetIncomeTaxSystem(SNITS)wasin
issue.
TheSupremeCourtsaidthatuniformityandequalityarekindredconcepts;theyhavethesame
standards.AccordingtotheCourt,uniformityoftaxationmerelyrequiresthatallsubjectsor
objectsoftaxation,similarlysituatedaretobetreatedalikebothinprivilegesandliabilities.
WhenistheUniformityandEqualityClausesviolatedgiventhatconcept?
Ifalltaxpayerswithinthesameclasswerenottreatedaliketaxwise.So,theUniformityand
Equalityclauseswillbeviolateifalltaxpayersofthesameclassweretaxeddifferentlyorgivena
differenttaxtreatment.
ThefactthattheUniformityandEqualityClausestalksofsimilarconditionswhichwould
warrantsimilartreatmentimpliesthatclassificationisallowedforpurposesoftaxationaslongas
thestatementsameclassisbeinggiventhesametaxtreatmentisobserved.
Whataretherequisitesforvalidclassification?
1. Itmustrestonsubstantialdifferencesordistinctions;
2. Itmusttakeintoconsiderationthepurposeofthelaw;
3. Itmustapplyequallytoallmembersofthesameclass;and
4. Itmustrefernotonlytopresentbutalsotofuturesituations.
Giventhesecriteria,anyclassificationwouldbevalid.
Inshort,withthesecriteria,taxlawscandifferentiateinthetaxtreatmentofindividualsor
propertiesaslongasthetaxtreatmentisthesamewhenyoutalkofindividualsbelongingtothe
sameclass.
Anaddedrationaleisthefactthatthepowertotaxincludesthepowertoselectthepowerto
selectwouldimplythepowertogointoreasonableclassificationforpurposeoftaxation.
ThecaseSisonv.Anchetainvolvesthetaxationoftwodifferentkindsofincome:thegross
compensationincomeversusthebusinessincome.Twokindsofincomebeinggiventwo
differenttaxtreatment.Theargumentwaswhywouldyoudifferentiatebetweengross
compensationincomeandbusinessincomewhenbothareincome.
TheSupremeCourtsaidthatthereissufficientdistinctiononwhichtheclassificationisbased.
Grosscompensationincomeisdifferentfrombusinessincome.Inshort,thereisnoviolationof
theUniformityClausebecausethereisvalidclassification
SupposingCongresspassesalawimposingahigherincometaxoninterestincomeofsavings
deposits,higherthaninterestincomeontimedeposits.Supposingthetaxlawisobjectedto
onthegroundthatitviolatestheUniformityandEqualityclausesasyouaretalkingabout
deposits.Whydifferentiatethetaxtreatment?
Thereisavalidclassification.Interestinasavingsdepositshasadifferentconceptandcharacter
tothatofatimedeposit.Notethatunderourpresenttaxlaw,interestincomeondepositsis
subjecttoaflat20%withholdingtax.
Cecille 2C 05-06
Requisites for Valid

Classification
27
SupposingoneofthemunicipalitiesintheSpratlyIslands,withapopulationof100200
people,passesataxordinancewhichimposesaSensationTaxorataxontheoccupationfor
beingasaunabathattendant.Itsohappensthatonthatisland,thereisonlyonesaunabath
attendant.ThissaunabathattendantnowobjectsonthegroundthatitviolatestheEquality
Clausebecausesheisbeingdiscriminatedagainstit.IstheSensationTaxvalid?
Itisavalidlaw.Thefactthatonlyonepersonisaffectedbyataxlaworordinance,whichis
otherwiseofgeneralapplication,doesnotrenderthelaworordinanceinvalidasbeing
discriminatory.Thelawisnotdiscriminatoryasittaxesallpersonsfallingwithinthesameclass.
Whatthelawtaxesistheoccupationitself.Thenumberofpersonsexercisingthatoccupationis
notmaterial.
Also,theSensationTaxwouldbevalidaslongasitwouldapplynotonlytothepresentsauna
bathattendantbuttoallsaunabathattendantsinthefuture.Classificationispermittedif:
a. ifthestandardsusearenotarbitrarybutreasonableandrestsonsubstantial
distinctions;
b. iftheclassificationisgermanetothepurposeofthelaw;
c. iftheclassificationappliestobothpresentandfutureconditions;and
d. iftheclassificationappliesequallytoallthosebelongingtothesameclass.
InthecaseofOrmocSugarv.TreasurerofOrmocCity,ataxordinancewasheldinvalidforitlevied
anexporttaxoncentrifugalsugarmilledbytheOrmocSugarCo.,mentioningonlythiscompany
byname.Theordinancedidnotsatisfytherequisitesofreasonableclassification.Although
OrmocSugarCentralwastheonlysugarcentralexistingatthattime,theordinanceisdefective
becauseevenifasimilarcompanyislatersetup,itcannotbesubjecttothetaxsincethe
ordinancespecificallypointstoOrmocastheonetobetaxed.
WhathappenedinthecaseofAssociationofCustomsBrokersv.CityofManila?
Inthatcase,theCityofManilapassedanordinancewhichimposedaUserChargeonvehicles
ownedbyitsresidentsusingthestreetsofManila.Theordinance,however,doesnottaxvehicles
registeredoutsideofManilabutusingthesamestreets.Thetaxispayableonlybytheowners
residinginManila.
Inthiscase,theordinanceviolatestheUniformityClausebecausebothsetoftaxpayersare
similarlysituated.Theybothusethesamestreetsandwhatisbeingtaxedistheuseofthe
streets.Theclassificationdoesnotrestonsubstantialdistinctionasbothsetoftaxpayersare
similarlysituated.Thereisnoreasontotreatthemdifferentlytaxwise.Inthiscase,ownersof
vehiclesresidingoutsideofManilawhoalsousethestreetsofManilaarenotmadetosharethe
correspondingburden.
WhathappenedinthecaseofPepsiColaBottlingCov.CityofButuan?
InPepsiColav.ButuanCity,therewasataxpassedbytheCityCouncilwhichtaxesagentsof
softdrinkdealerswhoareoutsidethecitywhileexemptingagentswithinthecity.Again,wecan
arguethatthereisaviolationoftheUniformityandEquitabilityClausebecausewhatisbeing
taxedisthesellingofsoftdrinks.Bothtaxpayerslivingwithinandlivingoutsidearesimilarly
situatedasbothofthemaresellingsoftdrinks.Theclassificationofsuchagentsandconsignees
whoaretaxableandlocaldealerswhoareexemptisnotbasedonsubstantialdistinctions.
Congresspassesalawtreatingdifferentlycompensationandbusinessincome.Canthelaw
differentiatewiththesetwokindsofincomewhenyouaretalkingofthesameanimal:
income?
Incomeoncompensationandincomeonbusinessaretaxeddifferentlyandgivendifferenttax
treatmentandthishasbeenheldvalid.(CIRv.Solidbank)
Cecille 2C 05-06
28
WhatisthepertinentConstitutionalprovisionwithregard toreligious,charitableor
educationalinstitutions?
Section28(3),ArticleVIoftheConstitutionprovides:Charitableinstitutions,churchesand
parsonagesorconventsappurtenantthereto,mosques,nonprofitcemeteriesandalllands,
buildingsandimprovementsactually,directly,andexclusivelyusedforreligious,charitable,or
educationalpurposesshallbeexemptfromtaxation.
Whatiscoveredundertheexemptiongrantedtoreligious,charitableandeducational
institutions?
TheexemptiongrantedbySection28(3),ArticleVIoftheConstitutionpertainsonlytoproperty
taxes,nottoincometax.(CIRv.CTA)
Whatisthetestofexemption?
Thetestofexemptionistheuseofproperty.
SupposingX,adruglord,ownsafivehectarepropertyinTagaytay.Heleasesthepropertyout
toa100%charitableinstitution,theCertifiedVirginsofAteneo.TheCVAconstructsonone
hectareofthelandafourstorybuilding.Theotherfourhectaresarenotbeingused.Thefirst
floorsisusedasofficesoftheCVA.Thesecondfloorisusedasaresidence.Therestofthe
floorsareusedasdormitoriesfortheincomingmembersoftheCVA.Istheonehectareon
whichthebuildingislocatedsubjecttorealpropertytax?Istheotherfourhectareswhichis
beingheldforfutureusesubjecttorealpropertytax?
Actualuseisthetestandnotownership.Hence,thefactthatthelandisownedbyX,adrug
lord,isofnoconsequence.Theofficesarepartofthecharitablefunctions.Theresidenceofthe
membersoftheCVAisonlyincidentaltothecharitablefunctions.Thedormitoriesforincoming
membersarereasonablynecessaryforitscharitablefunctions.Thefourhectareproperty,onthe
otherhand,isnotcurrentlybeingused.Itisheldonlyforfutureuse.
Supposingthesamesituationbutonthegroundfloorofthebuildingthereisa15square
meterarealeasedforcommercialpurposes.ItwasleasedtoYwhosellslingerietotheCVA.Is
theareaexemptfromrealpropertytax?
Noandtheargumentthatitshouldbeexemptconsideringthefactthattheareonly15square
meterswhenthetotalareais5hectaresisofnobasisbecausethekeyconceptisuse.Aslongasit
isnotusedforcharitablepurposesthenitisnotcoveredbytheexemption.
Acharitableinstitutionownsa1hectarepropertybutonlyhalfoftheareaisbeingoccupied
byabuilding.Thefirst6floorsofthebuildingarebeingusedforcharitablepurposes.The7th
floorisbeingusedfordancing.Apartofthevacantlotcontainsvegetableplantingswhilethe
partofithasnothingonit.Whicharesubjecttotax?
Allarecoveredbythetaxexemptionexceptmaybethevacantlotwithnothingonit.The
buildingistaxexemptedevenifnotallthefloorsareusedexclusivelyforcharitablepurposes.It
couldbearguedthatthelotplantedwithvegetablesisstillwithinthecoverageoftheexemption
sinceitisincidentaltotheaccomplishmentoftheinstitutionspurposes.Sincetheconstitution
qualifiesthepropertyshouldbeactuallyanddirectlyusedthenitwouldappearthattheidle
landisnotcoveredbythetaxexemption.Rememberthattheexemptioncoversonlypropertytax
andnotincomefromtheuseoftheproperty.
Thelawstatesactually,directlyandexclusivelyused.Whatdoyoumeanbyexclusivelyused?
TheSupremeCourthasexplainedexclusivelyusedasprimarilyusedandithasinterpreted
primarilyusedtoincludeincidentaluse.Itisnotlimitedtopropertyactuallyindispensablebut
extendstofacilitieswhichareincidentaltoandreasonablynecessaryfortheaccomplishmentof
saidpurposes.
Cecille 2C 05-06
Non-Infringement on
Religious Freedom
Exemption Granted to
Religious, Charitable and
Educational Institutions
29
Say,inthepreviousexample,therearealsocertainstructureslikebuildings,canteens,
dormitoriesandavegetablegardenwhichyieldsvegetabletobesoldandusedforthecharitable
institution.Eventhesestructureswouldbeconsideredasincidentaltoitscharitablepurposes.
However,primarilyincludesincidentalbutincidentalneverincludescommercial.Thatisthe
lessongivenbytheAbraValleycase.
Inthatcasetherewasafourstoreybuildingwherethegroundfloorwasleasedoutfor
commercialpurposes.TheyweretryingtoargueincidentalusebuttheCourtsaidincidental
meansreasonablynecessaryforitsmainorprimarypurpose.Itfurtherstressedthatwhile
primarymayincludeincidentaluse,incidentalneverincludescommercialuse.
InthecaseofTheRomanCatholicBishopofNuevaSegoviav.ProvincialBoardofIlocosNorte,the
rulingistotheeffectthatthetaxexemptionextendstoavegetablegardeninanadjacentlotand
anotherlotformerlyusedasacemetery.Exclusiveuseconsidersincidentalusealso.Hence,the
exemptionoftheconventincludesnotonlythelandoccupiedbythebuildingbutalsothe
adjacentgardendevotedtotheincidentaluseoftheparishpriestaswellasthelodgingplace
incidentaltoreligiousfunctions.
Itisimportanttonotealsothatforpurposesoftaxexemption,useoverridesownershipsuch
thatifproperty,althoughactuallyownedbyareligious,charitableoreducationalinstitution,is
actuallyusedforanonexemptpurpose,theexemptionfromtaxofsaidpropertyvanishes.
WhatdoestheConstitutionprovidesfornonstock,nonprofiteducationalinstitutions?
Section4(3),ArticleXIVofthe1987ConstitutionprovidesthatAllrevenuesandassetsofnon
stock,nonprofiteducationalinstitutionsusedactually,directly,andexclusivelyforeducational
purposesshallbeexemptfromtaxesandduties.
Also,Section4(4),ArticleXIValsoprovidesthatSubjecttoconditionsprescribedbylaw,all
grants,endowments,donations,orcontributionsusedactually,directly,andexclusivelyfor
educationalpurposesshallbeexemptfromtax.
Whatdoesthewordusedimply?
Itwouldimplythataslongastherevenuesbeingusedforeducationalpurposes,therevenues
wouldbeexempt.
ThephraseexclusivelyusedforeducationalpurposeswasclarifiedinthecaseofHerrerrav.
QuezonCityBoardofAssessmentAppealsandCIRv.BishopofMissionaryDistrictofthePhilippine
Islandstoincludeasinthecaseofahospital,aschoolfortrainingnurses,homeandhousing
facilitiesforinterns,residentdoctors,superintendentsandothermembersofthehospitalstaff,
recreationalfacilities,etc.
Accordingtothedecisioninsaidcase,theadmissionofpaypatientsdoesnotdetractfromthe
charitablecharacterofthehospitalifallofitsfundsaredevotedexclusivelytothemaintenance
oftheinstitutionasapubliccharity.Thefactthatthehospitalwhichisacharitableinstitution
admitspaypatientsdoesnotbaritfromclaimingthatitisdevotedexclusivelytobenevolent
purposesifitappearsthattheincomederivedfrompaypatientsisdevotedtotheimprovement
ofthecharitywardswhichrepresentsalmosttwothirdsofthetotalbedcapacityasidefromout
charitypatientswhocomeonlyforconsultation.
Cecille 2C 05-06
Non-Stock, Non-Profit
Educational Institutions
30
SupposingtheAteneo,anonstock,nonprofiteducationalinstitutionearnsPhp20Mbecause
itchargeshightuitionfees,Php1Mfromseminar,Php1Mfrominterestincome.Theexcess
moneywasusedtoimportcomputersforitscomputercoursesandofficesuppliesand
equipment.Whatwouldhavebeenthetaxtreatmentoftherevenues?
Tuitionfeesandseminarfeeswouldbeexemptasitisanincomederivefromeducational
purpose.
Asregardsinterestincome,whentheaboveprovisionwasinsertedinthe1987Constitutionmost
ofthenonstock,nonprofiteducationsinstitutionsaskedforaclarificationwiththeBIR.The
initialrulingwasthatinterestincomewasexempt.
However,latertheDepartmentofFinancecameoutwitharegulationdefiningrevenues.
Revenueswithrespecttotheaboveconstitutionalprovisionrefertoincomederivedin
pursuanceofeducationalpurpose.
Thatbeingthedefinition,interestincomecannotthenbeincomederivedfromeducational
activitiesbecauseifyouwouldsimplysayaslongasrevenuesareusedforeducationalpurposes
thenitwouldbeexemptthennonstock,nonprofiteducationalinstitutionwouldthenbeableto
putupdepartmentstoreandusetherevenuesforeducationalpurposesandthatwouldbe
exempt.
Remember,revenuesmeansincomederivedinpursuanceofeducationalpurpose.Toargueon
theconceptofinpursuanceofeducationalpurpose,(1)theincomemustbederivedfroman
activityinpursuanceofeducationalpurposesandthat(2)theproceedsmustbeusedfor
educationalpurposes.
Asregardsimportationofcomputersandfileequipment,VATandcustomdutiesneednotbe
paidastheyareexemptastheyareusedforeducationalactivities.
SupposingAteneohaswithinitspremisesabookstoreandacanteenyieldingincome.Would
thesebesubjecttotaxorexempt?
Revenueregulationsclassifytheseactivitiesasancillaryactivitiesaslongastheyareownedand
operatedbytheinstitutionwithinitspremises,theyarecoveredbytheexemption.
SupposingthecanteenisleasedbytheAteneotoaprivateentity?
Thenthatwouldnotbecoveredbytheexemption.Theexemptionistoeducationalinstitutions
andnottoaprivateentity.Remember,taxexemptionsaregenerallynontransferable.Tax
exemptionsarestrictlypersonal.
Also,Section30oftheNIRCprovidesthatincomefromanypropertyofexemptorganizations
(suchasnonstockandnonprofiteducationinstitution)aswellasthatarisingfromanyactivity
thatitconductsforprofitisstilltaxable.ThesaidprovisionprovidesthatNotwithstandingthe
provisionsintheprecedingparagraphs,theincomeofwhateverkindandcharacterofthe
foregoingorganizationsfromanyoftheirproperties,realorpersonal,orfromanyoftheir
activitiesconductedforprofitregardlessofthedispositionmadeofsuchincome,shallbesubject
totaximposedunderthisCode.Thismakesincomefromthepropertyoftheorganization
taxable,regardlessofhowthatincomeisusedwhetherforprofitorforloftynonprofit
purposes.
SupposingAteneoisanonstock,nonprofitinstitutionanditsponsorsaboldfashionshow
forthebenefitofunderpaidfacultymembers.TheeventraisedPhp300L.Canthisbesubject
totax?
Yes.Theactivitymustbeinpursuancetoanactivityrelatedtotheeducationalpurposeforitto
beexempted.
Cecille 2C 05-06
31
AteneoissuescarstickersforcarstoenterschoolpremisesatPhp300each.Forthatyear,
AteneogotPhp500Kasrevenue.Wouldthatbeexempt?
ABIRrulingsaidthisisexemptbecauseyouhavetoenterschooltostudy.BIRheldthisasa
regulationandnotrevenue.
St.PaulCollegewantedtoimportelevatorsforschoolbuildings.Willtheimportationbe
exempt?
Nobecauseonedoesnothavetotaketheelevatortostudy.
Supposingahospitalranbyamedicalschoolsellsmedicineandchargesmedicalfeesfrom
patients.Wouldtheincomebeexempt?
Underrevenueregulations,thehospitalmustbeanindispensableoressentialrequirementfor
theUniversitytorunitsmedicalschoolinordertobeexempt.Ifthehospitaloperationsassumea
profitseekingpurposewhichisunrelatedtothepursuanceofeducationalfunctions,itwouldbe
outoftheconstitutionalexemption.
AssumingAteneohasPhp20Mderivedfromactivityinpursuanceofitseducational
functionsandhasPhp30Mderivedfromactivitytotallyunrelatedtoitseducational
functions.WhatwouldbethetaxtreatmentofthePhp50M?
ThePhp20MwouldbeexemptwhilethePhp30Mwillbesubjectto10%PreferentialTax
imposedonprivateeducationalinstitutions.
TheBIRwouldthenarguethattheentirethattheentirePhp50Mshouldbesubjectto35%
CorporateTaxbecauseunrelatedincomeismorethan50%oftheunrelatedincomeas
espousedinSection24,thePredominanceTest.
TheBIRiswrongasyoudonotapplythePredominanceTestsinthiscaseasAteneoisa
constitutionallyexemptinstitution.
ThePredominanceTestappliesonlytotaxableprivateeducationalinstitutions.
Themorebasicreason,however,isthatifyouapplythePredominanceTests,itwouldresultin
thetaxationofthePhp20Mincomewhichisconstitutionallyexempt.
SupposingthiswasUP,willtheconstitutionalprovisionapply?
Nobecauseitappliesonlytoprivateeducationalinstitutions.
Wouldthetaxtreatmentbethesame?
NobecauseunderSection30,governmenteducationalinstitutionsareexemptcorporations.
Sotosummarize:fornonprofit,nonstockeducationalinstitutions,theyareconstitutionally
exemptundertheconstitutionalprovision;forprivateeducationalinstitutionswhichdonot
qualifyundertheconstitutionalprovisions,theyaretaxedunderourincometaxcodewiththe
10%PreferentialTax;andforgovernmenteducationalinstitutions,theyareexemptcorporations
underSection30.
WhatittheConstitutionalprovisiononreligiousfreedom?
TheConstitutionprovidesthatnolawshallbemaderespectinganestablishmentofreligionor
prohibitingthefreeexercisethereof.Thefreeexerciseandenjoymentofreligiousprofessionand
worshipwithoutdiscriminationorpreferenceshallforeverbeallowed.Noreligioustestshallbe
requiredfortheexerciseofcivilorpoliticalrights.
Howisthefreeexerciseofreligiousfreedom,religiousworship,alimitationonthepowerto
tax?
TheleadingcaseisstillthecaseofAmericanBibleSocietyv.CityofManila.
Cecille 2C 05-06
Religious Freedom
32

Inthatcase,theAmericanBibleSocietyisaU.S.basedAmericanreligiousgroup.Itwas
registeredinthePhilippinesanddoingbusinessordoingpropagationoffaiththrougha
Philippineoffice.Whatitdidwastosellbiblesthroughoutthecountryandtranslatingthebible
toPhilippinedialects.Becauseoftheextent,themagnitudeofitssellingorbibleoperations,the
CityofManilasaiditwasnowengaginginthebusinessofmerchandising,businessofselling,
andthereforeitshouldbesubjecttoamunicipallicense.
TheSupremeCourtsaidthatthisactivityoftheAmericanBibleSocietyissimplyandpurelya
propagationoffaith,andthereforetotaxitwouldbetorestrict,inawaytorestrain,inawayto
discriminateagainstareligioussect,togivepreferencebyprohibitingthefreeexerciseof
religiousprofession.TheCourtreliedonMurdockv.Pennsylvaniawhereitwasheldthatasa
licensefeeisfixedinamountandunrelatedtothereceiptsofthetaxpayer,thelicensefeewhen
appliedtoareligioussectwasactuallybeingimposedasaconditionfortheexerciseofthesects
rightundertheConstitution.Forthatreason,theCourtruledthatthelicensefeerestrainsin
advancethoseconstitutionallibertiesofpressandreligion,andinevitablytendstosuppresstheir
exercise.
TheConstitutionalguarantyofthefreeexerciseofreligioncarrieswithittherighttodisseminate
religiousinformation.Anyrestraintonsuchrightcanonlybejustifiedonthegroundthatthereis
aclearandpresentdangerofanysubstantiveevilwhichtheStatehastherighttoprevent.The
priceaskedmayinsomeinstancesabithigherthatactualcostbutthisdoesnotmeanthatthe
religiousorganizationisengagedinthebusinessoroccupationofsellingthemerchandisefor
profit.Tobeheldtobeengagedinbusiness,suchactivitymustbethecentralactivityandthe
transactionsarenotisolatedorincidentalones.
SupposingthatsameAmericanreligiousgroup,aftersayingthatthesellingofbibleswasthe
bestwaytopropagatefaith,putupseveraldistributionoutletsthroughoutthecountry,
distributing,sellingthebibles.Andontopofthat,thesamereligiousgroupputupa
publicationhousebecauseitwasthebestwaytopropagatethefaith.Sothroughoutthe
countryithasdistributionoutlets.IthasapublicationhousesinLuzon,Visayasand
Mindanao,allinthenameofreligiousandsellsbiblesatalittlemargin.Wouldthatbe
subjecttothestatespowertotax,invokingtheAmericanBibleSociety?
Ofcourse,theguideline,theoperativewordisprofitseeking.
Iftheactivityofareligiousgroupassumesaprofitseekingcharacter,commercialcharacter,or
businesscharacterthenitceasestobeprotectedbythatconstitutionalprovision.
Why?
Becauseprofitseekingnegatesreligiousworship.Commercialbusinessactivitynegatesexercise
ofreligiousprofession.
Givenaproblemlikethat,youhavetolookatthecircumstanceswhichwouldindicatethe
commercialcharacter,thebusinesscharacteroftheactivity.Ifthereisthatkindofcharacter,if
thereisthatkindofindication,thenitisbeyondtheconstitutionalexemption.
SupposingFr.Bernasdeliversaspeechonfreedomofreligion.Thefeescollectedonthe
lecturearenowbeingtaxed.Valid?
Taxisviolativeofthefreedomofreligionwhenitoperatesasapriorrestraint.Inthiscasethe
speechwastaxedafteritsdelivery.Itisonethingtoimposeataxontheincomeorpropertyofa
preacher.Itisanotherthingtoexactataxfromhimfortheprivilegeofdeliveringasermon.The
powertotaxtheexerciseofaprivilegeisthepowertocontrolorsuppressitsenjoyment.Ifatax
isimposedbeforeFr.Bernascandeliversuchspeech,asaflatlicensetax,thenitisataxlevied
andcollectedasaconditiontothepursuitofactivitieswhoseenjoymentisguaranteedbythe
Cecille 2C 05-06
33
constitutionallibertyofreligiousandinevitablytendstosuppressitsexercise.(Grossjeanv.
AmericanPressCo.)
SupposingCongresspassesalawimposing5%additionaltaxonrealpropertywiththe
purposeofbuildinganEDSAIIshrinetopropagateandperpetuatethelessonsofEDSAII.
Valid?
No.Thistaxisunconstitutionalbecauseitfavorsacertainreligion.Itviolatestheprohibitionin
theConstitutionregardingnonestablishmentofreligion.
Whenisataxsaidtobeviolativeofpressfreedomorfreedomofthoughtandexpression?
Section4,ArticleIIIoftheConstitutionprovides,Nolawshallbepassedabridgingthefreedom
ofspeech,ofexpression,orofthepress,ortherightofthepeoplepeaceabletoassembleand
petitionthegovernmentforredressofgrievances.
InthecaseofTolentinov.SecretaryofFinance,theSupremeCourtheldthatthereiscurtailmentof
pressfreedomandfreedomofthoughtandexpressionifataxisleviedinordertosuppressthis
basicrightofthepeopleundertheConstitution.Alongwithotherissuesinthatcase,the
constitutionalityofEVATwasassailed.TheCourt,citingAmericancasesuphelditsvalidity.The
courtdifferentiatedthedisputedEVATfromthetaxthatwasleviedinthecaseofGrosjeanv.
AmericanPressCo.,wherethediscriminatorycharacterofthetaxwasconsideredasan
abridgementofthefreedomofthepressandofexpression.
Actingonthepremisethat,likeothers,anewspaperpublishermustpayequitableandnon
discriminatorytaxesonthisbusiness,theCourtpointedoutthatintheGrosjeancase,thelaw
imposedalicenseequivalentto2%ofthegrossreceiptsderivedfromadvertisementsonlyon
newspaperswithacirculationofmorethat20,000copiesperweek.Becausethetaxwasnot
basedonthevolumeofadvertisementalone,butwasmeasuredbytheextentofitscirculationas
well,thelawappliedonlytothe13largenewspapersinLouisiana,leavinguntaxed4
newspaperswithacirculationofonlyslightlylessthan20,000copiesaweekand120newspapers
inquestion.Itwaswellknownthatthe13newspapershadbeencriticalofSenatorHueyLong,
andthatthelongdominatedlegislatureofLouisianarespondedbytaxingwhatSenatorLong
describedasthelyingnewspapersandbyimposingonthemataxonlying.Theeffectofthe
taxwastocurtailboththeirrevenueandtheircirculation.
AstheU.S.SupremeCourtnoted,thetaxwasadeliberateandcalculateddeviseintheguiseof
ataxtolimitthecirculationofinformationtowhichthepublicisentitledinvirtueof
Constitutionalguarantees.Astatestatuteimposingalicensetax,basedongrossreceipts,forthe
privilegeofengaginginthebusinessofpublishingadvertisinginanynewspaper,magazine,
periodicalorpublicationwhateverhavingacirculationofmorethanastatednumberofcopies
perweek,abridgesthefreedomofthepress.Thecase,saidtheCourt,isaclassillustrationof
thewarningthatthepowertotaxisthepowertodestroy.
IndecidingtheTolentinocase,theSCheldthatevenwithduerecognitionofitshighestateand
itsimportanceinademocraticsociety,however,thepressisnotimmunefromgeneralregulation
bytheState.TheCourtalsoheldthatunlessjustified,thedifferentialtreatmentofthepress
createsrisksofsuppressionofexpression.Incontrast,theEVATlawappliedtoawiderangeof
goodsandservices.TheCourtheldthattheargumentthatbyimposingtheVATonlyonprint
mediawhosegrosssalesexceedsPhp480,000butnotmorethatPhp750,000,thelaw
discriminatesiswithoutmeritsinceithasnotbeenshownthatasaresultoftheclasssubjectto
taxhasbeenunreasonablenarrowed.Thefactisthatthislimitationdoesnotapplytothepress
alonebuttoallsales.
Inthesamecase,itwasallegedthattheannualregistrationfeeprovisionofthelaw,althoughof
generalapplicability,isnonethelessinvalidwhenappliedtothepressbecauseitlaysaprior
Cecille 2C 05-06
Freedom of Expression
34
restraintonitsessentialfreedom.Inthisissue,theCourtheldthatthefeeprovidedinSection7
ofthelaw,althoughafixedamount,isnotimposedfortheexerciseofaprivilegebutonlythe
purposeofdefrayingpartofthecostofregistration.Theregistrationfeeisamereadministrative
fee,onenotimposedontheexerciseofaprivilege,muchlessaconstitutionalright.
Speakingfurtheronthenatureofpressfreedominrelationtotaxation,particularlyasitrefersto
licensetaxesimposedmainlyforregulationandtaxes,whichliketheVATimposedpurelyfor
revenuepurposes,theCourtsaidthattheimpositionofalicensetaxisunconstitutionalbecause
itlaysapriorrestraintonsaidright.Thelicensemightapplytothesaleofgoodsbuttoextendit
tothepresswouldofcoursebeunconstitutional.(PhilippineAirlinesv.SecretaryofFinance)
Insummary,ifthetaxoperatesasapriorrestraintonthepartofthepress,thensuchshallbe
heldinvalid.Ataxthatlimitsthecirculationofinformationtowhichthepublicisentitledis
contrarytotheconstitutionalguaranteesofpressfreedomandfreedomofthoughtand
expression.
Whatisthenonimpairmentclause?
TheConstitutionprovidesnolawimpairingtheobligationsofcontractsshallbepassed.
Thereshouldbenoproblemaboutthisconstitutionallimitationnowbecauseofthe
pronouncementoftheSupremeCourtintheTolentinocase.
Inthesaidcase,therealestatebusinesssectorraisedtheconstitutionalobjectionthatsincevalue
addedtaxlawisbeingmadetoretroacttoacertainperiodpriortotheeffectivityofthevalue
addedtaxlawandtocovercertainleasesofrealproperty,itwouldimpairleasecontractentered
intopriortothevalueaddedtaxlaw,andthereforethatwouldbeanimpairmentofthe
obligationofcontracts.
TheSupremeCourtsaidthattheimpairmentclauseofthecontractingpowerofindividualswas
neverthoughttorestrictinanywaythepowertotax.
Why?Becausethepowertotaxisanexerciseofsovereignty,itisanattributeofsovereignty
whichisreadintoanycontract.Andtherefore,thecontractingpartiescannotfetter,cannot
diminishthepowerthroughtheexpedienceofacontract.
True,ataxmayresultinpecuniaryburden,additionalfinancialinconvenience,butthatshould
notdiminishtheStatespowertotax.
TheCourtsaidtheonlyinstancewhenyoucaninvokeimpairmentclausewouldbewhenthe
governmententersintoacontract,thegovernmentitselfentersintoacontractgrantingtax
exemption.Thatistheonlycasewhereyoucaninvoketheimpairmentclause.Whenthe
governmententersintoacontractgrantingtaxexemptionandthattaxexemptioniswithdrawn,
thatwithdrawalwillbeanimpairmentofcontract.
Isthereanexceptiontothenonimpairmentclause?
Theonlyexceptioniswhenyouaretalkingofafranchise.Afranchisetaxexemptiongranted
underthefranchisecanbewithdrawn,modified,orterminatedanytimewithoutviolatingthe
impairmentclause.ThisisbecausetheConstitutionexpresslyauthorizesthemodificationofthe
franchise.
Thus,intheCagayanElectriccasewherethetaxexemptionwaswithdrawntheCourtheldthat
suchwasnotaviolationofthenonimpairmentclausebecauseitinvolvedafranchise.
Cecille 2C 05-06
Non-Impairment Clause
35
XandYenteredintoa2yearcontractfordistributionoffertilizeratPhp500perbag.
Congresspassesalawimposing5%taxonsellingpriceoffertilizers.CanXandYarguenon
impairmentbecauseitincreasesburdensonbothsides?
No.XandYcannotinvoketherightagainstnonimpairmentofcontracts.Forthistobeargued,
itisthegovernmentitselfthatentersintoacontractthatinvolvesthepowertotax,throughtax
exemptionwhethergrantedbylaworpursuanttoalaw.
Howwastheissueofnonimpairmentofobligationsofcontractsresolvedinthecaseof
Tolentinov.SecretaryofFinance?
Inthatcase,therealestatebusinesssectorraisedtheconstitutionalobjectionthatsincetheVAT
lawisbeingmadetoretroacttoacertainperiodpriortotheeffectivityoftheVATandtocover
certainleasesofrealproperty,itwouldimpairleasecontractsenteredintopriortothelaw.
TheCourtheldthatthecontractimpairmentclausehasneverbeenthoughtasalimitationor
restrictionontheexerciseoftheStatespoweroftaxationsaveonlywhereataxexemptionhas
beengrantedforavalidconsideration.Fornotonlyareexistinglawsreadintocontractsinorder
tofixobligationsasbetweenparties,butthereservationofessentialattributesofsovereign
powerisalsoreadintocontractsasabasicpostulateofthelegalorder.
Whatisapolltax?
Polltaxorpersonalorcapitationtaxisataxofafixedamountonindividualsresidingwithina
specifiedterritory,whethercitizensornot,withoutregardtotheirpropertyortheoccupationin
whichtheymaybeengaged.
Lawpassedstatingthatfornonpaymentofpolltax,anoffendershallpay20timesthevalue
ofthetax.Isthelawvalid?
Yes.Theprohibitionisonlyonimprisonmentfornonpaymentofpolltaxes.Itsaysnothing
aboutbeingmadetopayfinesandpenaltiesfornonpaymentofpolltax.Aslongasthepenalty
isnotimprisonment,itisavalidlaw.Violationmustbenonpayment.Thereasonforthe
prohibitionisthatapolltaxisimposedregardlessofresidency,occupationorbusiness.
Meanwhile,taxesitselfarebasedonabilitytopay,onresidency,onoccupation,onbusiness,and
onpropertyheld.Onecanbeimprisonedfornonpaymentoftaxesbutnotpolltaxes.
HowdoestheSupremeCourtlimitthepowertotax?
TheSupremeCourtmayvoidataxlawbecauseitgoesagainsttheConstitutionallimitations
undertheConstitution,theSupremeCourtshallhavethepowertoreview,revise,reverse,
modifyoraffirmonappealorcertiorari,aslaworRulesofCourtmayprovide,finaljudgments
andordersoflowercourtsincallcasesinvolvingthelegalityofanytax,impost,assessment,
ortolloranypenaltyimposedinrelationthereto.
Whatistherequirementtopassavalidtaxlaw?Howaboutgrantingoftaxexemption?
Topassalaw,asimplemajorityofthememberspresentisenough.However,topassatax
exemption,theconcurrenceofamajorityofallthemembersoftheCongressisneeded.
Supposealawauthorizestherefundofataxalreadycollectedorgrantsthedeductionof
certainitemsofexpensesforincometaxpurposes.Consideringthatrefundsoftaxesand
deductionspartakeofthenatureofexemptions,isthisvotingrequirementapplicable?
Itisasettledrulethatrefundspartakeofthenatureofexemptions.Condonationoftaxesalready
paidoryetunpaidarealsointhenatureoftaxexemptions.
Cecille 2C 05-06
Poll Tax
How Supreme Court

