TAXATION

SEPT. 7, 2010 Tuesday

DISGUISED DIVIDENDS

- Disguised dividends may be considered as distributed to an individual who is not a stockholder. Agree or disagree?

o Disagree. Dividends are only given to stockholders of a corporation. o Thus, whenever an excessive payment of honorarium (1M a month) is given to a President of the

Company, who is not a stockholder, it will not be treated as disguised dividends. But what will happen to the payment? Taxable still?

It will be taxable on the part of the President but not as dividends. Whatever income will be derived by an individual, it will be taxable. In what way? It depends on what is the treatment given by the Tax Code. In case excessive payment is made to an individual who is a stockholder, it will be treated as disguised dividends and subject to the usual rates of 10% for RC, NRC and RA, 20% for NRA-ETB, and 25% for NRA-NETB. But if it so happens that the individual who received excessive payouts or payments is not a stockholder, it will not be considered as disguised dividends. No dividends shall be given to a non-stockholder. But still, being an income or an inflow of wealth in the hands of such individual, it will be taxable subject to the ordinary rates to be withheld, if he’s an employee, of the 5-32% income tax according to the withholding tax on wages table.

LIQUIDATING DIVIDENDS

- Whenever a corporation dissolves, liquidates and winds up its business operations, it may happen that assets will be left after paying all the creditors and these assets will be distributed to the stockholders in accordance with the proportion of ownership that they have in the business and it’s called liquidating dividends. It’s taxable.

o Liquidating dividends given, like cash, properties or other remaining assets after paying out all the creditors of the corporation, if distributed to the stockholders, will it be subject to FWT 10%, 20% or 25% depending on the classification of the taxpayer or the corporation?

NO. Do you think a stockholder will experience loss in receiving a liquidating dividend? YES.

Example: 46M as invested by 46 people for 1M each 10 years ago and 0 liability. Net worth, therefore, is 46M. Capital stock of first day of operation is 46M and profits is 0. 10 years after, assets grew to 100M, liabilities to 60M. Net worth, therefore, is 40M. If you dissolve and wind up the affairs of the corporation, you distribute the 40M after you payout the liabilities to the creditors. Would the stockholders be receiving the same amount that they invested of 1M each? NO. The stockholders will receive less than 1M. Is there a gain subject to tax? NO, since there is a loss. Can we consider the less than 1M receipt of cash, property or assets as liquidating dividend? YES. Would such liquidating dividend be taxable? NO, it will be deductible.

So if it will happen that your receipt of liquidating dividend is less than what you have invested in the corporation, you actually suffered a loss from the investment. Whatever you received, considered as liquidating dividend, is not subject to tax. But if it’s the other way around, there is a gain or you receive more than what you have invested. And whatever you have invested is the cost of your investment. Any difference of what you receive as liquidating dividend from such cost will be considered as taxable income subject to the rate of 5-32%.

So whenever you receive a liquidating dividend, just treat it as a capital income. Compute your tax liability together with all your other income. It’s never subject to FWT.

What happens if the stockholder receiving the liquidating dividend is a corporation?

o Example: Corporation XYZ is owned by A-F and JKL Corporation. If XYZ Corporation liquidates and distributes the remaining assets to all 6 individual stockholders and a corporate stockholder. Is such corporate stockholder subject to tax?

Whatever the taxability, on a normal basis, if the stockholder, whether he is subjected to 5-32% or 25% because he is a NRA-NETB, or the stockholder is a corporation subject to 30%, then use those rates in computing the tax due on the difference between your liquidating dividend and the initial investment or the cost of the investment that you put into the corporation. After all, it’s the income that matters. You shall not be taxed on the cost of the investment you put into unlike cash and property dividend, you get it out free from the cost as yet because the corporation is not winding up. Still whenever you receive cash and property dividends, your capital is intact in the corporation. But in liquidating dividends, it’s the end of the corporation and the end of your investment. Any income is taxable. Any loss is deductible.

NOTE: Losses from investment or income from investment, such as liquidating dividends, are capital losses and capital income, respectively. They’re only taxable as capital income and deductible against capital income if a loss is experienced.

