ATENEO CENTRAL BAR OPERATIONS 2007Taxation LawSUMMER REVIEWERAdvisers: Atty. Serafin Salvador, Atty. Michael Dana Montero, Atty. Gaudencio Mendoza; Head: Julie Ann B.Domino, Juan J. P. Enriquez III; Understudies: Rachelle T. Sy, Aldwin Mendoza, Timothy John BatanQuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.PART I GENERAL PRINCIPLESTAXATION power inherent in every sovereignState to impose a charge or burden upon persons,properties, or rights to raise revenues for the use andsupport of the government to enable it to dischargeits appropriate functionsSCOPE OF TAXATIONTAXATION IS: Unlimited, Far-reaching, Plenary Comprehensive SupremeSTAGES OF TAXATION: (LAP)1. Levy2. Assessment3. PaymentBasic Principles of a Sound Tax System1. Fiscal Adequacy2. Theoretical Justice3. Administrative FeasibilityINHERENT LIMITATIONS (SPING)1) Situs or territoriality of taxation2) Must be for a Public purpose Test is whether proceeds will beused for something which is theduty of the State to provide. Legislature is not required toadopt a policy of all or none. Incidental benefit to individualdoes not defeat exemption3) International comity Property of a foreign State ofgovernment may not be taxed byanother4) Non-delegability of the taxing power Contemplates power todetermine kind, object, extent,amount, coverage, and situs oftax; Distinguish from power to assessand collect Exemptions: (a) presidentialtaxing powers; (b) localgovernments5) Exemptions of Government agencies Taking money from one pocketto the other Applies only to entities exercisinggovernment functions (acta jureimperii)CONSTITUTIONAL LIMITATIONSA. Direct1) Due process Should not be harsh, oppressive,or confiscatory (Substantive) By authority of valid law(Substantive) Must be for a public purpose(Substantive) Imposed within territorialjurisdiction (Substantive) No arbitrariness in assessmentand collection (Procedural) Right to notice and hearing(Procedural)2) Equal protection All persons subject to legislationshall be treated alike, under likecircumstances and conditionsboth in privileges conferred andliabilities imposed. Power to tax includes power toclassify provided:(a) Based on substantialdistinction(b) Apply to present and futureconditions(c) Germane to purpose of law(d) Apply equally to all members ofthe same class3) Non-impairment clause Rules(a) When government is party tocontract granting exemption cannot be withdrawnwithout violating nonimpairmentclause(b) When exemption generallygranted by law withdrawaldoes not violate(c) When exemption grantedunder a franchise may berevoked; Consti provides thatfranchise is subject toamendment, alteration, orrepeal by Congress.4) Must be uniform and equitableTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 2 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture. Uniform: all articles or propertiesof the same class taxed at samerate Equity: apportionment must bemore or less just in the light oftaxpayers ability to shoulder taxburden5) Non-imprisonment for non-paymentof poll tax Taxpayer may be imprisoned fornon-payment of other kinds oftaxes where the law so expresslyprovides.6) Congress shall evolve a progressivesystem of taxation As resources of the taxpayerbecomes higher, his tax ratelikewise increases (ex. Incometax) Constitution does not prohibitregressive taxes; this is adirective upon Congress, not ajusticiable right.7) All appropriation, revenue or tariff bills shalloriginate exclusively in the House ofRepresentatives, but the Senate maypropose or concur with amendments It is the bill, not the law, that mustoriginate from House; bill may undergoextensive changes in Senate Rationale: members of House are moresensitive to local needs.8) Freedom of religion Activities simply and purely forpropagation of faith are exempt (e.g. saleof bibles and religious articles by nonstock,non-profit organization at minimalprofit). Tax is unconstitutional if it operates as aprior restraint on exercise of religion Income even of religious organizationsfrom any activity conducted for profil orfrom any of their property, real orpersonal, regardless of disposition ofsuch income, is taxable9) Freedom of press/expression Tax that operates as a prior restraintinvalid. If fee is only for purpose of defraying costof registration and not for exercise ofprivilege, no violation.10) Charitable institutions, churches, andparsonages or convents appurtenant thereto,mosques and non-profit cemeteries and alllands, buildings and improvementsACTUALLY, DIRECTLY and EXCLUSIVELYUSED for charitable, religious andeducational purposes shall be exempt fromtaxation Pertains only to real estate tax. Test of exemption: actual use of theproperty, not ownership Use of word exclusively meansprimarily rather than solely. Exemption extends to property incidentalto or reasonably necessary for theaccomplishment of the purposesmentioned.11) Tax exemption of all revenues and assets of(a) non-stock, non-profit educationalinstitutions(b) used ACTUALLY, DIRECTLY ANDEXCLUSIVELY for educationalpurposes Exemption covers income, property,donors tax, and customs duties(distinguish from previous which pertainsonly to property tax) Revenue must both be (a) derived froman activity in pursuance of educationalpurpose; and (b) proceeds must be usedfor the same purpose (ex. hospitaladjunct to medical school tax exempt)(ex. Interest income not exempt). Income exempt provided it is used formaintenance or improvement ofinstitution. Distinguish from tax treatment of (a)proprietary educational institutions(Preferential Tax); and (b) governmenteducational institutions (exempt, ex. UP)12) Delegated authority of President to imposetariff rates, import and export quotas,tonnage and wharfage dues delegated by Congress through a law subject to Congressional limits andrestrictions within the framework of nationaldevelopment program13) Law granting tax exemption (includesamnesties, condonations and refunds) shallbe passed with concurrence of Congress -majority of all members voting separately Relative majority (majority of quorum) issufficient to withdraw exemption.14) No use of public money or property forreligious purposes except if priest is assignedto armed forces, penal institutions,government orphanage or leprosariumTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 3 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.15) Special purpose - special fund for saidpurpose, balance goes to general funds16) Veto power of the President - revenue/tariffbill17) Power of review of the SC18) Power of Local Government to create theirown sources and levy taxes, fees, charges19) Just share of local government in nationalrevenue which shall be automaticallyreleased.20) Tax exemption of all revenues and assets of(a) proprietary or cooperative educationalinstitutions(b) subject to limitations provided by law21) Tax exemption of grants, endowments,donations or contributions USEDACTUALLY, DIRECTLY and EXCLUSIVELYfor educational purposesCIR v. CA (298 SCRA 85)Facts: YMCA is a non-stock, non-profit institution,which conducts various programs and activitiesbeneficial to the public pursuant to its religious,educational and charitable objective. In 1980, YMCAearned an income of more than P600K from leasingout a portion of its premises to small shop ownersand P47K from parking fees.Issue: Is the rental income from real property ownedby the YMCA subject to income tax?Held: YES, the exemption claimed by YMCA isexpressly disallowed by the last paragraph of then27 of the NIRC. Furthermore, Art. XIV, 4 (3) of theConstitution only exempts YMCA from property taxesNOT income tax. YMCA cannot be considered as aneducational institution within the purview of theabove-cited article. The term educational institutionunder the Education Act of 1982 refers to schools.The school system is synonymous with formaleducation, which refers to hierarchically structuredand chronologically graded learnings organized andprovided by the formal school system and for whichcertification is required in order for the learner toprogress through grades or more to higher levels.Nothing in the Articles of Incorporation or By-Laws ofthe YMCA suggests that it is an educationalinstitution.Classification of TaxesA. As to subject matter of object1) personal, poll, capitation tax (a) fixed amount(b) individuals residing within specifiedterritory(c) without regard to their property,occupation or businessEx. Community Tax (Cedula)2) property tax (a) imposed on property, real or personal(b) in proportion to its value or otherreasonable method of apportionmentEx. Real estate tax3) excise, privilege tax - (different from theexcise tax in Taxation II)(a) imposed upon performance of an act, theenjoyment of a privilege or the engagingin an occupation, profession or businessEx. Income tax, VAT, estate tax, donors taxB. As to who bears the burden1) Direct the tax is imposed on the personwho also bears the burden thereofEx. Income tax, community tax, estate tax2) Indirect imposed on the taxpayer whoshifts the burden of the tax to anotherEx. VAT, specific tax, percentage tax,customs dutiesC. As to determination of amount1) Specific tax imposed and based on aphysical unit of measurement, as by head,number, weight, length or volumeEx. Tax on distilled spirits, fermentedliquors, cigars2) Ad Valorem - tax of a fixed proportion of thevalue of property with respect to which thetax is assessed; requires intervention ofassessor.Ex. Real estate tax, excise tax on cars, nonessentialgoodsD. As to purpose1) General, fiscal or revenue - imposed for thegeneral purpose of supporting thegovernmentEx. Income tax, percentage tax2) Special or regulatory - imposed for aspecial purpose, to achieve some social oreconomic objectivesEx. Protective tariffs or customs duties onimported goods intended to protect localindustriesE. As to authority imposing the tax1) National - imposed by the nationalgovernmentEx. National internal revenue taxes, customduties2) Municipal or local - imposed by themunicipal corporations or local governmentsEx. Real estate tax, occupation taxTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 4 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.F. As to graduation of rate (Three systems oftaxation)1) Proportional - based on a fixed percentageof the amount of the property, income orother basis to be taxedEx. Real estate tax, VAT, percentage tax2) Progressive or graduated - tax rateincreases as the tax base or bracketincreasesEx. Income tax, estate tax, donors tax3) Regressive - tax rate decreases as the taxbase increases4) Degressive - increase of rate is notproportionate to the increase of tax base SITUS OF TAXATION - the place of taxation, thecountry that has the power to levy and collect thetax.TAX DISTINGUISHED FROM POLICE POWERTAX POLICE POWER (inthe form of a FEE)Purpose Raise revenue Exercise to promotepublic welfare throughregulationAmount ofexactionNo limit Limited to the cost ofregulation, issuanceof license, orsurveillanceSuperiorityofcontractsContracts maybe impairedunless (a)government isparty