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Tax I Reviewer, Bello Syllabus (Academic Year 2014 2015) Case Tio v. Videogram Regulatory Board, 151 SCRA 208 (1987)
Fast Facts: PD 1994 was enacted, placing an annual tax of five pesos on processed video-tape cassettes.
I. INTRODUCTION AND GENERAL PRINCIPLES Locally manufactured or imported blank video tapes were also subjected to local sales tax. TP contended
that PD 1994 is unconstitutional because the 30% tax imposed is harsh, confiscatory, oppressive, in
A. General Principles
unlawful constraint of trade, and thus in violation of due process clause.
Read BENJAMIN B. ABAN, LAW OF BASIC TAXATION IN THE PHILIPPINES 1-29 (2000)
Doctrine:
Characteristics of taxation
The tax imposed is NOT harsh, oppressive, confiscatory, and in restraint of trade. It is a regulatory and a
! It is enforced revenue measure. The levy is for a public purpose, in order to answer the need to regulate the videogram
o By the state against its subjects industry. It is also a revenue measure because the P600 million industry has never been subjected to tax.
! It is a proportionate contribution
o Based on ones ability to pay The power to impose taxes by the legislatiure is one so unlimited in force and so searching in extent that the
! It is inherently legislative in nature courts scarcely venture to declare that it is subject to any restrictions whatever.
! The taxing authority must have taxing jurisdiction
o Based on nationality Bello Notes: Primary purpose of taxation is to raise revenue. Regulatory purposes are merely secondary.
o Based on residence However, a tax does not become invalid merely because it is regulatory in nature
o Based on source of income/situs
! It is personal in nature Case Lutz v. Araneta, 98 Phil. 148 (1955)
Fast Facts: Lutz sought to recover from the CIR an amount paid by the estate as taxes based on his claim
Purposes of taxation that Section 3 of the Act is unconstitutional and void because it was levied for the aid of the sugar
! Primary raising of revenue industry exclusively. In his opinion, it was not for a public purpose.
! Secondary regulatory, for the general welfare, reduce social inequity (through a progressive tax
system), etc. Doctrine:
The tax imposed in supporting the sugar industry is valid. It is inherent in the power to tax that the state is
Tax does not become invalid merely because it is regulatory in nature free to select the subjects of taxation. The protection and promotion of the sugar industry is a matter of
public concern, it follows that the legislature may determine within reasonable bounds what is necessary for
its protection and expedient for its promotion.
Principles of a sound taxation system
! Theoretical justice If objective and methods are alike constitutionally valid, no reason is seen why the state may not levy taxes
! Fiscal adequacy to raise funds for their prosecution and attainment. Taxation may be made the implement of the state's
! Administrative feasibility police power.

Main purpose of taxation: revenue generation Case Commissioner of Internal Revenue v. Algue, 241 Phil. 829 (1988)
! This is what separates it from the other powers of government Fast Facts: CIR assessed Algue, an engineering company, for deficiency taxes covering the years 1958-
1959 for deductions based on promotional fee payments. Algue filed a protest. After the BIR denied the
Compensation given from paying taxes protest, it was then that Algue accepted the warrant of restraint and levy. Algue then filed a petition for
! Benefits and protection from the government review against the CIR with the CTA.

Persons affected by taxes Doctrine:

! Community or class of individuals The said amount had been legitimately paid by the private respondent for actual services rendered, thus the
deductions were valid. The payment was in the form of promotional fees and not personal holding company
Authority which exercises taxation power income, as contended by the CIR. The promotional fees, though paid to the same family members, were not
! Only by the government or its political subdivisions excessive and were substantiated. Algue overcame the burden to prove the validity of the deduction,
showing they were reasonable and necessary in light of their efforts in the corporation.
Amount of imposition
Taxes are the lifeblood of the government and so should be collected without unnecessary hindrance.
! Theoretically, there is no limit However, it is necessary to reconcile the conflicting interests of authorities and the taxpayers so that the
! As long as it does not infringe on inherent limitations real purpose of taxation, promotion of common good, is achieved.
! Exception sources of income from governments proprietary functions

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B. Limitations on Taxing Power of petroleum operations. In return, the proceeds of the sale of the petroleum will be the source of funds for
1. Inherent Limitations on Taxing Power ABAN, 53-66 payment of a stipulated service fee and operated expenses due to the service contractors. They would also
be exempt from all taxes except income taxes based on PD 87. The Service Contractors received letters
Inherent limitations on taxation from the RDO informing them that their sale of natural gas would now be subject to VAT pursuant to RA
! Taxation must be for a public purpose 9337.
! Taxation is inherently legislative thus, non-delegable (but with exceptions)
o President in certain cases as shown in the Constitution Doctrine:
o LGUs through Constitutional provisions Service contractors sale of natural gases are exempt from VAT. It was already confirmed that service
o Administrative agencies contractor under SC 38 is exempt from all taxes except from income tax including exemption from VAT.
There is also the constitutional precept of non-impairment of contracts. The tax exemption granted to a
Territoriality/Situs of taxation Service Contract under SC 38 is a contract tax exemption granted by the government in exchange for a
! Exceptions valid material consideration (the furnishing of services, technology, and financing was the material
o Nationality consideration). Hence, the tax exemption is not granted out of legislative franchises but out of a contract
o Tax treaties lawfully entered between the Service Contractor and the government. This then means that the exemption
may not be unilaterally withdrawn without violating the non-impairment clause.
Government cannot tax itself
C. Double Taxation
Case Mactan Cebu Intl Airport Authority v. Marcos, 261 SCRA 667 (1996) ABAN, 113-118
Fast Facts: MCIAA was given exemption from realty taxes imposed by the National Government on any ! No constitutional prohibition
of its political subdivisions, agencies, and instrumentalities. However, Cebu City government demanded ! Taxing (tantamount to confiscation of property without due process of law)
payment of realty taxes on lands belonging to the MCIAA. MCIAA objected and invoked its tax o Upon the same subject matter
exemption and that it was an instrumentality performing governmental functions. The city refused o For the same purpose
insisting that MCIA is a GOCC performing proprietary functions whose tax exemption was withdrawn by o By the same taxing authority
the LGC. o Within the same jurisdiction
o Within the same taxing period
Doctrine: The tax imposed by Cebu City was valid. Though the power to tax is primarily vested in o Of the same kind or character
Congress, it may be exercised by local legislative bodies, no longer by virtue of a valid delegation but ! Avoided through
pursuant to direct authority under our Constitution. The exercise of such power may be subject to o Unilateral means
guidelines and limitations that Congress may provide, which must be consistent with the basic policy of o Bilateral means
local autonomy.
D. Construction of Tax Statutes
2. Constitutional Limitations on Taxing Power 1. Liberal Construction in Favor of Taxpayers ABAN, 144
ABAN, 66-94 Case Manila Railroad v. Collector of Customs, 52 Phil. 950 (1929)
Fast Facts: Manila Railroad Company uses dust shields on its railway wagon to cover the axle box in
Constitutional limitations on taxation order to protect from dust the oil deposited therein. Dust shields are manufactured of wool and hair mixed.
! Directly affecting limitations constitution specifically places limitation under specific instances The Insular Collector decided that dust shields should be classified as "manufactures of wool, not
! Indirectly affecting limitations otherwise provided for." under Par. 141 of the Tariff Law. Judge saw otherwise and held that they should
o Due process grounds be classified as "detached parts" of vehicles for use on railways under Par. 197.
o Equal protection
o Religious freedom Doctrine: Dust shields are classified for the purposes of the tariff under paragraph 197 of section 8 of the
o Non-impairment of contracts clause Tariff Law of 1909 as detached parts. The court took into account the purpose of the article,
Example: Congress cannot unilaterally revoke a privilege when coupled with material acknowledging that it is in reality used as a detached part of railway vehicles In the interpretation of
considerations statutes levying taxes or duties, the general rule is not to extend their provisions beyond the clear import
of the language used. In case of doubt, the statutes must be construed strongly against the government,
Case VAT Ruling No. 7-2006, June 7, 2006 and in favor of the citizen.
Fast Facts: Service contractors entered into SC 38 with the government for the exploration and utilization
of petroleum. Here, service contractors would furnish services, technology and financing for the conduct

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Case Commissioner of Internal Revenue v. Firemens Fund Ins. Co., 148 SCRA 315 (1987)
Fast Facts: From 1952 to 1956, documentary stamps were bought and affixed to the monthly statements of
policies issued by Firemans Fund; and from 1957 to 1958 documentary stamps were bought and affixed
to the corresponding pages of the policy register, instead of on the insurance policies issued. The company
discovered that its monthly statements of business and policy register were lost. CIR examiner ascertained
that Firemans Funds failed to affix the required documentary stamps to the insurance policies issued by
it. CIR assessed and demanded from company the payment of DST. In a protest to the assessment, the
CTA ruled for Firemans Funds
Doctrine: DST is deemed paid by the purchase of documentary stamps; affixture of documentary stamps
to the document or instrument taxed or to such other paper as may be indicated by law or regulations; and
cancellation of the stamps as required by law. The three steps are just a means to an end. No dispute on
the fact that the documentary stamps corresponding to the various policies were purchased and paid for.
No justification for the government which has already realized the revenue which is the object of the
imposition of subject stamp tax, to require the payment of the same tax for the same documents.
The general rule in the interpretation of statutes levying taxes or duties, is that in case of doubt, such
statutes are to be construed most strongly against the government and in favor of the subjects or citizens,
because burdens are not to be imposed or presumed to be imposed beyond what statutes expressly and
clearly import.
2. Strict Construction of Tax Exemptions
ABAN, 118-124
Case Sea-Land Services, Inc. v. Commissioner of Internal Revenue, G.R. No. 122605, April 30,
2001
Fast Facts: SEA-LAND claims it is exempted from the payment of income tax according to Article XII,
paragraph 4 of the Military Bases Agreement, that no corporation organized under US laws, resident in
the US, shall be liable to pay income tax in the Philippines in respect of any profits derived under a
contract made in the US with the government of the US in connection with the construction, maintenance,
operation and defense of the bases.
Doctrine: It is obvious that the transport or shipment of household goods and effects of the military
personnel is not included in those mentioned terms. The performance of this service could also not be
interpreted as directly related to the defense and security of the Philippine territories. Any interpretation of
laws that would grant exemption from tax is construed strictissimi juris against the taxpayer and liberally
in favor of the taxing power.
Case Maceda v. Macaraig, G.R. No. 882291, May 31, 1991
Fast Facts: NPC claims for refund of taxes and duties original paid by Caltex, Petrophil and Shell on
petroleum products after RA 938 (exempting it from all forms of taxes, duties, fees imposts as well as
costs and service fees including filing fees, appeal bonds, in any court or administrative proceeding) was
issued. BIR was of the opinion that because of RA 938, the tax exemption privileges of NPC covers only
taxes for which it is directly liable and not on taxes which are only shifted to it.
Doctrine: NPC is exempt not only for direct taxes but also for indirect taxes. The charter of the NPC and
laws granting it tax exemption shows the intention of giving and strengthening NPCs enjoyment of
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preferential tax treatment. The lawmakers did not intend that PD 938 shall be construed strictly against
NPC.
The rule on strict interpretation does not apply in the case of exemptions in favor of a government
political subdivision or instrumentality; the express exemption should not be construed with the same
degree of strictness that applies to exemptions contrary to the policy of the state, since as to such property
exemption is the rule and taxation the exception.
Case Commissioner of Internal Revenue v. CA, 240 SCRA 368 (1995)
Fast Facts: EO 41 was promulgated declaring a one-time tax amnesty on unpaid income taxes from 1981-
1985. CIR assessed ROH Auto Products of deficiency income and business taxes. The company wrote to
CIR that it availed of the tax amnesty and that the deficiency tax should be cancelled. CIR denied the
request on the ground that the Revenue Memorandum Order, implementing EO 41, had construed the
amnesty to include only assessments by the BIR after the promulgation of said EO.
Doctrine: EO 41 is explicit and requires only a simple application of its provisions. If EO 41 had not been
intended to include tax liabilities already assessed prior to the EO, the law could have simply so provided
in its exclusionary clauses. But it did not. Therefore, the EO had been designed to be in the nature of a
general grant of tax amnesty subject only to the cases specifically excepted by it.
3. Liberal Construction vs. Strict Construction: When Applicable?
Case Commissioner of Internal Revenue v. Pilipinas Shell Petroleum Corp., G.R. No. 192398,
Sept. 29, 2014
Fast Facts: PSPC entered into a Plan of Merger with SPPC. The assets and liabilities of SPCC will be
transferred to and absorbed by PSPC. PSPC paid DST to BIR on the original issuance of shares of stock it
issued in exchange for the surrendered SPPC shares. BIR ruled and confirmed the tax-free nature of the
merger stating that no gain or loss shall be recognized by the stockholders of SPPC on the exchange of
stocks. However, the issuance by PSPC of its own shares of stock to the shareholders of SPPC in
exchange for the surrendered certificates of stock of SPPC is subject to another DST. The exchange of
land improvements by SPPC to PSPC was also held to be subjected to DST based on the consideration
paid at fair market value. PSPC paid to the BIR the amount of representing DST on the transfer of real
property. Believing it wrongly paid DST on its absorption of real property, PSPC filed a formal claim for
refund or tax credit in the same amount. CTA granted its petition stating that the transfer was
by operation of law and thus not subject to tax. CIR is questioning the act of the CTA.
Doctrine: The transfer is not subject to DST. Section 196 of the Tax Code only covers transfers by virtue
of a sale. A perusal of the subject provision would clearly show it pertains only to sale transactions where
real property is conveyed to a purchaser for a consideration. The phrase granted, assigned, transferred or
otherwise conveyed is qualified by the word sold which means that DST under Section 196 is imposed
on the transfer of realty by way of sale and does not apply to all conveyances of real property.
Bello Notes: When the tax is not applicable to the case, there is no need to dwell on the issue of how the
tax provision is to be construed because it is not subjection or exception, but an item thats not even taxed.
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E. Tax Avoidance v. Tax Evasion were not given the first opportunity to buy, Hydro Pipes, assignees of a lease agreement with a right of
ABAN, 124-128 first reusal over the land, filed a complaint for reconveyance.

! Shifting transferring the burden (but not the liability) of the tax to someone else Doctrine: The records do not point to anything wrong or objectionable about this "estate planning"
o Example: VAT (which is an indirect tax) scheme resorted to by the Pachecos. The legal right of a taxpayer to decrease the amount of what
o Generally is not prohibited by law otherwise could be his taxes or altogether avoid them, by means which the law permits, cannot be
o If the tax is not paid, BIT goes after the one who has the tax liability doubted.
o Income taxes cannot be shifted/passed on
! Impact
o Where the tax liability is imposed II. MEANING OF INCOME AND REALIZATION PRINCIPLE
! Incidence
o Where the tax liability finally lies Sec 32 (A), NIRC
! Avoidance is not illegal; evasion is illegal
Section 32. Gross Income. -
o Avoidance is taking advantage of legal tax methods and formulas in order to pay less taxes (A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever
! Elements of tax evasion (things to be considered) source, including (but not limited to) the following items:
o End to be achieved (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and
o State of mind similar items;
Evil, in bad faith, willful, deliberate (2) Gross income derived from the conduct of trade or business or the exercise of a profession;
(3) Gains derived from dealings in property;
o Unlawful course of action (4) Interests;
! Abusive tax avoidance may not be illegal, but the BIR has tools to re-characterize the subject (5) Rents;
transactions (6) Royalties;
o Thin line between abusive avoidance and evasion (7) Dividends;
(8) Annuities;
Ends are the same but the means are different
(9) Prizes and winnings;
(10) Pensions; and
Case Commissioner of Internal Revenue v. Estate of Toda, 438 SCRA 290 (2004) (11) Partner's distributive share from the net income of the general professional partnership.
Fast Facts: Toda is the president and 99.991% of CIC sold a building and 2 parcels of land for P100M to
Altonaga. The latter sold the property on the same day to RMI for P200 M. He paid CGT of P10M. Toda
sold all his shares to Choa and died 3 years later. BIR sent CIC an assessment for tax deficiencies to the Sec 36, Rev Reg 2
amount of P80M. The new CIC asked for reconsideration because CIC is owned by entirely new set of
SECTION 36. Meaning of net income. The tax imposed by law is upon income. In the computation of the tax, various
stockholders. Estate of Toda received notice of assessment for P80M. Estate filed a protest. Commissioner
classes of income must be considered:
dismissed the protest, stating that a fraudulent scheme was deliberately perpetuated by the CIC wholly
owned and controlled by Toda by covering up the additional gain of P100 million resulting in the change (a) Income, in the broad sense, meaning all wealth which flows into the tax-payer other than as a mere return of capital. It
in the income structure of the proceeds of the sale to an individual capital gains, thus evading the higher includes the forms of income specifically described as gains and profits, including gains derived from the sale or other
corporate income tax rate of 35%. disposition of capital assets. Income cannot be determined merely by reckoning cash receipts, for the statute recognizes as
income determining factor other items, among which are inventories, accounts receivable, property exhaustion, and accounts
payable for expenses incurred.
Doctrine: This was a case of tax evasion. It is obvious that the objective of the sale to Altonaga was to
reduce the amount of tax to be paid especially that the transfer from him to RMI would then subject the (b) Gross income, meaning income (in the broad sense) less income which is by statutory provision or otherwise exempt from
income to only 5% individual CGT ,and not the 35% corporate income tax. Here, all the factors for tax the tax imposed by law.
evasion were present: 1) the end to be achieved, i.e., the payment of less than that known by the taxpayer
to be legally due, or the non-payment of tax when it is shown that a tax is due; (2) an accompanying state (c) Net income, meaning gross income less statutory deductions. The statutory deductions are, in general, though not
exclusively, expenditures other than capital expenditures, connected with production of income.
of mind which is described as being evil, in bad faith, willfull,or deliberate and not accidental;
and (3) a course of action or failure of action which is unlawful. (d) In the case of a taxpayer other than a corporation as defined in Section 84 (b) of the Code, net income means gross income
less exemptions. Ordinarily the net income is to be computed in accordance with the method of accounting regularly employed
Case Delpher Trades Corp. v. IAC, 157 SCRA 349 (1988) in keeping the books of the taxpayer.
Fast Facts: A deed of exchange was executed between lessors Pacheco and Delpher Trades Corporation
(actually owned by the Pachecos) whereby the lessors conveyed the leased property to Delpher with
another parcel of land for the consideration of shares of stock of said corporation. On the ground that they

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A. What is Income (A Definitional Concept) Case Eisner v. Macomber, 252 U.S. 189 (1920)
Fast Facts: (Same situation and doctrine as the Fisher case) Mrs. Macomber is a stock holder in a
Gross income all income derived from whatever source corporation, which had surplus and undivided profits of $45M. Instead of distributing the earnings to
stockholders, the earnings were recapitalized. Mrs. Macomber received 1,100 additional shares; the
Not all economic gains are taxable authorities made her pay income tax on this. She complied under protest and is now seeking to recover the
! It is taxed only when it is realized sum paid.
o Realization need not be in cash
Doctrine: The TP is right. It is important to distinguish between capital and income, as only income is
An increase in capital is not taxable subject to income tax. What a stock dividend does is only increase the capital investment of each
! Unless it is sold or disposed of shareholder, not profits realized or earned out of it.
o Difference in market value (selling price acquisition cost) will be the tax base
Punitive damages are taxable Case U.S. v. Kirby Lumber Co., 284 U.S. 1 (1931)
! Basis: such damages brought plaintiff to a situation where he gained much more that what he lost Fast Facts: Kirby Lumber Co. issued around 12M USD worth of its bonds at par value. In the same year,
o If damages brought plaintiff back only to original state, such damages are not taxable it then the purchased the same stocks from the market at a lower value. Is the gain from the difference of
i.e. Actual damages price a taxable income?
o If damages are awarded on the basis of the loss of profit, such damages are taxable
TP would have earned that amount awarded in damages as profit Doctrine: Yes. When corporations sell bonds and repurchase them at a lower price, there is a taxable gain.
It is clear in this case that there is benefit derived.
Expanded meaning of income (see: Glasgow)
! All accessions to wealth actually realized Case Helvering v. Bruun, 309 U.S. 461 (1940)
o Where taxpayer has complete dominion Fast Facts: Lessor (Bruun) leased his lot of land and the building thereon to lessee. The lessee was to
! Gain from whatever source surrender the land, upon termination of the lease, with all buildings and improvements thereon.
Subsequently, the lease was cancelled for default and the lessor regained possession everything. Tax
Definition in the Eisner case was never intended to be the touchstone for all income controversies (see: authorities want to tax the gain realized by the lessor from the improvements.
Eisner)
Doctrine: The gain realized by the lessor is taxable as part of his income. It is settled that the realization of
Illegal sources of wealth are taxable income gain need not be in cash derived from the sale of an asset. Gain may occur as a result of exchange of
! Because of the catch-all provision property, payment of the taxpayer's indebtedness, relief from a liability, or other profit realized from the
! Taxable on the year such gain was realized completion of a transaction.

Case Fisher v. Trinidad (Oct. 30, 1922) Case CIR v. Glenshaw Glass Co., 348 U.S. 426 (1955)
Fast Facts: Fisher is a stockholder of a certain corporation, which declared stock dividends. Fishers Fast Facts: In one case, Glenshaw Glass Co won against another company in an antitrust lawsuit wherein
proportionate share of said stock divided was P24,800; the authorities made Fisher pay income tax on this. it was awarded around 300K USD as exemplary damages for fraud and treble damages for injury to its
Fisher complied under protest and is now seeking to recover the sum paid. business.

Doctrine: Fisher, the TP, is correct. Stock dividends are NOT income. The stockholder who receives a Doctrine:
stock dividend has received nothing but a representation of his increased interest in the capital of the Income is realized whenever there are instances of
corporation. The dividend normally is payable in money and when so paid, only then does the stockholder [1] undeniable accessions to wealth
realize a profit or gain, which becomes his separate property, and thus derive an income from the capital [2] clearly realized
that he has invested. Until that is done the increased assets belong to the corporation and not to the [3] over which the taxpayers have complete dominion
individual stockholders.
Money received as exemplary damages for fraud or as antitrust recovery must be reported as gross
Notes: Contrast this with an extraordinary cash dividend, which is a disbursement to the stockholders of income.
accumulated earning. The rule is well established that a cash dividend, whether large or small, are
regarded as "income" while all stock dividends, are regarded as capital or assets.

