Tax 1 Midterm Reviewer Bello

TAXATION
1 ATTY. BELLO ALC D 2017

Evolve a progressive system of taxation resort to indirect taxes

I. INTRODUCTION AND GENERAL PRINCIPLES
should be minimized but not avoided entirely
5. Imposed by the State on persons, property or services within its jurisdiction
A. GENERAL PRINCIPLES 6. Levied for a public purpose
It is the primarily a civil liability but non-payment thereof creates a
Taxation - Power by which the sovereign through its law-making body, raises revenue to criminal liability
defray the necessary expenses of the government Importance of Taxes
Taxation is the lifeblood of the government so they should be calculated w/out
- As a symbiotic relationship: in exchange for the protection of that the citizens get from necessary hindrance; thus, taxes should be paid and collected without delay
the Government, taxes are paid Primary purpose is to generate funds for the state to finance the needs of the
o Rationale: Taxes are what we pay for civilized society and w/out it, citizenry and to advance common weal
the government will be paralyzed
o This theory dispels the erroneous notion that it is an arbitrary Taxes, personal to taxpayer
method of exaction by those in the seat of power Corporations delinquency cannot be enforced against its stockholders
Stockholders may be held liable for unpaid taxes of a dissolved corporation if it
Taxes - Enforced proportional contributions from persons and property levied by the appears that the corporate assets have been passed into their hands
law-making body of the State by virtue of its sovereignty for the supports of the Estate taxes must be paid out of the estate and cannot be enforced against the
government and for public needs. heirs

Exception: if properties have already been distributed to the beneficiaries prior
Characteristics of Taxation
payment of the state tax due, beneficiaries shall be subsidiarily liable

Enforced Nature of the taxing power
Proportionate Contribution It is an attribute of sovereignty and inherent in the State
Levied by the legislature Unlimited in its range, acknowledging in its very nature no limits, so that
Within taxing jurisdiction security against its abuse is to be found only in the responsibility of the
o Nationality legislature which imposes the tax on the constituency who are to pay it
o Residence An awesome power that must not be exercised arbitrarily
o Source (territoriality)
Power emanating from necessity preservation of States sovereignty
Personal in nature Not granted by the Constitution
Primary purpose is to raise revenue
Legislative in character

Attributes/Characteristics of Taxes (Aban)
Purpose and Objectives of Taxation
1. As a forced charge, imposition or contribution it operates in invitum
1. Primary to raise revenues fir the support of the govt
It is in no way dependent on the will or contractual assent, express or 2. Secondary
implied, of the taxpayer
a. Regulation: Illustrated in the case of taxes levied on excises or
They are also not contracts but positive acts of the government
privileges or for the rehabilitation and stabilization of threated
2. As a pecuniary burden payable in money
industries
A tax is not necessarily confined to those payable in money

E.g. backpay certificates under RA 304 could be used as payment of
TIO v. VIDEOGRAM REGULATORY BOARD, 151 SCRA 208 (1987)
taxes
PD 1987 (Act Creating the VRB) imposes 30% tax on sales. Videogram operators
3. As creations by law
assail the constitutionality of the said provision claiming that the said tax imposed
4. Assessed in accordance w/ some reasonable rule of apportionment
is harsh, confiscatory, oppressive and/or unlawful and is a restraint on trade. Court
Progressive so based on ability to pay
upheld its constitutionality.
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TAXATION 1 ATTY. BELLO ALC D 2017

30% tax on sale, lease or disposition of videograms is for a public purpose. Taxation correlation with the lifeblood theory.
could be a tool to implement the States public power. Tax was imposed primarily Without revenue raised from taxation, the government will not survive, resulting in
to answer the need to regulate the video industry due in part to rampant film detriment to society. Without taxes, the government would be paralyzed for lack of
piracy, violation of IP rights and proliferation of porn. motive power to activate and operate it.
A tax does not cease to be valid merely because it regulates, discourages or even
definitely deters the activities taxed. 2. Necessity Theory: The existence of government is a necessity that it cannot
continue w/out the means to pay its expenses so it has the right to compel all
b. Promotion of General Welfare: E.g. for strengthening industries citizens and property within its limits to contribute.
3. The Benefits-Protection Theory
LUTZ v. ARANETA, 98 PHIL. 148 (1955) So called Symbiotic Relationship theory
Petitioners in this case assail the legality of taxes imposed by CA 567 (Sugar Reciprocal duties of protection and support between State and
Adjustment Act). Lutz, Judicial Administrator of Ledesmas estate goes to court to inhabitants
recover from CIR taxes paid on the ground that the said tax is unconstitutional for Inhabitants pay taxes and in return receive benefits and protection from
being levied exclusively for the benefit of the sugar industry; thus, there is no public the State
purpose to speak of. 4. Jurisdiction over subject and object
Tax collected on land devoted to cultivation of sugar cane, which tax shall accrue The person or property taxed must be within the competent authoritys
exclusively and for the aid and support of the sugar industry, is valid. Tax levied taxing jurisdiction
with a regulatory purpose, to provide means for the rehabilitation and stabilization o Situs, source or territoriality (location of economic activity,
of the threatened sugar industry. Since sugar production is one of the great location of property, source of income)
industries of the nation, its promotion, protection and advancement therefore o Citizenship
redounds greatly to the general welfare. o Residence
The protection of a large industry constituting one of the great sources of the
states wealth and therefore directly of indirectly affecting the welfare of so great a Scope of the Legislative Taxing Power
portion of the population of the State is affected to such extent by public interests 1. Person, property or occupation to be taxed
as to be within the police power of the sovereign 2. Amount or rate of the tax
3. Purposes for which taxes shall be levied (public purposes)
c. Reduction of Social Inequality: Made possible by progressivity 4. Kind of tax to be collected
those who are able to pay should shoulder the bigger portion of the 5. Apportionment of the tax
tax burden 6. Situs of taxation
d. Encourage Economic Growth: Tax exemptions and tax reliefs are 7. Method of collection
granted as incentives or exemptions in order to encourage
investments and thereby promote economic growth Is the power to tax the power to destroy?
e. Protectionism: E.g. Taxes like protective tariffs and customs duties Power to tax involves the power to destroy but this principles is pertinent only
when there is no power to tax a particularly subject and has no relation to a
Theory and Basis of Taxation case where such right to tax exists
This principles does not refer to the purposes for which taxing power may be
1. Lifeblood theory: used but to the degree of vigor with which the taxing power may be employed
in order to raise revenue
COMMISSIONER OF INTERNAL REVENUE v. ALGUE, 241 Phil. 829 (1988)
Algue declared in his income tax return promotional fees as expenses that are Constitutional Restrains Re: Taxation is the power to destroy
deductible to his gross income. CIR disallowed the deduction but Algue was able to The power to tax is unlimited because a legislative body having the power to
prove that such was a legitimate expense that is necessary and reasonable. tax a certain subject matter actually imposes such a burdensome tax as
The burden is on the taxpayer to prove that validity of a claimed deduction, in effectually destroy the right to perform the act or to use the property subject
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to the tax, the validity of the enactment depends upon the nature and Power of Taxation Compared with Other State Powers
character of the right to destroy. Taxation Eminent Domain Police Power
The power to tax is not the power to destroy in accordance with constitutional Purpose To support govt For public use Promote general
restrains welfare, public
It must be used justly and not treacherously health, public
Power of Judicial Review in Taxation morals and public
Courts cannot acquire into the wisdom of a taxing act safety
As long as the legislature does not violate applicable constitutional limitations, Compensation Protection and Just compensation Maintenance for
courts have no concern with the wisdom or policy of the exaction, the political benefits received public order
or other collateral motives behind it, the amount to be raised or the persons, from govt
property or other privileges to be taxed. Persons Operate upon a Operates on individual Operate upon a
Courts power in taxation is limited only to the application and interpretation Affected community or a class property owner community or a
of the law of individuals class of individuals
This principles of judicial non-interference also extends into the administration Authority w/c Exercised only by the May be exercised by Exercised only by
realm exercises govt or its political public services the govt or its
power subdivisions corporation or public political subdivisions
Aspects of Taxation utilities if granted by
1. Levy - a legislative power which includes the determination of persons, law
property or excises to be taxed, the sum or sums to be raised, the due date Amount of Generally no limit to No imposition; rather Limited to cost of
thereof and the time and manner of levying and collecting taxes imposition the amount of tax it is the property regulation
2. Collection manner or enforcement of the obligation on the part of those who that may be imposed owner of who will be
are taxed paid just
compensation
Basic Principles of Sound Tax System
1. Theoretical Justice
Principles mandate that taxes must be just, reasonable and fair Taxes Distinguished From Other Impositions
Taxation must be based on TPs ability to pay (progressive)
Violation of this principle could result in unconstitutionality of the tax Toll Toll is a demand of ownership; tax is a
imposition (under the Constitution, taxes shall be uniform and equitable) demand of sovereignty
2. Fiscal adequacy Penalty Tax is a civil liability and it only becomes a
Sources of government revenue should be sufficient to meet government criminal liability when there is non-
expenditures and other public needs payment; penalty is a punishment for the
Even if the tax law fails to observe this principle, in that tax proceeds are commission of a crime
insufficient to meet spending, the tax law is still valid Compromise or compromise penalty An amount collected as a compromise in
3. Administrative Feasibility cases involving violations of the Tax code,
Should be capable of being effectively enforced rules or regulations. It cannot be imposed
Tax laws should close loopholes for tax evasion and deter corruption of by the commissioner
tax officials Special assessment 1) levied only on a land 2) cannot be made
No law requiring compliance with this principle a personal liability 3) based wholly on a
benefit and 4) is exceptional both as to
time and locality; tax exemptions under
Sec. 28(3) of Art VI of the Constitution do
not apply to special assessments; LGC
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provides that SAs do not apply to Tribute Synonymous with tax but. Implied as
properties exempt from the basic real something from the government to some
property tax under Sec. 234 form of sovereignty
License fee a) License fee emanates from the Impost In the general sense, it signifies any tax,
police power; taxation is a power tribute or duty; in the limited sense, it
b) Purpose is to regulate not to means a duty on imported goods and
raise revenue merchandise
c) Amount of exaction or charge
*motor vehicle registration was ruled to Classification of Taxes
be a tax because such was collected for Personal Tax Also known as capitation or poll
the construction and maintenance of Taxes of a fixed amount upon al persons of a certain class
highways plus expenses of LTO within the jurisdiction of the taxing power w/out regard to
**3 kinds of licenses: the amount of their property or the occupations or
1) licenses for the regulation of businesses which they may be engaged
useful occupations Property Tax Assessed on all property or all property of certain class within
2) licenses for the regulation or the jurisdiction of the taxing power
restriction of non-useful e.g. real property tax
occupations or enterprises Direct Tax Taxes wherein both the incidence of or liability for the
3) licenses for revenue only payment of the tax as well as the impact or burden of the tax
Margin Fee Not a tax but a currency measure designed falls on the same person
to stabilize the currency such as the E.g. income tax where the person subject to tax cannot shift
exaction of a certain fee under RA 2069 on the burden of the tax to another person -> estate and donors
the remittance of profits earned in the gift taxes
country
Indirect Tax Taxes within the incidence of or the liability of the payment
Debt Debt is an obligation that is created by
of the tax falls on one person, but the burden thereof can be
contract while tax is imposed by law. Thus,
shifted or passes on to another person
taxes cannot be set-off or compensated
E.g. sales tax (VAT)
under the Civil Code.
When the seller passes on the burden to the buyer, it is not
Regulatory Fees An exaction may both be a tax and a
against the rule that provides that taxes are personal
regulatory fee. (Tio v. Videogram)
liabilities so payment thereof cannot be transferred. He is
Subsidy A subsidy is a legislative grant of money in
only shifting the tax burden and not the liability to pay it to
aid of private enterprise deemed to
the purchaser as part of the cost of the goods or services sold
promote public welfare. It is not tax
a) When consumer or end-user is tax exempt, such exemption
although it may be necessary to raise the
covers only those which he is directly liable; hence, he cannot
money to pay the subsidy by means of a
claim for exemption for the payment of sales tax or refund
tax. Subsidies are sometimes given in lieu
such tax passed on to him
of tax exemptions.
b) When the transaction itself is the one that is tax-exempt but
Custom duties and fees They are taxes but charged upon through error seller pays the tax and shifts it to the buyer, he
commodities on their being seller gets the refund but he must hold it in trust for the
imported/exported but tax is a broader buyer
term which includes other taxes as well c) When the exemption from the indirect tax is given to the
Revenue It is a broad term and it includes not only contractee but the evident intention is to exempt the
taxes but other incomes as well contractor so that such contractor may no longer shift or pass
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on any tax on the contractee, the contractor may claim tax Taxpayers Suit
exemption on the transaction
d) When a it is the intention of the law to exempt an indirect The taxpayer has the right to file an action questioning the validity or
tax, the buyer has the right to be reimbursed the amount of constitutionality of a statute or law on the theory that the expenditure of
the taxes the sellers passed to him public funds by an officer or the Government for the purpose of administering
Excise Tax Laid upon the manufacture, sale or consumption of or implementing an unconstitutional or invalid law constitutes a misapplication
commodities or even upon licenses to purse certain of such funds
occupations and upon corporate privileges A duly elected Senator and taxpayer has the legal capacity to file an action
General Tax Levied for the general or ordinary purposes of the questioning the legality of a claimed refund of indirect taxes (Maceda v.
government. Macaraig)
E.g. internal revenue taxes A derivative or representative suit filed by a group of taxpayers who are
Special Tax Taxes levied for special purposes also concilors of a city where it appeared that there was an illegal
E.g. additional 1% real estate tax levied under RA 5447 for the disbursement of public funds emanating from such taxes was held valid (City
benefit of the public school system Council of Cebu City v. Cuizon et al.)
All money collected on any tax levied for a special purpose In order to justify such suit, public funds should be involved so an action will
shall be treated as a special fund and paid out for such fail if what are alleged to be illegally disposed are objects which were acquired
purpose only from private sources (Joya et al v. PCGG et al)
Specific Tax A tax imposed on specific sum by the hear or number or by
some standard or weight or measurement and which requires B. LIMITATIONS ON TAXING POWER
no assessment beyond a listing and classification of the 1. Inherent Limitations on Taxing Power
subject to be taxed They proceed from the very nature of the taxing power itself
E.g. alcohol, tobacco Such limitations exist whether declared or not declared in the written
Ad Valorem Tax upon the value of the article or thing subject to taxation constitution
Tax a. Public purpose of taxes
E.g. real property tax
o Legislature is without the power to appropriate revenues for
Custom Duty sometimes used in the general sense as synonymous
anything but for public purposes
Duties with tax
o Public money can only be spent for a public purpose
Duties charged upon commodities imported/exported
o Tests:
National Tax Taxes levied by the national government WoN thing to be furthered by the appropriation of public
Local governments have a just share in these taxes which are revenue is something which is the duty to the state as a
automatically released to them government to provide
Local Tax Levied by LGUs subject to guidelines and limitations provided WoN the proceeds of the tax will directly promote the
by the Congress welfare of the community in equal measure
Progressive Taxes imposed whereby the rate or amount of tax increases o E.g. infrastructure, charity, self-help projects for the destitutes,
Tax as the amount of income or earning to be taxed increases tax levied for the upliftment of the sugar industry
Regressive Taxes whereby the tax rate decreases as the amount of b. Inherently legislative
Tax income or earning to be taxed increases o To whom can be delegated:
Proportionate Tax based on a fix proportion of the value of the subject being i. President
Tax taxed Authorization of President to fix
E.g. real estate tax which is a fixed proportion of the value of a. Tariff rates
the property assessed b. Improt and export quotas
c. Tonnage an wharfage dues

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d. Other duties and imposts within the development o Manner of paying taxes
program of the Government o Etc.
Flexible tariff clause (Sec. 401 TCCP): in the interest of o What cannot be delegated:
national economy, general welfare and/or national Selection of property to be taxed
security, the President upon the recommendation of Determination of the purposes for which taxes shall be
the NEDA is empowered: levied
o To increase, reduce or remove existing Fixing of the rate of taxation
protective rates of import duty, provided that Rules of taxation in general
the increase should not be higher than 100% c. Territoriality or situs of taxation
ad valorem o Situs Principle in General place of taxation
o To establish import quota or to ban imports of o The State where the subject to be taxed has a situs may
any commodity rightfully levy and collect the tax.
o To impose additional duty on all imports, not Exceptions
exceeding 10% ad valorem - Where the tax laws operate outside the territorial
ii. LGUs each LGU has the power to create its own revenue jurisdiction of the taxing state e.g. taxation of
and levy taxes, fees and charges subject to such guidelines resident citizens on their foreign source income
and limitations as the Congress may provide (Art X, Sec 5, - Where tax laws do not operate within the territorial
1987 Constitution) jurisdiction e.g. waiver of taxing jurisdiction via treaty
or international comity
MACTAN INTL AIRPORT AUTHORITY v. MARCOS, 261 SCRA 667 (1996) o Situs of income tax
City of Cebu tries to collect from MCIAA claiming that the latter is a GOCC so its tax Domiciliary theory based on residence
exemption was already removed by the LGC. Nevertheless, Court ruled in favor of Nationality theory based on citizenship
MCIAA emphasizing the fact that the power of LGUs to tax is limited and subject to Source rule where the activity that produced the
guidelines. income took place
The power to tax is primarily vested in Congress; however, in our jurisdiction, it o Situs of property taxes
may be exercised by local legislative bodies, no longer by virtue of a valid Real property lex rei situs or where the property is
delegation as before, but pursuant to direct authority conferred by Sec. 5, Art X of located
the Constitution. Under the latter, the exercise of the power may be subject to such Personal Property mobilia sequntur personam or
guidelines and limitations as the Congress may provide which, however, must be where movable follows owner; movables follow
consistent with the basic policy of local autonomy. domicile of the owner
Currently, Titles I (Local Taxation) and II (RPT) of Book II, LGC of 1991 prescribe the d. Exemption of the Government from Taxes
guidelines and limitations of local taxing power o Government cannot tax itself
o Sec.32(B)(7)(b): income derived from any public utility or
iii. Administrative Agencies from the exercise of any essential government function
For the delegation to be valid, the law must be accruing to the Government of the Philippines or to any
complete in itself and must set forth the sufficient political subdivision thereof
standards e. International comity
Examples: Sec. 244 of the NIRC authorizes the SOF o Harmonious and productive relationships among the various
upon recommendation of the CIR, to promulgate states should be maintained
needful rules and regulations for the effective o Certain representatives of foreign states stationed and
enforcement of the NIRC property of such foreign states found within our territory be
o Manner n which returns, information and exempted from taxation from taxation
reports is prepared and reported o Sec. 159 of LGC: Diplomatic and consular representatives
are exempted from community tax
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Service Contract under SC 38 is a contractual tax exemption granted by the

2. Constitutional Limitations on Taxing Power government in exchange for a valid and material consideration obtained by the
government in exchange for granting SC 38 the right to be exempt from all taxes
Constitutional Provisions directly affecting taxation except income tax. Such contact is protected by the non-impairment clause of the
a) Prohibition against imprisonment for non-payment of poll tax Constitution.
b) Uniformity and equality of taxation Tax exemptions granted by government in contracts vs. tax exemptions contained
- All taxable articles or kinds of property of the same class shall be taxed at the special franchises: A franchise partake the nature of a grant which is beyond the
same rate purview of the non-impairment clause of the Constitution. Thus, contractual tax
c) Grant by Congress of authority to the President to impose tariff rates exemptions are subject to the NIC of the Constitution while tax exemptions granted
d) Prohibition against taxation of religious, charitable entities, and educational under legislative franchises are no.
entities
e) Prohibition against taxation of non-stock, non-profit institutions
f) Majority vote of Congress for grant of tax exemption C. DOUBLE TAXATION
g) Prohibition on use of tax levied for special purpose
h) Presidents veto power on appropriations, revenues, tariff bills Double Taxation Taxing the same property twice when it should be taxed but once OR
i) Non-impairment of jurisdiction of the SC taxing the same person twice by the same jurisdiction over the same thing
- The Supreme Court has the right to review, revise, reverse, modify or affirm
on appeal or certiorari final judgments and order of lower courts in all cases No prohibition against double taxation
involving the legality of any tax, impost, assessment or toll, or any penalty It is something not favored but nevertheless permissible
imposed in relation thereto Not forbidden by our fundamental law
j) Grant of power to the LGUs to create its own source of revenues
k) Flexible tariff clause Requisites of double taxation in the obnoxious sense (hence may be invalidated under
l) Exemption from real property taxes the due process clause)
m) No appropriation or use of public money for religious purposes Same property is taxed twice
Both taxes are imposed on the same property or same subject matter for the
Constitutional provision indirectly affecting taxation same purpose
a) Due process a tax should not be of a confiscatory nature Imposed by the same taxing authority
b) Equal protection - reasonable and natural classifications for the purpose of Within the same jurisdiction
taxation During the same period and
c) Religious freedom Covering the same kind and character of tax
d) Non-impairment of obligations of contracts
Kinds of Double Taxation
VAT RULING No. 7-2006, June 7, 2006 1. Direct Duplicate Taxation
SPEX, SPL, CHEVRON and PNOC-EC are service contractors of the government Same property is taxed twice when it should be taxed only once AND both
trough the DOE Service Contract 38. Through Section 12(a) of PD 87, they are taxes are imposed on the same property or subject matter for the same
exempted from all taxes except income tax. purpose by the same State, Government or taxing authority
The query delves on the issue WoN pursuant to RA 9337, their sales of natural gas 2. Indirect Duplicate Taxation
in whatever form or state from the Malampaya Project have become subject to VAT Opposite of direct duplicate taxation
BIR in its reply expressed that RA 9337 provides an enumeration of the laws its Instances
enactment has rendered repealed. PD No. 87 was not included in the list. o TPs businesses as distinct taxable businesses from one another
Moreover, the general repealing clause cannot also be deemed to have affected o License tax on business or occupation v. Property tax on land or
the provisions of PD 87 which was a special law. property used in connection therewith
As regards the non-impairment of contracts, the tax exemption privilege of the
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o Both license fee and tax imposed on business or occupation for It is an immunity or privilege; it is freedom from a financial charge or burden to
selling the same article which others are subjected
o Local tax levied on the sale or disposal of an article v. Tax on the Exemption allowed only if the law clearly provides for it; not presumed
business of selling such product Not violative of equal protection clause so long as there is a substantial
o Tax imposed both on the occupation of fishing and the fishpond itself distinction
o Local tax on storage of copra v. Sales tax Rationale: Among others, to confer a benefit to a particular class which the
o Additional 1% tax v. Penalty thereof legislature feels outweighs the foregone revenue
o Income tax v. Tax on dividends Grounds for granting exemptions:
o May be based on a contract, e.g. petroleum service contract under
Means Employed to Avoid Double Taxation PD 987
Unilateral: Tax reliefs, tax deductions, tax credits, tax exemption, allowance on o May be based on public policy, e.g. to encourage new industries (e.g.
the principle of reciprocity MCIT exemption for 4 years of operation) or to foster charitable
o Applies also to resident aliens provided that the reciprocity institutions
requirement is satisfied: o May be based on international reciprocity (e.g. exemption of foreign
Alien invidividual WoN resident in the PH only those vessels from excise tax on petroleum products destined for
income derived within the Philippines are taxable consumption outside PH)
Foreign corporation WoN engaged in trade or business in Nature:
the Philippines - same o Personal to the grantee
Bilateral: tax treaty o Generally revocable by government (unless exemption founded on a
o Treaty override: Sec 34(B)(5) contractual tax exemption
o Treaty provision mitigates, if not entirely avoids, double taxation o Considered a waiver by the government of sovereign right to collect
o Purpose of treaty: facilitate international trade and investment by taxes
lowering tax barriers o Not necessarily discriminatory (e.g. class legislation) so long as
Income Exclusions: Treaty Override exemption has reasonable foundation or rational basis
o Non-transferrable
US Kinds:
RP
o Express when certain persons, property or transactions are by
express provisions of law, exempted from certain taxes, in while or in
USCo Know-How PhilCo part
o Implied when a tax is levied on certain classes without mentioning
other classes
Misnomer because there is no exemption by implication;
exemption must be expressed in clear and unmistakable
Royalties subject to US Income Royalties subject to 30% final language, what is involved here is the rule on strict
Tax withholding tax construction of tax imposition in favor of TP
Revocation:
o General Rule: a tax exemption may be revoked by the government
International Juridical Double Taxation anytime
Since taxation is the rule and exemption therefrom is the
Tax Exemptions exception, the exemption thus may be withdrawn at the
Grant of immunity to a particular class or persons from a tax which persons pleasure of the taxing authority. Mactan Cebu Intl Airport
generally within the same state or taxing district are obliged to pay Authority v. Marcos, 261 SCRA 667 (1996)
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o Exception: a contractual tax exemption cannot be revoked anytime He who claims an exemption must be able to justify his claim or right
without impairing the obligation of contracts thereto by a grant express in terms too plain to be mistaken and too
The only exception to this is where the exemption was categorical to be misinterpreted
granted to private parties based on material consideration Deductions, exclusions, condonations and claims for refund are akin
of a mutual nature, which then becomes contractual and is to exemption; hence, strictly construed against TP
thus covered y the non-impairment clause of the
Constitution. SEA-LAND SERVICES, INC. v. COMMISSIONER OF INTERNAL REVENUE, G.R. NO. 122605,
APRIL 30, 2001
D. CONSTRUCTION OF TAX STATUTES SEA-LAND claims that it is exempted from paying income tax under the RP-US
Military Bases Agreement so it is claiming a refund; nevertheless, transport or
1. Construction of Tax Laws shipment of household goods is not within the scope of the exemption.
A tax cannot be imposed without clear and express words for that Laws granting exemption from tax are construed strictissimi juris against the TP and
purpose so they are not to be implied liberally in favor of the taxing power. He who seeks to be thus privileged must
MANILA RAILROAD v. COLLECTOR OF CUSTOMS, 52 PHIL. 950 (1929) justify it by words too plain to be mistaken and too categorical to be
Classification of dust shield/dust guard in terms of taxation misinterpreted.
In case of doubt, tax statutes are construed most strongly against the Government
and in favor of the TP because burdens are not to be imposed beyond what the Exceptions:
statute expressly and clearly import o When the law itself provides for a liberal construction
COMMISSIONER OF INTERNAL REVENUE v. FIREMENS FUND INS. CO., 148 SCRA 315 (e.g. laws granting fiscal incentives for foreign
(1987) investments)
Firemans Fund Insurance Company erroneously affixed the required doc stamps in o In case of exemptions granted to religious, charitable
its insurance policies. CIR wants to collect payment for penalties due to such and education institutions or to the government, its
violation. agencies or to public property because they are
Doc stamps were considered paid already giving emphasize to the fact that the real generally exempt from taxation
purpose for such provisions is the collection of taxes. Thus, the purchase of stamps
is the form of payment made that considered just a means to an end that will MACEDA v. MACARAIG, G.R. NO. 882291, MAY 31, 1991
insure that the corresponding tax has been paid for such document while Issue: WON NPC the tax exemption of NPC as to indirect taxes has ceased. Court
cancellation of the stamps is to obviate the possibility that said stamps will be riled that it did not.
reused for similar documents for similar purposes. There appears to be no dispute The rule on strict construction cannot be applied with respect to the interpretation
on the fact that the documentary stamps have been paid for already by the of laws granting exemptions to NPC. The rule on strict interpretation does not apply
company. in the case of exemptions granted to political subdivisions or instrumentalities of
In case of doubt, a statute levying a tax should be interpreted in favor of the tax the government.
payer because burdens are not to be imposed, nor presumed to be imposed
beyond what statutes expressly and clearly import. 3. Construction and Interpretation of IRRs
Authority of the SOF, in conjunction with CIR, to promulgate rules
Tax laws nevertheless are not promulgated in order to encourage tax and regulations beyond question. Such rules and regulations, as well
evasion or tax avoidance as administrative opinions and rulings, ordinarily should deserve
weight and respect by courts
2. Construction of Tax Exemptions COMMISSIONER OF INTERNAL REVENUE v. CA, 240 SCRA 368 (1995)
Strictly Construed against TP ROH product claimed to tax amnesty but BIR collected for tax deficiency positing
Exemptions are not favored and are construed stictissimi juris against that the tax amnesty includes only assessments by the BIR after promulgation of EO
the TP 41.
EO 41 is explicit and requires only a simple application of its provisions. If it had not
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been intended to include tax liabilities already assessed prior to the EO, the law Tax Avoidance v. Tax Evasion
could have simply provided in its exclusionary clauses but it did not. Tax avoidance is permissible; tax evasion is illegal
However, IRRs, rulings and other issuances must not override, but must remain Tax avoidance occurs when taxpayers take advantage of legally permissible
consistent with, the law they seek to apply and implement. They are intended to alternative tax rates or methods of assessing taxable
carry out, neither to supplant nor to modify, the law. property/income/transactions in order to avoid or minimize tax liability
Tax Avoidance
4. Liberal Construction v. Strict Construction: When Applicable? Minimization of tax liabilities through legal means
COMMISSIONER OF INTERNAL REVENUE v. PILIPINAS SHELL PETROLEUM CORP, G.R. Attempt to minimize taxes does not necessarily constitute fraud. A TP may
NO. 192398, SEPT. 29, 2014 diminish his liability by any means which the law permits
Issue: WoN DST should be paid in lieu of a merger as regards transfer of real E.g. Donation
property
DST is due on all conveyances, deeds, instruments, or writings whereby any land, COMMISSIONER OF INTERNAL REVENUE v. ESTATE OF TODA, 438 SCRA 290 (2004)
tenement or other realty sold shall be granted, assigned, transferred or otherwise
conveyed to the purchaser or purchasers, or to any other person or persons
designated by such purchaser or purchasers. CIC Altonaga RMI
In SEA-LAND, there is a law that provides for tax exemption so the case called for a
P200M
strict construction. On the other hand, CIR v. PILIPINAS SHELL involves a law that
levies tax, specifically DST, on certain subjects. As a general rule, a tax law should be
Taxpayers Position
strictly construed. A liberal construction then is used in determining WoN a certain P300M