tocontractgrantingexemption; or(b) involvesfranchiseContracts may beimpairedTransferofpropertyrightsTaxes paidform part of thepublic fundsAllows merely therestraint on theexercise of propertyrightsTAX DISTNGUISHED FROM EMINENT DOMAINTAX EMINENT DOMAINPurpose RaiserevenueThe taking ofproperty for publicuseCompensation Payment of Just compensationtaxes accrueto the generalbenefit of thecitizens of thetaxing Stateis given the ownerof the expropriatedpropertyPersonsaffectedApplies to allpersons,property andexcises thatmay besubjecttheretoOnly particularproperty iscomprehendedTAX DISTINGUISHED FROM LICENSE FEETAX LICENSE FEESource Exercise ofTaxing powerEmanate from the policepower of the StatePurpose RaiserevenueRegulationObject Persons,property andprivilegeRight to exercise aprivilegeAmount no limit only necessary to carryout regulation Distinction lies in the primary purpose: License fee if primary purpose is toregulate and the excess of the amountcollected from the cost to carry out theregulation is minimal and incidental. Tax if primary purpose, or at least one ofthe real and substantial purposes is toraise revenue. If amount is too high for regulation, it wouldbe a tax; unless imposed on non-usefuloccupations or businesses. Purpose of distinction: limitations andexemptions apply only to one and not to theother (ex. Exemption from taxation does notinclude exemption from fee)TAX DISTINGUISHED FROM DEBTTAX DEBTSource Law; legalobligationBased on contractPersonal AssignableTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 5 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.Generally notsubject tocompensation/setoffMay be the subjectofcompensation/setoffImprisonment issanction for nonpaymentNo imprisonmentfor non-paymentGENERAL RULE: Taxes cannot be the subject ofcompensation or set-off* A person cannot refuse to pay a tax on the groundthat the government owes him an amount equal to orgreater than the tax being collected. The collection oftax cannot await the results of a lawsuit against thegovernment.Reasons:a) lifeblood theoryb) taxes are not contractual obligation (absenceof consent of taxpayer)c) taxpayer and government are not mutualdebtors and creditors of each otherEXCEPTIONS:1) Both claims already became overdue anddemandable as well as fully liquidated theremust have already been an act of appropriationby the government (legislative) of funds forpayment of the debt.2) Tax overpayment (BIRs obligation to refund orset-off arises from time tax was paid)3) If the case involves local government taxesTAX DISTINGUISHED FROM SPECIALASSESSMENTTAX SPECIALASSESSMENTImposedonpersons,properties, etc.Only on landWhyimposedregardless ofpublicimprovementPublic improvementthat benefits the landPurpose Support ofgovernmentContribution to costof publicimprovementWhenimposedRegular exaction Exceptional as totime and localityBasis Necessity Benefits obtainedTAX DISTINGUISHED FROM TOLLTAX TOLLKind ofdemandDemand ofsovereigntyDemand ofownershipPurpose support ofgovernmentCollection for theuse of propertyAmount no limit dependson need of thegovernmentFair return of thecost of the propertyor improvementTAX DISTINGUISHED FROM CUSTOMS DUTYTAX CUSTOMSDUTYCoverage More comprehensivethan customs dutykind of taxObject Persons, prop, etc goods importedor exportedDOCTRINE OF EQUITABLE RECOUPMENT1) refund of a tax illegally or erroneously collectedor overpaid by a taxpayer2) such tax refund is barred by prescription3) tax presently being assessed against a taxpayer4) may be recouped or set-off against the tax barredby prescriptionnot allowed in Philippines, reason - LIFE BLOODCONCEPT OF DOUBLE TAXATIONKinds of Double TaxationA. DIRECT DUPLICATE taxing same person, property or righttwice for the same purpose by the same taxing authority within the same jurisdiction or taxingdistrict within the same taxable period and they must be of the same kind orcharacter of taxB. INDIRECT DUPLICATE Exists if any of the elements for Directtaxation is not present No constitutional prohibition on double taxation.However, where there is direct duplicate taxationthen there may be violation of the constitutionalprecepts of equal protection and uniformity intaxation.Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 6 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.TAX TREATY AS A MODE OF ELIMINATINGDOUBLE TAXATION:1) EXEMPTION METHOD the income or capitalwhich is taxable in the state of source or situs isexempted in the state of residence, although insome instances it may taken into account indetermining the rate of tax applicable to the taxpayers remaining income or capital (ex. TaxSparing Credit scheme)2) CREDIT METHOD the tax paid in the state ofsource is credited against the tax levied in thestate of residenceAfisco Insurance Corp v. CA (G.R. No. 112675,Jan. 25, 1999)Petitioners are local non-life insurance corps. Whichformed a pool in order to enter into a ReinsuranceTreaty with a German company. BIR assesseddeficiency taxes against the pool on the ground thatit is considered a partnership taxable as a corp.Petitioners insist that the pool is a mere agent, notacting on its own and therefore, cannot be taxed as acorp., there being no risk undertaken by the pool, nocommon fund and no control exercised by its board inthe management of its fund.Issue (1) : Is the Pool Taxable as a Corp?Held (1): YES. Pursuant to 24 of the NIRC, thepool is included within the definition of domesticcorps. Which comprises even unregisteredpartnerships and associations. In this case, theceding cos. Entered into an association that wouldhandle all business under the Treaty. It has acommon fund and an executive board to manage itsaffairs. Moreover, even if the pool itself did not issueany policies on its own, its work was indispensable tothe business of the ceding companies and theGerman Co,Issue (2): Is there double taxation?Held(2): NO. Double taxation means taxing thesame person twice by the same jurisdiction for thesame thing. The pool is a taxable entity distinct fromthe individual corporate entities of the cedingcompanies. The tax on its income is obviouslydifferent from the tax on the dividends received bythe said companies.Power to Tax Involves Power to Destroy [ChiefJustice Marshall, McCullough v. Maryland, 4 L.Ed.579 (1819)]The imposition of a valid tax could not be judiciallyrestrained merely because it would prejudice ataxpayers property. As long as the power to taxdoes not violate any constitutional or statutoryprovisions, said power can be a power to destroy.But for all its plenitude, the power to tax is notunconfined as there are restrictions. Adverselyeffecting as it does property rights, both the dueprocess and equal protection clauses of theConstitution may properly be invoked to invalidate inappropriate cases a revenue measure. If it wereotherwise, there would be truth to the dictum that thepower to tax involves the power to destroy. The webor unreality spun from Justice Marshalls famousdictum was brushed away by one stroke of Mr.Justice Holmes pen, thus: The power to tax is notthe power to destroy while this Court sits. So it is inthe Philippines. [Reyes v. Almanzor (1991), citingSison v. Ancheta (1984); Obillos v. CIR (1985)].Tax Avoidance (Tax Minimization) tax savingdevice that is legally permissibleTax Evasion (Tax Dodging) connotes fraudthrough the use of pretenses and forbidden devicesto lessen or defeat taxes; must be willful andintentional.CIR vs. The Estate of Benigno Toda, GR No.147188, Sept. 14, 2004Facts: This Court is called upon to determine inthis case whether the tax planning scheme adoptedby a corporation constitutes tax evasion that wouldjustify an assessment of deficiency income tax.CIC authorized Toda, Jr., President and ownerof 99.991% of its issued and outstanding capitalstock, to sell the Cibeles Building and the twoparcels of land on which the building stands for anamount of not less than P90M. Toda thenpurportedly sold the property for P100 M to RafaelAltonaga, who, in turn, sold the same property onthe same day to RMI for P200M. These 2transactions were evidenced by Deeds of AbsoluteSale. For the sale of the property to RMI, Altonagapaid capital gains tax in the amount of P10M.CIC filed its corporate annual ITR for the year1989, declaring, among other things, its gain fromthe sale of real property in the amount ofP75,728.021. Toda sold all his shares. He died 3yrs. later.The BIR sent an assessment notice anddemand letter to the CIC for deficiency income taxfor the year 1989 in the amount of P79,099,999.22,representing the tax, surcharge, & interest on theTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 7 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 8 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.NATURE OF TAX AMNESTY1) general or intentional overlooking by the State ofits authority to impose penalties on personsotherwise guilty of evasion or violation of arevenue or tax law2) partakes of an absolute forgiveness or waiver ofthe Government of its right to collect3) to give tax evaders, who wish to relent & arewilling to reform a chance to do soRULES ON TAX AMNESTY1) Tax amnesty(a) like tax exemption, never favored norpresumed(b) construed strictly against the taxpayer (mustshow complete compliance with the law)2) Government not estopped from questioning thetax liability even if amnesty tax payments werealready receivedReason: Erroneous application andenforcement of the law by public officers donot block subsequent correct application ofthe statute. The government is neverestopped by mistakes or errors of its agents.Basis: Lifeblood Theory3) Defense of Tax amnesty, like insanity, is apersonal defense.Reason: Relates to the circumstances of aparticular accused and not the character ofthe acts charged in the informationPART II THE NATIONAL INTERNAL REVENUECODE OF 1997TITLE I. ORGANIZATION AND FUNCTION OF THEBUREAU OF INTERNAL REVENUE (BIR)POWERS AND DUTIES OF THE BIR (ACEEGA)1) Assessment and Collection of national internalrevenue:(a) taxes(b) fees(c) charges2) Enforcement of all(a) forfeitures(b) fines and(c) penaltiesconnected therewith3) Execution of all judgments decided in BIRs favorby(a) the Court of Tax Appeals (CTA) and(b) the ordinary courts4) Give effect to and Administer the supervisory andpolice powers conferred to it by NIRC or by otherlaws. (Sec. 2)Officials of the BIR1) one chief - Commissioner of Internal Revenue(Commissioner)2) four assistant chiefs - Deputy Commissioners(Sec. 3)*E.O. 430 (July 28, 1997) designates each of the4 Deputy Commissioners to head the followingfunctional groups:(a) Operations group(b) Legal Enforcement Group(c) Information Systems Group(d) Resource Management GroupPowers of the CommissionerA. Power to interpret tax law and decide taxcases (Sec 4)1) Interpret provisions of NIRC and other taxlaws subject to review by the Secretary ofFinance2) Decide:(a) disputed assessments(b) refunds of internal revenue taxes, feesand charges(c) penalties imposed in relation thereto(d) other matters arising from NIRC or otherTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 