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Case James v. U.S., 366 U.S. 213 (1961)
Fast Facts: James, the TP, is a union official who embezzled around 700K USD from his employer. This
amount was not reported in his gross income.
Doctrine: This is part of taxable income. A gain "constitutes taxable income when its recipient has such
control over it that, as a practical matter, he derives readily realizable economic value from it." Since the
gains of the honest laborer is taxed, so much so that the gains of the dishonest may not be immune.
B. Realization Requirement
Sec 38, Rev Reg 2
SECTION 38. Bases of computation. Approved standard methods of accounting will be ordinarily regarded as clearly
reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross
income and all deductions are treated with reasonable consistency. All items of gross income shall be included in the gross
income for the taxable year in which they are received by the taxpayer and deductions taken accordingly, unless in order
clearly to reflect income such amounts are to be properly accounted for as of a different period. For instance, in any case in
which it is necessary to use an inventory, no accounting in regard to purchases and sales will correctly reflect income except an
accrual method. A taxpayer is deemed to have received items of gross income which have been credited to or set apart for him
without restriction. On the other hand, appreciation in value of property is not even an accrual of income to a taxpayer prior to
the realization of such appreciation through sale or conversion of the property. (For methods of accounting and determination
of accounting period, see Sections 166 to 169 of these regulations.)
Realization requirement must be met before there is taxability
! Applies to both gains (for taxation purposes) and losses (for deduction purposes)
Absence of realization requirement
! Annual property appraisals
! Liquidity
! Forced liquidation
Realization requirement
! Taxpayer enjoyed the benefit of the economic gain
o Includes procurement of other satisfactions
! Postpones liability until final enjoyment
Case Helvering v. Bruun, supra
Fast Facts: Lessor realized a taxable gain when he repossessed the property with improvements by the
tenant. (For the facts, see the third case above this.)
Doctrine: Realization of gain need not be in cash derived from the sale of an asset. Here, as a result of a
business transaction, the lessor received back his land with a new building on it, which added an
ascertainable amount to its value. Such gain is recognized as realized taxable gain.
Case Helvering v. Horst, 311 U.S. 112 (1940)
Fast Facts: Horst, the TP, detached negotiable interest coupons worth around 25K USD from his
negotiable bonds and gave them to his son, who collected the same at maturity. The TP kept his books on
a cash basis which is why he never recorded the transfer to his son. Tax uthorities seek to include this
donation as part of his taxable income.
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Doctrine: A donation made during a donors taxable year is part of the donors taxable income. This is so
because such income has already been realized in the hands of the donor albeit the fact that he donated the
same to a third person. Disposition of income is correlated to ownership of it, and as such it remains
taxable even if donated.
Case Cottage Sav. Assn v. CIR, 499 U.S. 554 (1991)
Fast Facts: Cottage Savings is a savings and loan association (S&L) which held numerous long-term, low-
interest mortgages. S&L institutions could possibly achieve tax savings from selling these mortgages at a
loss as they would be able to claim tax-deductible losses. However, they were deterred from doing so
since the government required them to record the losses on their books, which could possibly place them
into insolvency. The government relaxed some recording requirements by declaring that S&Ls need not
report losses associated with mortgages that are exchanged for "substantially identical" mortgages held by
other lenders. Pursuant to this, Cottage Savings exchanged its mortgage loans for mortgage loans held by
other financial institutions. And when Cottage Savings filed its federal income tax return, it claimed a
$2.5 million loss - the difference between the original value of the mortgages it gave away and the current
value of the mortgages it received in return. The CIR disallowed the deductions.
Doctrine:
The TP is entitled to tax deductible losses. The IRC gives a straightforward test for realization: the taxpayer
must engage in a "sale or other disposition of the property in order to realize a gain or loss in the value of
property, " And it must be noted that for disposition (whether resulting in a gain or loss) to take place, there
should be a material difference between the properties exchanged. As long as the properties being
exchanged are not identical, a realization takes place.
In this case, the properties exchanged were not identical i.e. "materially different." Therefore, the exchange
was a "disposition of property" and since such disposition incurred losses, tax deductions should be
allowed.
C. Other Relevant Concepts
1. Tax-Free Imputed Income v Taxable Barter
Imputed income vs. taxable barter
! Imputed income
o No cash involved
o Value of the service rendered
o Economic gain from services rendered
o Imputed to a person when avoiding to pay for services by providing such services to himself
o Imputed rent: to avoid paying rent for usage of assets, own such assets instead
o Imputed income is not taxed
Administrative practicality
Excluded from gross income
! Taxable barter
o Results still in realization
Service-for-service exchange
o Example: X-deal
There are actually two sales
Two taxable events for income taxation purposes
Challenge now is to figure out monetary value but such is still taxable
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Sec 41, Rev Regs 2
SECTION 41. Compensation paid other than in cash. Where services are paid for with something other than money, the fair
market value of the thing taken in payment is the amount to be included as income. If the services were rendered at a stipulated
price, in the absence of evidence to the contrary, such price will be presumed to be the fair value of the compensation received.
Compensation paid an employee of a corporation in its stock is to be treated as if the corporation sold the stock for its market
value and paid the employee in cash. When living quarters are furnished in addition to cash salary, the rental value of such
quarters should be reported as income.
Case CIR v. Minzer, 279 F.2d 338 (5th Cir. 1960)
Fast Facts: Minzer, the TP, is an insurance agent or broker. As a representative of the insurance
companies that issued the policies, he became entitled to commissions on the policies to the same extent
as though the insurance had been on the life of someone else. He received these commissions, or the
benefit of them, upon policies on his own life either by remitting the premiums, less commissions, to the
companies, OR by remitting the premiums in their entirety and receiving back from the companies their
checks to him for the amounts of the commissions. He did not report these commissions as part of his
taxable income.
Doctrine: The commissions received by the agent were compensation for services and as such is part of
taxable income. It must then be said that a benefit inured to the taxpayer to the extent of his commissions.
The benefit is neither diminished nor eliminated by referring, as does the Tax Court, to the word
"commission" as a verbal trap.
Case Rev. Rul 79-24, 1979-1 CB 60
Fast Facts:
Scenario 1 In return for personal legal services performed by a lawyer for a housepainter, the
housepainter painted the lawyer's personal residence.
Scenario 2 An individual who owned an apartment building received a work of art created by a
professional artist in return for the rent-free use of an apartment for six months by the artist.
Doctrine: These are examples of taxable barter. If services are paid for other than in money, the fair
market value of the property or services taken in payment must be included in income. If the services
were rendered at a stipulated price, such price will be presumed to be the fair market value of the
compensation received in the absence of evidence to the contrary.
*Additional Notes: Imputed income is the accession to wealth that can be attributed, or imputed, to a
person when he avoids paying for services by providing the services to himself or herself, or when the
person avoids paying rent for durable goods by owning the durable goods, as in the case of imputed rent.
This is not taxable.
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2. Tax-Free Return of Capital
Return of capital
! Not taxable
! It is only amounts in excess of capital that are taxed
o Such excess is actual income
Sec 36, Rev Regs 2, supra (See the previous section, B. Realization Requirement, for the codal reference)
Case Clark v. CIR, 40 B.T.A. 333 (1939)
Fast Facts: In 1932, Clark retained a tax counsel to prepare his tax necessary returns. Said counsel advised
Clark to file just one return instead of two separate returns. Then, the government recommended an
additional assessment from Clark worth around $32K, which Clark paid. Recomputations were done
which revealed that if Clark and his wife had filed separate returns for 1932, instead of just one, then their
combined tax liability would have been around $19K less than the final assessment paid. The tax counsel
admitted his fault and accordingly, the erring tax counsel paid Clark the sum of $19K, which Clark
accepted. The government wants to include this amount as part of Clarks taxable income for 1934.
Doctrine: No, this should not be included as part of his taxable income. Clark, in paying that obligation,
sustained a loss which was caused by the negligence of his tax counsel. The $19K was paid to Clark, not
as taxes, but as compensation for his loss. Recoupment on account of such losses (compensation for ones
loss) is not income.
Case BIR Rul 51-00 (October 30, 2000)
Fast Facts: A Retirement Plan was established to provide retirement benefits for qualified employees of
schools and other institutions subsequently accepted by the Retirement Board. The Fund was non-
contributory; however, members may, prior to their retirement elect to contribute an amount equal to at
least 2% of their current monthly salary. These contributions were made not subject to withdrawal, unless
for causes provided therein. But due to the prevailing economic crisis, some members were financially
incapable of continuing their contributions and requested the withdrawal of the said contributions. There
is now a question on w/n income or earnings derived from the personal contributions by the employee
members' in this case are subject to income tax
Doctrine: Yes it is. Any and all amounts which represent a mere return of the personal contributions of the
employees to the Fund, who are still in the active service in their respective institutions shall not be
subject to income tax, since the same are considered as mere return of capital. However, amounts actually
distributed to said member-employees over and above their personal contributions shall be taxable to
them in the year in which so paid or distributed, considering that such distribution has been effected
before their retirement. It is only upon retirement, the total benefits which the employees shall receive
consisting of their personal contributions, counterpart contribution for the employer and the income of the
Fund to which the employees are entitled and are distributed to them shall be exempt from income tax.
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Case BIR Rul 184-90 (Sept 20, 1990)
Fast Facts: Lessor and lessee entered a contract of lease. In the contract, the lessee agreed to build a 3 to
4-storey building on lessors land. Lessee failed to comply and instead, agreed to pay liquidated damages
for actual and compensating damages suffered by the lessor as a result of the aforementioned breach of
contract.
Doctrine: Damages that compensate the taxpayer for lost profits (damages in lieu of profits) are includable
in gross income. The damages from a breach of contract constitute taxable income to the recipient thereof
in the year received only to the extent that such damages constitute a loss of anticipated profits and non-
taxable to the extent that the same represent a return of capital or investment.
Case Rev Rul 81-277, 1981-2 CB 14
Fast Facts: A constructor agreed to build a nuclear generating plant for a company. The contract specified
that the contractor would provide, at no additional cost to the company, any additional items that would be
necessary to deliver a complete, safe, licensable, fully operational plant. Subsequently, while the
constructions were already ongoing, regulatory agencies imposed stricter environmental safeguards on
nuclear generating plants. And because of this, the parties agreed that the contractor was responsible to
deliver a plant that met the stricter environmental safeguards while the company was required to forward
an additional amount to the contractor. But eventually, the contractor stopped and instead, returned the
additional amount paid by the company. There is now a question of whether or not the payment/return
made by the contractor to the company constitutes as income on the part of the company.
Doctrine:
No, it does not constitute income and is only a return of capital. If the recovery represents damages
for lost profits, it is taxed as ordinary income. If, however, the recovery is treated as a replacement
of capital, the damages received from the lawsuit are treated as a return of capital and are not
taxable as income. The payment/return made by the contractor to the company does not constitute
as income on the part of the company. It is only a return of capital.
Payments by the one causing a loss that do not more than restore a taxpayer to the position he or
she was in before the loss was incurred are not includible in gross income because there is no
economic gain.
3. Windfall Receipts
SEC. 32. Gross Income.
(A) General Definition. - Except when otherwise provided in this Title, gross income means all
income derived from whatever source, including (but not limited to) the following items:
xxx
(9) Prizes and winnings;
xxx
(B) Exclusions from Gross Income. - The following items shall not be included in gross income and shall be exempt from
taxation under this title:
xxx
(7) Miscellaneous Items. -
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(a)
(b) .
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious, charitable, scientific, educational,
artistic, literary, or civic achievement but only if:
(i) The recipient was selected without any action on his part to enter the contest or proceeding; and
(ii) The recipient is not required to render substantial future services as a condition to receiving the prize or award.
Windfall receipts
! Gain without pain is still taxable income
! It comes from whatever source
! Discovered treasure trove
o Taxable on the point where possession over such treasure is reduced to undisputed possession
! As compared to valuable treasure acquired through purchase (at a really low price in a flea market)
o The actual cost of the treasure is unrealized gain
Realized at the point of sale/disposition
Case Cesarini v. U.S., 296 F. Supp. 3 (ND Ohio 1969)
Fast Facts: In 1957, Sps. Cesarini purchased a used piano at an auction sale for approximately $15. In
1964, while cleaning the piano, they discovered the sum of around $4K in old currency. They reported
this sum on their 1964 joint income tax return as ordinary income from other sources. They now claim a
refund. They further substantiate their claim by stating that the discovered money should be included in
the their gross income in 1957 (date of purchase of piano) and therefore the collection of tax was already
barred by the statute of limitations.
Doctrine: The refund cannot be granted for the sum found in the piano, without explanation to its origin,
is included in the gross income. Moreover, the plaintiffs claim of prescription cannot be sustained. Even
if they bought the piano in 1957, the $4K in old currency was not "reduced to undisputed possession"
until its actual discovery in 1964. And thus the United States was not barred by the statute of limitations
from collecting tax in 1964.
Case Hornung v. CIR, 47 TC 428 (1967)
Fast Facts: For his athletic performance in an NFL championship game, Hornung was given a Corvette by
Sport Magazine. Hornung then sold this. He reported the sale of the Corvette in his 1962 Federal income
tax return but he did not include the fair market value of the car in his gross income. Ideally, as a
taxpayer, he should have reported BOTH the value of the car AND the profit from the sale of the car as
part of his income pool. BUT in this case, he only reported the profit from the sale as part of his income
so, in a way, he escaped taxation on the value of the car itself. Hornung argues that the Corvette, given as
a gift, should not be included as part of his taxable income.
Doctrine: Hornung is wrong. Gross income includes amounts received as prizes and awards unless section
117 (relating to scholarships and fellowship grants), or other exceptions are available. Also, unless the gift
is given out of pure, detached and disinterest generosity then the gift should be included in the taxable
income of donee. The Court held that in this case, it is clear that there was no detached and disinterested
generosity on the part of Sport Magazine, as this was really a form of advertisement for them.
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4. Tax Benefit Principle Recovery of Deducted Items
Sec. 34(E)(1), proviso
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
xxx
(E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year except
those not connected with profession, trade or business and those sustained in a transaction entered into between parties
mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts previously allowed as deduction in the
preceding years shall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of
said deduction.
xxx
Tax benefit principle
! Benefit for every deduction allowed on gross income
o Example: Bad debts
When taxpayer recovers on a bad debt which had been deducted erroneously (believing
that such bad debt could not be recovered), include it as income at the point of recovery
Case BIR Rul. 102-95 (July 7, 1995)
Fast Facts: A company recently let go of a number of its employees. The company has a Retirement Fund,
with a bank as trustee. The employees were given their retirement and separation pay from the Fund.
Eventually, it was discovered that the Retirement Fund was overfunded by about 100 million. Hence this
request of a BIR opinion by the trustee bank as to w/n the excess of 100 million can be reverted back to
the companys accounts, and if income tax is due thereon.
Sec. 50, Rev. Regs. 2
SECTION 50. Forgiveness of indebtedness. The cancellation and forgiveness of indebtedness may amount to a payment of
income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for example, an individual performs services
for a creditor, who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation
for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the
debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a
corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend.
Case BIR Rul. 76-89 (April 17, 1989)
Fast Facts: General Motors Pilipinas, Inc. (GM-PI) is a joint venture corporation owned 60% GM-US and
40% by Isuzu. Due to economic recession, GM-PI ceased its operations. From that time, GM-PI was
insolvent and has since remained insolvent and is now petitioning for dissolution. In its unaudited
financial statements, it has outstanding liabilities/indebtedness to banks and affiliates. It was agreed that
GMPI would "clean-up" its current outstanding liabilities except the liability to Isuzu. This was to be
accomplished in three steps:
(1) By having GM-PI's creditor banks waive accrued interest on the non-trade and trade related
debt;
(2) By having these banks assign to GM-US, its GM-PI non-trade related receivables. At that time
GM-US will condone the total GM-PI indebtedness due to it, including the aforementioned non-
trade debt as well as other non- trade liabilities
(3) By having the banks grant a participation to GM-US in GM-PI trade related receivables, GM-
US would then assign these receivables to Isuzu.
The question posed before the BIR is w/n the bank's waiver (of accrued interest on the non-trade and trade
related indebtedness of GMPI) and GM-US condonation (of GMPI's non-trade related indebtedness) are
subject to income tax or to gift tax.

Doctrine: The overfunded 100 million from the Retirement Fund can be reverted back to the companys Doctrine: No, the banks waiver and GM-US condonation are NOT subject to income or gift tax
account as gain and income tax is due thereon. Condonation of debts, depending on the circumstances, may be viewed, for taxing purposes, as payment
of income, a gift, or a capital transaction. If the condonation was done solely for the benefit of the debtor
5. Indirect Receipts Cancellation of Indebtedness and Discharge by 3rd with no ulterior donative interest, it is non-taxable. If the cancellation was the consideration for a certain
Parties service, such would be viewed as an addition to gross income. However in this case, the condonation was
done by the creditor solely for the benefit of the debtor GPMI. Thus the amount of the debt is viewed as a
! Example: Cancellation of debt gift and need not be included in the gross income
o Different treatments based on circumstances
o Economic benefit still Case Old Colony Trust Co. v. CIR, 279 U.S. 716 (1929)
! Example: Third person shoulders the income tax of a person Fast Facts: A certain company adopted a resolution declaring that it would pay for their employees
o Such assumed tax serves as a benefit to the person income taxes so that the income the employees received would no longer be deducted. The tax authorities
Realized benefit notifed the President of the company of his deficiency in the declaration and payment of his income taxes.
Constructive reception The government found that the income tax paid by the company in behalf of their employees constituted
o Solution is to gross up the amounts (see: Old Colony Trust) another form of taxable income
X = Target take-home pay (100 tax rate)
X tax rate = income tax Doctrine: The payment of income taxes by a third person constitutes another form of taxable income. In
this case, the payment of taxes by the employee was in consideration of work done. It is imperative the
payment of income taxes must be paid directly by the person who has actually benefited from the taxes
paid.

