tax law reviewer

8/3/2019 Tax Law Reviewer

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PART 1

A. INTRODUCTION

1. General Principles sources of tax laws1. Constitution2. NIRC

3. Other Tax Statutes4. Revenue Regulations implementing NIRC

2. Constitutional Limitations

SISON V. COMMISSIONERBP 135 was enacted amending sec 21 of the NIRC1. Petitioner Sison assails the amendment claiming it would unduly discriminate against him by the imposition ofhigher tax rates upon his income from the exercise of his profession vis--vis against those earning a fixed income. He claims that the measure is arbitrary andviolative of both the equal protection and due process clauses of the constitution.

Held: The power to tax is inherent in sovereignty. However, it is not limitless. The constitution sets forth its limitations. Adversely affecting as it doesproperty rights, both the due process and the equal protection clauses may properly be invoked to invalidate a revenue measure. However, there has to be sufficient basis to support such a claim. The due process clause may be invoked if the measure is so arbitrary that it finds no support in the Constitution, as whenit amounts to a confiscation of property or where it beyond the authority of the taxing authority, or is not for a public purpose. As for equal protection, itis sufficient if the law operates equally and uniformly on all persons under the same circumstances or that all persons must be treated in the same manner, theconditions not being different, both in privileges conferred and liabilities imposed.In the case of BP 135, there is ample distinction to adopt a gross system of inc

ome taxation to compensation income. In such law, the basis for classificationis the susceptibility of the income to the application of generalized rules removing all deductible items for all tax payers whithin the class and fixing a setof reduced tax rates to be applied to all of them.

3. Classification of Income taxpayers- Individual- Corporations or others with separate juridical personality

B. TAX ON INDIVIDUALS

1. Kinds of Individual Taxpayers

a) Individual Citizens- Taxable on all sources of income, whether withinor without the Philippinesb) Non-resident Citizen- Taxable only on income from within the Philippi

nesc) Individual Resident Aliens- Taxable only on income from within the Ph

ilippinesd) Non- Resident Aliens-taxable only on income from within the Philippin

es

2. Rates of Income TaxA uniform tax rate schedule is used to determine tax liability of reside

nt citizens, of non-resident citizens, and of resident aliens, subject however to the rule set under no.1 above.

Not over P10,0005%Over P10,000 but not over P30,000P500 plus 10% of the excess


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Over P10,000Over P30,000 but not over P70.000.P2,500 plus 15% on the excessOver P70,000 but not over P140,000...P8,500 plus 20% on excessOver P140,000 but not over P250,000.P22,500plus 25% on excessOver P250,000 but not over P500,000.P50,000plus 30% on excessOver 500,000P125,000plus 32% of excess

For married individuals, both shall compute their individual income tax based on their own taxable income, provided however that if they do not derive income purely from compensation, they shall file a return for the taxable year toinclude the income of both spouses. If is impractical to file just one return,each spouse may file a separate return but such will be consolidated by the Bureau.2

The taxable income subject to the rates above do not include the income derived from passive income, capital gains from sales of shares of stock not traded in the stock exchange and capital gains from sale of real property, the tax rates of which are as follows:

Passive income

Interest of Bank deposits, deposit substitutes, from trust funds.20%Interest received by a resident under the expanded foreign

Currency deposit system3.7.5%Interest from a long-term deposit or investment. tax exemptInterest from a preterminated long term deposit or investment

With a remaining maturity of 4 to less than 5yrs..5%3 to less than 4yrs..12%less than 3 yrs20%

Royalties except from books, etc...20%Royalties from books, literary works and musical compositions..10%Prizes up to P10,000..taxable as income

Prizes exceeding P10,00020%Winnings other than fr sweepstakes or lotto...20%Sweepstakes and lotto winningsexemptCash or property dividends, actually or constructively received

fr a domestic corp, joint stock co., insurance or mutual fund coand regional operating headquarters of multinationals or on theshare in the distributable net income after tax of a partnershipof which he is a partner, or of an association, a joint accountor a joint venture or consortium taxable as a corporation of whichhe is a member or co-venturer10%

Capital Gains from shares

Gains from shares of stocks sold, bartered or exchanged outside theStock market if not more than P100,0005%

If over P100,000.10%

Capital Gains from the sale of Real Property

Tax rate is now 6% based on the gross selling price or current fair market value, whichever is higher. However, if the sale is made to the government orany of its subdivisions or to any GOCC, it may be taxed as part of the taxpayers income ( as set forth in the fist paragraph of this part), at the option of the taxpayer. (RR 8-98)

EXCEPTION: If the sale is of the taxpayers principal residence of a natural person and the proceeds are used to purchase a new home, it shall be exemptprovided:


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- a return is filed with the Bureau within 30 days from the sale statingthe intention to avail of the exemption- Proceeds are used within 18 months from sale to purchase a new residence- The historical costs of the residence sold is carried over to the new home- Exemption can only be availed of once every 10 years- If proceeds are not fully utilized, portion of the gain is taxable using thisformula: Taxable gain= gsp or fmv (whichever is higher) x unutilized portion/gs

p

Tax on Nonresident AliensA nonresident alien engaged in trade or business in the Philippines shal

l be taxed in the same manner as an individual citizen and a resident alien individual on taxable income derived from sources within the Philippines. A nonresident alien is one who shall come to the Philippines and stay herein for an aggregate period of more than 180 days during a calendar year. Tax on their passiveincome is likewise the same.

The rate of tax on income from all sources within the Philippines of a non resident alien NOT engaged in business here shall be 25%, except for gains from sale of real property and sale or exchange of stocks not thru the stock marke

t. An alien individual employed by the regional or area headquarters and regional operating headquarters established in the Philippines by multinational companies shall be taxed 15% on his gross income PROVIDED the same tax treatment is given to Filipinos employed in the same position by the same multinational companies.

Those aliens employed by off shore banking units4 established in the Philippines shall be taxed 15% on their gross income PROVIDED the same tax treatment is given to Filipinos employed and occupying the same positions as aliens employed by these off shore banking units.

Aliens who are permanent residents of a foreign country but are employedand assigned in the Phil by a foreign service contractor or subcontractor engaged in petroleum operations in the Philippines shall be taxed 15% on their gross

income PROVIDED that the same tax treatment is given to Filipinos occupying thesame positiona as aliens by the petroluem contractor or subcontractor.

3. Exemptions

Resident Citizens and Resident AliensThe following personal exemptions are allowed for the purpose of determi

ning the tax to be imposed upon resident citizens and resident aliens:

For single individual or married individual judicially decreed asLegally separated w/ no qualified dependentsP20,000

For head of the family.P25,000For each married individualP32,000

In the case of married individuals where only one spouse is deriving gross income, only such spouse shall be allowed the personal exemption

An additional exemption of P8,000 is also allowed for each dependent notexceeding four. However, only one spouse may claim such exemption and in case of married individuals who are legally separated, the one who has custody of thechild/ children can claim such exemption.

Non-resident citizenRR 1-79

Non resident citizens are allowed the following exemptions:Personal exemptions:

Single or married but legally separated$2,000Married or head of the family...$4,000


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Also, the total amount of the national income tax actually paid to the national government of the foreign country of his residence shall be deducted fromhis taxable income.

Non-resident aliens engaged in business in the Philippines or in the exercise of a profession

These persons are entitled to personal exemptions in the amount equal to

the exemptions allowed in the income tax law of the country of which he is a citizen, to citizens of the Philippines not residing in that country. Such amountshall not exceed the amount fixed in Sec 36 of the NIRC. However, such nonresident alien shall file a true and accurate return of the total income received byhim from all sources within the Philippines.

4. Definitions

Head of the family- An unmarried or legally separated person with one or both parents, or with one or more brothers or sisters, or with one or more legitimate,recognized natural or legally adopted children living with and dependent upon him for their chief supposrt. Such brother, sister, or child shall not be more th

an 21 yrs old, unmarried and not gainfully employed. If over 21 yrs of age butincapable of self support because of mental or physical defect, they shall not be excluded.

Dependent- Means a legitimate, illegitimate or legally adopted child chiefly dependent upon and living with the taxpayer if such dependent is not more than 21yrs old unmarried and not gainfully employed or if such dependent, regardless of age, is incapable of self support because of mental or physical defect.

5. Change of status

If the taxpayer should change his or her status during the taxable year,he may claim the corresponding additional exemptions in full for such year.

