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Kinds of taxpayers

a) Individual taxpayers (Sec 24 Tax Code)


(i) Citizens
(a) Resident citizens
(b) Non-resident citizens
(ii) Aliens
(a) Resident aliens
(b) Non-resident aliens (Sec 25 Tax Code)
(1) Engaged in trade or business
(2) Not engaged in trade or business
(iii) Special class of individual employees
(a) Minimum wage earner

b) Corporations (Sec 27 Tax Code)


(i) Domestic corporations
(ii) Foreign corporations
(a) Resident foreign corporations
(b) Non-resident foreign corporations
(iii) Joint venture and consortium

c) Partnerships
d) General professional partnerships (Sec 26 Tax Code)
e) Estates and trusts (Sec 60 Tax Code)
f) Co-ownerships

Q. Classify taxpayers. What are the four (4) groups of taxpayers?


Ans. The term "taxpayer" means any person subject to tax imposed by this Code [Sec. 22(a),
NIRC]. Income taxpayers are persons who derive taxable income (Tan v. Del Rosario, 237 SCRA
324, 331). Under the Tax Code income taxpayers in the Philippines are classified into:
(1) Individual taxpayers;
(2) Corporate taxpayers ;
(3) Estates under judicial settlement; and
(4) Trusts (irrevocable both as to corpus and as to income (Tan v. Del Rosario, 237 SCRA 324,
331).

NIRC CHAPTER I Definitions

SECTION 22 Definitions When used in this Title:

(A) The term 'person' means an individual, a trust, estate, or corporation.

(B) The term 'corporation' shall include partnerships, no matter how created or organized, joint-
stock companies, joint accounts (cuentas en participacion), associations, or insurance companies,
but does not include general professional partnerships and a joint venture or consortium formed
for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal
and other energy operations pursuant to an operating or consortium agreement under a service
contract with the Government. 'General professional partnerships' are partnerships formed by
persons for the sole purpose of exercising their common profession, no part of the income of
which is derived from engaging in any trade or business.

(C) The term 'domestic,' when applied to a corporation, means created or organized in the
Philippines or under its laws.

(D) The term 'foreign,' when applied to a corporation, means a corporation which is not
domestic.

(E) The term 'non resident citizen' means:

(1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact
of his physical presence abroad with a definite intention to reside therein.

(2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside
abroad, either as an immigrant or for employment on a permanent basis.

(3) A citizen of the Philippines who works and derives income from abroad and whose
employment thereat requires him to be physically present abroad most of the time during the
taxable year.

Computation of Taxable Income

SECTION 31 Taxable Income Defined The term 'taxable income' means the pertinent items
of gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws.

D. BASIS OF TAXABILITY
Q. In general on what does taxability of income depend as regards individuals? Explain
your answer, citing the incomes taxable under our Income Tax Law.
Ans. The law in levying the tax adopts the most comprehensive tax situs of nationality and
residence of the taxpayer (that renders resident citizens subject to income tax liability on their
income from all sources) and of the generally accepted and internationally recognized income
taxable base (that can subject nonresident aliens and foreign corporations to income tax on their
income from Philippine sources (see Tan v. del Rosario, Jr. 237 SCRA 342, 334).
As regards individuals, the taxability of income depends upon:
(1) citizenship;
(2) residence of the recipient; or
(3) the place where such income is derived.
Q. Why is it important to know the different groups of taxpayers or the kinds of individual
taxpayers?
Ans. In order to determine and to know the applicable tax rates, exemptions and allowable
deductions.
Q. For taxation purposes, how are Filipinos classified?
Ans. They are classified as follows:
(1) Resident citizens- Filipinos residing in the Philippines;
(2) Non-resident citizens- means one who establishes to the satisfaction of the Commissioner
the fact of his physical presence abroad with a definite intention to reside thereto [Sec. 20(e),
NIRC as amended by PD No. 1457].
The taxpayer shall submit proof to the Commissioner of Internal Revenue to show his intention
of leaving the Philippines to reside permanently abroad or to return to and reside in the
Philippines as the case may be for purposes of this section [Sec. 20(e)(4), NIRC]. Non- resident
may leave the Philippines as:
(1) Immigrant- one who leaves the Philippines to reside abroad as an immigrant for which a
foreign visa as such has been issued.
(2) Permanent employee- one who leaves the Philippines on account of contractual
employment, more or less on permanent basis.
(3) Contract worker- one who leaves the Philippines on account of a contract of employment
which is renewed from time to time within or during the taxable year under such circumstances
as to require him to be physically present abroad most of the time during the taxable year. A
contract worker must have been outside the Philippines for not less than 183 days during such
taxable year (New Implementing Regulations).

Q. What are the general principles governing individual income taxation in the
Philippines?
Ans. These general principles as follows :
(1) A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines.
(2). A nonresident citizen is taxable only on income derived from sources within the Philippines.
(3) An individual citizen of the Philippines who is working and deriving income from abroad as
an oversea contract worker is taxable only on income from sources within the Philippines;
Provided, That a seaman who is a citizen of the Philippines and who receives a compensation for
service rendered abroad as a member of the complement of a vessel engaged exclusively in
international trade shall be treated as an oversea worker;
(4) An alien individual, whether a resident or not of the Philippines, is taxable only on income
derived from sources within the Philippines. ( NIRC Sec 23 )

NIRC Sec 22 (GG) The term 'statutory minimum wage' shall refer to the rate fixed by the
Regional Tripartite Wage and Productivity Board, as defined by the Bureau of Labor and
Employment Statistics (BLES) of the Department of Labor and Employment (DOLE).

(HH)The term 'minimum wage earner' shall refer to a worker in the private sector paid the
statutory minimum wage, or to an employee in the public sector with compensation income of
not more than the statutory minimum wage in the non-agricultural sector where he/she is
assigned.

Q. What are the steps involved in computing taxable compensation income?


Ans. The steps are:
ADD: The aggregate taxable compensation(gross) income
EXCLUDE: The excluded and exempted items
DETERMINE: The taxable net income by deducting the premium deduction of the taxpayer
including personal exemption only; or (c) The deductions of the taxpayer without personal and
additional exemptions for health/hospitalization/personal exemption, additional personal
exemption for dependents.
APPLY: Tax rates (for 1998-5%-34%; for 1999- 5% -33% and effective January 1, 2000- 5%-
32%)(32% effective Jan 2009 under RA 9337) upon the difference to determine tax due:
DEDUCT: taxes withheld and describe the difference as taxes
refundable/payable (excess tax/deficiency tax).

Q. In relation to the mentioned steps, what is the formula in computing taxable


compensation income?
Ans .The formula:
ADD: Gross compensation income and exclude the excluded items.
LESS: (1) Basic personal exemption (P50,000) (2) Additional exemption (P25,000.00 for each
dependent)
EQUALS: Taxable Income
MULTIPLIED BY: Taxable rate: 5%-30% (RA 9337 starting Jan 2009 )
RESULT: Tax Due
LESS: Withholding tax
DIFFERENCE: Tax Payable or the Tax Refundable (excess or deficiency tax).

Q. Who are the taxpayers covered by business/trade/and professional income?


Ans. They are:
(1) Self-employed persons engaged in business/proprietor;
(2) Professionals engaged in the practice of their profession;
(3) Resident/non-resident Filipinos.
(4) Nonresident alien engaged in trade or business within the Philippines.

Q. What is meant by engaged in trade or business? What does the term include?
Ans. It is synonymous with "carrying on a business". It connotes more than a single act or
isolated transactions for it involves continuity of action (Day v. Equitable Life, 83 Fed/144.268;
BIR Ruling January 15, 1959). The term includes the performance of the functions of a public
office [Sec.22(S), NIRC] and performance of personal services within the Philippines (Par. 2,
Sec. 8, Regs. No. 2).

Q. What are the steps involved in computing the taxes due for those taxpayers engaged
in trade, business and engaged in the exercise of their professions?

Ans. The steps involved are:


ADD: The aggregate of compensation he received to determine the gross income derived from
business/profession.
EXCLUDE; Exclude the excluded/exempted items.
DEDUCT:
(1) Optional standard deduction (40%). or
(2) Itemized allowable deductions;
DIFFERENCE: Taxable Income
LESS:
(1) Basic personal exemption (P50, 000.00,
(2) Additional exemption (P25, 000.00 for each dependent but not more than 4
dependents.
To determine the Net Taxable Income
APPLY: Schedular Tax rates [5%- 32%, effective Jan.1,2009].RA 9337
DEDUCT: Tax withheld
DIFFERENCE: Tax Payable or Tax Refundable.

Q. What is the formula for computing the taxes for taxpayers engaged in trade, business
and those exercising their profession?
Ans. Basically , the formula for computation of types of income being as follows:
ADD: Gross income from business/trade/profession
LESS:
(1) optional standard deduction-(40%) or Itemized deductions
(a) business expenses
(b) Interest,
(c) Taxes;
(d) bad debts;
(e) Depreciation, depletion, etc.etc.
(2) Basic personal exemption (P50, 000)
(3) Additional exemptions (P25,000.00 for each dependent);
EQUALS: Taxable Income
MULTIPLIED BY TAX RATES- 5%-32% effective Jan. 1, 2009 (RA 9337)
RESULT: Tax Due
LESS: Withholding Tax
DIFFERENCE: Tax Payable/Refundable (excess or deficiency tax).

Q. Classify aliens individuals for taxation purposes.


Ans. They are classified as follows:
(1) Resident aliens- They are non-Filipinos (i.e., resident Chinese)but residing permanently
in the Philippines [Sec. 20 (f), NIRC]. They are placed for taxation purposes in the same
category as citizens of the Philippines.
(2) Non-resident aliens-aliens not residing in the Philippines.

Q. Since Filipinos and resident aliens for taxation purposes are subject to the same
income taxation, what taxes are they subjected to ?
Ans. Filipinos and resident aliens shall be subject to the following income taxes under Sec. 24 of
Rep. Act No. 8424 (Tax Reform Act of 1997):
(1) Graduated income tax on taxable compensation income;
(2) The same graduated income tax on taxable net income from business, profession, etc.
(3) Final income tax on royalties, prizes and other winnings;
(4) Final income tax on interest from bank deposits and yield or any other monetary benefit from
deposit substitutes and from trust fund and similar arrangements;
(5) Final income tax on dividends and share of individual partners in the net profits of taxable
partnership.

SECTION 24 Income Tax Rates


(A) Rates of Income Tax applies to Individual Citizen and Individual Resident Alien of the
Philippines.

RESIDENT ALIENS
Q. For taxation purposes, how are resident aliens classified?
Ans. Basically, resident aliens for taxation purposes are classified as follows:
(1) Resident alien with:
(a) Compensation income in the Philippines;
(b) Gross income in the Philippines are taxed similarly as citizens of the Philippines.
(2) Resident aliens whose country does not grant Filipinos with tax credit cannot enjoy tax credit
deduction under the principle of reciprocity.

TAXABLE NON- RESIDENT ALIENS


Q. For taxation purposes, how are nonresident aliens, classified?
Ans. Nonresident aliens are classified as:
(1) Nonresident alien doing business in the Philippines;
(2) Nonresident alien not doing business in the Philippines.
(3) Nonresident aliens employed by regional or area headquarters of multi-national corporations;
(4) Nonresident aliens employed by offshore banking units;
(5) Nonresident aliens employed by petroleum service contractors.