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Case BIR Rul. 85-95 (June 13, 1995)
Fast Facts: Subic Power Corporation has a contract with the National Power Corporation to develop,
construct and operate a power station in the Subic Bay Freeport. To finance the project, SPC has
undertaken a "Rule 144 A" offering in the U.S. and has issued notes under an Indenture Agreement. To
attract investors, under the Indenture Agreement, SPC will pay interest to the holders of the notes without
any withholding or deduction for any taxes imposed or levied by the Philippine Government. Therefore,
the Philippine withholding tax on the interest is passed on to SPC and it assumes the payment of the tax
such that SPC becomes directly liable to the tax otherwise due from the bondholders. The Philippine
withholding tax on the interest becomes SPC's additional tax liability, and an addition to its financing
charges associated in the construction of the power plant. SPC now seeks the opinion of BIR w/n the
withholding tax base for purposes of applying the 5% final withholding tax is the total amount of income
to be remitted without grossing up the 5% final withholding tax due thereon.
Doctrine: The assumption of the tax constitutes an additional income of the non-resident creditor-
bondholders, which in turn should be subject to tax. The 5% final withholding tax assumed by SPC under
the circumstances described above should be considered its additional financing charges is hereby
confirmed. Thus, the tax base should be grossed-up by adding to the interest income payments the amount
of tax assumed.
III. GROSS INCOME
A. Inclusions
Sec. 32(A)
Section 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever
source, including (but not limited to) the following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and
similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional partnership.
1. Compensation: Special Problems on In-Kind Compensation
Sec. 2.78.1(A) and (1), Rev. Regs. 2-98 (April 17, 1998)
SECTION 2.78.1. Withholding of Income Tax on Compensation Income.
(A) Compensation Income Defined. In general, the term "compensation" means all remuneration for services performed by
an employee for his employer under an employer-employee relationship, unless specifically excluded by the Code.
The name by which the remuneration for services is designated is immaterial. Thus, salaries, wages, emoluments and
honoraria, allowances, commissions (e.g. transportation, representation, entertainment and the like); fees including director's
fees, if the director is, at the same time, an employee of the employer/corporation; taxable bonuses and fringe benefits except
those which are subject to the fringe benefits tax under Sec. 33 of the Code; taxable pensions and retirement pay; and other
income of a similar nature constitute compensation income.
The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes
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compensation. Thus, it may be paid on the basis of piece-work, or a percentage of profits; and may be paid hourly, daily,
weekly, monthly or annually. rep
Remuneration for services constitutes compensation even if the relationship of employer and employee does not exist any
longer at the time when payment is made between the person in whose employ the services had been performed and the
individual who performed them.
(1) Compensation paid in kind. Compensation may be paid in money or in some medium other than money, as for example,
stocks, bonds or other forms of property. If services are paid for in a medium other than money, the fair market value of the
thing taken in payment is the amount to be included as compensation subject to withholding. If the services are rendered at a
stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the fair market value of the
remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the
employee, the amount of such remuneration is the fair market value of the stock at the time the services were rendered.
Generally, cash and non-cash benefits
o Non-cash benefits are in-kind
Pose a valuation issue
A future expectation of secured earnings are taxable now (see: US vs Drescher)
a. Limited Choice and Restricted Property
Case U.S. v. Drescher, 179 F.2d 863 (2nd Cir. 1950)
Fast Facts: An employee was granted a pension plan (in recognition of prior services rendered) which he
was to receive in the future (when they reach the age of 65). The pension plan was non-assignable
however, the employee can designate a beneficiary in case he dies before receiving the proceeds. The
employer held onto the pension plans for the time being. The employee did not pay the tax for being
granted the pension plan hence the Commissioner assessed him a deficiency tax claim.
Doctrine:
A pension plan, the annuities of which would be received by the taxpayer in the future, is still
subject to income taxation as of the year they are granted to them as part of their compensation
plan.
The court ruled that the employee still gained an advantage or benefit that would be classified as
taxable. Atty. Bello said the benefit was security (financial I guess) for the employee.
Even though the taxpayer might die before the annuity started paying, he had some present rights
to a future income stream, which he could designate to a beneficiary.
The present value of an annuity which is non-transferable is equal to the cost to the taxpayer of
acquiring identical rights.
Dissent: The value of the pension plans should have been the amount paid by the employer
because it represented the present value of the future payments and was the consideration for the
contract between the taxpayer and the company.
Case BIR Rul. 9-04 (Sept. 13, 2004)
Fast Facts: ANZ bank established the Employee Share Acquisition Plan where all employees with at least
one year of service will be offered shares in ANZ bank free of charge. Under the two schemes (incentive
and general), there existed a trading lock (could not be disposed of) for three years from the date of award
or from termination of employment where a trustee would hold the stocks in trust for the employees and
the dividends would be reinvested in ANZ shares hence the employees wouldnt receive cash dividends
yet. In the general scheme, the shares were not forfeitable under any circumstances while in the incentive
scheme, the shares and dividends were forfeitable if the employee resigned or was dismissed before the
trading lock period.
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Doctrine:
The shares granted pursuant to an employer-employee relationship under the ANZ ESAP Plan
which are subject to disposal restriction and forfeiture clause at the time of grant shall NOT be
taxed until the disposal restriction is lifted, that is, for a period of three years from the date the
shares are awarded or the termination of employment with ANZ in case of the general scheme and
a period of three years from the date the shares are awarded in the case of the incentive scheme
whichever is earlier, as the same will only be taxable when actually or constructively received.
Section 2.83.6 of RR 2-98 provides that the withholding tax on compensation shall apply to
compensation actually or constructively paid.
Compensation is constructively paid when it is credited to the account of or set apart for the
employee so that it may be drawn upon by him at any time although not then actually
reduced to possession.
Dividends: should be recognized on date of declaration. The reason is that when dividends are
declared, the stockholder already has the right thereto so much so that if the stocks are sold, the
sale price includes the dividends.
However, stock dividends whether of the same class or different are not income. The reason is
that there is no distribution of the assets of the corporation. The stock dividends create only a
change in the composition of the stockholders' equity, that is, a transfer from retained earnings
to capital stock.
b. Forced Consumption: Convenience of the Employer Rule
Sec. 2.78.1(A)(2), Rev. Regs. 2-98 (April 17, 1998)
(2) Living quarters or meals. If a person receives a salary as remuneration for services rendered, and in addition thereto,
living quarters or meals are provided, the value to such person of the quarters and meals so furnished shall be added to the
remuneration paid for the purpose of determining the amount of compensation subject to withholding. However, if living
quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as
part of compensation income
! Convenience of the employer rule
o Developed as a rule for purposes of uniformity
If not, then subjective application of tax laws on the basis of economic benefit or utility
administrative nightmare
o Added benefits are merely incidental to requirements of persons employment
Sec. 2, Rev. Audit Mem. Order 1-87 (April 23, 1987)
Case Benaglia v. CIR, 36 B.T.A. 838 (1937)
Fast Facts: TP (hotel manager), together with his wife, occupied a suite and received meals in the same
hotel where he worked for proper performance of his duties and for convenience because he was
constantly on duty. His salary was fixed without reference to his meals and his lodging and such were not
reported in his income. The commissioner included the said amounts as part of his taxable income arguing
that they were in fact compensation.
Doctrine:
A taxpayer employee may exclude the value of food and lodging received from his employer, if he
receives it solely for the convenience of his employer and as a necessary incident of the proper
performance of his duty.
The benefits which the TP received were merely incidental.
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c. De Minimis Benefits
Sec. 2.78.1(A)(3), Rev. Regs. 2-98 (April 17, 1998)
(3) Facilities and privileges of a relatively small value. Ordinarily, facilities and privileges (such as entertainment, medical
services, or so called "courtesy" discounts on purchases), furnished or offered by an employer to his employees generally, are
not considered as compensation subject to withholding if such facilities or privileges are of relatively small value and are
offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his
employees.
Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the
amount of the tax required to be withheld is available for payment to the Commissioner.
! For the goodwill and contentment of employees
! Not taxable
! Exclusive enumeration (see: Rev. Reg 5-11)
Case BIR Rul. 23-02 (June 21, 2002)
Fast Facts: Sodexho came up with a system where client companies transfer a specific amount to
Sodexho, to be allotted for meal and food allowance and/or rice subsidies to the employees of the client
companies (in accordance with the de minimis threshold). Sodexho would, in turn, issue meal and food
vouchers which would be given by the client companies to their employees where the employees would
use them in food establishments. The food establishments would then ask Sodexho for reimbursement by
presenting the said vouchers.
Issues:
WON the meal and food benefits may be considered as tax exempt benefits.
WON the meal and food allowances of not more than Php 100 per day is considered de minimis
benefits.
WON the rice allowance (Php 1,000 per month) may be aggregated with the meal allowance
through the meal vouchers and shall still be exempt from withholding (as to compensation) and
fringe benefit taxes.
Doctrine:
The meal and food benefits provided to their employees by client companies through Sodexho
meal and food vouchers may be tax-exempt, subject to:
o the standards set for de minimis thresholds for fringe benefits. (Its in Atty. Bellos PPT
slides)
o the conditions set for the benefits to be exempt pursuant to the tests of convenience of the
employer and the promotion of health, goodwill, contentment, or efficiency of the
employees. (Check provision above)
Meal and food benefits not exceeding 25% of the daily minimum wage may be considered de
minimis meal benefit and therefore, tax exempt.
The excess of the meal and food allowance given over the de minimis ceiling shall still be exempt
provided that it, together with the total amount of other benefits, shall not exceed Php30,000.
There can be no aggregation of the values set for each item of benefit. The intent of the
Regulations is to treat each item of de minimis benefits independently of each other. The
Regulations separately provide maximum values for rice allowance and for meal allowance. There
can be no aggregation of de minimis values for rice and meal and food benefits through Sodexho
meal and food vouchers.
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d. Travel and Entertainment
! If primarily for business, it is not taxable
! If it is for pleasure, it is taxable
! Though there really is no hard and fast rule look at the facts and circumstances
Case Rudolph v. U.S., 370 U.S. 269 (1962)
Fast Facts: TP and his wife resided in Texas, where the home office of the TPs employer was located. TP
and his wife attended a convention in NY where the company-employer paid all the expenses. TP did not
include the amount in their joint tax return hence the Commissioner assessed a tax deficiency.
Doctrine: The value of Rudolphs all expense trip to the convention constituted gross income, the value
of the trip being "in the nature of a bonus, reward, and compensation for a job well done," was income to
Rudolph, and being "primarily a pleasure trip in the nature of a vacation," the costs were personal and
nondeductible.
If a taxpayer who travels to a destination engages in both "business and personal activities," the
traveling expenses are deductible only if the trip is "related primarily" to the taxpayer's business. If
"primarily personal", the traveling expenses are not deductible even though the taxpayer engages
in some business there. (Check dominant motive and purpose)
Whether a trip is related primarily to the taxpayer's business or is primarily personal in nature
depends on the facts and circumstances in each case.
The deductibility of the expenses of a taxpayer's wife who accompanies her husband depends,
first, on whether his trip is a "business trip". If so, it must further be shown that the wife's presence
on the trip also had a bona fide business purpose.
2. Business Income
3. Gains
4. Interests
5. Rents
6. Royalties
7. Dividends
Sec. 73
SEC. 73. Distribution of dividends or Assets by Corporations. -
(A) Definition of Dividends. - The term "dividends" when used in this Title means any distribution made by a corporation to its
shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property.
Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the
stockholder, whether individual or corporate, is a taxable income or a deductible loss, as the case may be.
(B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.
However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the
distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend,
the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it
represents a distribution of earnings or profits.
(C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. - Any distribution made to the
shareholders or members of a corporation shall be deemed to have been made form the most recently accumulated profits or
surplus, and shall constitute a part of the annual income of the distributee for the year in which received.
(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The taxable income declared by a
partnership for a taxable year which is subject to tax under Section 27 (A) of this Code, after deducting the corporate income
tax imposed therein, shall be deemed to have been actually or constructively received by the partners in the same taxable year
and shall be taxed to them in their individual capacity, whether actually distributed or not.
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Sec. 250-256, Rev. Regs. 2
SECTION250. Dividends. Dividends, for the purpose of the law, comprise any distribution whether in cash or other
property, in the ordinary course of business, even though extraordinary in amount, made by a domestic or resident foreign
corporation, joint-stock company, partnership, joint account (cuentas en participacion), association, or insurance company to
the shareholders or members out of its earnings or profits accumulated since March 1, 1913.
Although interest on certain Government bonds and other similar obligations is not taxable when received by a corporation,
upon amalgamation with the other funds of the corporation, such income loses its identity and when distributed to shareholders,
is taxable to the same extent as other dividend.
A taxable distribution made by a corporation to individual stockholders or members shall be included is the gross income of the
distributees when the cash of other property is unqualifiedly made subject to their demand. Dividends, in cash or other property
received by an individual, are subject to tax in his hands in the same manner another income.
Dividends, whether in cash or other property, received by a domestic or resident foreign corporation from a domestic
corporation are taxable only to the extent of 25 per cent thereof in accordance with Section 24 of the Code. Dividends received
by a domestic corporation from a foreign corporation, whether resident or nonresident, are taxable to the extent that they
constitute income from sources within the Philippines, as provided in Section 37 (a) (2) (b) of the Code. Dividends paid by the
domestic corporation to a nonresident foreign corporation are taxable in full. (For definition of the different classes of
corporations, see Section 84 of the Code).
AIHDcC
SECTION 251. Dividends paid in property. Dividends paid in securities or other property (other than its own stock), in
which the earnings of a corporation have been invested, are income to the recipients to the amount of the full market value of
such property when receivable by individual stockholders. When receivable by corporations, the amount of such dividends
includible for purposes of the tax on corporations are specified in Section 24 of the Code. (See also Section 250 of these
regulations). A dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed was
acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is
distributed as a dividend. Where a corporation declares a dividend payable in a stock of another corporation, setting aside the
stock to be so distributed and notifying the stockholders of its action, the income arising to the recipients of such stock is its
market value at the time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the warrants are
issued.
SECTION 252. Stock dividends. A stock dividend which represents the transfer of surplus to capital account is not subject
to income tax. However a dividend in stock may constitute taxable income to the recipients thereof notwithstanding the fact
that the officers or directors of the corporation (as defined in Section 84) choose to call such distribution as a stock dividend.
The distinction between a stock dividend which does not, and one which does, constitute income taxable to the shareholder is
the distinction between a stock dividend which works no change in the corporate entity, the same interest in the same
corporation being represented after the distribution by more shares of precisely the same character, and a stock dividend where
there either has been a change of corporate identity or a change in the nature of the shares issued as dividends whereby the
proportional interest of the shareholders after the distribution is essentially different from his former interests. A stock dividend
constitutes income if it gives the shareholder an interest different from that which his former stock holdings represented. A
stock dividend does not constitute income if the new shares confer no different rights or interests than did the old the new
certificates plus the old representing the same proportionate interest in the net assets of the corporation as did the old.
SECTION 253. Sale of stock received as dividends. Stock issued by a corporation, as a dividend, does not constitute taxable
income to a stockholder in such corporation, but gain may be derived or loss sustained by the stockholder, whether individual
or corporate, from the sale of such stock, which gain or loss will be treated as arising from the sale or exchange of a capital
asset. (See Section 34 of the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale
of the stack with respect to which it is issued, shall be determined in accordance with the following rules:
(a) Where the stock issued as dividend is all or substantially the same character or preference as the stock upon which the stock
dividend is paid, the cost of each share (or when acquired prior to March 1, 1913, the fair market value as of such date) will be
the quotient of the cost (or such fair market value) of the old shares of stock divided by the total number of the old and new
shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or preference materially different from the stock
upon which the stock dividend is paid, the cost (and when acquired prior to March 1, 1913, the fair market value as of such
date) of the old shares of stock shall be divided between such old stock and the new stock, in proportion, as nearly as may be,
to the respective value of each class of stock, old and new, at the time the new shares of stock are issued, and the cost (or when
acquired prior to March 1, 1913, the fair market value as of such date) of each share of stock will be the quotient of the cost (or
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such fair market value as of March 1, 1913) of the class to which such share belongs divided by the number of shares in that
class.
(c) Where the stock with respect to which a stock dividend is issued was purchased at different times and at different prices and
the identity of the lots can. not be determined, any sale of the original stock, will be charged to the earliest purchases of such
stock, and any sale of dividend stock issued with respect to such stock will be presumed to have been made from the stock
issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to such stock.
(d) Where the stock with respect to which a stock dividend is declared was purchased at different times and at different prices,
and the dividend stock issued with respect to such stock can not be identified as having been issued with respect to any
particular lot of such stock, then any sale of such dividend stock will be presumed to have been made from the stock issued
with respect to the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.
SECTION 254. Declaration and subsequent redemption of a stock dividend. A true stock dividend is not subject to tax on its
receipt in the hands of the recipient. Nevertheless, if a corporation, after the distribution of a stock dividend, proceeds to cancel
or redeem its stock at such time and in such manner as to make the distribution and cancellation or redemption essentially
equivalent to the distribution of a taxable dividend, the amount received in redemption or cancellation of the stocks shall be
treated as a taxable dividend to the extent of the earnings or profits accumulated by such corporation since March 1, 1913.
SECTION 255. Sources of distribution. For the purpose of income taxation every distribution made by a corporation is
made out of earnings or profits to the extent thereof and from the most recently accumulated earnings or profits. In determining
the source of a distribution, consideration should be given first, to the earnings or profits of the taxable year; second, to the
earnings or profits accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution made
during the taxable year are not regarded as out of the earnings or profits of the taxable year and all the earnings or profits
accumulated since February 28, 1913, have been distributed; and, fourth, to sources other than earnings or profits only after the
earnings or profits have been distributed.
SECTION256. Distribution in liquidation. In all cases where a corporation (as defined in Section 84) distributes all of its
property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder, whether
individual or corporate, is taxable to the extent recognized in Section 34(b) of the Code. For this purpose, the term "complete
liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of
its stock in accordance with a bona fide plan of liquidation under which the transfer of all the assets under liquidation is to be
complete within a reasonable time from the date of the first distribution, usually not to exceed one year from the time of such
first distribution. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, the
loss in the transaction is deductible to the extent allowed in Section 34(c) of the Code.
! Ordinary distributed to stockholders from retained earnings
o Taxable
o CIR vs Manning
Such ordinary shares were taxed because they were issued from Reeses shares and not
from retained earnings
! Liquidating distributed upon dissolution
o Taxable to the extent of amount distributed less capital
o Taxed similar to the sale of shares
! Stock re-capitalization from retained earnings
o Not taxable
Case Wise & Co., Inc. v. Meer (June 30, 1947):
Fast Facts: An HK company was sold to a Philippine corporation. The HK company distributed previous
earnings, purportedly as dividends, to its stockholders. A surplus from the said sale was also distributed to
the stockholders. Income tax was paid by the HK company on said surplus. Upon liquidation, HK
company distributed its capital among the stockholders. CIR made deficiency tax assessments on the
stockholders of the HK company. Stockholders argued that they were ordinary dividends while CIR
argued that they were liquidating dividends.
Doctrine: The money distributed are considered as liquidated dividends and are subject to income tax
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The distributions were payments for surrendered or relinquished stock in a corporation in complete
liquidation called liquidating dividends.
The determining element is whether the distributions were in the ordinary course of business and
with intent to maintain the SC: Contention is untenable. The HK Co. was at the time of the sale of
its business the business corporation as a going concern, or after deciding to quit and with intent to
liquidate.
Ordinary Dividend Liquidating Dividend
Distribution is in the nature of a recurring return on Corporation is really winding up its business or
stock. recapitalizing or narrowing its activities, the
distribution is treated as in a complete or partial
liquidation and as payment by the corporation to
the stockholders for his stock.
Taxing liquidating dividends: the gain realized or loss sustained by the stockholder (in excess or a
deficit on TPs cost basis), whether individual or corporation, is a taxable income or a deductible
loss as the case may be.
The shareholder who received the consideration for the stock earned that much money as income
of his own, which again was properly taxable to him under the Income Tax Law. Liquidating
dividend is treated as a sale or exchange of stock.
At the time the case was decided, ordinary dividends were not taxable (now taxable at 10%) hence
distinction was important.
Case CIR v. CA (Jan. 20, 1999):
Fast Facts: Don Andres was a major stockholder in a corporation. The corporation declared stock
dividends to Don Andres and other stockholders. After Don Andres died, half of his shares were
transferred to his wife. The wife then exchanged her whole common shares to preferred shares after the
corporation increased its capital stock. The estate of Don Andres also did the same to some of its common
shares. The corporation then redeemed a big part of Don Andres common shares to partially retire such
stocks as treasury shares to reduce the corps foreign exchange remittances in case cash dividends are
declared. CIR assessed tax deficiencies based on the stock exchanges and redemptions.
Doctrine: ANSCORs redemption of stock dividends is considered as essentially equivalent to a
distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source.
A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.
Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient.
These are considered unrealized gains and shall be taxable only when realized.
Exception: If a corporation cancels or redeems stock issued as a dividend at such time and in
such manner as to make the distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the amount so distributed in
redemption or cancellation of the stock shall be considered as taxable income to the extent it
represents a distribution of earnings or profits accumulated.
o Designed to prevent the issuance and cancellation or redemption of stock dividends, which
is fundamentally not taxable, from being made use of as a device for the actual distribution
of cash dividends, which is taxable.
o May not be applicable if the redeemed shares were issued with bona fide business purpose
Whether the amount distributed in the redemption should be treated as the equivalent of a taxable
dividend is a question of fact, which is determinable on the basis of the particular facts of the
transaction in question.
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For the exempting clause of Section 83(b) to apply, it is indispensable that: Doctrine:
o (a) there is redemption or cancellation; 1. Bank A shall not be liable for income tax on its receipt of surrendered shares or transfer of
o (b) the transaction involves stock dividends and liquidating dividends.
o (c) the time and manner of the transaction makes it essentially equivalent to a The transfer by the liquidating corporation of its remaining assets to its stockholders is not
distribution of taxable dividends. considered a sale of these assets hence there was no realized gain or loss.
It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable 2. Yes, Bank A realized a gain or loss
dividends. "Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain
The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not realized or loss sustained by the stockholder, whether individual or corporate, is a taxable
related, for the redemption to be considered a legitimate tax scheme. The tendency is that income or a deductible loss, as the case may be." (Sec. 73 (A), Tax Code of 1997)
redemption can be used as a cloak to distribute corporate earnings. Amounts distributed in the liquidation of a corporation shall be treated as payments in
exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the
Case CIR v. Manning (Aug. 6, 1975) distributee as other gains or profits.
Fast Facts: Under a trust agreement, the stocks owned by a corporations stockholders were held in trust
by a law firm. The agreement provided that the shares of the majority stockholder were to be purchased 8. Annuities
by the corporation. New stock certificates were issued to the corporation upon the death of the majority
stockholder and upon partial payment by the corporation. A resolution was passed where the said stocks Life insurance
in the treasury were reverted to the capital account of the corporation as stock dividends to be distributed ! Proceeds paid to heirs or beneficiaries of the insured is exempt
to the stockholders (not fully paid yet at this point). CIR assessed a tax deficiency arguing that the o Interest on such, however, is taxable
distribution of stock dividends was in effect a distribution of the assets or property of the corporation. ! Amounts received by insured as return on premium is exempt
Doctrine: o Subject to estate tax though
The newly acquired shares were not treasury shares; their declaration as treasury stock dividends
was a complete nullity. 9. Prizes and winnings
o Should have been fully paid for and reacquired to be treasury shares 10. Pensions
o The trustees were authorized to vote and declare dividends which should not have been 11. Share in GPPs Income
allowed if such were treasury shares.
o The manifest intention in the trust agreement was to treat the shares as absolutely Sec. 26
outstanding shares of the estate of the deceased stockholder until fully paid. SEC. 26. Tax Liability of Members of General Professional Partnerships. - A general professional partnership as such shall
A stock dividend, being one payable in capital stock, cannot be declared out of outstanding not be subject to the income tax imposed under this Chapter. Persons engaging in business as partners in a general professional
corporate stock, but only from retained earnings. partnership shall be liable for income tax only in their separate and individual capacities.
For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the
The ultimate purpose of the trust agreement was to serve as a convenient device in order to bestow
same manner as a corporation.
upon themselves the full worth and value of Reeses corporate holdings with the use of the very Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the
earnings of the companies. partnership.
When the companies involved parted of their earnings to buy the corporate holdings of Reese,
they were in ultimate effect making a distribution of such earnings to the respondent stockholders. B. Exclusions
All these amounts are subject to income tax. Sec. 32(B)
o They made it appear that they did not receive income by declaring them as stock dividends. 1. Gifts, Bequests and Devises
Sec. 32(B)(3)
Case BIR Rul. 39-02 (Nov. 11, 2002) (3) Gifts, Bequests, and Devises. - The value of property acquired by gift, bequest, devise, or descent: Provided, however, That
Fast Facts: Bank As outstanding shares are wholly owned by Bank B. Bank A planned to decrease its income from such property, as well as gift, bequest, devise or descent of income from any property, in cases of transfers of
authorized capital stock where Bank B was to surrender shares to Bank A and cancelled immediately. In divided interest, shall be included in gross income.
exchange for such, Bank A was to transfer to Bank properties listed as distributable assets.
Issue/s: ! Exempt from gross income
1. WON Bank A was liable for income tax (for the surrendered shares or its transfer of properties as ! Taxed differently (not through income tax)
liquidating dividends) ! Test: consider the motive of the fiver (see: CIR vs Duberstein)
2. WON Bank B realized a gain or loss from the surrender of its shares in exchange for properties o Pure generosity makes it a gift
and WON such is taxable Detached and disinterested giving

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Case CIR v. Duberstein, 363 U.S. 278 (1960)
Fast Facts: (Case has two sets of facts but the first one is important)
A) Duberstein provided a list of potential customers to Berman for the latters business ventures (both
were Presidents of different companies and such companies previously worked together). Berman gave
Duberstein a Cadillac in exchange for his help. Berman deducted the cost as a business expense on its
corporate tax return. Duberstein did not include the value of the car in his gross income (deemed it as a
gift) hence the Commissioner assessed a tax deficiency.
B) TP was a previous employee in a Church corporation and a president in a subsidiary corporation of
such. He eventually resigned and was given a gift of $20,000 provided the corporation is released from all
rights and claims to pension and retirement benefits. The value was not included in the TPs gross income
hence the Commissioner assessed a tax deficiency.
Doctrine: The Cadillac was not a gift hence taxable.
Mere absence of a legal or moral obligation to make such a payment does not mean it is a gift
If the payment proceeds primarily from 'the constraining force of any moral or legal duty,' or from
the incentive of anticipated benefit' of an economic nature, it is not a gift.
A gift, in the statutory sense, on the other hand, proceeds from a detached and disinterested
generosity, out of affection, respect, admirality, charity or like impulses.
The Cadillac was a recompense for Dubersteins past services, or an inducement for him to be of
further service in the future.
Case Hornung v. CIR, supra
Relevant Doctrine:
The value of a gift may be excluded from gross income only if the gift proceeds from a detached
and disinterested generosity or out of affection, admiration, charity or like impulses and must
be included if the claimed gift proceeds primarily from the constraining force of any moral or
legal duty or from the incentive of anticipated benefit of an economic nature.
Officials of Fort believed that the use of Thunderbirds by well-known football stars of national
renown would constitute valuable implied personal endorsements favorable to the sales image of
Thunderbirds.
2. Compensation for Injuries or Sickness Sec. 32(B)(4)
! Compensatory/moral damages exempt
! Exemplary/punitive damages exempt
! Loss of income taxable
! To be exempt, damages must be on account of personal injury
In our jurisdiction, it can be physical or non-physical personal injury
! PRINCIPLE: If the thing replaced is taxable, the replacement is also taxable (in lieu of doctrine)
o Theory is similar to return of capital
Non-taxability of the return of human capital
Theory of involuntary conversion should not apply to human capital (thus the reversal
in Murphy does not make sense
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Case OGilvie v. U.S., 519 U.S. 79 (1996)
Fast Facts: TPs received actual and punitive damages in a tort suit (Their relative died of toxic shock
syndrome attributable to the maker of a product she was using). They paid income tax on the proceeds
representing the punitive damages but they eventually sought a refund.
Doctrine: The proceeds from the punitive damages were taxable.
The punitive damages received here were not received "on account of" personal injuries.
Damages were not "received . . . on account of" the personal injuries, but rather were awarded "on
account of " a defendant's reprehensible conduct and the jury's need to punish and to deter it.
Punitive damages are not covered because they are an element of damages not "designed to
compensate . . . victims;" rather they are " `punitive in nature.'
Case Murphy v. U.S., No. 05-5139 (D.C. Cir. Aug. 22, 2006)
Fast Facts: TP was awarded compensatory damages in a suit where her employer blacklisted her for
reporting to the authorities of environmental hazards in the employers airbase. In the court which decided
the amount of the damages, TP presented evidence showing that she suffered mental and physical injuries
on account of what happened. TP included the value of the damages in her income tax return which she
eventually amended, seeking a refund for the income tax she paid for such value.
Doctrine: Murphy may recover the tax she paid.
In lieu doctrine: In lieu of what were the damages awarded?
o Whether the taxpayers award of compensatory damages is a substitute for a normally
untaxed personal quality, good, or asset.
Murphys compensatory award was not received in lieu of something normally taxed as income
o Damages were awarded to make Murphy emotionally and reputationally whole and not
to compensate her for lost wages or taxable earnings of any kind
When the Sixteenth Amendment was adopted it supports the view that compensation for these
nonphysical injuries was not regarded differently than was compensation for physical injuries and,
therefore, was not considered income by the framers of the Amendment and the state legislatures
that ratified it.
Sec. 104(a)(2) is unconstitutional insofar as it permits the taxation of an award of damages for
mental distress and loss of reputation.
Case Murphy v. U.S., No. 05-5139 (D.C. Cir. July 3, 2007) (on rehearing)
Fast Facts: Same facts but the Government petitioned for rehearing arguing that even if the damages were
not income, there is no constitutional impediment in taxing such because it is not a direct tax and is taxed
uniformly.
Doctrine: Damages due to nonphysical harm are taxable.
Murphys damages were not awarded by reason of, or because of physical personal injuries as
required by sec. 104(a)(2) and thus does not permit Murphy to exclude her award from gross
income.
o The Board awarded her compensation only for mental pain and anguish and for injury
to professional reputation But her physical injuries themselves were not the reason for the
award.
1996 amendments to the latter provision explicitly provide that emotional distress shall not be
treated as a physical injury or physical sickness, thus making clear that an award received on
account of emotional distress is not excluded from gross income under 104(a)(2).
The definition of gross income in Sec. 61 should be read to include an award for damages from
nonphysical harms.
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Note: Our jurisdiction still renders damages proceeding from nonphysical harm as non-taxable
because our Tax Code states that damages for personal injuries are excluded in gross income,
whereas the US Tax Code specifically states that what are excluded in gross income are damages
for physical personal injuries. The Philippine Tax Code does not distinguish between physical
and nonphysical.
(d) Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States
administered by the United States Veterans Administration.
(e) Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No.
8282.
(f) Benefits received from the GSIS under Republic Act No. 8291, including
retirement gratuity received by government officials and employees.