individual/transaction is subject to an exemption while construction should be
CIC selling price: P100
against the government in trying to know WoN a certain subject/individual is subject Land and
Cost: P25
to such a tax. The latter situation is obviously different from that class that is Bldg.
Gain: P75
exempted since in the first place, the subject in this circumstance is not taxed so Tax (35%): P26.25
there is no way that it could be exempted to something it is not supposedly subject
to. Altonaga selling price: P200
Cost: P100
E. ESCAPE FROM TAXATION Gain: P100
Tax (5%): P5
Shifting
Shifting transfer of tax burden from the person directly liable for the tax to TOTAL TAX: P31.25
someone else (e.g., the buyer)
Shifting to tax burden is generally prohibited under the law
What is shifted is the tax burden, not the liability for the tax (i.e., person
directly liable for the tax remains liable WoN the tax burden is shifted)
Only indirect taxes are shifted (e.g. VAT, excise tax, percentage tax)

Impact and Incidence
Impact of taxation is the point on which a tax is originally imposed. From
governments perspective, the statutory taxpayer (i.e. the person directly liable
to pay the tax) is the person who must pay the tax to the government
Incidence of Taxation is the point on which the tax burden finally settles (e.g.,
final consumer in transactions subject to VAT)

10

o Scheme was entered into to convert P100M gain from ordinary gain
(subject to 35% tax) to a capital gain (subject to 5% tax)
CIC Altonaga RMI
Examples of tax evasion
o Under-declaration of taxable value
Dummy o Mis-declaration of dutiable goods
o Substantial under-declaration of taxable income for consecutive
years coupled with substantial overstatement of deductions
o Simulated sales
Land and o Keeping of two or more books of accounts
P200M
Bldg.
Examples of tax avoidance
BIRs Position

- Postponing sale of capital asset to take advantage go holding period rule which
CIC selling price: P200 reduces capital gain by 50%
Cost: P25
Gain: P175 DELPHER TRADES CORP. v. IAC, 157 SCRA 349 (1988)
Tax (35%): P61.25 Estate planning scheme resorted to by taxpayers in converting their property to shares
BIR v. TP: P61.25 v. P31.25 of stock in a corporation which they themselves owned and controlled valid. By virtue of
the deed of exchange, the taxpayers saved on estate tax. The legal right of taxpayers to
decrease the amount of what otherwise could be his taxes or altogether avoid them by
means which the law permits cannot be doubted.
Factors Considered in disregarding intermediate sale to Altonaga
o Sale to A and Sale to RMI executed on the same day (first sale was
even notarized ahead of the second sale)
o As early as May 1989, CIC received P40M partial payment from RMI
(sale occurred in Aug 1989), indicating that the true buyer was RMI,
not A
o A was a close associate of toda (majority shareholder of CIC)

Tax Evasion
Means used to minimize taxes are fraudulent and illegal
Tax evasion is a term that connotes fraud through the use of pretenses or
forbidden devices to lessen or defeat taxes
Elements
o The end to be achieved, i.e., payment of less than that known by the
TP to be legally due, or paying no tax when it is shown that tax is due
o An accompanying state of mind which is described as being evil, in
bad faith, willful, deliberate, and not accidental
o A course o action (or omission) that is unlawful
SC Findings in CIR v. Estate of Toda
o All elements of tax evasion are present
o First sale: tax ploy, a sham, and without business purpose and
economic substance
o First sale was entered into for no other purpose than to evade taxes
11

A. WHAT IS INCOME (A DEFINITIONAL CONCEPT)?

II. MEANING OF INCOME AND THE REALIZATION Gross Income Inclusions (32(A)) and exclusions (32(B)) xxx
PRINCIPLE Less: Deductions (34 and 35) xxx
Equals: Taxable Income (31( xxx

Multiplied by: Income Tax Rate (e.g. 32%) xxx
SECTION 32(A)
SEC. 32. Gross Income. - Income Tax Due xxx
(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 Gross Income starting point to determine income tax liability
following items: 32(A), All income derived from whatever source
(1) Compensation for services in whatever form paid, including, but not limited to fees, 32(A)(1) to (11), types of gross income
salaries, wages, commissions, and similar items; - Section 32 (A): a tautological definition gross income means all income
(2) Gross income derived from the conduct of trade or business or the exercise of a - in short, definition does not answer whether a particular item is, or is not, income
profession;
(3) Gains derived from dealings in property; EISNER v. MACOMBER, 252 U.S. 189 (1920) The Capital-labor formulation
(4) Interests; 32(A): All income derived from whatever source
(5) Rents; Macomber definition of income: Gain derived from capital, from labor, or from
(6) Royalties; both combined
(7) Dividends; While TP derived gain from capital, she received noting out of companys assets for
(8) Annuities; her separate use and benefit
(9) Prizes and winnings;
(10) Pensions; and
Mrs. Macomber Stock
(11) Partner's distributive share from the net income of the general professional
dividend
partnership.
of 1,100 Is this
SEC. 36, REV. REGS. 2
shares income?
SECTION 36. Meaning of net income. The tax imposed by law is upon income. In the
with par
computation of the tax, various classes of income must be considered: (a) Income, in the
value of
broad sense, meaning all wealth which flows into the tax-payer other than as a mere
$1,100

return of capital. It includes the forms of income specifically described as gains and Held: NO
profits, including gains derived from the sale or other disposition of capital assets. Standard Oil Company
Income cannot be determined merely by reckoning cash receipts, for the statute of CA
recognizes as income determining factor other items, among which are inventories,
accounts receivable, property exhaustion, and accounts payable for expenses incurred.
(b) Gross income, meaning income (in the broad sense) less income which is by Gain constituting income must have been derived from capital, from labor, or from
statutory provision or otherwise exempt from the tax imposed by law. (c) Net income, both combined; and
meaning gross income less statutory deductions. The statutory deductions are, in The gain constituting income must have ben severed from capital from the TPs
general, though not exclusively, expenditures other than capital expenditures, separate use, benefit and disposal
connected with production of income. (d) In the case of a taxpayer other than a Practical application of Macomber:
corporation as defined in Section 84 (b) of the Code, net income means gross income - Acquired in 2005 for P1M, FMV in 2007 of P1.2M
less exemptions. Ordinarily the net income is to be computed in accordance with the Was there an economic gain? Yes. TP purchased shares at P1M and now it is
method of accounting regularly employed in keeping the books of the taxpayer. P1.2M (on paper)
Was there a gain derived from capital or labor? Yes from capital
Was there a gain severed from from capital for the TPs separate use, benefit
and disposal? No still part of capital
12

Is the gain income then? NO applying their case CIR v. GLENSHAW GLASS CO., 348 U.S. 426 (1955) all realized gains unless specifically
- Informer collects 2M reward. Income? NO exempted
There was an economic gain Glenshaw Glass
But it was not derived from capital or from labor so it was not a taxable income Cash payment for damages - $800,000
- Lucky winner collects brand new Honda Civic. Income? NO. Prize not derived from Punitive (2/3): $475,470
capital or from labor Compensatory (1/3): $324,530
There was an economic gain
But it was not derived from capital or labor +

-
*Macomber test is problematic (too narrow; does not cover items that are clearly
income)
U.S. v. KIRBY LUMBER CO., 284 U.S. 1 (1931)
Buy-back by issuer of bonds at less than par Glenshaw Glass Co. Hartford Empire Co.
TPs contention relying on the definition in Eisner v. Macomber, the TP argued that (Plaintiff) (Defendant)
while the transaction improved its balance sheet, it did not produce any gain that Manufacturer of glass Machinery used b y
was severed from its capital bottles and containers Glenshaw
Antitrust lawsuit
Held: we see nothing to be gained form the discussion of judicial definitions. The TP
has realized within the year an accession to income, if we take words in their plain
popular meaning as they should be taken here
Cancellation of debt is a taxable income since there was en economic gain. TP contention: 2/3 of the damage awards (punitive portion) constituted
In a balance sheet, it will be labeled as a gain that will go to the net worth. punishment on the wrongdoer and, under the gross income definition In
Macomber, this punitive portion of the damages should not be treated as income
HELVERING v. BRUUN, 309 U.S. 461 (1940) derived either from capital or labor; only the 1/3 portion which compensated for
TP cancelled a lease and forfeited a leasehold improvement for nonpayment of loss of profits could be treated as derived from capital or from labor
rentals, the tenant having erected a building that added about $50,000 to the value Issue: Whether money received as exemplary damages for fraud or as punitive 2/3
of the property. portion of a treble damage antitrust recover must be reported by a taxpayer as
Contention of TP: the increase in value (represented by the forfeited leasehold) was gross income
not severed from his investment or received for his separate use, benefit and Held: damage awards taxable in their entirety
disposal (citing Eisner v. Macomber) Court cast aside Macomber definition of income stating that it was not meant to
There was an economic gain but when will the TP be taxed provide a touchstone to all future gross income questions:
Held: while economic gain is not always taxable, realization of gain need not be in Instead, court stated that Congress had applied not limitations as to the source of
cash derived from sale of an asset. Gain may occur as a result of taxable receipts, nor restrictive labels as to their nature
Exchange of property Congress intended to tax all gains, which court described as all accessions to
Payment of the TPs indebtedness wealth, clearly realized, and over which the taxpayers have complete dominion
Relief from a liability The mere fact that the payments were extracted form the wrong-doers as
Other profit realized from the completion of a transaction punishment for unlawful conduct cannot detract form their character as taxable
TP received back his land with a new building on it, which added an ascertainable income to the recipients
amount to its value. It is not necessary to recognition of taxable gain that he should RESTATED: Congress intended to tax all gains, except those specifically exempted
be able to sever the improvement begetting the gain from his original capital. If The catch-all provision of IRC 32(A) (from whatever source derived) is
that were necessary, no income could arise from the exchange of property; broad/sweeping
whereas such gain has always been recognized as realizable taxable gain. Source is irrelevant (income tax is source-blind)
The touchstone to all income questions become simple enrichment
(accessions to wealth) all gains are taxable (at least if clearly realized),
13

whether traceable to labor, to capital, or to mere good fortune Glenshaw glass: all accessions to wealth, clearly realized and over which
taxpayers have complete dominion
JAMES v. U.S., 366 U.S. 213 (1961) Why is A not taxable, while B is taxable (Because of the realization
-What is the income of a government official? requirement)
- Supplemental income
-Is a bribe taxable income? HELVERING v. BRUUN, supra
TP cancelled a lease and forfeited a leasehold improvement for nonpayment of
Gross income includes gains from illegal sources. (embezzled money is taxable rentals, the tenant having erected a building that added about $50,000 to the value
income of the embezzler in the year of embezzlement) of the property.
Unlawful, as well as lawful, gains are comprehended within the term gross income Contention of TP: the increase in value (represented by the forfeited leasehold) was
A gain constitutes taxable income, when its recipient has control over it that, as a not severed from his investment or received for his separate use, benefit and
practical matter, he derives readily realizable economic value from it disposal (citing Eisner v. Macomber)
When a TP acquires earnings, lawfully or unlawfully, and has actual command over Gain may occur as a result of exchange of property, payment of the taxpayers
it, he has received income which he is required to report, even though it may still indebtedness and relief from all liability, or other profit realized from the
be claimed that he is not entitled to retain the money and may be required to completion of a transaction. The fact that the gain is a portion of the value of
return the same property received by the taxpayer in the transaction does not negative its
realization.
B. REALIZATION REQUIREMENT HELVERING v. HORST, 311 U.S. 112 (1940)
Horst, Sr. detached interest coupons and donated same to Horst, JR prior to due
SEC. 38, REV. REGS. 2 date. Horst, Jr. presented coupons and collected interest payment at maturity.
Issue: Whether gift of coupons to Jr. is realization of taxable income to Sr.
SECTION 38. Bases of computation. Approved standard methods of accounting will The gift, during the donors taxable year, of interest coupons detached from the
be ordinarily regarded as clearly reflecting income. A method of accounting will not, bonds delivered to the done and later in the year paid at maturity is taxable income
however, be regarded as clearly reflecting income unless all items of gross income and in the hands of the donor
all deductions are treated with reasonable consistency. All items of gross income shall The power to dispose of income is equivalent of ownership. The exercise of that
be included in the gross income for the taxable year in which they are received by the power to procure the payment of income to another is the enjoyment and hence
taxpayer and deductions taken accordingly, unless in order clearly to reflect income the realization of the income by him who exercises it
such amounts are to be properly accounted for as of a different period. For instance, in The realization rule, w/c is founded on administrative convenience, GENERALLY
any case in which it is necessary to use an inventory, no accounting in regard to postpones taxability until final enjoyment of the income which is usually receipt
purchases and sales will correctly reflect income except an accrual method. A taxpayer of it by the TP
is deemed to have received items of gross income which have been credited to or set HOWEVER, the enjoyment of the income may occur when TP has made such use or
apart for him without restriction. On the other hand, appreciation in value of property is disposition of his power to receive or control the income as to procure in its place
not even an accrual of income to a taxpayer prior to the realization of such appreciation other satisfactions which are of economic worth
through sale or conversion of the property. (For methods of accounting and COTTAGE SAV. ASSN v. CIR, 499 U.S. 554 (1991)
determination of accounting period, see Sections 166 to 169 of these regulations.) Exchange of mortgages resulted to realized losses
Rationale for realization requirements:
- A acquired prop. In Jan 2005 for P1M. FMV of prop in Dec. 2005 is P2M: there is an Avoid annual valuation
economic gain only on paper. No realization yet o To avoid the cumbersome, abrasive, and unpredictable administrative
task of valuing assets annually to determine whether their value has
- B acquired prop in Jan 2005 for P1M. Sold for cash in Dec. 2005 for P2M. appreciated or depreciated, 1001(a) of the Code (similar to NIRC 40(a))
- Already realized the taxable economic gain defers the tax consequences of a gain or loss in property until it is realized
through the sale or disposition of the property
Serves administrative convenience
14

o This rule serves administrative convenience because in contrast a change CIR v. MINZER, 279 F.2d 338, (5th CIR. 1960)
in the investments form or extent can be easily detected by a taxpayer or Commissions derived by an insurance broker on life insurance policies procured on his
an administrative officer own life are taxable income
Problems that would arise in the absence of the realization requirement:
o Problem of annual property appraisals REV. RUL. 79-24, 1979-1 C.B. 60
o Problem of liquidity Lawyer and housepainter exchanging services; landlord and artist exchanging apartment
o Forced liquidation usage and a painting
When does realization occur? When the TP has enjoyed the benefit of the
economic gain 2. Tax-Free Return of Capital
When is the TP deemed to have enjoyed the benefit of the economic gain? Not all receipts of money are income; to arrive at income, there must be
B.I.G.; paper profits excluded therefrom an amount representing return of capital (Rev Regs. 2 36:
Sale, exchange or other disposition Income, in the broad sense, means all wealth which flows into the taxpayer
o Benta, puhunan, tubo other than as mere return of capital
o Head or tail? Basis recovery
o Sunog!!!! Sale or exchange of property is typical example
Examples of return of capital/basis recovery:
C. OTHER RELEVANT CONCEPTS Sale or exchange of property
1. Tax-Free Imputed Income v. Taxable Barter Gradual basis recovery through depreciation
Imputed income is excludable from gross income, not on the basis of a specific Certain indemnities
Code provision, but results from long standing administrative practice Damages under certain instances
House painting example Other instances
Rationale for exemption (administrative convenience, e.g. difficulty of valuing
imputed income) CLARK v. CIR, 40 B.T.A. 333 (1939)
Differentiate tax-free imputed income from taxable barter Reimbursement by tax adviser to client for erroneous tax advice resulting to payment of
o Ex. Lap dance in exchange for legal services; see Rev Regs 2 41: taxes client neednt have paid
where services are paid for with something other than money, the
FMV of the thing taken in payment is the amount to be included as BIR. RUL. 51-00 (OCT. 30, 2000)
income Return to employees of their contributions to a qualified retirement plan
o Endorsement in exchange for cosmetic surgery example - Should be upon retirement or else such will constitute benefits that shall be taxed
o See e.g., Rev. Rul. 79-24 BIR RUL. 184-90 (SEPT. 20, 1990)

Damages in lieu of lost profits damages, however that compensate the taxpayer for
SEC. 41, REV. REGS 2. lost profits are includable in gross income. (damages for breach of contract constitute
taxable income to the extent that such damages compensate loss of anticipated profits
SECTION 41. Compensation paid other than in cash. Where services are paid for with and non-taxable to the extent that the same represent a return of capital or investment)
something other than money, the fair market value of the thing taken in payment is the
REV. RUL. 81-277, 1981-2 C.B. 14
amount to be included as income. If the services were rendered at a stipulated price, in
Payment by a contractor of a sum of money to a buyer in exchange for a release of the
the absence of evidence to the contrary, such price will be presumed to be the fair value
buyers claims against the contractor for failure to fulfill the contract for construction of
of the compensation received. Compensation paid an employee of a corporation in its
a plant constitutes a return of capital rather than gross income to the buyer.
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.

15

Examples of recovered deductions:

3. Windfall Receipts o Collection of debt previously deducted as worthless (see NIRC
34(E)(1), proviso)
SEC. 32(A)(9) o Refunds of previously deducted taxes
(9) Prizes and winnings; o Reimbursements of previously deducted losses (e.g., payments by a
SEC. 32 (B)(7)(C) tortfeasor)
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious, o Business expense paid by check that is never cashed by the payee
charitable, scientific, educational, artistic, literary, or civic achievement but only if:
SEC. 34(E)(1), proviso
(i) The recipient was selected without any action on his part to enter the contest or (E) Bad Debts. - (1) In General. - Provided, That recovery of bad debts previously allowed
proceeding; and as deduction in the preceding years shall be included as part of the gross income in the
(ii) The recipient is not required to render substantial future services as a condition year of recovery to the extent of the income tax benefit of said deduction.
to receiving the prize or award.
BIR RUL. 102-95 (JULY 7, 1995) on example of tax benefit principle
Gain without pain is taxable income (effectively settled by Glenshaw Glass) Contributions made by the employer to employee retirement plans are claimed by
Examples of windfall receipts the employer as a deductible business expense
Lost and found property If it turns our later that the company contributed more that it should have, the
Unclaimed deposits or uncashed checks excess funds in the retirement plan revert to the employer
Prizes and winnings Reversion is a recovered deduction because the employer previously benefited
from the business expense deduction
CESARINI v. U.S., 296 F. SUPP. 3 (ND OHIO 1969)
Windfalls, including found monies, are includable in gross income 5. Indirect Receipts Cancellation of Indebtedness and Discharge by 3rd
Finder of treasure trove (i.e., property found by the taxpayer) is in receipt of Parties
taxable income for income tax purposes, to the extent of its value in U.S. currency,
for the taxable year in which it is reduced to undisputed possession SEC. 50, REV. REGS. 2
Steinway No.1 example
HORNUNG v. CIR, 47 TC 428 (1967) SECTION50. Forgiveness of indebtedness. The cancellation and forgiveness of
Involving a professional football player taxed (1) on value of a Corvette received indebtedness may amount to a payment of income, to a gift, or to a capital transaction,
from a sports magazine as MVP of the Super Bowl and (2) on the rental value of dependent upon the circumstances. If, for example, an individual performs services for a
two other automobiles made available by a car manufacturer creditor, who, in consideration thereof cancels the debt, income to that amount is
Tax Court held that use of the cars was an accession to wealth under Glenshaw realized by the debtor as compensation for his services. If, however, a creditor merely
Glass and was not a tax-free gift, since the manufacturer had a commercial motive. desires to benefit a debtor and without any consideration therefor cancels the debt, the
Court further held that the award did not fall under the exceptions from for amount of the debt is a gift from the creditor to the debtor and need not be included in
educational, artistic, scientific, and/or civic achievement (IRC 74(b); similar to NIRC the latter's gross income. If a corporation to which a stockholder is indebted forgives the
32(B)(7)(c)) court said that the TPs achievement was purely athletic debt, the transaction has the effect of the payment of a dividend.
Cancellation of a debt could amount to payment of income, a gift or a capital
4. Tax Benefit Principle Recovery of Deducted Items transaction
Recovery of deducted items includable as taxable income Ex. A Corp. owes B Corp. P5M; due to cash flow problems A was only able to
Rational for Inclusions: repay B P3M, with B condoning the balance of P2M
o TP enjoyed underserved tax benefits Assuming that the transaction is not otherwise a gift or a capital
o Conversely, if TP derived no tax benefit from the deduction, the transaction, A realizes income to the extent to P2M as its economic
recovery in later years of the deducted item would not be includable position or net worth improved
in gross income
16

BIR RUL. 76-89 (APRIL 17, 1989)
Waiver of interest by bank generally should have been subject to income tax.
HOWEVER, it was held that the debtor did not realize income from the forgiveness of
indebtedness because even after the condonation it remained insolvent (although the
debtors net worth improved)

OLD COLONY TRUST CO. v. CIR, 279 U.S. 716 (1929) discharge by third parties
Employer pays the income taxes of a keyman; discharge by a third person of
an obligation to him is equivalent to receipt by the person taxed
Such constitutes taxable income since they were paid upon valuable
consideration which is his services derived from his labor.