Q. For taxation purposes, into what categories the nonresident alien individuals being
categorized?
Ans. Non-resident aliens are placed for taxation purposes into five (5) categories, namely:
(1) Nonresident aliens engaged in trade or business in the Philippines.
(2) Nonresident aliens not engaged in trade or business in the Philippines;
(3) Aliens employed by regional or area headquarters of multinational corporations [Sec.22(c),
NIRC].
(4) Aliens employed by offshore banking units [Sec. 22(d), NIRC].
(5) Aliens employed by petroleum service contractors and sub-contractors [Sec. 22(e), NIRC].

Q. What is the format/steps/formula of nonresident alien individual doing business in the


Philippines.
Ans. The steps or format:
ADD: Gross income from sources within the Philippines
LESS: Allowable deductions
EQUALS: Net Income in the Philippines
DEDUCT: Exemption (if country grants similar rights to Filipinos).
EQUALS: Taxable Net Income
APPLY/MULTIPLY TAX RATES: 5%-32% effective Jan. 1, 2009.
DIFFERENCE: Tax Due/ Payable
Note: Reminders:
(a) Nonresident aliens cannot claim tax credit.
(b) Nonresident aliens gross income from outside the Philippines are not included (not taxable).
(c) Nonresident aliens enjoyment of personal exemption is subject to limitations/qualifications
(reciprocal exemptions).

Q. Give the formula or steps or format for nonresident alien individual not doing business
in the Philippines.
Ans. As presented:
GROSS INCOME from sources within the Philippines.. .P ...........
Apply: 25%..................................................... ............... x .25
Tax Due.................................................................. .....P..

Q, For Nonresident alien employed in regional/area headquarters, offshore banking


units, petroleum service contractor.
Ans. As presented
GROSS INCOME [from employment]................... . ....P.
Apply: 15%..................................................................... . x.15
Tax Due: P............

Q. Define the following terms: wages, employee, employer and payroll period.
(1) Wages- means all remunerations [other than fees paid to a public official] for service
performed by an employee for his employer, including the cash value of all remuneration paid in
any medium other than cash, except that such item shall not include remuneration paid for
agricultural labor, domestic service and casual labor,etc [Sec. 78(A)(1) to (4), Tax Code].
(2) Employee- refers to any individual who is the recipient of wages and includes an officer,
employee or elected official of the government and the Philippines or any political subdivision,
agency or instrumentality thereof; it also includes an officer of the corporation [Sec. 78(C), Tax
Code].
(3) Employer- means the person for whom an individual performs or perform any service, of
whatever nature, as the employee of such person [Sec. 78(D), Tax Code].
(4) Payroll period- means a period for which payment of wages is ordinarily made to the
employee by his employer, and the term miscellaneous payroll period means a payroll period
other than a daily, weekly, biweekly, semi-monthly, monthly, quarterly, semi-annual, or annual
period [Sec. 78(B), Tax Code].

Q. What are the requisites to withhold taxes of wages?


Ans. To effect withholding on wages, the following must be present:
(1) There must be employee-employer relationship.
(2) There must be wage payment;
(3) There must be payroll period
(4) There must be consideration of certain factors such as the follow-following:
4a) whether to consider the tax withhold as final tax;
4b) personal and additional exemption;
4c) certificates either for exemption, for change of status;
4d) average wages/withholding tax table/gross receipts from business profession;
4e) relationship (i.e. husband and wife);
4f) citizenship (i.e., nonresident alien)..

Q. Who are the persons required to deduct and withhold wages at source?
Ans. Every employer making payment of wages shall deduct and withhold upon such wages a
tax determined with the use of Withholding Tax Table prepared by the Department of Finance.
Just as not all wages are subject to withholding tax, there are also employees that may be
exempted from this requirement, particularly the following:
(1) Those holders of exemption certificates;
(2) Those wages paid to nonresident aliens
[Sec. 78(2)(D), Tax Code].
(3) Those tax paid directly by recipient [Sec. 79(B) Tax Code].

Q. What are the duties and obligations of the employer relative to wages?
Ans. The duties of employer as withholding agent of the
withholding tax are as follows:
(1) He shall deduct and withhold a tax in an amount equal to the tax due the employee's
compensation income for the entire year;
(2) He shall file a return and pay the taxes collected and held within 25 days from the close of
each calendar quarter [Sec. 58 (A). Tax Code; Sec. 2.58 Rev. No. 2-98 as amended by Rev. Reg.
No. 3-2002].
(3) He shall make year-end adjustment of the taxes withheld;
(4) He shall furnish to each employee on or before January 31 of the succeeding year, a written
statement showing wages paid and the amount deducted and withheld [Sec. 58(B), Tax Code].
(5) He shall submit the annual information return (BIR Form No. 1604-CF) of the amount
withheld [Sec. 58(C) Tax Code; Reg. No. 2-98 as amended by Rev. No. 3-2002].
(6) He shall comply and submit List of payees to form part of the Annual Information Return
(BIR Form No. 1604-CF) (Sec. 2.83.3 as amended by Sec.3, Rev. 2-2002 and Sec. 3. Rev.Reg...
No. 3-2002).

Q. In addition to withholding of wages, what are the other types of tax withheld at source?
Ans. They are:
(1) Final withholding tax;
(2) Creditable withholding tax on government money payments.
(3) Expanded withholding tax.
ESTATES AND TRUSTS
Q. What are the taxable estates and trusts under the Tax Code?
Ans. They are:
(1) Estates of deceased persons under administration or settlement.
(2) Trusts where the income is to be accumulated or held for future distribution by the fiduciary;
(3) Trusts where the income may be either accumulated or distributed at the discretion of the
fiduciary ; and
(4) Trusts where the income is collected by a guardian of an infant to be held or distributed as the
court may direct [Sec.,60(A), Tax Code].
Q. For taxation purposes, what are two classes or kinds of estates and trusts?
Ans. They are:
(1) Domestic or resident estate or trust administered in the Philippines;
(2) Estate or trust administered in foreign states or countries.

Q. What is the basic rule on estates/trusts taxation?


Ans. General Rule.- The tax imposed upon individual taxpayers shall apply to the income of
estates or any kind of property held in trust; that is, the items of "gross income" of individuals
Sec. 61, Tax Code the period of administration or settlement of the estate).are the same items of
gross income of estates and trusts.
Q. Who pays the tax on estates and trusts?
Ans. It is paid generally by the fiduciary except in the following cases:
(1) Revocable trust where the income is included in the taxable income of the grantor.
(2) Where the income of the trust is for the benefit of the grantor in which case the income of the
trust is included in the taxable income of the grantor [Sec.60 (C), (i), Tax Code].
Q. What incomes are included in the income of the estates or trusts subject to income taxes?
Ans. The items of gross income of estates and trusts are the same items of gross income of
individuals as provided in Sec.32 of the Tax Code. They include:
(1) Items accumulated in trust for the benefit of unborn or unascertained person or persons with
contingent interests, and income accumulated or held for future distribution under the terms of
the will or trust.
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries and income
collected by a guardian of an infant which is to be held or distributed as the court may direct;
(3) Income received by estates of deceased persons during the period of administration or
settlement of the estate.
(4) Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries
or accumulated [Sec. 60 (A), Tax Code].
Q. What is trust?
Ans. Trust is an agreement created by will or an agreement under which title to property is
passed to another for conservation or investment with the income therefore and ultimately the
corpus(principal) to be distributed in accordance with the directives of the creator as expressed in
the governing instrument. In its technical term, a trust is a right of property, real or personal, held
by one party for the benefit of another(Gayondato v. Treasurer of P.I. 49 Phil. 250); a confidence
given by person the grantor(creator) reposed in one person who is called fiduciary (trustee) for
the benefit of another who is called cestui que trust (beneficiary); hold property given by the
grantor(creator) to the fiduciary (beneficiary ) for the benefit of the cestui que trust.
Q. What is meant by trustor or grantor?
Ans. Trustor or grantor- is the person who establishes a trust (Art. 1440, Civil Code)
Q. Define beneficiary.
Ans. Beneficiary- is the person for whose benefit the trust has been created (Art. 1440, Civil
Code).
Q. What is the meaning of fiduciary?
Ans. Fiduciary- is the general term which applies to all persons or corporations that occupy
positions of peculiar confidence towards others, such as trustees, executors, guardians, or
administrators, receivers, or conservators. For income tax purposes, a fidudiciary is any person
or corporation that holds in trust an estate of another person or persons [Par. 1, Sec. 107 Regs.
No. 2, Sec.22(J), Tax Code]..
Q. Classify trust relations.
Ans. Trust relations may be: express or implied.
Q. What is meant by express trust?
Ans. Express trusts are those created by direct and positive acts of the parties or by some writing
or deed, or will or by word evidencing an intention to create a trust (Ramos v. Ramos,61 Phil.
284 citing 89 CJS, 722).
Q. Enumerate the classes or kinds of trusts. Explain them.
Ans. They are:
(1) Inter-vivos trust- one formed by a living grantor taking effect during his lifetime. Otherwise
called living trust.
(2) Testamentary trust- one formed under a will and may take effect during the grantor's lifetime
or after his death.
(3) Simple trust- one that distributes current income only, must distribute all current income, and
has no charitable beneficiaries.
(4) Complex trust-a trust with charitable beneficiaries or one that accumulates income or that
distributes the corpus or body of the trust.
(5) Annuity trust- one that may pay out annually a certain percentage of the net market value of
the trust of property valued on the transfer date for a certain period or for life.
(6) Unitrust- one that has the same requirements as an annuity trust except that it must pay out
annually a certain percentage of the net fair market value of the trust assets as valued annually.
(6) Pooled income fund trust- a trust to which each donor transfers property which is then
commingled. Income is paid for life to the beneficiary. The amount of annual income each
income beneficiary receives is determined by the trust's rate of return for that year.
(7) Insurance trust- is a form of living trust wherein by the trust agreement between the trustor
and the trustee, the latter is duty bound to conserve and manage the proceeds of the life insurance
policies of the trustor for the benefit of his beneficiaries.
Other types of express trusts are: investment trusts, liquidating trusts and personal trusts,
depending upon the specific purpose for which such trusts being created (O' lao v. Chit, 220
SCRA, 553, citing 89 CSS 724),
Q. What are implied trusts?
Ans. Implied trusts are those which without being express are deductible from the nature of the
transaction as matters of those which are superinduced on the transaction by operation of law66
irrespective of, and even contrary to, any such intention of the parties (Morales v. Court of
Appeals, 274 SCRA 286).
Q. Classify implied trusts. What are the kinds of implied trusts?
Ans. They are: resulting trusts and constructive trusts.
Q. What is meant by: (a) resulting trust; and (b) constructive trust.
Ans. Defining them:
(1) Resulting trusts- they arise from the nature or circumstances of the consideration involved in
any transaction whereby one person thereby becomes invested with legal title but is obligated in
equity to hold his legal title for the benefit of another (O'Lao v. Chit, 220 SCRA 656, citing 76
Am. Jur. 2nd 491; Morales v. Court of Appeals,274 SCRA 282).
(2) Constructive trusts- They are created by the construction of equity in order to satisfy the
demands of justice and prevent unjust enrichment. They arise contrary to intention against one
who, by fraud, duress or abuse of confidence, obtains or holds the legal right to property which
he ought not, in equity or good conscience to hold (O'Lao v. Chit, 220 SCRA 656, citing 76 Am.
Jur. 2nd 491; Morales v. Court of Appeals,274 SCRA 282),
Q. Can there be consolidation of income of two or more trusts?
Ans. Yes, provided these conditions for consolidation of net income are present:
(1) Two or more trusts ;
(2) The creator of the two or more trusts is the same person; and
(3) The beneficiary of the two or more trusts is the same.
Q. What would be the result of consolidation?
Ans. The resultant effects are:
(1) The taxable income of all the trusts shall be consolidated.
(2) Income tax computed on the consolidation income; and
(3) Such proportion of said tax shall be assessed and collected from each trustee which the
taxable income of the trust administered by him bears to the consolidated income of the several
trusts [Sec. 60(C) (2) Tax Code].
Q. Are there trusts that are exempted from income tax?
Ans. Yes, in the following cases:
(1) In case of employee's trust which forms part of a pension, stock bonus or profit-sharing plan
of an employer for the benefit of his employees [Sec. 60(B), Tax Code].
(2) When the amount is less than P20,000.00 (Sec. 62, Tax Code).
(3) Income of retirement plans whether employees trust or pension trusts are tax exempt.
Sec. 60(B), RA No. 4917; San Miguel Corporation Retirement and Death Benefit Plan-Foreign
Personnel represented by its Trustees v. Commissioner of Internal Revenue, CTA Cases No.
4331 and 4332 prom. January 5, 1995; BPI as trustees of various retirement funds v.
Commissioner of Internal Revenue, CTA Case No. 4533 to 4566 and 461 to 4681, prom. July 1,
1994).