Limits the Power to Tax
Requirement for Valid Tax

Law and Exemption
36
INCOMETAXATION
Whatisincome?
ThenewandbetterdefinitionofincomeisfoundintheCommissionerv.Glenshawcase.The
requisitesforincometobetaxableare:
1. theremustbeaccessiontowealthoradditiontonetworth(theremustbegain)
2. clearlyrealizedorreceivedactuallyorconstructively;havecompletedominionoverit
3. thegainmustnotbeexcludedbylawfromtaxation
Whyistherenoincomeifthedebtorisinsolvent?
Becausethereisnoincreaseinnetworth.Noincome.
XowesYPhp20,000.Subsequently,Ycondonedthedebt.Whohasincome?
ItdependsiftheX,thedebtorissolventorinsolvent.Andevenifthedebtorissolvent,therecan
stillbenoincomewhenthecondonationconstitutesagift.
Whatisincludedinthetermincome?
Incomefromwhateversourcederivedwouldcoveranything,anyflowofwealthtothetaxpayer
otherthanmerereturnofcapitalnotexcludedbylaw.
Thelegislativepolicyistotaxanykindofincomeaslongasthatincomeisincludedbylaw.In
incometaxation,thereisnosuchthingasillegalincome.Thelawdoesnotdistinguishbetween
legalandillegalsourceswhenitcomestotaxation.
WhatisthecaseofCIRv.ToursSpecialist?
Whathappenedinthatcasewasthataforeigntravelagencygavefundstoalocaltravelagency,
sayPhp100,000.Theobligationofthelocaltravelagencywastopaythehotelaccommodationof
touriststhatwillbesentbytheforeigntravelagency.ThelocaltravelagencyhasthePhp
100,000.ItisnotbeingtaxedasacontractoronthebasisofthePhp100,000entrustedtoitbythe
foreigntravelagency.Theissuethatwaspresentedwaswhetherthisentrustedfundwastaxable
receipt.Althoughitinvolvedcontractorstax,theissuewaswhethertheamountentrustedtoan
individualwhichtheindividualpossesswastaxablereceipt.
TheCourtsaiditwasnottaxablebecausethetaxpayercannotdispose,cannotenjoythereceipt.
Hehasnocontroloverthereceiptwhichmayresultinsomeeconomicbenefittothebuyer.
Grossreceiptsdonotincludemoniesorreceiptsentrustedtothetaxpayerwhichdonotbelong
tohimanddonotredoundtothetaxpayersbenefit.Itisnotnecessarythattheremustbealaw
orregulationwhichwouldexemptsuchmoniesandreceiptswithinthemeaningofgross
receiptsunderthetaxcode.Theamountentrustedisnottaxablebecausethetaxpayercannot
disposeandcannotenjoythatreceipt.
WhatabouttheJaviercase?
Inthatcase,Javiergotawindfallthroughmistakenremittance.Php1,000wasthesupposed
remittance,hegotPhp1M.WhathappenedtothedifferencebetweenthePhp1MandthePhp
1,000wasthathespentit.Hehadtheobligationtoreturnthemoney.Buthespendsthemoney,
althoughhewasheldtobesimplyholdingitintrustfortherightfulowner.
TheCourtsaiditisincomebecausehehadcontroloverthefund,hehadcompletedominion.
TheCourtsaidthathehadcompletedominionoverthefundbecausehecanuseitforhis
economicbenefit.
Cecille 2C 05-06
Definition of Income
37
AninsuranceagentcollectedpremiumsofPhp100,000.Hedidnotremitbutinsteadhespent
themoney.Embezzlement,isthatincome?
TheCourtsaiditisincomeasheldinUSv.Jones.
Thereisincomebecausethetaxpayerhadcompletecontroloverthefundwhichhecanusefor
hisowneconomicbenefit.
Thissituationwouldseemtoindicatethatthereissomethinginadequateinthedefinitionof
incomeassimplyaflowofwealthintothetaxpayerotherthanamerereturnofcapital.
Sothatifyouwillnotice,theSCisnotusingthedefinition.TheSCisusingaccessiontowealth,
increaseinnetworthclearlyrealized,andoverwhichthetaxpayerhascompletedominion
becausetheflowofwealthotherthanreturnofcapitalmustberealized,notonlyrealizedbut
willresultinincreaseinnetworthorifnotitwillresultinasituationwherethetaxpayerhas
completecontroloverthefundstobeusedonhisowneconomicbenefit.
Sohowdoyouputinclearerperspectivethedefinitionofwhatincomeis?
Itshouldbeaflowofwealthintothetaxpayerresultinginanincreaseofnetworthwhichis
clearlyrealizedoroverwhichthetaxpayerhascompletedominion.
Somesaythatdefinitioncoverseverything.WhatIamsayingistoputitinclearerperspective.
BecausetheSCindealingwithincomeorwhatisincomenotonlyinvokesUSjurisprudencebut
alsodefinitionnotgivenbytheRevenueRegulationsandthatdefinitionisaccessiontowealth,
increaseinnetworthclearlyrealizedandoverwhichthetaxpayerhascompletecontrol.TheSC
inawayissayingthatthatisthemoreaccuratedefinitionofincome.
Xboughtalandin1990forPhp10M.In2003,thevalueofthelandisPhp100M.Isthere
income?
No.Thereisnoincomeyet.Incomehasnotberealizedorreceived.Fortheretobeincome,there
mustbearealizationofincome.Itisonlywhenthelandissoldorotherwisedisposedofcan
therebeincomeonthepartofX.Increaseinthevalueofthepropertyisnotincomebecause
nothingisrealized.
Amereincreaseinthevalueofthepropertyisnotincomebutmerelyanunrealizedincreasein
capital.Theincreaseinvaluecanonlybetaxedwhenadispositionofthepropertyhasoccurred,
whichisofsuchanatureastoconstitutearealizationofsuchgain,thatis,aseveranceofthegain
fromtheoriginalcapitalinvestedintheproperty.
Isdepositwithnointeresttaxable?
Nobecauseeveniftheelementsofrealizationanddominionarepresentthereisnoflowof
wealth,noincreaseinnetworthbecausethedepositarydoesnotacquirethemoney.
Xborrowsmoneyfromabankwithnocollateralfora1yearterm.Afteroneyear,heleftfor
theUSwithoutintentionofreturning.Doeshehaveincome?
No.ThereisnoincomeapplyingtheUSv.Jamescase.Thereisstillanobligationtopay.WhenX
borrowedmoney,heinitiallyintendedtopay.Liabilityoffsetstheassetssonoincreaseinnet
worth.Sincethereisstillanobligationtoreturnthemoney,thereisreallynostrictdominion
overthemoney.Hence,thereisnoincomeonthepartofX.
InUSv.James,embezzlementistotallyunlikealoanbecausethereisnoconsensualrecognition
ofanobligationtorepay.Inaloan,thereisaconsensualacttoreturnorrepay.
Cecille 2C 05-06
38
WhathappenedinthecaseofU.S.v.James?
Inthatcase,Jameswasconvictedforfailingtoincludeembezzledfundsinhisgrossincomein
theyearinwhichthefundsweremisappropriated.
TheCourtheldthatunlawful,aswellaslawful,gainsarecomprehendedwithinthetermgross
income.Thequestionofthescopeofwhatisincludedingrossincomebeginswiththebasic
premisethatthepurposeofCongresswastousethefullmeasureofitstaxingpower.Ataxpayer
couldnotrelyupontheunlawfulnessofhisbusiness.
In1999,XembezzledfundsamountingtoPhp10M.Hewascaughtin2001andheexecuteda
promissorynotetopayPhp10Min6months.Whenshouldhebetaxed?
Theembezzlershouldbetaxedin1999sincehehadstrictdominionoverthefundsatthattime.
Itwasonlywhenhewascaughtthathehadanobligationtoreturn.
Atthetimeheborrowedmoney,Xhadnointentionofpaying(aswindler).Ishesubjecttotax
onmoneyborrowed?
Youmustestablishintentionnottopay.Swindlingisnodifferentfromembezzlement.
Lessorrequiredlesseetogivea1yeardeposit.Lessorusedthedeposittomakeimprovements
onpropertynotbeingleased.Isthereincomeonthepartoflessor?Thefactthatheusedthe
deposit?Didherealizedthegain?
Thereisalackofelementofincreaseinwealth.Thereisanobligationtoreturneventhough
therewasarealizationbecauselessorusedthefunds.OnecouldalsoargueusingthecaseofCIR
v.ToursSpecialistthatthelessorheldthemoneyintrustsotherereallywasnoaccessionto
wealth.
XlendsYPhp300,000.Yisinsolvent.ButYhadafriendZ.ZgaveXPhp500,000tocondone
Ysloan.Whohasincome?IfYnotinsolvent?HowaboutX?
Yhasnoincomebecausethereisnoaccessiontowealth.Remembertheconsequencesofbeing
declaredinsolvent.IfYisnotinsolvent,thereisaccretiontowealthbecausehisliabilitywas
writtenoff.Ycan,inthiscase,arguethatthemoneywasagiftandthereforeexemptedfromtax.
OnthepartofX,thereisnoincomeasthemoneyhegotinreturnwasamerereturnofcapital.
X,thecreditor,lendsPhp300,000toY,thedebtor.Theloanstipulatesinterestandpenalties.Y
spendsitallandbecameinsolventbutYaskedZ,Ysfriend,topayX.ZpaidXPhp500,000.
WhatisthetaxliabilityofX?
XisnotliabletopaytaxonthewholeamountofPhp500,000becausethereisonlyareturnof
capitalasregardsthePhp300,000.However,heisliabletopaytaxwithregardtoPhp200,000.
Lawyertolddentist:attendtomyfamilysdentalservices.ThedentalservicesareworthPhp
50,000.Dentisttellsthelawyer:renderlegalservicesworthPhp50,000.Whohasincome?Is
thereincome?
Yes,thereisincomeonthepartofboththelawyerandthedentist.Thesituationisnodifferent
fromthelawyerpayingthedentistincashtorenderservice,andthedentistpayingthelawyerin
cashforhisservice.Theelementsforincometobetaxablearepresent.
Arestockdividendstaxable?
No,becausethetaxpayerdidnotrealizeincome.Itisatransferofsurplustocapital.
Corporationdeclaresdividends.Taxondividendswasgiventoashareholder.The
shareholderdidnotpaytaxondividends.Corporationpaidtax.Willshareholderhave
income?(Thecorporationassumedtaxliabilityonthepartoftheshareholder)
Yes,theshareholderhasincome.Thetaxesweretheresponsibilityoftheshareholder.Inthis
case,thecorporationassumedthepaymentofthetaxes.ItisthesamesituationifYisnot
Cecille 2C 05-06
39
insolvent.Shareholdersliabilitytopaytaxeswaswrittenoff.
XrendersservicetoYInc.ValueoftheserviceisPhp300,000.XtellsYInc.togivethePhp
300,000toMr.ZforreasonsknownonlytoX.Whohasincome?
Xhasincomebecauseherealizedtheincome.TheincomeistaxabletoXevenifhedidnot
receivetheamount.Hewasabletorealizetheincome.Howrealized?Xrealizeditbydonating
it.Zhasincomeunlessitcanbearguedthatitwasagiftandthereforeexcludableorthatitwasa
merereturnoncapital(XowedZmoney).ThedonationtoZistherealizationofincome.
(AssignmentofincomedoctrineHelveringv.Horst)
SameexamplebutYInc.tellsXthathehasaPhp300,000managerscheckdatedDec.16and
hecangetitanytime.XdidnotgetthecheckuntilJanuary30.WhendidXhaveincome?Why
isthisimportant?
XhadincomeonDecember16.Receiptcanbeactualorconstructive.Thereisnophysicalreceipt
butdeemedaccruedtothetaxpayer.Thisisimportantbecausewithoutthedoctrineof
constructivereceipt,thetaxpayercanplayaroundwiththetaxationsystem,defeatthe
progressivetaxsystemtolowertheincomebracket.Maybebecauseforthatyearhealreadyhasa
highincometaxbracketanddefersreceiptuntilnextyearwhenheisinalowerincomebracket.
Constructivereceiptdoctrinetiedwithassignmentreceiptdoctrine.
YInc.ownsapieceofpropertyandleasesittoXforPhp300,000.TherentwillbepaidtoMr.
Z,astockholderofYInc.Whohasincome?
BothYInc.andZhaveincome.Zistaxablebecausethisisnotadonation.TheamountZ
receivedisdisguisedasadividend.Unless,Zcanarguethatitwasagiftorpaymentfora
liability.
Assignment of Income
Doctrine
Doctrine of Constructive
Receipt
Cecille 2C 05-06
40
GROSSINCOME
Whatisgrossincome?
Section32.Grossincome.(A)Generaldefinition.Exceptwhenotherwiseprovidedinthistitle,
grossincomemeansallincomederivedfromwhateversource,including(butnotlimitedto)the
followingitems:
1. Compensationforservicesinwhateverformpaid,including,butnotlimitedtofees,
salaries,wages,commissions,andsimilaritems;
2. Grossincomederivedfromtheconductoftradeorbusinessortheexerciseofa
profession;
3. Gainsderivedfromdealinginproperty;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizesandwinnings;
10. Pensions;and
11. Partnersdistributivesharefromthenetincomeofthegeneralprofessionalpartnership.
Lookatthedefinition.Thereisanimplicationthatitincludesanyreceiptoranythingthatflows
intothetaxpayer.
WhatisimportantinthecaseofCIRv.BOAC?
Grossincomeincludesgains,profits,andincomederivedfrombusiness,commerce,sales
Thesourceofanincomeistheproperty,activityorservicethatproducedthatincome.Forthe
sourceofincometobeconsideredascomingfromthePhilippines,itissufficientthattheincome
isderivedfromactivitywithinthePhilippines.Inthiscase,theticketsalesproceededfromand
occurredwithinPhilippineterritoryenjoyingprotectaccordedbythePhilippinegovernment.
Thedefinition,flowofwealthintothetaxpayerotherthanamerereturnofcapitalseems
inadequate.TheSupremeCourtwouldratheruse:accessiontowealth,increaseinnetworth
clearlyrealizedandoverwhichthetaxpayerhascompletedominion.
Reason:theflowofwealthotherthanreturnofcapitalmustnotonlyberealized,butalsomust
resultinanincreaseinthenetworthoratleastresultinasituationwherethetaxpayerhas
completecontroloverthefunds.
WhatisimportantinthecaseofCommissionv.Glenshaw?
Thiscasearosefromthemoneyreceivedfromasettlementofdemandsforexemplarydamages
forfraudandtrebledamagesforinjurytoitsbusiness.
Grossincomealsoincludesgainsorprofitsandincomederivedfromanysourcewhatever.Itis
anexertionoftheStatesfullmeasureofitstaxingpower.Congressappliednolimitationsasto
thesourceoftaxablereceiptsnorrestrictivelabelsastotheirnature.Liberalconstructionisused
inrecognizingtheintentiontotaxallgains.
Themerefactthatthepaymentswereextractedfromthewrongdoersaspunishmentfor
unlawfulconductcannotdetractfromtheircharacterastaxableincometotherecipients.
Whatiscompensation?
Compensationreferstoremunerationsforservicesinanemployeremployeerelationship,
includingfringebenefits.Exceptiontotherulethatallcompensationaretaxedarethose
furnishedtoworkersfortheconvenienceoftheemployer.Theconvenienceoftheemployerrule
Cecille 2C 05-06
Definition of Gross
Income
Definition of
Compensation
41
providesthatallowancesfurnishedtotheemployeeforandasanecessaryincidenttotheproper
performanceofhisdutiesarenottaxable.
Whatdoescompensation(withregardtogrossincome)forservicesinanemployeremployee
relationshipinclude?
Itincludeskind,cash,property,andfringebenefits.
SupposingXInc.engagedinmanufacturingbusinessinTaytay,Rizal.ZlivesinFairview.Z
isneededsoXInc.givesZpremisesinTaytay,Rizal.Xhashousingpremisesinsidetheplant
whereZcouldstayafterwork.ThevalueofthecorporatehousingisPhp20,000intermsof
rental.IsthelodginginthiscasecompensationthepartofZandthereforetaxable?
No.Thisisnotcompensation.Lodginganemployeewithintheemployerspremisesisnot
taxabletotheemployeebecauseitbenefitstheemployer.Thisshowsaconvenienceofthe
employersituation.
Remember,thelodgingorhousingmustbewithinthepremises.However,inaBIRruling,itwas
heldthathousingnotwithinthepremiseswillstillbeconsideredfringebenefitwhenunderthe
circumstances,havingaplaceforlodginginsidethebusinesspremiseswillbehazardoustothe
employee.
SupposingXInc.hasnohousingfacilitieswithinthepremisesoftheplant.Buthasa
townhousenearbyinBinangonan(assumingnearTaytay).XInc.leasesthetownhouseand
givestoZsohecanstaynearertotheplant.Isitconsideredcompensationincomeonthepart
ofZ?
Yes,itispartofthecompensationincomeofZ.Itisnotfortheconvenienceoftheemployer
becausefacilitieshavetobelocatedwithinthepremisesoftheplantforittobenotconsidered
compensationincome.
X,managerofahotel,usuallyhasaroominthehotelasdwelling.Thisyear,therewereno
availableroomsforthenext6monthssoXstayedatanotherhoteljustacrossofhishotel.The
valueofthedailyrentalis$200.Hestayedtherefor6months.IsthatincomeonthepartofX?
Premisesruleisstrictlyconstrued.Itiscompensationwhichistaxable.Itisasiftheemployer
gavetheemployeecashforrent(compensation).
ButbasedonBIRruling,alodging2kmfromtheplantisforthebenefitoftheemployer.You
mustlookifthepremisesarewithintheemployersplaceofbusiness.
Whatisthedeminimisrule?
Theseareexemptfromthefringebenefittaxandcompensationincometaxwhicharelimitedto
facilitiesorprivilegesfurnishedorofferedbyanemployertohisemployeesthatareofrelatively
smallvalueandareofferedorfurnishedbytheemployermerelyasameansofpromotingthe
health,goodwillofthecorporation,contentmentorefficiencyofhisemployees.
Supposingthecorporationgivesyoulaundryallowance,riceallowance,grocery,freeconcert
ticketonceamonth.Aretheseconsideredcompensationincome?
Theseareincomebutbecauseofthedeminimisrule,thesearenotconsideredtaxable
compensationincomebecauseofrelativelysmallvalueandprimarilyforthebenefitofthe
employer.
XCorp.has300employees.Aspartoftheemployeebenefits,thecorporationsendsthemon
excursiontwiceayear.XCorp.spendsPhp300,000.WillthePhp300,000beconsidered
compensationincomeoftheemployees?Tobedividedover300employees.Supposingalso
thecorporationmaintainsadaycarecenterwiththecorporationforchildrenofwomen
employees.XCorp.spendsPhp300,000forthemaintenanceofthedaycarecenter.Wouldthat
Cecille 2C 05-06
De Minimis Rule
42
beconsideredpartofcompensationincome?
Itwillnotbepartofthecompensationincome.
ThereasongivenbytheBIRisthatthiskindofbenefitisunquantifiableintermsofhowmuch
eachemployeewillget.Soadministratively,itshouldnotbetaxedascompensationincome.
Secondly,youcanarguethatitispartofthedeminimisrule.Sosomethingunquantifiablein
termsofbenefitoftheemployeethatwouldnotbepartofcompensationincome.
Youcanarguethatitispartofthedeminimisrule.Somethinggiventopromotethegoodwillof
thecorporationandtopromotetheefficiencyofemployees.
ThisexceptionisprovidedinRepublicActNo.7833.Thesaidlawexemptsandgrantsthe
followingexceptions:13thmonthpay,plusotherbenefits(otherbenefitsincludeChristmas
bonus,longetivitypay,productivitypaytobothgovernmentandprivateofficialsand
employees).ThemaximumamountforexemptbenefitsisPhp30,000.
WhatwasheldinthecaseofCIRv.CAregardingterminalleavepay?
Inthatcase,itwasheldthattheterminalleavepayreceivedbyagovernmentofficialor
employeeisnotsubjecttowithholdingtax.Terminalleaveisappliedforbyanofficeror
employeewhoretires,resigns,orisseparatedfromtheservicethroughnofaultofhisown.The
governmentrecognizesthatformostpublicservants,retirementpayisalwayslessthan
generousifnotmeagerandscrimpy.Notbeingpartofgrosssalaryorincomeofagovernment
officialoremployeederivedfromthanemployeremployeerelation,terminalleavepayisnot
subjectgoincometax.
Compensationinthecontextofnonemployeremployeerelationship
Intheconceptofanonemployeremployeerelations,itcanbeclassifiedasbusinessincomeor
noncompensationincomeforincometaxpurposes.
Nonemployeremployee:SupposingXrendersservicetoY,YpaidXPhp10,000.Thisis
compensationforservicebutcompensationoutsideofemployeremployeerelationship.Thisis
income,compensationincome.Butforpurposesofincometaxitiscallednoncompensation
income.ThiswouldbecoveredbySNITSlaw.
Whatwearesayingisthattherecouldbecompensationincomeoutsideofemployeremployee
relationship.
Whatifpaymentisinkindorthatitisbasedonamultiyearcontractbasis,orthatpaymentis
bypromissorynote?
Intheareaofpaymentofeverythingexceptincash,thevaluetobetakenisfairmarketvalue.
Butsupposingthetransactionislikethis:XasksY,adirector,todirectamovieforhimandX
willpayYbygivinghimacopyrighttoacertainmaterial.Howwillyouvaluethepayment?
Theremustbevalueattached.Fairmarketvalueorcomparativesalesorsomegivenmarket
standard.Theimportantthingisthattheremustbevalueattached,itmustbereduciblein
moneyormoneysworth.
Supposingpaymentisinpromissorynote.YrendersservicetoX.XpayshimPhp100,000with
18%interestmaturinginoneyear.Whatisthetaxableincome?Whatwouldbethetaxable
value?
Itisalwaysthefacevalue,Php100,000.
Itisdifferentwhenyousay,whendoyoureportitasincome?Itisalwaystaxableasincome.The
paymentorfacevalue.Itisaquestionofwhenshouldtheincomebereported.
Cecille 2C 05-06
43

UndertheBIRrules,thatwhatwasreceivedshouldbereportedasincome.Asforthe18%,it
shouldbereportedasincomenextyearoratmaturity.
Forservicesrendered,XreceivedonDecember1apromissorynoteforPhp5,000whichisdue
onJanuary30ofthesucceedingyear.ThediscountrateonDecember1was15%sothatthe
notehasadiscountedvalueofPhp4,250.Whatisthetaxableincome?Whatwouldbethe
taxablevalue?
HeshouldreportanincomeofPhp4,250intheyearhereceivedthenoteevenifhedidnot
actuallydiscountthenoteandanadditionalincomeofPhp750inthesucceedingyearhe
receivedthefaceofthenoteofPhp5,000.
Ifanindividualperformsservicesforacreditor,whoinconsiderationthereofcancelsor
forgiveshisdebt,isthereanincome?
Yes.Incometothatamountisrealizedbythedebtorascompensationforhisservices.
Whatifthecreditormerelydesirestobenefitadebtorandwithoutanyconsiderationthereof
cancelsthedebt?Isthereanincome?
None.Theamountofthedebtisagiftfromthecreditortothedebtorandneednotbeincluded
inthelattersgrossincome.
Whataboutinamultiyearcontract?
Thesameistruewhenyoutalkofamultiyearcontract,whichhasexistedforseveralyears.Itis
alwaysthepaymentforservicesrenderedistaxable.Theonlyquestionis:whendoyoureportit
asincome?
Inamultiyearcontract,youcanreportitonpercentagebasisassoonasreceivedorat
completionofthecontractdependingonwhereyoucangetataxadvantagebyreportingit,now
orlater.
Whatiscoveredinbusinessornoncompensationincome?
Inbusinessornoncompensationincome,businessincomewouldcoveranytransactionoutside
oftheemployeremployeerelationshipexceptthatwhatiscalledpassiveincome.
Anydealingsinpropertywhetherrealorpersonal,salesorexchangesinvolvingordinaryassets
orcapitalassetsiscoveredbybusinessincomeornoncompensationincome.
Forexample,inalessorlesseerelationshipwhererentalisPhp10,000permonth.Ontopof
thePhp10,000,thereisa2monthdeposit.Attheterminationoftheleaseitisreturnedtothe
lessee.TaxespaidbythelesseeonbehalfofthelessorarePhp3,000.Youhaveanadvance
paymentof2months,Php20,000.Rental,depositandtaxesarepaidbythelessee.
Rentalthiswillconstitutetherentalincomeofthelessor.
Advancepaymentthiswillbeanincomebecausethatisalreadyreceive.
Depositthiswillnotbeincome.Thereisanobligationtoreturn,itisnotyetrealized.
Hecannotuseitforhisowneconomicbenefit.
Taxesthiswillbeanincomebecausethisisanobligationofthelessorpaidbythe
lessee.
Supposingweaddanadditionalprovisiontothecontractoflease:Lesseecanextendtolessor
aninterestfreeloancoterminouswiththeleaseforpurposesofimprovingthefacilitiesofthe
premises.Wouldthatbepartoftherentalincome?
TheBIRsaidthatitisnotpartofrentalincomeaslongasyoucanshowthatitistruly
indebtednessextendedtothelessoranddoesnotformpartoftherentalarrangement.
Cecille 2C 05-06
Business Income
44
SupposingwehaveaPhp200,000loan.Thelessorissues2checksforPhp100,000.Attheend
ofthe1styear,thelesseecancelsthe1stcheckandatthe2ndyearhecancelsthe2ndcheck.Will
thatbepartoftherental?Canthelessorarguethatitwasagift?
Itshallbeconsideredrentalincome.Thisisanactualcasewhereinthecancellationof
indebtednesswasarguedbythelessorasagift.TheCourtsaiditisincomebecauseclearlyfrom
thebeginningofthepaymentandcancellationthatitformpartoftheleasepackage.Inalessor
lesseerelationship,anythinggivenfortheuseofthepropertydirectlyorindirectlywillbe
consideredasrentalincome.
Whataretheclassificationsofincome?
Therearebusinessincomeandpassiveincome.Inbusiness,thereiscapitalgainstransaction
involvingrealpropertyandpersonal.
Interestsanddividendsareexamplesofpassiveincome.
SupposingXisengagedin56businesses.HelendsYPhp200,000andgetsPhp10,000
interest.Isthatthekindofinterestincome?
Interestisanythingpaidfortheuseofmoney.
So,itcouldbeinterestbuttheinterestcategorizedaspassiveinSection27.Theintereststatedin
Section27islimitedtodepositsinanyfinancialinstitutionwhichissubjecttowithholdingtaxof
20%.
Inacreditordebtorrelationship,isthereincome?
Itisincomefromwhateversourcederived.
Butdoyoucallitinterestincome?
Thecivillawdefinitioninterestisthatyieldedfromloantransactions.
Sometextswouldlimitinterestincomeasincomederivedfromadepositorcreditorrelationship
withabankbutforthepurposesoftaxation,itisanythingpaidasinterest,anythingbasedona
loantransactionorindebtedness.Thetaxtreatmentwoulddependifitispassiveincomeunder
Section27(d).Ifitisapassiveincome,thenyougivetheSection27(d)taxtreatment.Ifitis
interestincomefromaregulartransactionthentheSNITStreatment.
Supposingthereisrentalarrangementwheretheleasestipulatesthatallimprovementswill
accruetothelessor.Supposingduringthelease,aboutPhp1Mofimprovementswere
introduced.Isthatincometothelessor?Howdoyoureportit?
Yes,itisincometothelessor.Youcanreportitatthetimeoftheterminationoramortizeitover
theperiodofthelease.Butthereisnoprohibitionfromusinganothermethodaslongasitis
reported.
Whataredividends?Isittaxableornot?
Dividendsareconsideredpassiveincome.Revenueregulationsdefinedividendsascash,stock
orproperty.Theyareanythinggivenbythecorporationfromitssurplusearningsorprofit.
Generally,dividendsaretaxable.However,stockdividendsmaybetaxableornontaxable.A
stockdividendconstitutesincomeifitgivestheshareholderaninterestdifferentfromthatwhich
hisformerstockholdingsrepresented.Anontaxablestockdividendisonewherethenewshares
conferthesamerightsandinterestastheoldshares.Itworksnochangeinthecorporateentity,
thesameinterestinthesamecorporationbeingrepresentedafterthedistributionbymoreshares
ofpreciselythesamecharacter.
Cecille 2C 05-06
Classifications of Income
Dividends
45
EXCLUSIONSFROMGROSSINCOME
Whatistheconceptofexclusion?
Thisisincomewhichwouldbetaxableifitwerenotfortheexclusioninthetaxcode.
Whatareexcludedingrossincome?
UnderSection32(B),thefollowingitemsshallnotbeincludedingrossincomeandshallbe
exemptfromtaxation:
(1) Lifeinsurance
(2) Amountsreceivedbyinsuredasreturnofpremium
(3) Gifts,bequests,anddevises
(4) Compensationforinjuriesorsickness
(5) Incomeexemptundertreaty
(6) Retirementbenefits,pensions,gratuities,etc.
a. Retirementbenefitsreceivedbyofficialsandemployeesofprivatefirms,
whetherindividualorcorporationinaccordancewithareasonableprivate
benefitplanmaintainedbytheemployer.
b. Amountreceivedasconsequenceofseparationfromtheserviceoftheemployer
duetodeath,sicknessorotherphysicaldisabilityorforanycausebeyondthe
controlofthesaidofficialoremployee.
c. Theprovisionsofanyexistinglaw.
d. PaymentsofbenefitsdueortobeduetoanypersonresidinginthePhilippines
undertheU.S.VeteransAdministration.
e. BenefitsreceivedfromorenjoyedundertheSSS.
f. BenefitsreceivedfromtheGSIS.
(7) MiscellaneousItems
a. IncomereceivedfrominvestmentsinthePhilippinesby:
i) foreigngovernments;
ii) financinginstitutionsowned,controlled,orenjoyingrefinancingfrom
foreigngovernments;and
iii) internationalorregionalfinancialinstitutionsestablishedbyforeign
governments.
b. Incomederivedfromanypublicutilityorfromtheexerciseofanyessential
governmentalfunctionaccruingtotheGovernmentofthePhilippinesortoany
politicalsubdivisionthereof.
c. Prizesandawardmadeprimarilyinrecognitionofreligious,charitable,
scientific,educational,artistic,literacy,orcivicachievementbutonlyif:
i) therecipientwasselectedwithoutactiononhisparttoenterthecontestor
proceeding;and
ii) therecipientisnotrequiredtorendersubstantialfutureservicesasa
conditiontoreceivingthepriceoraward.
d. Allprizesandawardsgrantedinlocalandinternationalsportscompetitions
andtournamentswhetherheldinthePhilippinesorabroadandsanctionedby
theirnationalsportsassociations.
e. Grossbenefitsreceivedbyofficialandemployeesofpublicandprivateentities
providedthatthetotalexclusionunderthisshallnotexceedPhp30,000.
f. GSIS,SSS,Medicareandothercontributions.
g. Gainsfromthesaleofbonds,debentures,orothercertificateofindebtedness,
h. Gainsfromredemptionofsharesinmutualfund.
Howmayalifeinsurancepolicybetotallyexcludedfromtax?
Theinsuredmustdie.Ifhesurvivesthepolicy,thereispartialtaxforthereturnofcapital.There
willonlybetotalexclusioniftheinsureddieswhiletherewillonlybepartialexclusionifthe
Cecille 2C 05-06
Concept of Exclusion
Exclusions from Gross

Income
Life Insurance Policy
46
insuredsurvivesthepolicy.
Thereasonfortheexclusionliesinthefactthatsuchproceedsareconsideredmoreasan
indemnityratherthanasgainorprofit.Thecontractofinsuranceisacontractofindemnity.
Amountreceivedbyinsuredasreturnforpremium
Amountsreceived(otherthanamountspaidbyreasonofthedeathoftheinsuredandinterest
paymentsonsuchamounts)bytheinsured,asareturnofpremiumspaidbyhimunderalife
insuranceendowment,orannuitycontractareexcludedfromgrossincome.Thereasonforthe
exclusionisthatthereturnofpremiumsamountstoareturnofcapital.
If,however,suchamounts(whenaddedtoamountsreceivedbeforethetaxableyearundersuch
contract)exceedtheaggregatepremiumspaid(whetherornotpaidduringthetaxableyear),
thentheexcessshallbeincludedinthegrossincome.
XgotaPhp1MlifeinsurancewithXasbeneficiarywithatermof20years.Uponmaturity,X
gotPhp1M.IsPhp1Mexcludableorincludableincome?
Fortheretobetotalexclusion,theinsuredmustdie.XdidnotdiesothePhp1Misnot
excludabletotally.IFXdidnotdie,partexclusiontotheextentthatitisareturnofpremium.
XhasPhp1Minsurance.X,employeeofYInc.,embezzledPhp300,000.Xassignedthe
proceedsofthepolicytoYInc.Xdies.Aretheproceedsexcludable?
ItisnotexcludabletotheamountofPhp700,000(thedifferenceofthevalueofinsurance
proceedsandtheembezzledfunds/debt).ThePhp700,000isincomethatistaxableonthepartof
YInc.
Whatamountissubjecttoincometaxwhenitcomestogifts,bequests,anddevises?
Thevalueofthepropertyreceivedasagift,orunderawillortestament,orthroughlegal
succession,isexemptfromincometax.Thereasonisthatsuchtransfersshallbesubjectto
donorsorestatetax.
Xinheritedfromhisparentsapropertyconsistingofalotandtheapartmentthereonvaluedat
Php500,000.HederivesanannualrentincomeofPhp36,000fromtheproperty.Whatamount
issubjecttoincometax?
Thelotandtheapartmentaregifts,thusthevalueofPhp500,000isnotsubjecttoincometax.
However,theannualrentincomeformspartofhisgrossincomesubjecttoincometax.Underthe
provisionongifts,theexclusionislimitedtotheproperty.Itdoesnotincludeincomederived
fromthegift.
SupposingAwasjogginginGreenbelt3.Whilejogging,shemetDonAyala.Donlikethe
wayAwasjogging.HegaveherPhp100,000.Isthatexcludable?
Yes,thisisexcludablebecauseitcanbeconsideredasagiftcharacterizedbydisinterested
generosityandpureliberality.
IfAwasanemployeeofDonAyalaandhethoughtAwasagoodemployeeandsogaveher
Php100,000forjogging.Excludable?
Fortheretobeagiftandbeexcludable,itmustbecharacterizedbyadisinterestedgenerosity
andpureliberality.Difficulttoarguethatitisagiftwhenthereisanemployeremployee
relationship.Inthiscase,itcouldbeabonusorassistance.
InDubersteincase,therewasnoreferralmade.Simplyfriendsfor10years.XgaveCadillacto
Y.Wouldthatstillbepureliberality?IfXtookadeduction,wouldthatnegateelementofa
gift?IfBIRlawyertellsyouitwasgivenoutoffriendship,notoutofpureliberality?Ifgiven
toYoutofpity?
Cecille 2C 05-06
Gifts, Bequests, &

Devises
47
Itisstillpureliberality.Pity,friendship,affection,love,admirationrespect,etc.areconsidered
sentimentsthatleadtogenerosityandpureliberality.
Remember,giftisanexclusion.Thus,itmustbestrictlyconstrued.
WhatwasheldinthecaseofCIRv.Duberstein?
Itwasheldthatifpaymentproceedsprimarilyfromtheconstrainingforceofanymoralorlegal
duty,orfromtheincentiveofanticipatedbenefitofaneconomicnature,itisnotagift.Where
paymentisinreturnforservicesrendered,itisirrelevantthatthedonorderivesnoeconomic
benefitfromit.Agiftinstatutorysenseproceedsfromadetachedanddisinterestedgenerosity
outofaffection,respect,admiration,charityandlikeimpulses.Themostcriticalconsiderationis
thegiversintentionormotive.
SupposingaboldactresswenttoToyotatobuyCamryforPhp1.4M.Inamicromini,satdown
andsmiledattheownerandtoldhimshewantstobuyaCamry.Ownersaysyoucanhaveit
forfree.Isthatagift?Inabusinesssituationwhenagiftisgiven,isthebusinesspurpose
notnecessarilyimplied
Itisdifficulttoarguegiftifthereisanemployeremployeerelationship.Inabusinesssituation,it
isdifficulttoarguegiftbecauseitispresumedforbusinesspurpose.Sinceoneisengagedina
businessandthisnecessarilymeansinpursuitofprofits,thengivinggiftcontradictsthepurpose
ofengaginginabusiness.
Supposinginasituationwherefatherandsonareworkingtogether.Thefathergavetheson
sharesofstockheboughtalongtimeagoatPhp400eachandnowthepriceisincreasedto
Php1000each.Isitagift?
Itisabusinesssituationbutthereisafilialrelationshipinvolved.Itcanbearguedthatitisagift.
Gift in the Context of a

Isagiftinthecontextofabusinesssituationtaxable?
Business Transaction
Itdependsonthecircumstances.Ifthebusinesspurposeismanifested,thenitistaxable.Butif
thegiftinvolvedfilialrelationship,thenitcouldbearguedthatitisreallyagiftbecauseofthe
relationship.Agiftinthestatutorysensemustproceedfromadetachedanddisinterested
generosity.
WhathappenedinthecaseofUSv.Kaiser?
Thecasepresentsthequestionswhetheralaborunionsstrikeassistance,bywayofroomrent
andfoodvouchers,furnishedtoaworkerparticipatinginastrikeconstitutesincometohimand
whethertheassistancefurnishedtothisparticularworker,whoisinneed,constitutedagiftto
him,andhencewasexcludedfromincome.TheCourtruledthattheassistanceproceeded
primarilyfromgenerosityorcharityratherthanfromtheincentiveofanticipatedeconomic
benefit.ItwasfurtherheldthattheCourtcanhardlysaythat,asamatteroflaw,thefactthat
thesetransfersweremadetoonehavingasympatheticinterestwiththegiverpreventsthem
frombeingagift.Inshort,sympatheticinterestdoesnotnegatetheconceptofitbeingagift.
Thus,theCourtaffirmedthedecisionofthejurywhichheldthatthestrikeassistancewasa
giftandexcludedfromincomeforincometaxpurposes.
Applyingthepresentlaw,istheKaiserrulinginaccordwiththeTaxCode?
Itwouldnotbeconsideredagift.Financialassistanceisconsideredanincome.Theassistance
wouldnothavebeengiveniftherewasnoshowingofsympatheticinteresttothestriking
members.Remember,exemptionsarestrictlyconstrued.
Acarexperiencedatotalwreckbutthereisnophysicalinjurytotheinsured.Iscompensation Compensation for Injuries

and Sickness
taxable?
No.Thereisonlyareturnofcapital.
Cecille 2C 05-06
48
XwasdrivingacarwhilecrossingAyala.Xscarwashitbyanothercar.Thedriverowner
sustainednoinjurybutthecarwasdamagedtotheamountofPhp1M.Excludable?Whatis
thedifferencebetweenthesetwosituations:(1)drivernoinjurybutcarwasdamagedPhp1M;
(2)driverinjuredandthecarwasdamagedPhp2M?
Thelawtalksaboutpersonalinjuryplusdamages.Underthe2ndsituation,suchisnottaxable
becausethedriverwasinjured.Inthefirstsituation,itmaybeexcludablebutnotunderthis
provision.Itcouldbeexcludabletotheextentthatthepaymentwasmadeasreturnofcapitalor
replenishmentoflosscapital(althoughnotspecificallyprovidedundertheexclusionprovision).
SupposingXcalledYaprostitute.Yfiledalibelcaseforinjurytoperson.TheCourtsustained
YandXwasordertopayPhp300,000.ShoulditbeconsideredasincometoY?Isit
excludable?SupposingBIRsaysitisincomebecauseitisconsiderednotphysicalinjuryand
thelawcontemplatesphysicalinjurytobeexcludable?
Theremustbephysicalinjuriesinthenewrulings.Thetrendisthattheremustbephysical
injuries.Butonecanstillargueexclusionunderreturnoncapital,thatsuchisaonlyapayment
orindemnityofwhatwaslost(compensatory).
Otherwise,incomefromwhateverapplies.Theremustbeinjurytoincludedamages.Aslongas
theelementofprofitnotthere,suchshallbeexcludable.
Theinjurypertainstophysicalinjury.Itmustnotbeaninjurytoyourrights.
Howaboutanawardbythecourtforbreachofpromisetomarry?
Therulethatthereisareturnofcapitalbecausethereisrestoredlostdignitybyvirtueofthe
awardhasbeenoverruled.
SupposingXpaidPhp100,000forhospitalexpenses,cardamagesforPhp1M,lossofincome
ofPhp150,000andgoldtoothlostforPhp20,000.
Theprovisioncontemplatesamountpaidforinjury.Thebasisforexcludingdamagedpropertyis
thesecondpart:amountofdamagesonaccountofsuchinjuries.Hospitalandtoothare
excludable.Astothelossofincome,ifXispaidPhp150,000amonthandnotworkingfora
monthbecauseofinjuries,suchwillbeexcludablebecauseitispaidtoreplacewhatwaslost
(conceptofindemnification).ItisexcludedunderSec.32B(4)injuryplustheamountsof
damagesreceived.TheamountpaidforthecarisexcludableunlessthecarisnotworthPhp
1M.IfthecarisnotworthPhp1M,thedifferencewouldbetaxable.Itwouldbetaxablebecome
thecompensationismorethanthevalueoftheproperty.Itisalreadyagift.
Isthecompensationforpropertydamagedtaxableifthecompensationismorethanthevalue
oftheproperty?
Yes,becauseitisalreadyconsideredasaprofit.
Xwashospitalizedforamonth.Becauseofthehospitalization,helostanincomeofPhp
150,000(hissalaryforonemonth).Isthisexcludable?
Yes,becauseitispaidontheaccountofhospitalizationoronsomethingthatyoulost.Itisbased
onindemnificationconcept.
Howaboutlostopportunity?WhatifXwasonthewaytoameetingwhichwouldhavegotten
himPhp300,000?Isthattaxable?
Yes.Thisispaymentnotoflossbutpaymentofprofitthatcouldhavebeenearned.Itisnota
paymentforactualdamagesbutmoreofprofit.RefertothecaseofCIRv.Glenshawwhereitwas
mentionedthatmoneyreceivedasexemplarydamagesforfraudorasthepunitivetwothirds
portionofatrebledamageantitrustrecoverymustbereportedbyataxpayerasgrossincome.
Damagesforpersonalinjuryarebydefinitioncompensatoryonly.Punitivedamages,onthe
otherhand,cannotbeconsideredarestorationofcapitalfortaxationpurposes.
Cecille 2C 05-06
49
DuringXshospitalization,helostanopportunitytoearnPhp1Minaninvestment.Isthe
compensationforlostopportunitytaxable?
Yes.Itisapaymentforprofitthatcouldhavebeenearned.Itisnotapaymentofactualdamages
butmoreofprofit.
Xis60yearsold.HerenderedserviceforYCorporationfor7years.HewaspaidPhp30,000.
Excludable?
ItisexcludableunderR.A.No,7641.
Remember,youmustdeterminefirstiftheretireefallsunderR.A.No.7641orunderR.A.No.
4917(ReasonablePrivateBenefitPlan).
Xis62yearsoldandherenderedservicetoYInc.for5years.Hethenretiredandwaspaid
Php100,000.Inthiscase,therewasnoprivateretirementplanprovided.Isthattaxable?Does
itfallunderR.A.No7641?
ThiscasefallsunderR.A.No.7641.Thelawsimplyrequiresatleast60yearsoldwith5yearsof
serviceatthetimeofretirement.Itconcernssituationofnoretirementplant.Thesearethe
minimumrequirement.Thus,themoneyisnottaxable.
Xis60yearsoldwith11yearsofservice.Excludable?
ItcouldbecoveredbyR.A.No.7641ifnoreasonableprivateretirementplanwasprovided.If
thereis,itshallstillbeexemptunderthesecondpartoftheexclusion.Whyisthedistinction
important?R.A.No.7641haslimitedexemption:monthsalaryforeveryyearofservice.In
privateretirementplan,anythingisexcludable.However,itmustberememberedthat
reasonableprivateretirementplansmustbeapprovedbytheBIR.
Xis52yearsoldwith10yearsofservicetoYInc.HewaspaidPhp300,000.Then,he
immediatelyworkedforZIncandretiredat63yearsonlywith11yearsofservice.Hewas
paidPhp100,000.Whichoneisexcludable?Inthefirstemployment,hewasprovidedwitha
privatereasonableretirementplanwhileinthesecondemployment,nothingwasprovided.
Thelimitationthatthebenefitsgrantedcanbeavailedofonlyonceandappliesonlytothose
havingareasonableprivateretirementbenefitplan.Ifthereisaprivatereasonableretirement
benefitplan,twominimumconditionsmustbepresentinorderthattheemployeesbenefitsmay
begrantedtaxexemptions:
1. theemployeehasbeenintheserviceofthesameemployerforatleasttenyears;and
2. heisatleast50yearsonlyatthetimeofretirement.
WhenareretirementbenefitsreceivedexcludableunderR.A.No.4917ortheReasonable
PrivateBenefitPlan?
Thefollowingrequisitesmustconcur:
1. Theretiringofficialoremployeehasbeeninthecontinuousserviceofthesame
employerforatleast10yearsandisnotlessthat50yearsofageatthetimeofhis
retirement;and
2. Thebenefitsgrantedshallbeavailedofbyanofficialoremployeeonlyonce.
Definereasonableprivatebenefitplan.
Thetermmeansapension,gratuity,stockbonusorprofitsharingplanmaintainedbyan
employerforthebenefitofsomeorallofhisofficialsoremployees,whereincontributionsare
madebysuchemployerforofficialsandemployees,orbothforthepurposeofdistributingto
suchofficialsandemployeestheearningsandprincipalofthefundthusaccumulated,and
whereinitisprovidedinsaidplanthatatnotimeshallanypartofthecorpusorcorpusofthe
fund,beusedfor,ordivertedto,anypurposeotherthanfortheexclusivebenefitofthesaid
officialsandemployees(Sec.32B,6,a).
Cecille 2C 05-06
Retirement Benefits /
Separation Benefits
Reasonable Private
Benefit Plan
50
X,agovernmentemployeeretiredatage65andwasgivenPhp1M.HethenworkedforYInc.
for10yearsandretiredattheageof75.HewaspaidPhp100,000underreasonableprivate
retirementplan.Whichoneisexcludable?
BothareexcludableunderdifferentexclusionsprovidedbytheTaxCode.(Section32B,6a&6f)
X,60yearsold,workedwithYInc.Herendered15yearsofservice.Whenheretired,hegot
Php1MretirementbenefitandPhp300,000terminalleaveservice.IsPhp1.3Mexcludable?
Whatisaterminalleavepaybenefit?
Giventogetherandstrictlyfollowingjurisprudence,theywouldnotbeexcludableifthe
beneficiaryisaprivateemployee.Ifthebeneficiaryisagovernmentemployee,bothwouldbe
excludable(casesofCastanedaandZialcita).Underjurisprudence,itwouldseemthatterminal
leavepaybenefitsareexemptonlyifgrantedtoagovernmentemployee.Remember,tax
exclusionsarestrictlyconstrued.
Terminalleavepayistheamountpaidforthecommutationofleavecredits.Beingnotpartofthe
grosssalaryorincomeofagovernmentofficialbutaretirementbenefit,suchisnotsubjectto
incometaxandtowithholdingtax.
Xworkedinaprivatesectoruntilhewas45yearsoldwith11yearsofservice.Heavailedof
theretrenchmentprogramwherehereceivedPhp1MseparationpayplusPhp300,000
terminalleavebenefits.Excludable?
Bothareexcludable.Becausethelawsaysanyamountreceivedasaconsequenceofseparation
andthisincludesterminalleavebenefits.Takenothowever,thatifXretires,theterminalleave
benefitsarenotexcluded.
UnderSec.32B,6a,anyamountreceivedbyanofficialoremployeeorbyhisheirsfromthe
employerasaconsequenceofseparationofsuchofficialoremployeefromtheserviceofthe
employerbecauseofdeath,sicknessorotherphysicaldisabilityorforanycausebeyondthe
controlofthesaidofficialofemployeeshallbeexcludedfromgrossincome.
Xavailedanearlyretirementplanofthecompany.Arethebenefitsreceivedbyhim
excludable?
No.Hehastheoptionofwhethertoavailoftheearlyretirementplan.Hecannotreasonoutthat
hewasseparatedfromthecompanybeyondhiscontrol.
XincurredSTD.Thus,hisemployercausedtheseparationofXfromemployment.Hegranted
himPhp300,000benefits.Excludable?Whatifthegroundofemployeeisduetosickness?
Itistaxable.Sicknessasagroundmustbejobthreatening.Hemustberenderedincapableof
working.STDdoespreventapersonfromworking.Thus,paymentwouldnotbeexcludable.If
sicknesswasinvokedasaground,suchsicknessshouldbethatwouldrendertheworker
incapableofworkingeffectively.
SupposingtheProvinceofAlberta,CanadamadeadepositwiththeADBofPhp10M
yielding6%interestinthePhilippines.Supposingapoliticalsubdivisionputsupatrading
centerandearnedPhp1Mincome.Isittaxable?
Thetermforeigngovernmentincludespoliticalsubdivision.Theincomeintradingcentershall
betaxable.Whatisexcludablerefersnottobusinessincomebutfrompassiveincome.With
regardtotheinterestyieldfromthedeposit,suchwouldbeexempt.Thisisbecauseinterest
incomeisconsideredaspassiveincome.
Whatdoestheexclusionofincomeaccruingtothegovernmentoritspoliticalsubdivisions
referto?
Thisprovisionwouldseemnottobeinlineoftheinherentlimitationthatthegovernmentdoes
notordinarilytaxitself.Thisisbecausethefactthatthelawincludesitmeansthatifitwerenot
Cecille 2C 05-06
Income Accruing to
Government
51
fortheexclusion,itwouldbeincluded.
Theexclusionrefertoincomederivedfromanypublicutilityorfromtheexerciseofany
essentialgovernmentfunctionaccruingtotheGovernmentofthePhilippinesortoanypolitical
subdivisionthereof,Thekeywordintheprovisionisincomeaccruing.Iftheincomedoesnot
accruetothegovernmentthenitisnotexcludable.
However,seeSection27Cwhichrequiresallgovernmentownedorcontrolledcorporations,
agencies,orinstrumentalitiesexcepttheGSIS,SSS,PhilippineHealthInsuranceCorporation,
PhilippineCharitySweepstakesOffice,andPhilippineAmusementandGamingCorporation,to
payincometaxes.
WhyistheincomeearnedbytheNationalPowerCorporationexcludedfromtaxation?
Becauseitisagovernmentownedandcontrolledcorporation,whichispartofthegovernment,
performingessentialgovernmentfunctionsanditsincomeaccruestothePhilippinegovernment.
AbasketballplayerwasgivenanawardbytheRotaryforoutstandingachievement.Isthe
awardtaxable?Howaboutunderthenextsectionregardingprizesandwinningsofathletesin
asportscompetition?
Yes,itistaxable.Itdoesnotfallundertheexclusionforanawardforreligious,charitable,
scientific,educational,artistic,literaryorcivicachievement.Sinceitisataxexemption,itmustbe
strictlyconstrued.Itmustonlycomewithinthe7categoriestobeexcludable.Also,itisnot
exemptundertheprovisionontheprizesandawardsinsportscompetition.Thesaidprovision
contemplatesofaparticularcompetitionortournamentandnotacumulativeachievement.Also,
thenationalsportsassociationsanctioningsuchcompetitionmustbeaccreditedbythe
PhilippineOlympicCommittee.
Prizes and Awards
Cecille 2C 05-06
52

GENERALPRINCIPLESOFPHILIPPINEINCOMETAXATION
WhatarethegeneralprinciplesofincometaxationinthePhilippines?
UnderSection23oftheNIRC,exceptwhenotherwiseprovidedintheCode:
(A) AcitizenofthePhilippinesresidingthereinistaxableonallincomederivedfrom
sourceswithinandwithoutthePhilippines;
(B) Anonresidentcitizenistaxableonlyonincomederivedfromsourceswithinthe
Philippines;
(C) AnindividualcitizenofthePhilippineswhoisworkingandderivingincomefrom
abroadasanoverseascontractworkeristaxableonlyonincomefromsources
withinthePhilippines;Provided,thataseamanwhoiscitizenofthePhilippinesand
whoreceivescompensationforservicesrenderedabroadasamemberofthe
complementofavesselengagedexclusivelyininternationaltradeshallbetreatedas
anoverseascontractworker;
(D) Analienindividual,whetheraresidentornotofthePhilippines,istaxableonlyon
incomederivedfromsourceswithinthePhilippines.
(E) Adomesticcorporationistaxableonallincomederivedfromsourceswithinand
withoutthePhilippines;and
(F) Aforeigncorporation,whetherengagedornotintradeorbusinessinthe
WhoarethetaxpayerstaxableonincomewithinandwithoutthePhilippines?
AcitizenofthePhilippinesresidingthereinandadomesticcorporationaretaxedonincome
derivedfromsourceswithinandwithoutthePhilippines.
WhenisaFilipinocitizennottaxable?
UnderSection23(C),forpurposesofexemptionfromincometax,acitizenmustbederiving
foreignsourcedincomeforbeinganonresidentcitizenorforbeinganoverseascontractworker.
Allemployeeswhoseservicesarerenderedabroadforbeingsecondedorassignedforatleast
183daysmayfallunderthefirstcategoryandare,therefore,exemptfrompaymentofPhilippine
tax.
Thesameexemptionappliestoanoverseascontractworkerbutassuchworker,thetimespent
abroadisnotmaterialfortaxexemptionpurposes.Allthatisrequiredisfortheworkers
employmentcontracttopassthroughandberegisteredwiththePhilippineOverseas
EmploymentAgency(POEA).
Whatdoesthephrasemostofthetimemeans?
Itmeansthatthesaidcitizenshallhavestayedabroadforatleast183daysinataxableyear.
SupposingXleavesfortheU.S.BeforeleavingfortheU.S.,heearnsthefollowingfrom
JanuarytoAprilinManila:compensationincome,businessincome,deposits,andshares
givenasdividends.HeleftonMay1andhadthesameincomeintheU.S.Hecamebackin
thePhilippinesinSeptember?WhatwouldbesubjecttoPhilippinetaxjurisdiction?
ThefirstissueisdidXbecomeanonresident?Thereasonisthatthenewlawprovidesthatnon
residentcitizennotsubjecttotaxonincomewithout.Also,takenoticeofthe183dayrule
regardingacitizenwholeavesforabroadandnotanOCW.Allincomeinhissituationissubject
toPhilippinetaxalthoughdifferinginamount/ratesasitcouldbeassumedthatXisaFilipino
residentcitizen.
AresidentcitizenearnedinthePhilippinesandinaforeigncountryinterestfromhissavings
Cecille 2C 05-06
When a Filipino Citizen