If the taxpayer dies during the taxable year, his estate may claim the personal and additional exemptions for himself and his dependents as if he died at the close of such year.

If the spouse or any of his dependents dies or if any of such dependentsmarries, becomes 21 or becomes gainfully employed during the taxable year, thetaxpayer may still claim the same exemptions as if no such change had occurred.

6. Premium payments on health and/or hospitalization insurance

Premium payments of such nature paid during the taxable year, not exceeding P2,400 per family OR P200 a month paid during the taxable year by the taxpayer for himself, incld his family, shall be allowed as deductions from his grossprovided that the gross income of the family does not exceed P250,000 for the taxable year. For married couples, only the spouse claiming deductions for the dependents may avail of such exemption.

PART 2

C. Tax On Corporations

Commissioner v. Batangas Tayabas Bus Co. (102 P 822)Issue: W/n the 2 transportation companies are liable to payment of income tax asa corporation on the theory that the Joint Emergency Operation organized & operated by them is a corporation w/in the meaning of the Revised Internal Revenue Code.

Held:Yes, liable as a corporation.In the present case, the 2 companies contributed money to a common fund t

o pay the sole gen. manager, the accounts & office personnel attached to the off


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ice of said manager, as well as for maintenance & operation of a common maintenance & repair shop. Said common fund was also used to buy spare parts, & equipment for both companies, including tires. Said common fund was also used to pay all the salaries of the personnel of both companies, & at the end of each year, the gross income receipts of both companies were merged, & after deducting therefrom the gross expenses of the 2 companies, also merged, the net income was determined & divided equally between them, wholly disregarding the expenses incurred

in the maintenance & operation of each company & of the individual income of said companies.

From the standpoint of income tax law, this procedure & practice of determining the net income of each company was arbitrary & unwarranted, disregardingas it did the real facts of the case. Considering that Batangas Transportation &the Laguna Bus operated different lines, under different franchises, w/ different equipment & personnel, it cannot possibly be true & correct to say that at the end of each year, the gross receipts & income & the gross expenses of the 2 companies are exactly the same for purposes of the payment of income tax. Therefore, the Joint Emergency Operation in this case is a corporation under the Internal Revenue Code & is liable to income tax as a corporation.

Ona vs CIR (25 Scra 74)Ruling:For tax purposes, the co-ownership of inherited properties is automatically converted into an unregistered partnership the moment the said common properties are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares in the inheritance. From the moment ofsuch partition, the heirs are entitled already to their respective definite shares of the estate & the incomes thereof, for each of them to manage & dispose ofas exclusively his own w/o intervention of the heirs, & accordingly, he becomesliable individually for all taxes in connection therewith. If after such partition, he allows his share to be held in common with his co-heirs under a single management to be used with the intent of making profit thereby in proportion to his share, there can be no doubt that even if no document or instrument were executed for the purpose, for tax purposes, at least, an unregistered partnership is

formed.For purposes of tax on corporations, the NIRC, includes partnerships-wit

h the exception of only duly registered gen. co-partnershipswithin the purview ofthe term corporation.

BIR Ruling No. 317-92Ayala Land, Inc.(ALI) & Appleyard Properties, Inc(API) entered into a Memorandumof Agreement (MOA) for the construction of the 6750 Bldg.. Pursuant to the MOA, they will contribute equal amounts to the construction costs & ALI will own 60% of the building while API will own 40%, while there is separate ownership, they will share common area expenses, real estate taxes, etc in the same proportion. ALI & API now propose to enter into a another agreement, a Joint Venture Agreement(JVA). Under the JVA,both ALI & API will contribute money as additional working capital & ALI will be appointed as manager & will be responsible for leasing the floors.HELD: The MOA has not by itself created a taxable joint venture. However , the joint venture to be subsequently entered into by & between ALI & API will create a joint venture subject to tax.

Obillos Jr. vs CIRThis is about the tax liability of 4 brothers & sisters who sold 2 parcels of land which they had acquired from their father. In 1973, Jose Obillos Sr bought 2parcels of land from Ortigas & Co & transferred his rights to his 4 children toenable them to build their residences. In 1974, the 4 children resold the lotsto Walled City Securities Corp & earned profit. CIR assessed the 4 children wit

h corporate income tax.HELD:It is error to hold that petitioners(Obillos) have formed a taxable unregistered partnership simply because they contributed in buying the lots, resold the


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same & divided the profit among themselves. They are simply co-owners. They were not engaged in any joint venture by reason of the isolated transaction. Theoriginal purpose was to divide the lots for residential purposes. The divisionof the profit was merely incidental to the dissolution of the co-ownership.

Dept Order # 149-95Non-stock, nonprofit educational institutions are exempt from taxes on all their

revenues and assets used actually, directly, and exclusively for educational purposes. They shall, however be subject to internal revenue taxes on income fromtrade, business or other activity the conduct of which is not related to the exercise or performance by such educational institution of its educational purposeor function.

BOAC v. CIRBOAC maintained a general sales agent in the Phil. The gen sales agent was engaged in selling & issuing tickets, breaking down the whole trip into series of trips, receiving fare from the whole trip & allocating to the various airline companies the services rendered. In fact, the regular sales of ticket, its main activity is the very lifeblood of the airline business, the generation of sales bein

g the paramount objective. There should be no doubt that BOAC was engaged in business in the Phil thru a local agent. It is a resident foreign corporation subject to tax upon its total net income from all sources w/in the Phil.

Source of income is the property, activity or service that produced theincome. For the source of the income to be considered as coming from the Phil,it is sufficient that the income is derived from activity within the Phil. In BOACs case, the sale of tickets in the Phil is the activity that produces the income. The tickets exchanged hands here & payments for fares were also made here in Phil currency. The situs of the source of payment is the Phil. The absence of the flight operations to & from the Phil is not determinative of the source ofincome or the situs of income taxation.

CIR v Procter & Gamble(including MR)

Please read the originals. This is a very important case, especially on the computation part.

CIR v Wander Phils. (160 Scra 573)Wander Phils. Inc is a domestic corporation, a wholly-owned subsidiary of GlaroS.A. Ltd. A Swiss corp not engaged in trade or business in the Phil. In 1975&1976, Wander remitted to Glaro dividends on which 35% was withheld & paid to the BIR. In 1977, Wander filed a claim for refund contending it is liable only to 15% withholding tax in accordance with sec 24(b)(1) of the Tax Code.

Under the said provision, dividends received from a domestic corporationliable to tax shall be 15% of the dividends received, subject to the conditionthat the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% w/c represents the difference between the regular tax of 35% on corporations & the tax of 15%on dividends.HELD: In the instant case, Switzerland did not impose any tax on the dividendsreceived by Glaro. The fact that Switzerland did not impose any tax on the dividends received by Glaro from the Philippines should be considered as a full satisfaction of the given condition. Wander liable only to withholding tax rate of 15% & is therefore entitled to refund.

As to the contention of the Commissioner that Wander is but a withholdingagent of the government & therefore can not claim reimbursement of the allegedoverpaid taxes is UNTENABLE. Wander is a wholly owned subsidiary of Glaro. Thefact that it became a withholding agent of the government, which was not by cho

ice, cannot be considered as an abdication of its responsibility to its mother company. As the Philippine counterpart, Wander is the proper entity who should claim for the refund or credit of overpaid withholding tax on dividends paid or r


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emitted by Glaro.