Q. What is revocable trust?


Ans. It is kind of trust where at any time the power to re-vest (return) in the grantor title to any
part of the corpus (the body) of the trust is vested:
(1) In the grantor either alone or in conjunction with any person not having a substantial adverse
interest in the disposition of such part of the corpus or the income therefrom, or
(2) In any person not having a substantial adverse interest, in the disposition of such part of the
corpus or in the income therefrom (Sec. 63, NIRC of 1997).
Q. What should be the tax treatment of a revocable trust?
Ans. The income of the property subject to a revocable trust shall not be included in the income
of the trust for tax purposes, but shall instead be included in computing the taxable income of the
grantor (Sec. 63, Tax Code).
The following which consists of any part of the income of a trust shall be included in computing
the net income of the grantor:
(1) Any art of the income of trust which is in the discretion of the grantor or of any person not
having a substantial adverse interest in the disposition of such part of the income.
(2) May be held or accumulated for future distribution to the grantor or may be distributed to the
grantor or may be applied to the payment of premium upon policies of insurance on the life of
the grantor (Sec. 64 (A), Tax Code).
Q. What are the basic rules on deductions?
Ans. The rules are:
(1) Deductions allowed to individuals are allowed to be deducted from the gross income of estate
and trust to arrive at the net income.
(2) Deductions allowed only for trusts administered within the Philippines [Sec. 61 (E), Tax
Code].
Q. How is net income of an estate or trust computed?
Ans. Net Income.- Except for some exceptions [see Sec.61(A)(B)(C) Tax Code], as a rule, the
net income of the estate or trust shall be computed in the same manner and the same basis as in
the case of an individual.
Q. How are taxable income of estates/trusts be computed?
Ans. Computation.- The formula for computing it is this:
Gross Income
Less: Deductions
Equals: Net Income
Net Income
Less: Exemption (P20,000.00, Sec. 62)
Apply: Tax Rates: 5%-32%
Result: Tax Due
or:
Consolidated Gross Income
Less: Consolidated Deductions
Equals: Consolidated Taxable Income
Less: Exemption of P20,000.00
Equals: Taxable Income
Multiplied by: Tax Rate: 3%- 32%
Result: Tax Due on consolidated taxable income.
The guide for computing being as follows:
(1) Basis- Net Income of the estate/trust;
(2) Rates: same as individual
(3) Exemption- P20,000.00 [Sec. 62, Tax Code]
(4) Taxable year: Calendar year.

CONCEPT OF CORPORATION
Q. Generally, define corporation.
Ans. .A "corporation" is an artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly authorized by law or incident to its
existence (Sec. 2, Corporation Code).
Q. In income taxation, what does the term corporation include? State the coverage of
corporation'
Ans. The term "corporation" shall include partnerships no matter how created or organized,
joint stock companies, joint accounts [cuentas en participacion], association or insurance
companies but does not include:
(1) General professional partnerships- are partnerships formed by persons for the purpose of
exercising their common profession and no part of the income of which is derived from engaging
in any trade or business.
(2) Joint venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or
consortium agreement under a service contract with the Government [Sec. 22(B), Tax Code ].

Q. For taxation purposes, how are corporations classified?


Ans. Corporations are divided or classified. into:
(1) Domestic corporations-The term "domestic" when applied to a corporation means created
or organized in the Philippines or under its laws [Sec. 22, (C), Tax Code].
(2) Foreign corporations- means a corporation which is not domestic or one organized in
accordance with foreign laws and subdivided into two for taxation purposes:
(a) Foreign corporations engaged in trade or business in the Philippines; or
(b) Foreign corporations not engaged in trade or business in the Philippines [Sec.,
22(D) Tax Code].

Q. How are domestic corporations classified for taxation purposes under the Tax Code?
Ans. They are:
(1) Domestic corporations in general, including partnerships other than general professional
partnerships.
(2) Proprietary educational institutions and hospitals.
(3) Government-owned or controlled corporations, agencies or instrumentalities.

Q. Classify foreign corporations under the Tax Code?


Ans. They are classified for taxation purposes as:
(1) Resident foreign corporations, sub- classified:
(a) Resident foreign corporations in general
(b) International carriers;
(c) International air carriers;
(d) Offshore banking units;
(e) Regional or area headquarters and regional operating headquarters of multinational
companies;
(2) Non-resident foreign corporations, sub-classified as:
(a) Nonresident foreign corporation in general;
(b) Nonresident cinematographic film owners, lessors or distributors;
(c) Non-resident owners of vessels chartered by Philippine nationals;
(d) Nonresident lessors of aircrafts, machineries and other equipment.

Q. Distinguish domestic corporation from resident foreign corporation.


Ans. Distinguishing both:
(1) Domestic corporations are taxed on all their incomes derived from sources within or
without the Philippines; whereas, resident foreign corporations are taxed only on their income
derived from sources without the Philippines.
(2) Domestic corporations are organized under the Philippine law whereas, resident foreign
corporations are organized under the foreign laws.
(3) Dividends declared by domestic corporations are taxable while that of resident foreign
corporations may or may not be taxable.
Q. What is the meaning of "doing" or "engaging in" or "transacting" business?
Ans. The term implies continuity of commercial dealings and arrangements, performance of
acts or works or the exercise of some of the functions normally incident to, and in prosecution of
commercial gain of for the purpose and object of the business organization, with intention to
establish a continuous business and not one of a temporary character (Commissioners of Internal
Revenue. British Overseas Airways Corp. et. al. 148 SCRA 405).

Q. What is "piercing the veil of corporate personality"?


Ans. This phraseology (otherwise termed: "disregarding the fiction of corporate entity",
"looking at substance rather than the form") has reference to cases where the principle:
"That a corporation is a separate and distinct from the members or stockholders who compose it
may be disregarded as when the legal entity is used to defeat public convenience, justify wrong,
protect fraud or defeat crimes and violate the law."
Hence, the entity-rule of corporation may be disregarded in the following instances:
(1) For illegal acts of members (People v. North River Sugar Refining Co. 121 NY 572).
(2) For being used for fraudulent acts (i.e., as a dummy corporation or for perpetrating a fraud
and/or confusing legitimate issues, the corporate veil may be pierced (AD Santos Inc. v.
Vasquez, GR No. l-3376, March 20, 1968).
(3) Being a mere agency or alter ego or business "conduit" or "adjunct" to another (parent)
corporation [1Fletcher 52; Koppel (Phil). Inc. v. Yatco, 45 OG. 4604, Cease v. Court of Appeals,
L-33272, Oct. 18, 1979]..
(4) Where stocks of corporation are owned by one person or closely related persons like
husband and wife.
Ramirez Telephone Corp. v. Bank of America, F. Herbosa et. .al. GR NO. L-179614, August
29, 1969; Lido Export Inc. v. Commissioner of Internal Revenue CTA Case No. 4879, prom. April
24, 1997;
(5) For prevention or evasion of statute (i.e. used as shield for tax evasion (Liddel and Co. v.
Collector of Internal Revenue, L-9697, June 30, 1969). or to defeat the ends of the SSS or to
evade the effects of contracts (Ballantine 34; Rea v. Phase, 31 Mich .490).
(6) The corporate fiction is used to avoid payment of money judgment in favor of laborers (La
Compana Coffee Factory Inc. v. Kaisahan ng Manggagawa, 49 O.G. 2300).
(7) The business operations of the corporation are so merged with those of the stockholders so
as to be indistinguishable McConnel v. Court of Tax Appeals, L-10510 March17, 1961).
(8) Organization of subsidiaries and affiliations.
(9) Tax evasion or avoidance scheme (Agbayani, Piercing Corporation Veil, Aspect of
Philippine Corporate Practices, UP Law Center, 1967 ed. pp. 270-271).

B. EXEMPTED CORPORATIONS
Q. Who are the exempted corporations from income tax? Enumerate the corporations or
organizations which are exempt from income taxation under the existing Tax Code?
Ans. The following corporations are exempted from the payment of income tax:
(1) Labor, agricultural or horticultural organizations;
(2) Mutual savings banks;
(3) A beneficiary society, order or association.
(4) Cemetery company owned and operated exclusively for the benefit of its members.
(5) Non-stock corporations exclusively for religious, charitable, etc. purposes;
(6) Business league, chamber of commerce or board of trade;
(7) Civil league or organization not organized for profit;
(8) Government educational institution;
(9) Farmers or other mutual typhoon or fire insurance company,
(10) Farmers fruit growers [Sec. 30(A) to (K), Tax Code].

Q. Is a corporation exempt from tax simply because it is primarily not organized and not
operated for profit? or Is the tax imposed by law on corporations applicable only to those
organized and operated for profit?
Ans.. No. Corporate creation, form of organization and purpose of its organization not
determining factor of exemption (Sec. 16, Regs. No. 2). Further, incomes of tax exempt
organization of whatever kind and nature from any of their properties real or personal, from any
of their activities conducted for profit regardless of their disposition made of such income shall be
subject to tax (Last par. Sec.30, Tax Code).

Q. What requirements must be complied with by the corporations or associations seeking


exemption from income taxation?
Ans. The following requirements or steps:
(1) It must file an affidavit with the BIR showing:
(a) The character of the league or organization;
(b) The purpose for which it was organized;
(c) Its actual activities.
(d) The sources of its income and disposition thereof, whether or not any of the income
is credited to surplus or inures or may inure to the benefit of any private shareholder or
individual; and
(e) In general, all facts relating to its operation which affect the right to its exemption.
(2) It must attach to the affidavit a copy of the charter or articles of incorporation, the by-laws of
the organization and the latest financial statement showing the assets, liabilities, receipts and
disbursements of the organization (Sec. 24, Regs. No. 2).

NIRC Sec 27(B) Proprietary Educational Institutions and Hospitals. Proprietary educational
institutions and hospitals which are nonprofit shall pay a tax of ten percent (10%) on their
taxable income except those covered by Subsection (D) hereof: Provided, That if the gross
income from unrelated trade, business or other activity exceeds fifty percent (50%) of the total
gross income derived by such educational institutions or hospitals from all sources, the tax
prescribed in Subsection (A) hereof shall be imposed on the entire taxable income. For purposes
of this Subsection, the term 'unrelated trade, business or other activity' means any trade, business
or other activity, the conduct of which is not substantially related to the exercise or performance
by such educational institution or hospital of its primary purpose or function. A 'proprietary
educational institution' is any private school maintained and administered by private individuals
or groups with an issued permit to operate from the Department of Education, Culture and Sports
(DECS), or the Commission on Higher Education (CHED), or the Technical Education and
Skills Development Authority (TESDA), as the case may be, in accordance with existing laws
and regulations.
II. DETERMINING CORPORATE TAXATION
A. CORPORATE INCOME
Q. Every corporation domestic or foreign, not otherwise exempt from tax under the Tax
Code, or any other law, is liable to tax. From what sources of its income is domestic
corporation liable to tax? And what sources of income is a foreign corporation liable to tax?
Ans. A domestic corporation is subject to tax on all its taxable income during the taxable year
derived from sources within and without the Philippines [Sec. 27(A) Tax Code]. On the other hand,
a foreign corporation is liable to income tax upon its taxable income during the taxable year derived
from sources within the Philippines [Sec. 28(A) Tax Code].