DEDUCTIONS

- Are corporations allowed deductions? YES. The same as the available deductions for individual taxpayers? NO.

o What types of deductions and/or exemptions are available to individual taxpayers? 1. Personal and additional exemptions 2. Premiums on health and hospitalization insurance 3. Itemized deductions, or in lieu of such, optional standard deductions

However, not all these three are available to all types of individuals. If an individual is purely a compensation income earner, only 1 and 2 would be deductible. But if the individual is into business already, whether together with ER-EE relationship, he can also claim any of the itemized deductions or optional standard deductions because itemized deductions is for business expenses. But then, all three would not be available to an individual who is classified as a NRA-NETB. In so far as the corporation is concerned, which of the 3 deductions are available to a corporation?

o Itemized deductions, or in lieu of such, optional standard deductionso REASON: Corporations venture into an activity which is for profit.

Therefore, it is for business and with it comes the incurrence of business expenses. That’s why as a rule, corporations doing business in the Philippines, in fact, all corporations engaged in trade or business in the Philippines can deduct itemized deductions or optional standard deduction if it so chooses. But exemptions are not available because it covers for personal and family living expenses and corporations are not natural persons. And premiums on health and hospitalization insurance are not as well considered as deductions.

- What are the underlying principles that need to be followed before a corporation can deduct itemized deductions?

o i. The taxpayer must prove that there is a law authorizing deductionso ii. The taxpayer must prove that he is entitled to deductionso iii. If the law provides for requirement that the amount or the expense payment needs to be

withheld of tax, a tax should have been withheld, otherwise, the deduction is not allowedo iv. Always, we construe it strictly against the taxpayer

- But what about OSD? Can corporations really claim OSD?o YES, except NRFC.

REASON for exception: Such corporation, its tax base is at gross. And the mere fact that a NRFC is construed as a corporation NETB, there is no deductions allowed from their

income. Whatever they earn in the Phil. is subject to 30% income tax except those capital gains from the sale of shares of stocks in a domestic corporation.

- Can OSD be allowed as a deduction if the corporation is not allowed to claim itemized deductions? o NO, OSD is in lieu of itemized deductions. So if a corporation or any taxpayer is not allowed to

claim itemized deductions, there is no OSD allowed. But there are cases or exceptions when itemized deduction is allowed but OSD is not allowed, such as when the taxpayer is a NRA-ETB since OSD can be claimed by any individual except NRA but NRA-ETB can claim itemized deductions because they are subject to tax on net income.

o OSD example: If your gross income is 1M, you can automatically deduct OSD of 400K. Pay tax as a corporation on the 600K. Itemized deduction is only 300K, go for OSD. You don’t need to substantiate it with receipts. You don’t even have to incur such expense. But if your itemized deduction is 900K, forget about OSD. Claim such itemized deduction as an expense. The only problem is that your books will be audited to determine whether you really have incurred 900K in total expenses and whether it is substantiated with official receipts, or invoices or in contracts.

- Who are not allowed to claim itemized deductions?o 1. Individuals, whoever that individual is, if he is purely earning income from ER-EE relationship,

forget about itemized deduction because itemized deduction is only in business, trade, or profession.

o 2. If the individual is a NRA-NETB, no itemized deduction.o 3. NRFC are never allowed itemized deduction or OSD.

- Itemized deduction becomes the default of every businesses. Every business, whether individual taxpayer or a corporation, is required to report on a quarterly basis the income tax liability of that business.

o If the taxpayer forgets to choose which option is it taking, whether it is itemized deduction (ID) or OSD, automatically, the default is ID. But once in the first quarter, the taxpayer has already chosen OSD, you can no longer shift back to or revert back to ID for the entire year. So that means, OSD, as an option, is irrevocable for the year at issue.

o Can the taxpayer choose ID the following year? YES because irrevocability of an OSD is only for the current year. It’s on a year-to-year basis.

o If a GPP, who is not taxable, elects to report its taxable income choosing OSD, then the partners who have to report their tax liability and paid will also be liable under OSD. If the GPP elects ID, the partners don’t have any other choice but to go for ID. So GPPs and the individual partners are taken as a single entity for tax purposes. Not one of the taxpayers, GPP or the partners, can choose the other and the other one go for the other option.

EXPENSES

- What are ordinary and necessary expenses?o Ordinary expenses (OE) – refers to the expenses which are normal, usual or common to the

business, trade or profession of the taxpayer.o Necessary expenses (NE) – one which is useful and appropriate in the conduct of the taxpayer’s

trade or profession.