9 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.laws or portions thereof administered bythe BIR subject to the exclusive appellatejurisdiction of the CTAB. Power to obtain information, summon,examine and take testimony of persons (Sec.5)1) For the Commissioner to ascertain:(a) correctness of any return or in making areturn where none has been made(b) liability of any person for any internalrevenue tax or in correcting such liability(c) tax complianceThe Commissioner is authorized:2) to Examine any relevant Book, paper, recordor other data3) to Obtain any Information (costs, volume ofproduction, receipts, sales, gross income,etc), on a regular basis from:(a) any person other than the person underinvestigation or(b) any office or officer of the national/localgovernment, government agencies andinstrumentalities (Bangko Sentral,GOCCs)4) To Summon(a) the person liable for tax or required to filea return or(b) any officer or employee of such personor(c) any person having in hispossession/custody/ care1. the books of accounts2. accounting records of entries relatingto the business of the person liablefor tax or any other person5) to Produce such books, papers, records andother data and to give testimony6) to take the Testimony of the personconcerned, under oath as may be relevant tothe inquiry7) To cause revenue officers and employees tomake a Canvass of any revenue district orregion nothing in Section 5 shall be construed asgranting the Commissioner the authority toinquire into bank deposits other than as providedfor under Sec. 6 (F) of the Code (authority toinquire into bank deposits).C. Power to make assessments, prescribeadditional requirements for tax administrationand enforcement (Sec. 6)1) Examination of returns and determination oftax due -(a) After a return has been filed theCommissioner or his representative mayauthorizei. the Examination of any taxpayer;andii. the Assessment of the correctamount of tax;(b) Failure to file a return shall not preventthe Commissioner fromauthorizing the examination of anytaxpayer;Any tax or deficiency tax so assessed shall bepaid upon notice and demand from theCommissioner or his representative.Any return, statement or declaration filed in anyauthorized office shall not be withdrawn; butwithin THREE YEARS from date of filing, thesame may be modified, changed or amended;provided that no notice for audit or investigationof such return, has in the meantime, beenactually served upon the taxpayer.2) Failure to submit required returns and otherdocumentsIf a person(a) fails to file a required return or report atthe time prescribed or(b) Willfully or otherwise files a false orfraudulent return,The Commissioner shall Make or Amend thereturn from(a) his own knowledge or(b) from such information as he can obtainthrough testimony or otherwisewhich shall be prima facie correct and sufficientfor all legal purposes3) Inventory-taking, Surveillance, PresumptiveGross Sales(a) Commissioner may, at any time duringthe taxable year1. order the Inventory taking of goodsof any taxpayer; or2. may place the business operations ofany person (natural/juridical) underObservation or Surveillanceif there is reason to believe that suchperson is not declaring his correctincome, sales or receipts for taxpurposes.The findings may be used as basis forassessing the taxes and shall be deemedprima facie correct.Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 10 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.(b) Commissioner may prescribe a Minimumamount of gross receipts, sales andtaxable base (taking into account thesales and income of other personsengaged in similar business) :1. When a person has failed to issuereceipts as required by Sec. 113(Invoice requirements for VATregisteredpersons) and Sec. 237(Issuance of Receipts or CommercialInvoices); or2. When the books of accounts orrecords do not correctly reflect thedeclarations made or required to bemade in a return,such minimum amount shallbe prima facie correct4) Terminate taxable period -Commissioner shall declare the tax period ofa taxpayer terminated and send notice to thetaxpayer of such decision with a request forimmediate payment of the tax, when it hascome to the knowledge of the Commissioner:(RIRHO)(a) that a taxpayer is Retiring from businesssubject to tax or(b) is Intending to leave the Philippines or(c) to Remove his property therefrom or(d) to Hide or conceal his property or(e) is performing any act tending to Obstructthe proceedings for the collection of tax5) Prescribe Real Property Values -The Commissioner is authorized to:(a) divide the Philippines into different zonesor areas and(b) determine the fair market value of realproperties located in each zone or areaFor tax purposes, the value of the propertyshall be whichever is higher of:(a) Fair market value as determined by theCommissioner; or(b) Fair market value as shown in theschedule of values of the provincial andcity assessors.6) Authority to Inquire into Bank Deposit -Notwithstanding R.A. 1405 (Bank SecrecyLaw) the Commissioner is authorized toinquire into the Bank deposits of:(a) a decedent to determine his gross estate(b) a taxpayer who has filed an application tocompromise payment of tax liability byreason of financial incapacityThe taxpayers application for compromiseshall not be considered unless he waives inwriting his privilege under RA 1405 and othergeneral or special laws. Such waiver shallauthorize the Commissioner to inquire intohis bank deposits.7) Authority to Register tax agents -(a) The Commissioner shall Accredit andRegister, individuals and generalprofessional partnerships and their rep.who prepare and file tax returns andother papers or who appear before theBIR(b) The Commissioner shall create nationaland regional accreditation boardsThose who are denied accreditation mayappeal the same to the Sec. of Finance whoshall rule on the appeal within 60 days fromreceipt of such appeal. Failure of the Sec. ofFinance to rule on the appeal within the saidperiod shall be deemed as approval foraccreditation.8) Authority to Prescribe AdditionalRequirements-The Commissioner may prescribe themanner of compliance with any documentaryor procedural requirement for the submissionor preparation of financial statementsaccompanying tax returns.D. Authority to delegate power (Sec. 7)The Commissioner may delegate the powers vestedin him to subordinate officials with rank equivalent toDivision Chief or higher, subject tolimitations/restrictions imposed under the rules andregulations EXCEPT, (the following powers shallNOT be delegated): (RIR CoA A)1) power to Recommend the promulgationof rules and regulations by the Sec. ofFinance2) power to Issue rulings of first impressionor to Reverse, revoke, modify anyexisting rule of the BIR3) power to Compromise or Abate any taxliabilityEXCEPT, the regional evaluation boardmay compromise:(a) assessments issued by regionaloffices involving deficiency taxes ofP500,000 or less; and(b) minor criminal violations as may beTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 11 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.determined by the rulesRegional Evaluation Board is composedof:i. Regional Director as Chairmanii. Asst. Regional Directoriii. Heads of the Legal, Assessment andCollection Div.iv. Revenue District Officer havingjurisdiction over the taxpayer4) power to Assign or reassign internalrevenue officers to establishments wherearticles subject to excise tax are keptE. Assignment of Internal Revenue Officers(Secs. 16 &17)The Commissioner may assign/ reassign internalrevenue officers:1) involved in excise tax functions as often as theexigencies of revenue service may require;provided that he shall in no case stay in hisassignment for more than 2 years (Sec. 16)2) without change in rank and salary, to other orspecial duties connected with the enforcementand administration of internal revenue laws asthe exigencies of the service may require;provided that officers assigned to performassessment or collection functions shall notremain in the same assignment for more than 3years; assignment of officers and employees tospecial duties shall not exceed 1 year (Sec. 17)F. Internal Revenue Districts (Sec. 9)The Commissioner, with approval of the Sec. ofFinance, shall divide the Philippines into suchnumber of revenue districts for administrativepurposes. Each district shall be under the supervisionof a Revenue District Officer.Duties of the Commissioner: (PASO)1) To Prescribe, provide and distribute to the properofficials the requisite licenses, internal revenuestamps, labels, all other forms, certificates,bonds, records, invoices, books, receipts,instruments and appliances used in administeringlaws falling within the jurisdiction of BIR2) To Acknowledge payment of any tax under thisCode expressinga) the amount paid andb) the particular account for which paymentwas made (Sec. 8)3) To Submit reports to the appropriate committeeof Congress upon its request and in aid oflegislation, which information or report shallinclude, but not be limited to:(a) industry audits(b) collection performance data(c) status reports in criminal actions initiatedagainst persons(d) taxpayers returnsprovided, any return or information which canbe associated with or identifies, directly orindirectly a particular taxpayer, shall befurnished to the appropriate committee ofCongress only when sitting in ExecutiveSession, unless the taxpayer consents inwriting to such disclosure4) Submit reports to the Oversight Committeethrough the Chairman of the Committee on Waysand Means of the Senate and House ofRepresentatives, on the exercise of his powers ofabatement and compromise of taxes (Sec. 204)every 6 months of each calendar year. (Sec. 20)NATIONAL INTERNAL REVENUE TAXES: (Sec.21) (I VEE DOO)1) Income tax2) Estate and Donors tax3) Value-Added tax4) Other percentage tax5) Excise tax6) Documentary stamp tax7) Such Other taxes as are or hereafter may beimposed and collected by the BIRTITLE II. TAX ON INCOMEDEFINITION OF TERMS1) Person an individual, a trust, estate or corp.2) Corporation include partnerships (distinguishbetween ordinary and general professionalpartnership)3) General professional partnership partnerships formed for the sole purpose ofexercising their common profession, no part of itsincome being derived from engaging in any tradeor business4) Shares of stock includes shares of stock of acorp., warrants & options to purchase shares ofstock, as well as units of participation in apartnership (except gen. professionalpartnership), joint stock companies, jointaccounts, joint ventures taxable as corp.,associations & recreation or amusement clubs &mutual fund certificates5) Taxpayer any person subject to tax6) Taxable Year can either be calendar year (Jan1 to Dec 31), or the fiscal year7) Fiscal Year an accounting period of 12 monthsending on the last day of any month other thanDecember (ex. Feb 1 to Jan 31)8) Paid or incurred (cash method) or Paid oraccrued (accrual method) payment actuallymade or if not paid, actually liable for theexpense