To be taxed, a joint venture need not be constituted in accordance with usual legal requirements.
The qualifying expression: "the term corporation includes partnerships, no matter how created
or organized" clearly indicates that a joint venture need not be undertaken in any of the standard
forms, or in conformity with the usual requirements of the law on partnerships, in order that one
could be deemed constituted for purposes of the tax on corporations.
Eufemia Evangelista vs. Collector of Internal Revenue, et al., G.R. No. L-9996, October 15, 1957

For tax purposes, the co-ownership of inherited properties is automatically converted into an
unregistered partnership the moment the said common properties and/or the incomes derived
therefrom are used as a common fund with intent to produce profits for the heirs in proportion to
their respective shares in the inheritance as determined in a project partition either duly
executed in an extrajudicial settlement or approved by the court in the corresponding testate or
intestate proceeding. The reason for this is simple. From the moment of such partition, the heirs
are entitled already to their respective definite shares of the estate and the income thereof, for
each of them to manage and dispose of an exclusively his own without the intervention of the
other heirs, and, accordingly, he becomes liable 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.
Ona vs. Commissioner, G.R. No. L-19342, May 25, 1972

What constitutes a "partnership" under American law.


Under American law, the term 'partnership' includes a syndicate, group, pool, joint venture or
other unincorporated organization, through or by means of which any business, financial
operation, or venture is carried on. For purposes of the tax on corporations, our National
Internal Revenue Code, includes these partnerships with the exception only of duly registered
general copartnershipswithin the purview of the term "corporation."
Eufemia Evangelista vs. Collector of Internal Revenue, et al., G.R. No. L-9996, October 15, 1957

Tax on income of insurance pool is different from tax on dividends received by individual
corporate entities.
An insurance pool is a taxable entity distinct from the individual corporate entities of the ceding
companies. The tax on its income is obviously different from the tax on the dividends received by
the said companies. Clearly, there is no double taxation here.
Afisco Insurance Corp., et al. vs. Court of Appeals, et al., G.R. No. 112675, January 25, 1999

Unregistered partnerships and associations are included in the concept of "corporations".


The Philippine legislature included in the concept of corporations those entities that resembled
them such as unregistered partnerships and associations. Parenthetically, the NLRC's inclusion
of such entities in the tax on corporations was made even clearer by the Tax Reform Act of 1997.
Afisco Insurance Corp., et al. vs. Court of Appeals, et al., G.R. No. 112675, January 25, 1999

Personality is not a condition precedent to the existence of partnerships.


The term 'corporation' includes among others, joint accounts (cuentas en participacion) and
associations, none of which has a legal personality of its own, independent of that of its
members. The lawmakers could not have regarded personality as a condition precedent to the
existence of partnerships referred to therein.
Florencio Reyes, et al. vs. Commissioner of Internal Revenue, et al., G.R. No. L-24020-21, July
29, 1968

Taxes enforced against a corporate taxpayer cannot be imposed on its officers and stockholders.
Taxes being personal to the taxpayer, it can only be enforced against petitioner because the
payment of unpaid customs duties and taxes are the personal obligation of the petitioner as a
corporate taxpayer, thus, it cannot be imposed on its corporate officers, much so on its
individual stockholders, for this will violate the principle that a corporation has personality
separate and distinct from the persons constituting it.
Proton Pilipinas Corp. vs. Republic of the Phil., G.R. No. 165027, October 16, 2006

SECTION 26 Tax Liability of Members of General Professional Partnerships


A general professional partnership as such shall not be subject to the income tax imposed under
this Chapter. Persons engaging in business as partners in a general professional partnership shall
be liable for income tax only in their separate and individual capacities.
For purposes of computing the distributive share of the partners, the net income of the
partnership shall be computed in the same manner as a corporation.
Each partner shall report as gross income his distributive share, actually or constructively
received, in the net income of the partnership.

CLASSIFICATION OF INCOME
A. CONCEPT OF INCOME
Q. What is the basis of the right of a government to tax income?
The government has such right to tax income on businesses or professionals from its partnership
in the production of income, by providing the protection, resources, incentives and proper
climate for such production ([Commissioner v. Dickey, 11 SCRA 603 (1964)].

Q. Define income for tax purposes.


Ans. Income has been given varied legal definitions and among them are:
(1) It means all wealth which flows into the taxpayer other than a mere return of capital. It
includes the forms of income specifically described as derived from the sale or other disposition
of capital assets.[Sec. 36, Regs. No 2; see also Madrigal v. Rafferty, 38 Phil. 414],
(2) An amount of money coming to a person or corporation whether as payment for services,
interest or profit from investment. Unless otherwise specified specified it mean cash or its
equivalent (Conwi et. al. v. Court of Tax Appeals, 213 SCRA 83 , 87-88 citing Fisher v.
Trinidad, 43 Phil. 493). The gain derived from capital, from labor, or from both combined
provided it be understood to include profit gained through a sale or conversion of capital
assets ((Fisher v. Trinidad,43 Phil. 981).
Earnings ,lawfully or unlawfully acquired without consensual recognition , express or
implied, of an obligation to repay and without restriction as to their disposition ((James v. US
366 US 213).
Q. What are the tests for determination that income is earned for income tax purposes?
Ans. They are:
(1) Severance test theory.
There is no taxable income until there is a separation from capital of something of
exchangeable value, thereby supplying the realization or transmutation which would result in
the receipt of income (Eisener v. Macomber, 252 US 189, 207-208),
(2) Claim of right doctrine.
(3) Ownership, command or control of income.
The power to dispose of income is equivalent of ownership of it. The exercise of that power
to procure the payment of income to another is the enjoyment and hence, the realization of the
income by him who exercises it. The dominant purpose of the revenue laws is the taxation of
income to those who earn or otherwise create the right to receive it and enjoy its benefit when
paid (Helvering v. Horts, 311 US 112-122);
(1) Doctrine of proprietary interest.
Where stock options, shares of stocks or other assets are transferred by an employer to
an employee to secure better services they are plainly compensation which is taxable
income (Commissioner v. LaBue, 351 US 243

(2) Doctrine of actual receipt;


When income considered received for Philippine income tax purposes if: (1) actually or
physically received by taxpayer; and (2)If constructively received by taxpayer (Sec. 5-
21, Rev. Regs. No. 2) and
(3) Doctrine of constructive receipt.

Q. What are the requisites for an income to be taxable?


Ans. The requisites are:
(1) There must be in fact income, whether in cash, or its equivalent because income does not
only refer to money a taxpayer received but includes anything of value, whether tangible or
intangible.
(2) The gain must be realized or received. Even if there is material gain not excluded by law if
the material gain is not yet realized by the taxpayer there is no income to speak of. Hence, the
realization principle. Thus,
(a) Mere increase in the value of property is not income but merely an unrealized increase in
capital ((James v. US 366 US 213).
(b) Mere increase in the net worth of a taxpayer which was not the result of the receipt by it
of unreported or unexplained taxable income, but was merely the outcome of the correction of
errors in its entries in its books relating to its indebted indebtedness to certain creditors which had
been erroneously over stated or listed as outstanding when they had in fact been duly paid does
not give rise to taxable income ([Fernandez Hnos. Inc. v. Commissioner 29 SCRA 552 (Sept. 30,
1969)]. Or a case of uncollected adjudged attorney's fees. Under the realization principle, revenue
(1) Capital is a fund while income is a flow;(2) A fund of property existing at an instant of time is
called capital, while a flow of services rendered by that capital by the payment of money from it
or any other benefit rendered by a fund of is generally recognized when both of the following
conditions are met: (1) The earning process is complete or actually complete; and (2) An exchange
has taken place. This principle requires that revenues must be earned before it is recorded (Manila
Mandarin Hotel Inc. v. The Commissioner of internal Revenue, CTA Case No. 5046 prom. March
24, 1997).
Income is received not only when it is actually or physically transferred to a person but also
when it is merely constructively received by him. The latter is known as the "doctrine of
constructive receipt"
The doctrine of constructive receipt of income is designed to prevent the taxpayer on the cash
basis from deferring or postponing the actual receipt of taxable income. Without the rule, the
taxpayer can conveniently select the year in which he will report his income.
Income is considered constructively received where the taxpayer has an unjustified right to
receive the same but by his own choice the income is not reduced to possession (i.e.,
undistributed shares in the profits of general partnership of a partner). Thus, the following are
examples of constructive receipt:
(a) Matured interest coupons which are due and payable but not yet collected by the
taxpayer should be included in his gross income for the year during which the coupons
matured;
b) The share in the profits of a partner in a general professional partnership is regarded as
received by him although not yet distributed.
(c) Interest collected on savings bank deposit is income to the depositor when credited (Sec.
53, Regs. No. 2).
(d) Dividends applied by the corporation against the indebtedness of a stockholder are
taxable income to the stockholder ((Sec. 50, Regs. No. 2).
(e) Rental payments refused by the lessor, when the lessee tendered payment and the
latter made a judicial deposit of the rental due((Limpian Investment Corp. v. Comm. 17
SCRA 703).
(3) The gain must not be excluded by law or treaty from taxation.- This implied that not all
income is required to be included in computing the taxable income. Example: certain passive
incomes of individuals like interest on bank deposits are not reported for income tax being
subject to a final tax on passive income [Sec. 21(B) (1), NIRC of 1997].

Q. Distinguish income from capital. How does income differ from capital? Explain.
Ans. Distinguishing the two:
(1) Capital is a fund while income is a flow;
(2) A fund of property existing at an instant of time is called capital, while a flow of services
rendered by that capital by the payment of money from it or any other benefit rendered by a fund
of capital in relation to such fund through a period of time is called income.
(3) Capital is wealth while income is the service of wealth.
(4) Capital is the tree while income is the fruit.
Madrigal v. Rafferty, 38 Phil. 414' Waring v. City of Savannah (1879) 60 Ga. 93; Eisner v.
Amacomber, 252 US 189 (1920); Commissioner v. Glenshaw Glass , 348 US 426 (1955)

Q. Define the following: capital, receipt and revenue.


Ans. Defining them:
(1) Capital- is a fund or property existing at one distinct point of time. It differs from income.
(2) Receipts- has reference to all wealth that flows into the taxpayer which includes return of
capital. It is evident that receipt is broader in scope than income.
(3) Revenue- as applied to taxation, refers to all the funds or income, derived by the government
whether from tax or any other source.

B. INCOME, CLASSIFIED

Q. What are the criteria of income.


Ans. There are various criteria in classifying income and prominently, are the following criteria:
(1) Taxability or non-taxability.
(2) Sources;
(3) Income of individual taxpayer.
(4) Other classification or criteria.