Not Taxable
53
account(sameamountandsameinterestrate),capitalgainsfromthesaleofhis2houseshere
andabroadofthesameamount,anddividends(samevalue).Isthetaxrateofthewithinand
withoutsourcesthesame?
No.Section24(B)providesforspecificratesforpassiveincome,interests,capitalgains,and
dividends.ButtheseshouldbewithinthePhilippines.ForsourceswithoutthePhilippines,these
amountswouldbeaddedtothecomputationofthenetincome,thentherateswouldbeimposed
basedontheschedule.
XleftforSaudiArabia.Heworkedtherefortwomonths.Wouldtherebeadifference?
IfheisanOFW,incomederivedfromsourceswithoutisnottaxable.Lengthofstayisimmaterial
aslongastheworkersemploymentcontractisregisteredwiththePOEA.
Xisaresidentalien.Samefactsasabove.Isthereisadifferenceontaxstatusifresidentor
nonresident?
Therewouldbethesametaxtreatment,whetherresidentornonresidentalien.Botharetaxed
onlyonincomederivedfromsourceswithinthePhilippines.Thequestionofresidenceisno
longermaterial.Itwillonlybesignificantwithregardtotreatmentofpassiveincome.
Whatisthedifferenceinthetaxtreatmentbetweenresidentandnonresidentalien?
Thereisadifferenceintaxrateandtaxbase.Nonresidentalienengagedintradeistreatedlikea
citizenandresidentalien.Anonresidentaliennotengagedintradeissubjecttoaflattaxrateon
grossincome.EveryoneelseintheenumerationinSection23istaxedonnetincome.
Whataretherequisitesforaseamantobetaxable?
Hemustbe:
1. AcitizenofthePhilippines;
2. Receivescompensationforservicesrenderedabroadasamemberofthecomplementof
avessel;and
3. Thevesselmustbeengagedexclusivelyininternationaltrade.
WhoarepersonsconsideredcitizensofthePhilippines?
UndertheConstitution,thefollowingareconsideredcitizensofthePhilippines?
1. ThosewhoarecitizensofthePhilippinesatthetimeoftheadoptionoftheConstitution
(on2February1987)
2. ThosewhosefathersormothersarecitizensofthePhilippines;
3. Thosebornbefore17January1973ofFilipinomotherswhoelectPhilippinecitizenship
uponreachingtheageofmajority;
4. Thosewhoarenaturalizedinaccordancewithlaw.
WhatisthedifferencebetweenanonresidentcitizenandanOCWwithregardtotheirlength
ofstayabroad?
Anonresidentcitizenmusthavealongpresenceabroad(intentionofresidingabroad)sothat
hisincomeabroadmaybeexcluded.InthecaseofanOCW,hisstayabroadmaybeshorter,so
evenifanOCWstayinKuwaitonlyfor10days,hisincomeearnedthereisstillnottaxable.
Forpurposesincometax,whoareresidentaliens?
TheyarethosewhoareactuallypresentinthePhilippinesandwhoarenotmeretransientsor
sojourners.Butresidencedoesnotmeanmerephysicalpresence.Analienisconsidereda
residentornonresidentdependingonhisintentionwithregardtothelengthandnatureofhis
stay.
Lengthofstayisindicativeofintention.AnalienwhoshallhavestayedinthePhilippinesfor
morethanoneyearbytheendofthecalendaryearisaresidentalien.
Cecille 2C 05-06
Difference in Tax
Treatment Between
Resident and NonResident Alien
Requisites for a Seaman
to be Taxable
Citizens of the
Philippines
Resident Aliens
54
WhoisanonresidentalienengagedinbusinessorpracticeofprofessioninthePhilippines?
Byprovisionoflaw,analienwhoshallcometothePhilippinesandstayforanaggregateperiod
ofmorethan180daysduringacalendaryearshallbeconsideredanonresidentalienin
business,orinthepracticeofprofession,inthePhilippines.Theonlycriterionislengthofstay.
Whataretherulesontaxationofaliens?
1. ResidentaliensaretaxableascitizensofthePhilippines,butonlyonincomederived
fromsourceswithinthePhilippines.
2. Nonresidentaliensarelikewisetaxableonlyonincomederivedfromsourceswithinthe
Philippines;
3. NonresidentaliensengagedintradeorbusinessinthePhilippinesaresubjecttotaxin
thesamemannerascitizensandresidentaliensontaxableincomereceivedfrom
Philippinesources.
4. NonresidentaliensnotengagedintradeorbusinessinthePhilippinesaresubjecttoa
flattaxrateof25%or15%ontheirincome.
Whatisthedifferencebetweenthetaxtreatmentofanonresidentalienengagedintradeand
businessandanonresidentalienengagedintradeandbusiness?
Theengagednonresidentalien(Section25(A))issubjecttoanincometaxinthesamemanneras
anindividualcitizenandaresidentaliencitizen(netincome)whileanotengagednonresident
alien(Section25(B))shallbetaxeduponhisentireincome(grossincome)fromallsourceswithin
thePhilippines.
Whatistheschedularapproachinincometaxation?
Itisasystememployedwhentheincometaxtreatmentvariesandmadetodependonthekind
ofcategoryoftaxableincomeofthetaxpayer.
Whatistheglobalapproachinincometaxation?
Itisasystemwherethetaxtreatmentviewsindifferentlythetaxbaseandgenerallytreatsin
commonallcategoriesoftaxableincomeofthetaxpayer.
Rules on Taxation of
Aliens
Schedular Approach
Global Aproach
Cecille 2C 05-06
55
INDIVIDUALINCOMETAXATION
Uniformrulesforindividualoncapitalgainstax
(a)
Onsaleofsharesofstockofadomesticcorporationnotlistedandtraded
thrualocalstockexchange,heldascapitalassets
Onthenetcapitalgain:
NotoverPhp100,000
OnanyamountinexcessofPhp100,000
(b)
OnsaleofrealpropertyinthePhilippinesheldascapitalasset
Onthegrosssellingpriceorcurrentfairmarketvalueprevailingatthetime
ofsale,whicheverishigher
Finaltaxof5%
Finaltaxof10%
Finaltaxof6%
Incometaxrulesforresidentcitizen
(a)
NotoverPhp100,000
(b) OnsaleofrealpropertyinthePhilippinesheldascapitalasset
(c) FromsourceswithinthePhilippines,onpassiveincomeof:
Interestundertheexpandedforeigncurrencydepositsystem
(d) FromsourceswithinthePhilippines,onpassiveincomeof:
Royaltyfrombooks,literaryworksandmusicalcompositions
(e) FromsourceswithinthePhilippines,onpassiveincomeof:
Interestonanycurrencybankdeposit,yieldorothermonetarybenefits
fromdepositsubstitute,trustfundandsimilararrangement;
Royaltyotherthan(d)above;
PriceexceedingPhp10,000
Otherwinnings,exceptPhilippineCharitySweepstakesandlottowinnings
(f) FromsourceswithinthePhilippines,onpassiveincomeof:
Dividendfromadomesticcorporation,orfromajointstockcompany,
insuranceormutualfundcompany,andregionaloperatingheadquarters
ofmultinationalcompany,orshareinthedistributivenetincomeaftertax
ofapartnership(exceptageneralprofessionalpartnership),jointstockor
jointventureorconsortiumtaxableasacorporation
Cecille 2C 05-06
Uniform Rules on Capital

Gains Tax for Individuals
Finaltaxof5%
Finaltaxof10%
Income Tax Rules for

Resident Citizen
Finaltaxof6%
Finaltaxof7%
Finaltaxof10%
Finaltaxof20%
Finaltaxof10%
56

(g)
FromsourceswithinthePhilippines,onpassiveincomeof:
Interestonlongtermdepositorinvestmentinbanks(withmaturityof5
yearsormore)
(h)
Taxableincome(others)withinandoutsidethePhilippines
Exempt
5%to32%
Incometaxrulesfornonresidentcitizen
(a)
NotoverPhp100,000
(b)
(c)
Royaltyotherthan(c)above;
(g) FromsourceswithinthePhilippines,onpassiveincomeof:
yearsormore)
(h) Taxableincome(others)withinthePhilippines

Non-Resident Citizen
Finaltaxof5%
Finaltaxof10%
Finaltaxof6%
Exempt
Finaltaxof10%
Finaltaxof20%
Finaltaxof10%
Exempt
5%to32%
Cecille 2C 05-06
57
Incometaxrulesforresidentalien
(a)
NotoverPhp100,000
(b)
(c)
yearsormore)
Finaltaxof5%
Finaltaxof10%
Finaltaxof6%
Finaltaxof7%
Finaltaxof10%
Finaltaxof20%
Finaltaxof10%
Exempt
5%to32%
Incometaxrulesfornonresidentalienengagedinbusinessorpracticeofprofessioninthe
Philippines
(a)
NotoverPhp100,000
Cecille 2C 05-06

Resident Alien
Finaltaxof5%
Finaltaxof10%

Non-Resident Alien
Engaged in Business or
Practice of Profession
58

(b)
(c)
(f) GrossincomefromwithinthePhilippinesfrom:
Cinematographicfilmsandsimilarworks
yearsormore)
Finaltaxof6%
Exempt
Finaltaxof10%
Finaltaxof20%
Finaltaxof10%
Exempt
5%to32%
IncometaxrulesfornonresidentaliennotengagedinbusinessinthePhilippines
(a)
NotoverPhp100,000
(b)
(c)
GrossincomefromwithinthePhilippines
Cecille 2C 05-06
Finaltaxof5%
Finaltaxof10%

Non-Resident Alien Not
Engaged in Business
Finaltaxof6%
Finaltaxof25%
59
SupposeXisaresidentcitizen.Whatshallbethetaxtreatmentofthefollowingincome?
IncomewithinthePhilippines
IncomeAbroad
Interest
Interest
Dividend
Divided
Capitalgainsfromsaleofreal
Capitalgainsfromsaleofreal
property
propertyintheU.S.
Foraresidentcitizen,theruleisthatincomederivedfromsourceswithinandwithoutare
taxable.Inthiscase,interestanddividendsarepassiveincomesubjecttofinaltaxrates.Interest
incomederivedfromsourceswithinthePhilippinesshallbesubjectto20%finaltax[Section24
(B)(1)].Ontheotherhand,dividendsreceivedfromsourceswithinthePhilippinesshallbe
subjectto10%finaltax[Section24(B)(2)].Asfortheincomederivedfromsourceswithoutthe
Philippines,theseshallformpartofthetaxablenetincomeofXwhichshallbesubjecttothe5%
32%taxrate.Itshallnotbesubjecttofinaltaxbutinsteadaddedtothetaxablenetincome.
Whatisthedifferencebetweencapitalassetandordinaryasset?
Acapitalassetisanassetnotusedinbusiness.Whenanassetheldisdescribedasaninvestment,
itisacapitalasset.Ordinaryasset,ontheotherhand,isassetusedinbusiness(ex.machinery).
XbuysarealpropertyinQuezonCityin1999forPhp2M.Xsellsitin2004forPhp1M.Isthat
subjecttoacapitalgainstax?Whatwouldbethetaxrate?
Whatthelawtaxesisthepresumedgain.Whencapitalassetsaresold,exchangedorotherwise
disposedof,thelawpresumesagain,evenifthereisaclearloss.Theprovisioninthelaw
includespactoderetrosalesandotherformsofconditionalsales,byindividuals,includingestates
andtrusts.
XleftfortheU.S.andstayedtherefor1year.HethencalleduphisbrotherinthePhilippines
tosellthesameproperty.Woulditbesubjecttocapitalgainstax?
Yes,itwouldbesubjecttocapitalgainstaxprovidedthatthesamepropertyremainsasacapital
asset.
Inthecapitalgainsfromsaleofrealproperty,whereshallthefinaltaxof6%bebased?
Thefinaltaxof6%isbasedonthegrosssellingpriceorcurrentfairmarketvalue,whicheveris
higher.
Whatiscost?
Costisthepurchasepriceincreasedbytheexpensesonthepurchase.
X,stayedintheU.S.,boughtrealpropertyinthereandsubsequentlysoldthesame.Isthat
subjecttotaxsupposedagainwasrealized?WhatifXisaresidentcitizen?
ThesaleintheU.S.isnotsubjecttocapitalgainstax.However,ifXisaresidentcitizen,thetax
imposedis532%.Thetacticistoconvertittoanordinaryasset.Butifitremainsascapitalasset
andsellsataloss,thereexiststhepresumptionofgain.
XboughtrealpropertyinQuezonCity(capitalasset)forPhp2M.Hesolditin2004forPhp
5M.ThepurposeistobuildaPhp5Mprincipalresidence.Woulditbesubjecttocapitalgains
tax?
Yes.Itdoesnotcomeundertheexceptionthatcapitalgainstaxbecausethepropertysoldisnot
theprincipalresidence.A6%finaltaxwillbeimposedonthePhp5M.Theexclusionpertainsto
thesaleordispositionoftheirprincipalresidentnotthebuyingofprincipalresidence.
Intheaboveexample,whatwouldbethebasisofcapitalgainstax,Php5MorPhp3M(the
actualnetincomeearned)?
Php5Mbecausethisisthegrosssellingprice.Thelawdoesnottalkaboutthenetgain.
Cecille 2C 05-06
Capital Asset v. Ordinary

Asset
Capital Gains Tax on Sale

of Real Property
Cost
60
Xboughtalotin1999forPhp2M.In2004,thefairmarketvalueisPhp5M.In2005,thelot
wasboughtbythegovernmentforPhp3M.Whatshallbethetaxapplicablerate?
ThetaxpayerhastheoptionoftreatingitastaxableincomeonthegainofPhp1MunderSection
24(A)orcapitalgainswiththefinaltaxof6%.Inactualpractice,sincethegovernmentisthe
buyer,theBIRrulingsaysthatthe6%capitalgainstaxshallbebasedonactualconsiderationof
Php3Msincethebuyertendstobuyatalowerpricethanthefairmarketvalue.Itisonlyfairto
baseitonactualconsideration.
Supposingthegovernmentiswillingtobuyapropertybuttheownerrefusedtosell.The
governmentthenexpropriatedthepropertyandpaidPhp3Masjustcompensation.What
wouldbethecapitalgainstax?
Thisisnotsubjecttocapitalgainstaxbecauseitisanexpropriation.Inthiscase,thereisno
meetingoftheminds.Whatthelawcontemplatesundertheprovisiononcapitalgainstaxfrom
saleofrealpropertyisvoluntarydispositionofpropertyandnotaforcedsale.
SupposingXandYareinvolvedinacourtaction.ThecourtorderedYtoconveyproperty
worthPhp5MtoX.Willitbesubjecttocapitalgainstax?
Nobecausethisisnotasalebutaconveyancebyajudicialorder.Itshallnotbesubjecttocapital
gainstaxbecauseitwasnotavoluntarytransaction.
XownsarealpropertyheldasacapitalassetinQuezonCityworthPhp10M.Yownsacapital
assetinPasigworthPhp15M.XandYexchangedlots.XgotthePhp15Mlot.Isitsubjectto
capitalgainstax?
Yes,itissubjecttocapitalgainstaxbecausethelawincludesexchangeofproperty.Ifitisasale,
thefinaltaxisimposedonthegrosssellingpriceorfairmarketvalue.Inanexchange,sincethere
isnoprice,thetaxisonthefairmarketvalue.Thefairmarketvalueisontheproperty
exchanged.Thecapitalgainstaxisimposedontheselleroftheproperty.Itisimposedonthe
valueofthepropertythathegaveupandnotonthevalueofthepropertythathereceived.In
thiscase,thereis6%finaltaxonthePhp10MforXandPhp15MforY.
Xsoldapropertyheboughtat3M.HesolditforPhp5MtoYsubjecttotherightof
repurchase.Afterayear,YsolditbacktoX.Isthetransactionsubjecttocapitalgainstax?
ThetransactionfromXtoYissubjecttocapitalgainstax.ThesecondtransactionfromYtoXis
notsubjecttocapitalgainstaxbecauseitisnotasale,exchangeorotherdisposition.Itismerely
theexerciseoftherighttorepurchase.
XboughtSMsharesworthPhp1MfromanAmericancitizeninthePhilippineswhoearlier
boughtthesharesinthePhilippines.XlatersoldthesamesharesforPhp2MtoaFilipino
citizenintheU.S.Whoissubjecttocapitalgainstax?
BoththeAmericanandXwillbeliableforcapitalgainstax.
WhatifXwasaresidentalien?Whatisthebasicrequirement?
Aslongaswhatisinvolvedinthetransactionaresharesofadomesticcorporationnotbeing
tradedinthestockexchange,thenheshallbeliableto5%or10%capitalgainstax.
SupposingthesaleofshareswasmadebyanAmericancitizentoX.Wouldthatbesubjectto
capitalgainstax?
Thetaxisimposedregardlessofwhothesellerisandwheresold.Sincethesharesarestillofthe
domesticcorporation,thefinaltaxof5%or10%isimposed.Thesaidfinaltaxappliesto
unlisted/untradedandlisted/nottradedsharesofadomesticcorporation.
Cecille 2C 05-06
Capital Gains Tax on Sale

of Shares of Stock
61
Xisanonresidentalienengagedintrade.Hehasdepositsearning18%amountingtoPhp1B
inaPhilippinebank.HeleftfortheU.S.andstayedthereforayear.Isthe18%interest
taxableinthePhilippines?
Therewouldbeadifferenceifhebecomesanonresidentaliennotengagedintradewhowillbe
subjecttoa25%flattaxrate.Ifheisanonresidentalienengagedintrade,heshallbesubjectto
20%tax.Thereisachangeintaxrateandtaxbase.
Whatisageneralprofessionalpartnership?
UnderSection22,ageneralprofessionalpartnershipisdefinedasoneformedbypersonsforthe
solepurposeofexercisingtheircommonprofession,nopartoftheincomeofwhichisderived
fromengaginginanytradeorbusiness.
Supposingtherearethreelawyers.Php10Mwasearnedinlegalfeesfromclients.Theyalso
earnedPhp2Mfrominvestment(passiveincome)andPhp500Kfromtradingofcomputers.
ThetotalincomeisPhp12.5M.Howshalltheincomebetaxed?
Sincetheexemptionisstrictlyconstrued,thismaynotbetreatedasageneralprofessional
partnershipwhoseincomeasapartnershipisexemptedfromincometax.Itmaybearguedthat
thattheprovisionrequiringthatnopartoftheincomeisderivedfromengaginginanytradeor
businessisnotmet.Butonemayalsoarguethattheincomeearnedbesidesthelegalfeescannot
becharacterizedasincomeearnedfromengaginginanytradeorbusinessbecausethisimplies
continuityandpermanence.Onemayarguethatthesetransactionsareisolatedtransactionsso
thepartnershipwillnotloseitsGPPstatus.
Howistheincomeofageneralprofessionalpartnershiptreatedonthepartnershipleveland
onthepartnerslevel?
FirstthenetincomeoftheGPPiscomputed.Thenthisnetincomeisdistributedtoeachpartner
astheirdistributivesharewhichbecomespartofthegrossincomeofthepartners.Thisisnotyet
taxablebecausetherearestilldeductionsthatmaybemade.Afterdeductions,thenitistaxedas
incomeofthepartners.
Arecorporationsliabletocapitalgainstaxonsalesofrealproperty?
Capitalgainstaxonsalesofrealpropertyonlyappliestoindividuals.Whenyoutalkof
corporations,capitalgainstaxappliesonlyincaseofsalesofsharesofstockofadomestic
corporation.
Whatifitinvolvessaleofsharesofstockofaforeigncorporation?
Whatevergainderivedfromthesaleofsharesofaforeigncorporationissubjecttothecorporate
incometax.
Whatisthedifferencebetweenadividendfromadomesticcorporationfromaforeign
corporation?
Dividendofadomesticcorporationisexcludedsincetheshareholderwouldpaythetaxwhilein
foreigncorporations,itistaxableaspartofthecorporateincome.
Cecille 2C 05-06
Taxability of General
Professional Partnerships
62
SPECIALTREATMENTOFFRINGEBENEFITS
Whatisfringebenefit?
UnderSection33(B),fringebenefitmeansanygood,serviceorotherbenefitfurnishedor
grantedincashorinkindbyanemployertoanindividualemployee(exceptrankandfile
employeesasdefinedherein)suchas,butnotlimitedto,thefollowing:
Housing;
Expenseaccount;
Vehicleofanykind;
Householdpersonnel,suchasmaid,driverandothers;
Interestonloanatlessthanmarketratetotheextentofthedifferencebetweenthemarket
rateandactualrategranted;
Membershipfees,duesandotherexpensesbornebytheemployerfortheemployeeinsocial
andathleticclubsorothersimilarorganizations;
Expensesforforeigntravel;
Holidayandvacationexpenses;
Educationalassistancetotheemployeeorhisdependents;and
Lifeorhealthinsuranceandothernonlifeinsurancepremiumsorsimilaramountsinexcess
ofwhatthelawallows.
Isfringebenefitanincomeonthepartoftheemployee?
Thetheoryisitiscompensationincome.
Iftheruleisthatitisincomeonthepartoftheemployee,doesitmeanthatitispaidbythe
employee?Theconceptisthathewhoearnsthemoneypaysthetaxonincome.Doesitviolate
thisconcept?
Inessence,thelawsaysthetaxispayablebytheemployerbutcandeductitasabusiness
expense(Section57).Grossedupmonetaryvalueincludesnotonlyactualbenefitsbutalsothe
tax.Itisreallytheemployerwhopaysthetaxbecausehegetsitbackbywayofdeduction.Ifno
fringebenefittaxispaid,theemployercannotdeductitasabusinessexpense.
Isitalwaysincomeonthepartoftheemployee?Howaboutthenontaxablefringebenefit?
Yes,itisincomeonthepartoftheemployee.Fringebenefitsarealwaysforcorporate
officers/managementwhileforrankandfileemployees,itiscalledanallowance.Stillthesame.
Whatarethefringebenefitsnotsubjecttotax?
ThefollowingfringebenefitsarenottaxableunderSection33:
Fringebenefitswhichareauthorizedandexemptedfromtaxunderspeciallaws;
Contributionsoftheemployerforthebenefitoftheemployeetoretirement,insuranceand
hospitalizationbenefitplans;
Benefitsgiventotherankandfileemployees,whethergrantedunderacollectivebargaining
agreementornot;and
Deminimisbenefitsasdefinedintherulesandregulationstobepromulgatedbythe
SecretaryofFinance,uponrecommendationoftheCommissioner.
Whatistheconvenienceoftheemployerrule?
Underthisconcept,whenafringebenefitisgiventoanemployeesolelyfortheconvenienceof
theemployer,thefringebenefitisexemptfromthefringebenefittax.Theemployeewillnot
recognizetheincomefromthebenefit,whethertheemployeeisamanagerialorsupervisory
employee,orarankandfileemployee.
Whataredeminimisbenefits?Arethesebenefitspartofincome?
Thetermdeminimisbenefitswhichareexemptfromthefringebenefittaxshall,ingeneral,be
limitedtofacilitiesorprivilegesfurnishedorofferedbyanemployertohisemployeesthatareof
Cecille 2C 05-06
Fringe Benefits
Convenience of the
Employer Rule
De Minimis Benefits
63
relativelysmallvalueandareofferedorfurnishedbytheemployermerelyasameansof
promotingthehealth,goodwill,contentment,orefficiencyofhisemployees.
Thesebenefitsarestillcompensationbutbecauseofitsrelativelysmallvalue,theyare
considerednotpartofcompensationincometobetaxed.
SupposinganemployergivesPhp700laundryallowance,Php1000sackofrice,Php1000
groceries,andPhp500parkingallowance.ThesebenefitsamounttoPhp3200.Willthe
amountstillfallunderdeminimis?
Theruleisthatyoudonotaggregateoraddalldeminimisbenefits.Youshouldtreatit
separately.Incaseofpaymentofmeals,ifitdoesnotexceed25%ofwages,stilldeminimis.As
longasthevalueofeverybenefitgivendoesnotexceed25%ofthebasicsalarythenitisstill
consideredademinimisbenefit.
Here,theruleistheincomeoftheemployeebutdeductiblebyemployer.Butthisisnot
necessarilytrueinSection34.
Cecille 2C 05-06
64
CORPORATEINCOMETAXATION
WhatarethebasicprinciplesofcorporateincometaxationunderSection23?
Adomesticcorporationistaxableonallincomederivedfromallsourceswithinandwithoutthe
Philippines.Aforeigncorporation,whetherengagedornotintradeorbusinessinthe
Whatisincludedinthetermcorporation?
UnderSection22(B),thetermcorporationshallincludepartnerships,nomatterhowcreatedor
organized,jointstockcompanies,jointaccounts,associations,orinsurancecompanies,butdoes
notincludegeneralprofessionalpartnershipandajointventureorconsortiumformedforthe
purposeofundertakingconstructionprojectsorengaginginpetroleum,coal,geothermaland
otherenergyoperationspursuanttoanoperationorconsortiumagreementunderaservice
contractwiththegovernment.Generalprofessionalpartnershipsarepartnershipsformedby
personsforthesolepurposeofexercisingtheircommonprofession,nopartoftheincomeof
whichisderivedfromengaginginanytradeorbusiness.
Underthesaidprovision,anycorporation,firm,orassociation,nomatterhowcreated,or
organized,orwhatthepurposeofitsorganizationmaybesubjecttotaxexceptasprovidedin
Section30withregardtoexemptionsfromtaxoncorporations.
Takenotethatthetermcorporationdoesnotinclude:
(a) Ageneralprofessionalpartnership;
(b) Ajointventureorconsortiumformedforthepurposeofundertakingconstruction
projects;
(c) Ajointventureorconsortiumforengaginginpetroleum,coal,geothermalandother
energyoperationspursuanttoanoperatingorconsortiumagreementunderaservice
contractwiththeGovernment.
Whoareyourcorporatetaxpayers?
Thesearethedomesticcorporationsandforeigncorporations.
Capitalgainstaxondomesticcorporation
Onsaleofsharesofstockofadomesticcorporationnotlistedandtradedthrua
localstockexchange,heldascapitalassets
NotoverPhp100,000
Onsaleoflandand/orbuildingheldascapitalasset
Finaltaxof5%
Finaltaxof10%
NotoverPhp100,000
Cecille 2C 05-06
Corporation
Capital Gains Tax on

Domestic Corporation
Finaltaxof6%
Incometaxrulesondomesticcorporations
(a)
Basic Principles of
Corporate Income
Taxation
Finaltaxof5%
Finaltaxof10%
Income Tax Rules on

Domestic Corporations
65

(b)
Onsaleoflandand/orbuildingheldascapitalasset
(c)
FromsourceswithinthePhilippinesonpassiveincomeof:
(d) FromsourceswithinthePhilippinesonpassiveincomeof:
Interestonanycurrencybankdeposit,yield,orothermonetarybenefit
fromdepositsubstitute,trustfundandsimilararrangement,royalty
(e) Dividendfromdomesticcorporations(intercompanydividend)
(f) Taxableincome(NET)fromallsourceswithinandoutsidethePhilippines
NORMALTAX
But,beginningwiththefourthyearfromstartofoperations,whicheverishigher
of:
NORMALTAX
MINIMUMCORPORATEINCOMETAX(MCIT),onMCIT
grossincome
(g) Inlieuof(f),beginningwiththeyear2000:
GROSSINCOMETAX(GIT),onGITgrossincome
Finaltaxof6%
Finaltaxof7%
Finaltaxof20%
Exempt
35%
35%
2%
15%
Incometaxrulesonresidentforeigncorporations
(a)
(b)
NotoverPhp100,000
(c)
Interestonanycurrencybankdeposit,yield,orothermonetarybenefit
fromdepositsubstitute,trustfundandsimilararrangement,royalty
(d) Dividendfromdomesticcorporation(intercompanydividend)
Cecille 2C 05-06
Finaltaxof5%
Finaltaxof10%
Income Tax Rules on

Resident Foreign
Corporations
Finaltaxof7%
Finaltaxof20%
Exempt
66

(e)
Taxableincome(NET)fromallsourceswithinandoutsidethePhilippines
NORMALTAX
But,beginningwiththefourthyearfromstartofoperations,whicheverishigher
of:
NORMALTAX
MINIMUMCORPORATEINCOMETAX(MCIT),onMCIT
grossincome
35%
35%
2%
Incometaxrulesonnonresidentforeigncorporations
(a)
NotoverPhp100,000
(b) Interestonforeignloans
(c) Dividendsfromdomesticcorporation(undercertainconditions)
(d) GrossincomefromsourceswithinthePhilippines
Finaltaxof5%
Finaltaxof10%
Finaltaxof20%
Finaltaxof15%
Finaltaxof35%
Incometaxrulesonspecialcorporations
Taxpayer
Proprietaryeducationalinstitutionandnon
profithospital
Residentinternationalcarrier
Nonresidentownerorlessorofvessel
Nonresidentcinematographicfilmowner,
lessorordistributor
Nonresidentlessorofaircraft,machinery
andotherequipment
Regionaloperatingheadquartersof
multinationalcorporation
Income Tax Rules on

Resident Foreign
Corporations
TaxBase
Taxableincomefromallsources
Rate
10%
GrossPhilippinebillings
2%
Grossrentals,leaseandcharterfees
fromthePhilippines
GrossincomefromthePhilippines
4%
Grossrental,chargesandotherfees
fromPhilippinesources
7%
Philippinetaxableincome
10%
Income Tax Rules on

Special Corporations
25%
Areallcorporationssubjecttoauniformflatrate?
Yes.Underthecorporateincometaxlaw,allcorporationsaresubjecttoauniformflatrateof
35%.Theydonotdifferintaxratesbutdifferontaxbase.
Cecille 2C 05-06
67
Whenwetalkofdomesticcorporation,thetaxis35%fromallsourceswithinandwithout.
Whenwetalkofresidentforeigncorporation,stillthesame35%butthetaxbaseistheNET
INCOMEfromwithin.
Whenwetalkofnonresidentforeigncorporation,stillthe35%flatrateisapplicablebutthetax
baseistheGROSSINCOMEfromwithin.
However,therearecertainincomeswhicharesubjecttoaspecialtaxtreatmentlikepassive
incomeandincomefromcapitalgainsfromdealingswithsharesofstockofdomestic
corporation,andtherearealsocertaincorporationswithintheclassesofcorporatetaxpayer
whichshallbegivenaspecificincometax.
Whatisthetaxtreatmentofdomesticcorporation?Whatincomeissubjecttotax?
Incomederivedfromallsourceswithinandwithoutissubjecttothe35%rule.
SupposingthedomesticcorporationhasabusinessincomeofPhp10Mandapassiveincome
ofPhp2M.Whatistheapplicabletaxrate?
The35%appliestobusinessincomeorthatincomegeneratedbythebusiness.Itisdifferent
whenitcomestopassiveincome.Passiveincomeofadomesticcorporationistreatedlike
passiveincomereceivedbyaresidentcitizen.Thebasicquestioniswhatkindoftaxpayeryou
aredealingwith.Thendeterminewhatthetaxtreatmentis.Passiveincomedoesnotenterthe
grossincomeanymore.
Isthe35%taxonincomeofcorporationanabsoluterule?Howdoyoudistinguishtax
treatmentofnonstock,nonprofitandprivateeducationalinstitutionandnonprofit,
proprietaryeducationinstitution?
Proprietaryeducationalinstitutionsandhospitals
10%
whicharenonprofit
Nonstockandnonprofit
0%
Proprietaryandnonprofit
10%
Proprietaryandforprofit
35%
AssumingADMUisanonstocknonprofit.ItearnsPhp10Mfromeducationalactivities
whileitearnsPhp6Mfromtradinganddoingbusiness.Whatwouldbetaxed?Whatwould
bethetaxtreatment?
Php10Mwillbeexemptbecauseofconstitutionalprovision.ThePhp6Mwillbetaxedby10%
andnot35%because35%appliesonlytocaseswhereyouapplythepredominancetest.ADMU
inthiscaseisaconstitutionalexemptee.UndertheConstitution,allrevenuesofnonstock,non
profiteducationalinstitutionsusedactually,directly,andexclusivelyforeducationalpurposes
shallbeexemptfromtaxes.
Innonstocknonprofit,unrelatedincomewillbegivena10%preferentialtaxrate.This
preferentialtaxrateonnonstock,nonprofiteducationalinstitutionalwillbethesamewhether
ornotthetotalunrelatedincomeexceedstheconstitutionallyexemptincomeorthatincomein
pursuanceofeducationalactivity.
SupposingArellanoUniversityisanonprofitproprietaryeducationalinstitution.Itearns
Php10Mfromeducationalactivities.ItalsoearnsPhp6Mfromunrelatedactivities.What
wouldbetaxed?Whatwouldbethetaxtreatment?
Php16Mwillbesubjectto10%underSection27(B).Predominancetestisnotapplicablebecause
thegrossincomefromtheunrelatedtrade(Php6M)doesnotexceed50%ofthetotalgross
income(Php16M).
Cecille 2C 05-06
68
SupposeanonstocknonprofiteducationalinstitutionhasPhp10Mfromeducational
activities,Php8Mfromtrading,andPhp2Mfrominterestincome.Whatwillbethetax
treatment?Whatifitisanonprofitproprietaryeducationalinstitution?
Income
Nonstock/Nonprofit
Proprietary/Nonprofit
Php10M
0%
10%
Php8M
0%
10%
Php2M
20%finaltax
20%finaltax
Interestincomeisnotincludedinthetaxableincome.
Forthenonstocknonprofiteducationalinstitution,theconstitutionalprovisionapplies.
Fortheproprietarynonprofiteducationinstitution,thepredominancetestwillnotapply
becausePhp8Mislessthan50%ofPhp18M.
Whatisthepredominancetest?
Asappliedtoproprietaryeducationalinstitutionsandhospitals,itmeansthatifthegrossincome
fromunrelatedtrade,businessorotheractivityexceeds50%ofthetotalgrossincomederivedby
sucheducationalinstitutionsorhospitalsfromallsources,the35%taxrateshallbeimposedon
theentiretaxableincome.Itshallbetaxedasanordinarycorporation.
Whatdoesthetermunrelatedtrade,businessorotheractivitymeanswhenappliedtothe
provisiononproprietaryeducationalinstitutionsandhospitals?
Itmeansanytrade,business,orotheractivity,theconductofwhichisnotsubstantiallyrelatedto
theexerciseorperformancebysucheducationalinstitutionorhospitalofitsprimarypurposeor
function.
AssumingAteneohasPhp20Mderivedfromactivityinpursuanceofitseducationalfunction
andithasPhp30Mderivedfromactivitytotallyunrelatedtoeducationalfunction,whatwill
bethetaxtreatmentofthePhp50M?Whattax?
Partoftheincomeisexemptwhilepartwillbesubjecttotax.Itwillbesubjecttothe10%
preferentialtaximposedonprivateeducationinstitution(Section27(B)).
Predominance Test
SupposingtheBIRsaysthattheentireamountshouldbesubjectto35%corporatetaxbecause
theunrelatedincomeismorethan50%oftherelatedincome?AndunderSection27,ifyoutax
itonthebasisofprivateeducationalinstitutionandyouapplythepredominancetext,the
entirethingwillbetaxedat35%.Isthatsointhiscase?
Itisnot.Youdonotapplythepredominancetesttothisconstitutionallyexemptcorporation.
The35%taxorthepredominancetestappliestotaxableprivateeducationalinstitutions.But
thereisamorebasicreason.Ifyouapplythe35%,thepredominancetest,thenthiswouldresult
inthetaxationofthePhp20Mincomewhichisconstitutionallyexempt.
Soyoudonotapplythe35%onthebasisofthepredominancetest,butsimplythe10%
preferentialtaxonprivateeducationalinstitutions.
SupposingthiswasUP,thebetterschool.Wouldthetaxtreatmentbethesame?Wouldthe
constitutionalprovisionapply?
Itwillnot.Becausetheconstitutionalprovisionappliestoprivateeducationinstitutions.
Butwhatwouldhappentotheincome?Wouldthatbeadissimilartreatment?
Itwouldnotbeadissimilartreatment.Section27,governmenteducationalinstitutionisan
exemptcorporation.
Cecille 2C 05-06
69

Sononprofit,nonstockprivateeducationalinstitutionsareconstitutionallyexemptunderthe
constitutionalprovisions;privateeducationalinstitutionswhichdonotqualifyunderthisare
taxedunderourincometaxcode,givena10%preferentialtaxtreatment;educationalinstitutions
areexemptcorporationsunderSection27.
Howaregovernmentcorporationstaxed?
ExceptonlyfortheGSIS,SSS,PHIC,PCSO,andPAGCOR,allsuchcorporationsaretaxableas
privatelyownedcorporationsengagedinasimilarbusiness,industryoractivity.I
Theexemptionsunderthisprovisionarenotexclusive.RefertoSections30and32oftheNIRC.
IfincomeofaGOCCwhichmaybeapublicutilityaccruestothegovernment,thenitisexempt.
Section27exclusionofGOCCisexpandedbySection32(B)(7)andSection30ongovernment
educationalinstitutions.Ifithaspassiveincome,thepassiveincomeistreatedequallyas
corporation.
Whatisminimumcorporateincometax(MCIT)?
UnderSection27(E),aminimumcorporateincometaxof2%ofthegrossincomeasoftheendof
thetaxableyearisherebyimposedonacorporation,beginningonthefourthtaxableyear
immediatelyfollowingtheyearinwhichsuchcorporationcommenceditsbusinessoperations,
whentheminimumincometaxisgreaterthanthetaxcomputedundersubsection(A)ofSection
27forthetaxableyear.
DomesticCorporation
Php10Mgrossincome
9.8Mdeductions
.2Mincome
ThisdomesticcorporationissubjecttoMCIT.2%ofPhp10Misgreaterthan35%ofPhp.2M,so
MCITistherateapplicable.
Whenshalltherebyacarryforwardoftheexcessminimumtax?
UnderSection27(E)(2),anyexcessoftheminimumcorporateincometaxoverthenormal
incometaxascomputedunderSection27(A)shallbecarriedoverandcreditedagainstthe
normalincometaxforthethreeimmediatelysucceedingtaxableyears.
CanyouapplyMCITifthecorporationhasnoincomeatallbutnotalosseither?
UnderRevenueRegulations,MCITappliesevenifthecorporationhasnoincome.Itisnotaform
oftaxingalosingcorporationbecausethecorporationisnotoperatingataloss.Thetaxwouldbe
2%onthegrossincomebecauseinthefirstplacethecorporationisnotlosing.
WhenisMCITsuspended?
TheSecretaryofFinanceisauthorizedtosuspendtheimpositionoftheminimumcorporate
incometaxonanycorporationwhichsufferslossesonaccountof:
(a) prolongedlabordispute;
(b) becauseofforcemajeure;or
(c) becauseoflegitimatebusinessreverses.
ThismeansyoudonotapplytheMCITbutyouapplythe35%regularcorporationtaxonthenet
income.
IsMCITapplicabletononresidentforeigncorporation?
No.Becauseitissubjectto35%onGROSSwhichisalwayshigherthan2%ofgross.MCIT
Cecille 2C 05-06
Taxation of Government
Corporations
Minimum Corporate
Income Tax
70
presupposesnormaltaxwhichisnotapplicabletononresidentforeigncorporation.
Whatisoptionalgrossincome?
TheconditionsforoptionalgrossincomearestatedunderSection27(A).Itauthorizesthe
Presidenttoallowcorporationstobetaxedat15%ofgrossincomeafterseveralconditionsare
met.
SupposingX,adomesticcorporationholdssharesofstockofadomesticcorporationworth
Php1MandofaforeigncorporationworthPhp1M.Whatisthetaxtreatment(notthe
dividendsbutthesale)?
Inthedomesticshares:
Php100KofthePhp1Mtaxedat5%
Intheforeignshares:
Itwouldbeincludedinthegrossincomewhichwillbetaxedat35%
Samefactsasabove.SupposingXInc.isaresidentforeigncorporation.
Inthedomesticshares:
Withregardtotheforeignshares,theproceedsofanysalewillnotbetaxed.
Whatistherulewhenadomesticcorporationsellsrealproperty?
Thedomesticcorporationwouldbetreatedinthesamewayasanindividualincomputingthe
capitalgainsfromsaleofrealpropertyprovidedthattherealpropertyshouldnotbeactually
usedinthebusinessandthatititstreatedasacapitalasset.Also,thepropertymustbesituated
inthePhilippinesbecausedeterminationoffairmarketvalueisdonebyprovincialandcity
assessorsasprovidedinSection6(E).
SupposingXInc.isadomesticcorporationengagedinleasing.IthasabuildinginQuezon
City,butithasnolesseeforthepast5years.Thenitsoldthebuilding.Whatisthetax
treatment?
Capitalgainstaxisnotapplicable.Forcapitalgainstobeapplicable,twoconditionsmusthave
beenmet:
1. thatthepropertyisnotactuallyusedinthebusiness;and
2. itistreatedasacapitalasset.
Inthiscase,thefactthatitwasntleaseddoesnotnecessarilymeanthatthetwoconditionsare
present.Revenueonsaleshouldbeaddedtothegrossincomesubjectto35%.
Ifhowever,thepropertyisheldasacapitalasset,thenitshallbesubjecttothecapitalgainstax
of6%onthefairmarketvalueorgrosssellingprice,whicheverishigher.
WhatifXInc.isaresidentforeigncorporationandgiventhesamefactsasabove?
Itwillnotbesubjecttotaxbecausethereisnocapitalgainstaxforforeigncorporation.Capital
gainstaxappliesonlytodomesticcorporation.
Whataretaxablepartnerships?
Partnerships,exceptgeneralprofessionalpartnerships,whetherregisteredorunregistered,are
treatedascorporationandsubjecttotaxassuch.Thepartnersareconsideredstockholdersand
therefore,profitsdistributedtothembythepartnershipareconsidereddividends.Thismeans
youapplythetaxrulesondividendsasregardsthepartners.
Cecille 2C 05-06
Optional Gross Income
Taxable Partnerships
71
WhathappenedinthecaseofOav.CIR?
Inthatcase,theheirshavepropertieswithOaasadministrator.Partitionwasapprovedbut
therewasnoattempttodividetheproperties.Propertiesremainedunderthemanagementof
Oa.Heinvestedtheincomederivedinrealpropertiesandsecurities.Theheirsdidnotreceive
theirsharesintheyearlyincome.
TheSCheldthatwhattheyhadwasanunregisteredpartnership.TheheirsallowedOato
continueusingtheirsharesaspartofthecommonfundfortheirventureswhichearnedprofit.
Fortaxpurposes,coownershipofinheritedpropertiesisautomaticallyconvertedintoan
unregisteredpartnershipthemomentthesaidcommonpropertiesandincomesderived
therefromareusedasacommonfundtoproduceprofits.
Supposing15personsboughtasweepstakesticket.Theycontributedmoneytobuytheticket.
TheticketwonPhp50K.Isitsubjecttoacorporatetax?
No.Itwasnotapartnershipbutacoownership.Why?Becausetheycontributedfundsfor
purposesofobtainingaproperty.Iftheycontributedtoacommonfundforthepurposeof
dividingtheprofitthenitisapartnership.
SupposingA,B,andCinheritedaparcelofland,6hectares.Theysoldthislandandreceived
Php100K.Isitsubjecttoprofittaxwhichmeansthattheyshouldbeconsideredasan
unregisteredpartnershiporsubjecttotaxofacoownership?
Thecourtsaidthatthereisnounregisteredpartnershipbecauseitwasjustameresharingof
returns.
Supposingtheyboughtan11hectareproperty.Theysoldthe4hectaresandtheproceeds
fromthesalewereusedforthepurposeofimprovingtheremaining7hectares.Thenthe
remaining7hectareswassoldforPhp5M.Werethesalessubjecttoacorporatetax?
Thefirstsaleof4hectarescannotbesubjecttoacorporatetaxbecausetheyonlyhadagross
returnbutthesecondsaleof7hectaresshouldbesubjecttoacorporatetaxbecauseatthattime,
therewasanunregisteredpartnershipalreadybecausetherewasacontributiontogainprofit.
Abought2parcelsofland.HegavethemtoB,C,D,andEwhowerebrothersandsistersfor
purposesofestablishingtheirrespectiveresidence.Theyabandonedtheresidentialplansand
soldthelandtothecorporationforPhp200K.Shouldtheybetaxableindividuallyorasa
partnership?
Ifwhatwassharedconsistsofthegrossreturnsonly,thenthereisnopartnership.Inthiscase,
therewasnointentiontoformataxableunregisteredpartnership.Thechildrenwerecoowners
pureandsimple.Theywerenotengagedinanyjointventurebyreasonofthatisolated
transaction.Thedivisionofprofitwasmerelyincidentaltothedissolutionofcoownership.To
paycorporateincometax,theremustbeanunmistakableintentiontoformapartnershiporjoint
venture.(Obillosv.CIR)
Butifuponreceivingthesaidlot,theindividualownersorthecoownerscontributedsomething
toimprovethelot,thenthereisalreadyunregisteredpartnershipbecausethereisalreadya
contributionforpurposesofearningprofit.
XandYin1999boughtrealpropertyworthPhp2M.XandYboughtrealpropertyworthPhp
5M.In2003,XandYsold1999realpropertyforPhp5M.In2004,XandYsold2001real
propertyforPhp10M.Willtheybetaxedasapartnership?
No.Thetransactionswouldnotbetaxableaspartnership.Thisisbecausethereisnoshowingof
intenttoengageinbusiness.Theremustbecontinuity.(Pascualv.CIR)
TheCourtsaidthatthisisanisolatedtransaction.Itdoesnotcomplywiththeprincipleof
partnershipbecauseinpartnership,thereshouldbeacontinuityorregularityofthetransaction.
Cecille 2C 05-06
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Buttherearealsoinstancesthattheintentionofthepartiesistogainprofit,inwhichcasethey
willbeconsideredasanunregisteredpartnership.
SupposingataxablepartnershipearnednetincomeofPhp1M.EqualsharingforpartnersA,
B,andC.Whatistaxedandhowtaxed?Whatwouldbedistributed?
Netincomeaftertaxwillbedistributedtopartners.Incomeshallbedistributedtopartnersas
dividendswhichshallbetaxedat10%.Whatisdistributedisconsideredascashdividends
subjectto10%tax.Thisscenarioisdifferentfromageneralprofessionalpartnership.Dividend
taxappliestosharesinataxablepartnership.
Intheprecedingexample,supposethatitisageneralprofessionalpartnership?
Ifitisageneralprofessionalpartnership,thenetincomedistributedwillbepartofthegross
incomeoftheindividualpartners.
WhatarethetwoelementsofpartnershipinPascualv.CIR?
Theelementsofpartnershipare:
1. anagreementtocontributemoney,property,orindustrytoacommonfund;and
2. intenttodividetheprofitsamongthecontractingparties.
Also,theremustbethecharacterofhabitualityorcontinuityofanagreementtoformabusiness.
Whatisajointventure?
Toconstituteajointventuretaxableasacorporation,thefollowingaretherequisites:
(a) eachpartytotheventuremustmakeacontributiontoacommonfundintheformof
capital,servicesorproperty;
(b) thepurposemustbetoobtainprofitsandtodividetheprofitsamongtheparties;
(c) thepartiesmusthaveajointproprietaryinterestandtherightofmutualcontroloverthe
subjectmatteroftheenterprise;and
(d) thepartiesmustbeconstitutedasasingleentity.
Whenisajointventurenottaxed?
UnderSection22(B),thefollowingjointventuresarenottaxable:
1. jointventureorconsortiumformedforthepurposeofundertakingconstruction
projects;or
2. jointventureorconsortiumformedforthepurposeofengaginginpetroleum,coal,
geothermal,andotherenergyoperationspursuanttoanoperatingorconsortium
agreementunderaservicecontractwiththeGovernment.
SupposingA,anindividual,andCInc.formedajointventurecalledA&CJointVentureto
engageinconstruction.TheJointVentureearnedPhp50M.DistributedPhp25Meachasnet
income.Whatisthetaxtreatment?
Thejointventureincomecouldbeexempt.Butoncedistributedtopartners,theamountshallbe
taxable.
Supposingajointventureisengagedinconsultancyservices.ItearnedPhp50M.Whatisthe
taxtreatment?
Priortodistribution,Php50Mwillbesubjectto35%corporatetax.Whenincomeisdistributed,
itshallbetaxedatthehandsofthejointventurerasdividends.CInc.sdividendsshallbe
exemptbecausesuchwillconsideredintercorporatedividends.However,Asdividendsshallbe
subjectto10%finaltax.
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Non-Taxable Joint
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Supposingthejointventureisaresidentforeigncorporation.Whatwouldbethetax
treatment?
Dividendsofaresidentforeignjointventurecorporationreceivedabyaresidentforeignjoint
ventureristaxable.
ThissituationisdifferentfromtheoneunderSection28(A)(7)(d)whichprovidesthat
dividendsreceivedbyaresidentforeigncorporationfromadomesticcorporationliabletotax
shallnotbesubjecttotax.Inthiscase,thejointventurecorporationisnotadomestic
corporation.
Inasituationwherethejointventureisanexemptcorporation,whatwillbethetaxtreatment
ofincomedistributedtoA,individualandBInc.,residentforeigncorporation?
Sincejointventureisexempt,taxconsequencewillbethesameasifjointventureisaGPP.Thus,
distributivesharegiventoAshallformpartofthelattersgrossincome.IncomereceivedbyB
Inc.shallbepartofthegrossincomesubjectto35%tax.(Leasanswer)
Supposingthereisjointventurecorporationwhichisadomesticcorporation.Oneofthejoint
venturersisadomesticcorporationandtheotheroneisaresidentforeigncorporation.
JointventurerRFCsdividendsareexempt.ThisisbecauseunderSection28(A)(7)(d),
dividendsreceivedbyaforeigncorporationliabletotaxfromadomesticcorporationshallnotbe
subjecttotax.
JointventurerDCsdividendsareexemptunderSection27(D)(4).
Problemariseswhenyouconsiderthejointventureraswhethertaxableornottaxableorwhen
partnershipistaxableornottaxable.
WhatisgrossPhilippinebillings(GBP)?
GPBforinternationalaircarrierreferstotheamountofgrossrevenuederivedfromcarriageof
persons,excessbaggage,cargoandmailoriginatingfromthePhilippinesinacontinuousand
uninterruptedflight,irrespectiveoftheplaceofsaleorissueandtheplaceofpaymentofthe
ticketorpassagedocument:Provided,thatticketsrevalidated,exchangedand/orindorsedto
anotherinternationalairlineformpartoftheGPBifthepassengerboardsaplaneinaportor
pointinthePhilippines:Provided,further,thatforaflightwhichoriginatesfromthePhilippines,
buttransshipmentofpassengertakesplaceatanyportoutsidethePhilippinesonanotherairline,
onlythealiquotportionofthecostoftheticketcorrespondingtothelegflownfromthe
PhilippinestothepointoftransshipmentshallformpartoftheGPB.
TheGPBruleundertheNIRCisadeparturefromtheoldrulewhichemphasizedwheretickets
wherebought.Now,weadopttheoriginatingrule.ThismeansthattoformpartofGPB,itmust
originatefromthePhilippines.
PAL Manila HongKong USA.Changedairplane.JapanAirlinestakingpassengerXto