Case BIR Rul. 57-83 (April 12, 1983) (7) Miscellaneous Items.
Fast Facts: TPs were illegally dismissed by their employer and were reinstated by the Labor Arbiter. xxx
(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and employees of public and private entities:
They were awarded back wages, allowances and benefits for the period of 1980-1983. Provided, however, That the total exclusion under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which
Issues: shall cover:
1. WON the said values are taxable. (i) Benefits received by officials and employees of the national and local government pursuant to Republic Act No. 6686;
2. WON they would be taxed in the years they should have been received or when it was rewarded. (ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated
Doctrine: August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential decree No. 851, as amended by Memorandum
1. Yes, they are taxable Order No. 28, dated August 13, 1986; and
2. The amounts should be spread in the years in which they should have been received. (iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the ceiling of Thirty thousand
GR: Salaries, commissions, tips, directors fees, and other forms of compensation are income in the pesos (P30,000) may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of
year received, and not in the year earned. Thus, a taxpayer whose income is from salary or the like the Commissioner, after considering among others, the effect on the same of the inflation rate at the end of the taxable year.
is required to file his income tax return on the cash basis. xxx
However, considering that such back wages, allowances and benefits constitute remunerations for
services that would have been performed by the said employees prior to the period when it was
actually received, a liberal construction of the statute is called for in this particular case if only to ! To be excluded:
protect employees who, in fact, had been deprived of the payment of their wages and other forms o Under Sec 32(B)(6)(B) Retirement pay
of remunerations, from the payment of a tax heavier than what should have been imposed if their At least 50 years old
employer had promptly met its obligation. In the service at least 15 years
Reasonable private benefit plan
Availed of only once
3. Retirement Benefits, Pensions, Gratuities, etc. o Under Labor Code
Sec. 32(B)(6) and (7)(e) Between 60 to 65 years old
o For separation pay
SEC. 32. Gross Income. Always excluded if beyond the control of the employee
(B) Exclusions from Gross Income. - The following items shall not be included in gross income and
property; Interests; Rents; Royalties; Dividends; Annuities; winnings; and
shall be exempt from taxation under this title: Case CIR v. CA (March 23, 1992)
xxx
(6) Retirement Benefits, Pensions, Gratuities, etc.-
Fast Facts: A retirement plan for employees, (to provide retirement, pension and disability and death
(a) Retirement benefits received under Republic Act No. 7641 and those received by officials and employees of private firms, benefits to employees) maintained by the employer, was approved to be exempt from income tax. The
whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer: Provided, plan made investments and received interest income from which tax was withheld. The plan filed a claim
That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than for refund claiming that it was exempt from income tax.
fifty (50) years of age at the time of his retirement: Provided, further, That the benefits granted under this subparagraph shall Doctrine: GCL was tax exempt even as to the interest income.
be availed of by an official or employee only once. For purposes of this Subsection, the term 'reasonable private benefit plan'
means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the benefit of some or all of his
GCL Plan was qualified as exempt from income tax by the Commissioner of Internal Revenue in
officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the accordance with Rep. Act No. 4917
purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein its The tax advantage in Rep. Act No. 1983, Section 56(b), was conceived in order to encourage the
is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any formation and establishment of such private Plans for the benefit of laborers
purpose other than for the exclusive benefit of the said officials and employees. The tax-exemption is for the benefit of the employee thus the taxation of those earnings would
(b) Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such
result in a diminution accumulated income and reduce whatever the trust beneficiaries would
official or employee from the service of the employer because of death sickness or other physical disability or for any cause
beyond the control of the said official or employee. receive out of the trust fund.
(c) The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions
and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside
permanently in the Philippines from foreign government agencies and other institutions, private or public.

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Case CIR v. CA (Oct. 17, 1991)
Fast Facts: TP retired from the government service and he received terminal leave pay. Commissioner
withheld a portion of the terminal leave pay in which TP filed a claim for refund contending that such is
exempt from income tax.
Doctrine: Terminal leave pay is not subject to income tax. Its not part of the gross salary or income of a
government official or employee but a retirement benefit
Terminal leave pay commutation of leave credits applied for by an officer or employee who
retires, resigns or is separated from the service through no fault of his own.
In the exercise of sound personnel policy, the Government encourages unused leaves to be
accumulated. The Government recognizes that for most public servants, retirement pay is always
less than generous if not meager and scrimpy. A modest nest egg which the senior citizen may
look forward to is thus avoided. Terminal leave payments are given not only at the same time but
also for the same policy considerations governing retirement benefits.
Case In Re: Atty. Bernardo Zialcita, A.M. No. 90-6-015-SC (Oct. 18, 1990)
Fast Facts: TP rendered government service and reached the compulsory retirement age of 65. The court
en banc ruled that the terminal leave pay which the TP received was not part of his salary subject to
income tax.
Doctrine: The terminal leave pay was not subject to income tax.
Terminal leave pay commutation of leave credits applied for by an officer or employee who
retires, resigns or is separated from the service through no fault of his own.
This is not considered part of his salary because he receives the money value of the credits after he
has severed his connection with the employer or is no longer working.
Any amount received by an official or employee or by his heirs from the employer as a
consequence of separationfor any cause beyond the control of the said official or employee.
Sec. 32 (B) (6)(b) on exclusions of gross income
Compulsory retirement may be considered as a cause beyond the control of said official.
Terminal leave pay may likewise be viewed as a retirement gratuity received by government
officials which is also one of the exclusions from Gross Income
A gratuity is that paid to the beneficiary for past services rendered purely out of generosity of the
giver or grantor.
When a government employee chooses to go to work rather than absent himself and consume his
leave credits, there is no doubt that the government is thereby benefited by the employee's
uninterrupted and continuous service. That which is given to him after retirement is out of the
Government's generosity and an appreciation for his having continued working when he
could very well have gone on vacation.
Case BIR Rul. 1-95 (Jan. 6, 1995)
Fast Facts: The company decided to take emergency cost-saving measures, one of which is a Voluntary
Retirement Program open to all employees (employees who opted to retire under this program were paid
in accordance with the CBA/company policy on reduction of Company staff).
Issue: WON the company properly withheld taxes from the retirement benefits
Doctrine: Yes, the taxes were properly withheld.
"For any cause beyond the control of the said official or employee" as stated in the
abovementioned provision in effect connotes INVOLUNTARINESS on the part of the OFFICIAL
or EMPLOYEE.
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2 sine qua non conditions:
o The official or employee's separation from service is due to death, sickness or other
physical disability or for any cause beyond his control; and
o The employer pays separation benefits to such official or employee separated from the
service of his employer or to his heirs as a consequence of such involuntary separation.
In this case, separation of the officials and employees are of their own making because the
Voluntary Retirement Program is availed of voluntarily hence taxable.
Rep. Act No. 4917 (June 17, 1967)
Rep. Act No. 7833 (Dec. 8, 1994)
Rev. Regs. 2-95 (Jan. 3, 1995)
RMC 36-94 (Dec. 14, 1994)
4. Income Derived by Foreign Government
Sec. 32(B)(7)(a)
SEC. 32. Gross Income.
(B) Exclusions from Gross Income. - The following items shall not be included in gross income and
property; Interests; Rents; Royalties; Dividends; Annuities; winnings; and
shall be exempt from taxation under this title:
xxx
(7) Miscellaneous Items. -
(a) Income Derived by Foreign Government. - Income derived from investments in the Philippines in loans, stocks, bonds or
other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing
institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial
institutions established by foreign governments.
Case CIR v. Mitsubishi Metal Corp. (Jan. 22, 1990)
Fast Facts: A Japanese corporation licensed to do (Corp A) extended a loan to Corp B and the latter
undertook to sell copper concentrates to the former. Corp A applied for a loan in a bank which was
conditioned on the fact that Corp A was to use the proceeds for its contract with Corp B. Both
corporations claimed for a tax credit. When the claim was ignored by the CIR, Corp A filed a petition for
review arguing mainly that it was an agent of the bank which was a financing institution owned,
controlled and financed by the Japanese government (that it had a governmental status).
Issue: WON the interest income from the loans extended to Corp B is excludible from gross income
taxation and therefore exempt from withholding tax.
Doctrine: No
The loan and sales contract between Corp A and Corp B does not contain any direct or inferential
reference to the bank whatsoever.
The bank had nothing to do with the sale of copper concentrates since all that Corp A stated in its
loan application with the bank was that the amount being procured would be used as a loan to an
in consideration for importing copper concentrates from Corp B (such was not a contract of
agency)
o What the subject of the 15% withholding tax is not the interest income paid by Corp A to
the bank, but the interest income earned by Corp A from the loan extended to Corp B.
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Thus, it does not come within the ambit of Section 29(b)(7)(A), and it is not exempt from
the payment of taxes.
Laws granting exemption from tax are construed strictissimi juris against the taxpayer and
liberally in favor of the taxing power.
5. Gains from the Sale of Bonds, Debentures or Other Certificates of Indebtedness
Sec. 32(B)(7)(g)
SEC. 32. Gross Income.
(B) Exclusions from Gross Income. - The following items shall not be included in gross income and
property; Interests; Rents; Royalties; Dividends; Annuities; winnings; and shall be exempt from taxation under this title:
xxx
(7) Miscellaneous Items.
(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. - Gains realized from the same or
exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5)
years.
Case Nippon Life Ins. Co., Inc. v. CIR, CTA Case No. 6142 (Feb. 4, 2002)
Fast Facts: The insurance company purchased a 10-yr Fixed Rate Treasury bond wherein it collected
interest income on such bond on three separate occasions. The company then sold the bond to a bank and
taxes were withheld on the selling price and interest income of the bonds. BIR eventually issued rulings
which provided that interest income, yield or gain derived from bonds, debentures, or certificates of
indebtedness with maturities of more than 5yrs are exempt from income tax. The company claimed for
a refund based on such rulings.
Doctrine: The refund was granted with regard to the gain derived from the sale, however it was denied as
regards the interest income.
Under Section 32(B)(7)(g) of the Tax Reform Act of 1997, gains realized from the sale or
exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of
more than five (5) years shall not be included in gross income and shall be exempt from taxation.
The gain derived from the sale was tax exempt by clear provision of law.
Gains as used in Sec.32(B)(7)(g) of the Tax Code cannot include interest since it clearly
refers to gains from the sale of bonds, debentures and other certificates of indebtedness.
Such gains from sale or exchange or retirement of bonds, debentures or other certificate of
indebtedness fall within the general category of "Gains derived from dealings in property", as
distinguished from interest from bonds, debentures or other certificate of indebtedness, which fall
within the general category of "Interests" under Section 32(A) of the Tax Code.
Only citizens, resident aliens and nonresident aliens engaged in trade or business are exempt from
income tax on interest from long-term investment.
If Congress intended to exempt from tax the interest from bonds, it would have done so in clear
and specific terms. The fact that it used the term gains from sale shows that it did not intend to
exempt such interest.
MISCELLANEOUS:
! Prizes & awards
o Religious, charitable, scientific, educational, artistic, literary, civic achievement
o A selection without voluntary on the part of the taxpayer
o No substantial future service required
! Prizes & awards in sports competition
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o Must be sanctioned by the relevant National Sporting Authority
Usually for amateur competitions
! 13th month pay and similar benefits
o Exclusion is capped at P30,000
Excess is taxable
IV. DEDUCTIONS
DEDUCTIONS
Sec. 34
For salaried individuals, they are not entitled to deductions under Section 34. The allowable deductions
for salaried individuals are only Section 34 (M) and personal and additional exemptions under Section
35.
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation
and/or conduct of the trade, business or exercise of a profession, including:
(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered,
including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided,
That the final tax imposed under Section 33 hereof has been paid;
(ii) A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or
profession;
(iii) A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or
possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking
title or in which he has no equity other than that of a lessee, user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation expenses during the taxable year, that are directly
connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are
directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession not to exceed such
ceilings as the Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the Commissioner,
taking into account the needs as well as the special circumstances, nature and character of the industry, trade, business, or
profession of the taxpayer: Provided, That any expense incurred for entertainment, amusement or recreation that is contrary to
law, morals public policy or public order shall in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed under Subsection (A) hereof unless the
taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records: (i) the amount of the
expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development,
management, operation and/or conduct of the trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income shall be allowed under Subsection (A)
hereof for any payment made, directly or indirectly, to an official or employee of the national government, or to an official or
employee of any local government unit, or to an official or employee of a government-owned or -controlled corporation, or to
an official or employee or representative of a foreign government, or to a private corporation, general professional partnership,
or a similar entity, if the payment constitutes a bribe or kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses allowable as deductions under this
Chapter, a private educational institution, referred to under Section 27 (B) of this Code, may at its option elect either: (a) to
deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the
expansion of school facilities or (b) to deduct allowance for depreciation thereof under Subsection (F) hereof.
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(B) Interest
(1) In General. - The amount of interest paid or incurred within a taxable year on indebtedness in connection with the
taxpayer's profession, trade or business shall be allowed as deduction from gross income: Provided, however, That the
taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages
of the interest income subjected to final tax:
Forty-one percent (41%) beginning January 1, 1998; Thirty-nine percent (39%) beginning January 1, 1999; and Thirty-eight
percent (38%) beginning January 1, 2000;
(2) Exceptions. - No deduction shall be allowed in respect of interest under the succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an
interest is paid in advance through discount or otherwise: Provided, That such interest shall be allowed a a deduction in the year
the indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic amortizations, the amount of interest
which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such
taxable year;
(b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under
Section 36 (B); or
(c)If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest incurred to acquire property used in trade
business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.
(C) Taxes
(1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business,
shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who
does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credits
for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.
Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part of gross income in the
year of receipt to the extent of the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or business in the Philippines
and a resident foreign corporation, the deductions for taxes provided in paragraph (1) of this Subsection (C) shall be allowed
only if and to the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his return his desire to have the benefits
of this paragraph, the tax imposed by this Title shall be credited with:
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic corporation, the amount of
income taxes paid or incurred during the taxable year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of a general professional partnership or a
beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership or the estate or
trust paid or incurred during the taxable year to a foreign country, if his distributive share of the income of such partnership or
trust is reported for taxation under this Title.
An alien individual and a foreign corporation shall not be allowed the credits
against the tax for the taxes of foreign countries allowed under this paragraph. (4) Limitations on Credit. - The amount of the
credit taken under this Section shall be subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax
against which such credit is taken, which the taxpayer's taxable income from sources within such country under this Title bears
to his entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the
taxpayer's taxable income from sources without the Philippines taxable under this Title bears to his entire taxable income for
the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts claimed as credits by the
taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine
the amount of the tax for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid
by the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or
refunded to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the
allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the
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Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found due
upon any such redetermination. The bond herein prescribed shall contain such further conditions as the Commissioner may
require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the option of the
taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year which the taxes of
the foreign country were incurred, subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the
taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued, the credits for all subsequent
years shall be taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the same or any
succeeding year.
(7) Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the taxpayer establishes to the
satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;
(b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said
paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such credits.
(D) Losses
(1) In General.- Losses actually sustained during the taxable year and not compensated for by insurance or other forms of
indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or other
casualties, or from robbery, theft or embezzlement.
The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and
regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss
sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, however, That the time limit
to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the
date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.
(c) No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the return, such loss has been
claimed as a deduction for estate tax purposes in the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the losses deductible shall be those
actually sustained during the year incurred in business, trade or exercise of a profession conducted within the Philippines, when
such losses are not compensated for by insurance or other forms of indemnity. The Secretary of Finance, upon recommendation
of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and
manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or
embezzlement during the taxable year: Provided, That the time to be so prescribed in the rules and regulations shall not be less
than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or
embezzlement giving rise to the loss; and
(3) Net Operating Loss Carry-Over. - The net operating loss of the business or enterprise for any taxable year immediately
preceding the current taxable year, which had not been previously offset as deduction from gross income shall be carried over
as a deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss:
Provided, however, That any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall
not be allowed as a deduction under this Subsection: Provided, further, That a net operating loss carry-over shall be allowed
only if there has been no substantial change in the ownership of the business or enterprise in that -
(i) Not less than seventy-five percent (75%) in nominal value of outstanding
issued shares., if the business is in the name of a corporation, is held by or on behalf of the same persons; or
(ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation, if the business is in the name of a
corporation, is held by or on behalf of the same persons.
For purposes of this subsection, the term "not operating loss" shall mean the excess of allowable deduction over gross income
of the business in a taxable year.
Provided, That for mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under
Executive Order No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first
ten (10) years of operation may be carried over as a deduction from taxable income for the next five (5) years immediately
following the year of such loss. The entire amount of the loss shall be carried over to the first of the five (5) taxable years
following the loss, and any portion of such loss which exceeds, the taxable income of such first year shall be deducted in like
manner form the taxable income of the next remaining four (4) years.
(4) Capital Losses. -
(a) Limitation. - Loss from sales or Exchanges of capital assets shall be allowed only to the extent provided in Section 39.
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(b) Securities Becoming Worthless. - If securities as defined in Section 22 (T) become worthless during the taxable year and are
capital assets, the loss resulting therefrom shall, for purposes of this Title, be considered as a loss from the sale or exchange, on
the last day of such taxable year, of capital assets.
(5) Losses From Wash Sales of Stock or Securities. - Losses from "wash sales" of stock or securities as provided in Section
38.
(6) Wagering Losses. - Losses from wagering transactions shall b allowed only to the extent of the gains from such
transactions.
(7) Abandonment Losses. -
(a) In the event a contract area where petroleum operations are undertaken is partially or wholly abandoned, all accumulated
exploration and development expenditures pertaining thereto shall be allowed as a deduction: Provided, That accumulated
expenditures incurred in that area prior to January 1, 1979 shall be allowed as a deduction only from any income derived from
the same contract area. In all cases, notices of abandonment shall be filed with the Commissioner.
(b) In case a producing well is subsequently abandoned, the unamortized costs thereof, as well as the undepreciated costs of
equipment directly used therein, shall be allowed as a deduction in the year such well, equipment or facility is abandoned by
the contractor: Provided, That if such abandoned well is reentered and production is resumed, or if such equipment or facility is
restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall
be amortized or depreciated, as the case may be.
(E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year except
those not connected with profession, trade or business and those sustained in a transaction entered into between parties
mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts previously allowed as deduction in the
preceding years shall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of
said deduction.
(2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are ascertained to be worthless and charged off
within the taxable year and are capital assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank or
trust company incorporated under the laws of the Philippines a substantial part of whose business is the receipt of deposits, for
the purpose of this Title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital
assets.
(F) Depreciation
(1) General Rule. - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear
(including reasonable allowance for obsolescence) of property used in the trade or business. In the case of property held by one
person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner
of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be
apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument
creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each.
(2) Use of Certain Methods and Rates. - The term "reasonable allowance" as used in the preceding paragraph shall include,
but not limited to, an allowance computed in accordance with rules and regulations prescribed by the Secretary of Finance,
upon recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method; (b) Declining-balance method, using a rate not exceeding twice the rate which would have been
used had the annual allowance been computed under the method described in Subsection (F) (1); (c) The sum-of-the-years-digit
method; and (d) any other method which may be prescribed by the Secretary of Finance upon recommendation of the
Commissioner.
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. - Where under rules and regulations prescribed by the
Secretary of Finance upon recommendation of the Commissioner, the taxpayer and the Commissioner have entered into an
agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon
shall be binding on both the taxpayer and the national Government in the absence of facts and circumstances not taken into
consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and
circumstances shall rest with the party initiating the modification. Any change in the agreed rate and useful life of the
depreciable property as specified in the agreement shall not be effective for taxable years prior to the taxable year in which
notice in writing by certified mail or registered mail is served by the party initiating such change to the other party to the
agreement: Provided, however, that where the taxpayer has adopted such useful life and depreciation rate for any depreciable
and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the
Commissioner or his duly authorized representatives, the aforesaid useful life and depreciation rate so adopted by the taxpayer
for the aforesaid depreciable asset shall be considered binding for purposes of this Subsection.
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(4) Depreciation of Properties Used in Petroleum Operations. - An allowance for depreciation in respect of all properties
directly related to production of petroleum initially placed in service in a taxable year shall be allowed under the straight-line or
declining-balance method of depreciation at the option of the service contractor. However, if the service contractor initially
elects the declining-balance method, it may at any subsequent date, shift to the straight-line method.
The useful life of properties used in or related to production of petroleum shall be ten (10) years of such shorter life as may be
permitted by the Commissioner.
Properties not used directly in the production of petroleum shall be depreciated under the straight-line method on the basis of
an estimated useful life of five (5) years.
(5) Depreciation of Properties Used in Mining Operations. - an allowance for depreciation in respect of all properties used in
mining operations other than petroleum operations, shall be computed as follows:
(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or
(b) Depreciated over any number of years between five (5) years and the expected life if the latter is more than ten (10) years,
and the depreciation thereon allowed as deduction from taxable income: Provided, That the contractor notifies the
Commissioner at the beginning of the depreciation period which depreciation rate allowed by this Section will be used.
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or Resident Foreign Corporations. - In
the case of a nonresident alien individual engaged in trade or business or resident foreign corporation, a reasonable allowance
for the deterioration of Property arising out of its use or employment or its non-use in the business trade or profession shall be
permitted only when such property is located in the Philippines.
(G) Depletion of Oil and Gas Wells and Mines. -
(1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for depletion or amortization computed in
accordance with the cost-depletion method shall be granted under rules and regulations to be prescribed by the Secretary of
finance, upon recommendation of the Commissioner. Provided, That when the allowance for depletion shall equal the capital
invested no further allowance shall be granted: Provided, further, That after production in commercial quantities has
commenced, certain intangible exploration and development drilling costs: (a) shall be deductible in the year incurred if such
expenditures are incurred for non-producing wells and/or mines, or (b) shall be deductible in full in the year paid or incurred or
at the election of the taxpayer, may be capitalized and amortized if such expenditures incurred are for producing wells and/or
mines in the same contract area.
"Intangible costs in petroleum operations" refers to any cost incurred in petroleum operations which in itself has no salvage
value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum:
Provided, That said costs shall not pertain to the acquisition or improvement of property of a character subject to the allowance
for depreciation except that the allowances for depreciation on such property shall be deductible under this Subsection.
Any intangible exploration, drilling and development expenses allowed as a deduction in computing taxable income during the
year shall not be taken into consideration in computing the adjusted cost basis for the purpose of computing allowable cost
depletion.
(2) Election to Deduct Exploration and Development Expenditures. - In computing taxable income from mining operations,
the taxpayer may at his option, deduct exploration and development expenditures accumulated as cost or adjusted basis for cost
depletion as of date of prospecting, as well as exploration and development expenditures paid or incurred during the taxable
year: Provided, That the amount deductible for exploration and development expenditures shall not exceed twenty-five percent
(25%) of the net income from mining operations computed without the benefit of any tax incentives under existing laws. The
actual exploration and development expenditures minus twenty-five percent (25%) of the net income from mining shall be
carried forward to the succeeding years until fully deducted.
The election by the taxpayer to deduct the exploration and development expenditures is irrevocable and shall be binding in
succeeding taxable years.
"Net income from mining operations", as used in this Subsection, shall mean gross income from operations less "allowable
deductions" which are necessary or related to mining operations. "Allowable deductions" shall include mining, milling and
marketing expenses, and depreciation of properties directly used in the mining operations. This paragraph shall not apply to
expenditures for the acquisition or improvement of property of a character which is subject to the allowance for depreciation.
In no case shall this paragraph apply with respect to amounts paid or incurred for the exploration and development of oil and
gas.
The term "exploration expenditures" means expenditures paid or incurred for the purpose of ascertaining the existence,
location, extent or quality of any deposit of ore or other mineral, and paid or incurred before the beginning of the development
stage of the mine or deposit.
The term "development expenditures" means expenditures paid or incurred during the development stage of the mine or other
natural deposits. The development stage of a mine or other natural deposit shall begin at the time when deposits of ore or other
minerals are shown to exist in sufficient commercial quantity and quality and shall end upon commencement of actual
commercial extraction.
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(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien individual or Foreign Corporation. - In the
case of a nonresident alien individual engaged in trade or business in the Philippines or a resident foreign corporation,
allowance for depletion of oil and gas wells or mines under paragraph (1) of this Subsection shall be authorized only in respect
to oil and gas wells or mines located within the Philippines.
(H) Charitable and other Contributions
(1) In General. - Contributions or gifts actually paid or made within the taxable year to, or for the use of the Government of the
Philippines or any of its agencies or any political subdivision thereof exclusively for public purposes, or to accredited domestic
corporation or associations organized and operated exclusively for religious, charitable, scientific, youth and sports
development, cultural or educational purposes or for the rehabilitation of veterans, or to social welfare institutions, or to non-
government organizations, in accordance with rules and regulations promulgated by the Secretary of finance, upon
recommendation of the Commissioner, no part of the net income of which inures to the benefit of any private stockholder or
individual in an amount not in excess of ten percent (10%) in the case of an individual, and five percent (%) in the case of a
corporation, of the taxpayer's taxable income derived from trade, business or profession as computed without the benefit of this
and the following subparagraphs.
(2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding subparagraph, donations to the
following institutions or entities shall be deductible in full;
(a) Donations to the Government. - Donations to the Government of the Philippines or to any of its agencies or political
subdivisions, including fully- owned government corporations, exclusively to finance, to provide for, or to be used in
undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and
in economic development according to a National Priority Plan determined by the National Economic and Development
Authority (NEDA), In consultation with appropriate government agencies, including its regional development councils and
private philantrophic persons and institutions: Provided, That any donation which is made to the Government or to any of its
agencies or political subdivisions not in accordance with the said annual priority plan shall be subject to the limitations
prescribed in paragraph (1) of this Subsection;
(b) Donations to Certain Foreign Institutions or International Organizations. - Donations to foreign institutions or
international organizations which are fully deductible in pursuance of or in compliance with agreements, treaties, or
commitments entered into by the Government of the Philippines and the foreign institutions or international organizations or in
pursuance of special laws;
(c) Donations to Accredited Nongovernment Organizations. - The term "nongovernment organization" means a non profit
domestic corporation:
(1) Organized and operated exclusively for scientific, research, educational, character-building and youth and sports
development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income of
which inures to the benefit of any private individual;
(2) Which, not later than the 15th day of the third month after the close of the accredited nongovernment organizations taxable
year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the
purpose or function for which it is organized and operated, unless an extended period is granted by the Secretary of Finance in
accordance with the rules and regulations to be promulgated, upon recommendation of the Commissioner;
(3) The level of administrative expense of which shall, on an annual basis, conform with the rules and regulations to be
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, but in no case to exceed thirty percent
(30%) of the total expenses; and
(4) The assets of which, in the even of dissolution, would be distributed to another nonprofit domestic corporation organized
for similar purpose or purposes, or to the state for public purpose, or would be distributed by a court to another organization to
be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved
organization was organized.
Subject to such terms and conditions as may be prescribed by the Secretary of Finance, the term "utilization" means:
(i) Any amount in cash or in kind (including administrative expenses) paid or utilized to accomplish one or more purposes for
which the accredited nongovernment organization was created or organized.
(ii) Any amount paid to acquire an asset used (or held for use) directly in carrying out one or more purposes for which the
accredited nongovernment organization was created or organized.
An amount set aside for a specific project which comes within one or more purposes of the accredited nongovernment
organization may be treated as a utilization, but only if at the time such amount is set aside, the accredited nongovernment
organization has established to the satisfaction of the Commissioner that the amount will be paid for the specific project within
a period to be prescribed in rules and regulations to be promulgated by the Secretary of Finance, upon recommendation of the
Commissioner, but not to exceed five (5) years, and the project is one which can be better accomplished by setting aside such
amount than by immediate payment of funds.
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(3) Valuation. - The amount of any charitable contribution of property other than money shall be based on the acquisition cost
of said property.
(4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if verified under the rules and
regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner.
(I)Research and Developments
(1) In General. - a taxpayer may treat research or development expenditures which are paid or incurred by him during the
taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable
to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred.
(2) Amortization of Certain Research and Development Expenditures. - At the election of the taxpayer and in accordance
with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the
following research and development expenditures may be treated as deferred expenses:
(a) Paid or incurred by the taxpayer in connection with his trade, business or profession;
(b) Not treated as expenses under paragraph 91) hereof; and (c) Chargeable to capital account but not chargeable to property of
a character which is subject to depreciation or depletion.
In computing taxable income, such deferred expenses shall be allowed as deduction ratably distributed over a period of not less
than sixty (60) months as may be elected by the taxpayer (beginning with the month in which the taxpayer first realizes benefits
from such expenditures).
The election provided by paragraph (2) hereof may be made for any taxable year beginning after the effectivity of this Code,
but only if made not later than the time prescribed by law for filing the return for such taxable year. The method so elected, and
the period selected by the taxpayer, shall be adhered to in computing taxable income for the taxable year for which the election
is made and for all subsequent taxable years unless with the approval of the Commissioner, a change to a different method is
authorized with respect to a part or all of such expenditures. The election shall not apply to any expenditure paid or incurred
during any taxable year for which the taxpayer makes the election.
(3) Limitations on Deduction. - This Subsection shall not apply to:
(a) Any expenditure for the acquisition or improvement of land, or for the improvement of property to be used in connection
with research and development of a character which is subject to depreciation and depletion; and (b) Any expenditure paid or
incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral,
ncluding oil or gas.
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide for the payment of reasonable
pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year
to cover the pension liability accruing during the year, allowed as a deduction under Subsection (A) (1) of this Section ) a
reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such
amount (1) has not theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a period of ten (10)
consecutive years beginning with the year in which the transfer or payment is made.
(K) Additional Requirements for Deductibility of Certain Payments. - Any amount paid or payable which is otherwise
deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed
under this Section, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld
therefrom has been paid to the Bureau of Internal Revenue in accordance with this Section 58 and 81 of this Code.
(L) Optional Standard Deduction. - In lieu of the deductions allowed under the preceding Subsections, an individual subject to
tax under Section 24, other than a nonresident alien, may elect a standard deduction in an amount not exceeding ten percent
(10%) of his gross income. Unless the taxpayer signifies in his return his intention to elect the optional standard deduction, he
shall be considered as having availed himself of the deductions allowed in the preceding Subsections. Such election when made
in the return shall be irrevocable for the taxable year for which the return is made: Provided, That an individual who is entitled
to and claimed for the optional standard deduction shall not be required to submit with his tax return such financial statements
otherwise required under this Code: Provided, further, That except when the Commissioner otherwise permits, the said
individual shall keep such records pertaining to his gross income during the taxable year, as may be required by the rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
(M) Premium Payments on Health and/or Hospitalization Insurance of an Individual Taxpayer. - The amount of premiums
not to exceed Two thousand four hundred pesos (P2,400) per family or Two hundred pesos (P200) a month paid during the
taxable year for health and/or hospitalization insurance taken by the taxpayer for himself, including his family, shall be allowed
as a deduction from his gross income: Provided, That said family has a gross income of not more than Two hundred fifty
thousand pesos (P250,000) for the taxable year: Provided, finally, That in the case of married taxpayers, only the spouse
claiming the additional exemption for dependents shall be entitled to this deduction.
Notwithstanding the provision of the preceding Subsections, The Secretary of Finance, upon recommendation of the
Commissioner, after a public hearing shall have been held for this purpose, may prescribe by rules and regulations, limitations
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or ceilings for any of the itemized deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of
determining such ceilings or limitations, the Secretary of Finance shall consider the following factors: (1) adequacy of the
prescribed limits on the actual expenditure requirements of each particular industry; and (2) effects of inflation on expenditure
levels: Provided, further, That no ceilings shall further be imposed on items of expense already subject to ceilings under
present law.
Sec. 36(A)
SEC. 36. Items Not Deductible.-
(A) General Rule. - In computing net income, no deduction shall in any case be allowed in respect to -
(1) Personal, living or family expenses;
(2) Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the
value of any property or estate;
This Subsection shall not apply to intangible drilling and development costs incurred in petroleum operations which
are deductible under Subsection (G) (1) of Section 34 of this Code.
(3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is
or has been made; or
(4) Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person
financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer
is directly or indirectly a beneficiary under such policy.
Secs. 119 to 120, Rev. Regs. 2
A. Expenses
SECTION 119. Personal, living, and family expenses. Personal, living, and family expenses are not deductible. Insurance
paid on a dwelling owned and occupied by a taxpayer is a personal expense and not deductible. Premiums paid for life
insurance by the insured are not deductible. In the case of a professional man who rents a property for residential purposes, but
incidentally receives his clients, patients, or callers in connection with his professional work (his place of business being
elsewhere), no part of the rent is deductible as a business expense. If however, he uses part of the house for his office, such
portion of the rent as is properly attributable to such office is deductible. Where the father is legally entitled to the services of
his minor children, any allowances which he gives them, whether said to be in consideration of services or otherwise, are not
allowable deductions in his return of income. Alimony, and an allowance paid under a separation agreement are not deductible
from gross income.
SECTION 120. Capital expenditures. No deduction from gross income may be made for any amounts paid out for new
buildings or for permanent improvements or betterments made to increase the value of the taxpayer's property, or for any
amount expended in restoring property or in making good the exhaustion thereof for which an allowance for depreciation or
depletion or other allowance is or has been made. Amounts expended for securing a copyright and plates, which remain the
property of the person making the payments, are investments of capital. The cost of defending or perfecting title to property
constitutes a part of the cost of the property and is not a deductible expense. The amount expended for architect's services is
part of the cost of the building. Commissions paid in purchasing securities are a part of the cost of such securities.
Commissions paid in selling securities are an offset against the selling price. Expenses of the administration of an estate, such
as court costs, attorney's fees, and executor's commissions, are chargeable against the "corpus" of the estate and are not
allowable deductions. Amounts to be assessed and paid under an agreement between bondholders or shareholders of a
corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in
return of income. DaACIH
In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees and accountants' charges, are
ordinarily capital expenditures; but where such expenditures are limited to purely incidental expenses, a taxpayer may charge
such items against income in the year in which they are incurred. A holding company which guarantees dividends at a specified
rate on the stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and increasing the value
of its stockholdings in the subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income,
but such payments may be added to the cost of its stock in the subsidiary.
Sec. 34(A)
Section 34
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(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation
and/or conduct of the trade, business or exercise of a profession, including:
(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered,
including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided,
That the final tax imposed under Section 33 hereof has been paid;
(ii) A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or
profession;
(iii) A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or
possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking
title or in which he has no equity other than that of a lessee, user or possessor;
(iv) A reasonable allowance for entertainment, amusement and recreation expenses during the taxable year, that are directly
connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are
directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession not to exceed such
ceilings as the Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the Commissioner,
taking into account the needs as well as the special circumstances, nature and character of the industry, trade, business, or
profession of the taxpayer: Provided, That any expense incurred for entertainment, amusement or recreation that is contrary to
law, morals public policy or public order shall in no case be allowed as a deduction.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed under Subsection (A) hereof unless the
taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records: (i) the amount of the
expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development,
management, operation and/or conduct of the trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income shall be allowed under Subsection (A)
hereof for any payment made, directly or indirectly, to an official or employee of the national government, or to an official or
employee of any local government unit, or to an official or employee of a government-owned or -controlled corporation, or to
an official or employee or representative of a foreign government, or to a private corporation, general professional partnership,
or a similar entity, if the payment constitutes a bribe or kickback.
(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses allowable as deductions under this
Chapter, a private educational institution, referred to under Section 27 (B) of this Code, may at its option elect either: (a) to
deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the
expansion of school facilities or (b) to deduct allowance for depreciation thereof under Subsection (F) hereof.
Gross income allowable deductions = taxable income
Business expenses
o Must be ordinary and necessary
o Current expense or capital investment
o Business or personal?
Not deductible
o Personal, living, family expenses
o Amounts for new buildings or improvements made in order to increase value of property/estate
o Amounts for restoration
o Key man insurance
Exclusions not part of income; deductions legislative graces
Deductions in general
o Sections 34 (A)-(J) do not apply to persons who earn purely through compensation income
(salaried individuals/employees)
Except Section 34 (M) premium payments on health and hospitalization insurance
of individual taxpayer
Section 35 applies as well to those who earn through compensation personal and
additional exemptions under this section
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o Section 34 applies to taxpayers engaged in trade, business, or practice of a profession in the They are a source of actual income and taxable as such. But that does not deprive the same work
Philippines performed by others of its personal character nor furnish a reason why its cost should be treated as
Personal expenses vs business expenses an offset in the guise of a deductible item.
o Expenses which are essentially personal in nature and have no connection to the carrying on of Certain disbursements normally personal may become deductible by reason of their intimate
taxpayers business are not deductible connection with an occupation carried on for profit. We must have a distinction between those
o Pevsner case activities which, as a matter of common acceptance and universal experience, are ordinary or
Test for deductibility usual as the direct accompaniment of business pursuits, on the one hand; and those which, though
Clothing of a type specifically required as condition of employment they may in some indirect and tenuous degree relate to the circumstances of a profitable
Not adaptable to general usage as ordinary clothing occupation, are nevertheless personal in their nature, of a character applicable to human beings
It is not so worn generally, and which exist on that plane regardless of the occupation, though not necessarily of the
An objective test is required a subjective test is not administratively feasible station in life, of the individuals concerned.
Subjective test will not be horizontally fair as well as on the basis of enjoyment But for strategy will not work because by analogy, all consumption expenditures such as food,
o Rudolph vis--vis Pevsner shelter, clothing, recreation, that enable a TP to carry on the days activity must be deductible as
Issue of exclusion vs deductibility well.
Exclusion is a matter of whether it is included in the computation of income
o Construed against the State
Deductibility is a matter of deducting the items from income Case Pevsner v. CIR, 628 F.2d 467 (5th Cir. 1980)
o Construed against taxpayer
Current expense vs capital expense Fast Facts: As manager of the boutique, the TP is expected by her employer to wear YSL clothes while at
o Current taxable on the taxable period it is enjoyed work. In addition to wearing YSL apparel while at the boutique, she wears them while commuting to and
o Capital taxable over the useful life of the capital expenditure from work, to fashion shows sponsored by the boutique, and to business luncheons at which she
Depreciation expense represents the boutique. The taxpayer bought: four blouses, three skirts, one pair of slacks, one trench
Entertainment expenses coat, two sweaters, one jacket, one tunic, five scarves, six belts, two pairs of shoes and four necklaces.
o Are deductible only if they are in fact ordinary and necessary expenses for carrying on of trade The total cost of which was $1,381.91 (+$240 for maintenance of items).
or business
If they are to an extent primarily social and personal in nature and bear no direct Doctrine:
relation to the operation of a business, it may not be deducted Test of deductibility: (Cost of clothing is deductible as a business expense only if)
Example: Wining and dining a client (1) The clothing is of a type specifically required as a condition of employment
o More social and personal, although there is a benefit to the business (2) It is not adaptable to general usage as ordinary clothing
(see: Schulz) (3) It is not so worn.
Capped only to an extent The controlling doctrine is the objective test. Under an objective test, no reference is made to
So that it will not be abused the individual taxpayer's lifestyle or personal taste. Instead, adaptability for personal or general use
Illegal entertainment expenses, bribes, kickbacks, etc., are not deductible depends upon what is generally accepted for ordinary street wear.
An objective test, although not perfect, provides a practical administrative approach that allows a
1. Non-Deductible Personal Expenses v. Deductible Business Expenses TP or revenue agent to look only to objective facts in determining whether clothing required as a
condition of employment is adaptable to general use as ordinary street wear.
Case Smith v. CIR, 40 B.T.A. 1038 (1939) The objective test also tends to promote substantial fairness among the greatest number of TPs.