Q. Classify income in accordance with the enumerated criteria.


Ans. Income are classified-
First, as to taxability or non-taxability of income, they may be classified as:
(1) Inclusions (or included income)- items subject to tax.
(2) Exclusions (excluded income)- items not subject to tax.
(3) Taxable income (Sec. 24 NIRC).
(4) Gross income subject to final tax [Sec, 24(b)(v)(d)(e), NIRC as amended].
(5) Passive income- which shall include interest on bank deposits, dividends, royalties, prizes
and other winnings, share in the net profits of a taxable partnership, and yields or any other
monetary benefits from deposit substitutes and from trust funds and other similar arrangements
shall be subject to final tax.
(6) Adjusted gross income [Sec. 24(b), NIRC].
(7) Taxable compensation income (Sec. 24, NIRC).
(8) Taxable net income [Sec. 39(a), NIRC].

Second, as to sources income may be classified as:


(9) Income from sources within the Philippines;
(10) Income from sources without(outside) the Philippines;
(11) Mixed sources, partly from the Philippines and outside the Philippines;

Third, income under the Tax Code and with respect to individual taxpayers may be classified as
follows:
(12) Gross compensation income, the taxable base of which shall be gross compensation
income (after deducting the exclusions) minus the personal and additional exemptions;
(13) Passive income like royalties, interest on bank deposit, etc shall be subject to final tax.
(14) Income from profession, trade or business as well as other income not classified as
compensation income.

Fourth, other classifications of income may result to these additional classifications.


(15) Ordinary income- includes any gain from the sale or exchange of property which is not
capital asset or exchange of property described in Sec. 39(a), NIRC (Sec. 39, Rep. Act No.
8424),
(16) Capital gains

Q. What incomes are subject to tax under the National Internal Revenue Code? From
what sources of income are the following persons taxable by the Philippine Government?
1. Citizens of the Philippines residing therein;
2. Non-resident citizen;
3. An individual citizen of the Philippines who is working and deriving income from abroad
as an oversea contract worker;
4. An alien individual, whether resident or not of the Philippines.
Ans. Income subject to tax under the Tax Code are:
(1) Income received from all sources by every individual resident of the Philippines [Sec. 23(A) ,
NIRC of 1999].
(2) Income derived by a non-resident citizen of the Philippines, an oversea contract worker or
seamen only from sources within the Philippines [Sec. 23(B)(C), NIRC].
(3) Income received from all sources within the Philippines by every alien individual, whether
resident or not [Sec. 23(D), NIRC].

Q. What are the general principles governing individual income taxation in the
Philippines?
Ans. These general principles as follows :
(1) A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines.
(2). A nonresident citizen is taxable only on income derived from sources within the Philippines.
(3) An individual citizen of the Philippines who is working and deriving income from abroad as
an oversea contract worker is taxable only on income from sources within the Philippines;
Provided, That a seaman who is a citizen of the Philippines and who receives a compensation for
service rendered abroad as a member of the complement of a vessel engaged exclusively in
international trade shall be treated as an oversea worker;
(4) An alien individual, whether a resident or not of the Philippines, is taxable only on income
derived from sources within the Philippines.

Q. As used in the Tax Code, what do the words "all income from whatever source
derived" embrace?
Ans. The words "income derived from any source whatever" Or whatever form derived from
any source"- is a legislative declaration to include all income not expressly exempted to be liable
under our laws, irrespective of the voluntary or involuntary action of the taxpayer in producing
the gains and whether derived from legal, illegal, moral or immoral sources.
Thus, where a taxpayer sued and was awarded damages by the trial court and the award were
received pending appeal, the money received is includible in gross income, notwithstanding the
possibility of repayment in case the judgment would be reversed by the appellate court (North
American Oil Consolidated v. Burnett, 286 US 417).
Moral damages for personal injuries like alienation of affection, defamation, libel or slander
are not taxable because said damages are compensatory, in payment of injuries (BIR Ruling, 1965;
see Hawkings, v. Commissioner 8 CTA 1032). Damages for injury to goodwill are not taxable
income because such damages represent return of capital, but compensation for loss of goodwill
in excess of its cost is part of the taxpayer's gross income.
Taxable constructive receipts are the following illustrative cases: (1) Interest coupons that have
matured and are payable but have been cashed; (2) Undistributed share in the profits of a general
partnership; (3) Interest credited on savings bank deposits; (4) Interest credited to shareholders of
a building and loan association when such credit passes without restrictions to the shareholder(5)
Dividends set off against valid debts in favor of the corporation are deemed constructively
received. however, if debt is not valid and/or controversial, dividends withheld to offset debts are
not deemed constructively received (Republic v. de la Rama, L-21108, Nov. 29, 1966).

Q. Under that broad coverage of taxable income derived from whatever source, can you
give examples?
Ans. Yes, the following gains, profits and income to be included in the taxpayer's gross income:
(1) Gambling gains and income from illegal business;
(2) Consideration paid in agreement to engage or compete business in income chargeable to the
recipient;
(3) Gains arising from expropriation of property which constitutes income from dealing in
property.
(4) Compensation for damages if it represents payment for the loss of expected profits; however,
damages received which represent a return of capital are not considered income.
(5) Taxes paid and subsequently refunded.
(6) Bad debts previously charge off but afterwards recovered.
(7) Income constructively received is taxable.

SOURCES OF INCOME
Q. What are the classes of sources of income?
Ans. The Tax Code (Tax Reform Act of 1997) as amended recognizes three classes of sources of
income, namely:
(1) Income from sources within the Philippines.
(2) Income from sources without (outside) the Philippines.
(3) Income from sources partly within/without the Philippines.

Q. Sub-classify Philippine sources of income.


Ans. Income from sources within the Philippines may be sub classified or sub-divided into:
(1). Gross income from sources within the Philippines- like the following: interest, dividends
from domestic/foreign corporations, services, rentals, and royalties (from copyrights, patent,
right to use scientific equipment, technical device, use of films, tapes, etc. sale of real property
and sale of personal property. [Sec. 42(A)(1) to(26);, NIRC].
(2) Taxable income from sources within the Philippines- remainder after deducting from gross
income, the expenses, losses and other allowable deductions [Sec.42(B)(1)(2) NIRC].

Q. What interests may be treated as gross income from sources within the Philippines?
Ans. Interest derived from sources within the Philippines, and interest on bonds, notes or other
interest-bearing obligations of residents, corporate or otherwise [Sec. 42(A) 2 (a) and (b), NIRC].

Q. What dividends are treated as gross income from sources within the Philippines?
Ans. The amount received as dividends from a domestic corporation or from a foreign
corporation unless:
(1) Less than fifty percent (50%) of the gross income of such corporation;
(2) For the three-year period ending with the close of its taxable year preceding the declaration of
such dividends or for such part of such period as the corporation has been in existence;
(3) Was derived from sources within the Philippines as determined under these provisions;
(4) But only in an amount which bears the same ratio to such dividends as the gross income of
the corporation for such period derived from sources within the Philippines;
(5) Bears to its gross income from all sources [Sec..42(A)(1), NIRC].

Q. What (a) services; (b) rentals and royalties; (c) sale of real property; and (d) sale of
personal property is treated as gross income from sources within the Philippines?
Ans. (a) Services treated as gross income within the Philippines are compensation for labor or
personal services performed in the Philippines [Sec. 42(A)(3), NIRC].

(b) Rentals and royalties from property located in the Philippines or from any interest in such
property, including rentals or royalties for:
(1) The use of or the right or privilege to use in the Philippines any copyright, patent, design or
model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or
right.
(2) The use of, or the right to use in the Philippines of any industrial, commercial or scientific
equipment;
(3) The supply of scientific, technical, industrial or commercial knowledge or information;
(4) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means
of enabling the application or enjoyment of, any such property, or right as is mentioned in par.
(1) or any such equipment as mentioned in par. (2) or any such knowledge or information as is
mentioned in par. (3); or
(5) The supply of services by a nonresident person or his employee in connection with the use of
property or rights belonging to, or the installation or operation of any brand, machinery or other
apparatus purchased from such non-resident person;
(6) Technical advise, assistance or services rendered in connection with such technical
management or administration of any scientific, industrial or commercial undertaking, venture,
project or scheme.
(7) The use of or the right to use motion picture films, films or video tapes for the use in
connection with television, tapes for use in connection with radio broadcasting [2nd par.
Sec.42(E), NIRC of 1997].

(c) Gains, profits and income from the sale of real property located in the Philippines
[Sec.42(A)(5) NIRC of 1997.

(d) The gains, profits and income derived:


(1) From the sale of personal property within and its sale without the Philippines; or
(2) From the purchase of personal property without and its sale within the Philippines shall be
treated as derived entirely from sources within the country in which sold; Provided, however,
that gains from the sales of shares of stock in a domestic corporation shall be treated as derived
entirely from sources within the Philippines regardless of where the said shares are sold [Sec.
42(A) (4), NIRC of 1997].

Q. What are the subclasses or subdivisions of income from sources outside the
Philippines?
Ans. Income from sources without (outside/foreign) the Philippines being subdivided into:
(1) Gross income from sources (without/outside) the Philippines-i.e. interest, dividends,
compensation, rentals, or royalties, gains, profits and incomes from sale of real property located
without the Philippines [Sec. 42(C) (1)(2), Tax Code].
(2) Net income from sources without the Philippines- gross income deducted with expenses,
losses and other allowable deductions [Sec. 42(d), NIRC].

Q. Sub classify income partly from both sources.


Ans. Income from sources partly within/without the Philippines being sub classified as:
(1) Gross income from sources partly within and partly without the Philippines; and
(2) Net income from sources partly within and partly without the Philippines [Sec. 42(e), NIRC],

Q. How to determine the allocation where the income is from sources partly within and
partly without the Philippines?
Ans. The rules being as follows:
(1) Items of gross income, expenses, losses and deductions other than those considered as gross
income from sources within the Philippines or gross income from sources without the
Philippines, shall be allocated or apportioned to sources within or without the Philippines under
the rules and regulations prescribed by the Secretary of Finance upon recommendation of the
Commissioner of Internal Revenue.
(2) Where items of gross income are separately allocated to sources within the Philippines there
shall be deducted (for the purpose of computing the taxable income there from) the expenses,
losses and other deduction which cannot definitely be allocated to some items or classes of
income. The remainder, if any shall be included in full as taxable income from sources within the
Philippines.
(3) In the case of gross income derived from sources partly within and partly without the
Philippines, the taxable income may first be computed by deducting the expenses, losses or other
deductions apportioned or allocated thereto and a ratable part of any expense, loss or other
deduction which cannot definitely be allocated to some items or classes of gross income, and the
portion of such taxable income attributable to sources within the Philippines may be determined
by processes or formulas of general apportionment prescribed by the Secretary of Finance.
(4) Gains, profits and income from sale of personal property produced (in whole or in part) by
the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the
taxpayer without and sold within the Philippines, shall be treated as derived partly from sources
within and partly from sources without the Philippines [First par. Sec.42(E), NIRC of 1997].

Q. What incomes are subject to tax under the National Internal Revenue Code? From
what sources of income are the following persons taxable by the Philippine Government?
1. Citizens of the Philippines residing therein;
2. Non-resident citizen;
3. An individual citizen of the Philippines who is working and deriving income from abroad
as an oversea contract worker;
4. An alien individual, whether resident or not of the Philippines.
Ans. Income subject to tax under the Tax Code are:
(1) Income received from all sources within and without the Philippines by every individual
resident of the Philippines [Sec. 23(A) , NIRC of 1999].
(2) Income derived by a non-resident citizen of the Philippines, an oversea contract worker or
seamen only from sources within the Philippines [Sec. 23(B)(C), NIRC].
(3) Income received from all sources within the Philippines by every alien individual, whether
resident or not [Sec. 23(D), NIRC].
A. CONCEPT OF GROSS INCOME

NIRC SECTION 32 Gross Income


(A) General Definition. Except when otherwise provided in this Title, gross income means all
income derived from whatever source, including (but not limited to) the following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries,
wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a profession;
(3) Gains derived from dealings in property;

Q. What is gross income for purposes of the income tax?


Ans. Gross income means the sum total of all the gains, profits and income, not exempt from tax
by law, derived by a taxpayer during the taxable year, whether from legal, illegal, moral or
immoral sources.