BIR RUL. 85-95 (JUNE 13, 1995)
Old Colony as applied: 5% final withholding tax on interest assumed by the borrower
constitutes additional income of the nonresident bondholders

17

III. GROSS INCOME 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.
A. INCLUSIONS The basis upon which the remuneration is paid is immaterial in determining whether the
SECTION 32(A) remuneration constitutes compensation. Thus, it may be paid on the basis of piece-
SEC. 32. Gross Income. - work, or a percentage of profits; and may be paid hourly, daily, weekly, monthly or
(A) General Definition. - Except when otherwise provided in this Title, gross income annually.
means all income derived from whatever source, including (but not limited to) the Remuneration for services constitutes compensation even if the relationship of
following items: employer and employee does not exist any longer at the time when payment is made
(1) Compensation for services in whatever form paid, including, but not limited to fees, between the person in whose employ the services had been performed and the
salaries, wages, commissions, and similar items; individual who performed them.
(2) Gross income derived from the conduct of trade or business or the exercise of a (1) Compensation paid in kind. Compensation may be paid in money or in some
profession; medium other than money, as for example, stocks, bonds or other forms of property.
(3) Gains derived from dealings in property; If services are paid for in a medium other than money, the fair market value of the
(4) Interests; thing taken in payment is the amount to be included as compensation subject to
(5) Rents; withholding. If the services are rendered at a stipulated price, in the absence of
(6) Royalties; evidence to the contrary, such price will be presumed to be the fair market value of
(7) Dividends; the remuneration received. If a corporation transfers to its employees its own stock
(8) Annuities; as remuneration for services rendered by the employee, the amount of such
(9) Prizes and winnings; remuneration is the fair market value of the stock at the time the services were
(10) Pensions; and rendered.
(11) Partner's distributive share from the net income of the general professional
partnership. a. Limited Choice and Restricted Property

1. Compensation: Special Problems on In-Kind Compensation U.S. v. DRESCHER, 179 F.2d 863 (2nd Cir. 1950)
Taxability of in-kind benefits (i.e. receipts in a form other than conventional An annuity purchased by the employer for the employee is taxable income to the
cash payment) employee in the year purchase by the employer (and not in the year of pay-out to
o Generally includable; 32 embraces cash and non-cash benefits alike
the employee) despite the fact that that the policies were non-assignable and were
(see e.g. 32(A)(1): compensation for services in whatever form retained in the possession of the employer
paid)
Non-assignability and retention by employer do not effect immediate taxability,
o Receipt of in-kind benefits often presents valuation difficulties not
although they may have affect the valuation of the includable income
encountered when cash is received
Amount includable is value greater than zero although less than the premium
o E.g. legal services in exchange for chicken
cost of $5,000

The stakes: tax now or tax later (time value of money)
SEC 2.78.1(A) AND (1), REV. REGS 2-98 (APRIL 17, 1998)
A loose end:
SECTION 2.78.1. Withholding of Income Tax on Compensation Income.
o Suppose that B&L had simply given Drescher $5,000 in 1939 as cash bonus and
(A) Compensation Income Defined. In general, the term "compensation" means all
that Drescher had then purchased the annuity on his own. In that case,
remuneration for services performed by an employee for his employer under an
Drescher clearly would have to report as income the $5,000. Should the result
employer-employee relationship, unless specifically excluded by the Code.
be different if the employer buys the annuity and delivers it to Drescher?
The name by which the remuneration for services is designated is immaterial. Thus,
o Note that taxing income in kind is equivalent to treating employees as if he or
salaries, wages, emoluments and honoraria, allowances, commissions (e.g.
she received income in cash and then used the cash to buy an item in question
transportation, representation, entertainment and the like); fees including director's
o Economic benefit: you look forward to something youll received (security at
fees, if the director is, at the same time, an employee of the employer/corporation;
present)
18

BIR Rul. 9-04 (Sept. 13, 2004) 2.4 Business premises of the employer means the place where the employee
Under ESAP, all employees were offered Australian registered shares in ANZ performs a significant portion of his duties or where the employer conducts a
Bank free of charge. These were subject to disposal restriction and forfeiture significant portion of his business. In case of doubt, the criteria to be used shall be (a)
clause at the time of the grant so they shall not be taxed until the disposal time, more than 50% of the employee's work time or (b) value of business, more than
restriction is lifted. 50% of the production of the said employee.
Dividends should be recognized on the date payment is approved since when
they are declared, the stockholder already has right thereto 2.5 Notwithstanding the provisions of the preceding paragraphs, if an employee is
Stock dividends are not income since there is no distribution of the assets of provided by his employer with company housing or living quarters outside the
the corporation. They only create a change in the composition of the business premises, and such employee, because of his position in the employer-
stockholders equity, that is, a transfer from retained earnings to capital stock. company, also uses said house or living quarters for the benefit of the latter, like
entertaining and putting up houseguests and guest of the employer-company, then
b. Forced Consumption: Convenience of the Employer Rule fifty percent (50%) of such allowance, rental value, or depreciation if the living
quarters are owned by the employer, shall be added to the compensation paid to
such employee and be subject to the withholding tax on wages. The employer may
SEC. 2.78.1(A)(2), REV. REGS, 2-98 (APRIL 17, 1998)
deduct the said housing expense as a business expense.
(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
2.6 Privileges such as "courtesy discounts" on purchases of company merchandise of a
value to such person of the quarters and meals so furnished shall be added to the
value not to exceed 1/2 basic month's salary of an employee or an officer shall not be
remuneration paid for the purpose of determining the amount of compensation
added to the remuneration of the employee.
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
2.7 Entertainment of and gifts to company officers and employees shall not be a
included as part of compensation income.
deductible expense except for Christmas and major anniversary celebrations (e.g.
SEC.2, REV. AUDIT MEM. ORDER 1-87 (APRIL 23, 1987)
25th year of company's establishment), sports tournament, company picnics not to
2. Housing and Meals
exceed one a year provided that the value of the gift when it is not a service award for

length of service shall not exceed in value of 1/2 month's of the basic salary of the
2.1 If an employee receives a remuneration for services salaries and/or allowances
employee receiving the gift.
and in addition thereto living quarters and/or meals, the value to such person of the

quarters and meals so furnished shall be added to the remuneration otherwise paid
for the purpose of determining the amount of compensation subject to withholding BENAGLIA v. CIR, 36 B.T.A. 838 (1937)
tax. Whether meals and lodging provided to a hotel manager for the proper
performance of his duties because he was on call taxable income
2.2 The value of lodging furnished to an employee by or on behalf of the employer No. Benefits merely incidental; imposed upon TP as a working condition for the
shall be excluded from the employee's gross income, if the lodging is furnished in the convenience of the employer
business premises of the employer; and the employee is required to accept such Convenience of the employer rule idea behind doctrine is that in-kind benefits
lodging as a condition of his employment. should not be taxed if furnished by the employer to enable the employee to
perform the job satisfactorily (such benefits are known as working conditions)
23 The value of meals furnished to an employee by or on behalf of his employer shall Other examples of working conditions: spacious office of the successful law firm
be excluded from the employee's gross income if the meals are furnished on the partner, tastefully decorated with modern art; trips to France, enjoyed by airline
business premises of the employer and the meals are furnished for the convenience pilot who works the NY to Paris route; plays attended by theatre critic with tickets
of the employer. Meals furnished without charge to an employee as regarded as supplied by producers
furnished for the convenience of the employer where they are furnished to the Kleinwachters conundrum
employee during his work day to have the employee available for work during his
meal period.
19

c. De Minimis Benefits benefits.

Exempt The meal and food allowance, although not for overtime work, is considered
Facilities and privileges of relatively small value de minimis if it does not exceed 25% of the basic minimum wage.
Furnished to employees as means of promoting their health, goodwill, Rules and regulations on de minimis benefits do not allow aggregation of the
contentment or efficiency amounts set for each type of benefit.

SEC. 2.78.1(A)(3), REV. REGS 2-98 (APRIL 17, 1998) d. Travel and Entertainment
(3) Facilities and privileges of a relatively small value. Ordinarily, facilities and
privileges (such as entertainment, medical services, or so called "courtesy" discounts on RUDOLPH v. US, 370 US 269 (1962)
purchases), furnished or offered by an employer to his employees generally, are not Whether all-expenses paid trip to attend a convention (spouses included) in NYC
considered as compensation subject to withholding if such facilities or privileges are of taxable income to the attendees
relatively small value and are offered or furnished by the employer merely as a means of One morning out of the entire week devoted to business meetings; the rest of
promoting the health, goodwill, contentment, or efficiency of his employees. the week devoted to travel, sight-seeing, entertainment, fellowship or free time

Value of trip income to the Rudolphs, the trip being in the nature of a bonus,
Where compensation is paid in property other than money, the employer shall make
reward, and compensation for a job well done
necessary arrangements to ensure that the amount of the tax required to be withheld is
Test to determine whether cost of travel is income: dominant motive and
available for payment to the Commissioner.
purpose (whether business or pleasure)
Monetized unused vacation leave credits of employees not exceeding 10 days

during the year and the monetized value of leave credits paid to government
2. Business Income
officials and employees
3. Gains
Medical cash allowance to dependents of employees not exceeding {750 per 4. Interests
employee per semester or P125 month; 5. Rents
Rice subsidy of P1,500 or one sack of 50-kg rice per month amounting to not more 6. Royalties
than P1,500 7. Dividends
Uniform and clothing allowance not exceeding P4,000 per annum Ordinary dividend (cash or property)
Actual yearly medical benefits not exceeding P10,000 per annum Liquidating dividend
Laundry allowance not exceeding P300 per month Stock dividend
Employees achievement awards, e.g. length of service or safety achievement,
which must be in the form of tangible personal property other than cash or gift SEC.73 (NIRC)
certificate, with an annual monetary value not exceeding P10,000 received by the
employee under an established written plan which does not discriminate in favor of SEC. 73. Distribution of dividends or Assets by Corporations. -
higly paid employees (A) Definition of Dividends. - The term 'dividends' when used in this Title means any
Gifts given during Christmas and major anniversary celebrations not exceeding distribution made by a corporation to its shareholders out of its earnings or profits and
P5,000 per employee per annum; payable to its shareholders, whether in money or in other property. Where a
Flowers, fruits, books or similar items given to employees under special corporation distributes all of its assets in complete liquidation or dissolution, the gain
circumstances, e.g., on account of illness, marriage, birth of a baby, etc; and realized or loss sustained by the stockholder, whether individual or corporate, is a
Daily meal allowance for overtime work not exceeding 25% of the basic minimum taxable income or a deductible loss, as the case may be.
wage (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
BIR RUL. 23-02 (JUNE 21, 2002) issued as a dividend at such time and in such manner as to make the distribution and
Sodexho subsidies cancellation or redemption, in whole or in part, essentially equivalent to the distribution
Mean and food benefits provided by the client-companies to their employees of a taxable dividend, the amount so distributed in redemption or cancellation of the
through Sodexo mean and food vouchers may be considered tax-exempt stock shall be considered as taxable income to the extent that it represents a
20

distribution of earnings or profits. dividend paid in stock of another corporation is not a stock dividend, even though the
(C) Dividends Distributed are Deemed Made from Most Recently Accumulated stock distributed was acquired through the transfer by the corporation declaring the
Profits. - Any distribution made to the shareholders or members of a corporation shall dividends of property to the corporation the stock of which is distributed as a dividend.
be deemed to have been made form the most recently accumulated profits or surplus, Where a corporation declares a dividend payable in a stock of another corporation,
and shall constitute a part of the annual income of the distributee for the year in which setting aside the stock to be so distributed and notifying the stockholders of its action,
received. the income arising to the recipients of such stock is its market value at the time the
(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The dividend becomes payable. Scrip dividends are subject to tax in the year in which the
taxable income declared by a partnership for a taxable year which is subject to tax warrants are issued.
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 SECTION 252. Stock dividends. A stock dividend which represents the transfer of
partners in the same taxable year and shall be taxed to them in their individual capacity, surplus to capital account is not subject to income tax. However a dividend in stock may
whether actually distributed or not. constitute taxable income to the recipients thereof notwithstanding the fact that the
SEC. 250-256, REV. REGS 2 officers or directors of the corporation (as defined in Section 84) choose to call such
SECTION250. Dividends. Dividends, for the purpose of the law, comprise any distribution as a stock dividend. The distinction between a stock dividend which does
distribution whether in cash or other property, in the ordinary course of business, even not, and one which does, constitute income taxable to the shareholder is the distinction
though extraordinary in amount, made by a domestic or resident foreign corporation, between a stock dividend which works no change in the corporate entity, the same
joint-stock company, partnership, joint account (cuentas en participacion), association, interest in the same corporation being represented after the distribution by more
or insurance company to the shareholders or members out of its earnings or profits shares of precisely the same character, and a stock dividend where there either has
accumulated since March 1, 1913. been a change of corporate identity or a change in the nature of the shares issued as
Although interest on certain Government bonds and other similar obligations is not dividends whereby the proportional interest of the shareholders after the distribution is
taxable when received by a corporation, upon amalgamation with the other funds of the essentially different from his former interests. A stock dividend constitutes income if it
corporation, such income loses its identity and when distributed to shareholders, is gives the shareholder an interest different from that which his former stock holdings
taxable to the same extent as other dividend. represented. A stock dividend does not constitute income if the new shares confer no
A taxable distribution made by a corporation to individual stockholders or members different rights or interests than did the old the new certificates plus the old
shall be included is the gross income of the distributees when the cash of other property representing the same proportionate interest in the net assets of the corporation as did
is unqualifiedly made subject to their demand. Dividends, in cash or other property the old.
received by an individual, are subject to tax in his hands in the same manner another
income. SECTION 253. Sale of stock received as dividends. Stock issued by a corporation, as a
Dividends, whether in cash or other property, received by a domestic or resident foreign dividend, does not constitute taxable income to a stockholder in such corporation, but
corporation from a domestic corporation are taxable only to the extent of 25 per cent gain may be derived or loss sustained by the stockholder, whether individual or
thereof in accordance with Section 24 of the Code. Dividends received by a domestic corporate, from the sale of such stock, which gain or loss will be treated as arising from
corporation from a foreign corporation, whether resident or nonresident, are taxable to the sale or exchange of a capital asset. (See Section 34 of the Code.) The amount of gain
the extent that they constitute income from sources within the Philippines, as provided derived or loss sustained from the sale of such stock, or from the sale of the stack with
in Section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a respect to which it is issued, shall be determined in accordance with the following rules:
nonresident foreign corporation are taxable in full. (For definition of the different (a) Where the stock issued as dividend is all or substantially the same character or
classes of corporations, see Section 84 of the Code). 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
SECTION 251. Dividends paid in property. Dividends paid in securities or other quotient of the cost (or such fair market value) of the old shares of stock divided by the
property (other than its own stock), in which the earnings of a corporation have been total number of the old and new shares.
invested, are income to the recipients to the amount of the full market value of such (b) Where the stock issued as a dividend is in whole or in part of a character or
property when receivable by individual stockholders. When receivable by corporations, preference materially different from the stock upon which the stock dividend is paid,
the amount of such dividends includible for purposes of the tax on corporations are the cost (and when acquired prior to March 1, 1913, the fair market value as of such
specified in Section 24 of the Code. (See also Section 250 of these regulations). A date) of the old shares of stock shall be divided between such old stock and the new
21

stock, in proportion, as nearly as may be, to the respective value of each class of stock, distributions made by a corporation in complete cancellation or redemption of all of its
old and new, at the time the new shares of stock are issued, and the cost (or when stock in accordance with a bona fide plan of liquidation under which the transfer of all
acquired prior to March 1, 1913, the fair market value as of such date) of each share of the assets under liquidation is to be complete within a reasonable time from the date of
stock will be the quotient of the cost (or such fair market value as of March 1, 1913) of the first distribution, usually not to exceed one year from the time of such first
the class to which such share belongs divided by the number of shares in that class. distribution. If the amount received by the stockholder in liquidation is less than the cost
(c) Where the stock with respect to which a stock dividend is issued was purchased at or other basis of the stock, the loss in the transaction is deductible to the extent allowed
different times and at different prices and the identity of the lots can. not be in Section 34(c) of the Code.
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 Wise & Co., Inc. v. Meer (JUNE 30, 1947) ordinary v. liquidating dividend
presumed to have been made from the stock issued with respect to the earliest Determining element is whether the distribution was in the ordinary course of
purchased stock, to the amount of the dividend chargeable to such stock. business and with intent to maintain the business as a going concern, or after
(d) Where the stock with respect to which a stock dividend is declared was purchased at deciding to quit with intent to liquidate
different times and at different prices, and the dividend stock issued with respect to Ordinary dividend: if the distribution is in the nature of a recurring return on stock
such stock can not be identified as having been issued with respect to any particular lot Liquidating dividend: if the corporation is really winding up its business or
of such stock, then any sale of such dividend stock will be presumed to have been made recapitalizing or narrowing its activities, the distribution is treated as in complete or
from the stock issued with respect to the earliest purchased stock, to the amount of the partial liquidation and as payt by the corporation to the SH for his stock
stock dividend chargeable to such stock. What is at stake?
o If ordinary dividend receipt of ordinary dividend then was not subject to
SECTION 254. Declaration and subsequent redemption of a stock dividend. A true income tax (subject to income tax now at 10%)
stock dividend is not subject to tax on its receipt in the hands of the recipient. o If liquidating dividend amount in excess of the TPs cost basis taxable gain; if
Nevertheless, if a corporation, after the distribution of a stock dividend, proceeds to TPs cost basis exceeds the amount distributed, TP realizes a deductible loss
cancel or redeem its stock at such time and in such manner as to make the Only the excess is taxable gain (or loss) because a liquidating dividend is
distribution and cancellation or redemption essentially equivalent to the distribution of treated as a sale or exchange of stock
a taxable dividend, the amount received in redemption or cancellation of the stocks Where a corporation distributes all of its assets in complete liquidation in
shall be treated as a taxable dividend to the extent of the earnings or profits exchange for the surrender by shareholders of their shares, a transaction
accumulated by such corporation since March 1, 1913. takes place which is no different in essence from a sale of the tame stock
to third persons
SECTION 255. Sources of distribution. For the purpose of income taxation every CIR v. CA (JAN. 20, 1999)
distribution made by a corporation is made out of earnings or profits to the extent
Illustration of dividend equivalence rules (cancellation or redemption of
thereof and from the most recently accumulated earnings or profits. In determining the
previously issued non-taxable stock dividend at such time and in such manner as to
source of a distribution, consideration should be given first, to the earnings or profits of
make the distribution and cancellation or redemption essentially equivalent to a
the taxable year; second, to the earnings or profits accumulated since February 28,
taxable dividend)
1913, only in the case where, and to the extent that, the distribution made during the
Tax-free reclassification of shares
taxable year are not regarded as out of the earnings or profits of the taxable year and all
Tax-free exchange of commons for prefs under certain conditions
the earnings or profits accumulated since February 28, 1913, have been distributed;
CIR v. Manning (Aug. 6, 1975)
and, fourth, to sources other than earnings or profits only after the earnings or profits
have been distributed. A stock dividend cannot be declared out of outstanding corporate stock, but only
from retained earnings
SECTION256. Distribution in liquidation. In all cases where a corporation (as defined A case of constructive distribution of taxable dividends in the guise of a non-taxable
in Section 84) distributes all of its property or assets in complete liquidation or stock dividend distribution
dissolution, the gain realized from the transaction by the stockholder, whether The series of transactions was equivalent to a distribution of E&P to the
individual or corporate, is taxable to the extent recognized in Section 34(b) of the Code. stockholders, who turned around and used the proceeds to purchase the
For this purpose, the term "complete liquidation" includes any one of a series of shareholdings of the deceased shareholder

22

BIR Rul.39-02 (Nov. 11, 2002) interest payments shall be included in gross income.
TA is planning to decrease its authorized capital stock. Pursuant to this, shares
shall be surrendered and cancelled in exchange for real and persona, tangible (2) Amount Received by Insured as Return of Premium. - The amount received by the
and intangible properties. insured, as a return of premiums paid by him under life insurance, endowment, or
TA shall not be liable for income tax either on its receipt of the surrendered annuity contracts, either during the term or at the maturity of the term mentioned in
shares, or its transfer for Distributed Assets to TMBC as liquidated dividends. A the contract or upon surrender of the contract.
liquidating corporation does not realize gain or loss in partial or complete
liquidation. (3) Gifts, Bequests, and Devises. _ The value of property acquired by gift, bequest,
No DST is also due. Transfer of property is not subject to DST on sale or devise, or descent: Provided, however, That income from such property, as well as gift,
transfer real property. So is transfer of Loan portfolio. bequest, devise or descent of income from any property, in cases of transfers of divided
Only transfer or assignment of any mortgage which stands as security for its interest, shall be included in gross income.
Loan Portfolio shall be subject to DST
It shall be the stockholder who shall realize capital gain or loss when a (4) Compensation for Injuries or Sickness. - amounts received, through Accident or
corporation distributes its assets as liquidating dividends since they are treated Health Insurance or under Workmen's Compensation Acts, as compensation for
as payments in exchange for stocks or shares so any gain or profit realized personal injuries or sickness, plus the amounts of any damages received, whether by
thereby shall b taxed. suit or agreement, on account of such injuries or sickness.
Liquidating gain or loss is in the nature of capital gain or loss, as the case may
be, and therefore treated in the manner stated in Sec. 39 of the NIRC. (5) Income Exempt under Treaty. - Income of any kind, to the extent required by any
Liquidating gain is subject to ordinary income tax rates. treaty obligation binding upon the Government of the Philippines.

8. Annuities (6) Retirement Benefits, Pensions, Gratuities, etc.-
9. Prizes and winnings
10. Pensions (a) Retirement benefits received under Republic Act No. 7641 and those received by
11. Share in GPPs Income officials and employees of private firms, whether individual or corporate, in
accordance with a reasonable private benefit plan maintained by the employer:
Provided, That the retiring official or employee has been in the service of the same
SEC. 26. Tax Liability of Members of General Professional Partnerships. - A general employer for at least ten (10) years and is not less than fifty (50) years of age at the
professional partnership as such shall not be subject to the income tax imposed under time of his retirement: Provided, further, That the benefits granted under this
this Chapter. Persons engaging in business as partners in a general professional subparagraph shall be availed of by an official or employee only once. For purposes of
partnership shall be liable for income tax only in their separate and individual capacities. 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
For purposes of computing the distributive share of the partners, the net income of the or all of his officials or employees, wherein contributions are made by such employer
partnership shall be computed in the same manner as a corporation. for the officials or employees, or both, for the purpose of distributing to such officials
Each partner shall report as gross income his distributive share, actually or and employees the earnings and principal of the fund thus accumulated, and wherein
constructively received, in the net income of the partnership. its is provided in said plan that at no time shall any part of the corpus or income of the
fund be used for, or be diverted to, any purpose other than for the exclusive benefit
B. EXCLUSIONS of the said officials and employees.