US.WillGPBapply?
No.BecauseforGPBtoapply,thecarriermustbearesidentforeigncorporation.PALisa
domesticcorporationsoGPBwillnotapply.
US Tokyo Manila Bangkok Japan EuropeviaNorthwestAirlinesplane.Technical

difficultieswereencounteredbetweenTokyotoManila.Passengerswereendorsedtoanother
internationalcarrier,USAirways.WhatwouldformpartofGPB?
AmountofticketendorsedshallformpartoftheGPBofthecarryingairlinebecauseitisthat
airlinethatperformedthebusiness.ThepointisthatitmustoriginatefromthePhilippines.Here,
GPBappliesbecausethecarriersareonlinecarriers.
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PIAisanofflinecarriersellsticketsherebuttheserviceisrenderedinBangkokthenNew
York.NoflightsfromManila BangkoklegbutBangkok NewYork.WillGPBapply?
No.BecausenoservicewasperformedhereinthePhilippines.GPBappliesonlytoonline
carriers.
Supposethevalueoftheticketis$1,200buttheactualreceiptis$750,whatisthebasisofthe
GPB?
ThebasisofGPBisthevalueasstatedintheticket.Itdoesnotmatterwhatwasactuallypaid
becauseoftheprincipleofadministrativefeasibility.Itwillbeimpossibletocheckwhatexactly
thepassengersactuallypaidfortheticket.Whatappearsintheticketisprimafacieevidenceof
grossrevenuewhichimpliesthattheairlinecansubmitevidencetothecompany.
TowhomisGPBcharged?
Itischargedtothecarryingairline.Iftheticketisindorsedtoanotherairline,theGPBwillbe
chargedtothetransferee/indorsee.
Whatisthedifferencebetweenonlineandofflinecarriers?
OnlinecarrierspertaintocarrierswithlandingrightsinthePhilippineswhileofflinecarriers
arethosewithoutlandingrightsinthePhilippines.Eveniftheydonothavelandingrights,off
linecarriersmaysellticketsinthePhilippines.
DoesGPBapplytoofflinecarriers?
No.Itonlyappliestoonlinecarriersbecausethetaxpaidisbasedonactualservice.FortheGPB
toapply,theflightmustoriginatefromthePhilippines.TherulinginBOACcasenolonger
applies.
InthedissentinthecaseofBOAC,itwasarguedthatwhatisboughtisnottheticketwhichisa
merepieceofpaperbutservices.Inbuyingtickets,thepassengerisbuyingtheairlineservicenot
thepieceofpaper.Thus,itwasarguedthattaxshouldbeappliedwhereactualserviceswere
rendered.ThedissentwasthebasisofthenewruleasappearingintheNIRC.However,takenot
thattheplaceofactivityruleisstillagoodrule.Thishasnotyetbeenabandoned.Butasprovided
inNIRC,itisnolongerapplicableinGPB.
ThemainpointofJusticeFelicianoisthatyouarenotsimplybuyingapieceofpaperbutyouare
buyingtheairtransportservice.Whenitinvolvesservice,itshouldbetaxedwhereitwas
performed.
WhatistheabsurdityintheapplicationoftheBOACruling(placeofactivityargument)?
Thiscanbeseeniftheplaceofactivityruleisappliedtosituationsinvolvingsubscriptionof
magazines.SupposingyouarewalkingalongthestreetofAyalaandyoustopbyanewsstandto
getamagazine.Youflippedthroughthepagesandsawasubscriptionform.Youfilledupthe
formandenclosedyourpaymentandsentitabroad,toTimbuktu.Isitincomewithinevenifthat
magazinecompanyisinTimbuktu?Yes,becausetheactivityhappenedhere.Whatisthe
activity?Thesubscriptionandpayment.
Anotherexampleiscableoperation,whichservicedoesnothappenherebutinouterspace,but
theincomestopsoverhere.Why?BecauseyouarefillingupthesubscriptiontoCNNand
payingCNN.Thefillingupofsubscriptionisherealthoughthebeamingupofservicesandin
outerspacebeameddownhere.
Thus,thatistheimplicationoftheBOACruling.Aslongasithappenshere,itisincomehere.
Cecille 2C 05-06
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Supposingthereisaforeignvesselwhichwassailingintheinternationalwaters.It
encounteredenginetroubleanddockedinthePhilippines.Afterrepair,itloadedpassenger
andcargo.ThepassengerspaidhereinthePhilippinesandthevesselleft.Istheincome/gross
revenuesubjecttoGPB?
No.BecauseGPBappliestoresidentforeigncorporation.Inthiscase,thevesselisownedbyanon
residentforeigncorporationwithanisolatedtransaction.Therefore,itshallbesubjecttoa35%
corporatetax.
Whatisbranchprofitremittancetax(PRT)?
Section28(A)(5)provides,anyprofitremittedbyabranchtoitsheadofficeshallbesubjecttoa
taxoffifteen(15%)whichshallbebasedonthetotalprofitsappliedorearmarkedforremittance
withoutanydeductionforthetaxcomponentxxx
TheconceptofPRTwasintroducedin1975.Priortothis,thesituationwasaforeigncorporation
wouldputupabranchhereinthePhilippines.Itwouldalsoputupasubsidiary(domestic
corporation).TheremittanceofprofitsrealizedbythebranchfromPhilippinesourceswasnot
subjecttoincometaxwhilethesubsidiarywassubjecttothecorporateincometaxonitsnet
taxableincomeanditsdividenddeclarationtotheparentcompanyisadditionallysubjecttoa
withholdingtax.Incasethebranchearnsincome,itisonlytaxedonce(ontheremittance).The
remittancenottaxedonthetheoryofsameentity.Ontheotherhand,asubsidiarytaxedtwiceon
profitsandremittanceeventhoughinvolvingsameoperation.
Abranchofaresidentforeigncorporationshallbesubjectedtothefollowingtax:
35%corporatetax
15%profitremittancetax
Ontheotherhand,theamountdividendsreceivedbyanonresidentforeigncorporationfroma
domesticcorporationshallformpartofitsgrossincomesubjecttoa35%corporateincometax.
However,ifthecountryinwhichthenonresidentforeigncorporationisdomiciled,shallallowa
creditagainstthetaxduefromthenonresidentforeigncorporationtaxesdeemedtohavebeen
paidinthePhilippines,thenonlya15%finalwithholdingtaxfromsuchdividendsreceivedwill
becollected.Thisistheconceptoftaxsparingcredit.
Whatwouldbethetaxrateapplicableforprofitsrealizedbyabranchoffice?
Thebusinessofabranchofficeisthebusinessoftheparentcorporationsituatedabroad.Profits
realizedfromthebusinesswhichisconnectedwiththeforeigncorporationissubjecttoa15%tax
rate.
Torepeat,aprofitremittanceissubjectto15%tax.Butthatisaseparateimpositionapartfrom
thetotalpercentagetaximposedonthebranchitselfwhenwetalkofunrelatedbusinessincome
orothertaxablereceiptwhichthebranchofficereceives.
SupposingabranchengagesinbusinessandearnsPhp10M.Canthebranchremitthewhole
amounttheoretically?
No.Youhavetopay35%corporatetaxandprofitsremittedshallbesubjectto15%PRT.
WhatthenisthetaxtreatmentofabranchofficeorsubsidiaryinthePhilippinesofaforeign
corporation?Why?
Ifaforeigncorporationhasabranch,thenitistreatedasanRFCwhileifithasasubsidiarythen
itistreatedasnonRFC.ItshallbetreatedasRFCifhavingabranchhereifitconductsitbusiness
throughthebranch.Ifitsbusinessisnotconductedthroughthebranch,thenitshallbetreatedas
nonRFC.
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Tax
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Thetaxtreatmentisthetreatmentgiventoanonresidentforeigncorporation.Becausewhenthe
foreigncorporationbypassesthebranchofficeanddoesbusinesswithanother,itdoesbusiness
onitsown.Itdoesnotdobusinesswiththebranchoffice,becauseifitdoesthenitisaresident
foreigncorporationdoingbusiness.
Ifitisaprofitremittance,itissubjecttoa15%taxotherwise,itissubjectto35%dividendtax.
WhathappenedinthecaseofMarubeniv.CIR?
Inthatcase,MarubeniJapanhasanequityinvestmentinAG&P,Manila.AG&Pdeclaredcash
dividendswhichwasdirectlyremittedtotheMarubeniJapan(headoffice)andnottothe
MarubenibranchhereinthePhilippines.Theissueiswhetherthedividendsreceivedby
MarubeniareconnectedwiththebusinessinthePhilippinesastobeconsideredbranchprofit
subjectto15%profitremittancetax.
TheSCheldthatthegeneralrulethataforeigncorporationisthesamejuridicalentityasits
branchofficecannotapplyhere.Theruleisbasedonthepremisethatthebusinessoftheforeign
corporationisconductedthroughitsbranchofficefollowingtheprincipalagentrelation.So,
whentheprincipaltransactsbusinessinthePhilippinesindependentlyofitsbranch,the
principalagentrelationissetasidethusmakingthetransactiononeoftheforeigncorporation
andnotofthebranch.Inthiscase,thetaxpayeristheforeigncorporationandnotthebranch.
Thus,thetaxapplicableisthatfornonresidentforeigncorporation.
SupposingXisaninternationalcorporationsituatedintheU.S.Italsohasasubsidiary
situatedalsointheU.S.TheU.S.subsidiaryhasabranchofficehereinthePhilippines.
SupposingthebranchofficehasaprofittoberemittedtotheparentcorporationintheU.S.
However,insteadofremittingit,theprofitisgiventotheregionalheadquartersfor
operationsoftheinternationalcompanywhichistheparentofthesubsidiary(thesubsidiary
isthemotherofthebranch).Willitbeconsideredasremittance?
Yes.Thisissubjecttoprofitremittancetaxbecauseourincometaxlawspeaksofdirector
indirectremittance.Anyformofremittance,directorindirect,madetotheheadofficeabroad
shallbepresumedtohavebeenmadefromtheaccumulatedprofitsofthebranch.
SupposingU.S.MultinationalhasaregionalheadquartershereinthePhilippines.U.S.
MultinationalalsohasasubsidiaryintheUSwhichsubsidiaryhasabranchofficehereinthe
Philippines.ThebranchofficeofthesubsidiarycontractedwithNPCandearnedPhp10M.
Then,U.S.MultinationaltoldsubsidiarytotellbranchofficetopayRHQforadministration
expenses.IsthissubjecttoPRT?
ThepaymenttotheRHQisanindirectremittancewhichwouldbesubjecttoPRT.
SupposingMarubenienteredintoacontractwithNPCtodoaproject.Mhasbeencontracting
someoftheworktoHitachiPhilippineswhichisabranchofficeofHitachi,Tokyo.WhatM
didwastopaytoHitachi,Tokyo.UponreceiptofthepaymentbyHitachi,Tokyo,itremitteda
certainamounttothebranchofficehereforpaymentoftheexpensesincurredindoingwork.
IsHitachi,Philippinessubjecttoaprofitremittancetax?
Yes.BecauseeventhoughttheprofitwasgivenbyHitachi,TokyotoHitachi,Philippines,the
paymentsrepresentedprofitofthebranchbeingremittedbecauseitwastheHitachibranchhere
thatdidthework.
Alltheprofitswhichwerepaidtothemotherofficerepresentprofitsmadebythebranchoffice
andthereforeshouldbesubjecttoprofitremittancetax.
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Whatisthetaxbaseofthe15%profitremittance?
UnderSection28(A)(5),PRTshallbebasedonthetotalprofitsappliedorearmarkedfor
remittancewithoutanydeductionforthetaxcomponentthereof.
Beforethe1997NIRCandasheldinthecaseofBankofAmericav.CourtofAppeals,the15%PRTis
basedonprofitsactuallyremittedandnottheamountpriortoPRT.However,withthe
promulgationofthe1997NIRC,theBankofAmericadoctrineisnolongerapplicable.Thebasis
nowisthetotalprofitswithoutanydeductionforthetaxcomponentthereof.
Whatisthesocalledtaxsparingcredit?
ThismeansthatthetaxreducedbythePhilippinesshouldbefullyappliedorcreditedtothetax
ondividendincomereceivedbythenonresidentforeigncorporationimposedbythecountryof
itsdomicile.Itservesasanincentivetoforeigninvestorsbyreducingtheirtaxliabilityinthe
Philippinesandintheirresidencecountries.
Example:
AInc.,adomesticcorporation,paidcashdividendofPhp100Ktoanonresidentforeign
corporationorganizedinBrazil.Brazilimposesanincometaxof30%ondividendsreceivedby
Brazilincorporations.
IfBrazilcollectsanincometaxof10%onthePhp100Kdividendincome,ithasineffectallowed
ataxcreditof20%(30%incometaxless10%taxcollected).Sincethetaxcreditisallowedisat
least20%,thentherateoftaxtobewithheldandpaidtothePhilippinegovernmentonthePhp
100Kdividendincomewillbe15%only.Ontheotherhand,shouldBrazilcollecttheusual30%
tax,thetaxtobewithheldandpaidtothePhilippinegovernmentwillbe35%.
Isanonresidentforeigncorporationsubjecttocapitalgainstaxonsaleofsharesofstockofa
domesticcorporation?
Yes.Whatiscontrollingisthatthesharesarethatofadomesticcorporation.Itdoesnotmatter
whothesellerisorwherethesharesweresold.ThisisinaccordancewithSection42.
Whatisimproperlyaccumulatedearningstax(IAET)?
UnderSection29(B),improperlyaccumulatedearningstaxshallapplytoeverycorporation
formedoravailedforthepurposeofavoidingtheincometaxwithrespecttoitsshareholdersor
theshareholdersofanyothercorporation,bypermittingearningsandprofitstoaccumulate
insteadofbeingdividedordistributed.Itisimposedforeachtaxableyearequaltotenpercent
(10%)oftheimproperlyaccumulatedtaxableincome.
Wherewillthistaxapply?
Onlytoimproperlyaccumulatedearnings.
WillacorporationsubjecttoIAETstillbesubjecttocorporatetax?
Yes.ItistheimproperlyaccumulatedearningsthatwillbesubjecttotheIAET.Itshallstillbe
requiredtopayitscorporatetax.
Whohastheburdenofprooftoshowthatearningsarenotimproperlyaccumulated?
Thetaxpayerhastheburdenofproof.Todischargetheburden,thetaxpayershouldshowthe
reasonableneedsofthecorporation.
UnderSection29(C),thefactthatanycorporationisamereholdingcompanyorinvestment
companyshallbeprimafacieevidenceofapurposetoavoidthetaxuponitsshareholdersor
members.Also,thefactthattheearningsorprofitsofacorporationarepermittedtoaccumulate
beyondthereasonableneedsofthebusinessshallbedeterminativeofthepurposetoavoidthe
taxuponitsshareholdersormembersunlessthecorporation,bytheclearpreponderanceof
Cecille 2C 05-06
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Improperly Accumulated
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78
evidence,shallprovetothecontrary.
IsIAETapenaltytax?
Yes.Therationaleisthatiftheearningsandprofitsweredistributed,theshareholderswould
thenbeliabletoincometaxthereon,whereasifthedistributionwerenotmadetothem,they
wouldincurnotaxinrespecttotheundistributedearningsandprofitsofthecorporation.This
taxisimposedasaformofdeterrenttotheavoidanceoftaxuponshareholderswhoare
supposedtopaydividendstaxontheearningsdistributedtothembythecorporation.
Whatcorporationsarecovered?
Itshallapplytoeverycorporationformedoravailedforthepurposeofavoidingtheincometax
withrespecttoitsshareholdersortheshareholdersofanyothercorporation,bypermitting
earningsandprofitstoaccumulateinsteadofbeingdividedordistributed.However,itshallnot
applytothefollowing:
(a) Publiclyheldcorporations;
(b) Banksandothernonbankfinancialintermediaries;and
(c) Insurancecompanies.
Arenonresidentforeigncorporationscovered?
No.Thelawcontemplatesofacorporationwhichisdoingbusinesshere.Thatiswhythebasic
defenseisreasonableneedsofbusiness.Nonresidentforeigncorporationsdoundertakeany
businesshereinthePhilippines.
WhathappenedinthecaseofCynanamidPhil.Inc.v.CA?
Inthatcase,theCIRisdemandinga25%surtaxonimproperlyaccumulatedprofitsfor1981from
Cynanamid.In1985,Cynanamidprotestedtheassessmentclaimingthattheprofitswere
retainedtoincreaseitsworkingcapitaltobeusedforreasonablebusinessneedsofthecompany.
TheissuewaswhetherCynanamidsaccumulatedearningsarenecessarytometreasonable
businessneeds.
TheSCheldthattheaccumulatedearningsarenotnecessarytomeetreasonablebusinessneeds.
Itsfinancialstatementrevealsthatithadconsiderableliquidfundsadequatetomeetthenormal
demandsofthebusiness.Inordertodeterminewhetherprofitsareaccumulatedforthe
reasonableneedsofthebusinesstoavoidsurtaxuponshareholders,itmustbeshownthatthe
controllingintentionofthetaxpayerismanifestedatthetimeoftheaccumulation,notintentions
declaredsubsequently,whicharemereafterthoughts.Furthermore,theaccumulatedprofits
mustbeusedwithinareasonabletimeafterthecloseofthetaxableyear.Inthiscase,Cynanamid
didnotestablishbyclearandconvincingevidencethatsuchaccumulationofprofitwasforthe
immediateneedsofthebusiness.
IftheCynanamidcaseistobedecidedunderthenewlaw,wouldtherulingbethesame?
Underthepresentlaw,reasonableneedsincludereasonablyanticipatedneeds(forfutureneeds)
ofthebusiness.Thisprovisionalreadyeliminatedtheimmediacytest.Thebasicrequirementof
reasonablyanticipatedneedsisthattheneedmustbedefiniteandspecific.Itmustbesupported
byfeasibilitystudiesandbusinessplanswhichshouldnotbemerespeculations.
Shouldtaxavoidancebethedominatingpurpose?
Taxavoidancedoesnothavetobethesoleandprimarypurposeoftheaccumulation.Thelaw
presumesthattheaccumulationisproper.
UnderthecaseofU.S.v.Donruss,thefactthattheearningsandprofitsofacorporationare
permittedtoaccumulatebeyondthereasonableneedsofthebusinessshallbedeterminativeof
thepurposetoavoidincometaxwithrespecttoshareholders,unlessthecorporationbya
preponderanceofevidenceshallprovetothecontrary.Thetaxpayermustestablishby
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preponderanceofevidencethatsuchtaxavoidancewithrespecttoshareholderswasnotoneofthe
purposesfortheaccumulationofearningsbeyondthereasonableneedsofthebusinessand
cannotrebutsuchpresumptionsimplybydemonstratingthattaxavoidancewasnotthe
dominant,controlling,orimpellingpurposefortheaccumulation.
IsitpossiblethatanexemptcorporationunderSection30wouldstillbetaxable?
Yes.LastparagraphofSection30provides,Notwithstandingtheprovisionsinthepreceding
paragraphs,theincomeofwhateverkindandcharacteroftheforegoingorganizationsfromany
oftheirproperties,realorpersonal,orfromanyoftheiractivitiesconductedforprofitregardless
ofthedispositionmadeofsuchincome,shallbesubjecttotaximposedunderthisCode.
WhatkindofincomeisexemptunderSection30?
Thelawexpresslysaysthattheorganizationsshouldnotbetaxedinrespecttoincomereceived
bythemassuch.Itonlyexemptsincomereceivedbythemassuchwhichshouldmeanthose
derivedinrelationtothenature,characterandpurposesoftheexemptorganization.If
unrelated,itbecomestaxable.Itisalsotaxablewithrespecttothoseenumeratedinthelast
paragraphofSection30.
Whatkindsofincomeoftheexemptorganizationarenotexempt?
(1) Incomefromanyoftheirproperties;and
(2) Incomefromanyoftheiractivitiesconductedforprofitregardlessofthedisposition
madeofsuchincome.
Supposingfeesarepaidtothereligiousorderforhouseblessings,burialservices,andfor
sayingofmasses.Arethesetaxable?
No.Theseareexemptincomebecausetheseareincomereceivedassuchbyareligious
organization.Ifthefeesarepocketedbythepriest,thenitistheincomeofthepriestandnottax
exempt.
Supposingareligiousorganizationsponsorsafashionshow,areligiouscauseandthe
proceedswillbeusedforputtingupashrine.Wouldtheincomefromsuchfashionshowbe
exempt?
Nobecauseitshouldbeincomeassuch.Thereisnorelationbetweenthefashionshowandthe
functionofthereligiousorganization.
Supposingacharitablehospitalwhichchargesnominalfee.Taxable?
Theincomeofacharitablehospitalwillbeexemptandthenatureofthecharitablehospital
wouldnotbeaffectedevenifthecharitablehospitalwouldchargenominalfees.Youcouldstill
arguethatitisincomeofthecharitablehospitalassuch.Exemptcorporationsarenotprohibited
fromearningincome.However,tobeexempt,incomemustbenecessaryorincidentaltothe
accomplishmentofitspurpose.
Supposingyouhaveasocialclub,theAteneoUPsocialclubapleasure/recreationclub
whichisoneoftheexemptorganizations.Theclubboughta20hectarepropertyforahunting
ground,forpleasure,recreation,socialactivities.Wouldincomefromsaidpropertytaxable?
Aslongasthatpropertyisbeingusedforthesocialclub,therewouldntbeaprobleminthe
incomeofthatproperty.Themembershipduesandpropertyfeespaidbythemembersare
exempt(incomeassuch).
Supposingareligiouscorporationboughtin1970apropertyworthPhp10M.In2000,itsold
thepropertyforPhp30Minordertobuildabiggerchurch.Thiswastheonlytransactionthat
ithadfor3decades.Isitsubjecttotax?
Yes.Itistaxablebecauseitisincomefromaproperty.Itistaxableregardlessofwhetheritis
profitornot.Incomeistaxablebecauseitisderivedfromproperty.Incomefromanypropertyof
Cecille 2C 05-06
Tax Exempt Corporations
80
exemptorganizationsaswellasthatarisingfromanyactivityitconductsforprofitistaxable.
Thephraseanyoftheiractivitiesconductedforprofitdoesnotqualifythewordproperties.
Incomefrompropertyoforganizationsistaxableregardlessofhowthatincomeisused.(CIRv.
CA/YMCA)
IntheYMCAcase,howdidthecourtexplainthelastparagraphofSection30?Howshouldit
beconstrued?
Incomefromanypropertyofexemptorganizations,aswellasthatarisingfromanyactivityit
conductsforprofitistaxable.Thephraseanyoftheiractivitiesconductedforprofitdoesnot
qualifythewordproperties.Thismakesincomefromthepropertyoftheorganizations
taxable,regardlessofhowthatincomeisusedwhetherforprofitorforloftynonprofit
purposes.
Thelastparagraphshouldbestrictlyconstrued.Aslongasitisincomefrompropertythenitis
taxable.UnderSection30,thefollowingshallbesubjecttotaxregardlessofthedispositionmade
ofsuchofsuchincomebyexemptorganizations:
(1) incomefromproperty;or
(2) fromanyoftheiractivitiesconductedforprofit.
InCIRv.CA/YMCA,whatisthecoverageofthetermeducationalinstitution?
TheSCheldthatitreferstoschools.Theschoolsystemissynonymouswithformaleducation
whichreferstothehierarchicallystructuredandchronologicalgradedlearningsorganizedand
providedbytheformalschoolsystem.
Arethelimitationsimposeduponexemptedcorporationsapplytononstocknonprofit
corporations(educationalinstitution)?
No.Astatutoryprovisioncannotlimittheconstitutionalprovisions.Thrustofargumentis
constitutionalshouldprevailoverthestatute.Theinsertionofnonstocknonprofiteducational
institutionwasnotexplainedbyCongress.Theprovisionalsoseparatedgovernmenteducational
institution.SeparatingnonstockfromgovernmentinstitutioninSection30wouldimplythat
theyarenotthesamething.ButaBIRrulingsaidthatgovernmentinstitutionisexemptandthis
istillgoodlawbecausetheconstitutiondidnotsaynotincludinggovernmentinstitution.
WhyisitthatunderSection30,governmenteducationalinstitutionwasseparateanddistinct
fromnonstocknonprofiteducationalinstitution?Whyaretheytreateddifferently?
Becauseifyoutreatgovernmenteducationalinstitutionasnonstocknonprofit,thenthe
constitutionalprovisionmaybeapplied.
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81

SOURCEOFINCOMERULES
WhatisthesourceruleunderSection42?
Thesourceruleisthestatutoryrulewhichtellsyouwhenincomeiswithinandwhenincomeis
withoutorwhenincomeispartlywithinandpartlywithout.
Whyarethesourcesrulesimportant?Towhomisitimportant?
Thesourceruleisimportantbecausewhentaxpayersareonlytaxableintheincomewithinand
theyarenottaxableonincomewithoutthenyouaretalkingofnonresidents.
Itisimportanttothosewhoaretaxableontheirincomewithinbecausetheirdefenseisalways
theirincomeiswithout.Itisnotimportanttocitizensandresidents.Itisnotasimportantasto
residentforeignandnonresidentforeign.Residentcitizensaretaxedonincomewithinand
withoutbuttherulesareimportanttothemwhenyoutalkaboutpartlywithinandpartly
withoutfortheallocationofdeductions.Itisalsoimportanttononresidentcitizensfortheyare
onlytaxableonincomederivedfromsourceswithinthePhilippines.
Whyisitimportanttoresidentforeignandnonresidentforeignortoaliens?
Inmostcases,nonresidentsdefenseisthatthisincomeisfromwithoutsotheruleshavetobe
definiteonwhichareincomewithinandwhichareincomewithout.Thisisanargumentwhich
isnotavailabletoresidentcitizens.
Whenareinterestsconsideredwithin?
Incomeiswithinwhentheinterestincomecamefromanyinterestearningtransactionwithin.
InterestsderivedfromsourceswithinthePhilippines,andinterestsonbonds,notesorother
interestbearingobligationofresidents,corporateorotherwise.
Thetestisthedebtorsresidence.Thus,ifthedebtorhasresidenceinthePhilippines,theninterest
incomeearnedbythecreditorisderivedfromPhilippinesources.Ontheotherhand,ifthe
debtorresidesoutsideofthePhilippines,theninterestincomeisderivedfromsourceswithout
thePhilippines.
SupposingadomesticcorporationborrowsfromaCanadianbank.Loansareevidenceby
promissorynoteswhichwereexecutedinCanada.Wouldtheinterestincomebesubjectto
Philippinetax?
Yes.Aslongastheobligorisaresident,thenitisincomewithin.TheCanadianBankistaxable.
WhathappenedinthecaseofNDCv.CIR?
Inthatcase,theNationalDevelopmentCorporation(NDC)enteredintocontractsinTokyowith
severalJapaneseshipbuildingcompaniesfortheconstructionof12oceangoingvessels.The
purchasepricewastocomefromtheproceedsofbondsissuedbytheCentralBank.14
promissorynotesweresignedforthebalancebytheNDCandguaranteedbytheRepublicofthe
Philippines.Pursuantthereto,theremainingpaymentsandintereststhereonwereremittedby
theNDCtoTokyo.ThevesselsweredeliveredtotheNDCinTokyo.Takenotethatinthiscase
theagreementswereenteredinJapan,thevesselswereconstructedinJapan,thepromissory
noteswereexecutedanddeliveredinJapan,andinshorteverythingwasmadeinJapan.The
issueiswhethertheinterestpaymentspertainingtothetransactionexecutedabroadisincome
withinbecausetheJapaneseshipbuildersaresayingthatitisincomewithoutandthereforenot
taxableasfartheshipbuildersareconcerned.
TheSCsaidthatitisincomewithin.Why?Becausethelawisspecific.Youhavewhatyoucall
theresidenceoftheobligorrulewhichiswhatthelawissaying.Ifthedebtorisaresident
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Section 42
Importance of the
Sources Rules
82
corporationorindividual,thentheinterestarisingfromsuchindebtednessisincomewithin
regardlesswherethetransactionwasmadeandregardlessofwherepaymentwasmade.The
expressprovisionofthelawisinSection42.Theinterestisincomewithinsointhiscase,the
nonresidentJapanesecorporationsaretaxable.
Thelawdoesnotspeakofactivitybutofsource,whichinthiscaseisNDC,adomesticand
residentcorporationwithprincipalofficesinManila.Theresidenceoftheobligorwhopaysthe
interestratherthanthephysicallocationofthesecuritiesortheplaceofpaymentisthe
determiningfactorofthesourceofinterestincome.
Howaredividendstaxed?Whataretaxabledividends?Whyarethesedividendstaxable?
Cashdividendsandpropertydividendsaretaxabledividendssubjecttofinalwithholdingtax.
Wherethereisaflowofwealthimmediatelyresultinginwealthtoshareholder,suchasin
cash/propertydividends,thenitistaxable.Forstockdividends,thereisnorealization.Stock
dividendsaretiedtothecorporationbecauseitformspartofthecapital.
Whenisstockdividendtaxable?
UnderSection73(B),Astockdividendrepresentingthetransferofsurplustocapitalaccount
shallnotbesubjecttotax.However,ifacorporationcancelsorredeemsstockissuedasa
dividendatsuchtimeandinsuchmannerastomakethedistributionandcancellationor
redemption,inwholeorinpart,essentiallyequivalenttothedistributionofataxabledividend,
theamountsodistributedinredemptionorcancellationofthestockshallbeconsideredas
taxableincometotheextentthatitrepresentsadistributionofearningsorprofits.
Redemptionandcancellationaregenerallyconsideredcapitaltransactionssoassuchtheyare
notsubjecttotax.Butlookingatthecircumstances,theproceedsofredemptionofstock
dividendsmayamounttoadistributionofcashdividends.Here,thecorporationredeemsthe
stockinthehandsoftheshareholderbypayingcashtohim.Thisprocessofissuanceredemption
amountstoadistributionoftaxablecashdividendswhichwasjustdelayedsoastoescapethe
tax.Thistransactionwillbetaxed.(CIRv.ANSCOR)
Isaresidentalienwhoreceivesdividendsfromaforeigncorporationliabletotax?
Yesif50%oftheworldwideincomeoftheforeigncorporationcomesfromsourceswithinthe
Philippinesbutonlyinanamountwhichbearsthesameratiotosuchdividendsasthegross
incomeofthecorporationderivedfromsourceswithinbearstoitsgrossincomefromallsources.
Iftheforeigncorporationhaslessthan50%ofthegrossincomederivedfromsourceswithinthe
Philippines,thennotwithinthePhilippines.If50%ormoreofgrossincomeofworldwide
incomecomesfromwithin,thensourceswithinthePhilippines(proportionateruleapplies).
Wheniscompensationforservicesconsideredincomewithin?Whenisitconsideredincome
without?
Themainpointwhenyouaretalkingofservicesiswhereitwasperformed.Iftheserviceis
performedhere,thenthecompensationisconsideredincomewithin.Ifserviceswereperformed
abroad,thenthecompensationforservicesisincomewithout.Thisisregardlessofwherethe
paymentwasmadeorwherethecontractofemploymentwasexecuted.
SupposingtheNTCgetstheservicesofaforeignconsultanttopreparefeasibilitystudies
regardingageothermalproject.Theprojecthasacomponentwhichhastobeperformedhere.
Whatwillbethetaxconsequence?
Theruleiswhereperformed.Soyouhavetoapportionwhichpaymentwasmadeforhis
serviceshereorabroad.
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Tax on Dividends
Compensation for
Services
83

Supposingaresidentaliensignsanagreementwithacorporationforworktobedonein
Japan.ThecontractisworthPhp10M.ThecontractisexecutedandsignedinthePhilippines.
ButtheserviceistobedoneinJapan.Istheservicetaxable?
No.Themainconsiderationofthecontractistheserviceandnotthesigning.Signingisnotthe
mainactivityofthecontract.BOACrulingisnotapplicableherebecausewhatiscontemplatedis
theperformanceofservice.
Basisiswheretheserviceswereperformed.Ifpartlywithin,usetheformula.Taxationof
services,whereperformed,alsohasasituationofservicesperformedpartlywithinandpartly
without.Exampleisservicerenderedbytelephonecallcenters.
Ifthecontractclearlytalksaboutservice,thenyouapplyservicerule.Butiftheactivityisthe
mainconsideration,thenapplyplaceofactivityrule.
WhatwasheldbytheSCinthecaseofCIRv.Marubeni?
Thiscaseinvolved2contractswhichweresignedherebutserviceswerepartiallyperformedin
JapanandpartiallyperformedinthePhilippines.TheCourtappliedtheservicerule.Itruledthat
servicesperformedoutsidearenottaxable.
Whatistherulewhenitcomestorentalsandroyalties?
Incomefromrentalflowfrompropertysituatedwithinincludingtherighttousetheproperty
withinwillallbeconsideredincomewithin.
AnexampleistheuseofMcDonaldsfranchisehere.Itshallbeconsideredincomewithin.Itisno
differentfromtheprincipalwherethepropertyislocatedwhenyoutalkofrentalorroyalties.
Whenthepropertyislocatedhere,itisincomewithin.Theuseofpropertyoftherighttouse
propertyisincomewithin.
Incaseofrentalandroyaltiesfromthesaleorexchangeofproperty,youhavetodistinguish
whetheritisrealpropertyorpersonalproperty.
Whenisincomefromsaleofrealpropertyincomewithin?Whenisitincomewithout?
Ifthepropertyislocatedwithin,itisincomewithin.Ifthepropertyislocatedwithout,itis
incomewithout.Why?Whatisthesitusrule?Thesitusrulewithregardtorealpropertyitits
location.Theruleisabsolute.
Whataboutinterestinthepropertylikeleasehold?
Ifthereisleasehold,thenthereispaymentofrentals.SincethepropertyisinthePhilippines,
thentheincomeiswithin.
Whatistheruleonthesaleofpersonalproperty?Isittaxable?
Incomederivedfromthepurchaseandsaleofpersonalpropertyistreatedasderivedentirely
fromthecountrywhereitissold.However,theruleisdifferentwithregardtothesaleofstock
ofadomesticcorporation.
Forpersonalproperties,thefollowingrulesapply:
Producedhereandsoldwithout incomepartlywithin,partlywithout
Producedhereandsoldhere incomewithin
Producedabroadandsoldhere incomepartlywithin,partlywithout
Incaseofpurchase,theruleiswheresold
Purchasedwithoutandsoldwithin incomewithin
Purchasedwithinandsoldwithout incomewithout
Purchasedwithinandsoldwithin incomewithin
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Rentals and Royalties
Sale of Real Property
Sale of Personal Property
84
Taxpayersellsitabroadthroughasalesoffice incomepartlywithin,partlywithout(gain,
profit,orincome)
IfXproducesithere,sellsithereitisincomewithin.Butwhenhesellsitabroad,itispartly
incomewithinandincomewithout.Forexample,supposingchildrensdressmanufacturehere
costsPhp300each.IfitissoldhereforPhp500,thePhp200isincomewithinbecauseitwas
manufacturehereandsoldhere.Supposingthissaleofapparelwasproducedhereandsold
abroadforPhp700.SinceitwouldhavesoldhereforPhp500(sothereisPhp200income
withint)thentheresanotherPhp200asincomewithout.Thisisthecontemplationofthelaw.
Thus,incomeispartlywithinandpartlyincomewithout.
Thecontemplationofthelawiswhenitissold(whichpresupposesthatthetaxpayerherehasa
salesofficeabroad),itwassoldbythesalesofficeabroad.Thatiswhyitisincomethatispartly
withinandpartlywithout.Supposingitwasastraightexport:itwassimplyexported,sold,and
paiduponpresentationofdocument.Isitpartlywithinandpartlywithout?Itiswithinbecause
hedidnotdothesellingabroad.Itwastechnicallysoldhere.Whydowehavethisconcept?For
purposesofdeduction.Whichdeductionpertainstoincomewithinandwhichdeduction
pertainstoincomewithout?Well,thatistheconcept:producedherethensoldabroad.
X,aresidentofSingapore,wenttoManilaandboughtPLDTsharesfromacitizen.Then,X
soldittoanAmericaninNewYork.Incomewithin?
Ifyouaretalkingofdomesticsharesofstock,anygainisincomewithinregardlessofwhereitis
soldandregardlessofwhothebuyeris.Anywhere,anybody,itisstillincomewithin.
Gainsfromsailofsharesofstockofadomesticcorporationisalwaysincomewithinregardless
ofwhothebuyer/transferorisandregardlessofwheretheplaceofpaymentis(becauseofactual
businesssitusrule).
Whyistheprovisiononincomepartlywithinandpartlywithoutimportant?
Thisisimportantbecauseoftheallocationofexpensesanddeductionspertainingtothistypeof
income.Taxpayersalwaysargueclaimingexpensesanddeductionsthatiswhythereisthisrule
onallocationonkindofincomewhetheritisfromwithinorwithout.Also,thisistoavoid
administrativedifficulty.
Whatisincludedinthewordssaleorsoldandproduced?
Thewordssaleorsoldincludeexchangeorexchangedwhilethewordproducedincludescreated,
fabricated,manufactured,extracted,processed,cured,oraged.
Cecille 2C 05-06
Income Partly Within and

Partly Without
85
ESTATESANDTRUSTS
Definitionofterms
Estatereferstoalltheproperty,rightsandobligationsofapersonwhicharenot
extinguishedbyhisdeathandalsothosewhichhaveaccruedtheretosincetheopening
ofsuccession.
Decedentisthegeneraltermappliedtothepersonwhosepropertyistransmittedthrough
succession,whetherornotheleftawill.Ifheleftawill,heisalsocalledthetestator.
Heiristhepersoncalledtothesuccessioneitherbytheprovisionofawillorbyoperationof
law.
Deviseeisapersontowhomagiftofrealpropertyisgivenbyvirtueofawill.
Legateeisapersontowhomagiftofpersonalpropertyisgivenbyvirtueofawill.
Trustororgrantoristhepersonwhoestablishesatrust.
Trustisanarrangementcreatedbywilloranagreementunderwhichtitletopropertyis
passedtoanotherforconservationorinvestmentwiththeincometherefromand
ultimatelythecorpus(principal)tobedistributedinaccordancewiththedirectionsof
thecreatorasexpressedinthegoverninginstrument.
Trusteeistheoneinwhomconfidenceisreposedasregardspropertyforthebenefitof
anotherperson.
Beneficiaryisthepersonwhosebenefitthetrusthasbeencreated.
Fiduciaryisthegeneraltermwhichappliestoallpersonsorcorporationsthatoccupy
positionsofpeculiarconfidencetowardsothers,suchastrustees,executors,or
administrators.Forincometaxpurposes,afiduciaryisanypersonorcorporationthat
holdsintrustanestateofanotherpersonorpersons.Thetermmeansaguardian,
trustee,executor,administrator,receiver,conservatororanypersonactinginafiduciary
capacityforanotherperson.
Underthelaw,whataretreatedasseparatetaxableentities?
UnderSection60(A),thefollowingaretreatedasseparatetaxableentities:
(1) Estatesofdeceasedpersonsunderadministrationorsettlement;
(2) Trustswheretheincomeistobeaccumulatedorheldforfuturedistributionbythe
fiduciary;
(3) Trustswheretheincomemaybeeitheraccumulatedordistributedatthediscretionof
thefiduciary;and
(4) Trustswheretheincomewhichistobedistributedcurrentlybythefiduciaryoris
collectedbyaguardianofaninfanttobeheldordistributedasthecourtmaydirect.
Whyisanestateaseparatetaxpayer?
Inestateandtrust,whatistaxedistheincome.Theestateisataxableentitywhentheestateis
subjecttoajudicialproceedingbecausethenthereisanexecutor/administratorwhoisthe
taxpayer.Inthissense,theestatebecomesataxableentity.Iftheestatehasrealpropertyand
personalproperty,thesepropertiesmayearnincome.Whatissubjecttotaxisnottheproperty
leftbuttheincomeofthepropertyleftbythedecedent.Incomegeneratedbythepropertyofthe
estateduringtheperiodofthesettlementissubjecttotax.
Inthecaseoftrustwhichhasgrantor,grantee,trustor,trustee,andbeneficiary,thetrustmustbe
irrevocable.Thetrustmustearnincome.Iftrustretainsincome,itistaxableastrust.Ifincomeis
distributedtothebeneficiary,thenthebeneficiaryistaxedandcorrespondingdeductionfrom
trustshallbemade.
Itisthegrantorwhoisliabletopayincasesofrevocabletrustsandincomefromtrustforthe
benefitofthegrantor.Incaseoftrustcreatedforthebenefitofthegrantor,itneednotnecessarily
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Definitions
Separate Taxable Entities
86
berevocable.
Whenisanestateaseparatetaxableentity?
Itistaxableasaseparateentitywhenitisalreadysubjecttoajudicialproceeding.
Howareestatestaxed?
Estatesandtrustaretaxablelikeanindividualtaxpayer.Butestatesmaygraduateto
unregisteredpartnershipwhereitwouldbeconsideredasacorporation.Butinthemeantime,
taxesofestatesarecomputedinthesamemannerasanindividual.
Whatwouldbethetaxtreatmentiftheestatesellsrealproperty?
Ifitisacapitalasset,then6%capitalgainstaxonthepresumedgain.Ifitisanordinaryasset,5
32%istheapplicabletaxrate.
Howaboutgainsfromsharesofstock?
Gainonsaleofsharesofstockwillbesubjectto5%or10%providedthatthestocksarenot
tradedinstockexchange/unlistedorlisted/untraded.
Howaboutbusinessincome?
The5%32%taxrateapplies.
Howaboutdividends?
Afinaltaxof10%shallbeimposeduponcashandpropertydividendsactuallyorconstructively
received.
Howaboutonpassiveincomeofinterestondeposits?
Ifthematurityismorethan5years,thenitisexempt.(Incorporations,youdonothavethatas
anexemption.Buttherearecaseswheretheestatemaygraduateintoanunregistered
partnership.Inthatcase,theestatewillthenbetaxedasacorporation)
Whatareincludedinthegrossincomeofestatesandtrusts?
Thegrossincomeshallincludeincomederivedduringthesettlementandadministrationofthe
estate.Theitemsofgrossincomeofestatesandtrustsarethesameitemsofgrossincomeof
individualsasprovidedinSection32andincludethefollowingincomeasenumeratedinSection
60(A):
(1) Incomeaccumulatedintrustforthebenefitofunbornorunascertainedpersonor
personswithcontingentinterests,andincomeaccumulatedorheldforfuture
distributionunderthetermsofthewillortrust;
(2) Incomewhichistobedistributedcurrentlybythefiduciarytothebeneficiaries,and
incomecollectedbyaguardianofaninfantwhichistobeheldordistributedasthe
courtmaydirect;
(3) Incomereceivedbyestatesofdeceasedpersonsduringtheperiodofadministrationor
settlementoftheestate;and
(4) Incomewhich,inthediscretionofthefiduciary,maybeeitherdistributedtothe
beneficiariesoraccumulated.
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Gains from Shares of