PART 3 PART 4

A. Inclusions and Exclusions from Gross IncomeSec. 32 (see Code)Secs. 39-60 Revenue Regulations No. 2 (see RR No. 2)

1. Definition of Gross IncomeSec. 32 (see Code)

2. Exclusions from Gross IncomeSec. 32 (B) (see Code)Secs. 61-64 Revenue Regs. No. 2 (see RR No. 2)

a. REPUBLIC ACT NO. 4917: AN ACT PROVIDING THAT RETIREMENT BENEFITSOF EMPLOYEES OF PRIVATE FIRMS SHALL NOT BE SUBJECT TO ATTACHMENT, LEVY, EXECUTION, OR ANY TAX WHATSOEVERThe retirement benefits received by officials and employees of private firms, wh

ether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer shall be exempt from all taxes and shall not be liable to attachment, garnishment, levy or seizure by or under any legal or equitable process whatsoever except to pay a debt of the official or employee concerned to the private benefit plan or that arising from liability imposed in a criminal action: Provided, That the retiring official or employee has been in the service of the same employer for at least 10 yrs and is not less than 50 yrs of ageat the time of his retirement: Provided, further, That the benefits granted under this Act shall be availed of by an official or employee only once: Provided,finally, That in case of separation of an official or employee from the serviceof the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee, any amount received byhim or by his heirs from the employer as a consequence of such separation shall

likewise be exempt as hereinabove provided.The term "reasonable private benefit plan" means a pension, gratuity, stock bonus or profit sharing plan maintained by an employer for the benefit of some or all of his officials and employees, wherein contributions are made by such employer or officials and employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated,and wherein it is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees. (June 17, 1967)

b. REPUBLIC ACT NO. 7641: AN ACT AMENDING ARTICLE 287 OF PRESIDENTIAL DECREE NO. 442, AS AMENDED, OTHERWISE KNOWN AS THE LABOR CODE OF THE PHILIPPINES, BY PROVIDING FOR RETIREMENT PAY TO QUALIFIED PRIVATE SECTOR EMPLOYEES IN THE ABSENCE OF ANY RETIREMENT PLAN IN THE ESTABLISHMENTArt. 287 of the Labor Code is hereby amended to read as follows: "Art. 287.Retirement. Any employee may be retired upon reaching the retirement age established in the collective bargaining agreement or other applicable employment contract.In case of retirement, the employee shall be entitled to receive such retirementbenefits as he may have earned under existing laws and any collective bargainingagreement and other agreements: Provided, however, That an employee's retirement benefits under any collective bargaining and other agreements shall not be less than those provided herein."In the absence of a retirement plan or agreement providing for retirement benef

its of employees in the establishment, an employee upon reaching the age of 60 years or more, but not beyond 65 years which is hereby declared the compulsory retirement age, who has served at least five (5) years in the said establishment,


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may retire and shall be entitled to retirement pay equivalent to at least one-half (1/2) month salary for every year of service, a fraction of at least six (6)months being considered as one whole year."Unless the parties provide for broader inclusions, the term one-half (1/2) month salary shall mean fifteen (15) days plus one-twelfth (1/12) of the 13th monthpay and the cash equivalent of not more than five (5) days of service incentiveleaves.

"Retail, service and agricultural establishments or operations employing not more than (10) employees or workers are exempted from the coverage of this provision. (December 9, 1992)

3. Exclusion of 13th Month Pay

a. REPUBLIC ACT NO. 7833: AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO RA NO. 6686 AND PD NO. 851, AS AMENDED, AND OTHER BENEFITS FROM THE COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF DETERMINING TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE SECTION 28(B)(8) OF THE NIRC, AS AMENDEDA new sub-paragraph to be known as sub-paragraph (F) is hereby inserted at the e

nd of Section 28(b)(8) of the National Internal Revenue Code, as amended, whichshall read as follows:"(F) 13th month pay and other benefits."(i) Benefits received by officials and employees of the national and local governments pursuant to Republic Act No. 6686;"(ii) Benefits received by employees pursuant to Presidential Decree No. 851,as amended by Presidential Memorandum Order No. 28 dated August 13, 1986 (requiring all employers to pay all their rank-and-file employees a 13th month pay notlater than December 24 of every year);(iii) Benefits received by officials and employees not covered by P.D. No. 851, as amended; and(iv) Other benefits such as productivity incentives and Christmas bonus in anamount not exceeding P12,000.00 which shall be integrated in the 13th month pay

solely for purposes of R.A. No. 7833.Provided, however, that the exclusion shall only apply to the first P30,000.00.

b. REVENUE REGULATIONS NO. 2-95: Implementing Republic Act No. 7833, An Act to Exclude the Benefits Mandated Pursuant to Republic Act No. 6686 andPresidential Decree No. 851, as Amended, and other Benefits from the Computation of Gross Compensation Income for the Purposes of Determining Taxable Compensation Income, Amending for the Purpose Section 28 (b) (8) of the National InternalRevenue Code, as Amended. (January 3, 1995)

Scope. Pursuant to Section 245 and 72 of the NIRC, as amended, in relation to Section 3 of Republic Act No. 7833, these Regulations are hereby promulgated to implement the provisions of Section 28 (b) (9) (6) of the NIRC, as amended, excluding from the computation of gross compensation income, for purposes of determining taxable compensation income, the 13th month pay and other benefits.

Definition of Terms. For purposes of these Regulations, the following definitions of words and phrases are hereby adopted:x x xb) "Exclusions" shall mean the total benefits which are not included in thecomputation of gross compensation income for purposes of determining taxable compensation income and are, therefore, exempt from the withholding tax on wages.c) "Gross compensation income" means all remunerations for services performed by an employee for his employer, whether paid in cash or in kind, unless specifically excluded under Secs. 27 and 28 of the NIRC, as amended.

x x xe) "Other benefits" refer to all benefits other than the 13th month pay, such as, the annual Christmas bonus given by private offices, 14th month pay, mid-


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year productivity incentive bonus, gifts in cash or in kind and other similar benefits received by an official or employee for one calendar year in an amount not exceeding Twelve Thousand Pesos (P12,000.00) as maximum limit.x x xg) "13th month pay" refers to the mandatory one month basic salary of an official or employee of the National Government, Local Government Units, agenciesand instrumentalities, including government-owned and -controlled corporations,

and of private offices received after the 12th month pay.x x xBenefits Exempted from Income Tax. For purposes of determining the taxable compensation income, the following benefits shall be excluded from the gross compensation income, viz:a) 13th month pay equivalent to the mandatory 1 mo. basic salary of officials and employees of the Government (whether national or local), including goccs,and of private offices received after the 12th month pay beginning CY 1994; andb) Other benefits, such as, Christmas bonus given by, private offices to their officials and employees, productivity incentives bonus, loyalty award, giftsin cash or in kind and other benefits of similar nature actually received by officials and employees of both Government and private offices in an amount not ex

ceeding P12,000.00 for 1 calendar year.The above-stated exclusions [(a) and (b)] shall cover benefits paid or accrued beginning January 1, 1994 but shall be limited only to an amount not exceeding P12,000.00 in the case of the "other benefits" contemplated under paragraph (b) above, provided, however, that when added to the 13th month pay, the total amountof tax exempt benefits shall not exceed P30,000.00.(for illustrations see the original revenue regulations)

Refund/Credit of Taxes Withheld from employees Separated from Employment. a) Anemployee separate from the service of his previous employer but is presently employed by another employer shall be refunded/credited the taxes withheld on his exempt 13th month pay and other benefits by his present employer.

(b) An employee who has been separated from a previous employer but has no present employment shall claim his refund of excess tax withheld on his 13th month pay and other benefits by filing with the BIR a refundable income tax return for CY 1994, provided that the refundable ITR for 1994 reflects the taxes withheld on his 13th month pay and other benefits.

Concurrent Multiple Employments. An employee is employed by two or more employers at the same time during the taxable year shall be refunded/credited the taxeswithheld on his 13th month pay and "other benefits" by his main employer, e.g.,the employer paying the highest wage/salary. The said main employer shall determine the maximum allowable 13th month pay and "other benefits" received from bothmain and secondary employer/s in annualizing the taxable compensation income atyear-end adjustment. For this purpose, the secondary employer/s shall furnish the main employer a certification as to the amount of the 13th month pay and other benefits received by the employee.x x xTransitory Provision. Employers who have already given the 13th month pay and "other benefits" to their employees and had withheld and remitted the tax due thereon prior to the approval of R.A. No. 7833 on December 8, 1994 shall, in annualizing and computing the annual income and the tax due from their employees, exclude the 13th month pay and "other benefits", which shall be limited only to an amount not exceeding P12,000.00 in the case of the "other benefits" contemplated under Sec. 3, par, (b) of these Regulations and provided, further, that when theamount of these said "other benefits" is added to the "13th month pay" contemplated under Sec. 3, par. (a) also of these Regulations, the total amount of tax ex

empt benefits shall not exceed P30,000.00.

c. REVENUE MEMORANDUM CIRCULAR NO. 36-94: Publishing the full text


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of Republic Act No. 7833 - an Act excluding the benefits mandated pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as amended, and other benefits from the computation of gross compensation income for purposes of determining taxable compensation income, amending for the purpose Section 28 (b) (8) of the National Internal Revenue Code, as amended. (December 14, 1994 )

SALIENT FEATURES of RA 7833

1. Before the amendment of Section 28 (b) (8) of the NIRC by R.A. No. 7833,the benefits received by officials and employees of both public (national and local) and private offices, viz:(F) 13th month pay and other benefits.a. Annual Christmas bonus equivalent to one (1) month basic salary and additional cash gift of One Thousand Pesos (P1,000.00) received by National and Local Government officials and employees starting CY 1988 in accordance with R.A. No. 6686;b. Benefits received by employees pursuant to P.D. No. 851 , as amended byPresidential Memorandum Order No. 28 dated August 13, 1986 requiring all employers to pay all their rank-and-file employees a 13th month pay not later than December 24 of every year;

c. Benefits received by officials and employees not covered by P.D. No. 851, as amended; andd. Other benefits such as productivity incentives and Christmas bonus in anamount not exceeding Twelve Thousand Pesos (P12,000.00) which shall be integrated in the 13th month pay solely for purposes of R.A. No. 7833.were taxable compensation income under Section 21(a) in relation to Section 72,both of the NIRC, as amended, subject to withholding tax under Revenue Regulations No. 6-82, as amended by Revenue Regulations No. 4-93.