(B) Exclusions from Gross Income. - The following items shall not be included in gross (b) Any amount received by an official or employee or by his heirs from the employer
income and shall be exempt from taxation under this title: as a consequence of separation of such official or employee from the service of the
employer because of death sickness or other physical disability or for any cause
(1) Life Insurance. - The proceeds of life insurance policies paid to the heirs or beyond the control of the said official or employee.
beneficiaries upon the death of the insured, whether in a single sum or otherwise, but if
such amounts are held by the insurer under an agreement to pay interest thereon, the
23

(c) The provisions of any existing law to the contrary notwithstanding, social security (i) Benefits received by officials and employees of the national and local
benefits, retirement gratuities, pensions and other similar benefits received by government pursuant to Republic Act No. 6686;
resident or nonresident citizens of the Philippines or aliens who come to reside (ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
permanently in the Philippines from foreign government agencies and other amended by Memorandum Order No. 28, dated August 13, 1986;
institutions, private or public. (iii) Benefits received by officials and employees not covered by Presidential decree
No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(d) Payments of benefits due or to become due to any person residing in the (iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
Philippines under the laws of the United States administered by the United States further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
Veterans Administration. through rules and regulations issued by the Secretary of Finance, upon
recommendation of the Commissioner, after considering among others, the effect
(e) Benefits received from or enjoyed under the Social Security System in accordance on the same of the inflation rate at the end of the taxable year.
with the provisions of Republic Act No. 8282.
(f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig
(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement contributions, and union dues of individuals.
gratuity received by government officials and employees.
(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. -
(7) Miscellaneous Items. - 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.
(a) Income Derived by Foreign Government. - Income derived from investments in
the Philippines in loans, stocks, bonds or other domestic securities, or from interest (h) Gains from Redemption of Shares in Mutual Fund. - Gains realized by the investor
on deposits in banks in the Philippines by (i) foreign governments, (ii) financing upon redemption of shares of stock in a mutual fund company as defined in Section
institutions owned, controlled, or enjoying refinancing from foreign governments, and 22 (BB) of this Code.
(iii) international or regional financial institutions established by foreign governments.
1. Life Insurance
(b) Income Derived by the Government or its Political Subdivisions. - Income derived Proceeds of life insurance paid to heirs or beneficiaries of insured exempt
from any public utility or from the exercise of any essential governmental function o Interest, however, on the proceeds taxable
accruing to the Government of the Philippines or to any political subdivision thereof. o Amounts
Amounts received by insured as return of premium exempt
(c) Prizes and Awards. - Prizes and awards made primarily in recognition of religious, o Simplest form of estate planning
charitable, scientific, educational, artistic, literary, or civic achievement but only if: o Fastest way liquidity
(i) The recipient was selected without any action on his part to enter the contest o Estate tax heirs settlement of estate
or proceeding; and 2. Gifts, Bequests and Devises
(ii) The recipient is not required to render substantial future services as a
condition to receiving the prize or award. Sec.32 (B)(3) Gifts, Bequests, and Devises. _ The value of property acquired by gift,
bequest, devise, or descent: Provided, however, That income from such property, as
(d) Prizes and Awards in sports Competition. - All prizes and awards granted to well as gift, bequest, devise or descent of income from any property, in cases of
athletes in local and international sports competitions and tournaments whether held transfers of divided interest, shall be included in gross income.
in the Philippines or abroad and sanctioned by their national sports associations.

CIR v. Duberstein, 363 US 278 (1960)
(e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and
Illustration of non-taxable gift vs. taxable compensation for services rendered
employees of public and private entities: Provided, however, That the total exclusion
under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall Court found that the Cadillac was a recompense for Dubersteins past services, or
cover: an inducement for him to be of further service in the future
When is a payment a non-taxable gift and when is a payment taxable compensation
24

for services rendered? Murphy v. US, No. 05-5249 (DC Cir. Aug. 22, 2006) compensation for emotional
o Mere absence of a legal or moral obligation to make such a payment does not distress: non-taxable return of human capital theory
mean it is a gift Whether the compensation for emotional distress and injury to professional
o If the payment proceeds primarily from the constraining force of any moral or reputation is taxable income( note: none of the award was for lost wages or
legal duty, or from the incentive of anticipated benefit of an economic diminished earning capacity)
nature, it is not a gift Held: not excludable because damages were not awarded on account of physical
o A gift in the statutory sense, on the other hand, proceeds from a detached injuries (she received the award of on account of her mental distress and
and disinterested generosity, out of affection, respect, admiration, charity or reputational loss, not her bruxism or other physical symptoms)
like impulses However, IRC 104(a)(2) is unconstitutional as applied to Murphys award because
Hornung v. CIR, supra compensation for a non-physical injury is not income under the 16th amendment if
Corvette received was in exchange of the promotional benefits it is unrelated to lost wages or earnings
Thus, taxable Application of in lieu of doctrine: in lieu of what were the damages awarded?
Was Murphys award of compensatory damages a substitute for a normally
3. Compensation for Injuries or Sickness untaxed personal quality, good or asset?
The damages were awarded to make Murphy emotionally and reputationally
Elements: ( 32(B)(4)): whole and not to compensate her for lost wages or taxable earnings of any kind.
o (i) damages received; The emotional well-being and good reputation she enjoyed before they were
o (ii) whether by suit or agreement; diminished by her former employer were not taxable as income
o (iii) on account of; and Murphy v. US, No. 05-5249 (DC. Cir. July 3, 2007)(on rehearing) involuntary
o (iv) personal injuries or sickness conversion theory; zero basis in human capital
- e.g. tricycle driver got hit by bus driver, asks for damages Award not excludable under IRC 104(a)(2)
o actual damages- exempt Award is not part of gross income as defined by IRC 61 (although Congress
o moral damages exempt cannot make a thing income which is not so in fact, it can label a thing income and
o exemplary damages not exempted tax it, so long as it acts within its constitutional authority)
o lost earnings exempt The tax upon the ward is an excise and not a direct tax subject to the
PM: personal injuries apportionment requirement of Article I, Section 9 of the Constitution. The tax is
uniform throughout the U.S. and therefore passes constitutional muster
Sec.32 (B)(4) Compensation for Injuries or Sickness. - amounts received, through Murphys situation seems akin to an involuntary conversion of assets; she was
Accident or Health Insurance or under Workmen's Compensation Acts, as compensation forced to surrender some part of her mental health and reputation in return for
for personal injuries or sickness, plus the amounts of any damages received, whether by monetary damages. CF. 26 U.S.C. 1033 (property involuntarily converted into
suit or agreement, on account of such injuries or sickness. money is taxed to extend of gain recognized)
AR ($70k) basis (zero) = gain ($70k)
OGilvie v. US, 519 US 79 (1996) an interpretation of on account of
Whether the gross income exclusion provision applies to punitive damages received BIR Rul. 57-83 (April 12, 1983)
by plaintiff in a tort suit for personal injuries WoN backwages, allowances and benefits such as cost of living and 13th month pay
Held: TPs punitive damages were not received on account of personal injuries; should be taxed
hence gross-income-exclusion provision does not apply and the damages are General rule: they are forms of compensation
taxable BUT liberal construction was called for to protect the employees who were
Exclusionary provision applies only to those personal injury lawsuit damages that deprived of the payment of their wages.
were awarded by reason of, or because of, the personal injuries, and not to
punitive damages that do not compensate injury, but are private fines levied by civil
injuries to punish reprehensible conduct and to deter its future occurrence

25

4. Retirement Benefits, Pensions, Gratuities, etc. (e) 13th Month Pay and Other Benefits. - Gross benefits received by officials and
employees of public and private entities: Provided, however, That the total exclusion
Sec.32 under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall
(6) Retirement Benefits, Pensions, Gratuities, etc.- cover:
(i) Benefits received by officials and employees of the national and local
(a) Retirement benefits received under Republic Act No. 7641 and those received by government pursuant to Republic Act No. 6686;
officials and employees of private firms, whether individual or corporate, in (ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
accordance with a reasonable private benefit plan maintained by the employer: amended by Memorandum Order No. 28, dated August 13, 1986;
Provided, That the retiring official or employee has been in the service of the same (iii) Benefits received by officials and employees not covered by Presidential decree
employer for at least ten (10) years and is not less than fifty (50) years of age at the No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
time of his retirement: Provided, further, That the benefits granted under this (iv) Other benefits such as productivity incentives and Christmas bonus: Provided,
subparagraph shall be availed of by an official or employee only once. For purposes of further, That the ceiling of Thirty thousand pesos (P30,000) may be increased
this Subsection, the term 'reasonable private benefit plan' means a pension, gratuity, through rules and regulations issued by the Secretary of Finance, upon
stock bonus or profit-sharing plan maintained by an employer for the benefit of some recommendation of the Commissioner, after considering among others, the effect
or all of his officials or employees, wherein contributions are made by such employer on the same of the inflation rate at the end of the taxable year.
for the officials or employees, or both, for the purpose of distributing to such officials
and employees the earnings and principal of the fund thus accumulated, and wherein Retirement under the Labor Code (Art. 287) in the absence of a qualified retirement
its is provided in said plan that at no time shall any part of the corpus or income of the plan
fund be used for, or be diverted to, any purpose other than for the exclusive benefit Retirement upon reaching the retirement age established in the CBA or other
of the said officials and employees. applicable employment contract
Upon reaching 60 years, but not beyond 65 years, which is the compulsory
(b) Any amount received by an official or employee or by his heirs from the employer retirement age
as a consequence of separation of such official or employee from the service of the Has served at least 5 years
employer because of death sickness or other physical disability or for any cause
beyond the control of the said official or employee. Retirement benefits from a qualified retirement plan ( 32(B)(6)(a)): conditions for
exemption
(c) The provisions of any existing law to the contrary notwithstanding, social security There is a reasonable private benefit plan
benefits, retirement gratuities, pensions and other similar benefits received by Retiring official or employee has been in the service of the employer for at
resident or nonresident citizens of the Philippines or aliens who come to reside least 10 years
permanently in the Philippines from foreign government agencies and other Retiring official or employee is not less than 50 yrs. Old at the time of
institutions, private or public. retirement
Exemption benefit is availed only once
(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 Separation benefits from involuntary separation ( 32(B)(6)(b)): conditions for
Veterans Administration. exemption
Official, employee or their heirs receive/s separation pay from employer
(e) Benefits received from or enjoyed under the Social Security System in accordance Separation is because of death, sickness, other physical disability, or for any
with the provisions of Republic Act No. 8282. cause beyond the control of the official or employee

(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement Other exempt retirement benefits
gratuity received by government officials and employees. Those received by resident and non-resident citizens and aliens who come to
reside in the Philippines from foreign government agencies and other
(7) Miscellaneous Items. - institutions, private or public
26

Benefits from the USVA

SSS benefits
GSIS benefits including retirement gratutity received by government officials
and employees RA 4917 (June 17, 1967)

CIR v. CA (March 23, 1992) AN ACT PROVIDING THAT RETIREMENT BENEFITS OF EMPLOYEES OF PRIVATE FIRMS
Tax exemption for employees trusts was conceived in order to encourage the SHALL NOT BE SUBJECT TO ATTACHMENT, LEVY, EXECUTION, OR ANY TAX
formation and establishment of such private Plans for the benefit of laborers. WHATSOEVER.
CIR v. CA (Oct. 17, 1991)
Terminal leave pay received by a government official or employee on the occasion Section 1. Any provision of law to the contrary notwithstanding, the retirement benefits
of his compulsory retirement from government service is exempt from income tax received by officials and employees of private firms, whether individual or corporate, in
(and consequently withholding tax on compensation) accordance with a reasonable private benefit plan maintained by the employer shall be
In the exercise of sound personnel service policy, the Government encourages exempt from all taxes and shall not be liable to attachment, garnishment, levy or seizure
unused leaves to be accumulated. The Government recognizes that for most public by or under any legal or equitable process whatsoever except to pay a debt of the
servants, retirement pay is always less than generous if not meager and scrimpy. A official or employee concerned to the private benefit plan or that arising from liability
modest nest egg which the senior citizen may look forward to is thus avoided. imposed in a criminal action: Provided, That the retiring official or employee has been in
Terminal leave payments are given not only at the same time but also for the same the service of the same employer for at least ten (10) years and is not less than fifty
policy considerations governing retirement benefits years of age at the time of his retirement: Provided, further, That the benefits granted
under this Act shall be availed of by an official or employee only once: Provided, finally,
In Re: Atty. Bernardo Zialcitia, A.M. 90-6-015 (Oct. 18, 1990)
That in case of separation of an official or employee from the service of the employer
Commutation or money value of accumulated leave credits is covered by exclusion
due to death, sickness or other physical disability or for any cause beyond the control of
under 32(B)(6)(b) and (f) (i.e., separation beyond the control and/or retirement
the said official or employee, any amount received by him or by his heirs from the
gratuity received by government officials and employees
employer as a consequence of such separation shall likewise be exempt as hereinabove
Compulsory retirement is considered separation beyond the control of the
provided.
employee, hence, any amount received by reason of such involuntary separation

(e.g., terminal leave pay) is exempt
As used in this Act, the term "reasonable private benefit plan" means a pension,
IBC v. Amarilla gratuity, stock bonus or profit sharing plan maintained by an employer for the benefit of
TPs opted to retire pursuant to 1993 CBA (mandatory retirement age in CBA was 60 some or all of his officials and employees, wherein contributions are made by such
years) employer or officials and employees, or both, for the purpose of distributing to such
Received retirement benefits on a staggered basis (no taxes withheld) officials and employees the earnings and principal of the fund thus accumulated, and
After retirement, retroactive salary differential of employees not given to TPs but wherein it is provided in said plan that at no time shall any part of the corpus or income
instead was applied against the withholding tax liability of the TPs upon retirement of the fund be used for, or be diverted to, any purpose other than for the exclusive
W/N retirement benefits received under the CBA exempt benefit of the said officials and employees.
No. No showing that CBA presented to the BIR for registration/approval RA 7833 (Dec. 8, 1994)

BIR Rul. 1-95 (Jan 6, 1995) AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO.
WoN client correctly withheld taxes from the retirement benefits of employees 6686 AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM
given under a voluntary retirement program offered by the company THE COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF
Exemption is only for those who are involuntarily separated since they are within DETERMINING TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE
the ambit of the phrase for any cause beyond the control of the said official or SECTION 28(B)(8) OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED
employee
Be it enacted by the Senate and House of Representatives of the
Philippines in Congress assembled:
27

d) "Immediately succeeding payroll period" refers to the payroll period beginning

SECTION 1. A new sub-paragraph to be known as subparagraph (F) is hereby inserted at January, 1995.
the end of Section 28(b)(8) of the National Internal Revenue Code, as amended, which
shall read as follows: . e) "Other benefits" refer to all benefits other than the 13th month pay, such as,
the annual Christmas bonus given by private offices, 14th month pay, mid-year
"(F) 13th month pay and other benefits. productivity incentive bonus, gifts in cash or in kind and other similar benefits
received by an official or employee for one calendar year in an amount not
"(i) Benefits received by officials and employees of the national and local exceeding Twelve Thousand Pesos (P12,000.00) as maximum limit.
governments pursuant to Republic Act No. 6686;
"(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as . f) "Taxable compensation income" means gross compensation income less
amended by Memorandum Order No. 28, dated August 13, 1986; personal and additional exemptions provided for under Sec. 29 (l) of the NIRC,
"(iii) Benefits received by officials and employees not covered by Presidential as amended.
Decree No. 851, as amended; and
"(iv) Other benefits such as productivity incentives and Christmas bonus in an . g) "13th month pay" refers to the mandatory one month basic salary of an official
amount not exceeding Twelve thousand pesos (P12,000) which shall be or employee of the National Government, Local Government Units, agencies
integrated in the 13th month pay solely for purposes of this Act. and instrumentalities, including government-owned and -controlled
Rev. Regs. 2-95 (Jan.3, 1995) corporations, and of private offices received after the 12th month pay.

Implementing Republic Act No. 7833, An Act to Exclude the Benefits Mandated . h) "Total benefits" refer to the sum of all the benefits received by an official or
Pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as Amended, and employee for one calendar year in accordance with the provisions of the "Act."
other Benefits from the Computation of Gross Compensation Income for the Purposes
of Determining Taxable Compensation Income, Amending for the Purpose Section 28 (b)
(8) of the National Internal Revenue Code, as Amended. . i) "Which shall be integrated in" shall mean "which shall be added to".
SECTION 1. Scope Pursuant to Section 245 and 72 of the National Internal Revenue SECTION 3. Benefits Exempted from Income Tax. For purposes of determining the
Code (NIRC), as amended, in relation to Section 3 of Republic Act No. 7833, these taxable compensation income, the following benefits shall be excluded from the gross
Regulations are hereby promulgated to implement the provisions of Section 28 (b) (9) compensation income, viz:
(6) of the NIRC, as amended, excluding from the computation of gross compensation
income, for purposes of determining taxable compensation income, the 13th month pay a) 13th month pay equivalent to the mandatory one (1) month basic salary of officials
and other benefits. and employees of the Government (whether national or local), including government-
owned and -controlled corporations, and of private offices received after the 12th
SECTION 2. Definition of Terms. For purposes of these Regulations, the following month pay beginning CY 1994; and
definitions of words and phrases are hereby adopted:
b) Other benefits, such as, Christmas bonus given by, private offices to their officials and
a) "Act" refers to Republic Act No. 7933. employees, productivity incentives bonus, loyalty award, gifts in cash or in kind and
other benefits of similar nature actually received by officials and employees of both
b) "Exclusions" shall mean the total benefits which are not included in the Government and private offices in an amount not exceeding Twelve Thousand Pesos
computation of gross compensation income for purposes of determining taxable (12,000.00) for one (1) calendar year.
compensation income and are, therefore, exempt from the withholding tax on wages.
The above-stated exclusions [(a) and (b)] shall cover benefits paid or accrued beginning
c) "Gross compensation income" means all remunerations for services performed by January 1, 1994 but shall be limited only to an amount not exceeding Twelve Thousand
an employee for his employer, whether paid in cash or in kind, unless specifically Pesos (P12,000.00) in the case of the "other benefits" contemplated under paragraph
excluded under Secs. 27 and 28 of the NIRC, as amended. (b) above, provided, however, that when added to the 13th month pay, the total
28

amount of tax exempt benefits shall not exceed Thirty Thousand Pesos (P30,000.00). other benefits of employees through the annualized computation prescribed in Section
71(8)(2)(b) of Revenue Regulations No. 6-82, as amended by RR No. 4-93, implementing
ILLUSTRATIONS: R.A. No. 7497, otherwise known as the "Final Withholding Tax on Compensation
Income."
CASE NO. 1.
(b) Refund/Credit to Employees of Excess Taxes Withheld. Any excess in the taxes
During CY 1994, Mr. "A", and official of a private corporation, received the following withheld resulting from the annualized computation shall be credited/refunded to the
13th month pay and other benefits from his employer, such as: employees. In return, the employer is entitled to deduct the amount refunded/credited
from the remittable amount of taxes withheld from compensation income in the
13th month pay P30,000.00 current month in which refund/credit was made, and in the succeeding months
Other benefits: thereafter until the amount refunded/credited by the employer is fully repaid.
Christmas bonus P15,000.00
14th month pay 30,000.00 ILLUSTRATIONS:

Mid-year productivity bonus 10,000.00 55,000.00 1.The year-end adjustment computation resulted to a REFUND.
TOTAL BENEFITS RECEIVED
for CY 1994 P 85,000
(aa)Employee with Only One Employee During the Year.
========
ABC COMPANY Employee "A" (single)
In this illustration, Mr. "A" shall only be exempted on his 13th month pay of P30,000.
His "other benefits" amounting to P55,000 are subject to the withholding tax on wages.
Salaries P78,000.00
13th month pay 12,000.00
CASE NO. 2. Other Benefits 10,000.00

On the other hand, Mr. "B", a government employee, received the following 13th Gross Compensation
month pay and other benefits, such as: Income P100,000.00
Less: Non-taxable
13th month pay P8,000.00
Benefits:
Other benefits:
Productivity incentives bonus P12,000.00 13th month pay P12,000
Cash gift 1,000.00 13,0000 Other benefits 10,000 22,000.00

TOTAL BENEFITS RECEIVED
P 78,000.00
for CY 1994 P 21,000
Less: Personal 9,000.00
========
Exemption
Taxable
Mr. "B" shall only be exempt on a total of P20,000.00, representing 13th month pay of
Compensation P69,000.00
P8,000.00 plus "other benefits" of P12,000.00 only.
Tax Due P7,785.00
SECTION 4. Computation of Refundable/Creditable Taxes Withheld on the Exempt 13th Less: Tax Withheld (13,675.00)
Month Pay and Other Benefits. (a) In general. The employer shall compute the
refundable/creditable amount of taxes withheld on the exempt 13th month pay and
AMOUNT TO BE (P 5,890.00)
29

REFUNDED by ========
ABC CO. to Employee *Other Benefits
"A" ABC Co. P10,000
on or before
DEF Co. 3,000
JANUARY 25, 1995 OR
TO BE CREDITED
against Taxes P13,000 10,000 30,000.00
Withheld due from P101,000.00
the Employee for LESS: Personal Exemption 9,000.00
Succeeding Month/s
Taxable Compensation Income P92,000.00
Beginning following
Sample Computation TAX DUE
TAX WITHHELD
No. 1 (cc).
ABC Co. P11,965.00

DEF Co. P3,279.66 (15,244.66)

AMOUNT TO BE REFUNDED BY DEF Co. to EMPLOYEE B
on or before JANUARY 25, 1995 (P3,089.66)
(bb) Employee with Successive Employment Within the Year. OR
Employee "B" (single) TO BE CREDITED against Taxes Withheld due from Employee
for Succeeding Month/s beginning January 1995 (Please see
Sample Computation No. 1 (cc).
ABC Co. DEF. Co.
(Previous Employer) (Present Employer)
(cc) Crediting of Refundable Amounts Against Taxes Withheld Due From
Jan.-June, 1994 Nov.-Dec., 1994
Employees For The Succeeding Month/s.
Amount of refund to be credited against taxes withheld due from Employee
Salaries/Allowances P78,000.00 Salaries P20,000.00 "B" [Based on Sample Computation No. 1 (bb) above) beginning January, 1995 P
13th Month Pay 12,000.00 13th month pay 8,000.00 3,089.66
Other Benefits 10,000.00 Other Benefits 3,000.00

Computation of Taxes Withheld for the month of
P100,000.00 P31,000.00 January, 1995
Less: Personal ADD: Income From
Salaries/Allowances
Exemption 9,000.00 Previous Employer 100,000.00
Taxable: P10,000.00

LESS:
Tax Required to be Withheld for the
Net Taxable Non Taxable
month of January, 1995
Income 91,000.00 Benefits:
(Use Line 2 Col. 8 of the
13th Month Pay
Withholding Tax Table): P1,359.66
TAX DUE P11,965.00 ABC Co. P12,000
TAX WITHHELD P11,965.00
Less: Refund for CY 1994 due to
DEF Co. 8,000 P20,000
Non-Taxability of Bonus and
30

Other Benefits beginning Gross Compensation Income After

Jan. 1995 (3,035.66) Deducting Exclusions Under RA 7333 68,000.00
Less: Personal Exemption 9,000.00
Balance to be credited in succeeding month/s (P1,730.00)

Taxable Compensation Income P59,000.00
February. 1995
Tax Due P3,925.00
Tax Required to be Withheld for the
Tax Withhold
Month of February P1,359.66
Amount to be credited Jan.-Nov., 1994 P393.80/mo. x 11 mos. (4,331.80)
for February
(1,730.00) Tax Collectible to be Withheld from December salary P1,593.20
Balance of Amount to be Credited for the Month (P370.34) =========
of March Note:
NO REFUND OF WITHHOLDING TAX FOR BONUS AND OTHER BENEFITS WOULD
March. 1995 RESULT DUE TO UNDER WITHOLDING IN PREVIOUS MONTHS OF THE YEAR.

Tax Required to be Withheld for the Month SECTION 5. Refund/Credit of Taxes Withheld from employees Separated from
of March P1,359.66 Employment. a) An employee separate from the service of his previous employer but
is presently employed by another employer shall be refunded/credited the taxes
withheld on his exempt 13th month pay and other benefits by his present employer.
Amount to be Credited
The present employer shall compute the aforesaid excess withholding tax using the
for March (370.34)
annualized computation set forth in Section 7I (B) (2) (b) of RR No., 6-82, as amended by
Amount to be Remitted RR No. 4-93.
for March on or before
April 10, 1995 P989.32 (b) An employee who has been separated from a previous employer but has no present
======= employment shall claim his refund of excess tax withheld on his 13th month pay and
2. The year-end adjustment resulted to a COLLECTIBLE AMOUNT (instead of a refund). other benefits by filing with the BIR a refundable income tax return for CY 1994,
provided that the refundable ITR for 1994 reflects the taxes withheld on his 13th month
During CY 1994, an employee (single) of a private corporation, received the following pay and other benefits.
compensation, month pay and other benefits:
SECTION6. Concurrent Multiple Employments. An employee is employed by two or
Salaries/allowances more employers at the same time during the taxable year shall be refunded/credited
P5,000/mo. x 12 mos. P60,000.00 the taxes withheld on his 13th month pay and "other benefits" by his main employer,
13th Month pay 5,000.00 e.g., the employer paying the highest wage/salary. The said main employer shall
Gift in kind 5,000.00 determine the maximum allowable 13th month pay and "other benefits" received from
Cash gift 10,000.00 both main and secondary employer/s in annualizing the taxable compensation income
Christmas Bonus 5,000.00 at year-end adjustment. For this purpose, the secondary employer/s shall furnish the
main employer a certification as to the amount of the 13th month pay and other
Total Gross Compensation Income P85,000.00 benefits received by the employee.