- Can a NE of one business be a NE of another business? Or is it always the case that if the expense is necessary in this business, it is always necessary expense for another?

o NO.o Example: If you’re into banking business and your friend is into siomai business. What expense is

necessary for your business but is not necessary for your friend’s business? Banking business has to hire security guards and rent armored car for its business as a NE, which is not a NE in a siomai business.

o So what is necessary, useful and appropriate for one type of business may not be useful and appropriate for another kind of business. So there is no standard rule for what type of expenses may be deductible for this corporation or another corporation. You can name more than a hundred expense accounts in your business, but may not be found in another type of business. But so long as the classification of that business is that it’s necessary, useful, appropriate and it’s ordinarily incurred in the business operations, for those who are similarly situated, then it is classified as a deductible business expense.

o Is a capital expense deductible? YES.

What are capital expenses (CE)? They are expenditures for the extraordinary repairs which are capitalized and

subject to depreciation. These are extraordinary expenses which tend to increase the value or prolong the life of the taxpayer’s property.

What important requisite for the deductibility of an expense is not complied with by a capital expenditure making it non-deductible on the year of incurrence?

Capital expenditures are extraordinary expenses which prolong the life of an asset that has been repaired. It either increases the value or increases the life or prolongs the life of the asset such that it violates the rule for an expense to be deductible, it must be paid or incurred during the taxable year.

When you say “paid”, it is expense but it must also pertain to the year for which that expense is related to the income generated by the business. If it’s incurred during the year, if the CE would prolong the life of an asset over which the asset would be useful for 10 years, then the expense of the CE should be distributed over 10 years as well to benefit the company. It’s the matching principle wherein you only deduct the expenses which is related to the business activity. If it’s only 1/10 every year, then only 1/10 of the expense is deductible.

The reason why it is deductible but not in the year of payment or not in the year when the year it was constructed, purchased, repaired, etc….

- What are the common requisites to make an ordinary or necessary expense deductible?o i. The expenses must be ordinary and necessary

It’s ordinary when it’s normal, usual and common. Although sometimes it does not necessarily need to be incurred day-in, day-out but so long as it’s usual in the type of business or the industry to which that business is in then it can be considered as OE, not unusual.

It’s NE when it’s useful and appropriate for the business activities.o ii. It must be paid or incurred during the taxable year (whether calendar or fiscal year)

Exception: net operating loss carry-over If the expense that you’re claiming as a deductible item this year is an expense for the

operation of the previous year, it is not deductible expense. So your expense claims must be paid this year or if not paid this year, it must have been incurred.

What’s the difference between paying an expense and incurring an expense? In the Phil., we do not usually follow the cash method in determining whether

your income is already taxable or not. We follow the accrual method of accounting. Cash method of accounting, whatever you receive in cash is considered as sales and whatever you have paid for in your expense, is deductible and the difference is taxable under the cash accounting method. But the accrual method, whatever you have sold, so long as you have completed the transaction, whether it has been paid by your customer or not, is reported as sales already and whatever you have paid as an expense including those expenses for which you have effected already the transaction, the services have already been performed in your favor, and it’s payable, meaning, the other party, your supplier, has already the legal right to demand payment from you but not as yet. Probably, there is a period within which you can pay. It’s already deductible. It simply follows the “all-events test”. You have all the events to complete the transaction, then the sale has been perfected, whether paid or not, taxable. Expense, whether paid or not, so long as service has been performed, goods have been delivered, it’s deductible.

So in the expense, so long as it has been paid this year or has been incurred and it pertains to this year’s operations, the expense is deductible.

If you’re claiming an expense which is for the future, advance rental payments, is it deductible?

o Under the accrual method, it would be deductible. Is the expense pertaining to last year’s activity deductible?

o NO. All the expenses must be paid or incurred during the year except net operating loss carry-over.

o NET OPERATING LOSS CARRY-OVER (NOLCO) If the business incurs a loss, it’s deductible. But once a business

incurs NOL, meaning, the bottomline figure for the entire year’s

operations is a loss, there is an option for the business to carry it over to the next 3 years.

So, it means to say if it’s carried over to the next 3 years, in the next 3 years, it’s not the expense during those years. It pertains to the previous years. But since it is mandated by law to be deductible, it’s an exception to the rule that it does not really have to pertain for this year’s operations.

o iii. It must be paid or incurred in connection with the trade, business or profession of the taxpayer

Example: In you’re in 3 businesses. One manufacturing corporation. One real estate business. And the other is a siomai business. You don’t mix the expenses. You cannot claim the expenses of this business to that business. It should necessarily be connected with the business that you’re in.

o iv. It must be reasonable in amount; If you are the president of the corporation earning 100K a month, it may be reasonable

in so far as that business is concerned but your 100K will be unreasonable in another type of corporation.