Stock
Business Inomce
Dividends
Interest on Deposits
Gross Income of Estate

and Trusts
87
Againstwhomwillthetaxesbecollected?
Income
Incomeaccumulatedintrustforthebenefitof
unbornorunascertainedpersonorpersonswith
contingentinterests,andincomeaccumulatedor
heldforfuturedistributionunderthetermsofthe
willortrust(Section60(A,1))
Incomewhichistobedistributedcurrentlybythe
fiduciarytothebeneficiaries,andincomecollected
byaguardianofaninfantwhichistobeheldor
distributedasthecourtmaydirect(Section60(A,
2))
Incomereceivedbyestatesofdeceasedpersons
duringtheperiodofadministrationorsettlement
oftheestate(Section60(A,3))
Incomewhich,inthediscretionofthefiduciary,
maybeeitherdistributedtothebeneficiariesor
accumulated(Section60(A,4))
Revocabletrusts(Section63)
Incomeforthebenefitofgrantor(Section64)
Liability
LiablefortheTax
Estateortrust
Beneficiary
Fiduciaryorbeneficiary,
dependingupontheamounts
whicharepropertypaidor
credited
Fiduciaryorbeneficiary,
dependingupontheamounts
whicharepropertypaidor
credited
Grantor
Grantor
SupposingthedecedenthasPhp1M.WhatisthetaxtreatmentofthePhp1M?
Theincomeformspartofthegrossincomesubjecttodeductions.Afterdeductions,theamount
willthenbesubjectto532%tax.
WhatifPhp500KwenttotheestatewhilePhp500wenttotheheirs.Whatisthetax
treatment?
Theamountremainingintheestateistaxabletotheestatewhiletheamountdistributedis
taxabletotheheirsinproportiontowhattheyreceived.
UnderSection61,thefollowingrulesapply:
A. Thereshallbeallowedasadeductionincomputingthetaxableincomeoftheestateor
trusttheamountoftheincomeoftheestateortrustforthetaxableyearwhichistobe
distributedcurrentlybythefiduciarytothebeneficiaries,andtheamountoftheincome
collectedbyaguardianofaninfantwhichistobeheldordistributedasthecourtmay
direct,buttheamountsoallowedasadeductionshallbeincludedincomputingthe
taxableincomeofthebeneficiaries,whetherdistributedtothemornot.Anyamount
allowedasadeductionunderthisSubsectionshallnotbeallowedasadeductionunder
Subsection(B)ofthisSectioninthesameoranysucceedingtaxableyear.
B. Inthecaseofincomereceivedbyestatesofdeceasedpersonsduringtheperiodof
administrationorsettlementoftheestate,andinthecaseofincomewhich,inthe
discretionofthefiduciary,maybeeitherdistributedtothebeneficiaryoraccumulated,
thereshallbeallowedasanadditionaldeductionincomputingthetaxableincomeof
theestateortrusttheamountoftheincomeoftheestateortrustforitstaxableyear,
whichisproperlypaidorcreditedduringsuchyeartoanylegatee,heirorbeneficiary
buttheamountsoallowedasadeductionshallbeincludedincomputingthetaxable
incomeofthelegatee,heirorbeneficiary.
C. Inthecaseofatrustadministeredinaforeigncountry,thedeductionsmentionedin
Subsections(A)and(B)ofthisSectionshallnotbeallowed:Provided,Thattheamount
ofanyincomeincludedinthereturnofsaidtrustshallnotbeincludedincomputingthe
incomeofthebeneficiaries.
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SupposingthatinOctober2000,theestateearnedPhp1M.Thefollowingmonth,thecourt
issuedapartitionorder,distributingthepropertiestotheheirs.However,theheirsdidnot
distributetheestate.TheestateearnedanadditionalPhp1M.Whatisthetaxtreatment?What
istheeffectofthepartitionorder?
Thisisanexamplewheretheestatehasgraduatedintoanunregisteredpartnership.(Oav.CIR)
Uponpartition,theestateceasesandthepropertiesbelongtotheheirs.Iftheyarenot
distributed,itisimpliedthattheheirscontributedtheirsharesintoacommonfunds.Thisisthen
taxedasacorporation(35%taxrate).
Whenisatrustaseparatetaxableentity?
Itshallbetaxableasaseparateentityifthetrustisirrevocable.Thisisbecausethegrantorhas
absolutelygivenupthecorpusandanyincidentsthereto.Inthiscase,thegrantorhasnocontrol
overthecorpusofthetrust.Thebenefitsofthetrustwillnotgotothegrantor.Thegrantorhas
transferredtheincomeearningpropertytoabeneficiary.Hehasabsolutelygivenupthe
incidentsofits.Ifthereisaconditionthatprovidesthataportionshallbereservedforthe
grantorsmedicalexpenses,thisconditiondoesnotconverttheirrevocabletrusttoarevocable
trust.Butthatportionistaxableincomeofthegrantor.Ifitisarevocabletrust,thenthewhole
incomeofthepropertyistaxableonthepartofthegrantor.
Isthereasituationwhereatrustmaygraduatetoanunregisteredpartnership?
None.Intrust,onlynakedtitledispassed.Thelegalrightremainswiththeowner.Thus,it
cannotgraduatetoacorporatetaxstatus.
Whataretherequisitesforthetaxabilityofatrust?
Therequisitesare:
(a) Itshouldbeanirrevocabletrust;
(b) Taxmustbeimposedontheincomeofthetrust;and
(c) Thetrustretainstheincome.
Whatisanirrevocabletrust?
Anirrevocabletrustisonewherethegrantorhasunconditionallypartedwithalltheincidentsof
ownership.Thisisanincomesplittingdevice.Ifyouareinahighbracket,whatyoushoulddo
taxwiseistotransferthepropertytothetrustsoyousplittheincome.Buttodothat,youmust
reallypartwiththeproperty.Otherwise,itwillstillbetaxedasifyouhavenotpartedwiththe
property.
Whatisthereasonofthelawrequiringirrevocabletrust?
Sothatthegrantorwillnotcircumventthelawandusethetrustasasimpleincomesaving
device.
Whatisarevocabletrust?
Arevocabletrustisonewhere,underthetrustinstrument,thepowertorevestinthegrantortitle
tothepropertytransferredtothetrustoranypartofthecorpusofsuchtrustisvested(a)inthe
grantor,eitheraloneorinconjunctionwithanypersonnothavingsubstantialadverseinterestin
thedispositionofsuchpartofthecorpus,ortheincometherefore;or(b)inanypersonnothaving
asubstantialadverseinterestinthedispositionofsuchpartofthecorpusortheincome
therefrom.
Inshort,itisatrustwherethetitlecanrevestbacktothegrantoranytime.
Itisnottaxableasanentitybecausetheincomeformspartoftheincomeofthegrantor.
Cecille 2C 05-06
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Requisites for the

Taxability of Trusts
Irrevocable Trust
Revocable Trust
89
Supposingthatitisatrustwithinadefiniteperiod(thatthetrustwouldterminateonafixed
date),wouldthatberevocabletrust?
Toberevocabletrust,itshouldberevocablewithintheperiodoftheexistenceofthetrust.
Supposeagrantorestablishedatrustforhiswifehavingatermof5yearsbutthegrantorhas
absolutecontrolovertheincomeofthetrust.Heexercisesactsofownershipoverthetrust.
Whatisthetaxtreatment?
Inthiscase,theincomeneverleftthegrantorbecauseheremainsincontrol.Incomeshallbe
taxabletothegrantorbecauseithasgivenittoanimmediatefamilymember.(Helveringv.
Clifford)
Supposingagrantortransferincomeyieldingproperty.Hepartswiththepropertyabsolutely.
PropertyearnsPhp200Kamonth.Hecannotrevokenorrevestthetrust.However,ithasa
conditionthatPhp20Kofwhichshallbeusedformedicalexpensesofthegrantor.Isthisa
revocabletrust.
InthiscaseyouapplySection24.ThePhp20Kshallbeconsideredincomeforthebenefitofthe
grantor.ThePhp20Kshallbeincludedincomputingthetaxableincomeofthegrantor.
Supposethetransferisrevocable?
Theentireincomeshallbetaxableinthehandsofthegrantor.Thelanguageofthelaw(Sections
6364)givesthedistinction.
Whatisemployeestrust?
UnderSection60(B),thetaximposedbythisTitleshallnotapplytoemployeestrustwhich
formspartofapension,stockbonusorprofitsharingplanofanemployerforthebenefitofsome
orallofhisemployeesunderthefollowingconditions:
(a) ifcontributionsaremadetothetrustbysuchemployer,oremployees,orbothforthe
purposeofdistributingtosuchemployeestheearningsandprincipalofthefund
accumulatedbythetrustinaccordancewithsuchplan,and
(b) ifunderthetrustinstrumentitisimpossible,atanytimepriortothesatisfactionofall
liabilitieswithrespecttoemployeesunderthetrust,foranypartofthecorpusorincome
tobe(withinthetaxableyearorthereafter)usedfor,ordivertedto,purposesotherthan
fortheexclusivebenefitofhisemployees.
Provided,Thatanyamountactuallydistributedtoanyemployeeordistributeeshallbe
taxabletohimintheyearinwhichsodistributedtotheextentthatitexceedstheamount
contributedbysuchemployeeordistributee.
Isemployeestrustaseparatetaxableentity?
Yesitisaseparatetaxableentitybutbyspecificprovisionoflawisexcepted.
Supposinganemployeewhois49yearsoldavailsofanemployeetrust.Hewasinservicefor
20years.HemadeatotalcontributionofPhp300K.Whatisthetaxtreatment?
Php300Kisexemptedasitisareturnofcontribution.Whatistaxableistheextentthatisexceeds
theamountcontributedbysuchemployeeordistribute.Whatisexcludedfromtheexemptionis
thatwhichpertainstotheemployerscontribution.Thus,itshallbetaxedifitexceedsthe
amountcontributedbytheemployee.
Sameexampleasintheprecedingcasebuttheemployeeis50yearsoldwith20yearsof
service.Whatisthetaxtreatment?
Applyunderexclusionifthereisnoreasonableprivatebenefitplan.UnderSection60(B),both
theemployerandemployeefundtheplan.Butinthecaseofreasonableprivatebenefitplan,itis
fundedbytheemployeralone.
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Employees Trust
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WhatistheeffectiftheretirementplanisapprovedbytheBIRandtheemployeesavailofthe
proceeds?
ThenitshallbeexcludedfromthecomputationoftaxableincomeunderSection32andnot
underSection60(B).
Supposingafathercreatesatrust.Thesonistheonlybeneficiaryinallthesetrusts.How
manytaxentitiesdoyouhave?
TrustAPhp1Mearnings
TrustBPhp1Mearnings
TrustCPhp1Mearnings
TrustDPhp1Mearnings
TrustEPhp1Mearnings
OnlyonebecauseunderSection60(C)(2),where,inthecaseoftwoormoretrusts,thecreator
ofthetrustineachinstanceisthesameperson,andthebeneficiaryineachinstanceisthesame,
thetaxableincomeofallthetrustsshallbeconsolidatedandthetaxprovidedinthisSection
computedonsuchconsolidatedincome,andsuchproportionofsaidtaxshallbeassessedand
collectedfromeachtrusteewhichthetaxableincomeofthetrustadministeredbyhimbearsto
theconsolidatedincomeoftheseveraltrusts.
Butwhatifallthesetrustsareirrevocable,canthisbeconsolidated?
Yes.Itwouldbetreatedasonseparatetaxableentitybyconsolidatingtheirincome.
Butwhatifallarerevocable?
Then,thetaxwillbeimposedtothegrantor.Noneedtogothroughconsolidationbecause
technicallynoseparatetaxableentity.
Wouldtherebeanydifferenceresultingfromtheconsolidation?
Yes.Differentratesareapplicable.
Whatisthedifferencebetweensegregatingandconsolidatingintaxconsequence?
Therewillbehighertaxifconsolidatedandlowertaxifsegregated.Ifsegregated,taxedata
lowerincometax.Ifconsolidated,itdoesnotescapetheprogressivetaxratesystem.Eachtrustis
entitledtodeductions/exemptionssoifnoconsolidation,thenseparatesetsof
deductions/exemptions.Ifconsolidated,onlyonesetofdeductions/exemptionsisallowed.Why
isitimportanttothegovernment?Becausehighertaxrateswouldapplyifconsolidated.
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DEDUCTIONSFROMGROSSINCOME
Whataredeductions?
Deductionsinthetenorofthelawareitemswhicharesubtractedfromgrossincometoarriveat
ataxableincome.
Howdoyoudifferentiatedeductionfromexclusionandtaxcredit?
Deductionisincludedinthegrossincomebutlaterondeducted.Exclusionisnotincludedinthe
computationofgrossincome.Exclusionreferstoincomereceivedorearnedbutisnottaxableas
incomebecauseofexemptionbyvirtueofalaworbyatreaty.Exclusionsaresimplynottaken
intoaccountindetermininggrossincome.Taxcreditispaidbeforehandandisdeductedfromthe
taxliabilityofthetaxpayer.
Whocannotavailofdeductions?
Thosewhoaretaxableongrossincomecannotavailofdeductions.
NonresidentaliensnotengagedintradeorbusinesswithinthePhilippinesandnonresident
foreigncorporationsorthosenotengagedintradeorbusinesswithinthePhilippinesornot
havinganofficeorplaceofbusinessthereinaretaxedonthebasisoftheirgrossincomefrom
Isagovernmentemployeeentitledtodeductions?
UnderSection34,taxpayersearningcompensationincomearisingfrompersonalservices
renderedunderanemployeremployeerelationshipcannotclaimdeductionsexceptforpremium
paymentsforinsurance/hospitalization.
Xisataxpayerwhoreceivesincome.Whatisthetaxconsequence?
Whengivenadeductionproblem,youmustfirstdeterminethekindofincomeandthekindof
taxpayer.
EmployerEmployeeRelationship: Nodeductionexceptpersonalexemptions
SelfEmployed:
SNITSdeductions
CorporateTaxpayer:
Section34onitemizeddeductions
Whataretheprinciplesapplicableintheitemizeddeductions?
(1) Noitemmaybedeductedfromgrossincomeunlessthedeductionisspecifically
authorized.
anytaxpayerwhoclaimsdeductionsmustpointaspecificprovisiontojustify
theentitlement
deductionisinthenatureortakesthenatureoftaxexemption,thusstrictly
construed
ifnospecificprovisioncanbepointedto,theincomewillbeconsideredas
incomefromwhateversourcederived
(2) Theexpenses,thedeductionsarelimitedtothoserelatedtothecarryingofbusiness.
thedeductionsmustbebusinessrelatedexceptintheareaofcharitable
contributionswhichmayhavenobusinesspurposeatall
(3) Taxpayersaretaxedonlyonincomefromwithincanonlyclaimdeductionsincurredin
carryingbusinessortradewithin.
(4) Deductionsdonotapplytocompensationincome.
whenyouhaveagrossincomesituation,nodeductionscanbeavailedofbythe
taxpayer
(5) Ifataxistobeormustbewithheldonanamountwhichisclaimasthedeductionbythe
Cecille 2C 05-06
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Deduction / Exclusion /
Tax Credit
92
taxpayer,nodeductionsshallbeallowedunlessthetaxwithheldhasbeenpaidtothe
BIR(Section34(K)).
(6) Deductionscannotbemadetoapplytoincomefinallytaxedasinthecaseofpassive
income.
Whatarebusinessexpenses?
Businessexpensesdeductiblefromgrossincomearetheordinaryandnecessaryexpensespaidor
incurredduringthetaxableyearincarryingonorwhicharedirectlyattributabletothe
development,management,operationand/orconductofthetaxpayerstrade,businessor
exerciseofaprofession.
Thesearedirectlyattributabletothedevelopment,management,operationand/orconductofhe
trade,businessorexerciseofaprofession.Youcannotargueproximity.Youcannotarguethat
theexpenseisindirectlyattributable.Theremustbeadirectrelationshipbetweenexpenditures
andbusiness.
Whataretherequisitesfordeductibilityofbusinessexpensesbycorporation?
Therequisitesare:
(1) Theexpensesmustbeordinaryandnecessary;
(2) Itmustbepaidorincurredduringthetaxableyear;
(3) Itmustbepaidorincurredincarryingonanytradeorbusiness;
(4) Itmustbesubstantiatedbyadequateproof;and
(5) Itmustnotbeagainstlaw,morals,publicpolicyorpublicorder.(fromthebookofDe
Leon)
Supposingoneisengagedinanillegalbusiness(ex.Prostitutionden)andderivesincome
therefrom,canheavailofdeductions?
Therearelegalexpensesofanillegalbusiness.Itwouldbeunfairtotaxillegalincomeand
disallowlegalexpensesasdeductions.
Wherethedisbursementitselfisillegal,thesameisnotdeductibleongroundsofpublicpolicy.
Thus,abribegiventoobtainprotectionfromarrestandprosecutionwasproperlydisallowed.To
permitalawviolatortoobtaintaxbenefitofataxdeductionforpaymentwouldfrustratethe
policyofthegovernmentinitsattempttopunishtheviolator.
Business Expenses
Requisites for
Deductibility of Business
Expenses
UnderSection34,nodeductionfromgrossincomeshallbeallowedforanypaymentmade,
directlyorindirectly,toanofficialoremployeeofthenationalgovernment,ortoanofficialor
employeeofanylocalgovernmentunit,ortoanofficialoremployeeofagovernmentownedor
controlledcorporation,ortoanofficialoremployeeorrepresentativeofaforeigngovernment,
ortoaprivatecorporation,generalprofessionalpartnership,orasimilarentity,ifthepayment
constitutesabribeorkickback.
Evenifthepaymentisnotinitselfillegal,deductionwillstillbedisallowedwherethepayment
wouldbecontrarytopublicpolicy.Thus,paymentstosecurepoliticalinfluencetoobtain
favorablepubliccontractsandprotectionpaymentstolawenforcementofficialswere
disallowedonsuchground.
Wherethebusinessisillegal,adistinctionismadebetweenlegitimateandillegitimateexpenses.
Thelegitimateexpensesofanillegitimatebusinessaredeductibleonthetheorythatthe
incometaxisnotataxongrossincomeevenifsuchincomeisearnedasanillegalbusiness.Thus,
thedeductionofsalariesandmiscellaneousexpensesincurredintheoperationofanillegal
horsebettingbusinesswasallowed.Butexpensesofanillegalbusinesscannotoffsettheprofits
ofalegalbusiness.(fromthebookofDeLeon)
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WhathappenedinthecaseofTankTruckRentalsv.CIR?
Inthatcase,TankTruckdeliberatelyoperatedabovetheweightlimits.Asaresult,itpaidfines
andpenaltiesforfailuretoobserveloadlimits.WhenTankTruckpaiditsyearlyincome,it
consideredthefinesandpenaltiesthattheypaidasallowabledeductionsfromtheirgross
income.
TheU.S.SupremeCourtheldthatthefinesandpenaltiesshouldnotandcannotformpartofthe
allowabledeductionsofTankTrunkfromitsgrossincome.Thefinesandpenaltiesarenot
consideredordinaryandnecessaryforthebusinessofthesaidcompany.Thefineswereinfact
incurredinutterdisregardofthelawimposedregardingloadlimitsofvehicles.Itwasheldthat
deductionsofordinaryandnecessaryexpensecannotbemadeiftheallowanceofdeduction
wouldfrustratesharplydefinednationalorstatepoliciesprescribingparticulartypesofconduct.
Toallowsuchdeductionswouldencouragecontinuedviolationsofstatelawbyincreasingthe
oddsinfavorofnoncompliance.
Inthiscase,theCourtheldthatthetestofnondeductibilityistheseverityandimmediacyofthe
frustrationresultingfromallowanceofthededuction.
Whatwouldbetheeffectifthebusinessislegal?Whatifthebusinessislegal?Whatisthe
standardusedbythecourt?
IntheTankTruckcase,whatwasinvolvedwasthepaymentoffine.Paymentoffineisnotperse
illegal.Itwouldbedifferentifthepaymentitselfisillegal.Inthiscase,thebusinessisnotillegal.
TheCourtlaiddownthetestofnondeductibilitywhichistheseverityandimmediacyofthe
frustrationresultingfromallowanceofthededuction.TheCourthadtobalancetheconceptof
taxationofnetincomewhichentailstheallowanceofordinaryandnecessarydeductionsandthe
unwrittenpolicythatataxprivilegeshouldnotencourageviolationoflaw.
IntheTankTruckcase,theCourthadtobalancetheinterestofCongressnottousethetaxsystem
toencourageaviolationofasharplydefinedpublicpolicy.TheCourtwassayingthatinthis
kindofdeductionyoucouldclearlyseethefrustrationofpublicpolicy.
TheTankTruckcaseisdifferentfromtheSullivancase.WhatwasinvolvedintheSullivancase
wasaprohibitedgamblingactivity.Theoperationwasbeingtaxedforitsincomeandtheissue
wasdeductibilityofrentandwages.TheU.S.SupremeCourtallowedthedeductionbecause
rentandwagesarelegal,ordinary,andnecessaryexpenses.Impliedly,theCourtarguedthat
sinceyouaretaxingillegalincome,thendeductionsshouldbeallowed.Thus,legalexpenseinan
illegalbusinessisdeductible.
Insubsequentcases,thefollowingwereconsideredasthestandardinallowingthedeductionof
expenses:
(1) lookatthefacts/circumstancesofthecase;and
(2) therelationshipofexpendituretofrustrationofpublicpolicy.
Hereyoucanarguenodirectrelation,thatdeductionisallowed.Ifitisnotanillegal
expenditure,thenitcanbearguedthatsuchexpenditureisordinaryandnecessary.Second,if
youdonotallowdeduction,thenyouaretaxingongrossincomewhichisnotthepolicyof
Congress.
Therearethreesituationsyouhavetotakeintoaccount:
expenditureisillegalbutbusinessislegal;
legalexpenditureandlegalbusiness;or
legalexpensebutbusinessisillegal.
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SupposingyouhaveadelinquenttaxpayerwithtaxliabilityofPhp100KandpenaltyofPhp
10K.Isthepenaltydeductible?
Itwillnotbedeductibleaspenaltybutjurisprudencesaysthatitwillbedeductibleasinterest.
Thetheoryisthatalthoughsuchwaspaidasviolation,itcouldbearguedthatitwasnotdoneto
encouragefrustrationofpublicpolicy.
SupposingXInc.sendshisVPforFinancetoattendacorporatemeeting.Hewasaskedtouse
thecompanycartogotothemeeting.Whilegoingbacktothecorporateheadquarters,he
receivedacallfromthePresidentaskinghimtoattendanothermeeting.Afterthemeeting
andonthewaybacktotheheadquarters,hebumpedapedestrian.Therewasacaseincourt
butsettlementwasmadewhereinthecorporationpaidPhp300Ktothefamily.Canthe
corporationclaimtheamountpaid?Isitabusinessexpense?
No.Itisnotabusinessexpensebecausetheaccidenthadnorelationtothebusiness.The
corporationisnotinthebusinessofsettlingdamages.Itisnotdirectlyattributabletothe
purposeofthecorporation.
Itcannotbeconsideredasareputationcasebutmerelyabailoutscheme.Itcanarguethatitis
necessary.Itcanalsoarguethatitisordinary.Butitisnotbusinessrelated.Itisnotdirectly
attributabletothemanagement,conductanddevelopmentoftradeandbusiness.
SupposingXInc.isamanagementcorporationengagedinloansandinvestmentconsultancy.
Oneofthecorporateofficerswasinvolvedinatransactionresultinginasituationwherehe
owedalotofmoney.Thenonpaymentofwhichcausesadeteriorationofthereputationof
thecorporationofwhichheistheVP.Knowingthis,thecorporationspaystheloanofthe
officerinordertosavethereputationofthecorporation.Wouldthatbedeductiblebusiness
expense?
TheAmericancourtsaidtherewasarelationtobusinessbecausethepurposewastokeepthe
goodwillintact,toprotectthereputationofthecorporation.
Philippinejurisprudencehasprovidedotherwise.Itwasheldnotabusinessexpensebecausethe
paymentoftheliabilityisentirelyunrelatedtothebusiness(directlyattributable..youmust
considerthepresentlanguageofthelaw).
Whenisanexpenseconsideredordinary?
Anexpenseisconsideredordinarywhenitiscommonlyincurredinthetradeorbusinessofthe
taxpayerasdistinguishedfromcapitalexpenditures.Anordinaryexpenseconnotesapayment
whichisnormalinrelationtothebusinessofthetaxpayerandthesurroundingcircumstances.
Butthepaymentneednotbenormalorhabitualinthesensethatthetaxpayerwillhavetomake
themoften.
InoneAmericancase,thestandardseemstobelikethis:ifabusinessorcorporationinthe
industryisconfrontedwiththesametypeofproblem,woulditbespendingthesametypeof
expensethatwouldbeordinary?Inshort,itshouldbethatpaymentorthatexpensewhichis
normallyordinaryinrelationtothetaxpayersbusiness.
Whenisanexpenseconsiderednecessary?
Anexpenseisconsiderednecessaryifitisappropriateandhelpfultothetaxpayersbusinessorif
itisintendedtorealizeaprofitortominimizealoss.Buttheexpenseneednotbeessentialor
indispensabletothebusinesstobeconsiderednecessary.
Itisnecessarywhenitishelpfultothebusinessofthetaxpayer.Itisalsonecessarywhenitis
neededfortheproductionofincomeorwhenitisproperforminimizingaloss.
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Ordinary Expense
Necessary Expense
95
Inshort,thedefinitionofnecessarycontains3elementsasprovidedinthecaseofEssov.CIR:
(1) Itisnecessaryfordevelopmentofthetaxpayersbusiness;
(2) forproductionofincome;and
(3) forminimizingaloss.
Ifitisnotoneofthose3elementsasthecourtwouldreasonout,itwillnotbeanecessary
expense.
Whatifitisaonetimeexpense?
Habitualityisnotmaterial.Itneednotberecurring.Thetestusuallygivenisifapaymentofa
certainexpenseditemwouldalsobedonebyanothercorporationengagedinthesameindustry.
Anexamplewouldbeseparationbenefit.
Theunderlyingcharacteristicofordinaryandnecessaryisreasonableness.
Theelementofreasonablenessoftheexpenseisinherentinthephraseofordinaryandnecessary.
Clearly,itisnottheintentionofthelawtoautomaticallyallowasadeduction,operation
expensespaidorincurredbythetaxpayerinanunlimitedamount.
Therenofixedstandardindefiningwhatisordinaryandnecessary.Thecircumstancesofthe
casemustbelookedintobutthecommonelementistheelementofreasonableness.
Ifitviolatesanationalpolicy,itcanneverbeconsideredasreasonable.
XInc.isengagedinthestoragebusiness.Inthestoragebusiness,thecorporationhasthehabit
ofrequiringthecustomerstoinsuretheirgoodsfirst.ACorporation,itsprincipalclient,has
goodsstoredinthewarehouse.Warehousewasdestroyedbyfire,includingthegoods.A
CorporationsgoodsworthPhp300Karenotinsured.XInc.paidthePhp300Kontheground
thatthiswouldallowittorelationACorporationasaclient.Canthecorporationdeductthe
paymentmadetotheclient?
No.Itisapaymentthatdetractsfromthecontract.Itisthecustomerwhoshouldinsurethe
goodsandnotthestoragecompany.Itisnotordinarybutratherextraordinarybecausenotall
mendothat.AsinthecaseofWelch,thepaymentsofthedebtsofanotherisanextraordinary
expense.
WhathappenedinthecaseofWelchv.Helvering?
Inthatcase,thecorporationwasdischargedtobankruptcy.Whenitwasreestablished,some
creditorsofthebankruptcorporationwerereimbursedforbalancesdueafterthecorporations
discharge.ItwaspaidbytheprevioussecretaryofWelch.Itwasdoneinordertoreestablishhis
relationswithcustomerswhomhehadknownwhenhewasstillwithWelchCompanyandto
solidifyhiscreditandstanding.
Thelawprovidesthatthetaxpayermayhaveasadeductionfromgrossincomeallnecessary
andordinaryexpensespaidorincurredduringthetaxableyearincarryingonanytradeor
business.TheCourtruledthatitcanbearguedthattheexpensesincurredinthiscasewere
necessary.Thereisnoway,however,thattheseexpensescanbetreatedasordinary.Infact,
theyareveryextraordinarypaymentsandnotexpensesofthebusinessatall.TheCourtheld
thatthepaymentmadewerenondeductibleassaidpaymentcameclosertocapitaloutlaysthan
toordinaryandnecessaryexpensesintheoperationofthebusiness.
Ordinaryandnecessaryisnotaruleoflaw.Thestandardisnotaruleoflaw,itisawayoflife.
Lifemustprovidetheanswer.
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IfyouapplySection34,howwouldyouanswertheWelchsituation(payingsomebodyelses
debtinordertoimprovestanding)?
IfyouapplySection34,itwouldbeeasiertodispensewiththecase.Thetaxpayerisnotengaged
inpayingdebtsofotherpeople.Thereisanindirectrelationbutwhatthelawallowsisadirect
relation.
SupposeXInc.isaninvestmenthouse.Y,thepresident,handles99%oftheaccounts.Y
incurredshortageofPhp1M.UnderXInc.srules,itwouldhavewarranteddismissal.
However,theBoardinsteaddecidedthePhp1Mshortagebepaid.XInc.isnowclaiminga
deductionclaimingthatthepaymentwasnecessarytosavethereputationoftheinvestment
house.Deductible?
No.Itisnotengagedinthebusinessofpayingdebt.
SupposeX,alawyer,wasengagedincollectingdebts.Xadvancethepaymentofadebttohis
clientcreditorbecausethedebtortoldhimthatdebtorwillbepaying.Subsequently,the
debtordidnotpay.Istheamountadvancedbythelawyerdeductible?
No.U.S.jurisprudenceheldsuchisnotdeductiblebecauseheisengageinthecollectionbusiness
andnotofpayingthedebtsofhisclients.
SupposingX,thepresidentofacorporation,isunderthethreatofbeingkidnapped.Sothe
corporationprovidedhimwithbodyguards.ThebodyguardswerepaidPhp40Kamonthon
topofthepaymentofbodyguardservices.SecuritydevicesworthPhp100Kwereinstallednot
onlyinhisofficebutalsoathome.Wouldthesebeordinaryornecessaryexpenses?
Necessary.Noargumenttoprotectthelifeofapresidentofacorporation.
Butisitordinary?Ordinarymustbemeasuredagainstwhatisreasonableinthesituation
consideringthecircumstancesofthecorporation,itsfinancialstandingandthevalueofthe
corporateofficer.Inshort,youhavetoarguetosupportthatitisordinaryandthatitis
reasonable.Thatgivensuchasituation,asimilarbusinesswithintheindustrywouldexpendthe
sametimeofexpense.
SupposingXInc.has300employees.Majorityoftheemployeesbelieveinfaithhealing.
Whensick,theemployeeswouldgotofaithhealersinsteadofgoingtothedoctors.Sothe
corporation,toattendtothemedicalrequirementsoftheiremployees,hiredafaithhealer.It
paysthefaithhealerPhp20Kamonth.Isthisordinaryornecessaryexpense?
Itisvaguelynecessarybutisitordinary?
Itisnotordinarybecausenoonehiresafaithhealertoattendtothemedicalrequirementsof
employees.Thatissomethingnotusuallydone,notnormallydoneintheindustry.Thisisan
extraordinaryexpense.ItcanbeclaimedasotherdeductionbutnotunderSection34.
WhatisimportantinthecaseofEssoStandardv.CIR?
Inthatcase,thecourtprovidedthestatutorytestofdeductibility.Theseareasfollows:
(1) Mustbeordinaryandnecessary;
(2) Mustpaidorincurredwithinthetaxableyear;and
(3) Mustbepaidorincurredincarryingonatradeorbusiness.
Therighttoadeductiondependsontheparticularfactsandtherelationofthepaymenttothe
typeofbusinessinwhichthetaxpayerisengaged.Theintentionofthetaxpayeroftenmaybethe
controllingfactinmakingthedetermination.Deductibilitymustbedeterminedfromthenature
oftheexpenditureitself,whichinturndependsontheextentandpermanencyofthework
accomplishedbytheexpenditure.
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AccordingtotheCourt,itisnecessaryifitishelpfulinthedevelopmentofthebusiness,
necessaryforminimizinglosses,anditisforproducingincome.Itisnotnecessaryifitdoesnot
produceincome.
WhathappenedinthecaseofAtlasMiningv.BIR?
Inthiscase,theCIRdisallowedthedeductionofSHrelationservicefeefromthetaxableincome.
Atlasclaimedthatitwaspaidforservicesofpublicrelationsfirmandhenceandordinaryand
necessarybusinessexpenseinordertocompetewithothercorporation.
TheCourtheldthatthetaxpayermustnotonlymeetthebusinesstest(ordinaryandnecessary,
incurredwithinthetaxableyear,incurredincarryingonatrade/business).Hemustprovesuch
throughevidenceandrecords.Themereallegationofthetaxpayerthatanitemisordinaryand
necessarydoesnotjustifyitsdeduction.Abusinessexpensemustbedeterminedformthenature
oftheexpenditureitself,whichinturndependsontheextentandpermanencyofthework
accomplishedbytheexpenditure.
Inthiscase,theexpensepaidtothepublicrelationsfirmisnotanordinarybusinessexpense
becauseitrelatestorecapitalizationandreorganization.Thus,itisacapitalexpenditure.
Whatisthecapitalexpenseargument(thatcapitaloutlayisrelatedtobusinessthus
deductible)?Whyisacapitaloutlaynotdeductible?
Whenyoutalkofcapitaloutlay,itisnotdeductiblethisyearbutdeductibleovertime.Youhave
thatbywayofamortizationordepreciation.Youwillrealizebenefitsinthefuture.
Whatisthedifferencebetweenbusinessexpenseandcapitalexpense?
Businessexpenseisexpenditurerelatedtothebusinessthatisdeductibleintheyearincurred,in
thesametaxableyear.Itisimmediatelydeductible.Capitalexpenseisexpenditurethatimproves
oraddstothevalueofyourpropertyorequipment.Itisnotimmediatelydeductible.Itis
deductibleoveraperiodoftime,suchasintheformofdeprecation.
Whataretherequisitesfordeductibilityofcompensation?
Thetestfordeductibilityincaseofcompensationpaymentsiswhether:
(1) thereexistsanemployeremployeerelationship;
(2) theyarepaymentsmadeforactualservicesrendered;
(3) incurredwithinthetaxableyear;
(4) theyarereasonable;and
(5) ordinaryandnecessary(impliedinreasonable).
SupposingXInc.hiresMr.AforPhp1Mamonth.XInc.isaPhp100Mgoingenterprise.Mr.
AisasummacumlaudegraduateofAMAUniversity(businessgraduate).Wouldthatbe
deductibleexpense?Hereportsfulltimefor18hours.Whatwouldbethefactors?Whatisthe
testofreasonableness?WhatifMr.Aisa10%shareholder?WhatifMr.Aonlywenttowork
for3daysandstayfor5hoursinall?
Php1Mpermonthisnotreasonable.Thestandardofreasonablenessistheamountaswould
ordinarilybepaidforlikeservicesbylikeenterprises.
AccordingtothecaseofC.M.Hoskinsv.CIR,thereisnofixedtestfordeterminingthe
reasonablenessofagivenbonusascompensation.Thisdependsuponmanyfactors,oneofthem
beingtheamountandqualityoftheservicesperformedwithrelationtothebusiness.Othertests
suggestedare:
(1) paymentmustbemadeingoodfaith;
(2) thecharacterofthetaxpayersbusiness,thevolumeandamountofitsnetearnings,its
locality,thetypeandextentofservicesrendered,thesalarypolicyofthecorporation;
(3) thesizeoftheparticularbusiness;
Cecille 2C 05-06
Business Expense v.
Capital Expense
Requisites for
Deductibility of
Compensation
98
(4) theemployeesqualificationsandcontributionstothebusinessventure;and
(5) generaleconomicconditions.
Theissueofbeingashareholderdoesnottotallymeanthatitisnotdeductibleanymore.Other
factsstillhavetobelookedinto.Reasonablenessmuststillbestrictlycompliedwith.Thefact
alonethatMr.Aisa10%shareholderofthecorporationdoesnotnegatedeductibility.Butitmay
beshownthatthebonusgiventohimamountstoadistributionofdividendswhichwouldthen
betaxableinthehandsofMr.A.
Iftheofficerisalsoastockholder,astricterappreciationofstandardisapplied.Theremustbea
clearjustificationofactualservices.Ifthecircumstancesindicatethatthepaymentsarenot
reasonable,thentheconclusionisthatitisincomedistribution.Itisdisguiseddividendsand
thereforenotdeductibleasbusinessexpense.Itshallbeconsideredasconstructivedividends
taxableonthepartofthetaxpayer.
Theissueofgoingtoworkforonly3daysmaybeconsideredunreasonable.
Whatwouldhappenifitbecomesunreasonable?
TheTaxCodeisnotsayingwhotohire.Whatitissayingisthatwhenthesalarybecomes
unreasonable,itcannotbeclaimedasdeductions.Ifitbecomesunreasonable,thensuchwillnot
bedeductibleonthepartofthecorporationandtaxableonthepartofMr.A.
Supposingontopofsuchsalary,Mr.AgetsPhp1Masbonustwiceayear.Whatarethe
requisitesforbonustobedeductible?Whatdoyoumeanactualservices,additionalorsame
servicesthathehasbeenrendering?
Notnecessarilyadditionalservices.Deductibilitymustmeettherequirementasto
reasonableness.Bonusisalwaystreatedascompensationincome.
Whencompensationisbeingclaimedasdeduction,whetherthatcompensationtakestheformof
salaries,bonuses,commissionorfees,itisonlydeductiblewhen:
(1) theyarereasonable;and
(2) whentheyrepresentpaymentforservicesactuallyrendered.
Whataretherequisitesforthedeductibilityoftravelexpenses?
Therequisitesare:
(1) theexpensesmustbereasonableandnecessary;
(2) theymustbeincurredorpaidwhileawayfromhome;and
(3) theymustbepaidorincurredintheconductoftradeorbusiness.
Whatisthemeaningofwhileawayfromhome?
Itistravelingawayfromtaxhome.Everytaxpayerhasthesocalledtaxhome.Itmeanshis/its
principalplaceofbusiness.
Mr.AwassenttoU.S.forabusinessseminarwithwifeandchildren.Totalexpensesamount
toPhp500Kforonemonth.WouldthePhp500Kbedeductibleasbusinessexpense?
Supposingthetravelofhiswifeandchildrenispartoffringebenefit?Whyisthereaneedto
distinguish?
Itisdeductibleastothecorporateofficerbecauseofthebusinessrelation.Ifyouarguethatitisa
travelexpenseforMr.A,thenyoucannotclaimitasincomeonthepartoftheemployee.Itis
fringebenefitsastothewifeandchildren.ItisincomeonthepartofMr.A.Itissignificantto
distinguishbecauseofthedifferenceinthetaxtreatment.Thetaxpayerclaimingthefringe
benefitasdeductiblemustpayfirstthefringebenefittax.Ifwhatisgivenisintheformoffringe
benefits,thenpaymentoffringebenefittaxmustfirstbeshown.Fringebenefittaxispayableby
theemployer.Ifnofringebenefittaxhasbeenpaid,thennodeductions.
Cecille 2C 05-06
Requisites for
Deductibility of Travel
Expense
99