2. Under sub-paragraph (F) of Section 28 (b) (8) of the NIRC, as amended byR.A. No. 7833, the 13th month pay and other benefits aforestated, received by officials and employees of the National Government, LGUs and agencies, includingGOCCs, as well as by officials and employees of private corporations and entitie

s, are exempt from income tax, and consequently from the withholding tax on wages. Provided, that the exclusions/exemptions from gross compensation income shallcover the 13th month pay and "other benefits" in the aggregate amount not exceeding P30,000 received by the officials and employees paid or accrued beginning January 1, 1994. (April 17, 1998).

d. REVENUE REGULATIONS No. 02-98

SECTION 2.78.1. Withholding of Income Tax on Compensation Income. x x x(B) Exemptions from withholding tax on compensation. The following income payments are exempted from the requirement of withholding tax on compensation:x x x(11) Thirteenth (13th ) month pay and other benefits. (a) Thirteenth (13th) month pay equivalent to the mandatory one (1) month basic salary of officials and employees of the government, (whether national or local), including government-owned or controlled corporations, and or private offices received after the twelfth (12th) month pay; and(b) Other benefits such as Christmas bonus, productivity incentive bonus, loyalty award, gifts in cash or in kind and other benefits of similar nature actually received by officials and employees of both government and private offices.The above stated exclusions (a) and (b) shall cover benefits paid or accrued during the year provided that the total amount shall not exceed thirty thousand pesos (P30,000.00) which may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after consider

ing, among others, the effect on the same of the inflation rate at the end of the taxable year.(see original for further info.)


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e. REPUBLIC ACT NO. 7459: Investors and Invention Incentives Act of the Philippines

Tax Incentives. Inventors, as certified by the Filipino Inventors Society and duly confirmed by the Screening Committee, shall be exempt from payment of licensefees, permit fees and other business taxes in the development of their particul

ar inventions. This is an exception to the taxing power of the local governmentunits. The certification shall state that the manufacture of the invention is made on a commercial scale. Inventors shall exempt from paying any fees involvedin their application for registration of their inventions.

Tax Exemption. To promote, encourage, develop and accelerate commercialization of technologies developed by local researchers or adapted locally from foreign sources including inventions, any income derived from these technologies shall beexempted from all kinds of taxes during the first ten (10) years from the date of the first sale, subject to the rules and regulations of the Department of Finance: Provided, that this tax exemption privilege pertaining to invention shall be extended to the legal heir or assignee upon the death of the inventor. The tec

hnologies, their manufacture or sale, shall also be exempt from payment of license, permit fees, customs duties and charges on imports. (Approved: April 28, 1992)

Inventor refers to, for purpose of this Act, any patented machine, product, process including implements or tools and other related gadgets of invention, utility model and industrial design patents.Investor refers to the patentee/s, heir/s, assignment/s, of an Invention letterspatent, Utility Model letters or Industrial Design letters patent.

B. Items of Gross IncomeSec. 32 (see Code)

1. Compensation for personal servicesa. In moneyb. In kind

i. Convenience of the employer rule

Henderson vs. Collector (1 SCRA 649)Facts: Arthur Henderson is the President of the American Intl. Underwriters forthe Phils. w/c represents a group of American cos. engaged in the business of general insurance (exc. in life insurance). he receives a basic annual salary ofP30,000 and allowance for house rentals and utilities. Although he and his wife are childless and are only two in the family, they lived in a large apartmentprovided for by his employer. As company president, he and his wife had to entertain and put up houseguests for the company. The BIR now seeks to collect taxes on the allowances for rental and utilities expenses.Held: The exigencies of Henderson's high executive position, not to mention social standing, demanded and compelled them to live in a more spacious and pretentious quarters like the ones they had occupied. Because they had to entertain and put up houseguests, the employer had to grant him allowances for rental and utilities in addition to his annual basic salary to take care of those expenses for rental and utilities in excess of their personal needs. Hence, the fact thatthe taxpayers had to live or did not have to live in the apartment chosen by the employer is of no moment, for no part of the allowance redounded to the benefit of the Hendersons. Neither was there an amount retained by them. Their billsfor rental were paid directly by the employer to the creditor.

ii.a. REVENUE REGULATIONS NO. 02-98

(A) Compensation Income Defined. In general, the term "compensation" means a


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ll remuneration for services performed by an employee for his employer under anemployer-employee relationship, unless specifically excluded by the Code.The name by which the remuneration for services is designated is immaterial. Thus, salaries, wages, emoluments and honoraria, allowances, commissions (e.g. transportation, representation, entertainment and the like); fees including director's fees, if the director is, at the same time, an employee of the employer/corporation; taxable bonuses and fringe benefits except those which are subject to th

e fringe benefits tax under Sec. 33 of the Code; taxable pensions and retirementpay; and other income of a similar nature constitute compensation income.The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensation. Thus, it may be paid on the basisof piece-work, or a percentage of profits; and may be paid hourly, daily, weekly, monthly or annually.Remuneration for services constitutes compensation even if the relationship of employer and employee does not exist any longer at the time when payment is madebetween the person in whose employ the services had been performed and the individual who performed them.

(1) Compensation paid in kind. Compensation may be paid in money or in some

medium other than money, as for example, stocks, bonds or other forms of property. If services are paid for in a medium other than money, the fair market valueof the thing taken in payment is the amount to be included as compensation subject to withholding. If the services are rendered at a stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the fair market value of the remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the employee, the amount of such remuneration is the fair market value of the stock at the time theservices were rendered.(2) Living quarters or meals. If a person receives a salary as remunerationfor services rendered, and in addition thereto, living quarters or meals are provided, the value to such person of the quarters and meals so furnished shall beadded to the remuneration paid for the purpose of determining the amount of comp

ensation subject to withholding. However, if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as part of compensation income.(3) Facilities and privileges of a relatively small value. Ordinarily, facilities and privileges (such as entertainment, medical services, or so called "courtesy" discounts on purchases), furnished or offered by an employer to his employees generally, are not considered as compensation subject to withholding if such facilities or privileges are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees.Where compensation is paid in property other than money, the employer shall makenecessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the Commissioner.(4) Tips and gratuities. Tips or gratuities paid directly to an employee bya customer of the employer which are not accounted for by the employee to the employer are considered as taxable income but not subject to withholding.(5) Pensions, retirement and separation pay. Pensions, retirement and separation pay constitute compensation subject to withholding, except those provided under Subsection B of this section.(6) Fixed or variable transportation, representation and other allowances (a) IN GENERAL, fixed or variable transportation, representation and other allowances which are received by a public officer or employee or officer or employee of a private entity, in addition to the regular compensation fixed for his position or office, is compensation subject to withholding.(b) Any amount paid specifically, either as advances or reimbursements for t

ravelling, representation and other bonafide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are not compensation subject to withholding, if the following condi


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tions are satisfied:(i) It is for ordinary and necessary travelling and representation or entertainment expenses paid or incurred by the employee in the pursuit of the trade, business or profession; and(ii) The employee is required to account/liquidate for the foregoing expensesin accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses ove

r advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/ advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid toan employee while he is on an assignment or duty need not be subject to the requirement of substantiation and to withholding.(7) Vacation and sick leave allowances. Amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus,the salary of an employee on vacation or on sick leave, which are paid notwithstanding his absence from work, constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which were paid to the employee during the year are not subject to income tax and to the withholding tax.