Fast Facts: The Smiths wanted to apply the but for test. They propose that but for the nurses the wife Note:
could not leave her child; but for the freedom she secured she could not pursue her gainful labors; and but Why not include lifestyle?
for them there would be no income and no tax. o Administrative convenience
o Horizontal fairness
There could be 2 individuals with different lifestyles
Doctrine: Why cant you argue using Benaglia (convenience of the employer)?
The amounts spent on nursemaids for the care of an infant child of a couple both working is not o Deduction (Pevsner) is strictly construed against the TP
deductible as a business expense as it is personal in nature. o Inclusion (Benaglia) is strictly construed against the State
Clothes of artista arguably deductible

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Gym membership of basketball players deductible
Sexy star boob job not deductible expense, must capitalize then subject it to depreciation
overtime
Case Rudolph v. U.S., supra: Husbands who was sent to NY to attend a seminar with touring on the
side with their wives
Doctine:
If a TP who travels to a destination engages in both "business and personal activities," the
traveling expenses are deductible only if the trip is "related primarily" to the taxpayer's business.
If primarily personal, the traveling expenses are not deductible even though the TP engages in
some business there.
The crucial question is whether, under all the facts and circumstances of the case, the purpose of
the trip was "related primarily to business" or was, rather, "primarily personal in nature."
Subjective standard: whether the TPs primary purpose was business or pleasure
Case Schultz v. CIR, 16 T.C. 401 (1951):
Fast Facts: Jewelry and watch business --- Because of this shortage of supply, the buyers came to New
York City more frequently than usual. Petitioner entertained customers to maintain or promote good will,
not to drum up business. Petitioner elaborately entertained buyers and others connected with the jewelry
business, personally spending about $7,000. In addition thereto approximately $2,000 was expended by
his wife and employees on luncheons, drinks, weekend visits, conventions, suppers, theaters, and
nightclubs. Approximately $3,400 of the $7,000 expended by petitioner personally was spent on suppers,
theaters and nightclubs and other forms of evening entertainment. On these occasions petitioner would
bring his wife and the party or parties he was entertaining would also bring their wives.
Doctrine:
The purpose of the expenditure must be primarily business rather than social or personal, and that
the business in which TP is engaged benefited or was intended to be benefited thereby.
Entertainment expenses are allowed as a deduction from gross income only to the extent that they
are "ordinary and necessary" in carrying on a trade or business
Proof is required that the purpose of the expenditure was primarily business rather than social or
personal, and that the business in which TP is engaged benefited or was intended to be benefited
thereby.
These gatherings may have been desirable and helpful to the present and future success of
petitioner's business, but this is usually true of all entertaining done by business or professional
people for the purpose of acquiring or retaining the favor of patrons and clients. Such expenditures
are nonetheless nondeductible absent a showing that they were ordinary and necessary to the
taxpayer's business.
The requirements that the expense must be both ordinary and necessary must be strictly complied
with, and whether contested expenditures are ordinary and necessary is primarily a question of
fact.
o This is in the nature of an exemption therefore it is strictly construed against TP
2. Travel Expenses While Away from Home
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! Must be motivated by the exigencies of business and not for ones own convenience or personal
reasons (see CIR vs Flowers; Hantzis vs CIR)
Case CIR v. Flowers, 326 U.S. 465 (1946)
Fast Facts: A lawyer lives in Jackson and works in Mobile. He claims deduction for traveling expenses
to and from Mobile.
Doctrine:
Meaning of home is TPs place of business, not residence
Traveling expenses, as ordinarily understood, include railroad fares and meals and lodging. If the
trip is undertaken for other than business purposes, the railroad fares are personal expenses and
the meals and lodging are living expenses
If the trip is solely on business, the reasonable and necessary traveling expenses, including railroad
fares, meals, and lodging, is business expenses. ... Only such expenses as are reasonable and
necessary in the conduct of the business and directly attributable to it may be deducted.
Commuters' fares are not considered as business expenses and are not deductible.'
Three conditions must thus be satisfied before a traveling expense deduction may be made:
(1) The expense must be a reasonable and necessary traveling expense, as that term is generally
understood. This includes such items as transportation fares and food and lodging expenses
incurred while traveling.
(2) The expense must be incurred 'while away from home.'
(3) The expense must be incurred in pursuit of business. This means that there must be a direct
connection between the expenditure and the carrying on of the trade or business of the taxpayer or
of his employer. Moreover, such expenditure must be necessary or appropriate to the development
and pursuit of the business or trade.
Jackson was his regular home. Had his post of duty been in that city the cost of maintaining his
home there and of commuting or driving to work concededly would be non-deductible living and
personal expenses lacking the necessary direct relation to the prosecution of the business.
The character of such expenses is unaltered by the circumstance that the taxpayer's post of duty
was in Mobile, thereby increasing the costs of transportation, food and lodging. Whether he
maintained one abode or two, whether he traveled three blocks or three hundred miles to
work, the nature of these expenditures remained the same.
The fact that he traveled frequently between the two cities and incurred extra living expenses in
Mobile, while doing much of his work in Jackson, was occasioned solely by his personal
propensities
The railroad gained nothing from this arrangement except the personal satisfaction of the taxpayer.
The exigencies of business rather than the personal conveniences and necessities of the
traveler must be the motivating factors. Such was not the case here
Bello:
For Flowers to have claimed a deduction he should request his company, as a prerequisite of his
employment that the company should establish a satellite office in his place of residence in
Jackson so that for his purpose, this satellite office is considered as the tax home and in traveling
to the main office would be effectively traveling away from home and hence, he could claim tax
deductions for travel expenses.
Case Hantzis v. CIR, 638 F.2d 248 (1st Cir. 1981)
Fast Facts: Harvard law student interning in NY but lives in Boston. She kept her house in Boston because
of her husband.
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Doctrine:
TP who pursues temporary employment away from location of his usual residence but has no
business connection with that location is not away from home for purposes of travel expense
deduction.
The Tax Court has, with a notable exception, consistently held that a taxpayer's home is his place
of business. The exception: when the person lives in one place and works another
The traveling expense deduction obviously is not intended to exclude from taxation every expense
incurred by a taxpayer who, in the course of business, maintains two homes.
Section 162(a)(2) seeks rather to mitigate the burden of the taxpayer who, because of the
exigencies of his trade or business, must maintain two places of abode and thereby incur additional
and duplicate living expenses.
Mrs. Hantzis' trade or business did not require that she maintain a home in Boston as well as one
in New York. Though she returned to Boston at various times during the period of her
employment in New York, her visits were all for personal reasons.
Temporary employment doctrine: Where a taxpayer reasonably expects to be employed in a
location for a substantial or indefinite period of time, the reasonable inference is that his choice of
a residence is a personal decision, unrelated to any business necessity. Thus, it is irrelevant how
far he travels to work. The normal expectation, however, is that the taxpayer will choose to live
near his place of employment. Consequently, when a taxpayer reasonable expects to be employed
in a location for only a short or temporary period of time and travels a considerable distance to the
location from his residence, it is unreasonable to assume that his choice of a residence is dictated
by personal convenience. The reasonable inference is that he is temporarily making these travels
because of a business necessity.
The temporary employment doctrine does not, however, purport to eliminate any requirement that
continued maintenance of a first home have a business justification.
Only a taxpayer who lives one place, works another and has business ties to both is in the
ambiguous situation that the temporary employment doctrine is designed to resolve.
In summary, the court announces a sound principle that, in dual residence cases,
deductibility of traveling expenses depends upon a showing that both residences were
maintained for business reasons
3. Deductible Current Expenses v. Non-Deductible Capital Expenditures
Statutory basis for non-deductible CAPEX
SEC. 36. Items Not Deductible.-
(A) General Rule. - In computing net income, no deduction shall in any case be allowed in respect to
xxx
(2) Any amount paid out for new buildings or for permanent improvements, or betterments made to
increase the value of any property or estate;
xxx
! Capital assets
o Useful life beyond 1 year
o Not deductible in its entirety in the year it was acquired
Amortized/depreciated over useful life taxed as such
! Current assets
o Benefits the current period/fiscal year
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! Replacement vs addition (see: Mt. Morrison and Midland)
o Replacement is current
Oil seepage is unforeseeable, thus repair/replacement due to such is a current expense
o Addition is capital
Need for drainage system is unforeseeable, thus purchasing one is a capital expenditure
! In terms of advertising, tests given through jurisprudence are useless (see: CIR vs General Foods)
o Where do you draw the line between stimulating current sales or future sales?
Bello on current expense vs capital expense:
Current Expense Capital Expense
This expense benefits the taxpayer only in that This expense benefits the taxpayer in his
particular year when expense was incurred profession/business for all time (tax deduction will
be at a depreciated expense)
Case Mt. Morris Drive-In Theatre Co. v. CIR, 25 T.C. 272 (1955)
Fast Facts: A company built a theatre over a sloping land. Its president is fully aware of such slopes and of
the possibility of accelerating the flow of water if no drainage was provided. Neighbors filed a complaint.
Company settled and built a drainage and not the company claims it as an expense. It was ruled that such
drainage was a CAPEX which is not deductible even if later acquired.
Doctrine:
Foreseen: president fully knows
It was obvious at the time when the drive-in theatre was constructed, that a drainage system would
be required to properly dispose of the natural precipitation normally to be expected, and that until
this was accomplished, petitioner's capital investment was incomplete.
If they had placed the drainage to begin with, it would have been CAPEX anyway.
If petitioner had included in its original construction plans an expenditure for a proper drainage
system no one could doubt that such expenditure would have been capital in nature.
The drainage system was a permanent improvement to the petitioner's property, and the cost
thereof constituted a capital expenditure.
There was no mere restoration or rearrangement of the original capital asset, but there was
the acquisition and construction of a capital asset which petitioner had not previously had,
namely, a new drainage system.
The decisive test is still the character of the transaction which gives rise to the payment
Case Midland Empire Packing Co. v. CIR, 14 T.C. 635 (1950)
Fast Facts: Meat packing company had to construct additional lining to prevent oil from seeping in,
coming from a newly built oil refining company near the vicinity. The meat packing company was
advised by FDA to close down until the linings were fully installed. The repair was deductible as an
ordinary and necessary business expense.
Doctrine:
In determining whether expenditure is a capital one or is chargeable against operating income, it is
necessary to bear in mind that purpose for which the expenditure was made.
The evidence is that the expenditure did not add to the value or prolong the expected life of the
property over what they were before the event occurred which made the repairs necessary. The
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repairs merely served to keep the property in an operating condition over its probable useful life
for the purpose for which it was used.
Ordinary in this context does not mean that the payments must be habitual or normal in the sense
that the same taxpayer will have to make them often. The expense is an ordinary one because we
know from experiences that payments for such a purpose, whether the amount is large or small,
are the common and accepted means of defense against attack.
The petitioner here made the repairs in question in order that it might continue to operate its
plant. Not only was there danger of fire from the oil and fumes, but the presence of the oil led the
Federal meat inspectors to declare the basement an unsuitable place for the purpose for which it
had been used for a quarter of a century.
The expenditure served only to permit petitioner to continue the use of the plant, and
particularly the basement for its normal operations
MIDLAND CASE V. MORRIS THEATRE CASE DISTINGUISHED
The cost to petitioner of acquiring and constructing a drainage system in connection with its drive-
in theatre was a CAPEX. There was no sudden catastrophic loss caused by a physical fault
undetected by the TP in spite of precautions taken by it at the time of its original construction
work. There was no unforeseeable external factor as in the case of Midland.
REPAIR (Necessary) IMPROVEMENT (Capital)
To restore To replace
Purpose of keeping the property in an Adds value and prolongs the life of the
ordinarily efficient condition property
Maintenance charge Capital investment which should not be
applied against current earnings
Case INDOPCO, Inc. v. CIR, 503 U.S. 79 (1992)
Fast Facts: INDOPCO merged with another company and engaged the services of JP Morgan Chase for
the transaction, they claimed tax deduction on the amount they paid to JP Morgan. The court held that the
expenses here are considered as a CAPEX and hence is NOT deductible. The taxpayer said: there is no
separate existing asset that was created by the expenditure and hence cannot be considered as a
capitalization. The SC held that this requirement is indicative but not a requirement per se, so long as it
benefits other taxable years then it is in fact a tax deduction. Even though there was no separate existing
asset that was created by the expenditure, it is still considered as a capitalization.
Doctrine:
Deductions are exceptions to the norm of capitalization and are allowed only if there is clear
provision for them in the Code and the taxpayer has met the burden of showing a right to the
deduction.
The transaction produced significant benefits to National Starch that extended beyond the
tax year in question are amply supported by the record.
Courts long have recognized that expenses such as these, " 'incurred for the purpose of changing
the corporate structure for the benefit of future operations are not ordinary and necessary business
expenses
Although the presence of an incidental future benefit may not warrant capitalization, a TPs
realization of benefits beyond the year in which the expenditure is incurred is important in
determining whether the appropriate tax treatment is immediate deduction or capitalization
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To qualify for deduction under 162(a), "an item must
o be "paid or incurred during the taxable year,"
o be for "carrying on any trade or business,"
o be an "expense,"
o be a "necessary" expense, and
minimal requirement that the expense be appropriate and helpful
o be an "ordinary" expense."
It must relate to a transaction "of common or frequent occurrence in the type of business involved
Case CIR v. General Foods (Phil.), Inc. (April 24, 2003)
Fast Facts: General Foods, Inc., filed its income tax return, the corporation claimed as deduction, P9
million for media advertising for Tang.
Doctrine:
Under Section 34(A)(1) of NIRC, the advertising expense, to be deductible from gross income,
must comply with the ff. requisites:
1. the expense must be ordinary and necessary;
2. it must have been paid or incurred during the taxable year;
3. it must have been paid or incurred in carrying on the trade or business of the taxpayer; and
4. it must be supported by receipts, records or other pertinent papers.
The parties are in agreement that the subject advertising expense was paid or incurred within the
corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was
necessary. However, their views conflict as to whether or not it was ordinary. To be deductible,
an advertising expense should not only be necessary but also ordinary. These two
requirements must be met.
The right to a deduction depends on a number of factors such as but not limited to: the type and
size of business in which the taxpayer is engaged; the volume and amount of its net earnings;
the nature of the expenditure itself; the intention of the taxpayer and the general economic
conditions.
Media advertising expense claimed for Tang is more than 50% of its total marketing expense
The subject expense for the advertisement of a single product to be inordinately large. Therefore,
even if it is necessary, it cannot be considered an ordinary expense deductible
Advertising is generally of two kinds:
(1) Advertising to stimulate the current sale of merchandise or use of services and expenses
(2) Advertising designed to stimulate the future sale of merchandise or use of services CAPEX
(akin to goodwill)
That the subject media expense was incurred in order to protect respondent corporation's brand
franchise. Respondent corporation's venture to protect its brand franchise was tantamount to
efforts to establish a reputation
Note:
It is hard to draw a line if it is a current expense or CAPEX.
The test used in this case is not useful because it is subjective. The basis used here was the
amount.
4. Ordinary and Necessary
Statutory Basis: See Sec 34 (A) above
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! Both qualifications (that it is ordinary and necessary) mist concur in order for the expense to be deductible
! Purchasing of goodwill (see: Welch vs. Helvering)
o Not ordinary
o Capitalized
o Not deductible immediately amortized
Case Welch v. Helvering, 290 U.S. 111 (1933)
Fast Facts: Petitioner, in order to re-establish his relations with customers whom he had known when
acting for the Welch Company and to solidify his credit and standing, decided to pay the debts of the
Welch business so far as he was able. This is not an ordinary expense since it is contrary to human
experience to pay off the debts of another. It is considered as CAPEX and thus, it is not deductible.
Doctrine:
Even assuming that such payments are necessary for the development of the petitioners business,
still, many necessary payments are charges upon capital. Hence, there is a need to determine
whether they are both necessary AND ordinary.
Ordinary is a variable affected by time, place, and circumstance. Ordinary does not mean that the
payments must be habitual or normal in the sense that the same taxpayer will have to make them
often. An expense is an ordinary one because we know from experience that payments for such a
purpose, whether the amount is large or small, are the common and accepted means of defense
against attack.
Men do at times pay the debts of others without legal obligation or the lighter obligation imposed
by the usages of trade or by neighborly amenities, but they do not do so ordinarily, not even
though the result might be to heighten their reputation for generosity and opulence. Such instance
is a high degree extraordinary. The payments in controversy came closer to capital outlays than
to ordinary and necessary expenses in the operation of a business
Reputation and learning are akin to capital assets, like the good will of an old partnership.
The money spent in acquiring them is well and wisely spent. It is not an ordinary expense of the
operation of a business
Case Atlas Consolidated Mining & Devt Corp. v. CIR (Jan. 27, 1981)
Fast Facts: Atlas wants to deduct as expenses the fees paid to the PR firm to create a favorable image of
the company in order to gain or maintain publics and stockholders patronage, the recurring stock listing
fees and the litigation expenses.
Doctrine:
Statutory Test of Deductibility: where it is axiomatic that to be deductible as a business expense,
three conditions are imposed, namely:
(1) the expense must be ordinary and necessary,
(2) it must be paid or incurred within the taxable year, and
(3) it must be paid or incurred in carrying in a trade or business.
In addition, not only must the taxpayer meet the business test, he must substantially prove by
evidence or records the deductions claimed under the law, otherwise, the same will be
disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary
does not justify its deduction.
Ordinarily, an expense will be considered "necessary" where the expenditure is appropriate and
helpful in the development of the taxpayer's business. It is "ordinary" when it connotes a
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payment which is normal in relation to the business of the taxpayer and the surrounding
circumstances.
The intention of the taxpayer often may be the controlling fact in making the determination. A
business expense must be determined from the nature of the expenditure itself, which in turn
depends on the extent and permanency of the work accomplished by the expenditure
The expenses paid for the services rendered by a PR firm CAPEX
The stockholders relation service fee is NOT an ordinary expense, hence NOT deductible from
Atlas gross income in 1958, because it resulted in full subscription of the additional shares issued
by Atlas which was in effect spent for the acquisition of additional capital, thus a CAPEX.
Recurring stock listing fee Expense
We deal with the stock listing fee paid annually to a stock exchange for the privilege of having its
stock listed. It must be noted that the CTA rejected the Dome Mines case because it involves a
payment made only once, hence, it was held therein that the single payment made to the stock
exchange was a capital expenditure, as distinguished from the instant case, where payments were
made annually.
Suit expense CAPEX
Litigation expenses under consideration were incurred in defense of Atlas title to mining
properties. It is well established in jurisprudence that litigation expense incurred in defense or
protection of title are CAPITAL in nature and NOT deductible and that such expense constitute a
part of the cost of the property.
5. Reasonable Compensation
Statutory Basis: Section 34(A)(1)(a)(i)
Section 34
(A) Expenses. -
(1) Ordinary and Necessary Trade, Business or Professional Expenses.-
(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the
development, management, operation and/or conduct of the trade, business or exercise of a profession,
including:
(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services
actually rendered, including the grossed-up monetary value of fringe benefit furnished or granted by the
employer to the employee: Provided, That the final tax imposed under Section 33 hereof has been paid;
For it to be considered as reasonable compensation, it must be:
1) reasonable compensation
2) for services actually rendered
Measure for reasonableness are the facts and circumstances of each case
Case C.M. Hoskins & Co., Inc. v. CIR (Nov. 28, 1969)
Fast Facts: Hoskins own 99% of the shares of the company. Every year, he declares P5million salary for
himself. On a particular year, the company earned P15 million. Hoskins therefore declared P10million
bonus claiming that it is reasonable.
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Doctrine:
This is a case of disguised dividends
Payment by petitioner corporation to Hoskins of the additional sum of P99,977.91 as his equal or
50% share of the 8% supervision fees received by petitioner as managing agents of the real estate,
subdivision projects of 2 other corporations was inordinately large and could not be accorded
the treatment of ordinary and necessary expenses allowed as deductible items within the
purview of the Tax Code
It is a general rule that 'Bonuses to employees made in good faith and as additional compensation
for the services actually rendered by the employees are deductible, provided such payments, when
added to the stipulated salaries, do not exceed a reasonable compensation for the services
rendered.
The conditions precedent to the deduction of bonuses to employees are:
(1) the payment of the bonuses is in fact compensation;
(2) it must be for personal services actually rendered; and
(3) the bonuses, when added to the salaries, are reasonable when measured by the amount and
quality of the services performed with relation to the business of the particular taxpayer.
There is no fixed test for determining the reasonableness of a given bonus as compensation. This
depends upon many factors, one of them being the amount and quality of the services performed
with relation to the business.' Other tests suggested are: payment must be 'made in good faith'; 'the
character of the taxpayer's business, the volume and amount of its net earnings, its locality, the
type and extent of the services rendered, the salary policy of the corporation'; 'the size of the
particular business'; 'the employees' qualifications and contributions to the business venture'; and
'general economic conditions. However, 'in determining whether the particular salary or
compensation payment is reasonable, the situation must be considered as whole.
Employers right may be conceded, but for income tax purposes the employer cannot legally claim
such bonuses as deductible expenses unless they are shown to be reasonable.
Case Kuenzle & Streiff, Inc. v. Collector (Oct. 20, 1959)
Fast Facts: Petitioner corporation claims as deduction the (1) salaries, directors fees, and bonuses given
to its non-resident president and vice-president; (2) bonuses of its resident officers and employees; and (3)
interests on earned but unpaid salaries and bonuses of its officers and employees. The CTA ruled that the
bonuses given to the non-resident officers are reasonable, while the bonuses given to the resident officers
and employees are quite excessive.
Doctrine:
Measure of reasonableness: facts and circumstances test
There is no fixed test in determining reasonableness. This depends on many factors such "the
amount and the quality of the services performed with relation to the business."
However, "in determining whether the particular salary or compensation payment is reasonable,
the situation must be considered as a whole. No single factor is decisive but the interplay of
several factors.
6. Period for Which Deductions and Credits Taken
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Sec. 45
SEC. 45. Period for which Deductions and Credits Taken. - The deductions provided for in this Title
shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the
method of accounting the basis of which the net income is computed, unless in order to clearly reflect the
income, the deductions should be taken as of a different period. In the case of the death of a taxpayer,
there shall be allowed as deductions for the taxable period in which falls the date of his death, amounts
accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior
period.
! Paid or incurred during the taxable year
o Paid = actual spending
o Incurred = liability has accrued
! Cash basis accounting year paid
! Accrual basis accounting year incurred
! All events test
o Expense must be claimed as a deduction when liability is:
Fixed
The amount can be determined with reasonable accuracy
Case CIR v. Isabela Cultural Corp. (Feb. 12, 2007)
Fast Facts: TP wants to claim the deduction in 1986 despite the fact that the cost of legal and auditing
services were rendered in 1984 and 1985.
Doctrine:
The requisites for the deductibility of ordinary and necessary trade, business, or professional
expenses, like expenses paid for legal and auditing services, are:
(a) the expense must be ordinary and necessary;
(b) it must have been paid or incurred during the taxable year;
(c) it must have been paid or incurred in carrying on the trade or business of the TP; and (d) it
must be supported by receipts, records or other pertinent papers.
Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of
accounting, expenses not being claimed as deductions by a taxpayer in the current year when they
are incurred cannot be claimed as deduction from income for the succeeding year
For a taxpayer using the accrual method, the determinative question is, when do the facts present
themselves in such a manner that the taxpayer must recognize income or expense? The accrual of
income and expense is permitted when the all-events test has been met. This test requires:
(1) fixing of a right to income or liability to pay; and
(2) the availability of the reasonable accurate determination of such income or liability.
The all-events test requires the right to income or liability be fixed, and the amount of such income
or liability be determined with reasonable accuracy. However, the test does not demand that the
amount of income or liability be known absolutely, only that a taxpayer has at his disposal the
information necessary to compute the amount with reasonable accuracy.
The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable;
the test is satisfied where a computation may be unknown, but is not as much as unknowable,
within the taxable year.
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As previously stated, the accrual method presents largely a question of fact and that the taxpayer
bears the burden of establishing the accrual of an expense or income.
Note:
The question of when one should claim tax deductions depends upon the method of accounting employed
by the taxpayer.
Accrual method of accounting pay taxes/claim deductions during the year the expense is incurred
Cash method of accounting pay taxes/claim deductions during the year the expense was paid
B. Interest
Sec. 34(B)
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising
from personal services rendered under an employer-employee relationship where no deductions shall be
allowed under this Section other than under subsection (M) hereof, in computing taxable income subject
to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and (C); and 28 (A) (1), there shall be
allowed the following deductions from gross income;
xxx
(B) Interest.-
(1) In General. - The amount of interest paid or incurred within a taxable year on indebtedness in
connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross
income: Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall
be reduced by an amount equal to the following percentages of the interest income subjected to final tax:
Forty-one percent (41%) beginning January 1, 1998; Thirty-nine percent (39%) beginning January 1,
1999; and Thirty-eight percent (38%) beginning January 1, 2000;
(2) Exceptions. - No deduction shall be allowed in respect of interest under the succeeding subparagraphs:
(a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an
indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That such
interest shall be allowed a a deduction in the year the indebtedness is paid: Provided, further, That if the
indebtedness is payable in periodic amortizations, the amount of interest which corresponds to the amount
of the principal amortized or paid during the year shall be allowed as deduction in such taxable year;
(b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons
specified under Section 36 (B); or
(c)If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest incurred to acquire
property used in trade business or exercise of a profession may be allowed as a deduction or treated as a
capital expenditure.
xxx
! Deductible either as interest (stand-alone) or interest on tax (for delinquency in payment of taxes)
! Interest accrued is taxable in that year
Case Paper Ind. Corp. of the Phil. v. CA (Dec. 1, 1995)
Fast Facts: PICOP obtained loans from foreign creditors in order to finance the purchase of machinery
and equipment needed for its operations. In its 1977 ITR, PICOP claimed interest payments made in
1977, amounting to P42 million on these loans as a deduction from its 1977 gross income.
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The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the
purchase of machinery and equipment, the interest payments on these loans should have been capitalized
instead and claimed as a depreciation deduction.
Doctrine:
The carrying charges which may be capitalized under the above quoted provisions of the US
Internal Revenue Code include, as the CIR pointed out, interests on a loan (but not theoretical
interest of a TP using his own funds).
What the CIR failed to point out is that such carrying charges may, at the election of the TP,
either be (a) capitalized in which case the cost basis of the capital assets, e.g., machinery and
equipment, will be adjusted by adding the amount of such interest payments or alternatively, be (b)
deducted from gross income of the taxpayer.
In other words, the taxpayer is not entitled to both the deduction from gross income and the
adjusted (increased) basis for determining gain or loss and the allowable depreciation charge.
We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a
loan incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel
the capitalization of interest payments on such a loan.
The Tax Code is simply silent on a TPs right to elect one or the other tax treatment of such
interest payments. Accordingly, the general rule is that interest payments on legally
demandable loan are deductible from gross income.
TP now has the option to deduct currently or capitalize interest incurred to acquire property used
in trade, business or exercise of a profession.
Case CIR v. Vda. de Prieto (Sept. 30, 1960)
Fast Facts: TP conveyed, by way of gifts to her children, real property. CIR appraised the real property tax
donated. TP paid the total assessed value; half of it represents the total interest on account of delinquency.
TP claimed amount of delinquency as deduction in her income tax return
Doctrine:
For interest to be deductible, it must be shown that there be an:
o Indebtedness
o That there should be interest upon it
o That what is claimed as an interest deduction should have been paid or accrued within
the year.
The term "indebtedness" as used in the Tax Code of the United States has been defined as an
unconditional and legally enforceable obligation for the payment of money. Within the meaning of
this definition, it is apparent that a tax may be considered an "indebtedness"
Thus, interest on taxes is interest on indebtedness and is deductible. This rule applies even though
the tax is nondeductible.
NOTE: It is not deductible as taxes but it is deductible as interest
Rev. Regs. 13-2000 (Nov. 20, 2000)
Scope: Requirements for deductibility of interest expense from the gross income of a corporation or an
individual engaged in trade, business or in the practice of profession
Content:
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Applicable to TP, whether natural or juridical, engaged in trade, business or in the exercise of a
profession, EXCEPT one earning compensation income arising from personal services rendered
under an employer-employee relationship
Requisites:
o There must be indebtedness, that of the TP, connected with his TP's trade, business or
exercise of profession
o Interest expense paid or incurred upon such indebtedness, during the taxable year
o Interest must be stipulated in writing and legally due
o Interest payment arrangement must not be between related TPs as mandated in Sec.
(B)(2)(b) in relation to Sec. 36(B), both of the Tax Code of 1997
Brothers, sisters, spouse, ancestors and lineal descendants
Individual and a corporation, more than 50% in value of outstanding stock owned,
directly or indirectly, by or for such individual
Between 2 corporations, more than 50% in value of outstanding stock owned,
directly or indirectly, by or for such individual
Grantor and fiduciary of any trust
Fiduciary of a trust and the fiduciary of another trust if the same person is a grantor
with respect to each trust
Fiduciary of a trust and a beneficiary of such trust
o In interest incurred to acquire property used in trade, business or exercise of profession, the
same was NOT treated as a CAPITAL EXPENDITURE
Limitation
o Amount of interest expense shall be reduced by an amount equal to the following
percentages of the interest income earned which have been subjected to final withholding
tax depending on the year when the interest income was earned, viz:
41% beginning Jan. 1, 1998
39% beginning Jan. 1, 1999
38% beginning Jan. 1, 2000 and thereafter
o Limitation shall apply regardless of WON a tax arbitrage scheme was entered into by the
TP or regardless of the date when the loan and investment was made for as long as, during
the taxable year, there is an interest expense incurred on one side and an interest income,
subjected to final withholding tax, earned
Interest incurred or paid by TP on all unpaid business-related taxes shall be fully deductible
from gross income and shall not be subject to the limitation
Deduction not allowed from gross income:
o TP reporting income on the cash basis incurs an indebtedness wherein interest is paid in
advance through discount or otherwise
Interest shall be allowed as deduction in the year indebtedness is paid
If interest is payable in periodic amortization, amount of interest which corresponds
to the amount of the principal amortized or paid during the year shall be allowed as
deduction in such taxable year
Uses cash-basis accounting method: interest expense paid in advance shall only be
allowed as deduction in the year self-employed individual has fully paid his
liability
o Sec. 36(B)
o Interest expense is paid incurred to finance petroleum exploration in the Philippines
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Interest expense on a capital expenditure incurred to acquire property used in trade, business or exercise
of a profession may be allowed as a deduction in full year when incurred
1. Interest arbitrage
! Base of interest expense reduced by 38% of interest income subject to final tax
! The difference is then multiplied by 30% to get the final deductible interest expense
! For every P1, tax lessened by P0.30
! Intent is to prevent revenue leakage
Case BIR Rul. No. 006-00 (Jan. 5, 2000)
Fast Facts: TP derived interest income from the treasury bonds. It now requests that said interest income
be excluded in the determination of the interest expense not allowable as deduction from gross income
Doctrine:
The amount of interest expense paid or incurred by a TP within a taxable year on indebtedness in
connection with his trade, business or exercise of profession shall be allowed as a deduction from
his gross income (Interest expense shall be reduced if the TP has derived certain interest income
which had been subjected to final withholding tax)
Limitations shall apply regardless of WON a tax arbitrage scheme was entered into by the TP or
regardless of the date of the interest bearing loan and the date when the investment was made, for
as long as, during the taxable year, there is an interest expense incurred on one side and
interest income earned on the other side.
Request by TP that said interest income be excluded in the determination of the interest expense
not allowable as deduction from gross income: DENIED
C. Taxes
Section 34(C)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
xxx
(C) Taxes
(1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business,
shall be allowed as deduction, except
(a) The income tax provided for under this Title;
(b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who
does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credits
for taxes of foreign countries);
(c) Estate and donor's taxes; and
(d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.
Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part of gross income in the
year of receipt to the extent of the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or business in the Philippines
and a resident foreign corporation, the deductions for taxes provided in paragraph (1) of this Subsection (C) shall be allowed
only if and to the extent that they are connected with income from sources within the Philippines.
(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his return his desire to have the benefits
of this paragraph, the tax imposed by this Title shall be credited with:
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(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic corporation, the amount of
income taxes paid or incurred during the taxable year to any foreign country; and
(b) Partnerships and Estates. - In the case of any such individual who is a member of a general professional partnership or a
beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership or the estate or
trust paid or incurred during the taxable year to a foreign country, if his distributive share of the income of such partnership or
trust is reported for taxation under this Title.
An alien individual and a foreign corporation shall not be allowed the credits
against the tax for the taxes of foreign countries allowed under this paragraph. (4) Limitations on Credit. - The amount of the
credit taken under this Section shall be subject to each of the following limitations:
(a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax
against which such credit is taken, which the taxpayer's taxable income from sources within such country under this Title bears
to his entire taxable income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the
taxpayer's taxable income from sources without the Philippines taxable under this Title bears to his entire taxable income for
the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts claimed as credits by the
taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine
the amount of the tax for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid
by the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or
refunded to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the
allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the
Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found due
upon any such redetermination. The bond herein prescribed shall contain such further conditions as the Commissioner may
require.
(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the option of the
taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year which the taxes of
the foreign country were incurred, subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the
taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued, the credits for all subsequent
years shall be taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the same or any
succeeding year.
(7) Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the taxpayer establishes to the
satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines;
(b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said
paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and
(c) All other information necessary for the verification and computation of such credits.
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! Tax credit
o Taxes incurred and paid to both the Philippines and a foreign country
o Contemplates a case where there is double taxation between two taxing jurisdictions
! Deduction for taxes paid to a foreign country is allowed if taxpayer eligible for foreign tax credit
o Only if there was no intention to obtain the foreign tax credit
o So if taxpayer is not entitled to foreign tax credit, taxpayer cannot claim tax deductions
! Requisites for foreign tax credit
o Foreign source income
o Tax credit paid twice
Case CIR v. Lednicky (July 31, 1964)
Fast Facts: Sps. TP, both alien residents, derived income from PH sources. They paid total assessed value
of taxes, but later on claimed deduction for the amount paid to the U.S government as federal income tax.
They now claim refund for the overpayment of taxes.
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Doctrine:
The right to deduct income taxes paid to foreign government from the TP's gross income is given
only as an ALTERNATIVE or SUSBSTITUTE to his right to claim a tax credit for such foreign
income taxes under Sec. 30(C)(3) and (4)
Unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from
deducting the foreign income taxes from his gross income. Note that Sps. TP derive its income
from PH sources.