So there is no fix amount within which we can determine whether this type of expense claimed is reasonable or not. No fix amount but you have to consider it in so far as the operation is concerned.

But there is one type of expense that is regulated by the tax authorities and that expense is Entertainment, Amusement and Recreation expense (EAR expense).

Why? Because this type of expense as a deduction has been abused. Many businesses claim representation expense – bringing clients to clubs. And the amount is unreasonable. Instead of distributing as dividends, they claim it as representation expense – they require stockholder or employee to bring in receipts and thy can even ask receipts from you and have it reimbursed, such as medical representatives.

EAR expense has been abused. There is already a regulation that sets a quota for such expense. What is the

ceiling set by the Secretary of Finance?o EAR expense – to the extent only of 1% of the net sales if the

corporation is engaged in services. And 0.5% of the net sales if the corporation is into the sale of goods or properties.

o REASON for the difference: Because those engage in services usually needs representation expense to entertain their clients or treat them over meetings, lunch meetings, etc. But if it is goods or properties, so long as you have the product, you can sell it.

o What happens if you are both engaged in the sale of service or in the sale of goods? Which will you follow?

You still have to follow the formula – 1% for the service and 0.5% for the goods and properties.

Example: So it means to say that if the corporation, net sales is 1M and it is engaged in the sale of service and goods, the maximum EAR expense for services is only 10K while for goods or properties, it’s only 5K.

If the corporation has 50K expense, automatically, 45K is not deductible for goods or properties since only 5K is the maximum deductible amount.

In so far as salaries are concerned or bonuses of directors, it’s provided under the Corporation Code that Board of Directors, as honorarium, should not exceed 10% of the net income of the corporation because if it exceeds, it will be considered already as disguised dividends.

o Example: If the net income is only 1M, only 100K should be given to the Board of Directors for the entire year – for all of them. Any excess will be considered as unreasonable.

o v. It must be substantiated by sufficient evidence such as official receipts and other official records; and

Official receipts Adequate records

Amount of expense being deducted Date and place where such expense is paid or incurred Nature of expense – direct connection or relation of the expense being deducted to the

development, management, operation and/or conduct of the trade, business, or profession of the taxpayer

The evidence must be recognized or produced by the third party. If the evidence solely comes from the company – you made it, you drafted it, no signature from the other party, it is self-serving so it is not sufficient evidence.

Example: You’re in the business of manufacturing wooden toys for export in Europe. And for cost-cutting purposes, you don’t have a large pool of employees so that you sub-contract the raw materials to the different homeworkers. And those homeworkers are actually not registered in the business. They just do what they’re required to do and when they bring it back to you, you pay them. Homeworkers, not being registered with the tax authorities because they’re not really into business, cannot produce an O.R. nor an invoice. What proof will you present to the tax authorities in order to claim the payments you made to these homeworkers?

o A contract or an acknowledgment receipt will do. They can surely sign. It’s not always in all cases that you can require your supplier to produce an O.R. In one of the major cases that we have in the Philippines is those in the business of manufacturing “carajinan”. You purchase it from different suppliers to grow such but they are not registered in the business of supplying. They cannot produce an O.R. The problem is that if they do not produce an O.R., what proof do you present to the government that indeed that you’ve made payments for these when it cost millions?

So in one of the companies here, the only thing that they can produce is the proof that it had been weighed by a reputable weighing company, the deposit that they made in millions to an individual in Mindanao. But if you really want them to produce an O.R., they can show you their guns. So as a business man, you don’t force them to issue an O.R. So how to prove to the BIR that these are valid and legitimate expenses?

There’s already a SC actually following the Cohan Rule in the U.S. that some expenses need not be supported by O.R. but so long as it can be substantiated with other adequate records proving that in fact it has been purchased by the company and the goods received by the company which were actually converted to the product sold, can be proof enough that expenses have been paid or incurred. But not in all instances.