(8) Deductions made by employer from compensation of employee.Any amount which is required by law to be deducted by the employer from the compensation of a

n employee including the withheld tax is considered as part of the employee's compensation and is deemed to be paid to the employee as compensation at the timethe deduction is made.(9) Remuneration for services as employee of a nonresident alien individualor foreign entity. The term "compensation" includes remuneration for services performed by an employee of a nonresident alien individual, foreign partnership orforeign corporation, whether or not such alien individual or foreign entity isengaged in trade or business within the Philippines. Any person paying compensation on behalf of a non-resident alien individual, foreign partnership, or foreign corporation which is not engaged in trade or business within the Philippines is subject to all provisions of law and regulations applicable to an employer.

(10) Compensation for services performed outside the Philippines. Remuneration for services performed outside the Philippines by a resident citizen for a domestic or a resident foreign corporation or partnership, or for a non-resident corporation or partnership, or for a non-resident individual not engaged in tradeor business in the Philippines shall be treated as compensation which is subjectto tax.A non-resident citizen as defined in these regulations is taxable only on incomederived from sources within the Philippines. In general, the situs of the income whether within or without the Philippines, is determined by the place where the service is rendered.

ii.b. REVENUE REGULATION NO. 03-98: Implementing Section 33 of the National Internal Revenue Code, as Amended by Republic Act No. 8424 Relative to the Special Treatment of Fringe Benefits (January 1, 1998)

SPECIAL TREATMENT OF FRINGE BENEFITSImposition of Fringe Benefits Tax A final withholding tax is hereby imposed on the grossed-up monetary value of fringe benefit furnished, granted or paid by theemployer to the employee, except rank and file employees as defined in these Regulations, whether such employer is an individual, professional partnership or acorporation, regardless of whether the corporation is taxable or not, or the government and its instrumentalities except when: (1) the fringe benefit is required by the nature of or necessary to the trade, business or profession of the employer; or (2) when the fringe benefit is for the convenience or advantage of theemployer. The fringe benefit tax shall be imposed at the

following rates: Effective 1/1/1998 - 34%; 1/ 1/1999 - 33%; 1/1/2000 - 32%.

Definition of Fringe Benefit In general, except as otherwise provided under thes


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e regulations, for purposes of this Section, the term "FRINGE BENEFIT" means anygood, service, or other benefit furnished or granted by an employer in cash orin kind, in addition to basic salaries, to an individual employee (except rank and file employee as defined in these regulations) such as, but not limited to the following:(1) Housing;(2) Expense account;

(3) Vehicle of any kind;(4) Household personnel, such as maid, driver and others;(5) Interest on loan at less than market rate to the extent of the difference between the market rate and actual rate granted;(6) Membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations;(7) Expenses for foreign travel;(8) Holiday and vacation expenses;(9) Educational assistance to the employee or his dependents; and(10) Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.

CoverageThese Regulations shall cover only those fringe benefits given or furnished to managerial or supervisory employees and not to the rank and file.

The term, "RANK AND FILE EMPLOYEES" means all employees who are holding neithermanagerial nor supervisory position. The Labor Code of the Philippines, as amended, defines "managerial employee" as one who is vested with powers or prerogatives to lay down and execute management policies and/or to hire, transfer, suspend, lay-off, recall, discharge, assign or discipline employees. "Supervisory employees" are those who, in the interest of the employer, effectively recommend suchmanagerial actions if the exercise of such authority is not merely routinary orclerical in nature but requires the use of independent judgment.Moreover, these regulations do not cover those benefits properly forming part ofcompensation income subject to withholding tax on compensation in accordance wi

th Revenue Regulations No. 2-98.Fringe benefits which have been paid prior to January 1, 1998 shall not be covered by these Regulations.The grossed-up monetary value of the fringe benefit shall be determined by dividing the monetary value of the fringe benefit by the following percentages and inaccordance with the following schedule: Effective 1/1/1998 - 66%; 1/ 1/ 1999 -67%; 1/ 1/2000 - 68%.The grossed-up monetary value of the fringe benefit represents the whole amountof income realized by the employee which includes the net amount of money or netmonetary value of property which has been received plus the amount of fringe benefit tax thereon otherwise due from the employee but paid by the employer for and in behalf of his employee, pursuant to the provisions of this Section.

Determination of the Amount Subject to the Fringe Benefit Tax In general, the computation of the fringe benefits tax would entail (a) valuation of the benefit granted and (b) determination of the proportion or percentage of the benefit which is subject to the fringe benefit tax. That the Tax Code allows for the cases where only a portion (i.e. less than 100 per cent) of the fringe benefit is subject to the fringe benefit tax is clearly stated in Section 33 (a) of R.A. 8424 which stipulates that fringe benefits which are "required by the nature of, or necessary to the trade, business or profession of the employer, or when the fringebenefit is for the convenience or advantage of the employer" are not subject tothe fringe benefit tax. Thus, in cases where the fringe benefits entail joint benefits to the employer and employee, the portion which shall be subject to the fringe benefits tax and the guidelines for the valuation of fringe benefits are d

efined under these rules and regulations.

Unless otherwise provided in these regulations, the valuation of fringe benefits


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shall be as follows:(1) If the fringe benefit is granted in money, or is directly paid for by the employer, then the value is the amount granted or paid for.(2) If the fringe benefit is granted or furnished by the employer in property other than money and ownership is transferred to the employee, then the valueof the fringe benefit shall be equal to the fair market value of the property asdetermined in accordance with Sec. 6 (E) of the Code (Authority of the Commissi

oner to Prescribe Real Property Values).(3) If the fringe benefit is granted or furnished by the employer in property other than money but ownership is not transferred to the employee, the value of the fringe benefit is equal to the depreciation value of the property.Taxation of fringe benefit received by a non-resident alien individual who is not engaged in trade or business in the Philippines A fringe benefit tax of twenty-five percent (25%) shall be imposed on the grossed-up monetary value of the fringe benefit. The said tax base shall be computed by dividing the monetary valueof the fringe benefit by seventy-five per cent (75%).

Taxation of fringe benefit received by (1) an alien individual employed by regional or area headquarters of a multinational company or by regional operating hea

dquarters of a multinational company; (2) an alien individual employed by an offshore banking unit of a foreign bank established in the Philippines; (3) an alien individual employed by a foreign service contractor or by a foreign service subcontractor engaged in petroleum operations in the Philippines; and (4) any of their Filipino individual employees who are employed and occupying the same position as those occupied or held by the alien employees. A fringe benefit tax of fifteen per cent (15%) shall be imposed on the grossed-up monetary value of the fringe benefit. The said tax base shall be computed by dividing the monetary valueof the fringe benefit by eighty-five per cent (85%).

Taxation of fringe benefit received by employees in special economic zones Fringe benefits received by employees in special economic zones, including Clark Special Economic Zone and Subic Special Economic and Free Trade Zone, are also cover

ed by these regulations and subject to the normal rate of fringe benefit tax orthe special rates of 25% or 15% as provided above.(For further info. see the original RR 03-98)

C. Interest Income1. Taxable2. Not Taxable3. Imputed interest on the inter-company loans/advances

a. Sec. 50 (see Code)b. REVENUE MEMORANDUM ORDER NO. 63-99: Determination of Ta

xable Income on Inter-Company Loans or Advances applying Sec. 50 of the NIRC, asamended

Coverage: This paper applies to all forms of bona fide indebtedness and includes:1. Loans or advances of money or other consideration (w/n evidenced by a written instrmt);2. Indebtedness arising in the ordinary course of business out of sales, leases, or the rendition of services by or between members of the group,, or any othersimilar transaction;3. But does not apply to alleged indebtedness w/c was in fact a contribution ofcapital or a distribution by a corporation w/ respect to its shares.

This order adopts the arm's length distribution by a corporation w/ respect to its shares.

The shall be the rate of interest w/c was charged or would have been charged atthe time the indebtedness arose in independent transaction w/ or between relatedunrelated parties under similar circumstances. All relevant factors will be co


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nsidered, incl. the amount and duration of the loan, the security involved, thecredit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans. For domestic transactions, the standard of interest rate is the Bank Reference Rate prescribed by the Central Bank.