TAXABLE INCOMEREQUISITES FOR INCOME TO BE TAXABLE:1) There must be a gain or addition to net worth;

2) The gain must be realized or received, actually or constructively; recipient must have complete dominion;

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

Note: Not recognized as income - when funds were merely entrusted/held money in trust (with obligation to return) to taxpayer because taxpayer acquires no control and does not receive economic benefit from it.

Proceeds of embezzlement/swindling areincome because embezzler/swindler already has complete dominion over them and can use such for his economic benefit. Increase in the value of property is not recognized as income; this only constitutes an unrealized increase which becomes taxable income only upon disposition and realization of gains. Same situation for stocks and stock dividends.

Deposit with no interest does not produce income for the depositary; there is no flow of wealth.

In a debt/loan situation it is important to determine whether there was an original intention to pay/consensual recognition of an obligation to repay.

If yes, then the liability that results just offsets the increase in assets of the taxpayer borrower; therefore, no increase in net worth and no income derived from the debt/loan.

If no (as in the case of a swindler/estafa), the proceeds will be considered as income and therefore taxable in the hands of the borrower swindler.

Income can be realized actually and constructively.

Assignment of Income Doctrine Ex: A is entitled to his salary of P10m but assigns it to B for unknown reasons. In this case, both A and B realize income. A constructively received income (because he was able to assign thus has complete control/dominion over it) and B actually received it. The income is taxable in the hands of both A and B.

Doctrine of Constructive Receipt Ex: A was informed that his check dated December 16 is already available and he can get it anytime. A did not get the check until January 30. In this case, A constructively received income in December and is taxable in that taxable period.

Not recognized as income if proceeds aremerely a return of capital. Ex. Creditor lends debtor x amount. Debtor repays x amount plus y interest. Creditor does not have income on x amount as this is merely return on capital; he has income only with respect to the amount of y interest.

COMPUTATION OF TAXABLE INCOME1) Taxpayer earning purely compensatoryIncome-Gross Compensation - Personal Exemption premium payments on health and/or hospital insurance amounting to P2,400 per year = Taxable income

2) Taxpayer doing business, whether individual or corporation (domestic or FC doing business)

Gross Revenue/Sales - Cost of Sales = Gross Income

Gross Income - Allowable Deductions = Taxable Income

for individuals, an additional deduction forpersonal exemptions is allowed

Situs of Taxation is the place or authority that has the right to impose and collect taxes (CIR v. Marubeni Corp).

The state where the subject to be taxed has a situs may rightfully levy and collect the tax.

The situs is necessarily in the state which has jurisdiction or which exercises dominion over the subject in question.