Canthetravelofwifeandchildrenbeclaimedasadeductibleexpenseandnotafringe
benefit?
No,itcannotbeclaimedasadeductibleexpense.Youcannotargueabusinesspurposeina
travelawayfromhomeifitincludesthewifeandchildren.Thevacationexpensesofthewife
shallbeconsideredincomeontheparttheemployee.
Canthesetravelexpensesbeconsideredasafringebenefittaxabletotheemployer?
Yesbecauseexpensesforforeigntravelisoneoffringebenefitsallowedbylaw.
Whataboutrankandfileemployees?
Youhavetaxablefringebenefitsandnontaxablefringebenefits.Itisnontaxableinthesense
thatitisnotsubjecttothefringebenefittaxbutissubjecttotheincometax.Thenontaxable
fringebenefitsaredeductiblebecausepartofcompensationtoemployee.Theonlydifferenceis
inthecaseofthenontaxablefringebenefit,thereisnoneedtopaythefringebenefittaxbefore
onecanclaimdeduction.Inbothcases,theyareconsideredincomeexceptwhenexcludedlikede
minimis,fortheconvenienceoftheemployerThesearedeductibleonthepartoftheemployer.
Arefringebenefitsalwaysconsideredincomeonthepartoftheemployees?
Yesexceptfordeminimisbenefitsandunlessthefringebenefitisrequiredbythenatureof,or
necessarytothetrade,businessorprofessionoftheemployer,orwhenthefringebenefitisfor
theconvenienceoradvantageoftheemployer.
SupposeX,VPofacorporation,wasgivenahousingoutsidethepremisesofthecompany
worthPhp2M.Ontheotherhand,Y,ChiefEngineer,wasgivenfreehousingwithinthe
premises.Whichisdeductible?Whichisincome?Whatisthetaxconsequence?
OnthepartofX,itshallbeconsideredastaxablefringebenefit.OnthepartofY,itmaybe
consideredasnontaxablefringebenefit.ItisnotanincomeonthepartofYbecauseofthe
convenienceoftheemployerrule.However,itmaybedeductibleasothercompensation.For
housingtobedeductible,itmustbelocatedwithinthepremisesofthecompanyunlesshousing
locatedfewkilometersfromthecompanybecauseitishazardoustohavehousingwithinthe
corporatepremises.
SupposingA,anemployeeofXInc.,livesinAntipolo.HecommutestoCaloocanCityand
spendsPhp150aday,Php4,500amonth.XInc.paysthis.WouldthisPhp4500amonthbe
deductibleasabusinessexpense?
Yes,itispartofcompensation.Whetherdeminimisornot,itwouldstillbedeductible.Itis
consideredasanincomeonthepartoftheemployeebutnotasaforeigntravelexpense.Itis
deductibleaspartofcompensationbutnotdeductibleasatravelexpense.
Whatifthecorporationgivestransportationallowanceforthetraveloftheemployeesfrom
theirresidencetooffice?Isittravelawayfromhome?
No.Thatisnottravelingawayfromhome.Thatisapersonalexpensenotdeductibleasa
businessexpense.
Whatisarental?
Rentalispaymentmadefortheuseorpossessionofpropertyusedinbusiness.
Whataretherequisitesforrentaltobedeductible?
Areasonableallowanceforrentalsand/orotherpaymentsshallbeallowedasdeductionwhen
suchpaymentsareincurred:
(1) asaconditionforthecontinueduseorpossession;
(2) forpurposesofthetrade,businessorprofession;and
Cecille 2C 05-06
Rental
Requisites for
Deductibility of Rentals
100
(3) ofpropertytowhichthetaxpayerhasnottakenorisnottakingtitleorinwhichhehas
noequityotherthanthatofalessee,userorpossessor.
SupposingAInc.ownsasevenstoreybuilding.AsellsittoB,a100%subsidiary.Afterwards,
AleasesitforPhp200K.Woulditbedeductible?
Yes.Thelawcontemplatesequityinproperty.WhenAsoldittoB,Alostallitsrights.Asequity
isdifferentfromB.ButtheanswerwouldbedifferentiftheBInc.isjustasham.Whatthelaw
prohibitsisthecorporationhavingequityintheproperty,notinothercorporations.Whatthe
lawcontemplatesisequityintheproperty,notintheowneroftheproperty.
SupposingXisastockholderofYInc.Xownsa3storybuildingwithPhp10Mmarketvalue.
Heentersintoa2yearleaseagreementwithYwithPhp400Kmonthlyrentalpayableatthe
endoftheterm.Thereisanoptiontopurchaseattheendoftheterm.Wouldtherentalsbe
deductible?
No.Theoptiontobuyissimilartotakingtitlealready.Inaleaseagreement,itshouldbepurely
forleasepurposes.Ifitisasale(orleaseandsale),itisnotdeductible.Also,thereshouldbea
reasonableallowance.Inthiscase,theamountofrentalspaidisnotreasonablebecausethe
corporationwouldbepayingPhp400Kamonth,andthatsinceitisa2yearlease,the
corporationwouldbepayingPhp9.6Mwhichapproximatesthefairmarketvalueofthe
property.
ThefactthatXisastockholderisconsistentwiththetheorythattherentalpaymentis
unreasonablebecauseintheprocess,therentalisdisguiseddividend.Theexcessrental
(whateverexceedsthereasonableamountofrent)wouldbedeemeddividendstaxableinthe
handsoftheshareholder.
Supposingalesseepaysanadvancepaymentof1yearandalsogivesasecuritydepositfor1
year.Thelesseealsopaysanamounttopayfortherighttoleaseortherighttooccupy.The
lesseealsoagreedtopayrealestatetaxontheproperty.Thelesseelateronintroduces
improvements.Undertheleaseagreement,theimprovementswouldtransfertothelessor
uponterminationofthelease.Whatarethedeductibleexpenses?
AdvancePayment
Underrevenueregulation,thisisdeductiblebusinessexpensebutaportionoverthe
turnofthelease(costofdoingbusinessforthetaxableyear).Thelesseemaytakeas
deductioninitsreturnanaliquotpartofsuchsumeachyear,basedonthenumberof
yearstheleasehastorun.
SecurityDeposit
Itisnotadeductiblerentalexpense.Iftheamountreceivedisinthenatureofsecurity
depositforthefaithfulcompliancebythelesseeofthetermsofthecontract,thereisno
incometothelessorunlesstheconditionswhichmakethesecuritydeposittheproperty
ofthelessoroccur.
Tax
Insomecases,thelesseemayagreetopaycertainobligationsofthelessortothird
parties(ex.Loans,interest,taxes,insurancepremiums,etc.).Thepaymentsmadebythe
lesseeundersuchtermsoftheleasecontractshouldbeconsideredasadditionalrent
incomeofthelessor.Taxespaidbeatenanttoorforalandlordforbusinesspropertyare
additionalrentandconstituteadeductibleitemtothetenantandtaxableincometothe
landlord.
Cecille 2C 05-06
101
RighttoOccupy
Somerulingshavesaidthatitisnotadeductiblebusinessexpense.Itwasasifthelessee
purchaseagoodwillwhichisacapitalitem.
Improvements
Thecostbornebyalesseeinerectingbuildingsormakingpermanentinvestmentson
thegroundofwhichheisthelesseeisheldtobeacapitalinvestmentandnotdeductible
asabusinessexpense.Inordertoreturntosuchtaxpayerhisinvestmentofcapital,an
annualdeductionmaybemadefromthegrossincomeofanamountequaltothecostof
suchimprovementsdividedbythenumberofyearsremainingofthetermoflease,and
suchdeductionshallbeinlieuofadeductionfordepreciation.
Theimprovementscouldbeamortizedbythelesseeovertheturnoftheleaseorover
thelifeoftheimprovementorwhicheverisshorter.Therule,therefore,is:Dividethe
costoftheimprovementbytheestimatedusefullifeoftheimprovementorbytheterm
ofthelease,whicheverisshorter.
RentalPayments
Rentalpaymentspresupposealeasecontract.So,forthetaxpayer,therentalpayments
mustbereallyinpursuancetoaleasecontract.Thus,theissueofwhetherthecontractis
reallyaleasecontractorasalearises.Thegoverninginstrumentistheleaseagreement.
Iftheleaseagreementisnotsimplyaleasebutisaconditionalsaleorapurchase
agreement,thentherentalswouldnotbetreatedasrentalexpense.Thatwillbea
paymentforpropertywhichisnotdeductibleasrentalexpense.
YInc.isanAmericancorporationengagedinlingeriebusiness.XInc.isadomestic
Entertainment Expense
corporationengagedinpiggerybusiness.YInc.spresidentandsecretaryentertainedbyXInc.
Istheentertainmentdeductible?
Yes.Ifaftertheentertainment,theytalkedaboutbusiness,thenitisdeductible.TheAmerican
companymightbediversifyingandthatitmaybeinterestedininvestinginapiggerybusiness.
Theremustbeletterofintentorthattheremustbeadiscussiontothiseffectduringthe
entertaining,thatthereisintenttoinvest.
Business Discussion Test

SupposingXInc.broughtYInc.sofficerstoanightclub.Insidethenightclub,theywere
givenexpensivewineandwomentoentertainthem.Assumingthatsuchactisnotviolativeof
publicmorals.
Yesbutitisimportanttoshowthatbusinessdiscussionwasdone(businessdiscussiontest).Even
iftheentertainmenttookplaceforthreehoursandthatthediscussiontookplaceforfive
minutes,itisstilldeductible.Theymustshowthatbusinessdiscussionwasdoneorpossibly
done.Itmustalsobeshownthatitwasdonebypeoplewhocancommitbusiness.Under
Americanjurisprudence,thisisreferredtoascostforsocializing.
However,anyexpenseincurredforentertainment,amusementorrecreationthatiscontraryto
law,morals,publicpolicyorpublicordershallnotbeallowedasdeductionfromgrossincome.
Supposingnodiscussiontookplacebecauseoftheenvironment.Woulditstillbedeductible?
Iftheatmospheremakesitimpossibletodiscussbusiness,theyyoucannothaveentertainment
expensesdeductible.Theexpendituremustprecedeorfollowthediscussion.
Cecille 2C 05-06
102
Supposingtheentertainmenttook3hoursandthebusinessdiscussiononlytook5minutes.
Wouldthatrenderexpensesnotdeductible?
Aslongastherewasabusinessdiscussion,thiswouldmaketheexpendituredirectlyconnected
ordirectlyrelated.Whatisimportantisthattherewassadiscussionbefore,duringorafterthe
entertainment.
SupposingtheyentertainedthecorporateofficersofAmericaninvestingcorporationand
assumethatthereisadirectrelationbetweenbusinesses.Theywenttoentertainmentcenter.
Theyboughtacaringoingthere.Isthebuyingofthecardeductible?
Itisnotdeductiblebecauseentertainmentexpensesarelimitedonlytothecostsandnottothe
facilitiesused.Capitaloutlayisnotdeductiblethistimebutovertime.
SupposingX,acontractor,entersintoacontractwiththeDPWH.ThePhp50Mcontractwas
fortheconstructionofGMAbridge.Aspartoftheconsideration,SecretaryYoftheDPWH
requestedXtoemploy3personsrelatedtohimasstructuralengineers(notpublicofficers)to
becompensatedforPhp90K.Canthatexpensebedeductibletothecontractor?
Iftherearenoservicesrendered,itisanindirectkickback.Thus,itisnotdeductible.However,if
actualserviceswererendered,thenitisdeductible.Itwillnegatetheallegationofbribeand
kickback.Briberyispresumedifnoactualservicewererendered.Itisnotanordinaryand
necessaryexpensetodobusinessbybribery.TheprovisiononkickbacksinNIRCissuperfluous
becausetheviolationoflawisalwaysunreasonable,notnecessaryorordinaryexpense.Evenifit
isnotspecificallyprovidedasexcludedfromdeduction,itwouldstillnotbedeductiblebecause
itcanneverbeconsideredasnecessaryorordinary.
Whatarecapitalexpenditures?
Capitalexpendituresarethosethatresultinobtainingbenefitsofapermanentnaturesuchas
lands,buildings,andmachineries.Itisnotdeductibleasanordinaryornecessaryexpense.It
relatestothebusinessandisdeductedbydepreciationoramortizationoverthelifeoftheuseof
theasset.
Arecapitalexpendituresdeductible?
No.Capitalexpendituresarenotdeductiblebuttheymaybedeductibleinasense.Deductible
businessexpensesarethoseincurredwithinthetaxableyear.Ifbusinessexpensesare
capitalized,thetaxpayerdoesnotexpendduringthetaxableyear.Iftheexpendituresgiveyou
assetswhoselifetimeextendmorethanataxableyearoriftheassetwouldresulttoan
advantageorbenefitexceedingoneyear,thenitisacapitalexpenditure.Whenyoudeduct
businessexpenses,thisisdoneduringthetaxableyear.Whenyoucapitalize,whatyoucredit
overisthelifeoftheassetcapitalized.
Anexampleofthisiswhenabusinessbuysmachinery.Itusuallyspreadsexpensesoverthelife
oftheasset.Thestandardisiftheexpendituregivesyouanassetwithaliftthatexceedsthe
taxableyear,thensuchisacapitalexpense.
Doyouhavetopurchaseanassetforittobeacapitalexpenditure?
InWelchv.Helvering,itwasheldthatexpensesmadetobuildonesreputationandinvestments
forlearningareakintocapitalassetslikethegoodwillofanoldpartnership.Inthatcase,itwas
heldthatpurchaseofgoodwillisabenefitthatexceedsthetaxableyearandthusconsideredas
capitalexpenditure.Itisimportanttodistinguishbetweenpurchaseofgoodwillandprotection
ofgoodwill.Protectinggoodwillisabusinessexpense.
InthecaseofINDOPCOv.CIR,noassetwaspurchased.TheCourtsaidthatthetakeover
producedsignificantbenefitstoINDOPCOthatextendedbeyonditstaxableyear.Therewasa
financialstrengtheningwhichenabledINDOPCOtoeliminatepreviouslyauthorizedpreferred
sharesofstockandreducethetotalnumberofauthorizedcommonshares.TheCourtheldthat
Cecille 2C 05-06
Bribes, Kickbacks, and

Similar Payments
Capital Expenditure
103
theinvestmentbankingexpenses,legalexpenses,andothermiscellaneousexpensesarenot
ordinaryandnecessaryexpensesbutcapitalexpenditures.Inseveralcases,courtshad
characterizedanexpenditureascapitalinnaturebecauseitspurposewasrelatedtoa
corporationsoperationsandbettermentforlongerthanthecurrenttaxableyear.Also,thefact
thattheexpensesdidnotcreateorenhanceaseparateanddistinctadditionalassetisnot
controlling.
Thedistinctionbetweenbusinessexpenditureandcapitalexpenditureispremisedonbenefit
exceedingthetaxableyear.
XInc.isengagedinaleasingbusiness.Sometenantsfailedtopay.Thus,XInc.fileda
complainttorecoverrents.Isthelitigationexpensedeductible?
Yes.Itisabusinessexpensebecauseitisordinaryandnecessary.Itispartofdailyoperationsof
thebusiness.
WhatifXInc.obtainedtheservicesoflawyerstodefendtitletoproperty?Deductible?
ItcanbearguedthatsuchisacapitalexpensebecausethisgivesXInc.abenefitthatexceedsthe
taxableyear.Thecostofdefendingmaybecapitalizedtothevalueoftheproperty.Propertyis
Php1MandtheexpensewasPhp200K.Thus,thevalueofthepropertycapitalizedisPhp1.2M.
AcollegeputsupalibraryworthPhp30M.Isitacapitalexpenditureordeduction?
Itisadeduction.Thisexpensecanbetreatedasadeductibleexpenseevenifacapitalexpense
becausethelawexpresslyprovidesittobeabusinessexpense(Section34(A)(2)).Itisan
incentivetoprivateeducationalinstitutions.
Supposinganonstocknonprofiteducationalinstitutionputsupabookstoreincampus
whichearnedanincomeofPhp10M.Canthatbetreatedasabusinessexpense?
No.Itcannotbeadeductionbecauseitisnotaschoolfacility.Theoptiongrantedbylawdoes
notapply.Youcanargueeducationalpurposebutdeductionislimitedtoschoolfacilities.You
canarguethatthereisaconnectionbutintermsofdeduction,itmustbestressedthatdeductions
arestrictlyconstrued.Itismoreofacapitalexpensewhenyouconsideritasexpansionofschool
facilities.
Whatisinterestexpense?
Interestisthecompensationallowedbylaworfixedbythepartiesfortheloanorforbearanceof
money,goodsorcredits.Thegeneralruleisthatanyamountofinterestpaidorincurredwithin
thetaxableyearonindebtednessinconnectionwiththetaxpayerstrade,businessorprofession
maybedeductedfromgrossincome.
Onlyinterestsonbusinessdebtsaredeductible.Thus,anindividualtaxpayercannotdeduct
interestonamortgageloanonhisresidenceorinterestonmoneyborrowedtopurchasean
automobileforpersonaluse.
Whataretherequisitesforthedeductibilityofinterestexpense?
Theyare:
(1) thetaxpayermusthaveanindebtedness;
(2) theindebtednessmustbeconnectedwiththetrade,business,orprofessionofthe
taxpayer;
(3) theinterestmusthavebeenpaidorincurredduringthetaxableyear;
(4) interestmustbelegallydue;and
(5) theinterestmusthavebeenstipulatedinwriting(Art.1956oftheCivilCode:No
interestshallbedueunlessithasbeenexpresslystipulatedinwriting). itmustbein
writingtobelegallyenforceable
Cecille 2C 05-06
Interest Expense
Requisites for
Deductibility of Interest
Expense
104
Whatifataxpayerhasinterestincomesubjecttofinaltax?
Insuchacase,theotherwisedeductionforinterestexpenseshallbereducedbyanamountequal
to38%ofinterestincomesubjectedtofinaltax.
In2005,Mr.A,aresidentcitizenofthePhilippines,borrowedmoneyfromBBank,onwhich
loanhehadaninterestexpenseofPhp8,000.HedepositedthemoneywithCBank,from
whichhehadaninterestincomeofPhp10,000.Howmuchwashisdeductibleinterest
expense?
InterestExpense
Php8,000
Less:Adjustmentforinterestincomesubjecttofinaltax
3,800
(38%ofPhp10,000)
_________
Adjustedbalance,deductionforinterestexpense
Php4,200
XInc.borrowedfromASBBankPhp50Mat9%interestperannumfortheexpansionofits
businessfacilities.Uponthereleaseoftheloan,XInc.turnedaroundandinvestedthePhp
50MwithinterestbydepositingitwithCBankat6%perannum.Canitdeductoutrightthe
Php4.5Masinterestexpenseforthattaxableyear?XInc.gotthemoneyinthemorning
January3anddepositeditintheafternoon.
NobecausetheamounttobedeductedwillstillbereducedasprovidedinSection34(B)(1).
Interestexpenseshallbedeductible.Ontheotherhand,thedepositwillbesubjectedtoafinal
tax.Section34(B)(1)providesthatthetaxpayersotherwiseallowabledeductionforinterest
expenseshallbereducedbyanamountequaltothefollowingpercentagesoftheinterestincome
subjectedtofinaltax:
Fortyonepercent(41%)beginningJanuary1,1998;
Thirtyninepercent(39%)beginningJanuary1,1999;and
Thirtyeightpercent(38%)beginningJanuary1,2000.
Thus,theformulawouldbe:
InterestExpense
Less:42%ofAmountdeposited
Adjustedbalance,deductionforinterestexpense
Notethatthepercentagehasbeenchanged.Underthepresentlaw,theinterestexpenseshallbe
reducedbyanamountequaltothe42%oftheinterestincome.
WhatifXInc.lendsittoasubsidiaryfor9%interestinsteadofdepositingit?Deductible?
Yes.Theentireamountisnowdeductiblebecausetheinterestincomeisnotsubjecttoafinaltax.
Areinterestearnedinbankdepositsdeductible?
Nobecauseinterestsfrombankdepositsaresubjecttofinaltax.Remember,interestincomefrom
bankdepositsaresubjecttofinaltax,
XInc.has300employees.XInc.wasnotabletopaysalariesfor2months.WhatXInc.didwas
toadd10%toemployeessalarytreatingitasinterest(5%permonthinterest).XInc.deducted
itasaninterestexpense.Deductible?
Itisnotdeductibleasinterestexpensebecausethereisnoloan.Thereisnoevidenceof
indebtedness.Butthecompensationpaidshallbedeductibleassalary.
XInc.lendstoasubsidiarya5yearloanofPhp50Mwith6%interestperannum.Theloan
agreementsaysthatthepaymentoftheloanshallcomefromthenetincomeofthesubsidiary.
Istheinterestdeductibleonthepartofthesubsidiaryonthefirstyearoftheloan?
Remember,thattheborrowerhereisacorporationandnotanindividual.Thustheadvance
Cecille 2C 05-06
105
discountingprovisionunderSection34(B)(2)isnotapplicableinthiscase.
No.Itisnotdeductiblebecausetheinterestisnotyetlegallydueorenforceablebecausethere
wasnoproofthatthedebtwasalreadydueandthatthesubsidiaryhasanetincome.The
paymentineffectismadetodependonwhetherornotthesubsidiarywillhaveanincometo
beginwith.So,thefactofbeingrepaidisnotcertain.(PICOPv.CourtofAppeals)
Whenisinterestnotallowedasdeduction?
(1) Ifwithinthetaxableyearanindividualtaxpayerreportingincomeonthecashbasis
incursanindebtednessonwhichaninterestispaidinadvancethroughdiscountor
otherwise:
Provided,Thatsuchinterestshallbeallowedaadeductionintheyearthe
indebtednessispaid:
Provided,further,Thatiftheindebtednessispayableinperiodicamortizations,
theamountofinterestwhichcorrespondstotheamountoftheprincipal
amortizedorpaidduringtheyearshallbeallowedasdeductioninsuchtaxable
year;
(2) Ifboththetaxpayerandthepersontowhomthepaymenthasbeenmadeoristobe
madearepersonsspecifiedunderSection36(B);or
(3) Iftheindebtednessisincurredtofinancepetroleumexploration.
Whatisthesocalledoptionaltreatmentofinterestexpense?
UnderSection34(B)(3),attheoptionofthetaxpayer,interestincurredtoacquirepropertythat
willbeusedintradeorbusiness,orinthepracticeofaprofession,maybeallowed:
(1) asanoutrightdeductionfromgrossincome;or
(2) asacapitalexpendituretoformpartofthecostoftheasset.
XInc.borrowedPhp30Mat9%interestperannumfromabanktoexpanditsbusiness
facilities.XInc.boughtequipmentworthPhp30M.XInc.obtainedtheloaninJanuaryand
theinterestisdueinDecember.XInc.boughttheequipmentinMarch.Whatistheoptionof
XInc?CanXInc.deducttheinterestthefollowingyear?CanitdepreciatePhp30M?Whatif
theinterestisaddedtothecostoftheproperty?
XInc.candobothiftreatedseparately:Php30Mdepreciationandinterestasdeduction.
However,XInc.cannotdobothifitcapitalizedtheinteresttothecostoftheequipment(9%
interestisaddedtothevalueoftheequipmentandtheaddedvaluewillbethebasisfor
depreciation.Thus,ithasonlytheoptiontoeitherclaimtheinterestasadeductionorcapitalize
theinterestpaymentandclaimitaspartofthedepreciationexpenseoftheequipment.
WhathappenedinthecaseofHospitaldeSanJuandeDiosv.CIR?
Inthiscase,theCIRdisallowedinterestanddividendsfromsharingintheallocationofadmin
expensesonthegroundthattheexpensesincurredinthemanagementofpetitioners
investmentsarenotallowablebusinessexpensesinasmuchastheywerenotincurredincarrying
onanytradeorbusiness.
Itwasfoundthatinterestsanddividendsweremereincidentalincome.Petitionersactivities
neverwentbeyondthatofapassiveinvestor,whichunderexistingjurisprudencedonotcome
withinthepurviewofcarryingonanytradeorbusiness.Astheprincipleofallocating
expensesisgroundedonthepremisethatthetaxableincomewasderivedfromcarryingtrade,as
distinguishedfrommerereceiptofinterestanddividendsfromonesinvestments,theCTA
correctlyruledthatsaidincomeshouldnotshareintheallocationofadminexpenses.Itwasheld
thattheexpensesincurredbythepetitionerforhandlingitsfundsorincomeconsistingsolelyof
dividendsandinterests,werenotexpensesincurredincarryingonanytradeorbusiness,hence
notdeductibleasbusinessoradminexpenses.
Cecille 2C 05-06
Interest Not Allowed as

Deduction
Optional Treatment of
Interest Expense
106
Whataretherequisitesofthedeductibilityoftax?
Therequisitesare:
(1) taxespaidorincurredwithinthetaxableyear;and
(2) inconnectionwiththetaxpayersprofession,tradeorbusiness.
Meaningofthetermtaxes
Thetermtaxesincludenationalandlocaltaxes,andmeanstaxproperonly.Nodeductionshall
beclaimedforanysurcharge,fine,orpenaltyondelinquenttaxes.However,intereston
delinquenttaxes,althoughnotdeductibleastax,canbedeductedasinterestexpense.
Thetaxmustbeimposedonandpayablebythetaxpayer.Inshort,itmustnotbeashiftedtax.If
thelawimposesataxonaperson,andanotherpersonpaysthetax,thepayorcannotclaima
deductionforthepayment.
Arealltaxesdeductible?
No.Notalltaxesaretaxable.UnderSection34(C)(1),thefollowingarenotdeductible:
(a) TheincometaxprovidedforunderthisTitle;
(b) Incometaxesimposedbyauthorityofanyforeigncountry;butthisdeductionshallbe
allowedinthecaseofataxpayerwhodoesnotsignifyinhisreturnhisdesiretohaveto
anyextentthebenefitsofparagraph(3)ofthissubsection(relatingtocreditsfortaxesof
foreigncountries);
(c) Estateanddonorstaxes;and
(d) Taxesassessedagainstlocalbenefitsofakindtendingtoincreasethevalueofthe
propertyassessed.
Supposeamanufacturerimposesasalestaxtothedistributoraddingtothepricethesalestax.
Canthedistributordeductthetaxpaid?
No.Thedistributorcannotclaimadeduction.Thepersonwhopaidandonwhomtaxeswas
assessedistheonewhocanclaimadeduction.Inthiscase,itisthemanufacturer.
Ifthesalestaxisataxonthesellerortothemanufacturer,thebuyerorthedistributormaynot
deductit.Directtaxesaredeductiblenotindirecttax.Inthiscase,thesalestaxisnotadirecttax.
Supposingintheprecedingexample,ifthedistributorsolditfurther,addingtothecostthe
salestax,howmaythebuyerdeductthecosts?
Thetaxpayermaydeductitthroughdepreciationbecausethetaxisaddedtothecostofthe
equipment.
Percentagetaxes,suchasVAT,aredirectlyimposabletothetaxpayer.ThisVATisaddedto
thecostalreadyforthepurposeofdepreciation.Canthetaxpayerdeductthetax?
No.Evenifitisdirectlypayable,thetaxpayercannotjustdeductthetaxespaidifthetaxpayer
alreadyaddedthistothecostoftheequipmentandthereforeneedingittobecapitalized,added
tothecostofdepreciation.Otherwise,itwillresulttoadoublededuction.
Forexample,VATonimportofequipmentworthPhp10M.Php1MVATisaddedtothecostof
theequipment.Thus,Php11Miscapitalized.ThePhp1MVATisaddedtothecostfor
depreciationpurposes.EveniftheVATisdirectlypayablebythetaxpayer,ifthetaxpayer
capitalizesit,thenthetaxpayercannolongerdeductthetax.Toallowthetaxestobedeductible
wouldresultindoublededuction.
Cecille 2C 05-06
Requisites for
Deductibility of Tax
Definition of Taxes
107
Xwasmadetopaytaxes.Ontopofthetax,fines,surcharges,andinterestswereadded
becauseofXsdelinquency.Whatwouldbedeductible?TaxisPhp1M,interestisPhp50K,
surchargeis25%,andfineofPhp25K.
Finesandsurchargesarenotdeductible.Interestsaredeductibleasinterestonindebtedness
(interestdeduction).Asusedbythelaw,taxesmeantaxesproper.
OnlythePhp1Mwillbedeductibleasataxexpense.Php50Kshallbedeductibleasinterest
expense.
Thelawsimplysaystaxes.Ifitprovidestaxes,fines,surcharges,thenitwouldbe
deductible.Remember,deductionsarestrictlyconstrued.
Howareinterestsontaxesdeductible?
Interestsontaxesaredeductibleasinterestonindebtedness.Itisnotdeductibleastax.
Arepenalties,surcharges,andfinesdeductible?
No.Thelawsimplytalksoftaxes.Otherwise,publicpolicywouldbeviolatedifyouallow
deductionsoffines,penalties,andsurcharges.Youwouldnotbepenalizingdelinquent
taxpayers.Thiswouldinfactencouragetaxdelinquency.
Arefeesdeductibleastax?
No.Feesarenottaxes.FeesarenotdeductibleundertaxesasheldinthecaseofEssoStandard
Easternv.CIR.Thesewerenotallowedasadeductionunderthetaxdeductionprovisionbecause
feesarenottaxes.Butfeesmaybedeductedasbusinessexpenses.Whenyoutalkoflicensefees
orregulatorfees,thesearepartofthecostofdoingbusiness.Thesearebusinessexpensesbut
youcannotdeductitunderthetaxdeductionprovision.
Arefinaltaxesdeductible?
Althoughtheyaretaxes,theycannotbedeductedunderthetaxdeductionprovisionforone
simplereason.Theyareonlyfinaltaxes,finaltaxesonfinalgainorfinalincome.Thus,thegainis
finallytaxed.Finaltaxdoesnotenteryourgrossincomefigure.Itisnotevenreportedaspartof
yourgrossincomestatement.Thus,finaltaxisnotdeductible.
Whattaxescanbedeductedbyanonresidentalienindividualoraresidentforeign
corporation?
Thedeductionfortaxesshallbeallowedonlyifandtotheextentthattheyareconnectedwith
incomefromsourceswithinthePhilippines.
Whattaxescanbedeductedbynonresidentforeigncorporation?
Nonresidentforeigncorporationsarenotalloweddeductionsfortaxesbecausetheyaretaxed
onagrossbasis.
Whatistheruleonincometaxrefundorcredit?
Ataxrefundmayormaynotconstitutetaxableincomedependingonwhetherornotthetaxwas
previouslydeductedasanexpenseincomputingincometax.
Theruleisthatataxwhichwaspreviouslydeductedasanexpenseshouldbereportedas
incomewhenarefundofthesameisreceivedinasubsequentyear.
UnderSection34(C)(1),taxesallowedasdeductions,whenrefundedorcredited,shallbe
includedaspartofgrossincomeintheyearofreceipttotheextentoftheincometaxbenefitof
saiddeduction.
Cecille 2C 05-06
Rule on Income Tax

Refund / Credit
108

Ontheotherhand,ataxwhichisnotdeductiblewhenrefundedtothetaxpayerisnotanincome
subjecttotax.
Undertheproviso,iftheamountoftaxrefundedorcreditedisPhp10K,andtheincometax
benefitofthetaxdeductionisPhp3K,onlyPhp3Kshallbeincludedaspartofgrossincomein
yearofreceipt.
Supposingin2001,XclaimedaPhp200Ktaxasadeduction.In2003,hegotataxrefund.What
isthetaxconsequence?
Therefundshallbeincludedaspartofgrossincomein2003totheextentoftheincometax
benefitofsaiddeduction.Section34(C)providesthat taxesallowedunderthisSubsection,when
refundedorcredited,shallbeincludedaspartofgrossincomeintheyearofreceipttotheextent
oftheincometaxbenefitofsaiddeduction.
Ifthetaxdeductionreducedthetaxliabilityofthetaxpayer,thenthetaxrefundwillbeapartof
grossincomeintheyearofreceiptandonlytotheextentoftheincometaxbenefitofprevious
deductionobtainedbythetaxpayer.Thisistheproperapplicationofthetaxbenefitrule.
Soletussayin2000,Xincurredalossanddeductingthetaxeswouldstillresultinalossforthe
taxpayer.Eveniftherewasataxrefundlateron,thiswillnotberecognizedastaxablebecause
thedeductiontakenin2000didnotbenefitthetaxpayeratall.
Intheprecedingquestion,howcanitbeanincometaxbenefittothetaxpayer?
Itisabenefitbecauseduetothedeductionintheyearthatitwasallowedthetaxpaidbythe
taxpayerdecreased(alongwiththetaxrate).Thetaxpaidandclaimedasadeductiondecreased
thetaxliability.Thistaxbenefitistobeadded(thebenefitarisingfromthedeductionnotthe
amountitself)duringtheyearofrefund.
Definitionoflosses
Thetermlossesimplyanunintentionalpartingwithsomethingofvalue.Itisusedintheincome
taxlawinaverybroadsensetocomprehendalllosseswhicharenotgeneralornaturaltothe
ordinarycourseofbusinessandnotcoveredundersomeotherheadingsuchasbaddebts,
inventorylosses,depreciation,etc.(fromthebookofDeLeon)
Whataretherequisitesfordeductibilityofloss?
Forlosstobedeductible,itmust:
(1) bethatofataxpayer;
(2) beactuallysustainedandchargedoffwithinthetaxableyear;
(3) havebeenincurredintrade,business,orprofession;
(4) beevidencedbyaclosedandcompletedtransaction;and
(5) nothavebeencompensatedforbyinsuranceorotherformsofindemnity.
UnderSection34(D)(1),lossesactuallysustainedduringthetaxableyearandnotcompensated
forbyinsuranceorotherformsofindemnityshallbeallowedasdeductions:
(a) Ifincurredintrade,professionorbusiness;
(b) Ofpropertyconnectedwiththetrade,businessorprofession,ifthelossarisesfromfires,
storms,shipwreck,orothercasualties,orfromrobbery,theftorembezzlement;
(c) NolossshallbeallowedasadeductionunderthisSubsectionifatthetimeofthefiling
ofthereturn,suchlosshasbeenclaimedasadeductionforestatetaxpurposesinthe
estatetaxreturn.
Cecille 2C 05-06
Losses
Requisites for
Deductibility of Loss
109

Whatkindsoflossesaredeductibleforcorporations?
Allkindsoflossesinthecourseofbusinesswillbedeductibleaslongastheyareactually
sustainedandchargedoffwithinthetaxableyearandnotcompensatedforbyinsuranceor
otherwise.
Supposingyouhaveadomesticcorporationwithseverallinesofbusinessmanufacturing,
distribution,assembly,etc.Wouldthelossofonebeoffsetbytheincomeoftheothers?
Yes.Becauseyouaresimplytalkingofonecorporatetaxpayer,onecorporateincomeandoneset
ofdeductions.Sofordomesticcorporation,thatistherule.
Howaboutinthecaseofresidentforeigncorporations?
Byexpressprovisionoflaw,inthecaseofanonresidentalienindividualorforeigncorporation,
thelossesdeductibleshallbethoseactuallysustainedduringtheyearincurredinbusiness,trade
orexerciseofaprofessionconductedwithinthePhilippines,whensuchlossesarenot
compensatedforbyinsuranceorotherformsofindemnity.
Whenislossactuallysustained?
Thelosstobeactuallysustainedmustbeevidencebyaclosedandcompletedtransactionwhich
meansthattheremustalreadybeaprimaryloss.Ataxpayercannotlookforwardtoapossibility
ofcompensationorrecover.
Inlosses,thereisoneimportantprinciple:lossislossintheyearofoccurrence,incomeinthe
yearofrecovery.
Whenshouldlossesbededucted?
Generally,lossesshouldbedeductedonlyinthetaxableyeartheywereactuallysustained,anda
lossissustainedduringtheyearinwhichitoccursasevidencedbyaclosedandcompleted
transaction.Furthermore,theyshouldbechargedoffinthebooksoftheclaimantwithinthe
taxableyear.
Whatdoyoumeanbyclosedandcompletedtransaction?
Itisthetimewhichtellsyouthisisthelosssustainedbythetaxpayer.Itisthepointintimewhen
thetaxpayercanfinallydeterminehowmuchwaslost.
SupposingacorporationhasabuildingworthPhp30M.Itwasrazedtothegroundbyfirein
1990.Itisuninsured.Whenshallitbeconsideredaloss?
Itisalreadyalossintheyearofoccurrence,in1990.Thereisalreadyaclosedandcompleted
transaction.Itisuninsured.Thus,thereisnopossibilityofrecovery.
Supposein2003,XlostavehicleamountingtoPhp700K.In2004,XclaimedPhp700Kas
deduction.In2005,thevehiclewasreturned.In2005,thevehiclewasworthPhp500K.Will
thetaxbenefitruleapply?
Yes.Youclaimalossandyourecoveraloss.Itinvolvesthesameprincipleasappliedincasesof
taxrefundsandbaddebts.
XisahousewifemarriedtoY,atypicalcustomsofficial.Yobtained10Kbundlesofneckties.
WhenXsawtheneckties,Xtoldherfriendsabouttheneckties.Allthenecktieswerebought.
ThecarofYwhichwasusedbyXtogotoherfriendswasstolen.CanXdeductthevalueof
thecartoherincome?
No.Itisnotdeductiblebecausethehousewifeifnotengagedintrade,businessorprofession.
Deductiondoesnotapplytoasimpleprofitseekingactivity.Anisolatedactivity,suchaswhat
happenedinthiscase,isnottradeorbusiness.
Cecille 2C 05-06
110

Intheprecedingexample,supposeXregularlydoesselling.Thestolencarwascoveredby
insuranceforPhp800K.XdeductedPhp800Kintheyearoflossbecauseshedidnotbotherto
fileaclaim.Isitdeductible?
Yes.Insurancecoverageisnotrequiredasadeduction.Thelawsayscompensationfrom
insuranceandnotinsurancecoverage.Thelawprovidesnotcompensated.Inthiscase,shedid
notfileaclaim.Thus,shewasnotcompensatedforbyinsurance.Thelawdoesnotmean
coverage.
Usingthesameexample,whatifthewifeisengagedinthebusinessandthecarwasstolen?
Canshedeductitasaloss?
Yes.Section34(D)(1)(b)providesofpropertyconnectedwiththetrade,businessor
profession.Thesaidprovisiondoesnotrequireownership.
Whatistheeffectwhenthetaxpayertookthecoverageafteroneyearfromthetimewhenhe
claimedadeductionandtheinsurancepaidtheclaim?
Thelosshappenedin2001.In2002,XfiledaclaimforlossofPhp1M.Xwasimmediately
paidPhp1Mbytheinsurancecompany.Whatisthetaxconsequenceofthepaymentin2002
supposingintheyearXclaimedthededuction,thelossreducedthetaxliabilityofthe
taxpayer?
Youcanarguetaxbenefitrule(aslongaslossdeductionresultedintaxbenefit).Iftheloss
deductionintheprioryearresultedinreductionofliability,thenthepaymentmadebythe
insurancecompanywillformpartofgrossincometotheextentofthebenefit.
Whatdoesnotcompensatedforbyinsuranceorotherformsofindemnitymean?
Thiswordsotherformsofindemnityreferstocompensationdueunderatitleanalogousor
similartoinsurance.Thelosssustainedbythetaxpayermustbecoveredbyjudicially
enforceablerightarisingfromanyofthesourcesofobligation.
WhathappenedinthecaseofPlaridelSuretyv.CIR?
CMCCompanyagreedtobuylogsforexportfromXwhoobligatedhimselftosupplysaidlogs.
Tosecurethefaithfulperformanceofhisobligation,X,asprincipal,andPlaridelassurety,
executedaperformancebondinfavorofCMC.Xalsoexecutedachattelmortgageonhis
machineriesinfavorofPlarideltoprotectthelatteragainstlossordamageontheperformance
bond.AsXfailedtodeliverthelogs,thebondwasdeclaredforfeitedbythecourt.Plaridelpaid
CMCthetotalamountofitsclaim.Plaridelthentookalossdeduction,
TheSCheldthatthelosssustainedbyPlaridelwascompensatedfor(byinsuranceor)otherwise
and,therefore,ithasnotinfactandinlawsufferedanyloss.Theallegeddeductiblelosswas
coveredbyajudiciallyenforceablerightbasedonacontractanindemnityagreementsignedby
XinfavorofPlaridel.Thecourtsaidthereisstillapossibilityofrecoverybecauseofthe
indemnityagreement.Solongasthereisstillthatrighttocompensation,thecourtsaid,
technicallyyoucannotclaimalossbecausethereisthatpossibilityofcompensation.Theruleis
thatlossdeductionwillbedeniedifthereisareasonablerighttocompensatefortheloss,with
ultimatecollectionreasonablyclear.Wherethereisreasonablegroundforreimbursement,the
taxpayermustseekhisredressandmaynotsecureadeductionuntilheestablishesthatno
recoverymaybehad.
Cecille 2C 05-06
111
Whataretherequisitesfordeductibilityoflost property?
(1) thepropertymustbeconnectedwiththebusiness,trade,orprofession;and
(2) thelossmustbeduetocasualtyorfromrobbery,theftorembezzlementduringthe
taxableyear.
Theenumerationisimportant.Ifitisnotspecificallyincluded,thenthelosswillnotbe
deductible.
Abuildingbeingusedinbusinessistermiteinfested.After10years,thebuildingbecame
totallyunusable.Canthatbeclaimedasapropertyloss?
No.Thelawusesthewordcasualty.Thisimpliessuddennessorsomethingunexpected(likefire,
storm,shipwreck,etc.).Thetermisakintoanaccident.Inthiscase,itwasnotacasualtybuta
fact.
Whatisnetoperatingloss?
Netoperatinglossistheexcessofallowabledeductionsovergrossincomeofthebusinessor
enterpriseforanytaxableyear.WhenSection34deductionsexceedtheSection32income,then
theexcesscanbecarriedoverasdeductibleitemforthreeconsecutiveyearsimmediately
followingtheexcessyear.
Itisnowallowedtobecarriedoveranddeductedfromgrossincomeforthenext3consecutive
taxableyearsimmediatelyfollowingtheyearofsuchloss,provided:
(a) Thelosshadnotbeenpreviouslyoffsetasadeductionfromgrossincome;
(b) Thelosswasnotincurredinataxableyearduringwhichthetaxpayerwasexemptfrom
incometax;and
(c) Therehasbeennosubstantialchangeintheownershipofthebusinessorenterprisein
thatnotlessthan75%innominalvalueofoutstandingissuesharesorthepaidup
capitalofthecorporation,ifthebusinessisinthenameofthecorporation,isheldbyor
onbehalfofthesamepersons.
Whencanwageringlossesbedeductible?
Lossesingamblingcanbeclaimedasadeductionfromwinnings.Wageringlossisdeductible
onlyagainstwinnings.
Whencanworthlesssecuritiesbedeductible?
Ifsharesofstockheldasinvestmentorotherwisebecomeworthless,thecostorotherbasismay
bedeductedinthetaxableyearinwhichthestockbecameworthless,providedasatisfactory
showingofitsworthlessnessismade.
Thelosssustainedbytheholderofthesecurities,whicharecapitalassetstohim,istobetreated
asacapitallossasifincurredfromasaleorexchangetransaction.Whenthesecuritiesbecome
worthless,thereisstrictlynosaleorexchangebutthelawdeemsthelossanywaytobealoss
fromthesaleorexchangeofcapitalassets.
Whatarebaddebts?
Baddebtsaredebtsduetothetaxpayeractuallyascertainedtobeworthlessandchargedoff
withinthetaxableyearexceptthosenotconnectedwithprofession,tradeorbusinessandthose
sustainedinatransactionenteredintobetweenpartiesmentionedunderSection36(B).
Theyrefertothosedebtsresultingfromtheworthlessnessoruncollectibility,inwholeorinpart,
ofamountsduethetaxpayerbyothers,arisingfrommoneylentorfromuncollectibleamountsof
incomefromgoodssoldorservicesrendered.
Cecille 2C 05-06
Requisites for
Deductibility of Lost
Property
Net Operating Loss
Wagering Losses
Worthless Securities
Bad Debts
112