Double taxation becomes obnoxious only where the TP is taxed twice for the benefit of the SAME
governmental entity. As between the Philippines, where the income was earned and where the
taxpayer is domiciled, and the United States, where that income was not earned and where the
taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income
should accrue to the benefit of the Philippines. Any relief from the alleged double taxation should
come from the United States, and not from the Philippines
TP's claim for refund: denied
D. Losses
1. Casualty losses
Sec. 34(D)(1), (2)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
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(D) Losses
(1) In General.- Losses actually sustained during the taxable year and not compensated for by insurance or other forms of
indemnity shall be allowed as deductions:
(a) If incurred in trade, profession or business;
(b) Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or other
casualties, or from robbery, theft or embezzlement.
The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and
regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss
sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, however, That the time limit
to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the
date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.
(c) No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the return, such loss has been
claimed as a deduction for estate tax purposes in the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the losses deductible shall be those
actually sustained during the year incurred in business, trade or exercise of a profession conducted within the Philippines, when
such losses are not compensated for by insurance or other forms of indemnity. The Secretary of Finance, upon recommendation
of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and
manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or
embezzlement during the taxable year: Provided, That the time to be so prescribed in the rules and regulations shall not be less
than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or
embezzlement giving rise to the loss; and
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2. NOLCO
Sec. 34(D)(3)
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(3) Net Operating Loss Carry-Over. - The net operating loss of the business or enterprise for any taxable year immediately
preceding the current taxable year, which had not been previously offset as deduction from gross income shall be carried over
as a deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss:
Provided, however, That any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall
not be allowed as a deduction under this Subsection: Provided, further, That a net operating loss carry-over shall be allowed
only if there has been no substantial change in the ownership of the business or enterprise in that -
(i) Not less than seventy-five percent (75%) in nominal value of outstanding
issued shares., if the business is in the name of a corporation, is held by or on behalf of the same persons; or
(ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation, if the business is in the name of a
corporation, is held by or on behalf of the same persons.
For purposes of this subsection, the term "not operating loss" shall mean the excess of allowable deduction over gross income
of the business in a taxable year.
Provided, That for mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under
Executive Order No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first
ten (10) years of operation may be carried over as a deduction from taxable income for the next five (5) years immediately
following the year of such loss. The entire amount of the loss shall be carried over to the first of the five (5) taxable years
following the loss, and any portion of such loss which exceeds, the taxable income of such first year shall be deducted in like
manner form the taxable income of the next remaining four (4) years.
! Different classifications under the NIRC
o Casualty (Section 34 (D))
o Costs in excess of income (Section 34 (D))
o Sale or exchange
! Net operating loss allowable deductions > gross income
! Requisites for losses to be deductible
o Actually sustained and charged off within the taxable year
o Must be substantiated
! If the net operating loss transfers from one entity to another, leading to a substantial change in
ownership, taxpayer will not be entitled to NOLCO
o If no substantial change in ownership, entitled to NOLCO
o Substantial change in ownership change in ownership of more than 25%
o PICOP vs CA
Solution: Other entity should have survived, not PICOP
Substantial change in ownership of the other entity
Other entity was the one that suffered the loss
Case Paper Ind. Corp. of the Phil. v. CA, supra
Fast Facts: TP Corporation entered into a merger agreement with 2 corporations (A and B) wherein rights,
properties, privileges, powers and franchises of both corporations were to be transferred, assigned and
conveyed to TP Corp as the surviving corporation. It appeared that A had accumulated losses. TP Corp
claimed A's losses as deduction against its gross income for the same year as the merger.
Doctrine:
Ordinary rule is that net operating losses cannot be carried over
To allow the deduction claimed by the TP would be to permit one corporation or enterprise to
benefit from the operating losses accumulated by another corporation or enterprise
Upon the arrival of the effective date of the merger, only 1 corporation remained. The losses
suffered by the merging corporation and the gross income generated by TP came under one and
the same corporate roof. However, TP's claim for deduction is not only bereft of statutory basis,
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but it also does violence to the legislative intent which animates the tax incentive granted by R.A
No. 5186
Notes from sir:
What TP in this case should have done is to allow the corporation with net operating loss to be
the surviving corporation. In such a way, the same corporation, which incurred the losses, would
be the same entity to claim the deduction.
Rev. Regs. 14-01 (Aug. 27, 2001)
Scope: Deduction from gross income of the Net Operating Loss Carry-Over
Content:
Net Operating Loss Carry-Over shall be allowed only if there has been no substantial change in
the ownership of the business or enterprise in that:
o Not less that 75% in nominal value of outstanding issued shares if the business is in the
name of a corporation is held by or on behalf of the same persons
o Not less than 75% of the paid up capital of the corporation if the business is in the name of
a corporation, is held by or on behalf of the same persons
Net Operating Loss means the excess of allowable deduction over gross income of the business in
a taxable year
For mines other than oil and gas wells, NOL without benefit of incentives incurred in any of the
first 10yrs of operation may be carried over as a deduction from taxable income for the next 5
years immediately following such loss
Limited only to NOL accumulated beginning January 1, 1998
NOLCO shall be allowed as a deduction from the gross income of the same taxpayer who
sustained and accumulated the net operating losses regardless of the change in its ownership. This
rule shall also apply in the case of a merger where the taxpayer is the surviving entity
Unless otherwise provided in these Regulations, NOLCO of the taxpayer shall not be transferred
or assigned to another person, whether directly or indirectly
An individual (including estate or trust) engaged in trade or business or in the exercise of
profession, or a domestic or resident foreign corporation may be allowed to claim deduction of
his/its corresponding NOLCO.
o One who claims the 10% Optional Standard Deduction (OSD) can't claim deduction of the
NOLCO. The 3-year reglementary period shall continue to run notwithstanding the fact
that the individual availed of the 10% OSD during the said period
o Not entitled to claim deduction of NOLCO:
Offshore Banking Unit of foreign banking corporation, and Foreign Currency
Deposit Unit of a domestic or foreign banking corporation (authorized by BSP)
Enterprise registered with the BOI with respect to its BOI-registered activity
enjoying the Income Tax Holiday incentive
Enterprise registered with the PEZA
Enterprise registered under Bases Conversion and Development Act of 1992
Foreign corporations engaged in international shipping or air carriage business in
the PH
Natural or juridical person, enjoying exemption from income tax
NOLCO shall be availed of on a "first-in, first-out" basis
Substantial change in the ownership of the business or enterprise shall be determined as of the end
of the taxable year when NOLCO is to be claimed as deduction
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"By or on behalf of the same persons" refer to the maintenance of ownership despite change (from
direct to indirect ownership, or vice versa, in case of transfers or mergers)
o X Corporation owns 100% of Y Corporation. Y Corporation owns 100%, of Z
Corporation. Z Corporation has NOLCO. Z Corporation is merged into Y Corporation. Z
Corporation's NOLCO should be retained and transferred to Y Corporation. Prior to the
merger, X Corporation already indirectly owned Z Corporation, i.e., Z Corporation's shares
were held "by" Y Corporation "on behalf of" X Corporation. After the merger, X now
directly owns Z Corporation [absorbed corporation] which continues to exist in Y
Corporation.
NOLCO shall be separately shown in the TP's income tax return
Case BIR Rul. 30-00 (Aug. 10, 2000)
Fast Facts: Corp A and Others made investments in the form of equity and debt in 4 corporations, all of
which are in a net loss position (W, X, Y and Z). Y owns 99.63% of Y-1 Corporation. BODs of W, X, Y
and Z approved a proposal to integrate their business operations and activities under a single management
structure. In line with this proposal, the corporations swapped shares.
Doctrine:
Since the corporations are not dissolved but are merely integrated for a specific bona fide
business purpose, the NOL of each are preserved after the proposed share swap and may be
carried over and claimed as a deduction from their respective gross income
o Example: Since Corp. A owns 87.079% of W before the proposed integration plan, and
they continue to own 83.189% after, the issuance by W of new shares from the
unsubscribed portion of the authorized capital stock or from an increase in authorized
capital stock will neither result in a substantial nor in an effective change in ownership.
Thus, NOL of W are preserved and may continue to be claimed by W as a deduction from
its own gross income
3. Realized vs. unrealized losses
Case BIR Rul. No. 206-90 (Oct. 30, 1990)
Fast Facts: Corporation has existing US dollar loans. Parties to said loan agreed to convert said dollar
denominated loans into pesos at the exchange rate prevailing on June 30, 1989. There is a loss upon the
conversion of the loan to peso. Because of the approval by the Central Bank and the signing by parties of
the agreements, the loss became final and irrevocable.
Doctrine:
The annual increase in value of an asset is not taxable income because such increase has not yet
been realized. It can only be taxed when a disposition of the property occurred which was of such
nature as to constitute a realization of such gain. Same obtains as to losses. Annual decline in the
value of the property is not normally allowable as deduction. Hence, to be allowable the loss
must be realized.
When foreign currency acquired in connection with a transaction in the regular course of
business is disposed ordinary gain or loss results from the fluctuations. The loss is deductible
only for the year it is actually sustained. It is sustained during the year in which the loss occurs
as evidenced by the completed transaction and as fixed by the identifiable occurring that year
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The remittance of scheduled amortization, in this case, consisting of principal and interests
payment on the foreign loan has not actually been made. Thus, not deductible from gross income.
Case BIR Rul. No. 144-85 (Aug. 26, 1985)
Fast Facts: Foreign exchange losses, which accrued by reason of devaluation, arose from matured but
unremitted principal repayments on loans affected by the debt restructuring program in the Philippines..
Doctrine:
Annual increase in value of an asset is not taxable income because such increase has not yet been
realized. Thus, the annual decrease in the value of property is not normally allowable as a
loss. To be allowable, the loss must be realized.
No taxable event has yet been consummated prior to the remittance of the scheduled amortization.
Thus, the loss due to devaluation is not deductible from gross income for income tax purposes.
4. Losses from sales or exchanges (to be taken-up in XV below)
E. Bad Debts
Section 34(E)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
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(E) Bad Debts. -
(1) In General. - Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year except
those not connected with profession, trade or business and those sustained in a transaction entered into between parties
mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts previously allowed as deduction in the
preceding years shall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of
said deduction.
(2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are ascertained to be worthless and charged off
within the taxable year and are capital assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank or
trust company incorporated under the laws of the Philippines a substantial part of whose business is the receipt of deposits, for
the purpose of this Title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital
assets.
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! Requisites
o Existing indebtedness
o Indebtedness is related to taxpayers trade, business, or profession
o Indebtedness is actually charged off the books
Actual ascertainment of worthlessness and uncollectability during the taxable year
Facts and circumstances test (see: PRC vs CA; Fernandez Hermanos)
! Indebtedness vs capital contribution (see: Fernandez Hermanos)
o Capital contribution not deductible through bad debts
No due date for repayment
Payment will be from earnings of debtor company
Rev. Regs. 5-99 (March 10, 1999)
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Scope: Requirements for deductibility of bad debts from gross income of a corporation or an individual
engaged in trade or business or a professional engaged in the practice of his profession
Content:
"Bad debts" are those debts resulting from the worthlessness or uncollectibility, in whole or in
part, of amounts due the taxpayer by others, arising from money lent or from uncollectible
amounts of income from goods sold or services rendered
Requisites for deductibility:
o An existing indebtedness due to the TP which must be valid and legally demandable
o Same must be connected with the TP's trade, business or practice of profession
o Same must not be sustain in a transaction entered into between related parties
enumerated under Sec. 36(B) of the Tax Code of 1997
o Same must be actually charged off the books of accounts of the taxpayer as of the end of
the taxable year
o Same must be actually ascertained to be worthless and uncollectible as of the end of the
taxable year
He must ascertain and be able to demonstrate with reasonable degree of certainty the
uncollectibility of the debt. Commissioner will consider ALL pertinent evidence in determining
whether a debt is worthless
o Where the surrounding circumstances indicate that a debt is worthless and uncollectible and
that the legal action to enforce payment would in all probability not result in the
satisfaction of execution on a judgment, a showing of those facts will be sufficient
evidence of worthlessness
In case of banks, BSP through the Monetary Board, shall ascertain worthlessness and
uncollectability of the bad debts
In no case may a receivable from an insurance or surety company be written-off from the TP's
books and claimed as bad debts deduction UNLESS such company has been declared closed due
to insolvency or any such similar reason by the Insurance Commissioner
Recovery of bad debt previously allowed as deduction shall be included as part of the TP's
gross income in the year of such recovery to the extent of the income tax benefit of said
deduction. Where the TP did not benefit from the deduction of said bad debt written-off, then
his subsequent recovery shall be treated as a mere recovery or a return of capital, hence, not
treated as a receipt of realized taxable income
In case the debt is secured, TP has to prove through clear and convincing evidence that the
securities are in fact worthless. This rule is not true in case of banks or trust companies
Case Phil. Refining Co. v. CA (May 8, 1996)
Fast Facts: TP was assessed by Commissioner to pay a deficiency tax. TP protested on the ground that it
was based on the erroneous disallowances of "bad debts" and "interest expense."
Doctrine:
For debts to be considered as "worthless," TP should show that:
o There is a valid and subsisting debt
o Debt must be actually ascertained to be worthless and uncollectible during the taxable
year
o Debt must be charged off during the taxable year
o Debt must arise from the business or trade of TP
o TP must also show that it is uncollectible even in the future
Steps to be undertaken by TP to prove that he exerted diligent efforts to collect debts:
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o Sending of statement of accounts
o Sending of collection letters
o Giving the account to a lawyer for collection
o Filing a collection case in court
TP did no satisfy the requirements of "worthlessness of a debt" as to the 13 accounts. The only
evidentiary support given by TP was the explanation or justification posited by its financial
adviser or accountant. Her allegations were not supported by any documentary evidence
CTA is competent to determine the issue of whether or not the debt is deductible through the
evidence presented before it
Case Fernandez Hermanos, Inc. v. CIR (Sept. 30, 1969)
Fast Facts: Controlling stockholders of TP Corp are also the controlling stockholders of Corp B, who
requested financial help from TP Corp to enable it to resume its mining operations. Request was readily
and unanimously approved by the BOD. Corp B continued to suffer losses. While TP Corp continued to
give advances, convinced that past advances could no longer be recovered, they decided to write off the
debt as worthless.
Doctrine:
In giving advances to Corp B, TP Corp did not expect to be repaid. Although testimonial evidence
was given, no documentary evidence was presented to show that there was an agreement that the
advances would be repaid.
The consideration for the advances was 15% of the net profits of Corp B which shows that if there
were no earnings or profits, there was no obligation to repay those advances. It has been held that
voluntary advances made without expectation of repayment do not result in deductible
losses.
In this case, there being no expectation of repayment, no bad debt could arise as there is no valid
and subsisting debt.
Even assuming arguendo that there is a valid and subsisting debt, it will still not be deductible in
1951 as worthless debt. Corp B was still in operation in 1951 and 1952. It has been held that if the
debtor corporation, although losing money or insolvent, was still operating at the end of the
taxable year, the debt is not considered worthless and therefore not deductible.
Based on the facts, the advances made by TP Corp to its 100% subsidiary, Corp B, were
investments and not loans
Neither deduction by corporations of losses actually sustained and charged off during the taxable
year nor deduction of bad debts actually ascertained to be worthless and charged off within the
taxable year can be partially written off, as what was sought to be done by TP Corp.
F. Depreciation Sec. 34(F)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
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(F) Depreciation
(1) General Rule. - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear
(including reasonable allowance for obsolescence) of property used in the trade or business. In the case of property held by one
person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner
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of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be
apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument
creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each.
(2) Use of Certain Methods and Rates. - The term "reasonable allowance" as used in the preceding paragraph shall include,
but not limited to, an allowance computed in accordance with rules and regulations prescribed by the Secretary of Finance,
upon recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method; (b) Declining-balance method, using a rate not exceeding twice the rate which would have been
used had the annual allowance been computed under the method described in Subsection (F) (1); (c) The sum-of-the-years-digit
method; and (d) any other method which may be prescribed by the Secretary of Finance upon recommendation of the
Commissioner.
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. - Where under rules and regulations prescribed by the
Secretary of Finance upon recommendation of the Commissioner, the taxpayer and the Commissioner have entered into an
agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon
shall be binding on both the taxpayer and the national Government in the absence of facts and circumstances not taken into
consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and
circumstances shall rest with the party initiating the modification. Any change in the agreed rate and useful life of the
depreciable property as specified in the agreement shall not be effective for taxable years prior to the taxable year in which
notice in writing by certified mail or registered mail is served by the party initiating such change to the other party to the
agreement: Provided, however, that where the taxpayer has adopted such useful life and depreciation rate for any depreciable
and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the
Commissioner or his duly authorized representatives, the aforesaid useful life and depreciation rate so adopted by the taxpayer
for the aforesaid depreciable asset shall be considered binding for purposes of this Subsection.
(4) Depreciation of Properties Used in Petroleum Operations. - An allowance for depreciation in respect of all properties
directly related to production of petroleum initially placed in service in a taxable year shall be allowed under the straight-line or
declining-balance method of depreciation at the option of the service contractor. However, if the service contractor initially
elects the declining-balance method, it may at any subsequent date, shift to the straight-line method.
The useful life of properties used in or related to production of petroleum shall be ten (10) years of such shorter life as may be
permitted by the Commissioner.
Properties not used directly in the production of petroleum shall be depreciated under the straight-line method on the basis of
an estimated useful life of five (5) years.
(5) Depreciation of Properties Used in Mining Operations. - an allowance for depreciation in respect of all properties used in
mining operations other than petroleum operations, shall be computed as follows:
(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or
(b) Depreciated over any number of years between five (5) years and the expected life if the latter is more than ten (10) years,
and the depreciation thereon allowed as deduction from taxable income: Provided, That the contractor notifies the
Commissioner at the beginning of the depreciation period which depreciation rate allowed by this Section will be used.
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or Resident Foreign Corporations. - In
the case of a nonresident alien individual engaged in trade or business or resident foreign corporation, a reasonable allowance
for the deterioration of Property arising out of its use or employment or its non-use in the business trade or profession shall be
permitted only when such property is located in the Philippines.
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! Valuation point-of-view decrease in value of assets through passage of time
! Financial reporting/tax point-of-view allocation of cost of asset to periods in which the asset is used
! Taxpayer cannot recover accumulated amount equivalent to more than the acquisition cost of the
property (see: Basilan Estates)
! Depreciation is a question of fact (see: Limpan Investments)
Case Basilan Estates, Inc. v. CIR (Sept. 5, 1967)
Fast Facts: TP claims deductions for the depreciation of its assets up to 1949 on the basis of their
acquisition cost. As of Jan. 1950, it changed the depreciable value of said assets by increasing it to
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conform to the increase in cost for their replacement. From 1950 to 1953, it deducted from gross income
the value of depreciation computed on the reappraised value. Commissioner found out that the reappraised
assets depreciated in 1953 were the same ones upon which depreciation was claimed in 1952. Thus
Commissioner assessed TP a deficiency income tax on unreasonable accumulated profits.
Doctrine:
Depreciation is the gradual diminution in the useful value of tangible property resulting from wear
and tear and normal obsolescence. The law permits the TP to recover gradually his capital
investment in wasting assets free from income tax.
The income tax law does not authorize the depreciation of an asset beyond its acquisition
cost. To allow TP to claim deductible depreciation of an asset in excess of its acquisition cost
would result not only the recovery of the capital invested in the asset, but also some profit. Hence,
a deduction over and above such cost cannot be claimed and allowed. Commissioner's disregard of
the depreciation is correct.
Case Limpan Investment Corp. v. CIR (July 26, 1966)
Fast Facts: BIR discovered that TP had undeclared its rental income and had claimed excessive
depreciation of its building. On the basis of these findings, commissioner assessed and demanded
payment of deficiency income tax and surcharge. TP sought reconsideration. The sole witness of TP, its
Sec-Tres, claimed that some of its buildings are old and out of style, hence are entitled to higher rates of
depreciation.
Doctrine:
Depreciation is a question of fact and is not measured by the theoretical yardstick, but should be
determined by a consideration of actual facts. Findings of the Tax Court in this respect should
not be disturbed when not shown to be arbitrary or in abuse of discretion and petitioner has not
shown any arbitrariness or abuse of discretion on the part of the Tax Court in finding that TP
claimed excessive depreciation in its returns.
Tax Court correctly applied rates of depreciation in accordance with Bulletin "F" of the U.S
Federal Internal Revenue Service, after whose Income Tax Law ours is patterned.
G. Depletion
Sec. 34(G)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
xxx
(G) Depletion of Oil and Gas Wells and Mines. -
(1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for depletion or amortization computed in
accordance with the cost-depletion method shall be granted under rules and regulations to be prescribed by the Secretary of
finance, upon recommendation of the Commissioner. Provided, That when the allowance for depletion shall equal the capital
invested no further allowance shall be granted: Provided, further, That after production in commercial quantities has
commenced, certain intangible exploration and development drilling costs: (a) shall be deductible in the year incurred if such
expenditures are incurred for non-producing wells and/or mines, or (b) shall be deductible in full in the year paid or incurred or
at the election of the taxpayer, may be capitalized and amortized if such expenditures incurred are for producing wells and/or
mines in the same contract area.
"Intangible costs in petroleum operations" refers to any cost incurred in petroleum operations which in itself has no salvage
value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum:
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Provided, That said costs shall not pertain to the acquisition or improvement of property of a character subject to the allowance
for depreciation except that the allowances for depreciation on such property shall be deductible under this Subsection.
Any intangible exploration, drilling and development expenses allowed as a deduction in computing taxable income during the
year shall not be taken into consideration in computing the adjusted cost basis for the purpose of computing allowable cost
depletion.
(2) Election to Deduct Exploration and Development Expenditures. - In computing taxable income from mining operations,
the taxpayer may at his option, deduct exploration and development expenditures accumulated as cost or adjusted basis for cost
depletion as of date of prospecting, as well as exploration and development expenditures paid or incurred during the taxable
year: Provided, That the amount deductible for exploration and development expenditures shall not exceed twenty-five percent
(25%) of the net income from mining operations computed without the benefit of any tax incentives under existing laws. The
actual exploration and development expenditures minus twenty-five percent (25%) of the net income from mining shall be
carried forward to the succeeding years until fully deducted.
The election by the taxpayer to deduct the exploration and development expenditures is irrevocable and shall be binding in
succeeding taxable years.
"Net income from mining operations", as used in this Subsection, shall mean gross income from operations less "allowable
deductions" which are necessary or related to mining operations. "Allowable deductions" shall include mining, milling and
marketing expenses, and depreciation of properties directly used in the mining operations. This paragraph shall not apply to
expenditures for the acquisition or improvement of property of a character which is subject to the allowance for depreciation.
In no case shall this paragraph apply with respect to amounts paid or incurred for the exploration and development of oil and
gas.
The term "exploration expenditures" means expenditures paid or incurred for the purpose of ascertaining the existence,
location, extent or quality of any deposit of ore or other mineral, and paid or incurred before the beginning of the development
stage of the mine or deposit.
The term "development expenditures" means expenditures paid or incurred during the development stage of the mine or other
natural deposits. The development stage of a mine or other natural deposit shall begin at the time when deposits of ore or other
minerals are shown to exist in sufficient commercial quantity and quality and shall end upon commencement of actual
commercial extraction.
(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien individual or Foreign Corporation. - In the
case of a nonresident alien individual engaged in trade or business in the Philippines or a resident foreign corporation,
allowance for depletion of oil and gas wells or mines under paragraph (1) of this Subsection shall be authorized only in respect
to oil and gas wells or mines located within the Philippines.
xxx
Case Consolidated Mines, Inc. v. CTA (Aug. 29, 1974)
Fast Facts: Examiners of the BIR reported that TP Corp had overcharged depletion and depreciation
expenses
Doctrine:
In computing net income there shall be allowed as deduction, in the case of mines, a reasonable
allowance for depletion not to exceed the market value in the mine of the product thereof which
has been mined and sold during the year for which the return is made
Formula:
o Cost of Mine Property / Estimated Ore Deposit = Rate of Depletion Per Unit of
product Mined and Sold
"Cost of Mine Property" consists of:
Mine cost
Expenses of development before production (subject of dispute)
"Estimated Ore Deposit"
Does not include those already broken up into numerous small pieces
and practically useless for mining purposes as the same could not increase
the ore potentials of TP's mines
Depletion is wholly a creation of the statue. Hence, the TP has the burden of justifying the
allowance of any deduction claimed. TP Corp relies on the testimony of its treasurer (also assistant
secretary) as proof of the amount spent for developing the mines. Also, indicated in a pre-war
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balance sheet are the purchase price of the mine and cost of developing it. TP Corp has not
explained in detail in the cost spent for developing the mine.
Even with the presentation of said balance sheet the Company would still have had to prove:
o That the person who made the entry did so in his professional capacity or in the
performance of a duty
o That the entry was made in the ordinary course of business or duty, meaning entries have
been made regularly in the management of the trade or business
o That the entry was made at or near the time of the transaction to which it related
o That the one who made it was in a position to know the facts stated in the entry
o That he is dead, outside the Philippines or unable to testify.
A balance sheet is a paper which shows a "summation or general balance of all accounts," but not
the particular items going to make up the several accounts. TP Corp would still need to present
proof to justify its adoption of the figure. It had the burden of establishing the components of the
cost spent for development.
What appears to be the cost of development in the pre-war balance sheet is actually the
depreciable and/or amortizable instead of depletable expenditure (P1,738,974.37). Commissioner
correctly assessed the cost at P131,878.44
H. Charitable and Other Contributions
Sec. 34(H)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
Xxx
(H) Charitable and other Contributions
(1) In General. - Contributions or gifts actually paid or made within the taxable year to, or for the use of the Government of the
Philippines or any of its agencies or any political subdivision thereof exclusively for public purposes, or to accredited domestic
corporation or associations organized and operated exclusively for religious, charitable, scientific, youth and sports
development, cultural or educational purposes or for the rehabilitation of veterans, or to social welfare institutions, or to non-
government organizations, in accordance with rules and regulations promulgated by the Secretary of finance, upon
recommendation of the Commissioner, no part of the net income of which inures to the benefit of any private stockholder or
individual in an amount not in excess of ten percent (10%) in the case of an individual, and five percent (%) in the case of a
corporation, of the taxpayer's taxable income derived from trade, business or profession as computed without the benefit of this
and the following subparagraphs.
(2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding subparagraph, donations to the
following institutions or entities shall be deductible in full;
(a) Donations to the Government. - Donations to the Government of the Philippines or to any of its agencies or political
subdivisions, including fully- owned government corporations, exclusively to finance, to provide for, or to be used in
undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and
in economic development according to a National Priority Plan determined by the National Economic and Development
Authority (NEDA), In consultation with appropriate government agencies, including its regional development councils and
private philantrophic persons and institutions: Provided, That any donation which is made to the Government or to any of its
agencies or political subdivisions not in accordance with the said annual priority plan shall be subject to the limitations
prescribed in paragraph (1) of this Subsection;
(b) Donations to Certain Foreign Institutions or International Organizations. - Donations to foreign institutions or
international organizations which are fully deductible in pursuance of or in compliance with agreements, treaties, or
commitments entered into by the Government of the Philippines and the foreign institutions or international organizations or in
pursuance of special laws;
(c) Donations to Accredited Nongovernment Organizations. - The term "nongovernment organization" means a non profit
domestic corporation:
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(1) Organized and operated exclusively for scientific, research, educational, character-building and youth and sports
development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income of
which inures to the benefit of any private individual;
(2) Which, not later than the 15th day of the third month after the close of the accredited nongovernment organizations taxable
year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the
purpose or function for which it is organized and operated, unless an extended period is granted by the Secretary of Finance in
accordance with the rules and regulations to be promulgated, upon recommendation of the Commissioner;
(3) The level of administrative expense of which shall, on an annual basis, conform with the rules and regulations to be
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, but in no case to exceed thirty percent
(30%) of the total expenses; and
(4) The assets of which, in the even of dissolution, would be distributed to another nonprofit domestic corporation organized
for similar purpose or purposes, or to the state for public purpose, or would be distributed by a court to another organization to
be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved
organization was organized.
Subject to such terms and conditions as may be prescribed by the Secretary of Finance, the term "utilization" means:
(i) Any amount in cash or in kind (including administrative expenses) paid or utilized to accomplish one or more purposes for
which the accredited nongovernment organization was created or organized.
(ii) Any amount paid to acquire an asset used (or held for use) directly in carrying out one or more purposes for which the
accredited nongovernment organization was created or organized.
An amount set aside for a specific project which comes within one or more purposes of the accredited nongovernment
organization may be treated as a utilization, but only if at the time such amount is set aside, the accredited nongovernment
organization has established to the satisfaction of the Commissioner that the amount will be paid for the specific project within
a period to be prescribed in rules and regulations to be promulgated by the Secretary of Finance, upon recommendation of the
Commissioner, but not to exceed five (5) years, and the project is one which can be better accomplished by setting aside such
amount than by immediate payment of funds.
(3) Valuation. - The amount of any charitable contribution of property other than money shall be based on the acquisition cost
of said property.
(4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if verified under the rules and
regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner.
! Three types that are deductible
o Donations to government
o Donations to certain accredited domestic corporations or associations, social welfare
institutions, or NGOs
o Donations to certain foreign institutions or international organizations
If not among the three aforementioned, not deductible
! Deductible in full or partially?
o Up to 10% of taxable income of individual taxpayer can be deducted
o Up to 5% of taxable income of corporate taxpayer can be deducted
Case BIR Rul. 19-01 (May 10, 2001)
Question: WON international organization with home offices based abroad are qualified to be granted
donee institution status
Answer:
Since the Tax Code of 1997 and Rev. Regs. No. 13-98 requires that a non-stock, non-profit
corporation or organization be created or organized under the PH Laws and that an NGO be a non-
profit domestic corporation, a foreign corporation, whether resident or non-resident, cannot
be accredited as donee institution
I. Research and Development
Sec. 34(I)
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ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income;
xxx
(I)Research and Developments
(1) In General. - a taxpayer may treat research or development expenditures which are paid or incurred by him during the
taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable
to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred.
(2) Amortization of Certain Research and Development Expenditures. - At the election of the taxpayer and in accordance
with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the
following research and development expenditures may be treated as deferred expenses:
(a) Paid or incurred by the taxpayer in connection with his trade, business or profession;
(b) Not treated as expenses under paragraph 91) hereof; and (c) Chargeable to capital account but not chargeable to property of
a character which is subject to depreciation or depletion.
In computing taxable income, such deferred expenses shall be allowed as deduction ratably distributed over a period of not less
than sixty (60) months as may be elected by the taxpayer (beginning with the month in which the taxpayer first realizes benefits
from such expenditures).
The election provided by paragraph (2) hereof may be made for any taxable year beginning after the effectivity of this Code,
but only if made not later than the time prescribed by law for filing the return for such taxable year. The method so elected, and
the period selected by the taxpayer, shall be adhered to in computing taxable income for the taxable year for which the election
is made and for all subsequent taxable years unless with the approval of the Commissioner, a change to a different method is
authorized with respect to a part or all of such expenditures. The election shall not apply to any expenditure paid or incurred
during any taxable year for which the taxpayer makes the election.
(3) Limitations on Deduction. - This Subsection shall not apply to:
(a) Any expenditure for the acquisition or improvement of land, or for the improvement of property to be used in connection
with research and development of a character which is subject to depreciation and depletion; and (b) Any expenditure paid or
incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral,
ncluding oil or gas.
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide for the payment of reasonable
pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year
to cover the pension liability accruing during the year, allowed as a deduction under Subsection (A) (1) of this Section ) a
reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such
amount (1) has not theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a period of ten (10)
consecutive years beginning with the year in which the transfer or payment is made.
(K) Additional Requirements for Deductibility of Certain Payments. - Any amount paid or payable which is otherwise
deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed
under this Section, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld
therefrom has been paid to the Bureau of Internal Revenue in accordance with this Section 58 and 81 of this Code.
(L) Optional Standard Deduction. - In lieu of the deductions allowed under the preceding Subsections, an individual subject to
tax under Section 24, other than a nonresident alien, may elect a standard deduction in an amount not exceeding ten percent
(10%) of his gross income. Unless the taxpayer signifies in his return his intention to elect the optional standard deduction, he
shall be considered as having availed himself of the deductions allowed in the preceding Subsections. Such election when made
in the return shall be irrevocable for the taxable year for which the return is made: Provided, That an individual who is entitled
to and claimed for the optional standard deduction shall not be required to submit with his tax return such financial statements
otherwise required under this Code: Provided, further, That except when the Commissioner otherwise permits, the said
individual shall keep such records pertaining to his gross income during the taxable year, as may be required by the rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
xxx
Case 3M Phil., Inc. v. CIR (Sept. 26, 1988)
Fast Facts: TP Corp, a subsidiary of a non-resident Foreign Corp, is the exclusive importer, manufacturer,
wholesaler, and distributor in the PH of all products of the Foreign Corp. TP Corp entered into a "Service
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Information and Technical Assistance Agreement" and a "Patent and Trademark License Agreement" Exclusion Deductions
under which TP Corp agreed to pay Foreign Corp a technical service fee of 3% and a royalty of 2% of its They do not form part of your income, as such will They are legislative graces, they constitute what
net sales. TP Corp sought deductions as royalties and technical service (allowed for locally manufactured not be taxable as part of your gross income, strict can be deducted from the gross income to arrive at
products but disallowed on finished products imported) and pre-operational cost (allowed 1/5 of TP construction against the State the net income, strictly construed against the
Corp's capital expenditure because such expenditure should be amortized) taxpayer