Less: 13th Month Pay P5,000 SECTION7. The Employee's Withholding Statement (W-2). The employer shall furnish
Other Benefits 12,000 17,000.00 each employee with the original and duplicate copies of BIR

31

Form W-2 showing the name and address of the employer, employer's TIN, name and the month of termination/month of last payment of compensation during the
address of the employee, taxpayer/employee's TIN, amount of exemptions claimed, the year of termination;
sum of compensation paid (excluding the total non-taxable benefits), the amount of tax c) Employees (non-resident citizen) whose services are rendered abroad; and
due and the amount of tax withheld during the calendar year. d) Alien employees subject to final withholding tax.
The statement must be signed by both the employer or other authorized officer and the
SECTION9. Transitory Provision. Employers who have already given the 13th month
employee and shall contain a written declaration that it is made under the penalties of
pay and "other benefits" to their employees and had withheld and remitted the tax due
perjury.
thereon prior to the approval of R.A. No. 7833 on December 8, 1994 shall, in annualizing
and computing the annual income and the tax due from their employees, exclude the
If the employer is the Government of the Philippines, its political subdivision, agency or
13th month pay and "other benefits", which shall be limited only to an amount not
instrumentality or government-owned or controlled corporation, the statement shall be
exceeding Twelve Thousand Pesos (P12,000.00) in the case of the "other benefits"
signed by the duly designated officer or employee.
contemplated under Sec. 3, par, (b) of these Regulations and provided, further, that
when the amount of these said "other benefits" is added to the "13th month pay"
SECTION 8. Annual Return of Income Tax Withheld on Compensation. Every employer contemplated under Sec. 3, par. (a) also of these Regulations, the total amount of tax
or other person required to deduct and withhold the tax shall, on or before January 31st exempt benefits shall not exceed Thirty Thousand Pesos (P30,000.00).
of the succeeding year, file with either the Collection Agent or authorized Municipal
Treasurer or Revenue District Officer or Commissioner of Internal Revenue the Annual
Return of Income Tax Withheld on Compensation [BIR 1743-1R (Annex "A")] to be SECTION 10. Repealing Clause. All laws, decrees, orders, rules, and regulations and
submitted with an alphabetical list of employees both in duplicate copies. other issuances inconsistent with the "Act" and these Regulations are hereby amended,
modified or repealed accordingly.
The Annual Return of Income Tax Withheld on Compensation must show the following:
SECTION 11. Effectivity. These Regulations shall take effect fifteen (15) days after its
a) Withholding agent's registered name, address and taxpayer's identification publication in a newspaper of general circulation.
number (TIN);
b) Amount and date of remittance for the 12 months of one calendar year; and Footnotes
c) Name of Bank, Bank Code/ROR (if any).
* The maximum allowable deduction for "Other Benefits" is P12,000.00. However, since
The alphabetical list of employees must show the following: the total 13th month pay and 'other benefits' should not exceed P 30,000, only
a) Name and TIN of employees/taxpayers; P10,000.00 'other benefits" can be added to P 20,000, representing Mr. "B's" total 13th
b) Gross compensation paid by all present and previous employers for the month pay from his previous and present employers.
calendar year segregating the taxable from the non-taxable compensation
income;
c) Amount of exemptions;
d) Tax required to be withheld computed in accordance with Section 21(a) of the
Tax code;
e) Tax withheld by all present and previous employers for the calendar year; and
f) Adjustment, if any.

The alphabetical list of employees shall be prepared indicating separate listings of the
following:
a) Employees as of December 31 of the taxable year;

b) Employees terminated prior to the year-end adjustment computation showing
32

RMC 36-94 (Dec. 14, 1994) "For purposes of reimbursing the officials or employees who may have received the
benefits covered by this Act before its effectivity, the withholding agents are hereby
Subject : Publishing the full text of Republic Act No. 7833 - an Act excluding the benefits authorized not to deduct the withholding taxes in the immediately succeeding payroll
mandated pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as periods corresponding to the amount previously withheld from the benefits.
amended, and other benefits from the computation of gross compensation income for
purposes of determining taxable compensation income, amending for the purpose "Sec. 3. The Secretary of Finance shall, upon the recommendation of the Commissioner
Section 28 (b) (8) of the National Internal Revenue Code, as amended. of Internal Revenue, promulgate the necessary rules and regulations for the effective
implementation of the provision of this Act.
To: All Internal Revenue Officers and Others Concerned. For the information and
guidance of all concerned, quoted hereunder is the full text of Republic Act No. "Sec. 4. All laws, decrees, orders, rules and regulations and other issuances inconsistent
7833: "REPUBLIC ACT NO. 7833 with this Act are hereby repealed or amended accordingly.
"AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO. 6686 "Sec.5. This Act shall take effect fifteen (15) days after its complete publication in the
AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM THE Official Gazette or in any two (2) newspapers of general circulation, whichever comes
COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF DETERMINING earlier.
TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE SECTION 28 (b)(8)
OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED. SALIENT FEATURES
"Sec. 1. A new sub-paragraph to be known as sub-paragraph (F) is hereby inserted at 1. Before the amendment of Section 28 (b) (8) of the National Internal Revenue Code
the end of Section 28 (b) (8) of the National Internal Revenue Code, as amended, which (NIRC) by R.A. No. 7833, the following benefits received by officials and employees
shall read as follows: of both public (national and local) and private offices, viz:
"(F) 13thmonthpayandotherbenefits.cdasia (F) 13th month pay and other benefits.
"(i) Benefits received by officials and employees of the national and local governments a. Annual Christmas bonus equivalent to one (1) month basic salary and additional cash
pursuant to Republic Act No. 6686. gift of One Thousand Pesos (P1,000.00) received by National and Local Government
officials and employees starting CY 1988 in accordance with R.A. No. 6686;
"(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986; b. Benefits received by employees pursuant to P.D. No. 851 , as amended by
Presidential Memorandum Order No. 28 dated August 13, 1986 requiring all employers
to pay all their rank-and-file employees a 13th month pay not later than December 24
"(iii) Benefits received by officials and employees not covered by Presidential Decree
of every year;
No. 851, as amended; and
c. Benefits received by officials and employees not covered by P.D. No. 851, as
"(iv) Other benefits such as productivity incentives and Christmas bonus in an amount
amended; and
not exceeding Twelve Thousand Pesos (P12,000) which shall be integrated in the 13th
month pay solely for purposes of this Act.
d. Other benefits such as productivity incentives and Christmas bonus in an amount not
exceeding Twelve Thousand Pesos (P12,000.00) which shall be integrated in the 13th
"Provided, however, That the exclusion shall only apply to the first Thirty Thousand
month pay solely for purposes of R.A. No. 7833. were taxable compensation income
Pesos (P30,000).
under Section 21(a) in relation to Section 72, both of the NIRC, as amended, subject to
withholding tax under Revenue Regulations No. 6-82, as amended by Revenue
"Sec. 2. The exclusion herein provided shall cover benefits paid or accrued beginning
Regulations No. 4-93.
January 1, 1994. cdasia
33

2. Under sub-paragraph (F) of Section 28 (b) (8) of the NIRC, as amended by R.A. No. Mid-year productivity
7833, the 13th month pay and other benefits aforestated, received by officials and
incentive bonus 5,000 8,000
employees of the National Government, Local Government Units and agencies,
including government-owned and controlled corporations, as well as by officials and --- ---
employees of private corporations and entities, are exempt from income tax, and TOTAL P18,000
consequently from the withholding tax on wages. Provided, that the
exclusions/exemptions from gross compensation income shall cover the 13th month Less: P12,000 maximum exemption for
pay and "other benefits" in the aggregate amount not exceeding P30,000 received by other benefits as contemplated under
the officials and employees paid or accrued beginning January 1, 1994. The aforesaid Sec. 1(F)(iv) of RA 7833 (12,000)

"other benefits " as contemplated under Section 1 (F) (iv) of R.A. No. 7833 shall not
exceed P12,000, which amount shall be integrated in the 13th month pay. Accordingly,
TAXABLE OTHER BENEFITS SUBJECT TO
benefits in excess of P30,000.00 shall be taxable and subject to the withholding tax only
WITHHOLDING TAX ON WAGES P6,000
insofar as the amount in excess of P30,000.00.

Illustration:
II. Computation of total benefits excluded/exempted from withholding tax on wages when
the "other benefits" are integrated in the 13th month pay.
During CY 1994, Mr. "X", an employee of a private corporation, received the
following 13th month pay and other benefits from his employer, such as:
13th month pay P15,000
13th month pay P15,000.00
Plus: Maximum allowable exemption/
Christmas bonus 10,000.00
exclusion of P12,000 for
Other benefits:
"other benefits" as contemplated
Gift in kind 2,000.00
under Sec. 1 (F) (iv) of RA 7833
Additional cash gift 1,000.00
(please refer to Computation
Mid-year productivity
No. I above) 12,000
incentive bonus 5,000.00
---
TOTAL P33,000.00
TOTAL EXCLUSIONS/EXEMPTION FROM

Under the amendment introduced by R.A. No. 7833 to Section 28(b)(8) of the NIRC, wherein TAXABLE COMPENSATION INCOME P27,000
sub-paragraph (F) has been inserted at the end thereof, the computation of the amount of ======
the benefits which shall be excluded/exempted from the taxable compensation income
and/or those subject to withholding tax on wages, if any, shall be as follows:
3. For purposes of reimbursing the officials and employees of the income taxes withheld
I. Computation of whether the full amount of subject "other benefits", as and already remitted to the BIR, the following guidelines shall be followed:
contemplated under Section 1 (F) (iv) of RA 7833, is exempt from withholding tax
on wages. a. Employers who have already given the 13th month pay and other benefits to their
employees, and had withheld and remitted the tax due thereon prior to the approval of
R.A. No. 7833 (December 8, 1994) shall, in annualizing and computing the annual
Christmas bonus P10,000
income and the tax due from their employees, exclude the 13th month pay and other
Plus: Other benefits: benefits. Any excess in the tax withheld shall be refunded by the employer to the
Gift in kind P 2,000 respective employees or credited against the tax required to be withheld from the
Additional cash gift 1,000 compensation of the employees beginning January, 1995. The employer shall then be
34

allowed to credit and deduct from its subsequent remittances of taxes withheld on o Exclusion capped at P30,000
compensation income of their employees for the succeeding months; o Excess is taxable
Gains from redemption of shares in mutual fund
b. Taxes withheld on the 13th month pay and other benefits given last November, which
should otherwise be remitted by the employer-withholding agent on December 12, 1994, CIR v. Mitsubishi Metal Corp. (Jan 22, 1990)
shall no longer be remitted to the BIR. Said withheld amount should be refunded to the Mitsubishi Metal not an agent/conduit of Eximbank
employees concerned; and Loan from Eximbank was made on its own independent capacity
Therefore, exclusion under 32(B)(7)(a) does not apply
c. The exemption/exclusion provided for under R.A. No. 7833 shall cover the 13th month - Its from one pocket to another
pay and "other benefits" in the aggregate amount not exceeding P30,000 received by the - Must be from the exercise of PV
officials and employees paid or accrued beginning January 1, 1994, provided, however,
that the aforesaid "other benefits" as contemplated under Sec. 1 (F) (iv) of R.A. No. 7833 6. Gains from the Sale of Bonds, Debentures or Other Certificates of Indebtedness
shall not exceed P12,000 which amount shall be integrated in the 13th month pay. Sec.32 (B)(7) Miscellaneous Items.

It is desired that this Circular be given as wide a publicity as possible. (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.

5. Income Derived by Foreign Government Nippon Life Ins. Inc v. CIR, CTA Case No.6142 (Feb.4, 2002)
Gains as the term is used therein in 32(B)(7)(g) does not include interest since it
Sec.32 (B)(7) Miscellaneous Items. - clearly refers to gains from the sale of bonds, debentures and other certificates of
indebtedness
(a) Income Derived by Foreign Government. - Income derived from investments in NB: interest is periodic income derived from the forbearance of money; gain from
the Philippines in loans, stocks, bonds or other domestic securities, or from interest the sale of bonds is income derived form the conversion of an asset
on deposits in banks in the Philippines by (i) foreign governments, (ii) financing NB: interest is income derived from the continuance of the bond investment; gain
institutions owned, controlled, or enjoying refinancing from foreign governments, and from sale of bonds is income derived from the termination of the bond investment
(iii) international or regional financial institutions established by foreign governments.

Enumeration:
Income derived by foreign government
Income derived by the government of its political subdivisions to be exempt,
income must be from:
o Public utility or
o The exercise of any essential government function
Prizes and awards in recognition of religious, charitable, scientific,
educational, artistic, literary or civic achievement, provided
o Selection
o Substantial future services
Prizes and awards in sports competition
o The sports completion or tournament must be sanctioned by the
relevant NSA
13th month pay and other benefits
35

Premium on key-man insurance (36(A))

IV. DEDUCTIONS o
Ex. PLDT life insurance for keyman MVP
No deduction shall be allowed for:
Individuals w/Gross Individual w/ Gross For corporations o Losses from sales or exchanges of property; or
Compensation Income Income From Business or o Interest expense; or
Only Practice of Profession o Bad debts
PPPHHI (Premium OSD Itemized deductions --- where the transaction is bet. related TPs as follows:
payments on Health Itemized deductions OSD Between members of a family
and/or Hospitalization PPHHI Between an individual and a corp. more than 50% in value of the
Insurance) Personal exemptions outstanding stock of which is owned by or for such individual
Personal Exemptions Between grantor and fiduciary of any trust
Between fiduciary of a trust and fiduciary of another trust, if the
Sec. 36(A) same person is grantor with respect to each trust
Between fiduciary of trust and a beneficiary of such trust
SEC. 36. Items not Deductible.- Business expenses normally involve the following issues:
o W/N the particular expense was ordinary and necessary
(A) General Rule. - In computing net income, no deduction shall in any case be allowed o Whether the expenditure was a current expense or a capital
in respect to - investment
o Whether the expense was incurred in business or for personal
(1) Personal, living or family expenses; reasons
Almost all cases of business expenses can be assigned to one or
(2) Any amount paid out for new buildings or for permanent improvements, or another of these 3 categories
betterments made to increase the value of any property or estate; A. Expenses

This Subsection shall not apply to intangible drilling and development costs incurred in Sec.34(A)
petroleum operations which are deductible under Subsection (G) (1) of Section 34 of
this Code. SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation
income arising from personal services rendered under an employer-employee
(3) Any amount expended in restoring property or in making good the exhaustion relationship where no deductions shall be allowed under this Section other than under
thereof for which an allowance is or has been made; or 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
(4) Premiums paid on any life insurance policy covering the life of any officer or following deductions from gross income;
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
(A) Expenses. -
beneficiary under such policy.

The following are not deductible from gross income (1) Ordinary and Necessary Trade, Business or Professional Expenses.-
o Personal, living or family expenses
o Any amount paid out for new buildings or for permanent (a) In General. - There shall be allowed as deduction from gross income all the ordinary
improvements, or betterments, made to increase the value of any and necessary expenses paid or incurred during the taxable year in carrying on or which
property or estate (CAPEX) are directly attributable to, the development, management, operation and/or conduct
o Any amount expended in restoring property or in making good the of the trade, business or exercise of a profession, including:
exhaustion thereof for which an allowance is or has been made
36

(i) A reasonable allowance for salaries, wages, and other forms of compensation for expenditures otherwise considered as capital outlays of depreciable assets incurred
personal services actually rendered, including the grossed-up monetary value of fringe during the taxable year for the expansion of school facilities or (b) to deduct allowance
benefit furnished or granted by the employer to the employee: Provided, That the final for depreciation thereof under Subsection (F) hereof.
tax imposed under Section 33 hereof has been paid;
1. Non-Deductible Personal Expenses v. Deductible Business Expenses
(ii) A reasonable allowance for travel expenses, here and abroad, while away from home
in the pursuit of trade, business or profession; Smith v. CIR, 40 B.T.A. 1038 (1939)
TPs argued that since Mrs. Smith would have been unable to leave her child and
(iii) A reasonable allowance for rentals and/or other payments which are required as a take job but for the services of a nursemaid the latters fee should be regarded as
condition for the continued use or possession, for purposes of the trade, business or a necessary business expense
profession, of property to which the taxpayer has not taken or is not taking title or in If the nursemaids fee allowed because essential to the TPs employment, then by
which he has no equity other than that of a lessee, user or possessor; extension all consumption expenditures food, shelter, clothing, recreation
which enable TPs to carry on the days activities must become deductible as well
(iv) A reasonable allowance for entertainment, amusement and recreation expenses Yet these are the very essence of those personal expenses the deductibility of
during the taxable year, that are directly connected to the development, management which is expressly denied
and operation of the trade, business or profession of the taxpayer, or that are directly Pevsner v. CIR, 628 F.2d 467 (5th Cir. 1980)
related to or in furtherance of the conduct of his or its trade, business or exercise of a Test for deductibility: cost of clothing is deductible as a business expense only if:
profession not to exceed such ceilings as the Secretary of Finance may, by rules and 2. the clothing is a type specifically required as a condition of employment
regulations prescribe, upon recommendation of the Commissioner, taking into account 3. it is not adaptable to general usage as ordinary clothing
the needs as well as the special circumstances, nature and character of the industry, 4. it is not so worn
trade, business, or profession of the taxpayer: Provided, That any expense incurred for Rudolph v. US, supra
entertainment, amusement or recreation that is contrary to law, morals public policy or Deductibility of a combined business-pleasure trip depends on a subjective standard
public order shall in no case be allowed as a deduction. whether the TPs primary purpose was business or personal
Schultz v. CIR, 16 T.C. 401 (1951)
(b) Substantiation Requirements. - No deduction from gross income shall be allowed Entertainment expenses are deductible only if they are in fact ordinary and necessary
under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient expenses for carrying on a trade or business and to the extent that they are primarily
evidence, such as official receipts or other adequate records: (i) the amount of the social and personal in nature and bear no direct relation to the operation of a business
expense being deducted, and (ii) the direct connection or relation of the expense being such expenditures may not be deducted.
deducted to the development, management, operation and/or conduct of the trade,
business or profession of the taxpayer. NIRC 34(A)(1)(a)(iv): cap on entertainment expenses; non-deductibility of
entertainment expenses that are contrary to law, public morals, public policy
(c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income or public order
shall be allowed under Subsection (A) hereof for any payment made, directly or NIRC 34(1)(1)(c): non-deductibility of bribes, kickback and other similar
indirectly, to an official or employee of the national government, or to an official or payments
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 2. Travel Expenses While Away from Home
foreign government, or to a private corporation, general professional partnership, or a - Conditions for deductibility of traveling expenses
similar entity, if the payment constitutes a bribe or kickback. Reasonable and necessary
Expenses incurred while away from home
(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses Expense must be incurred in pursuit of business; there must be direct
allowable as deductions under this Chapter, a private educational institution, referred to connection between the expense and the carrying on of the trade or
under Section 27 (B) of this Code, may at its option elect either: (a) to deduct
37

business of the taxpayer or his employer; expense must be necessary or Whether deductible current expense or non-deductible CAPEX is a question of
appropriate to the development and pursuit of the business or trade timing: deduct now or spread out
What to use? Depends on the circumstance. It one is at loss already, theres
CIR v. Flowers, 326 U.S. 465 (1946) nose use of going for the deduction anymore since there will no tax to pay.
Contention of CIR: The word home must be understood to refer to the TPs place
of business (as opposed to TPs actual residence)
Held: although SC did not decide upon the meaning of home sustained the Mt. Morris Drive-In Theatre Co. v. CIR, 25 T.C. MT. MORRIS v. MIDLAND EMPIRE
disallowance on the ground that the expense in question had been incurred by the 272 (1955)
TP for his own convenience rather than for business reasons TP constructed an open-air theatre on A case of replacement or addition
Appropriate test of deductibility was whether the travel had been motivated by the sloping land without including in the Cost incurred in response to an
exigencies of business or by considerations of personal preference construction of any drainage system event somehow resembling a
- Because TP could have chosen to live in Mobile, thereby avoiding the need for TP spent $8,224 to construct a drainage natural disaster (e.g., oil seepage)
travel, the expenses were found to be self-imposed and personal system extending into and over adjacent Need for drainage system
What is the bottom line of this case> land belonging to another in compromise forseeable and obvious
o Commuting expenses, while certainly a matter of business exigency, have of a pending lawsuit against it based Oil seepage unforseeable
never been deductible upon allegations that TPs use of its own
o Daily commuting expenses is personal and not deductible property had caused accelerated and
Hantzis v. CIR, 638 F.2d 248 (1st CIR. 1981) concentrated drainage onto the adjacent
Held: deduction disallowed; Ms. Hantzis had no business home in Boston to be land
away from Held: the cost of drainage system was
TP who pursues temporary employment away from location of his usual residence CAPEX and was not deductible either as
but has not business connection with that location is not away from home for an ordinary and necessary business
purposes of travel expense deduction expense or as a loss
While Ms. Hantzis plainly occupied two homes during the summer months, the Midland Empire Packing Co v. CIR, 14 T.C. 635
home in Boston was maintained as a matter of personal choice rather than business (1950)
necessity Issue was whether the cost of lining
It followed that her transportation and added living costs in NYC were not basement walls with concrete to prevent
deductible as travel expense oil seepage created by a neighboring
Hantzis merely confirms the holding in Flowers that long-distance commuting refinery should be treated as a deductible
even combined with meals and lodging expense does not qualify as travel repair or a CAPEX
Held: deductible repair
3. Deductible Current Expenses v. Non-Deductible Capital Expenditures INDOPCO, Inc. v. CIR, 503 U.S. 79 (1992)
Whether certain professional expenses incurred by a target corporation in the course of
Statutory basis: non-deductible CAPEX: 36(A)(2) a friendly takeover are deductible by that corporation as ordinary and necessary
Expenditures whose benefit extends beyond current taxable year not business expenses or CAPEX
deductible CIR v. General Foods (Phil.), Inc. (April 24, 2003)
E.g. Land and buildings, machinery and equipment, patents and trademarks Advertising to stimulate the current sale of merchandise or use of services
Present payment for future economic benefit should be capitalized rather deductible current expense
than deducted as current expenses Advertising designed to stimulate the future sale of merchandise or use of services -
CAPEX recovered by way of depreciation or amortization CAPEX
Statutory basis: non-deductible CAPEX: 36(A)(2)
38

4. Ordinary and Necessary Option 1 Option 2

- To be deductible under 34(A) an expenditure must not only be incurred in Pre-salary income 15,000,000 15,000,000
carrying on of..[a] trade, business or exercise of profession, but also must Less: regular salary 5,000 5,000
qualify as ordinary and necessary Less: Bonus -NIL- 10,000,000
Taxable Income 10,000,000 -NIL-

Welch v. Helvering, 290 U.S. 111 (1933) Tax payments
Payment of anothers debt (restore the TPs credit and to reestablish his reputation Corporate income tax (P10M x 3,000,000 -NIL-
with other firms) is not ordinary, hence, not deductible currently 30%)
Efforts to establish reputation are akin to acquisition of capital assets and, Tax on dividends (P6.5M x 10%) 7,000,000 -NIL-
therefore, expenses related thereto are not business expense but CAPEX Tax on regular salary (P5M x 1,600,000
Atlas Consolidated Mining & Devt Corp. v. CIR (Jan. 27, 1981) 32%)
Fees paid to a P.R. firm to create a favorable image of the co. in order to gain or Tax on bonus paid -NIL-
maintain the publics and stockholders patronage CAPEX Total Taxes paid 5,750,000 4,800,000
Recurring stock listing fee paid to the stock exchange (not one-off) ordinary and BBs take Home (P15M less taxes 9,250,000 10,200,000
necessary

Kuenzle & Streiff, Inc v. Collector (Oct. 20, 1959)

Litigation expenses incurred in defense or protection of title - CAPEX Measure of reasonableness: facts and circumstances test

5. Reasonable Compensation 6. Period for Which Deductions and Credits Taken
- 34(A)(1)(a)(i) provides that the TPs business expenses include a Year in which deduction taken: paid or incurred during the taxable year
reasonable allowance for salaries, wags and other forms of compensation for depending also on the method of accounting
personal services actually rendered
If cash method year when expense is paid
- There s a possibility that BIR might characterize it to something
Why cant the taxpayer choose when to claim the deduction?