Sec. 50 applies to both taxable entities and tax exempt organizations.

D. Income under Lease AgreementsSec. 49, Revenue Regulations No. 2 (see RR No. 2)

1. Rent2. Obligations of lessor to 3rd parties assumed and paid by lessee3. Advance rental4. Leasehold improvements

PART 5PART 6

C. INTEREST

1. INTEREST DEDUCTIBLE FROM GROSS INCOME (Sec 34. B, NIRC)-The amount of interest paid or incurred within a taxable year on indebte

dness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income

Provided, that the taxpayer's otherwise allowable deduction forinterest expense shall be REDUCED by an amount equal to the following percentages of interest income subject to final tax:

41% beginning January 1, 199839% beginning January 1, 199938% beginning January 1, 2000

2. INTEREST NOT DEDUCTIBLE

No deduction is allowed in respect of interest under the following:

a. ADVANCE INTEREST - if within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwiseProvided, that such interest shall be allowed as a deduction in the year the indebtedness is paid.Provided furhter, that if the indebtedness is payable in periodic amortizationsthe amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as a deduction in such taxable year.

**under this provision, the phrase "within the taxable year" assumes a modifiedmeaning. For example, a taxpayer using the cash basis method of accounting borrows money in which interest is paid in advance through discount. He obtains a loan of P1,000,000 in October 1998 subject to 20% interest; hence, after paying the advance interest of P200,000 he receives only P 800,000.00 Can the borrower/taxpayer claim the deduction when he files his ITR in April 1999?

It depends on w/n the principal obligation had been paid.ii. if the entire principal obligation had been paid, then the entire amount ofinterest can be claimed as itemized deductioniii. if only 1/2 of the obligation has been paid, only 1/2 interest can be claimed as itemized deduction;iv. if no payment had been paid on the principal obligation, the advance interest paid cannot be claimed as deduction on the year that it was paid.

b. PERSONS UNDER 36b - if both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under section 36B, namely:i. between members of a family


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ii. between an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; andiii. between two corporations more than 50% in value of the outstanding stock ofeach of which is owned, directly or indirectly, by or for the same individual;iv. between the grantor and a fiduciary of any trust; orv. between the fiduciary of a trust and the fiduciary of another trust if the sa

me person is a grantor with respect to each trustvi. between a fiduciary or a trust and a beneficiary

c. PETROLEUM OPERATION - if the indebtedness is incurred to finance petroleum operation.

3. PREPAID INTEREST OF INDIVIDUAL ON CASH METHOD OF ACCOUNTING

COMM. V. VDA DE PRIETO (L-13912, Sept. 30, 1960, 109 Phils 592)The respondents, V.E. Lednicky and Maria Valero Lednicky, are husband and wife,both American citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years in question. In compliance

with Phil tax law, they filed their income tax return for 1955 and 1956. In 1956, they filed an amended income tax return claiming a tax deduction for federalincome taxes which they paid to the United States in the year 1955. In 1959, they likewise claimed a similar tax deduction for the 1956 return. Comm of IR failed to answer the claim for refund, thus they filed a petition with the Tax Court.Issue: whether a US citizen residing in the Philippines who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the US government for the taxable yearon the strength of sec 30 (c-1) of the Phil Internal Revenue Code?5SC:1. The wording of Sec 30 shows the code's intent that the right to deduct incometaxes paid to foreign government from the taxpayer's gross income is given only

as an ALTERNATIVE to his right to claim a tax credit for such foreign income taxes under Sec 30 so that unless the alien resident has a right to claim such taxcredit if he so chooses, he is precluded from deducting the foreign income taxes from his gross income. The law provides that the deduction shall be allowed if the taxpayer in his return does not signify his desire to have the benefits oftax credits for taxes paid to foreign countries. Thus, the statutes assumes that the taxpayer in question may also signify his desire to claim a tax credit and waive the deduction.2. No double credit (i.e, for claiming twice the benefits of his payment of foreign taxes, by deduction from gross income and by tax credit) exists here. Thisdanger cannot exist if the taxpayer cannot claim benefit under either of theseheadings at his option, so that he must be entitled to a tax credit (respondenthere are NOT entitled to tax credit because all their income is derived from Phil sources), or the option to deduct from gross income disappears altogether.3. No double taxation exists. Double taxation become obnoxious only when the taxpayer is taxed twice for the benefit of the same governmental entity. In the present case, although the taxpayer would have to pay two taxes on the same income but the Philippine government only receives the proceeds of one tax, there isno obnoxious double taxation.

D. TAXES(Sec. 34, C, NIRC, Sec. 80-82, RR-2)

1. DEDUCTIBLE FROM GROSS INCOME

GENERAL RULE: Taxes paid or incurred within the taxable year in connection withthe taxpayer's profession, trade or business, shall be allowed as deduction.


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** Import duties paid to the proper customs officers and business, occupation,license, privilege, excise and stamp taxes and any other taxes of every name ornature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes proper and no deduction shall be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are deductible as such only by the person upon w

hom they are imposed. Thus the merchants sales tax imposed by law upon sales isnot deductible by the individual purchasers even though the tax may be billed to him as a separate item.

EXCEPTIONS:a. Income taxb. Income taxes imposed by authority of any foreign country (but this deductionshall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of tax credits paid to foreign countries)c. Estate and donor's taxesd. Taxes assessed against local benefits of a kind tending to increase the value

of the property assessed.

Provided, that the taxes allowed under this subsection, when refunded or credited shall be included as part of gross income in the year of receipt to the extentof the income tax benefit of said deduction.

Others (under Sec 80-82, RR2):e. Taxes paid by a nonresident alien individual and a foreign corporation - taxes are deductible only if and to the extent that the taxes for which deduction isclaimed are connected with income from sources within the Philippines;f. Income tax imposed by the Philippine government - the law does not allow thededuction of the income tax paid to or accrued in favor of the government and inno case may the taxpayer avail of such deduction;

g. income, war profits, and excess profits taxes imposed by the authority of a foreign country - allowed as deductions only if the taxpayer does not signify inhis return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the caseof a citizen of a foreign country residing in the Philippines whose income fromsources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.

** In computing the net income of an individual, no deduction is allowed for the tax is imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corps w/o reimbursements from the taxpayer. The amountso paid should not be included in the income of the shareholder.** In case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct such payment from gross income onany ground.

3. TAX CREDITS vs. TAX DEDUCTIONS

CIR vs. LEDNICKY Gr l-18169, July 31, 1964)

4. FINES AND PENALTIES

GUTIERREZ vs. COLLECTOR 14 SCRA 33

E. LOSSES (Sec. 93-101, RR-2)


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1. KINDS OF TAXPAYERS AND THEIR LOSSESa. INDIVIDUALS - losses sustained by individuals during the year not compensatedfor by insurance or otherwise are FULLY deductible (except by nonresident aliens):-a.1. If incurred in a taxpayer's trade ora.2. if incurred in any transaction entered into for profit; ora.3. of property not connected with the trade or business if arising from fires

, storm, shipwreck, or other casualty, or from robbery, theft or embezzlement.No loss shall, however, be allowed as a deduction if at the time of filing of the return, such loss has been claimed as deduction for estate or inheritance taxpurposes in the estate or inheritance tax return.b. CORPORATIONS - Domestic corporations may deduct losses actually sustained andcharged off w/i the year and not compensated for by insurance or otherwise.c. NONRESIDENT ALIENS and FOREIGN CORPORATIONS - are only allowed:c.1. losses sustained in business or trade conducted within the Philippinesc.2. losses of property within the Philippines arising from fires, storms, shipwrecks, or other casualty and from robbery, theft or embezzlement, andc.3. losses actually sustained in transactions entered into for profit in the Philippines, although not connected with their trade or business, not compensated

by insurance or otherwise.