Doctrine:
Because remittances to foreign licensors of technical service fees and royalties are made in foreign
exchange, CB Circular No. 393 (Regulations Governing Royalties/Rentals) was as an exchange Optional standard deduction (OSD)
control regulation to conserve foreign exchange and avoid unnecessary drain on the country's ! Itemized deductions need to be substantiated
international reserves ! TP has the option to use OSD instead
Royalties shall be paid only on commodities manufactured by the licensee under the royalty o Individual taxpayer (Section 24) 40% of gross sales/receipts
agreement. No royalty is payable on the wholesale price of finished products imported by the o Corporate taxpayer (Section 24(A) or 28(A)(1)) 40% of gross income
licensee from the licensor. ! Straight payment
Although the Tax Code allows payment of royalty to be deducted from gross income as business ! No need for substantiation
expenses, it is CB Circular that defines what royalty payments are proper. Hence, improper o Taxpayer not required to submit audited financial reports/statements
payments of royalty are not deductible as legitimate business expenses. ! If itemized deductions do not exceed 40%, choose OSD
o Otherwise, choose itemized deductions
J. Pension Trusts ! Companies or individuals with big profit margins usually choose OSD
Sec. 34(J)
ALLOWABLE DEDUCTIONS
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services
rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under
V. TAXABLE INCOME
subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and Sec. 31
(C); and 28 (A) (1), there shall be allowed the following deductions from gross income; SEC. 31. Taxable Income Defined. - The term taxable income means the pertinent items of gross income specified in this
xxx Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide for the payment of reasonable or other special laws.
pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year
to cover the pension liability accruing during the year, allowed as a deduction under Subsection (A) (1) of this Section ) a
reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such VI. GENERAL PRINCIPLES OF INCOME TAXATION
amount (1) has not theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a period of ten (10) Sec. 23
consecutive years beginning with the year in which the transfer or payment is made. SEC. 23. General Principles of Income Taxation in the Philippines. - Except when otherwise provided in this Code:
xxx (A) A citizen of the Philippines residing therein is taxable on all income derived from sources within and without the
Philippines;
! Tax consequence of employer (as compared to retirement benefits as exclusions for employees) (B) A nonresident citizen is taxable only on income derived from sources within the Philippines;
! Based on a reasonable private benefit plan (C) An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker is
o Treated as ordinary and necessary expenses of the business taxable only on income derived from sources within the Philippines: Provided, That a seaman who is a citizen of the
o See: definition of benefit plan Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged
o See: definition of contribution plan exclusively in international trade shall be treated as an overseas contract worker;
(D) An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from sources within the
Employer matches contribution with the employee
Philippines;
! Annual contribution cost deductible in full (E) A domestic corporation is taxable on all income derived from sources within and without the Philippines; and
! Prior service cost deductible but amortized in 10 years (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived
from sources within the Philippines.
K. Additional Requirements for Deductibility