Q. What is the statutory definition of gross income?


Ans. Gross income means all the income from whatever source derived including (but not
limited to) the following items:
(1) Compensation for services in whatever form paid, including but not limited to fees, salaries,
wages, commissions and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a profession.
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prize and winnings
(10) Pensions; and
(11) Partner's distributive share of the gross income of the general professional partnership
(Sec.32(A),Tax Code].

Q. Currently, we hear of the system of income taxation by basing the tax on the gross
rather than on the net income, what do you understand by "gross income taxation"? What
is the system of gross income taxation?
Ans. Gross income taxation means the tax base is the total gross income of an individual during
the taxable year without any deduction allowed.
Q. What are the classes or kinds of taxable gross income?
Ans. They are:
(1) Pure gross income tax- is one where the tax base is the total gross income of an individual
during the taxable year.
(2) Adjusted or modified gross income.
(3) Certain passive income
(4) Gross income subject to final tax; and
(5) Taxable gross compensation income.

Q. What are the advantages if any, of income tax based on gross income over one based
on net income?
Ans. The advantages of gross income taxation are:
(1) The procedure for the computation of the tax is simpler than in the case of taxation based on
net income.
(2) Less discretion will be allowed to the tax examiners thereby minimizing graft.
(3) Examination and/or investigation of tax return can be made faster;
(4) If coupled with an effective withholding tax system would provide more returns to the
government.

Q. What are the disadvantages if any of an income tax based on gross income over one
based on net income?
Ans. The disadvantages of gross income taxation are as follow
(1) A taxpayer may derive gross income but suffers a net loss;
(2) The rule of taxation may not be more equitable; and
(3) if gross income were the basis, it may serve as a disincentive to further employment.
COMPUTING NET INCOME
Q. In brief, what is the meaning of taxable income for purposes of income tax?
Ans. The pertinent items of gross income specified in the Tax Code less the deductions and/or
personal and additional exemptions, if any, authorized for such types of income by the Tax Code
or other special laws ((Sec. 31, NIRC of 1997).

Q, What is the taxable income under the Tax Code?


Ans. The taxable income is:
(1) Taxable gross income
(2) Taxable passive/specified income;
(3) Taxable "adjusted" gross income.
(4) Taxable compensation income
(5) Taxable (net) income
(6) Taxable income from sources within the Philippines;
(7) Taxable (net) income from sources without the Philippines;
(8) Taxable income from sources within and partly without the Philippines.

Q. What is taxable compensation income?


Ans. Taxable compensation income during the year is determined by deducting from the gross
income the amount of personal and additional exemptions allowed by law.

Q. What is net income?


Ans. The term "net income" means gross income less allowable deductions (gross income -
deductions = net income). Under the Tax Code as amended, income for tax purposes is gross
income under Sec.34, NIRC less deductions allowed by Section 34 of the same code. Net income
minus personal/additional exemptions results in taxable net income.

Q. How is taxable net income being determined?


Ans. It is determined by deducting from the gross income the following:
(1) The amount of deductions allowed by Sec. 34 of the Tax Code as amended;
(2) The amount constituting the personal/additional exemptions. in the case of individual
taxpayer.

Q. Cite the concept of taxable income and its coverage.


Ans. Taxable income is the amount or tax base upon which the tax rate prescribed by law is to be
applied. Depending upon the class or kind of taxpayers, taxable income may refer to:
(1) Net compensation income.
(2) Gross compensation income.
(3) Net income; and
(4) Entire gross income.
NET COMPENSATION INCOME- The compensation income arrived at after subtracting
from gross compensation income derived by resident citizens or aliens only the personal and
additional exemptions and premium payments, of any, on health and hospitalization insurance
under certain conditions (par. 2 and (M) Sec. 34).
GROSS COMPENSATION INCOME- The gross compensation income derived by aliens
(including Filipinos) employed by regional and area headquarters and regional operating
headquarters of multinational companies, by offshore banking units, or by foreign petroleum
service contractors and subcontractors (Sec. 25(C) (D) (E), NIRC of 1997).
NET INCOME- The income arrived at after deducting from the gross income (from business or
profession, including compensation income) of a citizen, resident alien, and non-resident alien if
the latter is engaged in trade or business in the Philippines.(a) The deduction of the taxpayer
including personal and additional exemption; or (b) The deduction of the taxpayer including
personal exemption only, or (c_) The deductions of the taxpayer without personal and additional
exemptions.
ENTIRE GROSS INCOME-The entire or gross income (from business or profession,
including compensation income) without any deduction with respect to non-resident aliens not
engaged in trade or business in the Philippines.
Q. How is taxable net income computed?
Ans. The steps involved in computing taxable (net) income are as follows:
First step.- Add up all income received in a given taxable year. Exclude items which are
excluded from the gross income.
Second Step. Unless the income is classified as "compensation income", choose the kind of
deductions advantageous to the taxpayer: either optional standard deduction or the itemized
deduction.
Third step. After selecting the kind of deduction, if proper, deduct it from the gross income.
Fourth step. Determine the exemptions.
Fifth step. Subtract the exemption from the income (i.e., gross income less deductions equals net
income less exemption) to find the taxable net income.

TAX RATES ON PERSONAL INCOME


Q. Who are the taxpayers covered by taxable compensation income?
Ans. They are:
(1) Citizens of the Philippines;
(2) Resident/non-resident aliens;
(3) Overseas contract workers [Sec 23(A)(B)(C)(D), Tax Code of 1997].

Q. What are the steps involved in computing taxable compensation income?


Ans. The steps are:
ADD: The aggregate taxable compensation(gross) income
EXCLUDE: The excluded and exempted items
DETERMINE: The taxable net income by deducting the premium deduction of the taxpayer
including personal exemption only; or (c) The deductions of the taxpayer without personal and
additional exemptions for health/hospitalization/personal exemption, additional personal
exemption for dependents.
APPLY: Tax rates (for 1998-5%-34%; for 1999- 5% -33% and effective January 1, 2000- 5%-
32%)(32% effective Jan 2009 under RA 9337) upon the difference to determine tax due:
DEDUCT: taxes withheld and describe the difference as taxes
refundable/payable (excess tax/deficiency tax).
Q. In relation to the mentioned steps, what is the formula in computing taxable
compensation income?
Ans .The formula:
ADD: Gross compensation income and exclude the excluded items.
LESS: (1) Basic personal exemption (P50, 000) (2) Additional exemption (P25, 000.00 for each
dependent)
EQUALS: Taxable Income
MULTIPLIED BY: Taxable rate: 5%-30% (RA 9337 starting Jan 2009 )
RESULT: Tax Due
LESS: Withholding tax
DIFFERENCE: Tax Payable or the Tax Refundable (excess or deficiency tax).

Q. What is meant by gross compensation income?


Ans. It means all remuneration for services performed by an employee for his employer under
an employee relationship unless exempted by the Tax Code [1st Sec. 2.78(A) (9), Rev. Regs. No.
2-98].
The term compensation includes remuneration for services performed by an employee of a
nonresident alien individual, foreign partnership or foreign corporation, whether or not such alien
individual or foreign entity is engaged in trade or business within the Philippines [First par. Sec.
2.78.1 Rev. Regs. No. 2-98].

Q. Explain the nature of gross income taxation of the compensation income.


Ans. Compensation income as understood in the Philippines is subject to an adjusted or modified
gross income tax because it is reduced only to the personal and additional exemption and
premium payments on health and/or hospitalization insurance, which deductions are not subject
to the discretion of tax authorities and manipulation by taxpayer.

Q. Since gross compensation income is defined as "income arising out of employer-


employee relationship", what is meant by employer-employee relationship?
Ans. Generally, an employer-employee relationship exists when the person for whom services
are performed has the right to control and direct the individual who performs the services, not
only as to the result to be accomplished by the work but also as to the details and means by
which that result is accomplished.

Q. What are some indicia or indication or characteristics of the existence of such


employer-employee relationship?
Ans. The following:
(1) Employee is subject to the will and control of the employer in directing and detailing the
services to be performed.
(2) The right to dismiss enjoyed by employer over the employee;
(3) The furnishing of tools and place of work to the individuals who perform the services (See
also 2nd and 3rd par.Sec. 1.78.3 Rev. Regs. No. 2,-98).

Q. Who are: (a) employers; and (b) employees for tax purposes?
Ans. (a) The term employer means:
(1) Any person for whom an individual performs or performed any service, of whatever nature,
under an employer-employee relationship; it is not necessary that the services be continuing and
the wages are paid in order that the status of employer may exist (Sec. 2.88./4, Regs. No. 2-98).
(2) Any person having control of the payment of the compensation in cases where the services
are or were performed for a person who does not exercise such control ((First Sentence, Sec.
2.78.4(A) Rev. Regs. No. 2,98).
(3) Any person paying compensation on behalf of a non-resident alien individual, foreign
partnership or foreign corporation who is not engaged in trade or business in the Philippines
[First Sentence, Sec. 2.78.4(B) Rev. Regs. No. 2-98].
(b) An employee is an individual performing services under an employer-employee relationship.
The term likewise covers all employees, including officers (i.e., superintendent, managers of a
corporation) and employees, whether elected or appointed, of the Government of the Philippines
or any political subdivision thereof or any agency or instrumentality (Par. Sec. 2, 78.3 Rev. Regs.
No. 2-98).

Q. Who are not employees for tax purposes?


Ans. The following are not considered as employees:
(1) An individual is not considered an employee if he is subject to the control or direction of
another merely on the result to be accomplished by the work and not on the means and methods
for accomplishing the result ((Last Sentence, 3rd par. Sec. 789.3, Rev. Regs. No. 2-98).
(2) Individual who follows an independent trade, business, or profession, in which he offers his
services to the public is not an employee (4th par. Sec. 2.78.3i Rev. Regs. No. 2-98).

Q. What are the examples of gross compensation income?


Ans. Examples are:
(1) Proceeds from profit sharing;
(2) Cost-of-living allowances, children's allowances, medical, grocery bills, etc. unless excluded
from gross income. (3) Overtime pay, 13th month pay, emergency pay, hazard pay.

Q. What are the various names of income that may be considered as compensation
income?
Ans. Names by which remuneration for services are called are immaterial; however, these names
are considered compensation income:
(1) Salaries;
(2) Wages;
(3) Emoluments and honoraria,
(4) Bonuses;
(5) Allowances;
(6) Commissions (e.g.,transportation,,representation, entertainment and the like);
(7) Fees, including director's fees, if the director is at the same time an employee of the
employer/corporation;
(8) Taxable bonuses and fringe benefits except those which are subject to the fringe benefits tax;
(9) Taxable pensions and retirement pay; and
(10) Other income of a similar nature ((2nd par. Sec. 2.78.1 Rev. Regs. No. 2-98).
Note:
(a) Wages, salaries, fees, bonuses, commissions on sales or on insurance premium, pension and
retirement fees, "dismissal payments" are wages within the meaning of the statute, if paid as
compensation for services performed by the employee for his employer (Sec. 8, par. 8th, 10th
par. Rev. Regs. 1-82).
(b) The following are considered compensation income: (1) certain facilities and privileges
offered by the employer to promote health, goodwill, contentment or efficiency to his employees
((Sec. 8, 6th par. Ibid) necessary traveling expenses connected with employer's business85 and
payments made by a general professional partnership. (Sec. 8, 9th par.; Rev. Regs. 1-82).