o If you claim a deduction, theres no tax benefit. Therefore, you might
C.M. Hoskins & Co., Inc. v. CIR (Nov. 28, 1969)
shift it to a year when then there is such
A case of disguised dividends o No accurate matching of financial expenses
Reduction of corporate-level tax through deductible excessive compensation
instead of non-deductible dividends Sec. 45
Illustration: BB owns all of the shares of Adult Entertainment Co. and also serves as
its president SEC. 45. Period for which Deductions and Credits Taken. - The deductions provided for
The corporation usally earns about P5M a year before BBs salary in this Title shall be taken for the taxable year in which 'paid or accrued' or 'paid or
But since BB normally takes a reasonable salary of precisely the same amount, incurred', dependent upon the method of accounting the basis of which the net income
the companys annual taxable income customarily zero and it pays no corporate is computed, unless in order to clearly reflect the income, the deductions should be
income tax whatever taken as of a different period. In the case of the death of a taxpayer, there shall be
BB of course, pays an individual tax on the salary he receives allowed as deductions for the taxable period in which falls the date of his death,
Suppose however, that 2005 was a specially good year and the corporations pre- amounts accrued up to the date of his death if not otherwise properly allowable in
salary earnings balloon to P15M respect of such period or a prior period.
BB is eager to get his greedy hands on the entire P15M for his personal use
BB has 2 options: (i) pay himself the customary reasonable salary of P5M, then CIR v. Isabela Cultural Corp. (Feb. 12, 2007)
declare the after-tax net income as dividends; (ii) pay himself the customary TP may not claim as a deduction in 1986 the cost legal and auditing services
reasonable salary of P5M, then pay himself an excessive bonus of P10M rendered in 1984 and 1985, although billed only and paid in 1986
All events test: expense must be claimed as a deduction when liability is (1) fixed
39

and (2) the amount can be determined with reasonable accuracy 2. Underlying indebtedness must be in connection with the trade or business or
exercise of profession
3. There must be an indebtedness
4. There should be an interest expense paid or incurred upon such indebtedness;
5. The indebtedness must be that of the TP;
6. The indebtedness must be connected with the taxpayers trade, business or
B. Interest exercise of profession;
7. The interest expense must have been paid or incurred during the taxable year;
Sec.34(B) 8. The interest must have been stipulated in writing;
9. The interest must be legally due;
(B) Interest.- 10. The interest payment arrangement must not be between related parties under
36(B)
11. The interest must not be incurred to finance petroleum operations; and
(1) In General. - The amount of interest paid or incurred within a taxable year on
12. In case of interest incurred to acquire property used in trade, business or exercise
indebtedness in connection with the taxpayer's profession, trade or business shall be
of profession, the same was not treated as a capital expenditure
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:
Paper Ind. Corp. of the Phil. v. CA (Dec. 1, 1995)
The Tax Code does not prohibit the deduction of interest on a loan incurred for
Forty-one percent (41%) beginning January 1, 1998;Thirty-nine percent (39%) beginning acquiring machinery and equipment. Neither does the Tax Code compel the
January 1, 1999; and Thirty-eight percent (38%) beginning January 1, 2000; capitalization of interest payments on such a loan
NB: 34(B)(3) now gives the TP the option to deduct currently or capitalize interest
(2) Exceptions. - No deduction shall be allowed in respect of interest under the incurred to acquire property used in trade, business or exercise of a profession
succeeding subparagraphs: CIR v. Vda. de Prieto (Sept. 30, 1960)
Although interest payment for delinquent taxes is not deductible as tax under Section
(a) If within the taxable year an individual taxpayer reporting income on the cash basis 30(c) of the Tax Code [now 34(C) and section 80 of the Income Tax Regulations, the
incurs an indebtedness on which an interest is paid in advance through discount or taxpayer is not precluded thereby from claiming said interest payment as deduction
otherwise: Provided, That such interest shall be allowed a a deduction in the year the under section 30(b) of the same Code [now 34(b)]
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 Rev. Regs. 13-2000 (Nov. 20, 2000)
amortized or paid during the year shall be allowed as deduction in such taxable year;
Subject: Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for
(b)If both the taxpayer and the person to whom the payment has been made or is to be Deductibility of Interest Expense from the Gross Income of a Taxpayer.
made are persons specified under Section 36 (B); or
To: All Internal Revenue Officers and Others Concerned
(c)If the indebtedness is incurred to finance petroleum exploration.
SECTION 1.
Scope. Pursuant to the provisions of Section 244 of the Tax Code of 1997, these
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest
Regulations are hereby promulgated to implement the provisions of Section 34(B) of the
incurred to acquire property used in trade business or exercise of a profession may be
same Code on the requirements for deductibility of interest expense from the gross
allowed as a deduction or treated as a capital expenditure.
income of a corporation or an individual engaged in trade, business or in the practice of

profession.
Requisites for deductibility

1. Paid or incurred within the taxable year
40

SECTION 2. Definition of Terms. For purposes of these Regulations, the following

words and phrases shall have the following meanings, viz: (b) Limitation. The amount of interest expense paid or incurred by a taxpayer in
connection with his trade, business or exercise of a profession from an existing
(a) Interest shall refer to the payment for the use or forbearance or detention of indebtedness shall be reduced by an amount equal to the following percentages of the
money, regardless of the name it is called or denominated. It includes the amount paid interest income earned which had been subjected to final withholding tax depending on
for the borrower's use of money during the term of the loan, as well as for his detention the year when the interest income was earned, viz:
of money after the due date for its repayment.
Forty-one percent (41%) beginning January 1, 1998;
(b) Taxpayer shall refer to a person, whether natural or juridical, engaged in trade, Thirty-nine percent (39%) beginning January 1, 1999; and
business or in the exercise of profession, except one earning compensation income Thirty-eight percent (38%).beginning January 1, 2000 and thereafter.
arising from personal services rendered under an employer-employee relationship.
This limitation shall apply regardless of whether or not a tax arbitrage scheme was
SECTION3. Requisites for Deductibility of Interest Expense. In general, subject to entered into by the taxpayer or regardless of the date when the interest bearing loan
certain limitations, the following are the requisites for the deductibility of interest and the date when the investment was made for as long as, during the taxable year,
expense from gross income, viz: there is an interest expense incurred on one side and an interest income earned on the
other side, which interest income had been subjected to final withholding tax. This rule
(a) There must be an indebtedness; shall be observed irrespective of the currency the loan was contracted and/or in
whatever currency the investments or deposits were made.
(b) There should be an interest expense paid or incurred upon such indebtedness;
Illustration: Supposing on January 15, 1998, Company A, who has a deposit account with
(c) The indebtedness must be that of the taxpayer, BCD Bank, obtained a loan from XYZ Financing Corporation in connection with the
operation of its business. Assume that Company A's net income for the year 1998 before
(d) The indebtedness must be connected with the taxpayer's trade, business or exercise the deduction of the interest expense amounted to P1,000,000. For the year 1998, the
of profession; interest income it derived from the said deposit with BCD Bank amounted to P180,000
on which a final tax of P36,000 had been withheld. Its interest expense on the loan
(e) The interest expense must have been paid or incurred during the taxable year; obtained from XYZ Financing Corporation during the same year amounted to P150,000.
Under this illustration, the deductible interest expense, the taxable income and the
(f) The interest must have been stipulated in writing; income tax due of Company A shall be computed as follows:

(g) The interest must be legally due;
1998
(h) The interest payment arrangement must not be between related taxpayers as Net Income before interest expense P1,000,000
mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997; Less: Interest expense P150,000
Less: 41% of interest income from 73,800
(i) The interest must not be incurred to finance petroleum operations; and deposit (41% x P180,000)
(j) In case of interest incurred to acquire property used in trade, business or exercise of Deductible interest expense 76,200
profession, the same was not treated as a capital expenditure. Taxable Income P 923,800
Income tax due for taxable year 1998 P 314,092
SECTION 4. Rules on the Deductibility of Interest Expense. (34%)

(a) General Rule. In general, the amount of interest expense paid or incurred within a
taxable year on indebtedness in connection with the taxpayer's trade, business or (c) Interest on Unpaid Taxes. Provisions of Sec. 4(b) hereof to the contrary
exercise of profession shall be allowed as a deduction from the taxpayer's gross income. notwithstanding, interest incurred or paid by the taxpayer on all unpaid business-
41

related taxes shall be fully deductible from gross income and shall not be subject to the
limitation (2) If both the taxpayer and the person to whom the payment has been made or is to be
deduction heretofore mentioned. Thus, such interest expense incurred or paid shall not made are persons specified under Sec. 36(B) of the Tax Code of 1997, viz:
be diminished by the percentage of interest income earned which had been subjected
to final withholding tax. (i) Between members of a family. For purposes of this paragraph, the family of an
individual shall include only his brothers and sisters (whether by the whole or half-
(d) Other cases where interest expense is not deductible from gross income. No blood), spouse, ancestors and lineal descendants; or
interest expense shall be allowed as deduction from gross income in any of the
following cases: (ii) Between an individual and a corporation more than fifty percent (50%) in value of
the outstanding stock of which is owned, directly and indirectly, by or for such
(1) If within the taxable year, an individual taxpayer reporting income on the cash basis individual; or
incurs an indebtedness on which an interest is paid in advance through discount or
otherwise: Provided, That such interest shall be allowed as a deduction in the year the (iii) Between two corporations more than fifty percent (50%) in value of the outstanding
indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic stock of each of which is owned, directly or indirectly, by or for the same individual; or
amortization, 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. (iv)Between the grantor and a fiduciary of any trust; or

Illustration: Mr. Cruz, a self-employed individual, consistently employs the cash-basis (v)Between the fiduciary of a trust and the fiduciary of another trust if the same person
accounting method in keeping his books of accounts. Assuming that on January 1, 1998, is a grantor with respect to each trust; or
he contracted a loan of P1,000,000 from XYZ Bank for use in his business operations.
Terms: (vi) Between a fiduciary of a trust and a beneficiary of such trust.

Payable in two (2) years at 15% interest per annum, payable in advance. On January 1, (3) If the indebtedness on which the interest expense is paid is incurred to finance
1998, he received from the bank the proceeds of his loan in the sum of P700,000, net of petroleum exploration in the Philippines. The non-deductible interest expense herein
interest paid in advance in the amount of P300,000. referred to pertains to interest or other consideration paid or incurred by a Service
Contractor engaged in the discovery and production of indigenous petroleum in the
In general, the interest expense shall be taken for the taxable year in which "paid or Philippines in respect of the financing of its petroleum operations, pursuant to Section
incurred" or "paid or accrued" depending upon the method of accounting upon the 23 of P.D. No. 8, as amended by P.D. No. 87, otherwise known as "The Oil Exploration
basis of which the net income is computed, unless in order to clearly reflect the income, and Development Act of 1972."
the deduction should be taken as of a different period. Thus, a self-employed individual
is allowed to deduct from his gross income the entire amount of interest expense (e) Optional treatment of interest expense on capital expenditure. At the option of
actually paid during the taxable year. However, if the interest expense is paid in advance the taxpayer, interest expense on a capital expenditure incurred to acquire property
and the accounting method used by the self-employed individual is the cash-basis used in trade, business or exercise of a profession may be allowed as a deduction in full
accounting method, such interest expense paid in advance shall only be allowed as in the year when incurred, the provisions of Sec. 36 (A)(2) and (3) of the Tax Code of
deduction in the year when he has fully paid his liability. So that if the said debtor has 1997 to the contrary notwithstanding, or may be treated as a capital expenditure for
fully paid his loan as of the end of the taxable year 1999, his interest expense paid in which the taxpayer may claim only as a deduction the periodic amortization of such
advance on January 1, 1998 in the amount of P300,000 shall only be allowed as expenditure.
deduction from his gross income in the taxable year 1999.
SECTION5. Repealing Clause. The provisions of any revenue regulations or any
On the other hand, even if the interest expense is paid in advance but the indebtedness revenue issuance or ruling inconsistent with these Regulations are hereby repealed,
is payable in periodic amortization, the amount of interest expense which corresponds amended, or modified accordingly.
to the amount of the principal amortized or paid during the respective years 1998 and
1999 shall be allowed as deduction in such respective taxable years. SECTION 6. Effectivity Clause. These Regulations shall take effect immediately.
42

Non-deductible interest
- Interest Arbitrage Prepaid/advance interest of cash-basis individual
Anti-tax arbitrage provision: interest otherwise deductible reduce by 33% of TP and recipient of interest are related parties under section 36(B)
interest income subject to final tax Interest to finance petroleum exploration (capitalized under special rules)
o Back-to-back loans: TP takes out loan; uses proceeds to purchase
government securities; interest income from government securities
subject to 20% FWT; interest expense on loan deductible from gross Related Party transactions:
income (tax benefit is 32%/35%); tax advantage is 15% Between members of a family
o Tax arbitrage avoided by imposing limit on deductible business Between an individual and a corp. more than 50% in value of the
expense outstanding stock of which is owned by or for such individual
Rationale: 1997, banks and financial advisers used to take advantage over this. Between grantor and fiduciary of any trust
They acquire loan and use the proceeds for buying securities. So you have an Between fiduciary of a trust and fiduciary of another trust, if the
interest expense on one hand and an interest income on the other. same person is grantor with respect to each trust
Between fiduciary of trust and a beneficiary of such trust
BIR Rul. No. 006-00 (Jan.5, 2000)
Limitation applies regardless of whether or not a tax arbitrage scheme was entered into C. Taxes
by 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 Sec. 34(C)
expense incurred on one side and an interest income earned on the other side, which
interest income had been subjected to final withholding tax
(C) Taxes. -

Illustration:
1. Interest income from time deposit in BPI in 2007: P100,000 (subjected to 20% (1) In General. - Taxes paid or incurred within the taxable year in connection with the
FWT) taxpayer's profession, trade or business, shall be allowed as deduction, except
o Interest expense form business loan: P120,000
o Formula: interest expense 38% of interest income subjected to final (a) The income tax provided for under this Title;
tax = allowable interest expense
o P120,000 P38,000 = P82,000 (b) Income taxes imposed by authority of any foreign country; but this deduction shall
2. TP took out a loan for P1m; interest at 10% p/a be allowed in the case of a taxpayer who does not signify in his return his desire to have
o Uses P1M loan proceeds to purchase T-bills paying interest at 10% to any extent the benefits of paragraph (3) of this subsection (relating to credits for
p/a, subject to 20% final tax taxes of foreign countries);
o For every P1.00 of interest income earned from T-bills, TP pays tax of
P0.20 (c) Estate and donor's taxes; and
o For every P1.00 of interest expense claimed as a deduction, income
tax liability is reduced by P0.30
(d) Taxes assessed against local benefits of a kind tending to increase the value of the
o P0.30 tax benefit vs. P0.20 tax paid = P0.10 tax advantage/revenue
property assessed.
leak
3. With anti-tax arbitrage provision in palce, TP can deduct only P0.62 (P1.000
interest expense less 38% of P1.00 interest income) Provided, That taxes allowed under this Subsection, when refunded or credited, shall be
o Tax benefit of P0.62 interest expense is P0.186 included as part of gross income in the year of receipt to the extent of the income tax
o Tax paid on P1.00 interest income is P0.20 benefit of said deduction.
o Tax loop hole is plugged by anti-arbitrage provision
43

(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in condition precedent to the allowance of this credit may require the taxpayer to give a
trade or business in the Philippines and a resident foreign corporation, the deductions bond with sureties satisfactory to and to be approved by the Commissioner in such sum
for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to as he may require, conditioned upon the payment by the taxpayer of any amount of tax
the extent that they are connected with income from sources within the Philippines. found due upon any such redetermination. The bond herein prescribed shall contain
such further conditions as the Commissioner may require.
(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 (6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this
shall be credited with: 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
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a country were incurred, subject, however, to the conditions prescribed in Subsection
domestic corporation, the amount of income taxes paid or incurred during the taxable (C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the
year to any foreign country; and 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.
(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 (7)Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed
incurred during the taxable year to a foreign country, if his distributive share of the only if the taxpayer establishes to the satisfaction of the Commissioner the following:
income of such partnership or trust is reported for taxation under this Title.
(a) The total amount of income derived from sources without the Philippines;
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. (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
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be and regulations prescribed by the Secretary of Finance; and
subject to each of the following limitations:
(c) All other information necessary for the verification and computation of such credits.
(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 In General
taxpayer's taxable income from sources within such country under this Title bears to his Taxes paid or incurred in connection with the TPs trade, business or
entire taxable income for the same taxable year; and profession are deductible
Exception: the following taxes are not deductible
(b) The total amount of the credit shall not exceed the same proportion of the tax o Income tax
against which such credit is taken, which the taxpayer's taxable income from sources o Foreign taxes, if TP elects FTC
without the Philippines taxable under this Title bears to his entire taxable income for o Donors and estate tax
the same taxable year. o Special assessments imposed by an LGU over an adjoining
landowner who is benefitted. This seldom happens
Examples: Local business taxes
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from
Why would a taxpayer choose a tax credit over a deduction?
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 o Tax benefit has an effective rate
o Deduction: Tax benefit is the entire P1
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 Foreign Tax Credits
the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a Granted when there is foreign source income + tax foreign and domestic
44

Resident citizens and domestic corporations are taxed on income from within NIRC uses the term loss in three distinct ways;
and without the Philippines (23(A) & (E)) a) Casualty - TP parting of something of value (money or property) as a result of
If a resident citizen or a domestic corporation derive both Philippine source an identifiable event e.g., abandonment of property ( 34(D)(7), expenditure
and foreign source income, it is possible that they may be subject to tax in of funds or a casualty ( 34(D)(1)), obsolescence loss (medicines not sold but
more than one country about to expire already)
o The right of a foreign country to tax income derived from any activity b) Excess of deductions over items of income e.g., NOL under 34(D)(3); such
of a TP within its territorial boundary may coincide with the loss could be composed of hundreds or even thousand of distinct items of
Philippines right to tax the same TP on the basis of citizenship or income and deduction
residency c) Sale exchange or other disposition of property Gain/loss = AR-AB ( 40)
o Ex. fight purse of Manny Pacquiao earned in a boxing match in the
U.S.
Result: Types of deductible losses under section 34(D):
o International double taxation exists when a single item of income is Losses incurred in trade, business or profession ( 34(D)(1))
subject to income tax by more than one country Casualty losses and losses from robbery, theft & embezzlement ( 34(D)(3))
Remedies to eliminate or mitigate effects of double taxation: NOL- law allows carry-over of NOLs under certain conditions ( 34(D)(3)
o Granting a credit for foreign taxes paid (unilateral mechanism) - Capital losses governed by 39
34(C)(3), subject to the limitation set forth in subsection (C)(4) Losses from wash sales - 38
o Allowing foreign taxes paid as a deduction against income (unilateral Wagering losses deductible only to the extent of wagering gains
mechanism) - 34(C)(1)(b) Abandonment losses covered by special laws (e.g. PD 87)
o Income tax treaties (bilateral mechanism) - 32(B)(5)
Foreign tax credit available only to resident citizens and domestic corporation 1. Casualty Losses
(not available to non-resident citizens, aliens and foreign corporation because
they are not taxable on foreign source income) Sec. 34(D)
FTC applies only if there is foreign source income and income tax on the
foreign source income is paid to another jurisdiction (D) Losses. -

* YOU MUST INVOKE THE TAX CREDIT
(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:
CIR v. Lednicky (July 31, 1964)
An alien resident who derives income wholly from sources within the Philippines
(a) If incurred in trade, profession or business;
may not deduct form gross income the income taxes he paid to his home country
for the taxable year
An alien residents right to deduct from gross income the income taxes he paid to a (b) Of property connected with the trade, business or profession, if the loss arises from
foreign government is given only as an alternative to his right to claim a tax credit fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.
for such foreign income taxes; so that unless he has a right to claim such tax credit
if he chooses, he is precluded from said deduction The Secretary of Finance, upon recommendation of the Commissioner, is hereby
An alien resident is not entitled to tax credit for foreign income taxes paid when his authorized to promulgate rules and regulations prescribing, among other things, the
income is derived wholly from sources within the Philippines time and manner by which the taxpayer shall submit a declaration of loss sustained
What they should have done: they should have just claimed foreign tax credit in the from casualty or from robbery, theft or embezzlement during the taxable year:
US for their income in the Philippines. 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
D. Losses discovery of the casualty or robbery, theft or embezzlement giving rise to the loss.

45

(c) No loss shall be allowed as a deduction under this Subsection if at the time of the (i) Not less than seventy-five percent (75%) in nominal value of outstanding issued
filing of the return, such loss has been claimed as a deduction for estate tax purposes in shares, if the business is in the name of a corporation, is held by or on behalf of the
the estate tax return. 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
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the same persons.
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 "For purposes of this subsection, the term 'not operating loss' shall mean the excess of
losses are not compensated for by insurance or other forms of indemnity. The secretary allowable deduction over gross income of the business in a taxable year.
of Finance, upon recommendation of the Commissioner, is hereby authorized to
promulgate rules and regulations prescribing, among other things, the time and manner Provided, That for mines other than oil and gas wells, a net operating loss without the
by which the taxpayer shall submit a declaration of loss sustained from casualty or from benefit of incentives provided for under Executive Order No. 226, as amended,
robbery, theft or embezzlement during the taxable year: Provided, That the time to be otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first
so prescribed in the rules and regulations shall not be less than thirty (30) days nor more ten (10) years of operation may be carried over as a deduction from taxable income for
than ninety (90) days from the date of discovery of the casualty or robbery, theft or the next five (5) years immediately following the year of such loss. The entire amount of
embezzlement giving rise to the loss; and 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
Losses under 34(D)(1): conditions for deductibility be deducted in like manner form the taxable income of the next remaining four (4)
Actually sustained in the year claimed years.
Not compensated for insurance or other forms of indemnity
Property is connected with a trade, business or profession and loss arises from Net operating loss (NOL): excess of allowable deductions over gross income of
fire, storm the business in a taxable year
Property is connected with a trade, business or profession and loss arises from NOLs may be carried over as a deduction from gross income for the next three
the fire, storm, shipwreck, or other casualty or from theft consecutive taxable years immediately following the year of loss
Sworn declaration of loss filed within 45 days (Rev. Regs. 12-77); failure to file Provided, there has been no substantial change in ownership of the business
results in disallowance enterprise
o Must substantiate loss through adequate records o Change in shareholders: corporation will still benefit
o There needs to be basis for the BIR to verify if there was really a loss o Merger and consolidation: there is a transfer from one entity to
another
2. NOLCO
- More allowable deductions than gross income: Net operating loss
- Started in 1997 TP can carry over NOL to 3 succeeding years
- NOL will be an additional deduction
- Provided that there should be no substantial change in the ownership
(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 -

46

substantial change in ownership (75% rule), NOL deductible in the hands of the
transferee
If NOL transfers from TP who sustained and accumulated the same to another
TP via merger, consolidation, or business combination, and there is substantial
PICOP v. CA change in ownership, NOL is lost
NOLCO allowed only if there has been no substantial change in the ownership
of the business enterprise
Illustration of substantial change in ownership rule (see NOLCO charts)

3. Realized v. Unrealized losses

BIR Rul. No. 206-90 (Oct.30, 1990)
Conversion of dollar denominated loans to pesos at the prevailing exchange rate
Not taxable income because such increase has not yet been realized. The increase
in value can only be realized when there is severance of the gain already.
It is also the same to obtaining losses. Annual decline in value of a property is not
normally allowed as a deduction.
The loss is only deductible for the year it was actually sustained and that is during
the year in which the loss occurs as evidenced by a complete transaction. There has
PICOP claimed P44M of
to be a taxation even that should happen.
RPPMs NOL as a deduction
BIR Rul. No. 144-85 (Aug. 26, 1985)
against its 1977 gross
Losses that arose from matured but unremitted principal repayments of loans
R S/H P S/H income
affected by debt restructuring program in the Philippines
To grant PICOPs claimed The increase in value, i.e., the gain, could only be taxed when a disposition of the
deduction would be to property occurred which was of such a nature as to constitute a realization of such
permit PICOP to purchase a gain, that is, a severance of the gain from the original capital invested in the
PICOP
tax deduction and RPPM to property. The same conclusion obtains as to losses. The annual decrease in the
peddle its accumulated value of property is not normally allowable as a loss. Hence, to be allowable the
operating loss loss must be realized.
NOL PICOP established the rule
that NOLCO is available 4. Losses from sales or exchanges (to be taken-up in XV below)
only to the TP which