In this type of requisite, is it necessary when you want to claim OSD?o NO, because the law in OSD says “whether or not you have incurred

actual expenses”. So this requisite applies only in so far as ID is concerned.

o vi. It must not be against law, morals, public policy or public order Example: Bribes and kickbacks given to government personnel

You have an assessment of 10M in unpaid taxes or delinquent taxes. You come into a compromise or common grounds. You will only pay 5M and you will be issued a tax clearance. And for the 5M that you will pay, only 2.5M will be receipted as received by the government. Wherever the other 2.5M will go, we do not know. How much is deductible from your business operations? 10M, 5M, 2.5M or none of the above?

o NONE of the above. Whatever payments you made to the government, as kickbacks or bribes, even to the members of the BOC or BIR or DOF, so long as it’s not a legitimate payment of an expense, it is not deductible.

o How about payments to rebels as revolutionary taxes? Telecommunications towers, so that it will not be blown up, you have to pay a certain amount. Is that deductible?

NO. All taxes, as a rule, are deductible, except income tax paid to the Phil. government, income tax paid to the foreign government, estate tax, donor’s tax and VAT. All the other taxes are deductible. However, even if they call it as a formal tax that is paid to the rebels, it doesn’t go to the government, therefore, however media will try to make it legal in the news, it’s still a non-deductible expense because it’s contrary to law and public order.

ADVERTISING AND PROMOTIONAL EXPENSE (APE)

- As a rule, APE are deductible unless it borders to creation of goodwill for the company or creating a name for the company, future recall, etc…

o Example: Dandruff shampoos – we have Guard, Head and Shoulders. We’ve been through that for years already. When Clear came in, almost all actors and actresses became endorsers for it. How much did they have as a budget for that? It’s 1B. Is it deductible as APE in the year it was incurred?

NO. It’s excessive and the purpose of actually of Clear is not to make it as an expense in the year of entry but rather its purpose was to give a brand and give a name recall for the customers and it’s expected to benefit a number of years for the company, therefore, whatever expense it had paid during the year of entry will be amortized over future years. Let’s say, for 5 years.

TRAVEL EXPENSES (TE)

- TE are deductible even if it’s not receipted because they’re TE that we incur without having a receipt from the carriers, etc…

OPTION TO PRIVATE EDUCTIONAL INSTITUTION (OPEI)

- PEIs have the option to deduct capital expenditures in the year it was paid or incurred or the other option is to depreciate the expense over the useful life of the asset.

o Example: USC would purchase a 100M value building. It can opt to deduct entirely the 100M in the year of purchase or amortized the 100M over its useful life. In any case, whatever the option chosen by USC, since it’s not subject to tax, it won’t have any effect. It doesn’t need to match the expense incurred today against the income for today or year-to-year basis.

INTERESTS EXPENSE (IE)

- What is interest?o It’s the amount paid for the use or forbearance of money.

Example: If you have a business and you obtained a loan for the working capital of your operation and you are to pay 10K monthly as interest. Is the 120K for the entire year be deductible as a business expense if it’s related to the business?

YES. As a rule, IE incurred by a business, corporation, company or PP is deductible so

long as the common requisites are complied with: o 1. The interest must be ordinary and necessary.

So if you obtained a loan to use it as a working capital of your operations, the interest paid is deductible.

o 2. It must be reasonable. Reasonableness would depend on the size of the business

operation.o 3. It must be paid or incurred during the taxable yearo 4. It must be paid or incurred in connection with the businesso 5. It must be substantiated by the contract itself and payment vouchers,

etc.o 6. It must not be contrary to lawo Other additional requisites to make IE deductible:

i. There must be an obligation which is valid and subsisting ii. There must be an agreement in writing to pay interest

Otherwise, not in writing, no IE deduction, whether or not you have actually paid an interest

iii. This must observe the limitation under the arbitrage rule iv. This must not be between related taxpayers

- IE which are non-deductible: (See outline)o Corporation to corporation where only one individual is maintaining the controlling interest, the

interest is not deductible. Example: Co. A (parent company) and Co. B (subsidiary company). Usually the parent

company grants a loan to a subsidiary company for operational purposes. If the agreement is stated that interest shall be paid in writing, is the individual, according to the grandfather rule… If Co. A is owning Co. B 100% and the loan is granted to the subsidiary company where interest is stipulated to be paid, is the interest payments made by the subsidiary to the parent company deductible? NO. Here, Co. A is a holding company of Co. B. When one is a holding company of the other and extends loans, the IE becomes a non-deductible expense. The 50%-rule (controlling interest rule) is only applicable to non-existing holding companies.

o Interest expense on preferred stock Example: A company declares dividends. Dividends comes out from your shareholdings

and shareholdings, usually, shares that you have can be classified as common shares or preferred shares. Whenever you organize a corporation, you may say that this group has common shares, this group will have preferred shares. The term preferred shares, you will have a preference in the distribution of dividends, as a rule. If there comes a point in time that the business, in a certain year, cannot declare a dividend, some dividend would accrue to them but not totally paid out, nothing would accrue to you. Meaning, they have a collectible. In the following year, when distribution happens, they will get their prior-year accrual dividends plus interest, you will receive yours for the year. Will the interest on the preferred shares be considered as deductible IE?