Whataretherequisitesforbaddebtstobedeductible?
Ingeneral,therequisitesfordeductibilityofbaddebtsare:
(1) Itmustbeanexistingindebtednessduetothetaxpayerwhichmustbevalidandlegally
demandable;
(2) Itmustbeactuallyascertainedtobeworthlessoruncollectibleasoftheendofthe
taxableyear;
(3) Itmustbeactuallychargedofffromthebooksofaccountsofthetaxpayerasoftheend
ofthetaxableyear;
(4) Itmusthaveariseninconnectionwiththetrade,business,orprofessionofthetaxpayer;
and
(5) Itmustnotbesustainedinatransactionenteredintobetweenrelatedparties
enumeratedunderSection36(B).
Mustthedebtbetotallywrittenof?
Yes.Thereisnopartialwritingoffwhenyoutalkofbaddebts.
Whenisanaccountworthless?
Beforeataxpayermaychargeoffanddeductabaddebt,itmustbeascertainedwithareasonable
degreeofcertaintythattheamountisuncollectible.Theremustbenolikehoodofrecoveryatany
timeinthefuture.Thetaxpayermusthavetakenreasonablestepstocollectthedebt,although
thereisnoneedtogotocourtifthelegalaction,inallprobability,wouldnotresultinthe
satisfactionorexecutionofjudgment.
Supposeacorporationhas70dealerseachgivenasupplyworthofPhp50K.Year2:timeto
collectbutnopaymentwasmade.Year3:stillnopayment.Year4:15paidandthetaxpayer
declaredtheremaining55accountsasuncollectible.Shouldthatbeconsideredbaddebts?
Notyet.Thefactthat15paidonthefourthyeargivesthepossibilitythatsomemaystillpayeven
onthefifthyear.Thereisstillanelementofcollectibility.Doubtofrecoveryisnotequivalentto
worthlessness.Inshort,theremustadebtwithremotepossibilityofcollection,almostno
collection.
Butinasimilarcase,thecourtconfrontedwithscattereddebtorsalloverthecountryandthe
debtswereveryminimal.Thecourtsaidyoucanalreadyclaimabaddebtdeduction.Why?Itis
impracticalforpurposesofcollection.Youhavealreadytakenreasonablestepsdemand
letters,etc.butnoresponse.Thefactthatitisminimal,scatteredalloverthecountry,youcan
alreadyclaimitasabaddebt,againthereasonisyouarenotrequiredtothrowgoodmoney
afterbad.Youarenotrequiredtospendmore,havingalreadyascertainedthattheclaimis
worthless.Youarenotrequiredtoreduceaworthlessclaimtoaworthlessjudgment.
Insummary,toascertainworthlessness,thelawrequiresmerelysufficientevidenceof
worthlessnessandsufficientevidenceistherewhenthetaxpayerhasalreadytakenthe
reasonablestepsandstillnopaymentwasmade.
Iscourtdeterminationofnoncollectibilitynecessary?
No.Byexerciseofsoundbusinessjudgment,youwillbeabletodetermineifthedebtis
worthless.Youlookintothefactualcircumstances.Toascertainworthlessness,allthatis
requiredisforthetaxpayertoundertakereasonablesteps.Ifonthebasisofthereasonablesteps,
thetaxpayeralreadyconcludedthatthedebtisuncollectible,thenyouhavesufficientevidence
ofworthlessness(PhilippineRefiningCompanyv.CourtofAppeals).
Cecille 2C 05-06
Requisites for
Deductibility of Bad
Debts
113
Inshort,underthePRCcase,whatthelawrequiresissufficientevidenceofworthlessness.
Reasonablestepsrefertosuchstepslikesendingastatementofaccounts,ademandletter,or
makingalawyersendafinaldemandletter.Thelawdoesnotrequireyoutogotocourtandfile
acase.
Whatifthecourtdismissedyourclaimonthegroundofmeretechnicality?Deductible?
No.Youcannolongerclaimdeductionbecausethecourtbythenhasestablishedthatthereis
actuallynodebt.
Whataretheinstancesshowingworthlessness?
insolventdebtor
debtoristerminallyill
debtorisaknownestafador
lostdocumentsofindebtednessanddebtorrefusestopay
Musttherebealoantobeabaddebtorcoulditbejustplainindebtedness?
Plainindebtednesswillsuffice.Whatisrequiredisadebt.Youcanhaveadebtwithoutaloan.
Saleorservicescanripenintoindebtedness.
Supposeyouaresellinggoodsbuttheydidnotpayyouorwhenyourenderedservicesbut
youwerenotpaidforyourservices.Canyoudeductitasbaddebts?
Yes.Uncollectedincomeorunpaidservicesbecomesindebtedness.Thus,itcouldbeclaimedas
baddebt.
SupposeacorporationgivesaloanofPhp10Mtoasubsidiary.Thesubsidiarysufferedaloss,
soitdidnotpay.Canthecorporationdeductthisasabaddebt?
Thecorporationcannotimmediatelysaythatthisisabaddebt.Itmaybeaninvestmentor
additionalcontributiontocapitalbutitmaynotbeindebtedness.Itmustbeanindebtednessfor
ittoqualifyunderthebaddebtdeduction.
Howmuchisdeductible?
Theruleisonlytotheextentoftaxpayersbasisorinvestment.
SupposeXhasareceivablewithafacevalueofPhp10M.XsoldthisreceivabletoYatPhp
8M.Ytriedtocollectbutwasnotpaid.WhatmayYdeduct?Php10MorPhp8M?
Php8MbecauseasfarasYisconcerned,hisbasisisPhp8M.Youcanonlydeducttotheextent
ofthebasis.
Supposesuppliersuppliesto40distributors.Thedistributorspaidpromissorynotes.
Promissorynotesdiscountedonfaceat10%.Thedealerdidnotpay.Theamountof
promissorynoteisPhp10,000.Itwasdiscountedat10%whichmeansPhp9,000.Whatwould
bethebaddebtdeducted?
Incaseofapromissorynote,ifitisrecordedanddiscounted,thedeductionshouldbetothe
extendofthediscountedvalue,notthefacevaluebecausethediscountedvalueisthebasisofthe
taxpayer.
Supposethesellersoldgoods.ThevalueofthegoodsisPhp1M.Thebuyertoldtheseller
thathewouldonlypayPhp600Kinacompromiseagreement.Thebuyeraccepted.Istheloss
deductible?
Yes.Itcouldbeclaimedasabaddebtastothebalance.
Cecille 2C 05-06
Instances Showing
Worthlessness
114
InaloanofPhp2MsecuredarealestatemortgageworthPhp1M,thedebtorabsconded.Is
thereabaddebt?
Thereisnobaddebtbecausethesecurityreplacedtheindebtedness.
Whatifthedebtispartiallysecured?Isthereabaddebt?
Yesbutonlytotheextentoftheunsecuredobligation.Whenwillyouclaimitasadeduction?
Onlywhenthiscollateralpertainingtothesecureddebthasbeenliquidatedorsold.Thatis
becausethatisonlytimewhenyoucandeterminehowmuchremainsunpaid.
Ifthereisonlypartialsecurity,youcannotclaimimmediately.Youmustliquidatethecollateral
foryoutodeterminehowmuchisbaddebt,howmuchisunpaid.
SupposeXInc.ascertainedadebtin1995tobeworthless.Xclaimeditasadeductionin1995.
Butthedebtorpaidthedebtin1999.Whatwouldbethetaxtreatment?
XhadacertaintaxbenefitintheyearthatXmadethededuction.Thepaymentwouldbeadded
aspartofgrossincomeonlytotheextentthatthetaxpayerhadataxbenefit.
Thisisinlinewiththetaxbenefittheory.Thereturnorpaymentwouldbetaxableincometothe
extentofthebenefitreceivedbythetaxpayerintheyearthebaddebtdeductionwastaken.
SupposeXwonthelottery.XlenthisfatherPhp10M.Hisfatherdidnotpay.Canheclaim
deductions?
No.HecannotclaimdeductionsbecauseitisdisallowedunderSection36(B).However,if
interestsarepaidbythefather,thenitshallbeconsideredasgainonthepartofX.
Section36(B)provides,incomputingnetincome,nodeductionsshallinanycasebeallowedin
respectoflossesfromsalesorexchangesofpropertydirectlyorindirectly:
(1) Betweenmembersofafamily.Forpurposesofthisparagraph,thefamilyofan
individualshallincludeonlyhisbrothersandsisters(whetherbythewholeorhalf
blood),spouse,ancestors,andlinealdescendants;or
(2) Exceptinthecaseofdistributionsinliquidation,betweenanindividualandcorporation
morethanfiftypercent(50%)invalueoftheoutstandingstockofwhichisowned,
directlyorindirectly,byorforsuchindividual;or
(3) Exceptinthecaseofdistributionsinliquidation,betweentwocorporationsmorethan
fiftypercent(50%)invalueoftheoutstandingstockofwhichisowned,directlyor
indirectly,byorforthesameindividualifeitheroneofsuchcorporations,withrespect
tothetaxableyearofthecorporationprecedingthedateofthesaleofexchangewas
underthelawapplicabletosuchtaxableyear,apersonalholdingcompanyoraforeign
personalholdingcompany;
(4) Betweenthegrantorandafiduciaryofanytrust;or
(5) Betweenthefiduciaryofandthefiduciaryofatrustandthefiduciaryofanothertrustif
thesamepersonisagrantorwithrespecttoeachtrust;or
(6) Betweenafiduciaryofatrustandbeneficiaryofsuchtrust.
SupposingXInc.lendsPhp1Mascertainedtobeworthlessin1992,claimedasadeductionin
1995,itisnow1997,thedebtorpaidPhp1M.WhatwouldbethetaxtreatmentofthisPhp1M?
Underourtaxlaws,itisonlydeductibletotheextentyouhadcertaintaxbenefitintheyearyou
deductedit.SupposingyouhavePhp1MandbecauseofthePhp1Mdeduction,youwereable
tomaketaxsavingsofPhp500Kbecauseitisdeductible,orevenifyouhadanincomeofPhp
1Mbecauseofthatbaddebtdeduction,0tax.Inthatcase,intheyearofthededuction,thereisa
taxbenefit.Thus,suchamountwillalsobetheamounttobeincludedinthegrossincomeincase
ofrefund.
Nowsupposingintheyearofdeduction,thecorporationincurredPhp5Mloss.ThePhp1M
Cecille 2C 05-06
115
deductionisinutilebecauseitservesnopurposeintheyearitwaspaidin1997.Whatisit?Itis
notincome.Itissimplyarecovery,areturnofcapital.Remember,ifyoulentsomething,youget
itback,noincomebecauseitisareturnofcapital.Sameprinciplehere,wherethereisabenefitin
1994,thatisincomebecauseitisnotonlyareturnofcapitalbutplusbenefit,thatiswhytothe
extentofthebenefitin1997.
Howisthetaxbenefitruleapplicabletobaddebts?
Underthelaw,therecoveryofbaddebtspreviouslyclaimeddeductionintheprecedingyearor
yearsshallbeincludedaspartofthetaxpayersgrossincomeintheyearofsuchrecoverytothe
extentoftheincometaxbenefitofsaiddeduction.
Thereisarecoveryofbaddebtaccountwhereareceivablewhichhadbeenwrittenoffinthe
booksissubsequentlypaidbythecustomerandthisshouldbereportedastaxableincomeinthe
yearoftherecovery.Inasmuchasthetaxpayerwasbenefitedintheyearthedebtwaswrittenoff
bypayingalowerincometax(becauseofthebaddebtdeduction),heshouldnowpayincome
taxontheamountwhichhecollectedonthatbadaccount.
Ifintheyearthetaxpayerclaimeddeductionofbaddebtswrittenoff,herealizedareductionof
theincometaxduefromhimonaccountofsaiddeduction,hissubsequentrecoveryfromhis
debtorshallbetreatedasareceiptofrealizedtaxableincome.
Conversely,ifthesaidtaxpayerdidnotbenefitfromthedeductionofthesaidbaddebtwritten
offbecauseitdidnotresulttoanyreductionofhisincometaxintheyearofsuchdeduction(ex.
wheretheresultofhisbusinessoperationwasanetlossevenwithoutdeductionofthebaddebts
writtenoff),thenhissubsequentrecoverthereofshallbetreatedasamererecoveryorareturnof
capital;hence,nottreatedasreceiptofrealizedtaxableincome.
However,wheresuchbaddebtexpensewasdisallowedbytheBIRasadeduction,the
subsequentcollectionofdebtisnottaxable.
Whatisdepreciation?
Depreciationisthegradualdiminutionintheusefulvalueoftangiblepropertyusedintradeor
businessresultingfromexhaustion,wearandtear,andnormalobsolescence.
Whatpropertymaybedepreciated?
Allpropertywhichhasadeterminableusefullife,personalorreal,usedinthebusinessmaybe
depreciated.
Canintangiblesbedepreciated?
Yes.Thetermisalsoappliedtoamortizationofthevalueofintangibleassets,theuseofwhichin
tradeorbusinessisdefinitelylimitedinduration.(BasilanEstatesv.CIR)
Inordertobedepreciated,theremustbeadeterminableusefullifetobeusedasabasisfor
depreciation.Theyaredepreciatedtotheextentofthevaluethatithasforthetaxpayerforthe
numberofyearswhereitisexpectedtobeofservicetothetaxpayer.Ifyoucannotdeterminethe
usefullifeofintangibles,thenyoucannotdepreciate.
UnderthePatentLaw,patentsandcopyrightshavedeterminableusefullifeof17years.
Whatisdepreciationdeduction?
Thereshallbeallowedasadepreciationdeductionareasonableallowancefortheexhaustion,
wearandtear(includingreasonableallowanceforobsolescence)ofpropertyused(or
temporarilynotused)inthetradeorbusiness,orinthepracticeofprofession.
Cecille 2C 05-06
Tax Benefit Rule as

Applied to Bad Debts
Definition of Depreciation
Depreciation Deduction
116

Maynonresidentaliensorforeigncorporationavailofdepreciationdeduction?
Incaseofanonresidentalienoraforeigncorporation,areasonableallowanceforthe
deteriorationofpropertyarisingoutofitsuseoremployment,intradeorbusinessshallbe
permittedonlywhensuchpropertyislocatedwithinthePhilippines.
Whatisthetheorybehinddepreciationallowance?
Thenecessityofdepreciationallowancearisesfromthefactthatcertainpropertiesusedinthe
tradeorbusiness,orinthepracticeofprofession,graduallyapproachapointwheretheir
usefulnessisterminated.
Whataretheallowablemethodsforcomputingdepreciation?
(1) straightlinemethod;
(2) decliningbalancemethod;
(3) sumoftheyearsdigitmethod;and
(4) anyothermethodwhichmaybeprescribedbytheSecretaryofFinanceuponthe
recommendationoftheCIR.
Whatisthedifferencebetweendepreciationandbusinessexpense?
Depreciation,asagainstbusinessexpense,wouldallowtherecoverofcapitalexpendituresover
acertainnumberofyears.
Isthereanexceptiontodepreciation?
Yes.Thereisanexceptionwhenyoutalkofprivateeducationalinstitutions.Theymaydeduct
capitalexpendituresasbusinessexpensesduringtheyear.Onlyprivateeducationalinstitutions
candeductitasbusinessexpensebyexpressprovisionoflaw.
Whomayclaimdepreciationdeduction?
Itisthetaxpayerusingtheproperty.
Whatisthebasisofdepreciationdeduction?
Thebasisofdepreciationistheusefullifeoftheproperty.
Supposeyouhavealesseelessorrelationship.Underthetermsofthelease,thelesseewill
turnovertheimprovementstothelessor.Whocanavailofthedepreciation?
Stillthelesseebecausehestillownstheimprovement.Thelesseebuildsabuildingimprovement
here,notthebuilding.Itisstillthelesseewhocanclaimdepreciation.
Supposeyouhaveamortgagormortgageerelationship.XInc.financedrequisitionof
equipmentforacartobeusedinthebusinessofY.XInc.totallyfinanceditandsoldtoY
withamortgage.OnthepartofY,buyer/mortgagee,noexpense,nocapitalinvestment
becauseitwastotallyfinancedbyXInc.Canthemortgagorwhomortgagedthefinancedcar
toXstillclaimdepreciationdeduction?
Yes.ThecorporateownerisnowYandnotXInc.althoughXInc.totallyfinancedtherequisition.
Itisthetaxpayerwhoownsthepropertyandusesthepropertyforbusinesspurposeswhoshall
bealloweddepreciationdeduction.
Supposeyouhaveafactory.Therewasastrikeanditwentonfor3years.Theequipmentof
thecompanywasnotused.Cantherestillbeadepreciationdeduction?
Yes.Thelawtalksofuseornotbeingused.Itisstillpartofthebusinessandtherefore
subjecttodepreciation.Oncedepreciablealwaysdepreciable.
Cecille 2C 05-06
Methods for Computing

Depreciation
117
Thedepreciationdeductiononlyendswhen:
(1) youhavealreadyrecoveredyourcapitalinvestment;or
(2) whenpropertyissubsequentlysold.
Xisengagedinthebusinessofbuyingandsellingtrucks.XboughttrucksatPhp2Mperunit.
Butthetruckswerenotsoldfor2years.Cantherebedepreciationdeduction?
No.Depreciationspeaksofwearandtear.Theremustbeuseofpropertynotmerelypropertyin
theinventory.Buttherecouldbeadeductionasalossifthetrucksweresoldinamountlessthan
theinvestment.
Remember,thepropertymustberelatedtothebusinessandnotpartoftheinventory/stockfor
theretobedepreciationdeduction.
WhathappenedinthecaseofBasilanEstatesv.CIR?
Inthatcase,Basilanclaimeddeductionsupto1949fordepreciationofassetsonacquisitioncost.
In1950,itchangedthedepreciablevalueofthesaidassetsbyincreasingittoconformtothe
increaseincostfortheirreplacement.
TheSCheldthatdepreciationisagradualdiminutionintheusefulvalueofthetangibleproperty
resultingfromwearandtearandnormalobsolescence.TheNIRCallowsadeductionfromgross
incomefordepreciationbutlimitstherecoverytothecapitalinvestedintheassetbeing
depreciated.Thetaxlawdoesnotauthorizethedepreciationofanassetbeyonditsacquisition
cost.Ifyourecovermorethantheamountofinvestment,thensuchamountshallbeconsidered
income.
SupposeXacquiredequipmentforPhp10Mhavingalifespanof10yearsusingthestraight
linemethod.Onthe5thyear,aftertaking4yearsdepreciation,XsoldtheequipmentforPhp
10M.Whatisthetaxconsequence?
Inthiscase,Xhasincome.
Whatisthetaxtreatmentforpropertysoldafterfulldepreciation?
Acquisitionbyasubsequentownerrestartsdepreciationbuthecannotdeductmorethanthe
amountinvested.Thesecondbuyercandepreciateuntiltheextentofcapitalinvestment.
SupposeXboughtequipmentworthPhp10Mhavingalifespanof10years.Itwasusedinthe
business.After10years,YboughtitforPhp10M.WhatisthetaxconsequenceofXandY?
XcanclaimadeductionofPhp10Mtobedeductedin10years.Ymayaclaimadeductionto
theremainingperiodoftheequipment.
Whywouldthelawallowafullydepreciatedpropertytobedepreciatedfurther?
Becauseintheprecedingcase,XisdifferentfromY.Xwouldhavetorecovertheinvestment.Y,
whomadeanotherinvestment,shouldalsobeallowedtorecover.Asageneralrule,youcannot
recovermorethanwhatyouhaveinvested.Anyexcesswouldbeincome.Ycanclaim
depreciationtoclaimthecapitalheinvestedtopurchasethefullydepreciatedproperty.Each
taxpayerhasacapitalexpensetoberecovered.Abuyerisanewtaxpayerwithadifferent
capitalexpense/investment.
Whatdoyoumeanbyobsolescenceindepreciation?
Itmeansthattheequipmentisnolongerdeemedasuseful.Althoughapropertymaynolonger
bedeemedasuseful,itmaystillhaveausefullife.Woulditbegivenanobsolescencededuction?
Yes.Inadditiontodeprecation,youhaveanobsolescenceallowance.
Anexampleofwhenobsolescenceoccurswouldbeasituationwhereinthereisanintroduction
ofnewerandmorereliableequipment.
Cecille 2C 05-06
118
Whenisdeductionforobsolescenceallowed?
Ifthewholeorportionofphysicalpropertyisclearlyshownbythetaxpayerasbeingaffectedby
economicconditionsthatwillresultinitsbeingabandonedatafuturedatepriortotheendofits
naturallife,sothatdepreciationdeductionalonewouldbeinsufficienttoreturnthecostatthe
endofitseconomictermofusefulness,areasonabledeductionforobsolescence,inadditionto
depreciation,maybeallowed.
Forexample,youboughtequipmenthavingalifespanof10yearssothatthedepreciationwould
bepaidin10years.Eventually,thisequipmentbrokeafter3years.Onthe3rdyear,thetaxpayer
mayclaimthewholeamountofdepreciation.
Whatisdepletion?
Depletionistheexhaustionofnaturalresourceslikeminesandoilorgaswellsasaresultof
productionorseverancefromsuchminesorwells.
Whatisthetheoryandpurposebehinddepletionallowance?
Thetheoryoftheallowancefordepletion,asinthecaseofthatfordepreciation,isthatasthe
productofthemineissold,agradualsaleisbeingmadeofthetaxpayerscapitalinterestinthe
property.Depletionallowanceenablesthetaxpayertorecoverthecapitalinterestfreeofincome
tax,atitscostoronsomeotherbasis.
Extractionrequireshugecapitalinvestment.Asresourceisdepleted,thecompanyincurslossof
capitalinvestment.Thus,deductionisallowed.Inshort,deductionofdepletionisallowedto
coverthelossofcapitalinvestment.
Whendeductionfordepletionshallequalthecapitalinvested,nofurtherdeductionshallbe
allowed.
Cancontributionsanddonationsbedeductible?
Yes.Contributionsanddonationsofataxpayermaybedeductibleinfull,ordeductiblebut
subjecttolimitation.
Whataretherequisitesfordeductibility?
(1) ThecontributionmustactuallybepaidormadetothePhilippineGovernmentorany
politicalsubdivisionthereofortoanyofthedomesticcorporationsorassociations
specifiedbytheNIRC;
(2) Itmustbemadewithinthetaxableyear;
(3) Itmustnotexceed10%oftheindividualstaxableincomeand5%ofthecorporations
taxableincomebeforedeductingthecontribution;and
(4) Itmustbeevidencedbyadequaterecordsorreceipts.
Arepersonalgiftstoanindividualdeductible?
No.Unlessyouarguethatsuchisabusinessexpense.
Arepersonalgiftstoacharitableinstitutiondeductible?
Yes.Inthiskindofdeduction,businessreasonsarenotrequiredaslongasyougive.
Mustcontributionsanddonationsbebusinessrelated?
No.Thebusinesspurposeisnotrequiredalthoughitwouldseemthatineverygiftordonation,
thereisanunderlyinggoodwill.Itcarries,inasense,abusinesspurpose,butyoudonot
necessarilyshowassuch.
Cecille 2C 05-06
Obsolescence
Depletion
Theory Behind
Depreciation Allowance
Contributions and
Donations
Requisites for
deductibility of
contributions and
donations
119

SupposeNestlegivesPhp10Mtoclassof2007forscholarshiptobeadministeredbyan
accreditedNGO.Wouldthatbedeductible?
No.Thebeneficiariesareagroupofindividualsandnottheinstitutionitself.Forthegifttobe
deductible,thebeneficiaryshouldbetheinstitution.Thebeneficiaryshouldnotbeindividualsor
groupofindividualsasinthecaseatbar.
Whatistheresearchanddevelopmentallowance?
UnderSection34(I)(1),ataxpayermaytreatresearchordevelopmentexpenditureswhichare
paidorincurredbyhimduringthetaxableyearinconnectionwithhistrade,businessor
professionasordinaryandnecessaryexpenseswhicharenotchargeabletocapitalaccount.The
expendituressotreatedshallbeallowedasdeductionduringthetaxableyearwhenpaidor
incurred.
Whataretherequisitesforexpensesforresearchanddevelopmenttobedeductible?
Expendituresforresearchanddeductibleshallbeallowedasdeductionduringthetaxableyear
whenpaidorincurredsubjecttothefollowingconditions:
(1) researchanddevelopmentexpendituresmustbeinconnectionwiththetaxpayers
trade,business,orprofession;
(2) mustbeordinaryandnecessary;and
(3) mustnotbechargeabletocapitalaccount.
Whendoyoutreatresearchanddevelopmentexpendituresasdeferredexpense?
UnderSection34(I)(2),attheelectionofthetaxpayerandinaccordancewiththerulesand
regulationstobeprescribedbytheSecretaryofFinance,uponrecommendationofthe
Commissioner,thefollowingresearchanddevelopmentexpendituresmaybetreatedasdeferred
expenses:
(1) Paidorincurredbythetaxpayerinconnectionwithhistrade,businessorprofession;
(2) Nottreatedasexpensesunderparagraph(1)hereof(thepropertymustnothavea
determinableusefullife;otherwise,youdepreciateitovertimenotasaresearchand
developmentitem);and
(3) Chargeabletocapitalaccountbutnotchargeabletopropertyofacharacterwhichis
subjecttodepreciationordepletion.
Forinstance,researchwasdonebutnoproductwasmade.Inthecourseoftheresearch,Php
10Mwasexpended.Thisexpendituremaystillbedeductiblebecausenocapitalaccountwas
chargedtoit.
Whatisthemeaningofchargeabletoacapitalaccountbutnotchargeabletopropertyofa
characterwhichissubjecttodeprecationordepletion?
Itmeansthatitisstillchargeabletothecapitalaccountbutnotchargeabletopropertysubjectto
depreciation.Thus,itformspartofthecostoftheequipmentsubjecttodepreciation
(capitalized).
Forexample,aPhp10Mresearchexpenseresultedtoequipmentusedintradebusinessor
profession.Itisnottreatedasdeferredexpensebecauseitformspartofthecostofmachine
subjecttodepreciation.
Ifinthecourseofresearchanddevelopment,expendituresincludepropertythatisdepreciable,
thenyouapplytheconceptofdepreciationinclaimingdeduction.However,ifresearchand
developmentexpendituresdonothavedeterminablefuturelife,thenyouapplytheconceptof
deferredexpenses.Thus,youamortize.
Cecille 2C 05-06
Research and
Development Allowance
Requisites for
Deductibility of Research
and Development
Expenses
120
Whatdoeschargeabletocapitalaccountbutnotchargeabletopropertymean?
Thismeansthatexpenseistreatedasdeferredexpense.Deductionisdistributedoveraperiod.
Theexpenseisamortized.
Ifitischargeabletocapitalaccountbutnotchargeabletoproperty,whatwouldbetheresult?
Whatwouldbethetreatmentofdeferredexpenses?
Itshallbetreatedasdeferredexpensesandshallbeallowedasdeductionratablydistributed
overaperiodofnotlessthan60monthsasmaybeelectedbythetaxpayer(beginningwiththe
monthinwhichthetaxpayerfirstrealizesbenefitsfromsuchexpenditures).
HowcanyoudeductinventionswithadeterminableusefullifeandworthPhp10M?
Itshallfallunderdepreciationasdepreciationcoversbothtangibleandintangible.Basicpremise
fordepreciationisthatthereisadeterminableusefullife.Thissubsectiondoesnotahavea
determinableusefullife.
Theuseofabusinessofaninvention,formula,and/ortrademarkislimitedindurationbutshall
stillbesubjectofadepreciationallowance.
Supposeitisonlyafter6yearsofresearchanddevelopmentthatthecompanycameupwitha
product.Canyoustilldeferit?
Yes.Aslongastheproductisnotadepreciableproperty.
Supposeyouhaveimprovementsinrealproperty,canyoutreatthemasordinaryand
necessaryexpenses?
Itcouldbetreatedasacapitalexpenditure.Landisnotsubjecttodepreciation.Thus,youtreatit
undercapitalexpenditure.
Cantheexpendituresintheexpensesusedinconstructingimprovementsinrealpropertybe
recoveredasadeduction?
Yes,itcanstillberecovered.Forexample,thelandisworthPhp10Mandyouputupaperimeter
wallworthPhp3M.YoucanrecovertheamountbycapitalizingthePhp3MtothePhp10.Thus,
thebasiswouldbePhp13M.Ifyoucapitalizeit,thentherewouldbenogain.
Whataretherequisitesfordeductibilityofpaymentstopensiontrusts?
(1) Theemployermusthaveestablishedapensionorretirementplantoprovideforthe
paymentofreasonablepensionstoitsemployees;
(2) Thepensionplanisreasonableandsound;
(3) Itmustbefundedbytheemployer(theemployercontributescashtotheplan);
(4) Theamountcontributedmustnolongerbesubjecttoitscontrolordisposition;
(5) Thepaymenthasnotbeenallowedbeforeasadeduction;and
(6) Theamountisapportionedinequalpartsoveraperiodof10consecutiveyears
beginningwiththeperiodinwhichthetransferorpaymentismade.
Whatisspecificallycoveredbytheprovision?Thepensionplanwhichyoupayyourretiring
employeeorthepensiontrustfundspayment(thesourceofthefundthatfinancesthe
pensionplan)?
Inpractice,whenyouaretalkingofpensionplan,youaretalkingaboutpensiontrust.
XInc.asemployerputsupapensionplanandestablishesapensiontrust.XInc.putsina
monthlycontributionofPhp100Ktothepensiontrust.TherewasaninitialfundofPhp10M
putupbyXInc.Whatisthedeductibleamount?
Php100KisexpensedwhilePhp10Misamortizedovertheyears(notlessthan10years).The
totaldeductionperyearwouldamounttoPhp1MplusPhp100K.
Cecille 2C 05-06
Requisites for
Deductibility of Payments
to Pensions Trusts
121
PERSONALEXEMPTIONS
Whoistheheadofthefamily?
Thetermheadoffamilymeansanunmarriedorlegallyseparatedmanorwomanwithoneorboth
parents,orwithoneormorebrothersorsisters,orwithoneormorelegitimate,recognized
naturalorlegallyadoptedchildrenlivingwithanddependentuponhimfortheirchiefsupport,
wheresuchbrothersorsistersorchildrenarenotmorethantwentyone(21)yearsofage,
unmarriedandnotgainfullyemployedorwheresuchchildren,brothersorsisters,regardlessof
ageareincapableofselfsupportbecauseofmentalorphysicaldefect.
Aheadofafamilyisanindividualwhoactuallysupportsandmaintainsinonehouseholdoneor
moreindividuals,whoarecloselyconnectedwithhimbybloodrelationship,relationshipby
marriage,orbyadoption,andwhoserighttoexercisefamilycontrolandprovideforthese
dependentindividualsisbaseduponsomemoralorlegalobligation.
UndertheNIRC,thetermmeansanunmarriedorlegallyseparatedmanorwomanwith:
(1) oneorbothparents;or
(2) oneormorebrothersorsisters;or
(3) oneormorelegitimate,recognizednatural,orlegallyadoptedchildren,livingwithand
dependentuponhimorherfortheirchiefsupport.
Arecognizednaturalchildisonebornoutsidewedlockbetweenamanandawomanwho,atthe
timeoftheconceptionofthechild,werefreetomarryeachotherandisrecognizedbyoneor
bothparents.
Chiefsupportmeansprincipalormainsupport.Itismorethanofthesupportrequiredbythe
dependent.Partialsupportnotamountingtochiefsupportwillnotentitlethetaxpayertoclaim
exemptionasheadofthefamily.
Canamarriedindividualbeadependentofasinglepersontomakehimheadofafamily(ex.
youaresinglebuyyouroldparentslivewithyou)?
Yesbecausethelawsayslivingwithoneorbothparents.
Whoareentitledtopersonalexemptions?
Thefollowingareentitledtopersonalexemptions(basicandadditional):
(1) residentcitizens;
(2) nonresidentcitizensontheirincomefromwithinthePhilippines;and
(3) residentaliensontheirincomefromwithinthePhilippines.
Nonresidentaliens,engagedinbusinessorpracticeofprofessioninthePhilippines,areentitled
topersonalexemptionsbutsubjecttotheruleonreciprocityasprovidedinSection35(B).
Nonresidentaliens,notengagedinbusinessorpracticeofprofessioninthePhilippines,are
NOTallowedpersonalexemptions.
Whoisanonresidentcitizen?
AnonresidentcitizenisacitizenofthePhilippineswhoisphysicallyinaforeigncountrywith
intentiontoresideinthatcountry.Lengthofstayisdeterminativeofintention,sothat,astay
outsidethePhilippinesfor183daysormorebytheendofthecalendaryearbyacitizenofthe
Philippinesmakeshimanonresidentcitizenforthatcalendaryear.
Cecille 2C 05-06
Head of the Family
Persons Entitled to
Personal Exemptions
122
Canseniorcitizensbeconsidereddependents?
Yes.UnderR.A.No.7432,seniorcitizensaretreatedasdependents,providedfortheTaxCodeof
theindividualtaxpayerscaringforthem,whetherthelatterarerelativesornot.Theexemption
grantedtobenefactorsofseniorcitizenisnotlimitedtothepersonalexemption.Theindividual
taxpayercanclaimadditionexemptionofPhp8,000foreachdependentseniorcitizennot
exceeding4.
Underthislaw,aseniorcitizenqualifiesasadependentwhetherrelatedornotandwhether
livingwiththepersonornotforaslongastheseniorcitizenisgivensupportandcare.
AmarriedBin1990.However,for12yearstheydonotmeeteachother.AlivedinTawitawi
whileBlivedinTugegarao.TheirsonliveswithAbutthesonissupportedbyBin
Tugegarao.Whoistheheadofthefamily?
ThereisnoreasonforAandBtoclaimheadofthefamilyiftheyarenotlegallyseparated.
Theyarestillconsideredmarried.
Intheprecedingexample,supposetheyarelegallyseparated,whoistheheadofthefamily?
Nooneisheadoffamily.Custodyandfinancialsupportmustconcurinoneindividualtoqualify
asheadofthefamily.Underthelaw,iftheheadoffamilyislegallyseparated,custodyofthe
childrenmustbegiventohim.Inthiscase,financialsupportisgivenbyBbutthechildisliving
withA.
Wouldaheadofthefamilybeentitledtopersonaladditionalexemption?
Yes,inthecaseofalegallyseparatedindividual.
SupposeXismarried,25yearsoldandphysicallyhandicapped.CanXqualifyasa
dependent?
No.Adependentreferstoachild,brother,orsisterwhois:
(1) livingwiththetaxpayer;
(2) dependentuponthetaxpayerforchiefsupport;
(3) notmorethan21yearsofage;
(4) unmarried;
(5) notgainfullyemployed;and
(6) regardlessofage,isincapableofselfsupportbecauseofmentalorphysicaldefect.
Remember,thatincaseofhandicapped,thehandicappedindividualmustnotbegainfully
employedandnotmarried.Butahandicappedcanqualifyasdependedregardlessofage.
SupposeXisasingleindividualwithanillegitimatechild.CanXclaimadditional
exemption?
Yes.Anillegitimatechild(conceivedandbornoutsidewedlock)iswithinthemeaningof
recognizednaturalchild.Fortheillegitimatechild,thetaxpayermayqualifyasheadoffamily,
withadditionalexemption.
Undertheprovisiononadditionalexemptionfordependents,illegitimatechildrenare
specificallyincludedunderthetermdependents.
Underthelaw,ataxpayerisentitledtoanadditionalexemptionofPhp8,000foreachdependent
childnottoexceedfour.Thefollowingaretherequisites:
Cecille 2C 05-06
Senior Citizens as
Dependents
123
(1) Thechildis
a. Legitimate;or
b. Illegitimate;or
c. Legallyadopted;and
(2) Thechildis
a. livingwiththetaxpayer;
b. dependentuponthetaxpayerforchiefsupport;
c. notmorethan21yearsofage;
d. unmarried;
e. notgainfullyemployed;and
f. regardlessofage,isincapableofselfsupportbecauseofmentalorphysical
defect.
Whenisadditionalexemptionallowed?
Additionalexemptionisallowedforchildrenandseniorcitizens.Parents,brothers,andsisters
qualifythetaxpayertothepersonalexemptionofPhp25Kasheadoffamilybutnottothe
additionalexemptionofPhp8K.
Asbetweenthehusbandandthewife,whoisdeemedheadofthefamily?
Thehusbandisdeemedasheadofthefamilyandtheproperclaimantoftheadditional
exemptionsunlessheexplicitlywaiveshisrightinfavorofhiswifeinthewithholding
exemptioncertificate.Onlyoneofthespousesshallclaimtheadditionalexemption.
Whataretherulesforexemptionsasaffectedbychangeofstatus?
Therulesare:
(1) Ifthetaxpayermarriesduringthetaxableyear,hemayclaimthepersonalexemptionin
fullasamarriedpersonforsuchyear.
(2) Ifthetaxpayershouldhaveadditionaldependentchildrenduringtheyear,hemay
claimtheadditionalexemptionsinfullforsuchyear.
(3) Ifthetaxpayerdiesduringthetaxableyear,hisestatemaystillclaimthepersonaland
additionalexemptionsforhimselfandhisdependents,asifhediedatthecloseofsuch
year.
(4) Ifthespouseoranyofthedependentsdiesduringthetaxableyear,thetaxpayermay
stillclaimthesameexemptionsasifhediedatthecloseofsuchyear.
(5) Ifanyofthedependentsbecome21yearsoldduringthetaxableyear,thetaxpayermay
stillclaimthesameexemptionasifsuchdependentbecame21yearsoldatthecloseof
theyear.
Foranyothereventthatresultsinachangeinthestatusofthetaxpayerasitaffectshispersonal
exemptions,andforwhichtherearenospecificrulesapplicablefromthoseabovementioned,
thestatusofthetaxpayerattheendoftheyearshalldeterminehispersonalandadditional
exemptions.
Whatarethepersonalexemptionsofnonresidentaliens?Whataretheconditions?
OnlynonresidentaliensengagedinbusinessorpracticeofprofessioninthePhilippinesare
allowedpersonalexemptions.Nonresidentaliensnotengagedinbusinessorpracticeof
professionarenotallowedpersonalexemptions.Theamountofpersonalexemptionallowedto
nonresidentaliensisthelesseramountbetweenthatallowedbytheincometaxlawofhis
countryandthatallowedbytheTaxCode(thosepertainingtoexemptionsallowedtoresident
Filipinocitizensandresidentaliens).
Cecille 2C 05-06
Additional Exemptions
Rules for Exemptions as

Affected by Change of
Status
Personal Exemptions of
Non-Resident Aliens
124
Anonresidentalienisentitledtopersonalexemptionunderthefollowingconditions:
(1) Thecountryofwhichheisasubjectorcitizenhasanincometaxlaw;
(2) TheincometaxlawofhiscountryallowspersonalexemptionstoFilipinocitizenswho
deriveincomeinsuchcountrybutwhoarenotresidingtherein;
(3) Thepersonalexemptionshallbeequaltothatallowedbytheincometaxlawofhis
countrytoacitizenofthePhilippinesnotresidingthereinbutderivingincome
therefrom,ortheamountprovidedinNIRCtocitizensofthePhilippines,whicheveris
lower;and
(4) HefilesatrueandaccuratereturnofhisincomefromallsourceswithinthePhilippines.
NONDEDUCTIBLEITEMS
Generalrule
Thefollowingarenotdeductibleincomputingtaxableincome:
(1) Personal,living,orfamilyexpenses;
(2) Anyamountpaidoutfornewbuildingsorforpermanentimprovements,orbetterments
madetoincreasethevalueofanypropertyorestate;
(3) Anyamountexpendedinrestoringpropertyorinmakinggoodtheexhaustionthereof
forwhichanallowanceisorhasbeenmade;or
(4) Premiumspaidonanylifeinsurancepolicycoveringthelifeofanyofficeroremployee,
orofanypersonfinanciallyinterestedinanytradeorbusinesscarriedonbythe
taxpayer,individualorcorporate,whenthetaxpayerisdirectlyorindirectlya
beneficiaryundersuchpolicy.
Personal,living,orfamilyexpensesarenotdeductiblefromindividualincometaxexceptinthe
formofpersonalandadditionalexemptions.
Whatarecapitalexpenditures?
Capitalexpendituresareexpendituresthatresultinobtainingbenefitsofapermanentnaturesuch
aslands,buildings,andmachineries.
Businessexpenseisexpenditurerelatedtothebusinessthatisdeductibleintheyearincurred,in
thesametaxableyear.Itisimmediatelydeductible.Capitalexpenseisexpenditurethatimproves
oraddstothevalueofyourpropertyorequipment.Itisnotimmediatelydeductible.Itis
deductibleoveraperiodoftime,suchasintheformofdeprecation.
SupposeXInc.ownsawarehouse.Php10KwasspentforrepairsofroofingwhilePhp500K
wasspentforrepainting.Arethesedeductible?
Theamountspentforroofingrepairsmaybedeductibleasabusinessexpense.However,the
amountspentforrepaintingisnotdeductibleduringtheyear.Theexpensemadeforrepainting
maybeconsideredasacapitalexpenditurethatenhancesthevalueoftheproperty.Itisnot
deductibleduringthetaxableyearbutovertime.Itcanbeclaimedasdeductionnotthistimebut
overtimethroughdepreciation.
Whenisapersonsaidtobefinanciallyinterestedinthetaxpayersbusiness?
Apersonissaidtobefinanciallyinterestedinthetaxpayersbusiness,ifheisastockholderthereof
orheistoreceiveashiscompensationashareofthepropertyofthebusiness.
Cecille 2C 05-06
125
SupposeXInc.gotaloanofPhp30Mfromabank.ThePresidentofXInc.wasmadeaco
signerofthenote.XInc.tookoutalifeinsuranceonlifeofthePresidentandmadethe
Presidentswifeabeneficiary.Deductible?
Yes,itisdeductibleasanexpense.ItdoesnotfallunderSection36(4).Inthiscase,the
beneficiaryisthewifeoftheofficerandnotthetaxpayer.Ifthecorporationisthebeneficiary,itis
notdeductiblesinceitwouldthenfallunderSection36(4).
DuringthelifetimeofthePresident,ispremiumanincomeonthepartofthePresident?
Theexcessofthepremiumspaidisincome.Butitcanbearguedthatsuchisafringebenefit.
SupposethePresidentdiesandthepremiumgoestothewife?
Then,itwouldbeexempted.
SupposeXInc.,afamilycorporation,tookalifeinsurancepolicyinthenameofitspresident
withhiswifeasthebeneficiary.ArethepremiumspaidbyXInc.deductible?
UnderaBIRruling,theamountofpremiumspaidisnotdeductible.Makinghiswifethe
beneficiarymakesthecorporationanindirectbeneficiaryunderthepolicy.
Whatistherulewithrespecttolossesfromsalesorexchangesofproperty?
Incomputingnetincome,nodeductionsshallinanycasebeallowedinrespectoflossesfrom
salesorexchangesofpropertydirectlyorindirectly:
(1) Betweenmembersofafamily.Forpurposesofthisparagraph,thefamilyofan
individualshallincludeonlyhisbrothersandsisters(whetherbythewholeorhalf
blood),spouse,ancestors,andlinealdescendants;or
(2) Exceptinthecaseofdistributionsinliquidation,betweenanindividualandcorporation
morethanfiftypercent(50%)invalueoftheoutstandingstockofwhichisowned,
directlyorindirectly,byorforsuchindividual;or
(3) Exceptinthecaseofdistributionsinliquidation,betweentwocorporationsmorethan
fiftypercent(50%)invalueoftheoutstandingstockofwhichisowned,directlyor
indirectly,byorforthesameindividualifeitheroneofsuchcorporations,withrespect
tothetaxableyearofthecorporationprecedingthedateofthesaleofexchangewas
underthelawapplicabletosuchtaxableyear,apersonalholdingcompanyoraforeign
personalholdingcompany;
(4) Betweenthegrantorandafiduciaryofanytrust;or
(5) Betweenthefiduciaryofandthefiduciaryofatrustandthefiduciaryofanothertrustif
thesamepersonisagrantorwithrespecttoeachtrust;or
(6) Betweenafiduciaryofatrustandbeneficiaryofsuchtrust.
Whatisthepurposeofnotallowingdeductionsforlossesfromsalesorexchangesofproperty
betweenmembersofafamily?
Thepurposeofthisprovisionisthepreventionofsimulatedsalesorexchangesbypersonswho
aremembersofafamilytoavoidpaymentofincometax.Itisimmaterialwhetherthesalesor
exchangesarebonafideornot.
However,whilethelossestherefromarenotdeductible,thegainsrealizedaretaxable.
Cecille 2C 05-06
Purpose
126
ALLOCATIONOFINCOMEANDDEDUCTIONS
WhatisthepurposeofSection50?
Itspurposeistoplaceacontrolledtaxpayeronataxparitywithanuncontrolledtaxpayer,by
determining,accordingtothestandardofanuncontrolledtaxpayer,thetruetaxableincome
fromthepropertyandbusinessofacontrolledtaxpayer.(CIRv.FirstSecurityBankofUtah)
Whatiswrongwiththeprovision?Thereisnothingwrongwiththefactthatoneentirely
controlsanother.
Thereisnothingwrong.Whatiswrongiswheresuchcontrolisusedtodistortormanipulate
income.
Anexamplewouldbesupposethereisamanufacturingsubsidiarywhichhasexcessprofits
whilethedistributingsubsidiaryhasexcessproduction.Botharecontrolledbyoneentity.
Manufacturingsubsidiarycanselltodistributingdivisionataloss(becausecanbeoffsetbythe
profits)anddistributingsubsidiarywillselltheproductsatmarketvalue.
Whatisthemeaningofcontrolinthisprovision?
Controlincludesanykindofcontrol,directorindirect.Itistherealityofthecontrolwhichis
decisive.
Insuchcases,whatstandardcantheBIRuseinordertoallocateincome?
Insuchcases,theCIRisgiventhepowertorectifyabnormalitiesanddistortionsinincome
broughtaboutbycommoncontrolthroughtheadoptionofstandardsconsideredfair,reasonable
oratarmslength.Itadoptsthearmslengthbargainingstandardastheultimatetestfor
determiningthecorrectgrossincomeanddeductionsbetweentwoormoreenterprisesunder
commoncontrol.Itsapplicationprovidesameansofredistributingorreapportioningincome
andexpensesoftaxpayersundercommoncontrol.
WhatwasheldinthecaseofCIRv.FirstSecurityBankofUtah?Wasthecourtconcernedwith
therelationbetweentheBankandtheSecurityLife?
No.Theconcernwaswiththeholdingcompanywhichexercisescontroloverthetwoormore
subsidiaries.Theremustbethesameinterestcontrolling2ormore.Inthiscase,thesuspicion
wasthatthecontrollingparentcontrollingtwoormorecoporationscouldmanipulatethe
controlledcorporations.
TheU.S.SupremeCourtheldthattheCIRwasincorrectinallocatingSecurityLifespremium
incometoFirstSecurityBank.Theunderlyingassumptionhasalwaysbeenthatinordertobe
taxedonincome,ataxpayermusthavecompletedominionoverit.Inthiscase,FirstSecurity
Bankhadnotreceivedtheincomebeingattributedtothem.Also,itwasheldthattowarrant
allocationoftheincomebytheCIR,itisnecessarythattheholdingcompanyhavecomplete
powertoshiftamongitssubsidiaries.Inthiscase,itwasfoundthattheholdingcompanydidnot
utilizeitscontroloverFirstSecurityBankandSecurityLifetodistorttheirtruenetincomes.
Cecille 2C 05-06
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Meaning of Control
127
CAPITALGAINSANDLOSSES
Whatarecapitalassets?
Capital Assets
Capitalassetsincludeallpropertyheldbythetaxpayerwhetherornotconnectedintradeor
businessbutNOTincludingthoseenumeratedinSection39(A)(1)asordinaryassets.
Thelawdefinesthetermbyexclusion.Ifthetaxpayersellsorexchangesanyoftheproperties
enumerated,anygainorlossrelativetheretoisanordinarygainorloss;thegainorlossfromthe
saleorexchangeofallotherpropertiesofthetaxpayerisacapitalgainoracapitalloss.Why?
Thesearebusinessassets.Thus,thereisapresumptionthatwhatisbeingtaxedisincomefrom
businessoperations.Outsideofthis,itisconsideredcapitalasset.
Ordinary Assets
Whatareordinaryassets?
UnderSection39(A)(1),theyare:
(1) stockintradeofthetaxpayerorotherpropertyofakindwhichwouldproperlybe
includedintheinventoryofthetaxpayerifonhandatthecloseofthetaxableyear
(inventoriableproperty);
(2) propertyheldbythetaxpayerprimarilyforsaletocustomersintheordinarycourseof
histradeorbusiness;
(3) orpropertyusedinthetradeorbusiness,ofacharacterwhichissubjecttotheallowance
fordepreciationprovidedinSubsection(F)ofSection34(depreciableproperty);or
(4) realpropertyusedintradeorbusinessofthetaxpayer.
Definitions
Definitionofterms
CapitalgainThegainderivedfromthesaleorexchangeofcapitalassets.
CapitallossThelossincurredfromthesaleorexchangeofcapitalassets
NetcapitalgainTheexcessofthegainsfromsalesorexchangesofcapitalassetsoverthe
lossesfromsuchsalesorexchanges.
NetcapitallossTheexcessofthelossesfromsalesorexchangesofcapitalassetsoverthe
gainsfromsuchsalesorexchanges.
Kinds of Capital Assets

Whatarethekindsofcapitalasset?
Theyare:
(1) Shorttermonewhichhasbeenheldbythetaxpayerfor12monthsorless;and
(2) Longtermonewhichhasbeenheldbythetaxpayerformorethan12months.
Whatdoesheldprimarilyforsalemean?
InthecaseofMalatv.Riddell,theU.S.SupremeCourtheldthatapropertyhasdualpurpose;for
investmentorforsale.Itwasalsoheldinthatcasethatprimarilymeansoffirstimportanceor
principally.
Whyisthedifferenceofalossinacapitalassetfromalossinanordinaryasset?
Loss in a Capital Asset v.
Loss in an Ordinary Asset
Ifloss,thetaxpayerwillalwaysarguethatthepropertyisanordinaryassetandordinaryloss
becauseordinarylossisdeductiblefromanykindofassetswhilecapitallossisdeductibleonly
againstcapitalgain.
Ontheotherhand,ifthereisagain,thetaxpayerwillalwaysarguethatthereisacapitalgain
becausecapitalgainhaspreferentialtreatmentinthatiftheholdingperiodismorethan12
months,thenwhatistaxedisonly50%ofthegain.
Cecille 2C 05-06
128