E. Bad Debts

Important rules (PICOP codified)
NOL is always available as a deduction in the hands of the TP who sustained Sec. 34(E)
and accumulated the NOL, regardless of the change in ownership (Rev Regs.
14-01 2.2) (E) Bad Debts. -
NOL is retained also if the TP who sustained and accumulated the NOL is
involved in a merger and the same TP is the surviving entity (1) In General. - Debts due to the taxpayer actually ascertained to be worthless and
If NOL transfers from the TP who sustained and accumulated the same to charged off within the taxable year except those not connected with profession, trade
another TP via merger, consolidation, or business combination, and there is no or business and those sustained in a transaction entered into between parties
47

mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts a corporation or an individual engaged in trade or business or a professional engaged in
previously allowed as deduction in the preceding years shall be included as part of the the practice of his profession.
gross income in the year of recovery to the extent of the income tax benefit of said
deduction. SECTION 2. Definition of Terms. For purposes of these regulations, the following
words and phrases shall have the following meaning, viz:
(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 a. "Bad debts" shall refer to those debts resulting from the worthlessness or
assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from
trust company incorporated under the laws of the Philippines a substantial part of money lent or from uncollectible amounts of income from goods sold or services
whose business is the receipt of deposits, for the purpose of this Title, be considered as rendered.
a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
b. "Securities" shall mean shares of stock in a corporation and rights to subscribe for
Requisites for deductibility or to receive such shares. The term includes bonds, debentures, notes or certificates, or
There must be an existing indebtedness due to the taxpayer which must be other evidence of indebtedness, issued by any corporation, including those issued by a
valid and legally demandable government or political subdivision thereof, with interest coupons or in registered form.
The same must be connected with the taxpayers trade, business or practice of
profession; c. "Actually ascertained to be worthless" In general, a debt is not worthless simply
The same must not be sustained in a transaction entered into between related because it is of doubtful value or difficult to collect. Worthlessness is not determined by
parties enumerated under NIRC 36(B) an inflexible formula or slide rule calculation but upon the exercise of sound business
judgment. The determination of worthlessness in a given case must depend upon the
The same must be actually charged off the books of accounts of the taxpayer
particular facts and the circumstances of the case.
as of the end of the taxable year; and

The same must be actually ascertained to be worthless and uncollectible as of
A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of
the end of the taxable year
ultimate collection or because of a continuance of attempts to collect notes which have

long become overdue, and where there is no showing that the surrounding
When is an indebtedness actually ascertained to be worthless?
circumstances differ from those relating to other notes which were charged off in a
No hard and fast rule; facts and circumstances
prior year. While a mere hope probably will not justify postponement of the deduction,
Debt no worthless simply because it is doubtful value or difficult to
a reasonable possibility of recovery will permit the account to be carried along
collect
notwithstanding that the probabilities are that the debt may not be collected at all. The
Deduction may not be postponed on the basis of a mere hope of
creditor may offer evidence to show some expectation that the debt would have been
ultimate collection paid in the intervening years, and that subsequently, the hope was shattered or
appeared to have been unfounded. If, for example, the creditor could show that during
Rev. Regs. 5-99 (March 10, 1999) the years he attempted to collect the debt, the debtor had property the title of which
was in dispute but which would enable him to pay his debts when the title was cleared,
SUBJECT : Implementing Section 34(E) of the Tax Code of 1997 on the Requirements the creditor would be entitled to defer the deduction on the ground that there was no
for Deductibility of Bad Debts from Gross Income genuine ascertainment of worthlessness.
Thus, accounts receivable, the amount whereof is insignificant and the collection of
TO : REVENUE REGULATIONS NO. 05-99 which through court action may be more costly to the taxpayer, may be written-off as
All Internal Revenue Officers and Others Concerned bad debts even without conclusive evidence that the taxpayer's receivable from a
debtor has definitely become worthless.
SECTION 1.
Scope. Pursuant to the provisions of Section 244 of the Tax Code of 1997, these Good faith does not require that the taxpayer be an "incorrigible optimist" but on the
regulations are hereby promulgated to implement the provisions of Section 34(E) of the other hand, he may not be unduly pessimistic. Creditors do not have to wait until some
same Code on the requirements for deductibility of bad debts from the gross income of
48

turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may from the debtor and who shall issue a statement under oath showing the propriety of
strike a middle course between pessimism and optimism and determine debts to be the deductions thereon made for alleged bad debts. Thus, where the surrounding
worthless in the exercise of sound business judgment based upon as complete circumstances indicate that a debt is and uncollectible and that legal action to enforce
information as is reasonably ascertainable. The taxpayer need not have perfect payment would in all probability not result in the satisfaction of execution on a
discernment. judgment, a showing of those facts will be sufficient evidence of the worthlessness of
the debt for the purpose of deduction.
d. "Actually charged off from the taxpayers books of accounts" This phrase means
that the amount of money lent by the taxpayer (in the course of his business, trade or Exception: In the case of banks, however, in lieu of requisite No. 5 above, the Bangko
profession) to his debtor had been recorded in his books of account as a receivable has Sentral ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and
actually become worthless as of the end of the taxable year, that the said uncollectibility of the bad debts and it shall approve the writing off of the said
receivable has been cancelled and written-off from the said taxpayer's books of account. indebtedness from the banks' books of accounts at the end of the taxable year. The
A mere recording in the taxpayer's books of account of estimated uncollectible accounts bank though should still comply with requisites Nos. 1-4 as enumerated above before it
does not constitute a write-off of the said receivable, hence, shall not be a valid basis for can avail of the benefit of deduction.
its deduction as a bad debt expense. In no case may any bad debt deduction be allowed
unless the facts pertaining to the money or property lent and its cancellation or write- Also, in no case may a receivable from an insurance or surety company be written-off
off from the taxpayer's accounting records, after having been determined that the same from the taxpayer's books and claimed as bad debts deduction unless such company has
has actually become worthless, have been complied with by the taxpayer. been declared closed due to insolvency or for any such similar reason by the Insurance
Commissioner. cda
SECTION 3. Requisites for Valid Deduction of Bad Debts From Gross income. General
Rule. In general, the requisites for deductibility of bad debts are: SECTION 4. Tax Benefit Rule. The recovery of bad debts previously allowed as
deduction in the preceding year or years shall be included as part of the taxpayer's gross
(1) There must be an existing indebtedness due to the taxpayer which must be valid and income in the year of such recovery to the extent of the income tax benefit of said
legally demandable; deduction.

(2) The same must be connected with the taxpayer's trade, business or practice of Example: If in the year the taxpayer claimed deduction of bad debts written-off, he
profession; realized a reduction of the income tax due from him on account of the said deduction,
his subsequent recovery thereof from his debtor shall be treated as a receipt of realized
(3) The same must not be sustained in a transaction entered into between related taxable income. Conversely, if the said taxpayer did not benefit from the deduction of
parties enumerated under Sec. 36(B) of the Tax Code of 1997; the said bad debt written-off because it did not result to any reduction of his income tax
in the year of such deduction (i.e. where the result of his business operation was a net
(4) The same must be actually charged off the books of accounts of the taxpayer as of loss even without deduction of the bad debts written-off), then his subsequent recovery
the end of the taxable year; and thereof shall be treated as a mere recovery or a return of capital, hence, not treated as
receipt of realized taxable income.
(5) The same must be actually ascertained to be worthless and uncollectible as of the
end of the taxable year. SECTION 5. Securities Becoming Worthless. If securities, as defined under Sec. 2(b)
hereof, held as capital asset, are ascertained to be worthless and charged off within the
Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to taxable year, the loss resulting therefrom shall be considered as a loss from the sale or
demonstrate with reasonable degree of certainty the uncollectibility of the debt. The exchange of capital asset made on the last day of such taxable year. The taxpayer,
Commissioner of Internal Revenue will consider all pertinent evidence, including the however, has to prove through clear and convincing evidence that the securities are in
value of the collateral, if any, securing the debt and the financial condition of the debtor fact worthless.
in determining whether a debt is worthless, or the assigning of the case for collection to This rule, however, is not true in the case of banks or trust companies incorporated
an independent collection lawyer who is not under the employ of the taxpayer and who under the laws of the Philippines, a substantial part of whose business is the receipt of
shall report on the legal obstacle and the virtual impossibility of collecting the same deposits.
49

life tenant. In the case of property held in trust, the allowable deduction shall be
SECTION6. Repealing Clause. The provision of any revenue regulations, revenue apportioned between the income beneficiaries and the trustees in accordance with the
memorandum order, revenue memorandum circular or any other revenue issuances pertinent provisions of the instrument creating the trust, or in the absence of such
inconsistent with these Regulations are hereby repealed, amended, or modified provisions, on the basis of the trust income allowable to each.
accordingly.
(2) Use of Certain Methods and Rates. The term reasonable allowance as used in the
SECTION 7. Effectivity Clause. These Regulations shall take effect fifteen (15) days preceding paragraph shall include, but not limited to, an allowance computed in
after publication in any newspaper of general circulation. accordance with rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, under any of the following methods:
Phil. Refining Co. v. CA (May 8, 1996)
Mere testimony of the accountant of the TP explaining the worthlessness of the (a) The straight-line method;(b) Declining-balance method, using a rate not exceeding
debts is self-serving; worthlessness of debts sought to be deducted must be twice the rate which would have been used had the annual allowance been computed
substantiated under the method described in Subsection (F) (1);(c) The sum-of-the-years-digit method;
Mere allegations cannot prove the worthlessness of debts sought to be deducted; and(d) any other method which may be prescribed by the Secretary of Finance upon
no documentary evidence presented (e.g., collection letters, field reports, referral recommendation of the Commissioner.
of letter to lawyers, police report that owners bankrupt due to fire that engulfed
store or that the owner was murdered, etc.)
(3) Agreement as to Useful Life on Which Depreciation Rate is Based. Where under
Steps to be undertaken generally by the TP to prove that he exerted diligent efforts rules and regulations prescribed by the Secretary of Finance upon recommendation of
to collect the debts the Commissioner, the taxpayer and the Commissioner have entered into an agreement
- sending of statement of accounts in writing specifically dealing with the useful life and rate of depreciation of any
- sending of collection letters property, the rate so agreed upon shall be binding on both the taxpayer and the
- giving the account to a lawyer for collection national Government in the absence of facts and circumstances not taken into
- filing a collection case in court consideration during the adoption of such agreement. The responsibility of establishing
Fernandez Hermanos, Inc. v. CIR (Sept. 30, 1969) the existence of such facts and circumstances shall rest with the party initiating the
No bad debt could arise where there is no valid and subsisting debt modification. Any change in the agreed rate and useful life of the depreciable property
There was no due date as specified in the agreement shall not be effective for taxable years prior to the taxable
Case involved advances made by one company to an affiliate year in which notice in writing by certified mail or registered mail is served by the party
Lender-TP did not expect to be repaid initiating such change to the other party to the agreement:
In consideration for the advances, TP entitled to 15% of net profits
Thus, if there were no profits, there was no obligation to repay the advances Provided, however, that where the taxpayer has adopted such useful life and
depreciation rate for any depreciable and claimed the depreciation expenses as
F. Depreciation 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
Sec. 34(F) depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall
be considered binding for purposes of this Subsection.
(F) Depreciation.
(4) Depreciation of Properties Used in Petroleum Operations. An allowance for
(1) General Rule. There shall be allowed as a depreciation deduction a reasonable depreciation in respect of all properties directly related to production of petroleum
allowance for the exhaustion, wear and tear (including reasonable allowance for initially placed in service in a taxable year shall be allowed under the straight-line or
obsolescence) of property used in the trade or business. In the case of property held by declining-balance method of depreciation at the option of the service contractor.
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 However, if the service contractor initially elects the declining-balance method, it may at
50

any subsequent date, shift to the straight-line method. acquisition cost

Rationale: The recovery, free of income tax of an amount more than the invested
The useful life of properties used in or related to production of petroleum shall be ten capital in an asset will transgress the underlying purpose of a depreciation
(10) years of such shorter life as may be permitted by the Commissioner. allowance. For then what the TP would recover will be not only the acquisition cost,
but also some profit.
Properties not used directly in the production of petroleum shall be depreciated under Limpan Investment Corp. v. CIR (July 26, 1966)
the straight-line method on the basis of an estimated useful life of five (5) years. Depreciation is a question of fact (e.g., appropriate useful life to adopt)
Bulletin F of the IRS has persuasive effect in Philippines jurisdiction
- The BIR has adopted Bulletin F under a revenue issuance
(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: G. Depletion

(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or Sec. 34(G)
(b) Depreciated over any number of years between five (5) years and the expected life if (G) Depletion of Oil and Gas Wells and Mines. -
the latter is more than ten (10) years, and the depreciation thereon allowed as
deduction from taxable income: Provided, That the contractor notifies the (1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for
Commissioner at the beginning of the depreciation period which depreciation rate depletion or amortization computed in accordance with the cost-depletion method shall
allowed by this Section will be used. 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
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or depletion shall equal the capital invested no further allowance shall be granted:
Resident Foreign Corporations. In the case of a nonresident alien individual engaged in Provided, further, That after production in commercial quantities has commenced,
trade or business or resident foreign corporation, a reasonable allowance for the certain intangible exploration and development drilling costs: (a) shall be deductible in
deterioration of Property arising out of its use or employment or its non-use in the the year incurred if such expenditures are incurred for non-producing wells and/or
business trade or profession shall be permitted only when such property is located in mines, or (b) shall be deductible in full in the year paid or incurred or at the election of
the Philippines. the taxpayer, may be capitalized and amortized if such expenditures incurred are for
producing wells and/or mines in the same contract area.
From a valuation standpoint: decrease in value of assets through the passage
of time, wear and tear of obsolescence 'Intangible costs in petroleum operations' refers to any cost incurred in petroleum
From financial reporting/tax standpoint: allocation of the cost of an asset to operations which in itself has no salvage value and which is incidental to and necessary
periods in which the asset expected to be used 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
Basilan Estates, Inc. v. CIR (Sept. 5, 1967) of a character subject to the allowance for depreciation except that the allowances for
Basilan Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 depreciation on such property shall be deductible under this Subsection.
on the basis of their acquisition cost
As of 1/1/50 it changed the depreciable value of said assets by increasing it to Any intangible exploration, drilling and development expenses allowed as a deduction in
conform with the increase in cost for their replacement computing taxable income during the year shall not be taken into consideration in
Accordingly, from 1950 to 1953 it deducted from gross income the value of computing the adjusted cost basis for the purpose of computing allowable cost
depreciation computed on the reappraised value depletion.
Issue: Whether depreciation shall be determined on the acquisition cost or on the
re-appraised value of the assets (2) Election to Deduct Exploration and Development Expenditures. - In computing
Held: Income ax law does not authorize the depreciation of an asset beyond its taxable income from mining operations, the taxpayer may at his option, deduct
51

exploration and development expenditures accumulated as cost or adjusted basis for "solely a matter of legislative grace." 22(22) Hence, the taxpayer has the burden of
cost depletion as of date of prospecting, as well as exploration and development justifying the allowance of any deduction claimed. 23(23) As in connection with all
expenditures paid or incurred during the taxable year: Provided, That the amount other tax controversies, the burden of proof to show that a disallowance of
deductible for exploration and development expenditures shall not exceed twenty-five depletion by the Commissioner is incorrect or that an allowance made is
percent (25%) of the net income from mining operations computed without the benefit inadequate is upon the taxpayer, and this is true with respect to the value of the
of any tax incentives under existing laws. The actual exploration and development property constituting the basis of the deduction. 24(24) This burden-of-proof rule
expenditures minus twenty-five percent (25%) of the net income from mining shall be has been frequently applied and a value claimed has been disallowed for lack of
carried forward to the succeeding years until fully deducted. evidence.
It had burden of establishing the components of the amount of P1,738,974.57:
The election by the taxpayer to deduct the exploration and development expenditures is what were the particular expenses made and the corresponding amount of each, so
irrevocable and shall be binding in succeeding taxable years. that it may be determined whether the expenses were actually made and whether
the items are properly part of cost of mine development, or are actually
'Net income from mining operations', as used in this Subsection, shall mean gross depreciable items.
income from operations less 'allowable deductions' which are necessary or related to
mining operations. 'Allowable deductions' shall include mining, milling and marketing H. Charitable and Other Contributions
expenses, and depreciation of properties directly used in the mining operations. This
paragraph shall not apply to expenditures for the acquisition or improvement of Sec. 34(H)
property of a character which is subject to the allowance for depreciation.
(H) Charitable and Other Contributions. -
In no case shall this paragraph apply with respect to amounts paid or incurred for the
exploration and development of oil and gas. (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
The term 'exploration expenditures' means expenditures paid or incurred for the subdivision thereof exclusively for public purposes, or to accredited domestic
purpose of ascertaining the existence, location, extent or quality of any deposit of ore or corporation or associations organized and operated exclusively for religious, charitable,
other mineral, and paid or incurred before the beginning of the development stage of scientific, youth and sports development, cultural or educational purposes or for the
the mine or deposit. rehabilitation of veterans, or to social welfare institutions, or to non-government
organizations, in accordance with rules and regulations promulgated by the Secretary of
The term 'development expenditures' means expenditures paid or incurred during the finance, upon recommendation of the Commissioner, no part of the net income of
development stage of the mine or other natural deposits. The development stage of a which inures to the benefit of any private stockholder or individual in an amount not in
mine or other natural deposit shall begin at the time when deposits of ore or other excess of ten percent (10%) in the case of an individual, and five percent (%) in the case
minerals are shown to exist in sufficient commercial quantity and quality and shall end of a corporation, of the taxpayer's taxable income derived from trade, business or
upon commencement of actual commercial extraction. profession as computed without the benefit of this and the following subparagraphs.
(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien (2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding
individual or Foreign Corporation. - In the case of a nonresident alien individual subparagraph, donations to the following institutions or entities shall be deductible in
engaged in trade or business in the Philippines or a resident foreign corporation, full;
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 (a) Donations to the Government. - Donations to the Government of the Philippines or
within the Philippines. 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
Consolidated Mines Inc v. CTA (Aug. 29, 1974) activities in education, health, youth and sports development, human settlements,
As an income tax concept, depletion is wholly a creation of the statute 21(21) science and culture, and in economic development according to a National Priority Plan
52

determined by the National Economic and Development Authority (NEDA), In (i) Any amount in cash or in kind (including administrative expenses) paid or utilized to
consultation with appropriate government agencies, including its regional development accomplish one or more purposes for which the accredited nongovernment
councils and private philantrophic persons and institutions: Provided, That any donation organization was created or organized.(ii) Any amount paid to acquire an asset used (or
which is made to the Government or to any of its agencies or political subdivisions not in held for use) directly in carrying out one or more purposes for which the accredited
accordance with the said annual priority plan shall be subject to the limitations nongovernment organization was created or organized.
prescribed in paragraph (1) of this Subsection;
An amount set aside for a specific project which comes within one or more purposes of
(b) Donations to Certain Foreign Institutions or International Organizations. - donations the accredited nongovernment organization may be treated as a utilization, but only if
to foreign institutions or international organizations which are fully deductible in at the time such amount is set aside, the accredited nongovernment organization has
pursuance of or in compliance with agreements, treaties, or commitments entered into established to the satisfaction of the Commissioner that the amount will be paid for the
by the Government of the Philippines and the foreign institutions or international specific project within a period to be prescribed in rules and regulations to be
organizations or in pursuance of special laws; 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
(c) Donations to Accredited Nongovernment Organizations. - the term 'nongovernment accomplished by setting aside such amount than by immediate payment of funds.
organization' means a non profit domestic corporation:
(3) Valuation. - The amount of any charitable contribution of property other than
(1) Organized and operated exclusively for scientific, research, educational, character- money shall be based on the acquisition cost of said property.
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 (4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if
benefit of any private individual; verified under the rules and regulations prescribed by the Secretary of Finance, upon
recommendation of the Commissioner.
(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 When are charitable and other contributions deductible in full?
received, makes utilization directly for the active conduct of the activities constituting Donations to the National Government, its agencies or political subdivisions
the purpose or function for which it is organized and operated, unless an extended and fully-owned government corporations
period is granted by the Secretary of Finance in accordance with the rules and
regulations to be promulgated, upon recommendation of the Commissioner; PARTIAL FULL
Donation exclusively for public purpose Donation for exclusive use in undertaking
(3) The level of administrative expense of which shall, on an annual basis, conform with priority activities in:
the rules and regulations to be prescribed by the Secretary of Finance, upon (i) education
recommendation of the Commissioner, but in no case to exceed thirty percent (30%) of (ii) health
the total expenses; and (iii) youth and sports devt
(iv) human setlements
(v) science and culture and
(4) The assets of which, in the even of dissolution, would be distributed to another
(vi) economit devt
nonprofit domestic corporation organized for similar purpose or purposes, or to the
In accordance with NPP of NEDA
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. o If not compliant with 2 reqts for full deductibility, still deductible but
with limitation (10%/5% cap)

Subject to such terms and conditions as may be prescribed by the Secretary of Finance,

the term 'utilization' means:

53

Donations to certain domestic corporations or associations, social welfare
institutions, NGO Donor- Deductible
taxpayer Govt In full
PARTIAL FULL
Donations to Donation to accredited NGOs organized
(1) accredited domestic and operated exclusively for Deductible
Certain Foreign
corporations or associations (i) scientific In full
Institutions

organized and operated and (ii) research

exclusively for (iii) educational
Deductible
(i) religious (iv) character-building and youth and
Accredited In full
(ii) charitable sports development
NGOs/Donee
(iii) scientific (v) health
Institutions
(iv) youth and sports devt (vi) social welfare
(v) cultural or educational (vii) cultural or charitable purposes, or a
purposes, or combination thereof, no part of the net
(vi) rehabilitation of veterans income of which inures to the benefit of Others Not
(2) social welfare institutions any private individual deductible
(3) NGOs
Direct utilization of the donation on or
before the 15th day of the 3rd month
following the close of the taxable year
Annual administrative expense must not
exceed 30% Donations to the National Government, etc. conditions for full deductibility:
Distibution of assets in case of dissolution Must be exclusive use in undertaking priority activities in
to a similar institution, to the state for o Education
public purposes, and by the court for o Health
another org. to be used in manner that o Youth and sports development
would best accomplish the general o Human settlements
purpose of the dissolved org o Science and culture
o Economic development
Donations foreign institutions or international organizations which fully AND, in accordance with the NPP of the NEDA
deductible in compliance with existing treaties or special law o If not compliant with the 2 reqts above, still deductible but with
limitation (10%/5% of taxable income without the benefit of the
charitable contribution)

Donations to accredited NGOs/done institutions: conditions for full deductibility
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
54

Direct utilization of the donation on or before the 15th day of the third month from such expenditures).
following the close of the taxable year of the done institution
Annual administrative expense must not exceed 30% The election provided by paragraph (2) hereof may be made for any taxable year
Distribution of assets in case of dissolution to a similar institution, to the state beginning after the effectivity of this Code, but only if made not later than the time
for public purposes, and by a court of law to another organization to be used in prescribed by law for filing the return for such taxable year. The method so elected, and
manner that would best accomplish the general purposes of the dissolved org. 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
BIR Rul. 19-01 (May 10, 2001) authorized with respect to a part or all of such expenditures. The election shall not apply
Whether or not international organizations with home offices based abroad are to any expenditure paid or incurred during any taxable year for which the taxpayer
qualified to be granted donee institution status makes the election.
A non-stock, non-profit corporation or organization must be created or organized
under Philippine Laws and that an NGO must be a non-profit domestic corporation, (3) Limitations on deduction. - This Subsection shall not apply to:
this Office is of the opinion that a foreign corporation, like Conservation
International, whether resident or non-resident, cannot be accredited as donee
(a) Any expenditure for the acquisition or improvement of land, or for the improvement
institution. of property to be used in connection with research and development of a character
which is subject to depreciation and depletion; and
I. Research and Development

(b) Any expenditure paid or incurred for the purpose of ascertaining the existence,
Sec. 34(I)
location, extent, or quality of any deposit of ore or other mineral, including oil or gas.

(I) Research and Development. -
In general deductible as ordinary and necessary expenses during the year
when R&D expenses paid, or incurred, provided:
(1) In General. - a taxpayer may treat research or development expenditures which are o In connection with the trade, business or profession
paid or incurred by him during the taxable year in connection with his trade, business or o Not chargeable to a capital account
profession as ordinary and necessary expenses which are not chargeable to capital Election to defer deduction TP may defer outright deduction and elect to
account. The expenditures so treated shall be allowed as deduction during the taxable spread out deduction over a period not less than 60 months (beginning with
year when paid or incurred. the month in which TP first realizes benefits from such expenditures)
o In connection with trade, business or profession
(2) Amortization of Certain Research and Development Expenditures. - At the election o Chargeable to a capital account, but not to property of a character
of the taxpayer and in accordance with the rules and regulations to be prescribed by the which is subject to depreciation or depletion
Secretary of Finance, upon recommendation of the Commissioner, the following o Not treated as outright expense
research and development expenditures may be treated as deferred expenses: 34(I) and election to defer not applicable to the ff:
o Expenditure for acquisition or improvement of land (expense is
(a) Paid or incurred by the taxpayer in connection with his trade, business or capitalized as part of the cost of the land)
profession;(b) Not treated as expenses under paragraph 91) hereof; and(c) Chargeable o Improvement of property to be used in connection with R&D of a
to capital account but not chargeable to property of a character which is subject to character subject to depreciation or depletion
depreciation or depletion. o Expenditure for exploration activities (minerals, oil & gas, etc.)