SOURCES OF INCOMEITEM SOURCEInterest Residence of the debtorCompensation forpersonal servicesPlace of performanceRent and royalty Location of propertyGain from sale ofreal propertyLocation of propertyGain from sale ofpersonal propertyPlace of saleGain from sale ofshares of stock ofdomesticcorporationPhilippine sourceDividend income (a) From a domestic corp. deemed income from withinPhil.(b) From a foreign corp. deemed income from withoutprovided more than 50% of thecorp.s worldwide income is notderived from Phil. sourcesAllocation of Unallocated Deductions (partly Phil.partly foreign)GI, Philippines x Unallocated = Phil deductionsGI, Worldwide deductionsGI, Outside Phil x Unallocated = ForeignGI, Worldwide deductions deductionsIncome from sale of personal property derived fromsources partly within and partly without the Phils.Gain from sale of personal property produced inwhole or in part in one country and sold in anothercountry, where one of the countries is the Philippinesis income derived from sources partly within andpartly outside the Philippines.Gains from the purchase of personal property withinand sold without the Philippines or the purchase ofpersonal property without and its sale within thePhilippines shall be treated as derived entirely fromsources within the country in which it was sold.GENERAL PRINCIPLES OF INCOME TAXATIONIN THE PHILIPPINESTaxpayer Tax Base Taxable onincomeResident Citizen TaxableIncomeWithin andwithout thePhilippinesNonresident Citizen TaxableIncomeWithin thePhilippinesResident Alien TaxableIncomeWithin thePhilippinesNonresident Alienengaged in trade orbusinessTaxableIncomeWithin thePhilippinesNonresident Alien notengaged in trade orbusinessGrossIncomeWithin thePhilippinesGeneral ProfessionalPartnershipTaxableIncomeWithinor/andwithout thePhilippines(dependingonclassificationof individualpartner)Estate and Trust TaxableIncomeSame basisas anindividual(dependingonclassificationof decedent,if estate,trustor, iftrust)Domestic Corporation TaxableIncomeWithin andWithout thePhilippinesResident ForeignCorporationTaxableIncomeWithin thePhilippinesNon-resident ForeigncorporationGrossIncomeWithin thePhilippines*Taxable Income = Gross income (less) Deductions(less) Personal and additional exemptions*Gross Income = all income derived from whateversourceTYPES OF INCOME TAXATION UNDER THE NIRC1) Net Income Tax/Taxable Income (GI Deductions Exemptions)2) Gross Income Tax (All income from whateversource)3) Final Income Tax (On passive income and capitalgains)4) Fringe Benefits Tax (amount of benefits toManagerial and Supervisory Employee paid byEmployer; Ee is taxed but burden is on Er)5) Capital Gains Tax (Real property and stocks nottraded in stock market)6) Optional Corporate Income Tax7) Minimum Corporate Income Tax (2% of GI)8) Improperly Accumulated Earnings Tax9) Preferential Rates (for special corporations)10) Branch Profit Remittance TaxTYPES OF TAXPAYERSA. IndividualsKinds of Individuals1) Resident Citizen2) Nonresident Citizen = citizen of thePhilippines who:(a) Establishes the fact of his physicalpresence abroad with a definite intentionto reside therein(b) Leaves the Philippines during the taxableyear to reside abroad, as immigrant or foremployment on a permanent basis(c) Works & derives income from abroad &whose employment requires him to bephysically present abroad most of thetime (i.e. not less than 183 days) duringthe taxable year(d) Previously considered as nonresidentcitizen & arrives in the Philippines at anytime during the taxable year to residepermanently in the Philippines3) Resident Alien4) Nonresident Aliena) Those engaged in trade or business inthe Philippines who come and stay in thePhilippines for an aggregate period ofmore than 180 days during any calendaryearb) Those not engaged in trade or businessin the Philippines, which include nonresidentaliens whose stay in thePhilippines is 180 days or lessc) Aliens employed by regional or areaheadquarters and regional operatingheadquarters of multinational companiesin the Philippinesd) Aliens employed by offshore bankingunitse) Aliens employed by petroleumcontractors and subcontractorsTYPES OF INCOME1) General (part of gross income, subject to 5-32%)a) Compensation Incomeb) Income from Businessc) Income from Exercise of Profession2) Special Types of Income (not part of grossincome, subject to final tax)a) Interests, royalties, prizes and otherwinnings subject to final tax (PassiveIncome)b) Cash & property dividends (does notinclude stock dividends; these arerealized only upon their subsequent sale)(Passive Income)c) Capital gains from sale of real propertyd) Capital gains from sales of shares ofstock not listed in the stock exchangee) Capital gains from sale of shares of stocklisted in stock exchange (subject topercentage taxB. Estates and TrustsEstate: property, rights and obligations of aperson which are not extinguished by his deathand those that accrues thereto; taxed in the sameway as an individual provided it is irrevocable andearns income; what is taxed is not the propertythat constitutes the trust (this was already subjectto donors tax) but the income of such property.Trust: arrangement created by agreement underwhich title to property is passed to another forconservation or investment with the income andthe corpus/principal distributed in accordancewith the directions of the creator; to be taxable asa separate entity, grantor must have absolutelyand irrevocably given up control and benefit overthe trust.C. CorporationA corporation shall include partnerships, no matterhow created or organized. Joint stock companies,joint accounts, associations, and insurancecompanies But does not include, for the purpose ofimposing ordinary 35% corporate income tax:o general professional partnershipso joint venture or consortium formed for thepurpose of undertaking constructionprojects or engaging in petroleum, coal,geothermal & other energy operationspursuant to an operating or consortiumagreement under a service contract withTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 15 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.the govt.General Types:1) Domestic Corporation is created ororganized in the Philippines or under its laws2) Foreign Corporation is organized andexisting under the laws of a foreign country(a) Resident foreign corporation foreigncorp. engaged in trade or business withinthe Philippines(b) Nonresident foreign corporation foreign corp. not engaged in trade orbusiness within the PhilippinesD. PartnershipsKinds of Partnerships1) General Professional Partnerships Established solely for purpose of exercisingcommon profession and not part of incomederived from engaging in trade or business. As an entity, it is not subject to income tax.Partners are liable for income tax on theirdistributive share (computed by dividing netincome of GPP). Each partner shall report hisdistributive share as part of his gross income.2) Taxable/Business/Ordinary Partnership All other partnerships no matter how createdor organized. Includes unregistered joint ventures andbusiness partnerships. Taxable as an entity ordinary corporateincome tax. Joint ventures are not taxable ascorporations when its purpose if a)undertaking construction projects; b)engaged in petroleum, coal and other energyoperation under a service contract with thegovernment. Partners are considered stockholders;therefore, their distributive share is taxed asdividends.TAX ON CORPORATIONSI. DOMESTIC CORPORATIONSA. In generalOn taxable income from allsources within and withoutthe Philippines32% (2000-2005)35% (2006-2008)30% (2009onwards)B. Optional Gross Income TaxationEffective Jan. 1, 2000: the President (uponrecommendation of the Sec of Finance) mayallow corporation an option to be taxed at 15% ofgross income after the ff. conditions aresatisfied:Tax effort ratio 20% ofGNPRatio of IT collection to total taxrevenue40%VAT tax effort 4% of GNPRatio of Consolidated PublicSector Financial Position(CPSFP) to GNP0.9%Ratio of Cost of Sales to GrossSales from all sourcesDoes notexceed 55%The election of the option shall be irrevocablefor 3 consecutive taxable years during which thecorp. is qualified under the scheme Gross Income = Gross Sales( - ) Sales returns,discounts andallowances( - ) Cost of goods soldCost of Goods SoldTrading and Merchandising Concern Invoice cost plus import duties andfreight in transporting goods to the placewhere actually sold, including insurancewhile in transitManufacturing concern Cost of production of finished goods (rawmaterials, direct labor and manufacturingoverhead, freight cost, insurancepremiums, and other costs to bring theraw materials to the factory)If taxpayer is engaged in sale of service: Gross Income = Gross receipts( - ) Sales returns,allowances anddiscountsC. Special Types of Domestic CorporationsProprietaryeducationalinstitutions andhospital which are10% On related trade,business or activity;35% (2006) if totalgross income fromTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 16 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.nonprofitunrelated trade,business, or activityexceed 50% of totalincomeGOCC, AgenciesandIntrumentalities,includingPAGCOR32%(2000-2005)35%(2006)Same tax rate upontheir taxableincome in a similarbusiness, industry,or activityGSIS/ SSS / PHIC/ PCSOExemptDepository Banks 10% On interest incomefrom foreigncurrencytransactionsincluding interestincome fromforeign loansProprietary Educational Institutions & Hospitals(non-profit) Proprietary educational institution anyprivate school maintained & administered byprivate individuals or groups with an issuedpermit to operate from DECS, or CHED orTESDA Taxable at 10% on taxable income, except oncertain passive income (which are subject to finaltax) Predominance Test: if GI from unrelatedtrade/business/other activity > 50% of the total GIfrom all sources, ENTIRE taxable income shallbe subject to the REGULAR corporate tax rate(35% Effective 2006) Distinguish from non-profit non-stock educationalinstitutions which are exempt from tax onrevenues and assets Actually, Directly andExclusively used for educational purposes (Seeabove for discussion).GOCCsGeneral Rule: all corporations, agencies, orinstrumentalities owned or controlled by the govt.are taxable.Exceptions:1) GSIS2) SSS3) PHIC4) PCSOD. Rule for Corporations Exempt from TaxationGeneral Rule: those enumerated under section 30are exempt.Exception: exempted corporations are subject toincome tax on their income from any of theirproperties, real or personal, or from any activitiesconducted for profit regardless of the dispositionmade of such income. Ex. Non-stock, non-profit religiousorganization is exempt from 35% ordinaryincome tax on corporations (by virtue ofsection 30 which uses as such) and from allproperty tax (by virtue of Constitution,provided ADE use for its religious purpose).However, if it derives income from itsproperty or conducts an activity that is forprofit (even if the proceeds will be used forthe religious purpose), the proceeds will betaxable. Ex. For educational institutions, theproceeds, to be exempt, must be both a)realized from educational activities and b)used for educational activities.E. Minimum Corporate Income Tax (MCIT)1. MCIT Rate = 2% of gross income (GI)When to begin/apply MCIT? Beginning on the4th taxable year immediately following the year inwhich such corporation commenced its businessoperation(Commencement of Business Operation:Upon Issuance of BIR Certificate ofRegistration)Imposed when on the 4th taxable year, 2% ofthe corporations GI is greater than 35% of its TI.Example: for 2006 calendar yearGI = P500,000 2% of GI = P10,000TI = P27,000 35% of TI = P9,4502006 IT = P10,000Rationale: This is designed to preventcorporations from escaping being taxed byincluding frivolous expenses in their statement ofincome (Ex. Over statement of depreciationexpense)2. Carry Forward of Excess Minimum TaxTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 17 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.Excess of MCIT over the normal income tax shallbe carried forward & credited against normalincome tax for the 3 succeeding yearsExample: (proceeding from above example)Situation A: If regular income tax (35% of taxableincome) is greater than MCIT (2% of GI) PayRegular Income TaxFor 2007 calendar year:GI = P500,000 2% of GI = P10,000TI = P50,000 35% of TI = P17,500Income Tax payable for 2007= 17,500 (Regular Income Tax) 550 (MCITCarry Forward from 2006: 10,000-9450)= 16,950NOTE: You can deduct MCIT Carry Forward only ifRegular Income Tax is greater than MCITYSituation B: If regular income tax is less thanMCIT Pay MCITFor 2007 calendar year:GI = P500,000 2% of GI = P10,000TI = P20,000 35% of TI = P7,000Income Tax payable for 2007= 10,000NOTE: MCIT carry forward as of 2007 is already3,550 (550 from 2006 and 3,000 from 2007).So if in 2008, Regular Income Tax is alreadygreater than MCIT, you may deduct 3,550from payable Regular Income