Q. In what method, period or mode, the income as compensation are being paid?
Ans. Measurement, method of payment, designation of compensation or such other basis of
payment are immaterial. So compensation may be paid in money, or some medium other than
money (i.e. bonds, stocks) or any kind as long as there is proper valuation. So it may be paid on
the basis of piecework percentage of profits, or may be paid hourly, daily weekly, monthly or
annually Sec . 8, 3rd and 4th par. Rev. Rag, 1-82; Third par. Sec. 2.78.1, Reg. Revs. No. 2-98].
Where compensation is paid in property other than money, the employer shall make necessary
arrangement to ensure that the amount of the tax required to be withheld is available for payment
to the Commissioner of Internal Revenue [2nd par. Sec. 1.78.1 (A), (3) Rev. Regs. No. 2-98].

Q. How is compensation paid in kind being valued?


Ans. These rules of valuation:
(1) If services are paid for in a medium other than money, the fair market value of the thing taken
in payment is the amount to be included as compensation subject to withholding.
(2) 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.
(3) If a corporation transfers to its employees its own stock as remuneration for services rendered
by the employee, the amount of such remuneration is the fair market value of the stock at the
time the services were rendered [Sec. 2.78.1(A)(1), Rev. Regs. No. 2-98].

Q. Under the Tax Code state the new method for taxation of compensation income?
Ans. Compensation income is now treated for tax purpose as consisting of two kinds:
(1) The basic compensation income which is subject to allowable deduction90 then to the
schedular rate. (Sec. 24, NIRC).
(2) Certain fringe benefits that are subject to a final withholding tax.( (Sec. 33, NIRC).
Fringe benefits exempted from the payment of fringe benefit tax shall still form part of the
employee's basic compensation income [Sec. 2.33(C), Rev. Regs. No. 3-98].

NIRC Sec 22 (GG) The term 'statutory minimum wage' shall refer to the rate fixed
by the Regional Tripartite Wage and Productivity Board, as defined by the Bureau
of Labor and Employment Statistics (BLES) of the Department of Labor and
Employment (DOLE).
(HH)The term 'minimum wage earner' shall refer to a worker in the private sector
paid the statutory minimum wage, or to an employee in the public sector with
compensation income of not more than the statutory minimum wage in the non-
agricultural sector where he/she is assigned.
BIR ISSUANCES
REVENUE REGULATIONS NO. 010-08 July 8, 2008
Implementing Pertinent Provisions of Republic Act No. 9504, "An Act Amending Sections
22, 24, 34, 35, 51, and 79 of Republic Act No. 8424, as Amended, Otherwise Known as
The National Internal Revenue Code" Relative to the Withholding of Income Tax on
Compensation and Other Concerns
Exemptions from Withholding Tax on Compensation. The following income payments
are exempted from the requirements of withholding tax on compensation:
xxxxxxxxx
Compensation income of Minimum Wage Earnerss who work in the Private sector and
being paid the Statutory Minimum Wage (SMW), as fixed by Regional Tripartite Wage
and Productivity Board (RTWPB)/National Wages and Productivity Commission
(NWPC), applicable to the place where he/she is assigned.
The aforesaid income shall likewise be exempted from income tax.
'Statutory Minimum Wage' (SMW) shall refer to the rate fixed by the Regional Tripartite
Wage and Productivity Board (RTWPB), as defined by the Bureau of Labor and
Employment Statistics (BLES) of the Department of Labor and Employment (DOLE). The
RTWPB of each region shall determine the wage rates in the different regions based on
established criteria and shall be the basis of exemption from income tax for this purpose.
Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the
aforementioned MWE shall likewise be covered by the above exemption. Provided,
however, that an employee who receives/earns additional compensation such as
commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory
amount of P30,000.00 (now 82,000 RA 10653), taxable allowances and other taxable
income other than the SMW, holiday pay, overtime pay, hazard pay and night shift
differential pay shall not enjoy the privilege of being a MWE and, therefore, his/her
entire earnings are not exempt form income tax, and consequently, from withholding tax.
MWEs receiving other income, such as income from the conduct of trade, business, or
practice of profession, except income subject to final tax, in addition to compensation
income are not exempted from income tax on their entire income earned during the
taxable year. This rule, notwithstanding, the SMW, Holiday pay, overtime pay, night shift
differential pay and hazard pay shall still be exempt from withholding tax.
For purposes of these regulations, hazard pay shall mean the amount paid by the
employer to MWEs who were actually assigned to danger or strife-torn areas, disease-
infested places, or in distressed or isolated stations and camps, which expose them to
great danger of contagion or peril to life. Any hazard pay paid to MWEs which does not
satisfy the above criteria is deemed subject to income tax and consequently, to
withholding tax.

FRINGE BENEFITS TAXATION (Sec 33 Tax Code)


Q. (a) What is meant by fringe benefits tax? (b) State its nature?
Ans. (a) Fringe benefits tax is a final withholding tax imposed on the grossed-up monetary value
of fringe benefits furnished, granted or paid by the employer to the employee, except rank and
file employees [First par. Sec. 2.33(A) Rev. Regs. NO. 3-98].
(b) The fringe benefits tax shall be treated as final tax of income of the employee [2nd par. Sec.
2.33 (A), Rev. Regs. No 3-98].

Q. In connection with fringe benefits tax, explain the meaning of: (1) rank and file
employees; (2) managerial employees and (3) Supervisory employees.
Ans. Explaining the meaning:
(1) Rank and file employees - mean employees who are holding neither managerial nor
supervisory position as defined under existing Labor Code of the Philippines [Sec. 22(AA),
NIRC of 1997].
(2) Managerial employee- is one who is vested with powers and prerogatives to lay down and
execute management policies and/or to hire, transfer, suspend, layoff, recall, discharge, assign
and/ or discipline employees.
(3) Supervisory employees are those who, in the interest of the employer, effectively
recommend such managerial actions if the exercise of authority is not merely routinary or
clerical in nature but require the use of independent judgment.

Q. What are fringe benefits?


Ans. Fringe benefits, for purposes of taxation, shall mean any good, service or other benefit
furnished or granted in cash or in kind by an employer to an individual employee (except rank
and file employees) such as but not limited to:
(1) Housing
(2) Expense account;
(3) Vehicle of any kind
(4) Household personnel, such as maid, driver and others;
(5) Interest on loan of 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 employer 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. Sec. 33(B)NIRC of 1997,[ lst par. Sec. 2.33(B) Rev. Regs. No. 3-98].

Q. Who are the employers subject to the fringe benefits tax?


Ans. Employer, whether an individual, professional partnership or corporation (taxable or
exempt), government granting fringe benefits is subject to fringe benefit tax [Sec. 33 (A) NIRC
of 1997; Sec. 2.33 (A), Rev. Regs. No. 3-98].
Unless exempted.
Sec. 32 (A) NIRC of 1997; lst par. Sec. 2.33(A) Rev. Rags. No. 3-98; last par. Sec. 32(C),
NIRC of 1997; Sec. 2.33 (C) Rev. Regs. No. 3-98.

Q. Who are the employees subject to the taxation of fringe benefits?


Ans. They are:
(1) Resident employees (not rank and file) receiving fringe benefits.
Sec. 33(A) NIRC of 1997;

(2) Non-resident alien individuals (not rank and file) receiving fringe benefits.
Sec. 33(A) in relation to Sec. 25(B(C)(D)(E) 1997 NIRC;

(3) Employees in special economic zones.


Last par. Sec. 2.33 (A) Rev. Regs. No. 3-98.

Q. What is subject to fringe benefits tax? How is it determined?


Ans. Grossed-up monetary value of the fringe benefits is the one subject to fringe benefits tax. It
is determined by:
(1) Valuation of the benefit granted; and
(2) Determination of the proportion or percentage of the benefit which is subject to the fringe
benefit tax.

Q. What does the taxable grossed-up monetary value of the fringe benefits consist of?
Ans. The grossed-up monetary value of the fringe benefit represents:
(1) The total amount of income realized by the employee which includes the net amount of
money or net monetary value of the property which has been received plus the amount of fringe
benefit thereon otherwise due from the employer but paid by the employer for and in behalf of his
employee. The percentage basis being: 66% effective January 1, 1998; 67% effective January 1,
1999 and 68% effective January 1, 2000 and thereafter (Sec. 33 (A) NIRC of 1997

(2) The grossed-up monetary value of the fringe benefit shall be determined by dividing the
actual monetary value of the fringe benefit
(a) By 68% if fringe benefits received by resident employees following this Formula: 100%
less 32% equals 68%.
(b) By 75% if fringe benefits received by nonresident alien individual not engaged in trade or
business with the Philippines at this formula: 100% less 25% equals 75%
(c) By 85% if fringe benefits received by nonresident alien individual employed in regional
or area headquarters. regional operating headquarters of multi-national companies, offshore
banking units and petroleum service contractor and subcontractor, or any Filipino individual
employees who are employed and occupying the same positions as those occupied or held by alien
employees following this formula: 100% less 15% equals 85%. Sec. 32(A) in relation to Sec.
25(B)(C)(D) (E) NIR of 1997; 10th par. Sec. 2.33 (A), Rev. Reg. Nos. 3-98; 11th par. Sec. 2.33
(A) Rev.Regs.. No. 3-98
(d) by normal rate of fringe benefit for fringe benefits received by employees in special
economic zones including Clark Special Economic Zone and Subic Special Economic and Free
Trade Zone.
Q. What are the general guidelines for valuation on fringe benefits subject to fringe
benefit tax?
Ans. The basic guidelines are:
(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 value of the fringe benefit shall be equal
to fair market value of the property as determined by the Commissioner of Internal Revenue.
(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.

Q. What are the cases when fringe benefits irrespective of kind are not taxable or when
exempt from fringe benefits tax?
Ans. The following:
(1) When 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 the employer [Sec. 32(A)
NIRC of 1997; 1st par. Sec. 2.33 (A)Rev. Regs. No. 3-98].

Q. What are the kinds of fringe benefits that are not taxable or not subject to the fringe
benefits tax?
Ans. The following:
(1) Fringe benefits which are authorized and exempted from income tax under the Tax Code or
under any special law; lst par. Sec. 2.78, 1(3) Rev. Regs. No. 2-98; Waller Maritime Services
Inc. v. Commissioner of Internal Revenue CTA Case No. 5181 prom. Sept. 3, 1996.
(2) Contributions of the employer for the benefit of the employee to retirement, insurance and
hospitalization benefits plan;
(3) Benefits given to the rank and file employees, whether granted under a collective bargaining
agreement or not; and
(4) De minimis benefits as defined in the rules and regulations to be promulgated by the
Secretary of Finance upon recommendation of the Commissioner of Internal Revenue [Sec.
2.33(c) Rev. Regs. No. 3-98].