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 3M Phil., Inc. v. CIR (Sept. 26, 1988)
the taxpayer (beginning with the month in which the taxpayer first realizes benefits Although the Tax Code allows payments of royalty to be deducted from gross income as
55

business expenses, it is CB Circular No. 393 that defines what royalty payments are with this Section 58 and 81 of this Code.
proper. Hence, improper payments of royalty are not deductible as legitimate business
expenses. 34(A)(1)(b) ordinary and necessary business expenses must be substantiated
by sufficient evidence (e.g., O/Rs and other adequate business records);
J. Pension Trusts amount of expense and connection with trade, business or profession
Reasonable private benefit plan 34(K) deduction will be disallowed if TP fails to withhold taxes, as may be
o Defined benefit plan required by law or regulations, and remit such withheld taxes to the BIR
Benefits to be received by retiring employees are defined or
fixed upon retirement (e.g., 2 months salary for every year of L. Optional Standard Deduction
service)
Employer bears investment risk, but will benefit from surpluses Sec. 34(L)
o Defined contribution plan (L) Optional Standard Deduction. - In lieu of the deductions allowed under the
Employers annual contribution to the pension plan is fixed preceding Subsections, an individual subject to tax under Section 24, other than a
Individual accounts are set up for participants and nonresident alien, may elect a standard deduction in an amount not exceeding ten
retirement benefits consist of aggregate contributions percent (10%) of his gross income. Unless the taxpayer signifies in his return his
credited to individual accounts plus investment earnings intention to elect the optional standard deduction, he shall be considered as having
Employee bears investment risk and rewards availed himself of the deductions allowed in the preceding Subsections. Such election
Normal cost annual employer contributions to the plan (whether defined when made in the return shall be irrevocable for the taxable year for which the return is
benefit or defined contribution) deductible as ordinary and necessary made: Provided, That an individual who is entitled to and claimed for the optional
business expenses under 34(A)(1) standard deduction shall not be required to submit with his tax return such financial
Past service cost deduction is spread out over a 10-year period statements otherwise required under this Code: Provided, further, That except when
the Commissioner otherwise permits, the said individual shall keep such records
Sec. 34(J) 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
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide Commissioner.
for the payment of reasonable pensions to his employees shall be allowed as a Amendment by RA 9504:
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 (L) Optional Standard Deduction. - In lieu of the deductions allowed under the preceding
(A) (1) of this Section ) a reasonable amount transferred or paid into such trust during Subsections, an individual subject to tax under Section 24, other than a nonresident
the taxable year in excess of such contributions, but only if such amount (1)has not alien, may elect a standard deduction in an amount not exceeding forty percent (40%)
theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a of his gross sales or gross receipts, as the case may be. In the case of a corporation
period of ten (10) consecutive years beginning with the year in which the transfer or subject to tax under section 27(A) and 28(A)(1), it may elect a standard deduction in an
payment is made. amount not exceeding forty percent (40%) of it gross income as defined in Section 32 of
this Code. Unless the taxpayer signifies in his return his intention to elect the optional
K. Additional Requirements for Deductibility 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
Sec. 34(K) 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 shall not be required
(K) Additional Requirements for Deductibility of Certain Payments. - Any amount paid to submit with his tax return such financial statements otherwise required under this
or payable which is otherwise deductible from, or taken into account in computing gross Code: Provided, further, That except when the Commissioner otherwise permits, the
income or for which depreciation or amortization may be allowed under this Section, said individual shall keep such records pertaining to his gross sales or gross receipts, or
shall be allowed as a deduction only if it is shown that the tax required to be deducted the said corporation shall keep such records pertaining to his gross income as defined in
and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance Section 32 of this Code during the taxable year, as may be required by the rules and
56

regulations promulgated by the Secretary of Finance, upon recommendation of the

Commissioner.

In lieu of itemized deductions under 34, an individual subject to tax under
24 (except a nonresident alien) may elect a standard deduction of 40% of gross
sales/receipts
In the case of a domestic corporation subject to tax under 24(A) and a
resident foreign corporation subject to tax under 28(A)(1), it may elect a
standard deduction of 40% of gross income
Intention to elect OSD must be made in the return (otherwise TP will be
considered to have elected to claim itemized deductions

M. Premium Payments

Sec. 34(M)
(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 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.

P2,400 per family, per year (or {200/month) for health and hospitalization
insurance
PPHHI may be claimed as a deduction, provided gross income of family does
not exceed P250,000 for the taxable year

57

Nonresident aliens not ETB and NRFCs generally subject to 25/30% flat tax on
V. TAXABLE INCOME Philippine source gros income

Resident citizen taxable on a net basis (with the benefit of deductions and/or
SEC. 31. Taxable Income Defined. - The term taxable income means the pertinent items
personal and addl exemptions)
of gross income specified in this Code, less the deductions and/or personal and
Resident alien taxable on a net basis (with the benefit of deductions and/or
additional exemptions, if any, authorized for such types of income by this Code or other
personal and addl exemptions)
special laws.
Nonresident citizen taxable on a net basis basis (with the benefit of

deductions and/or personal and addl exemptions)
Gross Income ( 32(A)) P xxx
Nonresident alien engaged in trade or business in the Philippines taxable on
Less: Deductions (34; itemized or OSD) and/or Addl and (xxx)
a net basis (with the benefit of deductions and/or personal and addl
Personal Exemptions ( 35)
exemptions)
Equals: Taxable Income ( 31) P xxx
Nonresident alien not ETB subject to flat tax of 25% of Philippines gross

income basis (without the benefit of deductions and/or personal and addl
Individuals earning compensation income under an employer-employee exemptions)
relationship:
Aliens employed by RQHQs, OBUs, petroleum service contractors subject to

flat tax of 15% on Philippien gross income (without the benefit of deductions
Gross compensation income ( 32(A)(1)) and/or personal and addl exemptions)
Less: PPHI ( 34(M))

Less: Personal and addl exemptiosn ( 35)
Domestic corporation generally taxable on a net basis (with the benefit of
Equals: Taxable Income ( 31)
deductions)

Resident foreign corporations generally taxable on a net basis (with the
Resident citizens, residents aliens and nonresidents citizens ETB or exercising a
benefit of deductions)
profession
Nonresident foreign corporations generally subject to 35% flat tax on

Philippine gross income (without the benefit of deductions)
Gross income ( 32)

Less: Personal and addl exemptions ( 35)
Less: Itemized deductions or optional dtf. Deduction ( 34)
Equals: Taxable income ( 31)

Domestic corporations; in general

Gross income ( 32)
Less: itemized deductions or OSD ( 34)

Resident foreign corporations; in general:

Gross income ( 32)
Less: itemized deductions or OSD ( 34)

58

VI. GENERAL PRINCIPLES OF INCOME TAXATION

SEC. 23. General Principles of Income Taxation in the Philippines. - Except when
otherwise provided in this Code:
(A) A citizen of the Philippines residing therein is taxable on all income derived from
sources within and without the Philippines;
(B) A nonresident citizen is taxable only on income derived from sources within the
Philippines;
(C) An individual citizen of the Philippines who is working and deriving income from
abroad as an overseas contract worker is taxable only on income derived from sources
within the Philippines: Provided, That a seaman who is a citizen of the Philippines and
who receives compensation for services rendered abroad as a member of the
complement of a vessel engaged exclusively in international trade shall be treated as an
overseas contract worker;
(D) An alien individual, whether a resident or not of the Philippines, is taxable only on
income derived from sources within the Philippines;
(E) A domestic corporation is taxable on all income derived from sources within and
without the Philippines; and
(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.

Resident citizens taxable on income derived from sources within and without
the Philippines
Nonresident citizens taxable only on Philippine source income
OCWs/OFWs taxable only on Philippine source income
Aliens (whether residents or nonresidents) taxable only on Philippine source
income
Domestic corporations taxable on income derived from sources within and
without the Philippines
Foreign corporations (whether residents or nonresidents) taxable only on
Philippine source income

59

VII. INCOME TAX ON INDIVIDUALS Ramnani v. CIR

TP won a money judgment in the amount of P65M
A. DEFINITIONS
CIR sought to impose a 30% flat tax on the money judgment on the ground that TP
1. Resident Citizens and Resident Aliens
was a nonresident alien not ETB

Held: TP is a resident alien (citing Rev. Regs. 25)
Sec. 22(F)
The establishment of a home even temporarily here in the Philippines for the
(F) The term 'resident alien' means an individual whose residence is within the accomplishment of a purpose even if he has the intention to return to his domicile
Philippines and who is not a citizen thereof. abroad categorizes on individual as a resident
Sec. 5, Rev. Regs. 2 TP is an American citizen who frequently comes to the Philippines for the most part
of the year to oversee his various investments as shown by his passport entries
SECTION 5. Definition. A "non-resident alien individual" means an individual The BI even approved the change of his status of admission from temporary visitor
to immigrant/resident alien under sec. 13(e) of the Philippine Immigration Act
(a) Whose residence is not within the Philippines; and TP has paid his Community Residence Certificates from 1987-1994

(b) Who is not a citizen of the Philippines. Resident Citizen a Filipino individual whose residence is in the
Philippines
An alien actually present in the Philippines who is not a mere transient or sojourner is a Resident alien an individual whose residence is in the Philippines
resident of the Philippines for purposes of the income tax. Whether he is a transient or but who is not a citizen thereof ( 22(f))
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 2. Non-Resident Citizens ( 22(E))
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 Sec. 22(E)
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 (E) The term 'nonresident citizen' means:
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 (1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner
to his domicile abroad when the purpose for which he came has been consummated or the fact of his physical presence abroad with a definite intention to reside therein.
abandoned.

(2) A citizen of the Philippines who leaves the Philippines during the taxable year to
Garrison v. CA
reside abroad, either as an immigrant or for employment on a permanent basis.
TPs were born in the Philippines, repatriated temporarily to the U.S., returned to
the Philippines and presently residing herein by virtue of their employment in the
(3) A citizen of the Philippines who works and derives income from abroad and whose
US Naval Base in Subic
employment thereat requires him to be physically present abroad most of the time
Some have married Philippine citizens, have children, and have purchased income
during the taxable year.
producing properties in the Philippines
TPs are resident aliens, not nonresident aliens
The fact that all the TPs were born here, repatriated to the US and to come back, in (4) A citizen who has been previously considered as nonresident citizen and who arrives
the latest in 1967, and to stay in the Philippines up to the present time, makes the in the Philippines at any time during the taxable year to reside permanently in the
TPs resident aliens not merely transients or sojourners 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
The TPs intention to return to their domicile abroad is immaterial because they
abroad until the date of his arrival in the Philippines.
have resided in the Philippines for quite a long time
60

(5) The taxpayer shall submit proof to the Commissioner to show his intention of leaving with respect to the income he derived from foreign sources from the date he actually
the Philippines to reside permanently abroad or to return to and reside in the departed from the Philippines.
Philippines as the case may be for purpose of this Section. A Filipino citizen who has been previously considered as a non-resident citizen and who
arrives in the Philippines at any time during the taxable year to reside therein
Physically present abroad with intention to reside therein permanently shall also be considered a non-resident citizen for the taxable year in which
Leaves the Philippines to reside abroad as immigrant or permanent he arrived in the Philippines with respect to his income derived from sources abroad
employee until the date of his arrival.
Works and derives income abroad as immigrant or permanent
employee SECTION 3. Proof of intention. A Filipino citizen who leaves the Philippines to
Works and derives income abroad; physically present abroad most reside abroad either as an immigrant or for permanent employment or a contract
of the time (i.e., at least 183 days in a taxable year) worker, shall submit to the Commissioner of Internal Revenue proof of his intention of
Arriving and departing nonresident citizens leaving the Philippines to reside permanently abroad. A returning non-resident citizen,
o OCWs ( 23(C)) a special class on the other hand, must present proof of his intention to return to and reside
permanently in the Philippines. Such proof of intention shall be attached to his income
Rev. Regs. 1-79 (Jan. 8, 1979) tax return (BIR Form No. 1701C) and may consist of the following:
SUBJECT : Regulations Governing the Taxation of Non-resident Citizens (a) In the case of an immigrant, photostat or xerox copy of his foreign visa.
TO : All Internal Revenue Officers and Others Concerned (b) In the case of one leaving for permanent employment abroad, a certificate
Pursuant to the provision of Section 326 in relation to Section 4 of the National Internal from his employer showing the nature and duration of his employment.
Revenue Code of 1977, as amended, the following regulations revising Revenue (c) In the case of a contract worker
Regulations No. 9-73 to implement the latest amendments to Section 20 of the same (1) Certificate of the employer; or
Code by P.D. No. 1457 are hereby promulgated. (2) Copy of the contract of employment; or
(3) Other documentary evidence.
SECTION 1. Scope. These amended regulations shall govern the manner of (d) In the case of a returning non-resident citizen
taxation of non-resident citizens as provided for under Section 21 of the Tax Code, as (1) Xerox copy of his passport bearing the stamp of Philippine
amended, and shall be known as Revenue Regulations No. 1-79. immigration authorities showing that he is a returning resident
as distinguished from a mere Balikbayan.
SECTION 2. Who are considered as nonresident citizens. (2) Other documentary evidence.
The term "non-resident citizen" means one who establishes to the satisfaction of the
Commissioner of Internal Revenue the fact of his physical presence abroad with the SECTION 4. Manner of filing returns. Every non-resident citizen must file an
definite intention to reside therein and shall include any Filipino who leaves the country income tax return covering all his income earned abroad on BIR Form No. 1701C. When
during the taxable year as: husband and wife are both non-resident citizens, only one return containing their
(a) Immigrant one who leaves the Philippines to reside abroad as an consolidated income is required to be filed on BIR Form No. 1701C.
immigrant for which a foreign visa as such has been secured. If aside from the foreign income, the non-resident citizen also derives income from
(b) Permanent employee one who leaves the Philippines to reside abroad Philippine sources, two separate returns should be filed, one on BIR Form No. 1701C
for employment on a more or less permanent basis. covering the income derived from foreign sources and the other on BIR Form No. 1701
(c) Contract worker one who leaves the Philippines on account of a or 1701A, as the case may be, covering the income from sources within the Philippines.
contract of employment which is renewed from time to time within or However, if the Philippine income is derived solely from salaries, wages, remunerations
during the taxable year under such circumstances as to require him to be or other similar compensation for services rendered and such gross income does not
physically present abroad most of the time during the taxable year. To be exceed P2,000, if the taxpayer is single, or P3,333.33, if married or a head of the family,
considered physically present abroad most of the time during the taxable the non-resident citizen is exempt from filing an income tax return with respect to such
year, a contract worker must have been outside the Philippines for not income.
less than 183 days during such taxable year. The income tax return of non-resident citizen covering his taxable income earned
Any such Filipino shall be considered a non-resident citizen for such taxable year abroad shall be accompanied by a copy of the income tax return filed with the national
61

government of the foreign country of his residence as well as the evidences of tax 5. Computation of tax. The computation of the tax due from a non-
payment. resident citizen on income derived abroad is illustrated as follows:
Mr. Juan de la Cruz, 35 years old, Filipino, married to Maria, with a dependent son, Jose
SECTION 5. Computation of income and tax. and a resident of Los Angeles, California.
A. On income derived from all sources outside the Philippines. For U.S. Federal Income Tax purposes, he filed a joint return containing the following
1. What to include as gross income. The gross income of a non- data and claimed the optional standard deductions and used the optional tax tablets:
resident citizen derived from sources outside the Philippines includes Income:
all income enumerated under Section 29 of the National Internal Wage, Salaries, Tips, Others $7,814.65
Revenue Code, whether or not such income is exempted from income Dividends received from qualified U.S.
tax in the foreign country where it was derived. domestic corporation $482.50 less
If the income is in foreign currency other than US dollars, it shall first be converted into exclusion $200.00 282.50
US dollars at the average annual rate of exchange of the foreign currency and the US Interest Income on savings deposit 110.17
dollar for the year in which the income was earned. Income other than wages (Wife's prize
2. Rate of tax. Beginning with the taxable year 1978, there shall be in photo contest) 200.00
imposed on the adjusted gross income of non-resident citizen a tax
computed as follows: TOTAL GROSS INCOME $8,407.32
On the amount not exceeding LESS: Adjustment to income (moving
$6,000 1% expenses) 60.00
On the amount exceeding $6,000
but not exceeding $20,000 $60.00 plus Adjusted Gross Income $8,347.32
2% of excess TAX DUE PER IRS TABLES $ 325.00
over $6,000. Tax payments and credits
On the amount exceeding Total Federal income tax
$20,000 $340.00 plus withheld $484.30
3% of excess Other payments (gasoline
over $20,000. tax, etc.) 32.67
3. Computation of Adjusted Gross Income. The adjusted gross
income is arrived at by deducting from the gross income the Total payments and credits $516.97
following:
a. Personal exemption of $2,000 if the non-resident citizen AMOUNT REFUNDABLE (191.97)
is single or a married person legally separated from his or ======
her spouse, or $4,000 if married or head of a family; For Philippine income tax purposes, his income shall be computed as follows:
b. The total amount of the national income tax actually paid Gross Income $8,407.32
to the national government of the foreign country of his ADD: Excluded dividend income taxable
residence. under Philippine Income Tax Law 200.00
4. Head of Family. The term "head of family" is defined as "an
unmarried man or woman with one or both parents, or one or more Total Gross Income $8,607.32
brothers or sisters, or one or more legitimate, recognized natural, or LESS:
adopted children living with and dependent upon him or her for their (a) Personal Exemption as
chief support where such brothers, sisters, or children are not more married $4,000
than twenty-one years of age, unmarried and not gainfully employed (b) Foreign National Income
or where such children are incapable of self-support because they are Tax paid (Attach copy
mentally or physically defective. of Federal Income Tax
62

Return and evidence SECTION 8. Effectivity. These regulations shall take effect immediately and
of payment) 325 shall apply to income earned beginning January 1, 1978.
Rev. Regs. 5-01 (July 31, 2000)
Total Deductions [add (a) & (b)] 4,325.00

ADJUSTED GROSS INCOME SUBJECT TO TAX $4,282.32 SUBJECT : Revoking the Requirement for Non-Resident Citizens, Overseas Contract
======= Workers (OCWs) and Seamen to File Information Returns on Income Derived from
Tax Due: Sources Outside the Philippines.
Adjusted Gross Income $4,282.32
At 1% rate (not over $6,000.00) x .01 TO : All Internal Revenue Officers and Others Concerned.

Amount payable $42.82

B. On income derived from sources within the Philippines. SECTION 1. 1997, in relation to Section 23(B) and (C) and Section 51(A)(2)(d) and (A)(3)
The tax due on income derived by a non-resident citizen from sources within the of the same Code, these Regulations are hereby promulgated to repeal Revenue
Philippines shall be computed in the same manner as the income tax payable by Memorandum Order No. (RMO) 30-99 and Revenue Regulations No. (RR) 9-99,
resident citizens and resident aliens. prescribing the filing of information returns by non-resident citizens, overseas contract
workers (OCWs) and seamen with respect to their income derived from sources outside
SECTION 6. When and where to file. The return must be filed, and the tax due, the Philippines.
if any, must be paid on or before April 15 following the year for which the return is
being filed with the Philippine Embassy or Office of the Consulate General nearest to the SECTION 2. FILING OF INFORMATION RETURNS (BIR FORM 1701C OR BIR FORM 1703)
taxpayer's place of residence or direct to the Commissioner of Internal Revenue, BIR NO LONGER REQUIRED. Non-resident citizens who are exempt from tax with respect
Bldg., Diliman, Quezon City, Philippines. to income derived from sources outside the Philippines in accordance with Section 23(B)
If the return and payment, if any, are sent by mail, the same should be mailed on such a and (C), in relation to Section 22 (E) and Section 51 (A)(2)(d) and (A)(3) of the Tax Code
date as to reach the Philippine Embassy, Philippine Consulate General or the of 1997, but who are nevertheless mandated to file information returns (BIR Form
Commissioner of Internal Revenue on or before April 15. The payment should be made 1701C or the new computerized BIR Form 1703) pursuant to RMO 30-99 and RR 9-99,
in the form of an international money order, bank draft or manager's check payable to shall no longer be required to file the same on their income derived from sources
the Commissioner of Internal Revenue. outside the Philippines beginning taxable year 2001.
If the return is filed and payment of the tax made in the Philippines by or for the non-
resident citizen, the tax may be paid in Philippine currency, the dollar amount of the tax SECTION3. REPEALING CLAUSE. For purposes of these Regulations, RMO 30-99 and
to be converted into pesos at the rate of exchange prescribed by Revenue RR 9-99 are hereby repealed accordingly.
Memorandum Circular No. 21-78 for internal revenue tax purposes.
When the tax due is in excess of two hundred dollars (U.S.$200.00), the non- SECTION 4. EFFECTIVITY CLAUSE. These Regulations shall take effect (15) days after
resident citizen may elect to pay the tax in two equal installments in which case, the first publication in any newspaper of general circulation.
installment shall be paid at the time the return is filed and the second installment, on or
before the fifteenth day of July following the close of the calendar year. If any BIR Rul. 33-00
installment is not paid on or before the date fixed for its payment, the whole amount of
Distinguished between a nonresident citizen and an OCW for purposes of
the tax unpaid becomes due and payable together with the delinquency penalties.
applying the most of the time rule

For the exemption on foreign source income to apply, an individual to be
SECTION 7. Repealing Clause. These regulations supersede Revenue
considered a nonresident citizen must be physically abroad for at least 183
Regulations No. 9-73 dated November 26, 1973. All existing rules, regulations,
days
administrative orders and general circulars or portion thereof, which are inconsistent
As regards OCWs, the time spent abroad is not material for tax exemption
herewith are hereby repealed, amended or modified accordingly.
purpose; all that is required is for the contract to be registered with the POEA
63

3. Non-Resident Aliens Engaged/not Engaged in Trade or Business in the "The additional exemption for dependents shall be claimed by only one of the spouses
Philippines in the case of married individuals.
Sec. 22(G)

"In the case of legally separated spouses, additional exemptions may be claimed only by
(G) The term 'nonresident alien' means an individual whose residence is not within the
the spouse who has custody of the child or children:
Philippines and who is not a citizen thereof.

Provided, That the total amount of additional exemptions that may be claimed by both
Secs. 5 and 6, Rev. Regs. 2
shall not exceed the maximum additional exemptions herein allowed.
SECTION 5. Definition. A "non-resident alien individual" means an individual
(a) Whose residence is not within the Philippines; and "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
(b) Who is not a citizen of the Philippines. dependent is not more than twenty-one (21) years of age, unmarried and not gainfully
employed or if such dependent, regardless of age, is incapable of self-support because
An alien actually present in the Philippines who is not a mere transient or sojourner is a of mental or physical defect.
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 5. Minimum Wage Earner
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 Sec.22(HH) as amended by Rep. Act. No. 9504
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 (HH) the term 'minimum wage earner' shall refer to a worker in the private sector paid
purpose is of such a nature that an extended stay may be necessary for its the statutory minimum wage, or to an employee in the public sector with compensation
accomplishment, and to that end the alien makes his home temporarily in the income of not more than the statutory minimum wage in the non-agricultural sector
Philippines, he becomes a resident, though it may be his intention at all times to return where he/she is assigned.
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

(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).
64

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TAXATION

1 ATTY. BELLO ALC D 2017

Evolve a progressive system of taxation resort to indirect taxes

Service Contract under SC 38 is a contractual tax exemption granted by the

A. WHAT IS INCOME (A DEFINITIONAL CONCEPT)?

Examples of recovered deductions:

c. De Minimis Benefits benefits.

Benefits from the USVA

d) "Immediately succeeding payroll period" refers to the payroll period beginning

Other Benefits beginning Gross Compensation Income After

a) Employees as of December 31 of the taxable year;

"(F) 13thmonthpayandotherbenefits.cdasia (F) 13th month pay and other benefits.

Premium on key-man insurance (36(A))

4. Ordinary and Necessary Option 1 Option 2

Kuenzle & Streiff, Inc v. Collector (Oct. 20, 1959)

SECTION 2. Definition of Terms. For purposes of these Regulations, the following

any subsequent date, shift to the straight-line method. acquisition cost

regulations promulgated by the Secretary of Finance, upon recommendation of the

(M) Premium Payments on Health and/or Hospitalization Insurance of an Individual

Notwithstanding the provision of the preceding Subsections, The Secretary of Finance,

VI. GENERAL PRINCIPLES OF INCOME TAXATION

(F) A foreign corporation, whether engaged or not in trade or business in the

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