Tax.3. Relief from MCITMCIT may be suspended by the Sec ofFinance when corporations losses are dueto:(a) prolonged labor dispute(b) force majeure(c) legitimate business reverses4. Gross Income (for purposes of applyingMCIT)Gross Income = Gross Sales( - ) Sales returns,discounts & allowances( - ) Cost of Goods soldIf taxpayer is engaged in sale of service:Gross Income = Gross Receipts( - ) Sales returns,discounts andallowances( - ) Cost of Services*means all direct costs and expensesnecessarily incurred to provide the servicesrequired by the customers including:a) salaries and employee benefits ofpersonnel, consultants and specialistsdirectly rendering the service;b) costs of facilities directly utilized inproviding the service such as depreciation orrental of equipment used and costs ofsuppliesII. RESIDENT FOREIGN CORPORATIONA. In General (the rest is the same as domesticcorp.)On taxable income from allsources within thePhilippines.32% (2000-2005)35% (2006-2008)30% (2009 onwards)B. MCIT - same as domestic corp.C. Special types of resident foreign corporations:International Aircarriers2.5% On Gross PhilippineBillings (see case of AirCanada vs. CIR infra)InternationalShipping2.5% On Gross PhilippineBillingsOffshorebanking units10% Any interest incomederived from foreigncurrency loans grantedto residents other thanoffshore banking unitsor local commercialbanks, including localbranches of foreignbanks that may beauthorized by the BSPto transact businesswith offshore bankingunitsOffshorebanking unitsExempt Income derived byoffshore banking unitsauthorized by the BSP,from foreign currencytransactions withnonresidents, otheroffshore banking units,local commercialbanks, includingTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 18 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.branches of foreignbanks that may beauthorized by the BSPto transact businesswith offshore bankingunits.Regional/AreaHeadquartersExemptRegionalOperatingHeadquarters ofMultinationalcompanies10% On taxable incomeGross Philippine Billings For international air carriers, refers to grossrevenue derived from carriage of persons,excess baggage, cargo, and mail originatingfrom the Philippines in a continuous anduninterrupted flight, irrespective of the placeof sale or issue and the place of payment ofthe ticket or passage document Provided, tickets revalidated, exchangedand/or indorsed to another internationalairline form part of the GPB if the passengerboards a plane in a port or point in thePhilippineso If the ticket is indorsed to another airline,the GPB will be charged to thetransferee/indorsee Provided, for a flight which orginates in thePhilippines but transshipment (transfer) ofpassenger takes place at any port outsidethe Philippine on another airline, only thealiquot portion of the cost of the ticketcorresponding to the leg flown from thePhilippines to the point of transshipment shallform part of the GPB.o Note: Transfer of airline company, nottransfer of aircraft GPB rule in the NIRC is a departure from theold rule which emphasized where ticketswere bought. Now we adopt the originating rule meaningto form part of GPB, passenger/cargo mustoriginate from the Philippines Does not apply to domestic corporations (Ex.PAL) Carrier must be an alien resident corporation;if its not, then it will be subject to 35% tax onGI as non-resident alien corporation. Does not apply to offline carrierso On line carriers: those with landing rightsin the Philippineso Off line carriers: those without landingrights but may nevertheless be sellingtickets in the Phil subject to taxtreatment of ordinary resident foreigncorporation Whats controlling is the amount stated in theticket and not the actual purchase value.Air Canada vs. CIR, CTA Case No. 6572, Dec. 22,2004It is evident that the definition of Gross PhilippineBillings under Section 28(A)(3)(a) of the 1997 TaxCode covers the gross revenue derived from thecarriage of persons, excess baggage, cargo and mailoriginating from the Philippines in a continuous anduninterrupted flight irrespective of the place or saleor issue and the place of payment of the ticket orpassage document. To originate would mean tocause the beginning of; to start (a person or thing) ona course or journey; to begin, start. In other words,the flights carrying the passengers must haveoriginated or started from the Philippines. Verily,petitioner, being an off-line international carrier, asauthorized to operate by the CAB and having noflights originating from the Philippines in a continuousand uninterrupted flight, cannot be taxed pursuant toSection 28(A)(3)(a) of the 1997 Tax Code, that is,based on their Gross Philippine Billings.However, although petitioner Air Canada is notliable to pay the tax as an international air carrier(2.5% on gross Phil. Billings), it is still liable to payincome tax as a resident foreign corporation.Under Section 22 of the 1997 Tax Code, the termresident foreign corporation applies to a foreigncorporation engaged in trade or business within thePhilippines, while the term non-resident foreigncorporation applies to a foreign corporation notengaged in trade or business within the Philippines.However, with regard to the term doing or engagedin business, there is no fixed or specific criterion aswhat constitutes doing or engaging in business. Inthe case of The Mentholatum Co., Inc., et al. vs.Mangiliman, et al., 72 PHIL 524, the HonorableSupreme Court had thoroughly and clearly explainedthe term in this way:There is no specific criterion as to whatconstitutes doing or engaging in or transactingbusiness. Each case must be judged in the light ofits peculiar environmental circumstances. The termimplies continuity of commercial dealings andarrangements, and contemplates, to that extent, theperformance of acts or works or the exercise of someof the functions normally incident to, and inprogressive prosecution of commercial gain or for thepurpose and object of the business organization.Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 19 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.In order that a foreign corporation may beregarded as doing business, there must be continuityof conduct and intention to establish a continuousbusiness, such as the appointment of a local agent,and not one of a temporary character. In otherwords, a foreign airline company selling tickets in thePhilippines through their local agents, whether liaisonoffices, agencies or branches, as in the case at bar,shall be considered as resident foreign corporationengaged in trade or business in that country for suchactivities show continuity of commercial dealings orarrangements and performance of acts or works orthe exercise of some functions normally incident toand in progressive prosecution of commercial gain orfor the purpose and object of the businessorganization.Branch Profit Remittance Tax BPRT shall be imposed on any profit remittedby a branch to its head office. Distinguish between a branch and asubsidiaryo If branch, subject to BPRTo If subsidiary amounts received bynon-resident foreign corporation wouldbe treated as dividends it becomespart of its Gross Income from withintaxable at 35% Branch will first be subjected to ordinarycorporate tax as a resident foreigncorporation (35%). Afterwards, the profits forremittance shall then be subject to 15%BPRT. (Because branch assumespersonality of an RFC and is thereforetaxable as such) Any remittance, so long as you can trace itfrom a branch to the foreign parentcorporation subject to BPRTo Ex. X foreign corp. has both regionalheadquarters and branch in Philippines.Instead of remitting straight to X, branchpays amount to regional headquarterssupposedly for administrative supportservices The amount paid for theservices will still be subject to BPRTbecause the tax is imposed on any formof remittance, direct or indirect.TAX SPARING CREDIT Tax reduced by the Philippines should befully applied or credited to the tax on dividendincome received by the non-resident foreigncorporation imposed by the country of itsdomicile. This serves as an incentive byreducing their tax liability in the Philippinesand in their residence countries. Ex. Domestic corporation paid cash dividendto non-resident foreign corporation (NRFC)organized in Brazil. This shall form part ofNRFCs income therefore taxable also inBrazil. The dividend received shall only betaxed at 15% in the Phils (instead of 35%) ifBrazil will reduce/credit at least 20% of thetax imposed in the Phils. from its tax imposedin Brazil. [See Section 28(5)(b)] If Brazil will credit/reduce less than 20% orwill not credit any amount, then the Phils willtax the dividend at 35% (ordinary incometax). Phils. cannot give more than 15% tax creditbecause the law only allows such.III. NONRESIDENT FOREIGN CORPORATIONA. In GeneralGross Income from all sourceswithin the Philippines (exceptCapital Gains on sale ofdomestic shares subject to finaltax)32% (2000-2005)35% (2006-2008)30% (2009onwards) Gross Income includes interest, dividends,rents, royalties, salaries, premiums (exceptreinsurance prem.), annuities, emoluments orother fixed/determinable annual,periodic/casual gains, Capital Gains (notsubject to FT)NON-RESIDENT FOREIGN CORPORATIONCinematographicFilm owner, lessoror distributor25% On gross incomeOwner or lessorsof vessel chartedby Philippinenationals4.5% On gross incomeOwner or lessorsof aircraft,machineries andother equipment7.5% On gross incomeINCOME TAX RATESI. INDIVIDUALSA. In generalTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 20 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture. Graduated rates of 5 to 32%.B. Passive Income Please see exhibitCapital Gains from Sale of Real Property Final tax on gross selling price or current fairmarket value, whichever is higher. Imposed upon capital gains presumed tohave been realized from the sale, exchange,or other disposition of real property located inthe Philippines, including pacto de retro salesand other forms of conditional sales. Law presumes a gain, hence, even if the salewas at a loss (bought for 2M, sold for 1M),CGT will still be imposed on entire proceedsof the disposition; law does not talk about thenet gain, it only considers gross sellingprice/FMV whichever is higher. Refers to real property held as capital asset(not used for business/investment) asopposed to ordinary asset (used in ordinarycourse of business). Special Rule for disposition to governmento Taxpayer has option of treating theproceeds as (a) taxable income (5-32%on net gain) or as capital gains (6% finaltax on FMV/gross selling price).o If second option is chosen: 6% final taxshall be based on actual considerationand not FMV since the former is usuallylower than FMV (BIR Ruling).o If the disposition took nature ofexpropriation (no meeting of the minds,not voluntary), transaction is not subjectto CGT. Net gain (if any) will be treatedas part of GI. Includes disposition byjudicial order and other forms of forceddisposition. Rule for Exchangeo FMV of the property exchanged/given upshall be basis of CGT. (Ex. A exchangesproperty worth 1M for Bs property worth2M CGT on A will be based on 1M,CGT on B will be based on 2M) Exception on Principal Residenceo Gains presumed to have been realizedfrom sale or disposition of principalresidence, the proceeds of which is fullyutilized in acquiring new principalresidence within 18 months fromdisposition shall be exempt from CGT.o Can be availed only once every 10 years.o If the new principal residence is cheaperthan old (meaning there is no fullutilization of the proceeds), the differencewill be subject to CGT.o Exemption does not include exchange ofprincipal residence for a new principalresidence subject to rules onexchange above.C. Special Tax Rates for Aliens Please seeexhibitII. CORPORATIONSA. In general2006-2008 35%2009-onwards 30%B. Passive Income and other income Please seeexhibitC. Tax rate for Resident Foreign Corporation Please see exhibitD. Tax rate for special types of Resident ForeignCorporation Please see exhibitIMPROPERLY ACCUMULATED EARNINGS TAX(IAET)(Sec. 29, as implemented by Rev. Reg. 2-2001which prescribes rules governing the imposition ofIAET)A. RuleThere is imposed for each taxable year, inaddition to other taxes, a tax equal to 10% of theimproperly accumulated taxable income ofdomestic and closely-held corporationsformed or availed of for the purpose of avoidingthe income tax with respect to its shareholders orthe shareholders of any other corporation, bypermitting the earnings and profits of thecorporation to accumulate instead of dividingthem among or distributing them to theshareholders (Ex. Holding company).B. RationaleIf the earnings and profits were distributed, theshareholders would then be liable for income tax;if the distribution were not made to them, theywould incur no tax in respect to the undistributedearnings and profits of the corporation. It is a taxin the nature of a penalty to the corporation