The concept of paying interest and interest as a deducible expense item is it must be payment for the use of someone else’s money – the forbearance of money. You temporarily borrow money, use it and for the use, you are to pay interest in addition to the principal payments that you will make. But dividend declaration is not an obligation of the corporation. In fact, under the Corporation Code, a dividend can only be declared if there is enough unrestricted retained earnings or corporate profits that a corporation has. If it is not dependent upon corporate profits on the preferred shares, it is deductible. If it is dependent upon corporate profits, as a rule, it is not deductible expense. REASON: The corporation did not really loan any money coming from the stockholders. The corporation is obligated to pay out dividends once it has profits.

- What is the Arbitrage Rule?o The taxpayer’s allowable deduction for IE shall be reduced by an amount equal to 33% of the

interest income earned by him which has been subjected to final tax.o The arbitrage rule automatically limits the deductibility of the IE by reducing 33% of the interest

income subject to final tax, whether or not engaged in back-to-back loan transactions. Example: Let’s say that the company has an IE of 600K but it has no interest income, is

the IE deductible fully? YES. Say for example, Co. A (earning interest income of 100K subject to 20% final tax), Co. B (earning 100K interest income from loans to employees) and Co. C (no interest income). All of them obtained the 1M loan running for 10 years wherein they would be liable each for 600K annually as IE. Which of the 3 corporations can claim the full 600K as expense and which cannot?

Co. A cannot claim fully the 600K as a deductible IE but only 567K (600K – [33% x 100K]). The arbitrage rule applies since Co. A is earning interest income subjected to final tax. If none, the arbitrage does not apply, automatically full interest payment can be deductible.

Co. B can fully claim the 600K as a deductible IE since its interest income is not subjected to final tax. Interest income subjected to final tax is only those coming from the banking institutions.

Co. C can fully claim the 600K as a deductible IE since it is not earning interest income.

o The principle why such rule exists: To discourage Back-to-Back loan transactions – obtaining loan from one bank and invest

it to another bank in order to benefit the difference between the tax due on interest income and the tax benefit from the IE.

o If the IE is 100K, interest income subject to final tax is 100K, do you have a deductible IE? YES. You have a deductible IE of 67K (100K – [33% x 100K]).

o If the interest income is 500K subject to final tax, IE is 100K, do you have a deductible IE? NO. 33% of 500K is 165K. So the 165K will be deducted to 100K, which results to no deductible IE.

- What is theoretical interest? Is it deductible?o It’s an interest which is computed or calculated, not paid or incurred, for the purpose of

determining the opportunity cost of investing in a business. It’s not real. There’s no payment at all. Thus, it’s not deductible nor taxable.

- What is imputed interest? Is it deductible? Is it an actual expense?o Sec. 50 of the tax code – Allocation of Income and Deductions – In the case of 2 or more

organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses.

o Such provision is powerful in the sense that the BIR can do anything with it so long as it sees relationships between corporations.

Example: If Co. A is related to Co. B as the controlling or fully owning the other corporation, any expense loan (let’s say 1M) to Co. B, which is interest-free, so Co. A did not earn any interest income. Can Co. B deduct IE? Automatically, no IE because IE must be stipulated in writing and there is no interest payment made. But the BIR can impute an interest based on the legal rate of 12% and subject such interest income on the part of Co. A to tax. But Co. B is absolutely not allowed to claim the IE for no interest has been paid and there is no stipulation in writing.

- Can payment of interest for delinquent taxes be deductible?o YES. Whenever a taxpayer, corporate or individual, is assessed of delinquent taxes, that taxpayer

is not only liable to pay the basic tax but also has to pay surcharges of 25% and 50% if it is found to be fraudulent plus interest of 20% pa and additional compromise penalties. So whether or not these payments are deductible, is interest deductible? YES, because it’s an indebtedness to the government. You temporarily withheld the payment of taxes to the government for the use of money during the time which you have not paid properly your taxes. But in so far as penalties, surcharges and compromise penalties are concerned, on top of the tax , these are not deductible. The taxpayer cannot benefit from a violation that he committed against the government. It is only the interest that is deductible.