***LOSSES IN GENERAL (SEC 34 d, NIRC, Sec. 96, RR2): must be:a. actually sustained during the taxable yearb. not compensated for by insurance or other forms of indemnityc. if incurred in trade, profession or business; or of property connected with trade, business or profession, if the loss arises from fires, storms, shipwreck,or other casualties, or from robbery, theft or embezzlement.d. evidenced by closed and completed transactions- proper adjustment must be made in each case for expenditures or itmes of lossproperly chargeable to capital account, and for depreciation, obsolescence, amortization or depletion.- The amount of loss must be reduced by the amount of any insurance or other com

pensation involved, and by the salvage value, if any of the property- A loss on the sale of residential property is NOT deductible unless the property was purchased or constructed by the taxpayer with a view to its subsequent sale for pecuniary profit- No loss is sustained by the transfer or property by gift or death- Loss sustained in illegal transactions are not deductible

2. COMPLETED TRANSACTIONS

FERNANDEZ HERMANOS vs. CIR 29 SCRA 552

3. SPECIAL RULES ON LOSSES

A. VOLUNTARY REMOVAL OF BUILDINGS (Sec. 97. RR-2)Loss due to the voluntary removal or demolition of old buildings, the scrappingof old machinery, equipment, etc. incident to renewals and placements will be deductible from gross income. When a taxpayer buys real estate upon which is located a building, w/c he proceeds to raze with a view to erecting thereon anotherbuilding, it will be considered that the taxpayer has sustained no deductible expense on account of the cost of such removal, the value of the real estate, exclusive of old improvements, being presumably equal to the purchase price of the land and building plus the cost of removing the useless building.

B. LOSS OF USEFUL VALUE OF ASSETS (Sec. 98, RR-2)When, through some change in business conditions, the usefulness in the busi

ness of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use insuch business, hey may claim as deduction, the actual loss sustained.


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In determining the amount of the loss, adjustment must be made for improvements, depreciation, the salvage value of the property. This exception to therule requiring a sale or other disposition of property in order to establish aloss requires proof of some unforseen cause by reason of which the property hasbeen prematurely discarded, as for example,1. where any increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is excl

usively devoted, or2. where legislation directly or indirectly makes the continued profitable use of the property impossible.This exception DOES NOT APPLY:1. to a case where the useful life of property terminates solely as a result ofthose gradual process for which depreciation allowance are authorized.2. To inventories other than capital assetsThis exception APPLIES to buildings only when they are permanently abandoned orpermanently devoted to a radically different use, and to machinery only when itsuse as such is permanently abandoned.

C. SHRINKAGE IN VALUE OF STOCKS (Sec. 99, RR-2)

A person possessing stock of a corporation cannot subtract from gross income anyamount claimed as a loss merely on account of shrinkage in value of a stock through fluctuation of the market or otherwise. The loss allowable in such case isthat wholly suffered when the stock is disposed of. If stock of a corporationbecomes worthless, its cost or other basis determined in accordance with these regulations may be deducted by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing of its worthlessness is made, as in the case of bad debts.

4.WAGERING LOSSES - allowed only to the extent of the gains from such transactions.

5. SUBSTANTATION OF LOSSES (Rev Reg 12-77)

6. FOREIGN EXCHANGE LOSSESa. BIR Ruling 144-85, August 26, 1985Issue: w/n foreign exchange losses which have accrued by reason of devaluationare deductible for income tax purposes?Ruling: foreign exchange losses which have accrued by reason of devaluation butwhere remittances have not yet been made are not deductible for income tax purposes.- the annual decrease in the value of property is not normally allowable as a loss. To be allowable, the loss must be realized- when foreign currency acquired in connection with a transaction in the regularcourse of business is disposed of, ordinary gain or loss results from the fluctuations. The loss is deductible only for the year it is actually sustained. Itis sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. A closed transaction is a taxable event which has been consummated. No taxable event has as yet been consummated prior to the remittance of the scheduledamortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis--vis the foreign currency, e.g., US Dollar, but which remittance of scheduled amortization consisting of principal and interests payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes.

b. Rev. Memo Circ 26-85, July 15, 1985, Interbank guiding rate- Beginning Jan 1, 1985, the conversion rate to be applied shall be the prevaili

ng interbank reference rate for the day of the transaction.- In the event that the foreign exchange rate as stated in the above paragraph (a) is impractical or not feasible, the average interbank reference during the ye


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ar shall apply.- For the purpose of converting the tax liability in US dollar to Philippine peso, the prevailing interbank rate at the time of payment shall be applied when paid before the due date of the tax or the prevailing interbank reference rate atthe due date of tax when paid on or after the due date of the tax.- When currency involved is other than US Dollar, the foreign currency shall first be converted to US dollar at the prevailing exchanges rate between the two cu

rrencies.- This circular does not apply to transaction covered by RMC 30-84 dated October19, 1984, regarding the imposition of additional 1% gross receipt tax on buyingand selling of foreign exchange of peso by bank, non-bank financial intermediaries and other authorized foreign exchange dealers or agents and RMC 32-854 datedNov 7, 1984, in determining (for income tax purposes) the cost basis of certaincommodities imported beginning Jan 1, 1984, the value and prices thereof are quoted in the foreign currency.

7. ABANDONMENT LOSSESA. If a contract area where petroleum operations are undertaken is partially orwholly abandoned, ALL accumulated exploration and development expenditures perta

ining thereto shall be allowed as a deduction: Provided, that accumulated expenditures incurred in that area prior to Jan 1, 1979 shall be allowed as a deduction only form any income derived from the same contract area. In all cases, notices of abandonment shall be filed with the Commissioner.B. If a producing well is subsequently abandoned, the unamortized costs and theundepreciated costs of equipment directly used therein, shall be allowed as a deduction in the year such well, equipment or facility is abandoned by the contractor: Provided, that if such abandoned well is registered and production is resumed, or if such equipment or facility is restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall be amortized or depreciated, as the case may be.

8. NET OPERATING LOSS CARRY-OVER:

A. THREE YEAR PERIOD: The net operating loss of the business or enterprise forany taxable year immediately preceding the current taxable year, which had notbeen previously offset as deduction from gross income shall be carried over as adeduction from gross income for the next three consecutive taxable years immediately following the year of such loss.Provided, that any net loss incurred in a taxable year during which the taxpayerwas exempt from income tax shall not be allowed as a deduction under this subsection.B. NO SUBSTANTIAL CHANGE IN OWNERSHIP (75% rule)Provided, further, that a net operating loss carry-over shall be allowed only ifthere has been no substantial change in the ownership of the business or enterprise in that --i. not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; orii. not less than 75% of the paid up capital of the corporation, if the businessis in the name of a corporation, is held by or on behalf of the same persons.** "net operating loss" = excess of allowable deduction over gross income of thebusiness in a taxable year

Fernandez v CIRFERNANDEZ HERMANOS, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.Facts: Fernandez Hermanos, Inc., is a domestic-corporation organized for the principal purpose of engaging in business as an "investment company". The CIR disa

llowed the following deductions (most were sustained by the CTA):1. losses in Mati Lumber Co. in 19502. losses or bad debts in Palawan Manganese Mines, I.nc. in 1951


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3. losses in Balamban Coal Mines in 1950 and 19514. losses in Hacienda Dalupiri and Hacienda Samal from 1950-1954Held: The Supreme Court discussed the allowance or disallowance of each in thefollowing manner:

1. Allowed. These losses represent the shares of stock (worth P8,050) pet. acquired from Mati Lumber Co. in Jan. 1, 1948. The pet. was correct in writing off and claiming as a deduction in 1950 the amount on the ground that the lumb

er company had ceased operations and became insolvent in that year. The CIR wasincorrect in arguing that since the company still owned a sawmill and some equipment, the shares of stock still had value. The proper assessment would be to treat as income for the year the proceeds the pet. would get from the liquidation of those assets.

2. Disallowed. These losses represent part of the loans extended by thepet. to its 100% owned subsidiary. Pet. advanced financial assistance to PalawanManganese Mines, Inc. from 1945 to 1952. By way of payment, Palawan was to givepet. 15% of its net profits. Whether Palawan was able to pay the loans or not because it continued to operate at a loss is immaterial. Pet. cannot properly claim as a loss the advances given to Palawan in 1951 for that year. There can be no partial writing off as a loss or bad debt under the Tax Code. Those losses or

bad debts ascertained within the taxable year are deductible in full or not at all. Pet. continued to give Palawan advances even beyond 1951. It was only in 1956 when Palawan decided to cease operations.

3. Disallowed. These losses represent sums spent by the pet. for the operation of its Balamban coal mines in 1950 and 1951. The pet. should have treatedthem as losses in 1952 when the mines were abandoned, and not in 1950 and 1951on the ground that the mines made no sales of coal during those years.