! Section 34 (K) as an additional requirement for deductibility VII. VII. INCOME TAX ON INDIVIDUALS
o Deduction will be disallowed if taxpayer fails to withhold certain taxes and remit to the BIR A. Definitions
1. Resident Citizens and Resident Aliens
Bello on Exclusion vs Deduction:
Sec. 22(F)

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SEC. 22. Definitions - When used in this Title:
xxx
(F) The term "resident alien" means an individual whose residence is within the Philippines and who is not a citizen thereof.
xxx
Sec. 5, Rev. Regs. 2
SECTION 5. Definition. A "non-resident alien individual" means an individual
(a) Whose residence is not within the Philippines; and
(b) Who is not a citizen of the Philippines.
An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for purposes
of the income tax. Whether he is a transient or not is determined by his intentions with regard to the length and nature of his
stay. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient. If
he lives in the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the Philippines for a
definite purpose which in its nature may be promptly accomplished is a transient. But if his purpose is of such a nature that an
extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the
Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose
for which he came has been consummated or abandoned.
A "non-resident alien individual" means an individual
- Whose residence is not within the Philippines; and
- Who is not a citizen of the Philippines.
An alien is a resident of the Philippines for income tax purposes if:
- He is actually present in the Philippines and is not a mere transient or sojourner
Whether he is a transient or not is determined by his intentions with regard to the
length and nature of his stay.
A mere floating intention indefinite as to time, to return to another country is not
sufficient to constitute him a transient.
- If he lives in the Philippines and has no definite intention as to his stay
One who comes to the Philippines for a definite purpose which in its nature may be promptly
accomplished is a transient
- But if his purpose is of such a nature that an extended stay may be necessary for its
accomplishment, and to that end the alien makes his home temporarily in the Philippines, he
becomes a resident, though it may be his intention at all times to return to his domicile abroad
when the purpose for which he came has been consummated or abandoned.
Case Garrison v. CA (July 19, 1990)
Fast Facts: All six petitioners are US citizens who entered this country under the Philippine Immigration
Act. They are born in the Philippines, repatriated temporarily to the US, returned to the Philippines, and
are presently residing here by virtue of their employment in the US Naval Base in Olongapo City.
Because of the income they earned, the BIR informed them of their failur to file their respective income
tax returns as required by the NIRC. TThey claimed that: (1) they are not resident aliens but only special
temporary visitors because of the Philippine Immigration Act and (2) they are exempted from filing the
return by virtue of the US-RP Military Bases Agreement (MBA).
Doctrine: All petitioners comply with requirements under the MBA in order to be exempt from paying
income tax in the Philippines. However, the MBA speaks of an exemption from the payment of income
tax, not from the filing of income tax returns. The petitioners contend that there is no logic in requiring
them to file income tax returns when in the end they cannot be required to pay for it. But filing is
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necessary because their exemption from payment of income tax is not absolute. According to the MBA,
the exemption is only as regards income derived from the employment in the Philippines in connection
with construction, maintenance, operation or defense of the base. The exemption does not apply in respect
of other income derived from Philippine sources or sources other than US sources. From these sources,
being resident aliens, the petitioners are legally bound to pay tax.
Transients vs Resident Aliens
Transient - comes to the Philippines for a definite purpose; it is determined by intentions with regard to
length and nature of stay; IS NOT TAXED
Resident alien if his purpose is of such a nature that an extended stay may be necessary to its
accomplishment, and to that end the alien makes his home temporarily in the Philippines, he becomes a
resident, though it may be his intention at all times to return to his domicile abroad; IS TAXED
!
Case!!Ramnani!v.!CIR,!CTA!Case!No.!5108!(Sept.!13,!1996)!
Fast!Facts:!Sps!Ishwar!and!Sonya!Ramnani!were!parties!in!several!cases.!The!adverse!party!that!the!
spouses!went!against,!as!payors!of!the!said!money!judgment,!requested!that!the!CIR!make!a!
clarificatory!ruling!with!regard!to!the!tax!implications!of!such!payment!made!by!them!to!the!
spouses.!The!tax!authorities!then!wanted!to!consider!the!money!judgment!rendered!by!the!RTC!as!
subject!to!income!tax.!The!Sps!Ramnani!contend!that!they!are!resident!aliens!and!hence,!the!money!
judgment!issued!in!their!favor!should!not!be!subject!to!tax.!
Doctrine: Ramnani is a resident alien. The establishment of a home even temporarily here in the
Philippines for the accomplishment of a purpose, even if he has the intention to return to his domicile
abroad,categorizes an individual as a resident.
Being a resident alien, Ramnani is required to file his income tax return declaring therein the income
awarded to him by the Court's judgment, amounting to Php57M in the year he received such income. But
the amount of Php57M should still be subject to allowable deductions, either itemized or optional
standard deductions (40%), personal and additional exemptions if any. This final output shall be the net
taxable income subject to the income tax of the resident alien.
2. Non-Resident Citizens
Sec. 22(E)
SEC. 22. Definitions - When used in this Title:
xxx
(E) The term "nonresident citizen" means:
(1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad
with a definite intention to reside therein.
(2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or
for employment on a permanent basis.
(3) A citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be
physically present abroad most of the time during the taxable year.
(4) A citizen who has been previously considered as nonresident citizen and who arrives in the Philippines at any time during
the taxable year to reside permanently in
percentage
the Philippines shall likewise be treated as a nonresident citizen for the taxable year in which he arrives in the Philippines with
respect to his income derived from sources abroad until the date of his arrival in the Philippines.
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(5) The taxpayer shall submit proof to the Commissioner to show his intention of leaving the Philippines to reside permanently "The additional exemption for dependents shall be claimed by only one of the spouses in the case of married individuals.
abroad or to return to and reside in the Philippines as the case may be for purpose of this Section. "In the case of legally separated spouses, additional exemptions may be claimed only by the spouse who has custody of the
xxx child or children:
Provided, That the total amount of additional exemptions that may be claimed by both shall not exceed the maximum
Rev. Regs. 1-79 (Jan. 8, 1979) additional exemptions herein allowed.
"For purposes of this Subsection, a "dependent" means a legitimate, illegitimate or legally adopted child chiefly dependent
upon and living with the taxpayer if such dependent is not more than twenty-one (21) years of age, unmarried and not gainfully
Rev. Regs. 5-01 (July 31, 2001) employed or if such dependent, regardless of age, is incapable of self-support because of mental or physical defect.
xxx
Case BIR Rul. No. 33-00 (Sept. 5, 2000)
Fast facts: With the Comprehensive Tax Reform Program, there was a question as to the status of the 5. Minimum Wage Earner
income tax liability of employees overseas for less than 183 days. Sec. 22(HH), as inserted by Rep. Act No. 9504
SEC. 22. Definitions. - when used in this Title:
Doctrine: For purposes of exemption from income tax, a citizen must be deriving foreign-sources income xxx
for being a non-resident citizen or for being an OCW. All employees whose services are rendered abroad (HH) the term 'minimum wage earner' shall refer to a worker in the private sector paid the statutory minimum wage, or to an
employee in the public sector with compensation income of not more than the statutory minimum wage in the non-agricultural
for being seconded or assigned overseas for at least 183 days (which qualifies as most of the time) may
sector where he/she is assigned.
fall under the first category and are exempt from payment of Philippine income tax. xxx

The same exemption applies to an OCW but as such worker, the time spent abroad is not material for tax
exemption purposes. All that is required is for the worker's employment contract to pass through and be
registered with the POEA. Thus their income is exempt from taxes.

3. Non-Resident Aliens Engaged/not Engaged in Trade or Business in the Philippines

Sec. 22(G)
SEC. 22. Definitions - When used in this Title:
xxx
(G) The term "nonresident alien" means an individual whose residence is not within the Philippines and who is not a citizen
thereof.
xxx

Secs. 5 and 6, Rev. Regs. 2

SECTION 5. Definition. A "non-resident alien individual" means an individual
(a) Whose residence is not within the Philippines; and
(b) Who is not a citizen of the Philippines.
An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for purposes
of the income tax. Whether he is a transient or not is determined by his intentions with regard to the length and nature of his
stay. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient. If
he lives in the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the Philippines for a
definite purpose which in its nature may be promptly accomplished is a transient. But if his purpose is of such a nature that an
extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the
Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose
for which he came has been consummated or abandoned.
SECTION 6. Loss of residence by alien. An alien who has acquired residence in the Philippines retains his status as a
resident until he abandons the same and actually departs from the Philippines. An intention to change his residence does not
change his status as a resident alien to that of a nonresident alien. Thus an alien who has acquired a residence in the Philippines
is taxable as a resident for the remainder of his stay in the Philippines.
4. Dependent
Sec. 35(B), as amended by Rep. Act No. 9504
SEC. 35. Allowance of Personal Exemption for Individual Taxpayer. -
xxx
(B) Additional Exemption for Dependents. - There shall be allowed an additional exemption of Twenty-five thousand pesos
(25,000) for each dependent not exceeding four (4).

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