- Optional treatment of IE (OTIE)o At the option of the taxpayer, interest incurred to acquire property used in trade, business or

exercise of a profession may be allowed as a deduction or treated as a capital expenditure. Example: Co. A obtained a loan for working capital purposes. Co. B obtained a loan for

construction of a building. Both of them paid 1M in interest. 1M in IE and no interest income subject to final tax. Thus, the IE not limited with the arbitrage rule. Does Co. A or Co. B have an option in treating the IE, whether deductible now or deductible in the future?

Co. A, the incurrence of expense is for working capital purposes, day-in day-out operations, the IE incurred, if it’s not subjected to arbitrage rule, would be fully deductible as an expense for the year of incurrence. But since Co. B obtained a loan to construct a property that is a capital expenditure, the IE can also be considered as a capital expenditure. Where the principal cost goes, the accessory interest expense can also join the principal cost. So if the building has an estimated life of 10 years or 20 years, the IE can be considered as capital

added to the cost of the building and it will be considered as an expense over the estimated life of the asset that was acquired using the loan amount.

TAXES

- GR: All taxes, national or local, paid or incurred within the taxable year in connection with the taxpayer’s trade, business or profession are deductible from gross income.

o E: i. Special assessment – tax imposed on the improvement of a parcel of land ii. Income tax – includes foreign income tax

Philippine income tax – absolute rule: totally not deductible Foreign income tax

o Paid by domestic corporations and resident citizens (taxable within and without) – may be claimed as a deduction if it opts for tax deduction, otherwise, it becomes non-deductible if it uses the foreign tax paid as tax credits.

If the foreign tax is claimed as a tax credit, you cannot claim it as a tax expense. But if you claim it as a tax expense, you cannot claim it as a tax credit.

Claiming it as a tax credit, you can claim the full benefit of the tax paid abroad since tax credit is a deduction from Philippine income tax. But if you claim it as an expense, only to the extent of 30% of that foreign tax will it reduce the tax due since tax deduction, as an expense, is a deduction from gross income in computing the net income. Thus, tax credit is more beneficial.

iii. Taxes which are not connected with the trade, business or profession of the taxpayer Whatever type of tax that is, since it’s not connected with the trade, business or

profession of the taxpayer, automatically, it’s not deductible. iv. Estate tax, donor’s tax v. VAT

- Is the real property tax (local tax) payment made by the corporation on its real property used in trade or business a deductible expense for purposes of computing income tax liability, not real property tax liability?

o YES. Real property taxes are deductible so long as: 1. It is ordinary and necessary 2. Reasonable in amount 3. It has been paid or incurred during the taxable 4. It has been paid or incurred in connection with trade, business or profession 5. Substantiated with O.Rs 6. It’s not contrary to law, public policy or morals

- Example of national tax that is deductible: Customs duties when the corporation is engaged in importation of goods.

- All taxes, whether national or local tax, will be considered as deductible from gross income in computing the net taxable income so long as it follows the requisites of being paid or incurred during the taxable year in connection with the trade, business or profession of the taxpayer subject to the exceptions.

- What type of taxpayer can offset the foreign taxes directly by 100% against the Philippine tax due?o i. Resident Citizens – since liable of income within and without to avoid double taxation

NRC – not included because liable of income within only – no double taxationo ii. Domestic corporations – since liable of income within and without to avoid double taxationo iii. Members of GPPso iv. Beneficiaries of estates and trusts

- If the tax paid in China is 10M and the tax due on your entire income here in the Philippines is 30M, can Co. B (which operates 80% in the Philippines and 20% in China with 100M total income. Thus, 20M from China and 80M from the Philippines), can Co. B fully deduct the 10M against the 30M?

o NO, since the foreign income tax paid to the foreign country is not always the amount that may be claimed as tax credit because under the limitation provided under the tax code, it must not be more than the ratio of foreign income to the total or global income multiplied by the Phil. income tax due.

o Thus, 20M (foreign income)/100M (global income) = 20% x 30M (Phil. income tax) due = 6M limit. Therefore, only 6M can only be claimed as a tax credit.

o Had it been the other way around, if the limit is higher than the actual tax payment abroad, you claim whichever is lower in favor of the government.