forthe improper accumulation of its earnings, and adeterrent to the avoidance of tax uponshareholders who are supposed to pay dividendsTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 21 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.tax on the earnings distributed to them.C. ExceptionThe use of undistributed earnings and profits forthe reasonable needs of the business wouldnot generally make the accumulated orundistributed earnings subject to the tax. What ismeant by reasonable needs of the businessis determined by the Immediacy Test. Immediacy Test It states that thereasonable needs of the business are the1) immediate needs of the business; and2) reasonably anticipated needs (Ex.Expansion) How to prove the reasonable needs ofthe business: The corporation should provethat there is1) an immediate need for the accumulationof the earnings and profits; or2) a direct correlation of anticipatedneeds to such accumulation of profits.D. Composition: The following constituteaccumulation of earnings for the reasonableneeds of the business: (ILL ABE)1) Allowance for the increase in theaccumulation of earnings up to 100% of thepaid-up capital of the corporation as ofBalance Sheet date, inclusive ofaccumulations taken from other years;2) Earnings reserved for definite corporateexpansion projects or programs requiringconsiderable capital expenditure as approvedby the Board of Directors or equivalent body;3) Earnings reserved for building, plants orequipment acquisition as approved by theBoard of Directors or equivalent body;4) Earnings reserved for compliance with anyloan covenant or pre-existing obligationestablished under a legitimate businessagreement;5) Earnings required by law or applicableregulations to be retained by the corporationor in respect of which there is legalprohibition against its distribution;6) In the case of subsidiaries of foreigncorporations in the Philippines, allundistributed earnings intended or reservedfor investments within the Philippines as canbe proven by corporate records and/orrelevant documentary evidence.E. Covered Corporations: Only domestic andclosely-held corporations are liable for IAET.1. Closely-held corporations are those:a) at least 50% in value of the outstanding capitalstock; orb) at least 50% of the total combined voting powerof all classes of stock entitled to vote is owneddirectly or indirectly by or for not more than 20individuals. Domestic corporations not fallingunder the aforesaid definition are, therefore,publicly-held corporations.F. Exempt Corporations: The IAET shall not applyto the following corporations:(BIG-PEN-T)1) Banks and other non-bank financialintermediaries;2) Insurance companies;3) Publicly-held corporations;4) Taxable partnerships;5) General professional partnerships;6) Non- taxable joint ventures; and7) Enterprises that are registered:(a) with the Philippine Economic ZoneAuthority (PEZA) under R.A. 7916;(b) pursuant to the Bases Conversion andDevelopment Act of 1992 under R.A.7227; and(c) under special economic zones declaredby law which enjoy payment of specialtax rate on their registered operations oractivities in lieu of other taxes, national orlocal.G. Period for Payment of Dividend/IAET: Thedividends must be declared and paid or issuednot later than one year following the close ofthe taxable year, otherwise, the IAET, if any,should be paid within fifteen (15) daysthereafter.H. Determination of Purpose to Avoid IncomeTax1) The fact that a corporation is a mere holdingcompany or investment company shall beprima facie evidence of a purpose to avoidthe tax upon its shareholders or members A holding or investment company is acorporation having practically no activities exceptholding property, and collecting the incometherefrom or investing the same; and2) where the earnings or profits of a corporationare permitted to accumulate beyond theTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 22 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.reasonable needs of the business.I. Prima facie instances of accumulation ofprofits beyond the reasonable needs of abusiness and indicative of purpose to avoidincome tax upon shareholders1) Investment of substantial earnings and profitsof the corporation in unrelated business orin stock or securities of unrelated business;2) Investment in bonds and other long-termsecurities; and3) Accumulation of earnings in excess of 100%of paid-up capital, not otherwise intendedfor the reasonable needs of the business.The controlling intention of the taxpayer isthat which is manifested at the time ofaccumulation. A speculative and indefinitepurpose will not suffice. The mere recognitionof a future problem or the discussion ofpossible and alternative solutions is notsufficient. Definiteness of plan/s coupled withaction/s taken towards its consummation isessential.Cyanamid Phils. vs. CA, GR No. 108067, Jan. 20,2000Ideally, the working capital should equal thecurrent liabilities and there must be 2 units of currentassets for every unit of current liability, hence the socalled"2 to 1" rule. A Debt-to-Equity ratio (CurrentAssets over Current Liabilites) of 2:1 is indicative ofthe liquidity of a corporation, and furtheraccumulation would expose it to the IAET.I. GROSS INCOMEAll income derived from whatever source, including(but not limited to the following items) (GRIP CARDGPP)1) Gross income derived from the conduct of tradeor business or the exercise of a profession2) Rent Income3) Interest Income4) Prizes & winnings5) Compensation for services in whatever form paid,including, but not limited to fees, salaries, wages,commissions & similar items6) Annuities7) Royalties8) Dividend Income9) Gains derived from dealings in property10) Pensions11) Partners distributive share from the net incomeof the GPP (distributive share from ordinarypartnerships is taxable as dividends; in this case,the ordinary partnership has already been subjectto ordinary corporate income tax) All income from whatever source derivedRecovery of damages (compensation forinjury; from tortious acts)NottaxableRecovery of items previously deductedfrom gross income (return of capital)TaxableForgiveness of indebtedness (if effect ofentire transaction is a reduction ofpurchase price of property acquired inprior year)NotTaxableIncome derived form illegal business(gain)TaxableRecovery of lost earnings TaxableBIR Ruling #017-2003The transfer of land made by a person to another inpayment of services rendered in the form of attorneysfees shall be considered as part of the gross incomeof the latter valued at either the fair market value orthe zonal valuation, whichever is higher, in thetaxable year received.II. EXCLUSIONS FROM GROSS INCOME (GIRLCRM)1) Gifts, Bequests & devises But, income from such property shall beincluded in GI Must be characterized by disinterestedgenerosity and pure liberality Difficult to establish gift situations if there isan Er-Ee relationship (A bonus/assistance asrecognition of service rendered is notexempt) If given under a) constraining force of anymoral or legal duty or b) from the incentive ofc) an anticipated benefit of an economicnature or where it is a return for servicesrendered, proceeds cannot qualify as a gift. Most critical consideration is the giversintention or motive. Can be a gift if given on account of filialrelationship.2) Income Exempt under Treaty To the extent required by any treatyobligation binding upon the Phil govt.3) Amount Received by Insured as Return ofPremium Under life insurance, endowment, or annuitycontracts, received either during the term orat the maturity of the terms or upon surrenderTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 23 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.of the contract4) Life Insurance Proceeds of life insurance policies paid to theheirs/beneficiaries upon the death of theinsured If such amounts are held by the insurer underan agreement to pay interest, the interestpayments shall be included in the GI Insured must die to avail of total exemption. Ifhe survives, there/s only partial exemption to the extent that the proceeds constitutereturn of capital (total amount of premiumspaid).5) Compensation for Injuries or Sickness Received through Accident/Health Insuranceor Workmens Compensation Act, ascompensation for personal injuries/sickness+ amount of damages received on account ofsuch injuries/sickness Damages will be exempt only if they arisetogether with personal injury; however, ifdamages only amount to return of capital, itis exempt (Ex. Damages from car accidentexempt only if claim includes compensationfor personal injury. If no personal injury,damages for car wreckage will only beexempt to the extent of the amount of theactual damage return of capital) Must be physical injury, not injury to rights.6) Retirement Benefits, Pensions, Gratuities Formsa) RA 7641 or Reasonable PrivateBenefit Plano See below for rulesb) Amount received as a consequenceof separation for any cause beyondcontrol (death, sickness or otherphysical disability)o Sickness must be job threatening must render taxpayerincapable of working (Ex. Doesnot include STD)o Benefits from separation due toretrenchment come underexemption (no choice/option; butif the Ee avails of an optionalearly retirement plan, he cannotreason that he was separated forreasons beyond his control,therefore, he cannot claimexemption of the benefits on thisground but he can claimunder other grounds such asRPBP or RA 7641.c) Benefits received from a foreigngovernment by resident of nonresident citizens or aliens who residepermanently in the Philippinesd) Veterans benefitse) Benefits under SSSf) Benefits received from GSIS 2 Options under paragraph (a), Section32(B)(6)g) RA 7641o Conditions: (i) at least 60 years old;(ii) 5 years of service at time ofretiremento Availed if there is no reasonableprivate benefit plan (benefits underthis option is less)o Limted exemption: month salaryfor every year of service. In RPBP,all is excludable.h) Reasonable Private Benefit Plano Conditions: (i) at least 50 yrs old; (ii)in the service of same employer forat least 10 years at time of retiremento Must be approved by BIRo A pension, gratuity, stock bonus orprofit-sharing plan maintained by anER for the benefit of some or all ofhis officials/employees, whereincontributions are made by such ERfor the officials/employees, or both,for the purpose of distributing to suchofficials & employees the earnings &principal of the fund thusaccumulated; & provided in the planthat no part of the income shall beused for/be diverted to any purposeother than for the exclusive benefit ofthe said officials & employees Service must be continuous. You can avail of the benefits only once(once youve availed of RPBP, you cannotavail of another RPBP); but you can avail ofexemption under another groundo Ex. A government employee can claimexemption for retirement benefitsreceived from the GSIS even afteravailing of RPBP taxpayer can claimRPBP after qualifying as a privateemployee then under GSIS proceedsexemption after qualifying as agovernment employeeo Ex. Employee can claim exemptionunder RPBP then later claim on theground that the amount he received is aconsequence of his separation in asubsequent job for any cause beyond hiscontrolTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 24 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture. Terminal Leave Pay: amount paid for thecommutation of leave creditso Excludable only for governmentemployees (this exemption does not findsupport in NIRC but is backed by SCdecision and BIR Ruling #143-98)7) Miscellaneous Items(a) income derived by foreign government (frominvestments in Philippines in loans, stocks,bonds or other domestic securities) Refers only to passive income. If theforeign government engages in trade,income is taxable.(b) income derived by govt./its politicalsubdivisions (from public utility or exerciseessential governmental function) Key: Income should accrue togovernment; if the income is retained bythe public utility, it is not exempt lookat charter of political subdivision/GOCCto determine whether its income accruesto the government or not.(c) prizes, awards in sports competitionsanctioned by national sports associationswhether held in Philippines or abroad Contemplates a particular competition,not a cumulative achievement (Ex.Sportsman of the year award does notqualify for exemption)(d) prizes & awards in recognition of religious, charitable,scientific, educational, artistic, literary orcivic achievement, but only if: recipient was selected without any actionon his part recipient not required to rendersubstantial future services as a conditionof receiving the prize/awardExample: Nobel prize award Construed strictly, take note of 7categories. It does not include athleticachievement. Contemplates a rational selectionprocess; cannot just be randomlyselected.