Whatisthesocalledstatuteofpartialexemption?
InthecaseofTuasonJr.v.Lingad,theSCheldthattheTaxCodesprovisiononlongtermcapital
gainsconstitutesastatuteofpartialexemption.Itwasdeemedthatcapitalassetsisnecessarily
narrow,whileexclusionsmustbeinterpretedbroadly.
UndertheNIRC,ifagainisrealizedbyataxpayer(otherthanacorporation)fromthesaleor
exchangeofcapitalassetsheldformorethan12months,only50%ofthenetcapitalgainshallbe
takenintoaccountincomputingthenetincome.Thisisataxexemptingprovision.Thus,forthe
taxpayertoavailofthiscapitalgainspreferentialtaxtreatment,thetaxpayermustshowthatitis
acapitalassettransactionandnotanordinaryassettransaction.Thisimpliesthatordinaryassets
provisionshallbewidelyconstruedwhilecapitalassetsprovisionshallbestrictlyconstrued.
Mayapropertyinitiallyclassifiedasacapitalassetbethereaftertreatedasanordinaryasset?
Yes,ifacombinationoffactors/circumstancesindubitablytendtoshowthattheactivitywasin
furtheranceoforinthecourseoftaxpayerstradeorbusiness.
WhathappenedinthecaseofTuasonJr.v.Lingad?
ThecaseinvolvedaprimepropertyinSta.MesaManilawhichisinheritedbyTuason.Itconsists
of29lots.The28lotswereputonsalewhilethe29thlot,whichwasafivehectareproperty,had
tobedeveloped.Itneededfillingbecauseofitsverylowelevation,andwasplantedwith
kangkongandothercrops.Afterinstitutingimprovements,Tuasonsoldtheproperty.Whenhe
filedhisincometaxreturn,hereportedlongtermcapitalgainsandrecognizedonly50%ofthe
gains.TheBIRfoundotherwiseandsaidthatthesepropertieswereordinaryassets.Itargued
thatsincefromtimethatthepropertywasdevelopedtothetimethepropertywasofferedfor
saleoninstallmentbasistodifferentbuyersincontinuoussuccessionandfrequentsales,the
propertyassumedthecharacterofanordinaryasset(asthatassetisnowbeingsoldtocustomers
intheordinarycourseofbusiness).
TheCourtheldthatunderthecircumstances,Tuasonssalesoftheseverallotsformingpartof
hisrentalbusinesscannotbecharacterizedasotherthansalesofnoncapitalassets.Inarrivingat
thisconclusion,theCourt,citingAmericanjurisprudence,consideredthefollowingfactors:
(1) thepurposeforwhichthepropertywasinitiallyacquired;
(2) thepurposeforwhichthepropertywassubsequentlyheld;
(3) theextenttowhichimprovements,ifany,weremadetothepropertybythetaxpayer;
(4) thefrequency,number,andcontinuityofsales;
(5) theextentandnatureofthetransactionsinvolved;
(6) theordinarybusinessofthetaxpayer;
(7) theextentofadvertising,promotion,orotheractivitiesusedinsolicitingbuyersforthe
saleofproperty;
(8) thelistingofpropertywithbrokers;and
(9) thepurposeforwhichthepropertywasheldatthetimeofsale.
WhathappenedinthecaseofCalasanzv.CIR?
Inthatcase,Calasanzinheritedfromherfatheranagriculturalland.Immediatelyafterinheriting
theproperty,shewantedtoliquidatetheinheritancebysellingit.However,shecannotsellthe
propertywithoutsubdividingtheproperty.Thus,shesubdividedthelandsintosmallerlots.
Improvements,suchasgoodroads,concretegutters,drainage,andlightningsystem,were
introducedtomakethelotssaleable.Soon,thelotsweresoldtothepublicataprofit.IntheirITR
for1957,thepetitionersdisclosedaprofitofaboutPhp31Krealizedfromthesaleofthe
subdividedlotsandreported50%thereofastaxablecapitalgains.Calasanzarguedthatthe
subdividingofthepropertywaspartoftheliquidationandtherefore,itcouldnotbeanordinary
asset.
Cecille 2C 05-06
Statute of Partial
Exemption
129
TheSCagreedwiththerulingoftheCTAthatpetitionersaredeemedtobeintherealestate
businessforhavinginvolvedinaseriesofrealestatetransactionspursuedforprofit.Property
acquiredbyinheritancemaybeconvertedfromaninvestmentpropertytoabusinesspropertyif,
asinthepresentcase,itwassubdivided,improved,andsubsequentlysoldandthenumber,
continuityandfrequencyofthesalesweresuchastoconstitutedoingbusiness.TheSCheld
thatinthecourseofsellingthesubdividedlots,thepetitionersengagedintherealestate
business.Thus,thegainsfromthesaleofthelotsareordinaryincometaxableinfull.Onestrong
factoragainstpetitionerscontentiontheSCconsideredisthefactofthedevelopmentoftheland.
Theydidnotsellthelandintheconditioninwhichtheyacquiredit.Whilethelandwas
originallydevotedtoriceandfruittrees,itwassubdividedintosmalllotsandwasconverted
intoaresidentialsubdivision.Also,theCourtheldthatthefactthatpropertyissoldforpurposes
ofliquidationdoesnotforecloseadeterminationthatatradeofbusinessisbeingconductedby
theseller.
Ineffect,theCourtissayingthatyoucouldstillhavetheliquidationifyouliquidateatanearly
stage.Itwillstillbeacapitalassetaslongastheliquidationdoesnotamounttocarryingonthe
businessofrealestate.
Onemayofcourseliquidateacapitalasset.Todoso,itisnecessarytosell.Thesalemaybe
conductedinthemostadvantageousmannertothesellerandhewillnotlosethebenefitsofthe
capitalgainprovisionofthestatuteunlessheenterstherealestatebusinessandcarriesonthe
saleinthemannerinwhichsuchabusinessisordinarilyconducted.Inthatevent,theliquidation
constitutesabusinessandasaleintheordinarycourseofsuchabusinessandthepreferredtax
statusislost.(p.672)
SupposethereisagainofPhp1Mfromthesaleofpropertyheldfor24months.Howwillit
betaxed?
BIR
Taxpayer
Wouldarguethatitisacapital
Gain
Wouldarguethatitisan
assetbecausetheonly50%of
ordinaryassetbecausethe
thegainwillbetaxed
gainistaxableinfull
Wouldarguethatitisan
Loss
Wouldarguethatitisa
capitalassetbecausetheloss ordinaryassetbecauselossis
deductiblefromallkindsof
isdeductibleonlyfromthe
income
capitalgain
SupposeXisaninvestorandaccountant.Xbuysafarmfieldtodevelopacommercialland.
Thereisnobuyertotheland.Xsubdividedthelandintoseverallotsinordertoliquidatethe
business.Isitordinaryorcapitalasset?
Itisacapitalassetbecausetheliquidationheredoesnotamounttobeingabusinessofselling
land.Herethesubdivisiondoesnotrenderitordinaryasset.Ifthereisalargescalesellingto
liquidate,thenitwouldnolongerbeconsideredasmerelyforliquidation.Thebasicstandardis
howthetaxpayerdealtwiththeproperty.Ifhetookitasarealtybusiness,itisanordinaryasset.
Butifhedealtwithitsimplybysellingthepropertytoliquidatehisinvestment,although
subdivisionforeasyliquidation,thenitisstillacapitalasset.
SupposeXinheritsthepropertywithapartnerandsoldtheparceloflandrightafter
inheritance.Whatwillbethetaxtreatment?
Itwillbesubjecttocapitalgainstax.Butifheimprovesthepropertybyexhibitingtheproperty,
hiringagents,frequentsalesetc.thenitisnolongersubjecttocapitalgainstaxbuttocorporate
tax.Becauseatthispointwhenitwasconvertedintoanordinaryasset,theyhavealreadycreated
apartnershipsubjecttocorporatetax.
Cecille 2C 05-06
130
SupposealawyerboughtaManansalapaintingworthPhp2Minyear2000.HesolditforPhp
3Min2003.WhatwouldbethetaxtreatmentbasedonSection39?
Thepaintinghereisacapitalasset.Itisnotusedinthelawyersbusiness.SothegainisPhp1M,
50%ofPhp1MisPhp500K.Only50%ofthegainistaxablebecausethepropertywasheldfor
morethan12months,thusitisalongtermcapitalgain.However,Section39doesnotgiveyou
theprovisionsonhowthecapitalgainistobetaxedbuttowhatextentthecapitalgainistobe
taxed.
OnlyPhp500Kistaxableandshallbeaddedtoordinaryincomesubjectto5%32%becausethe
taxpayerisanindividual.Gainistaxedasanindividualgainfromacapitalasset.
Supposethetaxpayerisacorporation?
Inacorporation,capitalgainistaxableinfull,regardlessoflengthoftime.Regardlessofthe
holdingperiod,gainistaxableinfullandlossisdeductibleinfull.Theprovisionregarding
holdingperioddoesnotapplytocorporation.
SupposeXinsteadboughtarealproperty.Hehelditfor24monthsbeforesellingit.What
wouldbethetaxtreatmentofthegain?
Itshallbesubjectto6%capitalgainstaxbasedonthegrosssellingpriceorfairmarketvalue
whicheverishigherifitisacapitalasset.
Theholdingperiodprovisiondoesnotapplyinthiscase.ThisisbecauseSection24(D)(1)says:
TheprovisionsofSection39(B)notwithstanding,afinaltaxofsixpercent(6%)basedonthe
grosssellingpriceorcurrentfairmarketvalueasdeterminedinaccordancewithSection6(E)of
thisCode,whicheverishigher,isherebyimposeduponcapitalgainspresumedtohavebeen
realizedfromthesale,exchange,orotherdispositionofrealpropertylocatedinthePhilippines,
classifiedascapitalassets,includingpactoderetrosalesandotherformsofconditionalsales,by
individuals,includingestatesandtrusts.
WhatifXisadomesticcorporation?
UnderSection27(D)(5):Afinaltaxofsixpercent(6%)isherebyimposedonthegainpresumed
tohavebeenrealizedonthesale,exchangeordispositionoflandsand/orbuildingswhichare
notactuallyusedinthebusinessofacorporationandaretreatedascapitalassets,basedonthe
grosssellingpriceoffairmarketvalueasdeterminedinaccordancewithSection6(E)ofthis
Code,whicheverishigher,ofsuchlandsand/orbuildings.
Theland/buildingmustnotbeactuallyusedANDtreatedascapitalasset.Itmustbetreatedasa
capitalassetbecausetherearecertainassetsthatthecorporationmaynolongerusebutthe
corporationstillappliesdepreciation.
Remember,incaseofcorporations,capitalgainstaxonlyappliestolandandbuildings.
SupposeXInc.boughtabuildingforrental.After5years,itabandonedtherentalbusiness.
Thebuildingwasinitiallyheldfor4years.Itwasboughtin1999.XInc.stoppedusingitin
2004andsubsequentlysoldit.Assumingthereisagain.Whatwouldbethetaxtreatmenton
thegain?Supposingthecorporationisstilltakingdepreciabledeductionsbutnotactually
used?
Inthiscase,theholdingperiodisimmaterialbecausethetaxpayerisacorporation.First,you
arguethatthebuildingisbeingtreatedasacapitalassetandnotbeingusedinthebusiness.
Second,arguethatitisnotsubjecttodepreciation.Thecorporationmustnotgetdepreciation
deductions.So,therearetworequirements:
(1) notactuallyused;and
(2) treatedascapitalasset.
Cecille 2C 05-06
131
Whatwouldbethetaxtreatmentifthetaxpayerisadomesticcorporationandithascapital
asset?
Itshallbesubjecttothesametreatmentifitisacapitalassetthatisnotactuallyusedinthe
business.Whenthecorporationdoesnotuseitanymoreinitsbusiness,itisacapitalasset.
However,thecorporationmustnotclaimdepreciationallowance.
Xbuysacapitalasset(painting)forPhp2MandsellsitforPhp1M.XhasalossofPhp1M.
Whatisthetaxtreatmentofthecapitalloss?
Php500K(50%ofcapitalloss)wouldbedeductedfromthecapitalgain.
SupposeXbuysin1999acapitalasset(painting)forPhp2M.Hesellsitin2002forPhp1M.
HesuffersaPhp1Mloss.Whatwouldbethetaxtreatmentoftheloss?Supposehehasa
capitalgainofPhp1Min2002fromanothertransaction.Whatwouldbesubjecttocapital
gainstax?
Capitalloss=Php1Min2002
Capitalgain=Php1Min2002
Netincomefromordinarytransaction=Php1M
YoufirstapplythelosslimitationruleunderSection39(C)whichprovidesthatlossfromsales
orexchangesofcapitalassetsshallbeallowedonlytotheextentofthegainsfromsuchsalesor
exchanges
Capitallosscanbedeductedfromcapitalgain.Remembertheholdingperiod.SoonlyPhp500K
losswillbedeductedfromthenetcapitalgainofPhp500K(sincetheassetwasheldfor3years).
Capitalgain=Php1Min2000
Netcapitalgain=Php500K
Thisisaddedtothetaxablenetincome.Whatisbeingtaxedisthetotalincome.Itshallnotbe
taxedseparately.
Supposealongtermcapitalloss.Nocapitalgainshere.YouhaveagrossincomeofPhp2M.
Whatwouldbethetaxtreatmentoftheloss?
Capitalloss=Php1M
Capitalgain=none
Ordinarygainduringtheyear
RememberyournetcapitallosscarryoverunderSection39(D)whichprovidesthatifany
taxpayerotherthanacorporationsustainsinanytaxableyearanetcapitalloss,suchloss(inan
amountnotinexcessofthenetincomeforsuchyear)shallbetreatedinthesucceedingtaxable
yearasalossfromthesaleorexchangeofacapitalassetheldfornotmorethan12months.
Inthissituation,therewasnocapitalgain.Rememberthatcapitallosscanbedeductedonlyto
theextentofthecapitalgain.Sincethereisnocapitalgain,thenthecapitallosssustainedinthat
yearcannotbedeductedforthatyear.So,letussayinthefirstyearyourcapitallossisPhp1M.
NocapitalgainbuthasincomeofPhp500K.YoucarryoverthelossofPhp1Mtothenextyear
(onlytothenextyear,nottosucceedingyears).IfinthenextyearyouhaveacapitalgainofPhp
2M,youcandeductPhp500K(sincetheincomefromlastyearwasonlyPhp500K).And
remembertheprovisionsaysthelossinanamountnotinexcessofthenetincomeforsuch
yearandthelossistreatedasalossfromthesaleorexchangeofacapitalassetheldfornot
morethanoneyear.So,100%ofthelossisrecognized.
So,ifinthenextyear,thereisstillnocapitalgain,thenthecapitallossoflastyearislostforever.
Cecille 2C 05-06
132
SupposeX,anindividual,obtainednocapitalgainin2003.Inthatyear,therewasPhp250K
taxablenetincomewhileyouhavePhp500shorttermcapitalloss.Supposein2004youhavea
netcapitalgainofPhp1M,canyoucarryovertheloss?
Yes,butyoucanonlydeductPhp250KfromthePhp1M.Thisisbecausethelimitofthecarry
overshallnotexceednetincomeintheyearthelosswasincurred.
SupposethesamesituationasabovebutXisacorporation.Whatwillhappentotheloss?
Theprovisiononthenetcapitallosscarryoverdoesnotapply.Thecapitallossislostforever.
Whatistherulewithrespecttosharesofstock?
Iflisted/tradedinstockexchange=of1%percentagetax
Iflisted/nottraded=5%or10%capitalgainstax
Supposethetaxpayerisanonresidentforeigncorporation?
Nonresidentforeigncorporationistaxableongross.Inthiscase,youapplySection28(B)(5)(c).
Finaltaxrateof5%or10%uponthenetcapitalgains.
XbuysPLDTsharesworthPhp500K(Php1Kpershare).After24months,itsoldtheshares
forPhp1M.Thesharesarenottradedandnotlisted.Howcanyoutaxthecapitalgain?Does
the24monthholdingperiodmatter?
BasedonSection24(C),theholdingperioddoesnotmatterbecausethesaidprovision
specificallystatesnotwithstandingtheprovisionsofSection39(B).
Whataretheothertransactionsconsideredsalesorexchangesofcapitalassetsbyexpress
provisionoftheNIRC?
UnderSection39(E)and(F),thefollowingareconsideredassalesorexchangesofcapitalassets:
(1) amountsreceivedbytheholderupontheretirementofbonds,debentures,notesor
certificatesorotherevidencesofindebtednessissuedbyanycorporation(including
thoseissuedbyagovernmentorpoliticalsubdivisionthereof)withinterestcouponsor
inregisteredform,shallbeconsideredasamountsreceivedinexchangetherefor;
(2) gainsorlossesfromshortsalesofpropertyshallbeconsideredasgainsorlossesfrom
salesorexchangesofcapitalassets;and
(3) gainsorlossesattributabletothefailuretoexerciseprivilegesoroptionstobuyorsell
propertyshallbeconsideredascapitalgainsorlosses.
SupposeXInc.issues4yearbondforPhp10M.YthensurrendersthebondforPhp10M.Is
thereacapitalgainorloss?
Thereisnocapitalgainorloss.Itwasasimplyextinguishmentofobligation.However,under
Section32(B)(7)(g),gainsrealizedfromthesaleorexchangeorretirementofbonds,debentures
orothercertificateofindebtednesswithamaturityofmorethan5yearsareexcludedfromthe
computationofgrossincome.
SupposeXInc.issuesa4yearbondofPhp10M.YInc.,theholderorthebond,earnsinterest
income.Onthe3rdyear,YInc.sellsthebondtoZInc.forPhp9M.Onthe4thyear,ZInc.
surrendersthebondtoXInc.forPhp10M.Isthereacapitalgain?
Yes,thereisacapitalgainonthepartofZInc.Inthiscase,thereisacapitalassettransaction.Itis
notasimplesurrenderorretirementofbonds.
Cecille 2C 05-06
Other Transactions
Considered Sales or
Exchanges of Capital
Assets
133

WhatifZisanindividualandthebondisheldmorethanoneyear?
Then,suchwillberecognizedasalongtermcapitalgain.Thus,theonly50%ofgainofPhp1M
willbetaxed.
Whatisashortsale?
Ashortsaleisatransactioninwhichthesellersellssecuritieswhichhedoesnotownand,
therefore,cannothimselfsupplythesecuritiesfordelivery,inexpectationofthedeclineintheir
price.
Ittakesplacewhenthesellerfirstmakesasaleofstockwhichhedoesnotown(hemerely
borrowsastockcertificatethroughorfromhisstockbroker)andsubsequentlybuysorcoversthe
stocktocompletethetransaction.Hesellsthesharesshortintheexpectationofadecreasein
valuethereofwithinareasonableshortperiodoftime.Hecovershisshortsalewhenthe
expecteddecreaseinvaluematerializesorwhenthetimeforthereturnoftheborrowedshares
comes.
Thesellerinthiscaseisamerespeculator.Consequently,ashortsaledoesnotgiverisetoprofit
orlossuntilthedeliverytothelenderofthesecuritiesacquiredbythetaxpayertocoverthesale.
Shouldthepriceofthesecuritiesgoup,heincursaloss;otherwise,hemakesagain.
Gainorlossonshortsalesisalwaysashorttermcapitalgainorloss.
Itisnotasaleintheordinarysalesconcept.Hereyouaresellingaborrowedpropertyandthe
saleiscompletedwhenyouhavereplacedtheborrowedproperty.Thecapitaltransactionhereis
whenyouselltheborrowedpropertyandyoureplaceitinashorttime.
SupposeXhasinformationthatPLDTshareswillgodown.ThecurrentpriceisPhp200per
share.XtellshisbrokertosellforhimPLDTsharesatPhp200pershare.Thebrokersells
1000sharesforPhp200K.HegivesittoX.Aweeklaterpricesgodown.Xbuys1000sharesfor
Php100pershare.HethenreplacestheborrowedsharesatPhp100,000.Isthereagain?
Yes.ThereisagainonthepartofX.
SameexampleasabovebutsupposethatthepricegoesuptoPhp300.
Insuchacase,thereisalossonthepartofX.XhastoreplacetheborrowedsharesatPhp300per
share.
Whyisitimportanttohaveshortsaleundercapitalasset?Sinceitisalwaysconsideredshort
term,canitnotbetreatedthesameasordinaryasset?
Itisimportantfromthepointofviewoflawbecauseofthetreatmentofthelosssincecapitalloss
isdeductiblefromcapitalgain.
SupposeXInc.ownsrealpropertyworthPhp10M.YgivesXInc.Php2Masoptionmoneyfor
a2yearoptionperiod.Beforethe2yearperiodends,Yexercisedtheoptionandboughtthe
property.Whatwillbethetaxtreatment?
Itwillbesubjectto6%capitalgainstaxunderSection27(D)(5).Section39(F)ortheprovision
onthefailuretoexerciseprivilegewillnotapply.
SupposethesamesituationasabovebutYfailstoexercisehisoption.Whatwillbethetax
treatment?
Inthatcase,theoptionmoneywillbeacapitalgainforXandacapitallossforY.
Cecille 2C 05-06
Short Sale
Gain / Loss from Failure

to Exercise Option to Buy
134

SupposeXisanindividual.Whatwillbethetaxtreatment?
Inthiscase,theruleforholdingperiodapplies.Sincetheoptionwasheldformorethan2years,
thenonly50%ofthegainwillberecognized.
Whatifitisanoptiontolease?
Itshallbeconsideredasanordinarygainbecauseitdoesnotinvolveoptiontobuyorsell
property.
Mustthepropertysubjectofoptionbeacapitalasset?
No.Thelawdoesnotsayifitshouldbeanordinaryorcapitalasset.Itonlysaysattributabletoa
property.Thus,thepropertyneednotbeacapitalasset.Also,here,youaredealingwiththe
optionandnotwiththepropertyunlikeintheU.S.provisionwhichrequiresthepropertysubject
ofoptiontobeacapitalasset.
Supposewithin2yearstime,Y,theoptionee,sellstheoptionforPhp3MtoZ.Istheoptiona
capitalassetoranordinaryasset?
ItisordinaryifYisengagedintheoptionbuying/selling.Thus,itdepends.Yougobacktothe
basicrule.Youshoulddistinguishthistransactionfromfailuretoexercise.
Whenwillatransactionbedeemedtobeacapitalassettransaction?
InthecaseofHammelv.Helvering,itwasstatedthatthesaleneednotbevoluntarytobedeemed
acapitalassettransaction.Inthatcase,thetaxpayerspurchasedlandbuttheydefaultedin
paymentssoitwasforeclosed.TheCIRtreatedthetaxpayersinterestinthelandasacapital
assetsothelossallowedtobedeductedfromthegrossincomewasonlytoacertainextent.The
taxpayersarguedthatthelossesthataremadedeductibleonlytoalimitedextentarethoselosses
resultingfromsalesvoluntarilymadeandsinceheretherewasaforeclosure,thensuchisnot
voluntary.
TheU.S.SCheldthatthereisnobasisfortheinterpretationthatlossesfromsalesofcapitalassets
weretobetreateddifferentlywhethertheyresultedfromforcedsalesorvoluntarysales.If
securities,whicharecapitalassets,areascertainedtobeworthlessandarechargedoffwithinthe
taxableyear,thelossshallbeconsideredasalossarisingfromthesaleorexchange.These
provisionsdiscloseaconsistentlegislativepolicytoenlargetheclassofdeductiblelossesmade
subjecttothecapitalassetsprovisionswithoutregardtothevoluntaryactionofthetaxpayerin
producingthem.
Areworthlesssecuritiescapitalorordinaryloss?
InthecaseofChinaBankingCorporationv.CA,theSCheldthatanequityinvestmentisacapital
assetandnotordinaryassetoftheinvestor,thesaleorexchangeofwhichresultsineithera
capitalgainorcapitalloss.Thegainorlossisordinarywhenthepropertysoldorexchangedis
notacapitalasset.Thesharesofstockwouldonlybeordinaryassetsonlytoadealerinsecurities
engagedinthepurchaseandsaleof,oranactivetrader(forhisownaccount)in,securities.Ifthe
sharesareinthehandsofonewhoholdsthesharesbywayofaninvestment,thentheshareswill
becapitalassets.Whenthesharesheldbysuchinvestorbecomeworthless,thelossisdeemedto
beacapitallossfromthesaleorexchangeofcapitalassets.Whensecuritiesbecomeworthless,
thereisstrictlynosaleorexchangebutthelawdeemsthelossanywaytobealossfromthesale
orexchangeofcapitalassets.Inthiscase,theSCstressedthatthecapitallosssustainedbyChina
Bankcanonlybedeductedfromcapitalgainsifanyderivedbyitduringthesametaxableyear
thatthesecuritieshavebecomeworthless.
Cecille 2C 05-06
135
FRAGMENTATIONTHEORY
Whatdoesthefragmentationtheoryrequire?
AsheldinthecaseofWilliamv.McGowan,thefragmentationtheorydealswiththesaleof
businesspropertyanditrequiresthatforthepurposeofcomputingagainorlossonthesaleofa
goingbusiness,thebusinessitnottreatedasasinglepieceofproperty.Thepropertysoldmust
becomminutedintoitsfragmentsandseparatelymatchedagainstthedefinitionofcapitalassets
inthelaw.
Eachassetmustbeseparated,described,andclassifiedascapitalorordinary.Thetaxpayermust
allocateacertainpriceforeachassettoclaimcapitalgain/losstreatment.
WhathappenedinthecaseofFerrerv.CIR?
Inthatcase,theLaSuizaBakeshop,asoleproprietorship,wassold.Everythingwasincludedin
thesale(equipment,furniture,etc.).Theownerwasclaimingcapitalgainstreatmentasopposed
toordinarygain.TheBIRwasclaimingthatitwasanordinarygain.
TheSCheldthattobeabletoclaimcapitalgainstreatment,allassetsshouldbeseparated;each
assetmustbeclassifiedascapitalorordinary.Ontopofthat,youhavetoallocateacertain
portionofthetotalpriceofthespecificassetinorderforyoutoclaimacapitalgainstreatmentof
anyincomeorcapitallosstreatmentincaseofloss.Here,theowner/taxpayerwasnotableto
provethat.Thus,itwasdeemedasanordinaryassettransaction.
WhatdoesthedecisioninthecaseofFerrerv.CIRmean?
Itmeansthatwhenthereisasaleofproperty,itisnotasaleofanentitybutasaleofdifferent
assetsmakingupthesoleproprietorshiportheentity.
Sowhatdoesthatimply?Forthetaxpayertoclaimacapitalassettreatment,thetaxpayermust
showthathisassetisacapitaassetandthereforethetransactionwoulddeserveacapitalasset
treatment.Notonlythat,ifthereistotalpurchaseprice,thetaxpayermustshowanallocationof
thepurchasepricetoeachandeveryspecificasset.Otherwise,therecouldbenocapitalasset
treatmentofwhateverlossorgaininthetransaction.
Inasaleofproprietorship,thetaxpayerwouldalwaysargue,ifthereisagaininthesaleofasset,
thatthereiscapitalgainwhileifthereisaloss,thetaxpayerwouldalwaysarguethatthereisan
ordinaryloss.Whilecapitalissubjecttoapreferentialtaxtreatment,ordinarylossisdeductible
fromalllosses.Ontheotherhand,theBIRwouldalwaysarguethatifthereisagain,itisan
ordinarygainwhileincaseofaloss,theBIRwouldalwaysarguethatitisacapitallossbecause
capitallossisdeductibleonlyfromthecapitalgain.
Thetaxpayerandtaxcollectorinasaleofsoleproprietorshipcouldbetakingoppositesidesof
thesameissue:whetherthereisacapitalassettreatmentorsimplyanordinaryassettreatment.
Thebottomlineisthatthetaxpayermustshowthatitisacapitalassettransaction(meaningthat
theassetinvolvedisacapitalasset).Why?Becausethecapitalassetruleisaruleofpartial
exemption,aruleofpreferentialtaxtreatmentandtherefore,theburdenofproofisonthe
taxpayer.
Cecille 2C 05-06
136
DETERMINATIONOFGAINORLOSS
Howdoyoudeterminegainorloss?
Thedeterminationofgainorlossisafunctionofbasisandamountrealized.
Thereisagainwhentheamountrealizedexceedsthebasis.Thereisalosswhenbasisexceedsthe
amountrealized.
Basisisdeterminedonthebasisormannerofnowthepropertywasacquired.
Basisofpropertysoldordisposedof
(1) Propertyacquiredbypurchaseitscost(thepurchasepriceplusexpensesofacquisition).
(2) Propertyacquiredbyinheritanceitsfairmarketpriceorvalueasofthedateofacquisition
ofthesame/
(3) Propertyacquiredbygiftordonationthebasistothetransfereeshallbethesameasit
wouldbeinthehandsofthedonororlastprecedingownerwhoacquireditnotbygift,
butifsuchbasisisgreaterthanthefairmarketvalueoftheproperty,thenforthe
purposeofdeterminingloss,thebasisshallbesuchfairmarketvalue.
(4) Propertyacquiredlessthananadequateconsiderationthebasisistheamountpaidbythe
transfereeforthepropery.
(5) PropertyacquiredwheregainorlossisnotrecognizedthebasisisasdefinedinSection40
(C)(5).
(6) Propertywhichshouldbeincludedintheinventoryitslatestinventoryvalue.
SupposeXboughtabuildingworthPhp100M.HeintroducedimprovementsworthPhp10M.
IfXsoldtheproperty,isitsafetoconcludethatthebasiswouldbePhp110M?
No.ThebasiscanbehigherorlowerifXwoulddeductthedepreciation.Itcouldevenbelower
thattheoriginalpriceofPhp100M.Youcanhaveahigheradjustedbasisoraloweradjusted
basis.
Whatwouldbethebasisifyouaresellingapropertysubjecttoamortgage?
Mortgageassumptionispartoftheacquisitioncostonthepartofthebuyer(theacquisitioncost
isthebasisatthetimewhenthebuyerboughttheproperty.Itisalsopartofthesellersbasis.
Whatisthebasisifthepropertyisacquiredbypurchase?
Thebasiswouldbeeverythingthatthetaxpayerspentinacquiringthepropertyincluding
assumptionofliabilities,attorneysfees,etc.Everythingthatthebuyerassumedwilltoperfect
thesaleandownershipwillbepartoftheacquisitioncost.
However,iflandcapitalassetissold,youdonothavetogothroughthiscomputationbecauseit
isalwayssubjectto6%capitalgainstax.
Whatisthebasisifthepropertyisacquiredbyinheritance?
Thebasiswillbethefairmarketvalueatthetimeofacquisition(thetimeofacquisitionisthe
timeofdeathofthedecedent).
Supposeafatheracquiredpropertyin1950forPhp1K.Hediedin2003.Thepropertywas
worthPhp100M.ThesonsolditforPhp100M.Whatisthegain?
None.Becausethebasisisthefairmarketvalueofthepropertyatthedateofacquisition(dateof
deathofdecedent).
Whatisthebasisifthepropertyisacquiredbydonationthensubsequentlysold?
Itwillbethedonorsbasis.Ifthereisseriesofdonation,itwouldbethebasisofthedonorwho
acquireditnotasagift.
Cecille 2C 05-06
Basis
Basis for Property

Acquired by Purchase
Basis for Property

Acquired by Inheritance
137

SupposefatheracquiredbygiftfromgrandfatherwhogotitforPhp1K.Whenthefather
acquiredit,thepropertywasworthPh100M.HegaveittosonwhentheFMVwasPhp100M.
SonsoldthepropertyforPhp100M.Whatisthegain?
Firststatetherule:donorsbasisinthehandsoftheprecedingownerwhodidnotacquireitby
gift.Whatdoesthatmean?Ifyouhaveaseriesoftransactions,thengoallthewaydownto
personwhodidnotacquirethepropertybygift.Thatwouldbeyourbasis.
Howdoyoudeterminegaininagiftsituation?
Todeterminegain,itisalwaysdonorsbasisversusamountrealized.
Howdoyoudeterminelossinagiftsituation?
Todetermineloss,itisstilldonorsbasisversusamountrealized.EXCEPTwhenthedonors
basisexceedsthecurrentfairmarketvalue.Inthiscase,thebasisisthefairmarketvalueonlyfor
purposesofdeterminingloss.
SupposedonorgotifforPhp100.TheFMVatthetimeofthegiftwasPhp105.Giventoson
donee.ThesonsolditforPhp105.Whatisthegainifany?
AmountrealizedisPhp105.ThereisagainofPhp5.
SupposedonorgotifforPhp100.TheFMVatthetimeofthegiftwasPhp105.Giventoson
donee.ThesonsolditforPhp75.Whatisthegainifany?
Here,thereisalossofPhp25.
SupposeafatherboughtapropertyworthPhp1K.Atthetimeofdonation,theFMVwasPhp
100K.ThesonsolditatPhp100K.Whatisthegain?
Thebasisisthedonorsbasis.
Gain=amountrealizeddonorsbasis
=Php100KPhp1K
=Php99K
SupposegrandfatherboughtapropertyworthPhp1Kin1950.In1970,thegrandfather
donatedittofather.In1990,thefatherdonatedittoson.In1990,theFMVoftheproperisPhp
50K.ThesonsolditatPhp100K.Whatisthegain?
Thebasisisthedonorsbasis.
Gain=amountrealizeddonorsbasis(basisisthelastdonorwhodidnotacquireditas
agift)
=Php100KPhp1K
=Php99K
SupposefatherboughtapropertyworthPhp200Kin1950.In1970,thefatherdonatedittohis
son.In1970,theFMVoftheproperisPhp50K.In1970,thesonsolditat100K.Whatisthe
gain?
Thereisnogain.
Gain=amountrealizeddonorsbasis
=100200
=nogain
Intheprecedingexample,isthereloss?
Thereisneithergainnorloss.WhendonorsbasisisgreaterthattheFMV,thebasiswouldbethe
FMVforthedeterminationoftheloss.
Loss=amountrealizedFMV
=10050
=noloss/nogain
Cecille 2C 05-06
Determination of Gain in
a Gift Situation
Determination of Loss in
a Gift Situation
138

SupposethedonorsbasisisPhp100.Atthetimeofthegift,theFMVwasPhp40.Then,it
wassoldforPhp30.Whatwouldbethebasis?
Inthiscase,thebasisexceedstheFMVatthetimeofthegift.Thus,thebasiswouldbetheFMV.
ThereisalossofPhp10.
SupposethedonorsbasisisPhp100.Atthetimeofthegift,theFMVwasPhp40.Then,it
wassoldforPhp50.Whatwouldbethebasis?
ThebasiswouldbetheFMV.Butinthiscase,thereisneithergainnorloss.Thisistheonly
transactionintaxcodewherethereisneithergainnorloss.Why?Becauseforpurposes
determininggain,theruleisthatthebasisisthedonorsbasis.
Here,theamountrealizedisPhp50.Thebasisfordetermininggainisstillthedonorsbasis
whichisPhp100.Thus,thereisnogain.Istherealoss?Nonebecausethedonorsbasisisgreater
thantheFMV,thenforpurposesfordeterminingloss,basisisFMV.
SupposethefatherboughtapropertyworthPhp200Kin1950.In1970,thefatherdonateditto
hisson.In1970,theFMVoftheproperisPhp100K.In1970,thesonsolditatPhp50K.What
isthegain?Isthereloss?
Thereisnogainbutthereisaloss.WhenthedonorsbasisisgreaterthattheFMV,thebasis
wouldbetheFMVforthedeterminationoftheloss.Butthisformulaisusedonlywhen:
(1) incaseofloss;
(2) incaseofgift;and
(3) thebasisisgreaterthantheFMV.
Loss=amountrealizedFMV
=50100
=Php50K
Whatwouldbethebasiswhenproperwasacquiredforinsufficientconsideration?For
exampleapropertyworthPhp10MwassoldforPhp5M.
Itwouldbethetransfereewhowouldhavethebasisproblemwhenhesells.Hemaysellitfor
Php10MorPhp5M.Whenhesells,whatwouldbethebasis?Istheregain?Orloss?Neithergain
norloss.Whatisthebasisforthetransferee?IfhesellsitforPhp5Mthenthereisnogain.Ifhe
sellsitforPhp10M,thereisgain.Thisisbecausethebasisistheamountwhenthepropertywas
acquired.
Butremember,ifthepropertyisacapitalasset,then6%capitalgainstaxwouldapply.
Whatistheruleontaxabilityofexchangesofproperty?
Thegeneralruleisthatuponthesaleorexchangeorproperty,theentireamountofthegainor
loss,asthecasemaybe,shallberecognized.However,Section40(C)(2)providesthe
exceptions.
Whatarethetaxfreeexchanges?
Ingeneral,thetaxfreeexchangescoverthefollowingsituations:
(1) merger/consolidation;and
(2) resultingincontrol.
Notethatinthesesituations,thelawprovidesthatnogainorlossshallberecognizedandnotthat
gainorlossisnotrealized.TheexplanationisintheU.S.legislativehistory.Itisnotreallytax
free,thetaxisjustdeferred.Thetaxiscaughtupinthesubsequentsale.
Cecille 2C 05-06
Taxability of Exchanges
of Property
Tax-Free Exchanges
139

Whydoesthelawuserecognizedandnotrealized?
Theoretically,itisrealizedbutitisnotrecognizedbecauseitisstillwiththecorporation.Itis
recognizeduponsubsequentsaleordispositionofthepropertybythecorporation.
SupposeAInc.hasaproperty,shareholderholdingstocks,bondholderholdingsecurities.B
Inc.takesinalltheseinexchangeforstocksofBInc.Whatisthetaxtreatmentofthe
exchange?
ThisisataxfreeexchangecoveredbySection40(C)(2).
SupposeAInc.haspropertyacquiredforPhp500.Atthetimeofthemerger,thevalue
appreciatedtoPhp700.ThepropertywasexchangedwithBInc.sshareswithavalueofPhp
100pershare.Istheregainrealized?
TheoreticallyagainofPhp200isrealizedbecausetheacquisitioncostisPhp500.Butthe
situationisataxfreeexchanged,thusthegainofPh200isnotrecognized.
Supposesamefactsasabovebuttheexchangeofpropertyresultedin51%controlofthe
corporation.Istheregain?Isthereabasisproblem?
Theoretically,thereisstillgainbutthisinvolvestaxfreeexchangesogainisnotrealized.
Inthiscase,therewillstillbenobasisproblem.Thebasisproblemwillcomeinifthesharesof
stockandpropertyaresubsequentlysoldbythetransferorandtransferee.
WhatisthemeaningofcontrolunderSection40?
Itmeansownershipofstocksinacorporationpossessingatleast51%ofthetotalvotingpowerof
allclassesofstocksentitledtovote.
SupposeA,B,andCalreadyhas31%interestinBInc.Theyenteredintoanexchange
transactionthatresultedtothemacquiringaddition42%interest.Willitstillbeconsidered
taxfreeexchange?
Nomore.Thetransfer/exchangewillalreadybetaxable.Thelawcontemplatesasituation
whereinapersonorpersons,notexceeding4,gainscontrolofacorporationbyvirtueofan
exchange.
Supposethepropertyexchangedwithsharesofstockresultingincontrolwasacquiredbythe
transferorbyinheritanceorgift.Whatwouldbethebasis?
ThenthebasiswilleitherbedonorsbasisorFMV.Thischangesthesituation.Itwouldhave
beensimpleifthetransferoracquireditbypurchase.
SupposefatherboughtpropertyworthPhp1M.HegaveittohissonwhentheFMVisPhp
10M.ThesonexchangeditforsharesofstockworthPhp10Mresultingincontrol.What
wouldbethebasis?
ThebasiswouldbethedonorsbasiswhichisPhp1M.
SupposeMr.XexchangeswithAInc.realpropertywhichresultedtoMr.Xhaving40%
interestinthecompany.Whatwouldthebasis?
First,youhavetodeterminewhetherthepropertyexchangedisacapitalassetoranordinary
asset.Ifitisanordinaryasset,thenthebasiswoulddependontheacquisitioncost,FMV,orthe
donorsbasis.
Cecille 2C 05-06
Recognized v. Realized
Control
140
Supposingthetransferdoesnotresultincontrol.Itonlyresultedto41%.Whatwouldbethe
gainorlosssinceitdidnotresultincontrol?
Thenthegainorlossisrecognized.Youapplythegeneralrulewhichisgainorlossrecognized
infull.
Whatisthebasisinapropertysoldinataxfreeexchange?
Transferoralwayshaspropertyorstock.Transfereealwayshasproperty,stock,orsecurity.To
knowgainorloss,knowthebasisandamountrealized.BasisisthatasprovidedinSection40
(C)(5).TransferorsbasisisSection40(C)(5)(a)whiletransfereesbasisisSection40(C)(5)(b).
Whatisboot?
Bootisanycashorpropertygiveninadditiontothesharesofstockreceivedbyatransferorina
taxfreeexhange.
SoifXexchangedhispropertytothesharesofcorporationandthecorporationwouldthenissue
sharesinXsnameplusproperties.TheadditionalpropertygivenbythecorporationtoXisthe
boot.
Inataxfreeexchange,whatwouldbethebasiswherethereisnoboot?
Whenthereisnoboot,thebasisisthetransferorspropertygivenupbecausetherulesprovided
thatthebasiswouldbethesamebasisasthepropertygivenupbythetransferor.Inthiskindof
transaction,theruleisalwaysthetransferorsbasis.
Inataxfreeexchange,whatwouldbethebasiswhenthereisboot?
Thelawprovidesthatthebasisisthesameastransferorsbasisminusbootincreasedbythe
recognizedgain.
SupposeXandAInc.enteredataxfreeexchange.XhadpropertiesworthPhp500K.whileA
Inc.issuedsharesworthPhp700K.Aftertheexchange,XsoldthesharesforPhp700andA
Inc.soldthepropertiesforPhp700.Whatisthebasis?
ThetransferorsbasisisPhp500(propertygivenup)whilethetransfereesbasisisalsoPhp500.
BothearnedagainofPhp200.
SupposeXacquiredapropertyworthPhp500K.ItsFMVisPhp700.Xenteredinataxfree
exchangewithAInc.Inexchangefortheproperty,AInc.issuedsharesofstockworthPhp
400K.Inadditiontothesharesofstock,AInc.gaveXpropertiesworthPhp200Kandcash
worthPhp100K.Whatisthebasis?
Here,thereisbootcomprisingofpropertiesworthPhp200KandcashworthPhp100K.
TransferorsBasis
=Transferorsbasisminusbootplusrecognized
gain
RecognizedGain
=(Stockplusboot)minusbasis
=700500=200
TransferorsBasis
=500300+200
=400
TransfereesBasis
=Transferorsbasisplusrecognizedgain
TransfereesBasis=
=500+200=700
Transferorsbasis
RememberinSection40(C)(5)(a),thebasisreceivedbythetransferoristhesameasthebasisof
theproperty,stockorsecuritiesdecreasedbymoneyreceivedandtheFMVoftheotherproperty
receivedandincreasedbytheamounttreatedasdividendoftheshareholderandtheamountof
anyrecognizedgainontheexchange.
Cecille 2C 05-06
Boot
Basis When There is No

Boot
Basis Where There is

Boot
141
Here,theacquisitioncostislessenedbythecashreceived.Thepropertyisstillwiththe
transferor.
Transfereesbasis
Here,itceasestobepuresharesofstock.ItgetspropertyandcashinsteadofPhp200because
onlytothatextentofthebootwillthegainberecognized.BasisisSection40(C)(5)(b).Itisthe
sameasitwouldbeinthehandsofthetransferorincreasedbytheamountofthegain
recognizedtothetransferoronthetransfer.
SupposeAacquiredpropertyworthPhp5M.ItappreciatedtoPhp10M.Athenexchangedit
withPhp10MsharesofstockfromXInc.Whatwouldbethetaxtreatmentsupposingthe
transferorsubsequentlysellsthePhp10Msharesofstock?
Then,the5%or10%capitalgainstaxwouldbeapplicable.
SupposeXInc.exchangessharesofstockforproperty.Whatisthebasis?
Thebasisisvalueofthesharesofstocks.Amountrealizedisthevalueofthepropertyitgot.
SupposesharesofstocksoldforPhp20MrealizingagainofPhp10M.Itwasthenexchanged
forsharesofstockworthPhp10M.Whatwouldbethebasis?
Thebasiswouldbethevalueofthestocklessamountrealizedlesssharesofstock.
SupposeapropertyworthPhp10MwasexchangedforsharesofstockworthPhp8M.Gainis
2M.Will5%or10%taxrateapply?
No.5%or10%capitalgainstaxdoesnotapplybecausethecorporationexchangeisownshares
ofstock.So,thePhp2Mwillbesubjecttocorporatetax.
Whathappenswhenthereisanassumptionofliabilityintheexchange?
UnderSection40(C)(4),forpurposesofrecognitionofgain,theliabilityassumedisnot
consideredasbootbutforpurposesofbasis,theliabilityassumedisconsideredmoney.
Typicaltestproblem:
Apropertywasacquiredbyfatherbygift.Giventosonwholaterdied.Thenthesonofthe
sonwhodiedinheritedtheproperty.Afterinheritance,exchangeditforsharesofstock
resultingincontrol.XInc.sellstheproperty.Thesonsellsthesharesofstock.Whatisthetax
consequence?
Toanswerthisquestion,youshoulddetermine:
(1) gain;and
(2) howitistaxed.
** GOOD LUCK **
This is a compilation of the Ateneo Bar Ops 1995 Reviewer, Araceli Habaradas Reviewer,
Jean Ferry Reviewer, and notes from the lectures of Atty. Gaudencio Mendoza S.Y. 2005-2006.
This is not a complete reviewer. Please refer to textbooks and codal provisions for clarifications.
Some of the doctrines and rates may already be outdated. Please refer to laws and revenue regulations.
Thanks to Ryan for obtaining copies of reviewers used in this compilation. Thanks to Julie and Lea for explaining most of the difficult concepts.
Cecille 2C 05-06
142

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Requisites for a Valid Tax

Direct Duplicate Taxation

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Exceptions to the Rule on

Actual Business Situs

Summary of Situs Rule

Requisites for Valid

How Supreme Court

Requirement for Valid Tax

Exclusions from Gross

Life Insurance Policy

Gifts, Bequests, &

Gift in the Context of a

Acarexperiencedatotalwreckbutthereisnophysicalinjurytotheinsured.Iscompensation Compensation for Injuries

Prizes and Awards

When a Filipino Citizen

Uniform Rules on Capital

Income Tax Rules for

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Capital Asset v. Ordinary

Capital Gains Tax on Sale

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Capital Gains Tax on

Income Tax Rules on

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PAL Manila HongKong USA.Changedairplane.JapanAirlinestakingpassengerXto

US Tokyo Manila Bangkok Japan EuropeviaNorthwestAirlinesplane.Technical

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Basis Where There is