4. Allowed. These losses represent sums spent by the pet. for the operation of the 2 Haciendas. The amounts were properly reported as deductions for thecorrect years. The only reason why the CIR disallowed them was on the ground that the farms were operated solely for pleasure or as a hobby and not for profit.But the Supreme Court is not convinced, and being for business, the pet. may properly deduct the same. (no factual details were mentioned to explain why)

Gutierrez vs CIRThe late LINO GUTIERREZ substituted by ANDREA C. VDA. DE GUTIERREZ, ANTONIO D. GUTIERREZ, GUILLERMO D. GUTIERREZ, SANTIAGO D. GUTIERREZ and TOMAS D. GUTIERREZ,petitioners, vs. COLLECTOR OF INTERNAL REVENUE, respondent.Facts: Lino Gutierrez was primarily engaged in the business of leasing real property for which he paid real estate broker's privilege tax. He filed his income tax returns for the years 1951, 1952, 1953 and 1954.

He claimed as deductions, among others the ff: transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission tickets to operas, the cost of furniture given as commission, expenses incurred in attending the National Convention of Filipino Businessmen, luncheon meeting and cruise to Corregidor of the Homeowners' Association, car expenses, salary of his driver and car depreciation, ordinary repairs for the maintenance ofrental apartments, litigation expenses to collect apartment rentals, fines and penalties for late payment of taxes, and contributions to an indigent family andvarious individuals.

On July 10, 1956 the Commissioner (formerly Collector) of Internal Revenue assessed against Gutierrez the following deficiency income tax:

1951(P1,400.00),1952(672.00),1953(5,161.00),1954(4,608.00) or a Total ofP11,841.00.Held: To be deductible, an expense must be (1) ordinary and necessary; (2) paid or incurred within the taxable year; and, (3) paid or incurred in carrying ona trade or business.

The transportation expenses which petitioner incurred to attend the funeral of his friends and the cost of admission tickets to operas were expenses relative to his personal and social activities rather than to his business of leasin


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g real estate, thus not deductible.According to the evidence, the taxpayer's car was utilized both for perso

nal and business needs. We therefore find it reasonable to allow as deduction one-half of the driver's salary, car expenses and depreciation.

The electrical supplies, paint, lumber, plumbing, cement, tiles, gravel,masonry and labor used to repair the taxpayer's rental apartments, did not increase the value of such apartments, or prolong their life. They merely kept the ap

artments in an ordinary operating condition. Hence, the expenses incurred therefore are deductible as necessary expenditures for the maintenance of the taxpayer's business.

Similarly, the litigation expenses defrayed by Gutierrez to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expensesin pursuing his business. It is routinary and necessary for one in the leasingbusiness to collect rentals and to eject tenants who refuse to pay their accounts.

Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30 of the Tax Code allows taxes to bededucted from gross income, it does not specifically allow fines and penaltiesto be so deducted.

As regards the alms to an indigent family and various individuals, contributions to Lydia Yamson and G. Trinidad and a donation consisting of officers' jewels and aprons to Biak-na-Bato Lodge No. 7, the same are not deductible from gross income inasmuch as their recipients have hot been shown to be among those specified by law. Contributions are deductible when given to the Government of the Philippines, or any of its political subdivisions for exclusively public purposes, to domestic corporations or associations organized and operated exclusivelyfor religious, charitable, scientific, athletic, cultural or educational purposes, or for the rehabilitation of veterans, or to societies for the prevention ofcruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual.PART 7

PART 8Calasanz vs. CIRPetitioners assail their liabilities as "real estate dealers" and seek t

o bring the profits from the sale of the lots under Section 34 [b] [2] 3 of theTax Code.

The theory advanced by the petitioners is that inherited land is a capital asset within the meaning of Section 34[a] [1] of the Tax Code and that an heir who liquidated his inheritance cannot be said to have engaged in the real estate business and may not be denied the preferential tax treatment given to gainsfrom sale of capital assets, merely because he disposed of it in the only possible and advantageous way.

Petitioners averred that the tract of land subject of the controversy was sold because of their intention to effect a liquidation. They claimed that itwas parcelled out into smaller lots because its size proved difficult, if not impossible, of disposition in one single transaction. They pointed out that once subdivided, certainly, the lots cannot be sold in one isolated transaction, Petitioners, however, admitted that roads and other improvements were introduced to facilitate its sale.

On the other hand, respondent Commissioner maintained that the imposition of the taxes in question is in accordance with law since petitioners are deemed to be in the real estate business for having been involved in a series of realestate transactions pursued for profit. Respondent argued that property acquired by inheritance may be converted from an investment property to a business property if, as in the present case, it was subdivided, improved, and subsequently sold and the number, continuity and frequency of the sales were such as to consti

tute "doing business." Respondent likewise contended that inherited property isby itself neutral and the fact that the ultimate purpose is to liquidate is of no moment for the important inquiry is what the taxpayer did with the property. R


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espondent concluded that since the lots are ordinary assets, the profits realized therefrom are ordinary gains, hence taxable in full.

We agree with the respondent.The assets of a taxpayer are classified for income tax purposes into ord

inary assets and capital assets. Section 34]a] [1] of the National Internal Revenue Code broadly defines capital assets as follows:"[1] Capital assets. - The term 'capital assets' means property held by the t

axpayer [whether or not connected with his trade or business], but does not include, stock in trade of the taxpayer or other property of a kind which would properly be included, in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customersin the ordinary course of his trade or business, or property used in the tradeor business of a character which is subject to the allowance for depreciation provided in subsection [f] of section thirty; or real property used in the trade or business of the taxpayer."

The statutory definition of capital assets is negative in nature. If theasset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain

depending on the kind of asset involved in the transaction.However, there is no rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer was held primarily forsale to customers in the ordinary course of his trade or business or whether itwas sold as a capital asset.

Although several factors or indices have been recognized as helpful guides in making a determination, none of these is decisive; neither is the presencenor the absence of these factors conclusive. Each case must in the last analysis rest upon its own peculiar facts and circumstances.

Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of the factors indubitably tendto show that the activity was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capi

tal gain or loss even though the property has to be subdivided or improved or both to make it salable. However, if the inherited property is substantially improved or very actively sold or both it may be treated as held primarily for sale to customers in the ordinary course of the heir's business.

Upon an examination of the facts on record, We are convinced that the activities of petitioners are indistinguishable from those invariably employed byone engaged in the business of selling real estate.

One strong factor against petitioners' contention is the business element of development which is very much in evidence. Petitioners did not sell the land in the condition in which they acquired it. While the land was originally devoted to rice and fruit trees, it was subdivided into small lots and in the process converted into a residential subdivision and given the name Don Mariano Subdivision. Extensive improvements like the laying out of streets, construction of concrete gutters and installation of lighting system and drainage facilities, among others, were undertaken to enhance the value of the lots and make them more attractive to prospective buyers. The audited financial statements submitted together with the tax return in question disclosed that a considerable amount was expended to cover the cost of improvements. As a matter of fact, the estimated improvements of the lots sold reached P170,028.60 whereas the cost of the land is only P4,742.66. There is authority that a property ceases to be a capital asset if the amount expended to improve it is double its original cost, for the extensive improvement indicates that the seller held the property primarily for sale tocustomers in the ordinary course of his business.

Another distinctive feature of the real estate business discernible fromthe records is the existence of contracts receivables, which stood at P395,693.

35 as of the year ended December 31, 1957. The sizable amount of receivables incomparison with the sales volume of P446,407.00 during the same period signifiesthat the lots were sold on installment basis and suggests the number, continuit


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y and frequency of the sales. Also of significance is the circumstance that thelots were advertised for sale to the public and that sales and collection commissions were paid out during the period in question. Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.

In Ehrman vs. Commissioner, the American court in clear and categoricalterms rejected the liquidation test in determining whether or not a taxpayer iscarrying on a trade or business. The court observed that the fact that property

is sold for purposes of liquidation does not foreclose a determination that a "trade or business" is being conducted by the seller. The court enunciated further:"We fail to see that the reasons behind a person's entering into a business - whether it is to make money or whether it is to liquidate - should be determinative of the question of whether or not the gains resulting from the sales are ordinary gains or capital gains. The sole question is - were the taxpayers in the business of subdividing real estate? If they were, then it seems indisputable thatthe property sold falls within the exception in the definition of capital assets. that is, that it constituted `property held by the taxpayer primarily for sale to customers in the ord

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