(e) 13th month pay & other benefits (i.e.productivity incentives & Christmas bonus) Total exclusion shall not > P30,000(f) GSIS, SSS, Medicare, Pag-ibig contributions& union dues of individuals(g) Gains form the sale of bonds, debentures orother certificates of indebtedness with amaturity of more than 5 years(h) Gains from redemption of shares in mutualfundBIR Ruling #125-98The phrase shall not have availed of the privilegeunder a retirement benefit plan of the same oranother ER found in Sec. 32 (B) (6) (a) of the TaxCode means that the retiring official or EE must nothave previously received retirement benefits from thesame or another employer who has a qualifiedretirement benefit plan.BIR Ruling #143-98The terminal leave pay of government employeeswhose employment is coterminous is exempt since itfalls within the meaning of the phrase for any causebeyond the control of the said official or EE found inSec. 32(B) of the CTRP.SPECIAL TREATMENT OF FRINGE BENEFITA. Fringe BenefitAny good, service or other benefit furnished orgranted in cash or in kind by an employer to anindividual employee (except rank and file employees)such as, but not limited to the ff:1) housing2) expense account3) vehicle of any kind4) household personnel (such as maid, driver &others)5) interest on loan at less than market rate to theextent of the difference between the market rate& actual rate granted6) membership fees, dues & other expenses borneby the employer for the employee in social &athletic clubs or other similar organizations7) expenses for foreign travel8) holiday & vacation expenses9) educational assistance to the employee or hisdependents10) life or health insurance & other non-life insurancepremiums or similar amounts in excess of whatthe law allowsB. Nature of FBTFinal tax imposed on the grossed-up monetary valueof fringe benefit furnished/granted to the EE by theER, whether an individual or corp. (payable by theemployer)Effective 1/1/98 34%Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 25 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.1/1/99 33%1/1/00 32%Fringe benefit is an income of the employee subjectto Fringe Benefit Tax but is payable by the Employer.Er can deduct FBT from its taxable income.Fringe benefits are only for corporateofficers/management. For rank and file, it is called anallowance. Allowances (benefits to rank and file) arenot subject to FBT.C. Fringe Benefits not subject to FBT(a) FB authorized & exempted from tax underspecial laws(b) Contributions of ER for the benefit of theemployee to retirement, insurance &hospitalizations benefit plan(c) Benefits given to the rank & file employees,whether granted under a CBA or not(d) De minimis benefitsDe Minimis benefitsa) Monetized unused vacation leave credits ofprivate employees not exceeding 10 daysduring the year and monetized value of leavecredits paid to government officials andemployeesb) Medical cash allowance to dependents ofemployees not exceeding P750 per semesteror P125 per monthc) Rice subsidy of P1,000 or 1 sack of 50 kgrice amounting to not more than P1,000d) Uniform and clothing allowance notexceeding P3,000 per yeare) Actual yearly medical benefits not exceedingP10,000f) Laundry allowance of P300 per monthg) Employee achievement awards, for length ofservice or safety achievement in the form oftangible personal property other than cash orgift certificate, with an annual monetary valuenot exceeding P10,000 received by theemployee under an established written planwhich does not discriminate in favor of highlypaid employeesh) Christmas and major anniversarycelebrations not exceeding P5,000 peremployee per annumi) Flowers, fruits, books or similar items givento employees under special circumstanceson account of illness, marriage, birth of ababy, etcj) Daily meal allowance of overtime work notexceeding 25% of basic minimum wageCONVENIENCE OF THE EMPLOYER RULE When a fringe benefit is given solely for theconvenience of the employer, the fringebenefit is exempt from FBT because theemployee does not recognize income fromthe benefit. Ex. Expenditure on housing of engineerwithin factory premises is not subject toFBT General Rule: If housing is locatedoutside, it is subject to FBT. Exception: If the nature of the Ersbusiness is hazardous to health ofEe, housing can be located outsidethe factory without being subject toFBT. Ex. If employee is given housing allowance incash, this will constitute compensation ofthe employee (income from whateversource). However, if it qualifies as a FringeBenefit, then it will be subject to FBT andthe burden is shifted to Er (Tax on Ee,Burden on Er)III. DEDUCTION FROM GROSS INCOME Defined as: Items or amounts which the law allowto be deducted from gross income in order toarrive at the taxable income. The basic principle governing deductions fromgross income apply to all taxpayers. Because deductions are strictly construedagainst the taxpayer, one seeking a deductionmust point to some specific provisions of thestatute in which that deduction is authorized &must be able to prove that he is entitled to thededuction which the law allows. Adequate records should be kept to support thedeductions. The deduction claimed must have beensubjected to withholding tax, if required. Deductions for income tax purposes partake ofthe nature of tax exemptions; hence, if taxexemptions are to be strictly construed, then itfollows that deductions must be STRICTLYconstrued. He must be able to prove that he is entitled to thededuction authorized or allowed. (AtlasConsolidated Mining & Devt. Corp. vs. CIR,January 12, 1981)WHO MAY AVAIL OF THE DEDUCTIONS?1) IndividualsTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 26 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.(a) citizen(b) resident alien(c) non-resident alien doing business in thePhilippines(d) member of GPP2) Corporations(a) domestic corp.(b) resident foreign corp.(c) proprietary educational institutions &hospitals(d) GOCCsWHO CANNOT AVAIL OF DEDUCTIONS FROMGROSS INCOME:1. Citizens and resident aliens whose income ispurely compensation income (except forpremium payments on health and/orhospitalization insurance);2. Non-resident aliens not engaged in trade orbusiness in the Philippines; and3. Non-resident foreign corporationTHE FOLLOWING ARE THE ALLOWABLEDEDUCTIONS FROM GROSS INCOME BASED ONCLASSES OF TAXPAYER:1. Individuals with gross income from employeeemployerrelationship only (gross income only):o Premium payments on health and/or hospitalinsurance (if requisites are complied with)o Personal exemptions and additionalexemptions2. Individuals with gross income from business orpractice of profession:o Optional Standard Deduction (OSD) ORItemized deductionso Optional Standard Deductions 10% of thegross income. May be availed only byindividuals (except nonresident aliens) whoare not purely compensation income earners.This is in lieu of the itemized deductions.o Premium payments on health and/or hospitalinsurance (if requisites are complied with)o Personal and additional exemptions3. Corporationso Itemized Deductions4. Estates and TrustsSection 62 of the NIRCITEMIZED DEDUCTIONS/ ALLOWABLEDEDUCTIONS SEC. 34 (BELT DID CRP)1) Bad Debts2) Expenses3) Losses4) Taxes5) Depreciation6) Interest7) Depletion of oil & gas wells & mines8) Charitable & other contributions9) Research & Development10) Pension trusts1. EXPENSES (SEC 34A)1) Ordinary & necessary trade, business orprofessional expenses onlyREQUISITIES FOR DEDUCTIBILITY:a. Must be ordinary AND necessary (bothmust be complied with)b. Must be paid or incurred during thetaxable yearc. Must be paid or incurred in carrying on orwhich are directly attributable to, thedevelopment, management, operationand or conduct of the trade, business orexercise of a profession, includingreasonable allowance for:1. salaries, wages & other forms ofcompensation for personal servicesactually rendered (including grossedupmonetary value of FB); but thefinal tax should have been paid2. travel expenses in pursuit of trade,business/ profession3. rentals &/or other payments aslessee, user or possessor4. entertainment, amusement &recreation expenses directlyconnected to the devt., mgt. &operation & conduct of trade,business/ profession> The Regulations impose a limit of0.50% of net sales (gross sales less salesreturns/allowances & sales discounts) fortaxpayers engaged in sale of goods orproperties; or 1% of net revenue (grossrevenue less discounts) for those engaged insale of services, including exercise ofprofession and use or lease of properties.(RR No. 10-02)EXPENSES TO BE DEDUCTIBLE:- Amount must be reasonable.- Amount must be substantiated.- It is not contrary to law, public policy or morals.- Tax required to be withheld must have been paid tothe BIR2) Substantiation Requirements: sufficientTaxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 27 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.evidence (i.e. official receipts, financialstatements or other adequate records) tosubstantiate:(a) amt. of expense deducted(b) direct connection/relation of the expenseto the development, managementoperation &/or conduct of the trade,business or profession of the taxpayer3) Bribes, Kickbacks & Other Similar Payments:not deductible Ordinary expense normal or usual in relationto the taxpayers business and the surroundingcircumstance. Necessary expense appropriate and helpful inthe development of taxpayers business and areintended to minimize losses or to increase profits.These are the day to day expenses. While illegal income will form part of the incomeof the taxpayer, expenses which constitute bribe,kickback, and other similar payment, beingagainst law and public policy are not deductiblefrom gross income (Sec. 34A1c). Business expense expenditure related to thebusiness that is deductible in the year incurred, inthe same taxable year. Capital expense expenditure that improves oradds to the value of your property or equipment.Not immediately deductible. It is deductible overtime, such as in the form of depreciation. Expenses allowable to private educationalinstitutions: In addition to the expensesallowable as deductions, a private educationalinstitution has the option to elect either:(a) to deduct as expense those otherwiseconsidered as capital outlays ofdepreciable assets for the expansion ofschool facilities(b) to capitalize asset & deduct allowancefor depreciation2. INTERESTRequisites for deductibility, as implementedby Rev. Reg. 13-2000(a) there must be an indebtedness(b) there should be an interest expense paidor incurred upon such indebtedness(c) indebtedness must be that of thetaxpayer(d) indebtedness must be connected withthe taxpayers trade, business orexercise of profession(e) interest expense must have been paid orincurred during the taxable year(f) interest must have been stipulated inwriting(g) interest must be legally due(h) interest payment arrangement must notbe between related taxpayers(i) interest must not be incurred to financepetroleum operations(j) in case of interest incurred to acquireproperty used in trade, business orexercise of profession, the same was nottreated as a capital expenditure(k) the interest id not expressly disallowedby law to be deducted from gross incomeof the taxpayer.GENERAL RULE ON DEDUCTION- The amount of interest expensepaid or incurred within a taxable yearof indebtedness in connection withthe taxpayers trade, business, orexercise of profession shall beallowed as a deduction from thetaxpayers gross income.LIMITATION ON DEDUCTIONInterest expense shall be reduced by an amt.equal to the ff. % of interest incomesubjected to FT:1/1/00 38%1/1/061/1/0942% (RA9337)33%Example: Year 2006Int. exp. = P2,000 Int. income subjected toFT = P1,500Deduct as int. exp.: P2,000 - (P1,500 x 42%)= P1,370The objective of the limitation is to discourage taxarbitrage on back to back loans, the proceeds ofwhich are invested in income earning interest thatis subject to 20% final tax.Tax arbitrage- is a method of borrowing withoutentering into a debtor/creditor relationship, oftento resolve financing and exchange controlproblems. In tax cases, back-to-back loan is usedto take advantage of the lower rate of tax oninterest income and a higher rate of tax oninterest expense deduction.DEDUCTIBLE INTEREST EXPENSE:Taxation Law Summer ReviewerATENEO CENTRAL BAR OPERATIONS 2007Page 28 of 145QuickTime and aTIFF (Uncompressed) decompressorare needed to see this picture.1. interest on taxes, such as those paid fordeficiency or delinquency, since taxes areconsidered indebtedness (provided that thetax is a deductible tax, except in the case ofincome tax). However, fines, penalties, andsurcharges on account of taxes are notdeductible. The interest on unpaid businesstax shall not be subjected to the limitation ondeduction.2. Interest paid by a corporation on scripdividends.3. Interest on deposits paid by authorized banksof the BSP to depositors, if it is shown thatthe tax on such interest was withheld.4. Interest paid by a corporate taxpayer who isliable on a mortgage upon real pro