Q. (a) What is meant by de minimis benefit? (b) Give examples of de minimis benefit.
Ans. (a) The term de minimis benefits which are exempt from the fringe benefits tax shall, in
general, be limited to facilities or privileges furnished or offered by an employer to his
employees that 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 [3rd
par. Sec.2.33(C) Rev.Regs. No. 3-98].
(b) Examples of benefits categorized as de minimis benefits and not subject to fringe
benefits tax are:
(1) Monetized unused vacation leave credits of employees not exceeding ten(10) days
during the year;
(2) Medical cash allowance to dependents of employees not exceeding P750.00 per semester
or P125.00 per month;
(3) Rice subsidy of P1,000.00 per month granted by an employer to his employees;
(4) Uniforms given to employees not more than P3,000.00 per
year;
(5) Medical benefits given to the employees by the employer;
(6) Employee achievement awards, e.g., for length of service or safety achievement, which
must be in the form of a tangible personal property other than cash or gift certificates, with an
annual monetary value not exceeding one-half (1/2) month of the basic salary of the employee
receiving the award under an established written plan which does not discriminate in favor of
highly paid employees;
(7) Christmas and major anniversary celebrations for employees and their guests;
(8) Company picnics and sport tournaments in the Philippines and are participated exclusively
by employees; and
(9) Flowers, fruits, book or similar items given to employees under special circumstances. etc.
on account of illness, marriage, birth of a baby, etc. [Last par. Sec. 2.33(C) Rev.Regs. No. 3-98

A. RESIDENT ALIENS
Q. For taxation purposes, how are resident aliens classified?
Ans. Basically, resident aliens for taxation purposes are classified as follows:
(1) Resident alien with:
(a) Compensation income in the Philippines;
(b) Gross income in the Philippines are taxed similarly as citizens of the Philippines.
(2) Resident aliens whose country does not grant Filipinos with tax credit cannot enjoy tax credit
deduction under the principle of reciprocity.
B. TAXABLE NON- RESIDENT ALIENS
Q. For taxation purposes, how are nonresident aliens, classified?
Ans. Nonresident aliens are classified as:
(1) Nonresident alien doing business in the Philippines;
(2) Nonresident alien not doing business in the Philippines.
(3) Nonresident aliens employed by regional or area headquarters of multi-national corporations;
(4) Nonresident aliens employed by offshore banking units;
(5) Nonresident aliens employed by petroleum service contractors.
Q. What is the format/steps/formula of nonresident alien individual doing business in the
Philippines.
Ans. The steps or format:
ADD: Gross income from sources within the Philippines
LESS: Allowable deductions
EQUALS: Net Income in the Philippines
DEDUCT: Exemption (if country grants similar rights to Filipinos).
EQUALS: Taxable Net Income
APPLY/MULTIPLY TAX RATES: 5%-32% effective Jan. 1, 2009.
DIFFERENCE: Tax Due/ Payable
Note: Reminders:
(a) Nonresident aliens cannot claim tax credit.
(b) Nonresident aliens gross income from outside the Philippines are not included (not taxable).
(c) Nonresident aliens enjoyment of personal exemption is subject to limitations/qualifications
(reciprocal exemptions).

Q. Give the formula or steps or format for nonresident alien individual not doing business
in the Philippines.
Ans. As presented:
GROSS INCOME from sources within the Philippines.. .P ...........
Apply: 25%..................................................... ............... x .25
Tax Due.................................................................. .....P..

Q, For Nonresident alien employed in regional/area headquarters, offshore banking


units, petroleum service contractor.
Ans. As presented
GROSS INCOME [from employment]................... . ....P.
Apply: 15%..................................................................... . x.15
Tax Due: P............

PROFESSIONAL INCOME/BUSINESS INCOME

Q. Who are the taxpayers covered by business/trade/and professional income?


Ans. They are:
(1) Self-employed persons engaged in business/proprietor;
(2) Professionals
engaged in trade or business within the Philippines.
(3) Resident/non-resident Filipinos.
(4) Nonresident alien

Q. What is meant by engaged in trade or business? What does the term include?
Ans. It is synonymous with "carrying on a business". It connotes more than a single act or
isolated transactions for it involves continuity of action (Day v. Equitable Life, 83 Fed/144.268;
BIR Ruling January 15, 1959). The term includes the performance of the functions of a public
office [Sec.22(S), NIRC] and performance of personal services within the Philippines (Par. 2,
Sec. 8, Regs. No. 2).

Q. What are the steps involved in computing the taxes due for those taxpayers engaged
in trade, business and engaged in the exercise of their professions?

Ans. The steps involved are:


ADD: The aggregate of compensation he received to determine the gross income derived from
business/profession.
EXCLUDE; Exclude the excluded/exempted items.
DEDUCT:
(1) Optional standard deduction (40%). or
(2) Itemized allowable deductions;
DIFFERENCE: Taxable Income
LESS:
(1) Basic personal exemption (P50, 000.00,
(2) Additional exemption (P25, 000.00 for each dependent but not more than 4
dependents.
To determine the Net Taxable Income
APPLY: Schedular Tax rates [5%- 32%, effective Jan.1,2009].RA 9337
DEDUCT: Tax withheld
DIFFERENCE: Tax Payable or Tax Refundable.

Q. What is the formula for computing the taxes for taxpayers engaged in trade, business
and those exercising their profession?
Ans. Basically , the formula for computation of types of income being as follows:
ADD: Gross income from business/trade/profession
LESS:
(1) Optional standard deduction-(40%) or Itemized deductions
(a) business expenses
(b) Interest,
(c) Taxes;
(d) bad debts;
(e) Depreciation, depletion, etc.etc.
(2) Basic personal exemption (P50, 000)
(3) Additional exemptions (P25,000.00 for each dependent);
EQUALS: Taxable Income
MULTIPLIED BY TAX RATES- 5%-32% effective Jan. 1, 2009 (RA 9337)
RESULT: Tax Due
LESS: Withholding Tax
DIFFERENCE: Tax Payable/Refundable (excess or deficiency tax).

GAINS FROM DISPOSITION OF PROPERTY

Q. Discuss this topic "income from sales or dealings in property."


Ans. Sales or dealings in property (real or personal ) may result either in gains or losses. The rule
is that the entire amount of gains or losses arising from such transaction shall be taxable or
deductible to some extent. When property is sold and the gain is measured by computing the
difference between the selling price and its cost less allowance for amortization. The rule is
applicable to sales of goodwill, patents, copyrights, and forced sales (i.e., expropriation).

Q. Discuss taxation of disposition of property.


Ans. The disposition of property for money (i.e., sale) or other property or item (exchange) or for
a combination of both, results in either gain (or losses).
Generally, the amount of gain (or losses) arising there from is taxable.

Q. What factors determine gains (or losses)?


Ans. The following factors are necessary:
(1) Basis of property disposed of in general is the cost at which the taxpayer acquired the
property.
(2) Adjustment as to the basis which may either make the form of additions(additional
expenditure) or recoveries (depreciation).
(3) Amount realized for the disposal of property.
(4) Nature or character of the property disposed of, whether capital asset or non-capital assets;
and
(5) Period during which the property was held by the taxpayer and this is known as the "holding
period."

Q. State the formula used in disposition of property.


Ans. The following:
(1) In case of gain:
Selling price of the property
Less: Basis of property
Equals: gain from the sale
(2) In case of loss:
Basis of property
Less: Selling price of property
Equals: loss from sale

Q. In case of property dealings and disposition, what should be the basis of computation?
Ans. The following:
(1) In case of property acquired by purchase, its cost (i.e., purchase price plus expenses of
acquisition) is the basis [Sec. 40(B), Sec. 136, Reg. No. 2].
(2) In case of property which should be included in the inventory, the basis is the latest inventory
value (Sec. 41; Sec. 136 Reg. No. 2).
(3) In case of property included in the inventory, the basis is the latest inventory value.
(4) In case of property acquired by devise bequest or inheritance- its fair market price or value as
of the date of the acquisition [Sec. 40(B), Sec. 139, Regs. No. 2].
(5) Property acquired by gift- the same as it would be in the hands of the donor or the last
preceding owner by whom it was not acquired by gift, except that if such basis is greater than the
fair market value of the property, then the purpose of determining loss, the basis shall be such
fair market value [Sec. 40(B) NIRC of 1997].
(6) In case of property acquired for less than an adequate consideration in money or money's
worth- The basis of such property is the amount paid by the transferee for the property, or the
transferor's adjusted basis; and
(7) Property acquired in a transaction where gain or loss not recognized, the basis shall be that
defined in Sec. 40 (C), 5 of the Tax Code.

Q. What are the dispositive transactions where gains and losses are not recognized?
Ans. They are as follows:
(1) Exchange of property where the property received is not substantially different from the
property disposed of (Sec. 140 Reg. No. 2).
(2) Exchange of property solely in kind in pursuant of corporate mergers and consolidation
(3) Exchange by a person of his property for stock in a corporation as a result of which said
person alone or together with others not exceeding four(4) persons, gains control of said
corporation [Sec. 34, (C), (2), NIRC].

Q. Are there transactions where gain is recognized but not the loss?
Ans. Yes, the following transactions:
(1) Transaction between related taxpayers [Sec. 36(B) Sec. 122, Regs. No. 2].
(2) Illegal transactions (Sec. 96, Regs. No. 2 ).
(3) Exchange of property, not solely in kind, in pursuance of corporate mergers and
consolidation [Sec. 40 (C) (3), NIRC of 1997].
Note: See more of this topic under Corporate Taxation, pp. 225-240 of this reviewer.

B . CAPITAL GAINS AND LOSSES


Q. Generally, how are assets classified?
Ans. Assets are classified for income tax purposes into:
(1) Ordinary assets;
(2) Capital assets which are subdivided into:
(a) Long term assets; and
(b) Short term assets.
Q. Give the concept of ordinary assets.
Ans. Ordinary assets are:
(1) Stock in trade of the taxpayer or other property of a kind which would properly be included
in the inventory of the taxpayer (e.g., merchandise inventory, finished goods, work in process
and raw materials inventories).
(2) Property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade or business (e.g., subdivision lots held for sale by subdivision owner);
(3) Property used in the trade or business and subject to depreciation (i.e., office equipment,
car); and
(4) Real property used in trade or business (e.g., land used in the operation of the business;
property primarily held for rent) [Sec. 39(A)(1), NIRC of 1997].

SECTION 39 Capital Gains and Losses


(A) Definitions - As used in this Title
(1) Capital Assets. The term 'capital assets' means property held by the taxpayer (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
customers in the ordinary course of his trade or business, or property used in the trade or
business, of a character which is subject to the allowance for depreciation provided in Subsection
(F) of Section 34; or real property used in trade or business of the taxpayer.

Q. What is meant by capital assets?


Ans. The term under Sec. 39 of the Tax Code refer to property held by taxpayer whether or not
connected in trade or business but not falling under the category of ordinary assets such as
account receivables, sugar quota (BIR Ruling Oct. 26, 1959), interest in partnership and joint
ventures (Sec. 142, Regs. No. 2); franchise rights, property subdivided and sold to tenants at the
instance of the government ; (Roxas v. CTA L-25045, April 28, 1968) , properties held for
investments and residential houses or as follows:
(1) Stock in trade of the taxpayer or other property of a kind which would properly be included
in the inventory of the taxpayer (e.g., merchandise inventory, finished goods, work in process
and raw materials inventories).
(2) Property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade or business (e.g., subdivision lots held for sale by subdivision owner);
(3) Property used in the trade or business and subject to depreciation (i.e., office equipment,
car); and
(4) Real property used in trade or business (e.g., land used in the operation of the business;
property primarily held for rent) [Sec. 39(A)(1), NIRC of 1997].

Q. Why is there a necessity of knowing the kind of assets?


Ans. It is important to know the classification because gains (or losses) from sales or exchange
of capital assets have preferential tax treatment not applicable to gains (or losses) from sales or
exchanges of ordinary assets.

Q. Define the following: (1) capital gain; (2) capital loss; (3) net capital gain; (4) net
capital loss; (5) ordinary gain; and (6) ordinary loss.
Ans. Defining them:
(1) Capital gain- the gain derived from sale or exchange of capital assets.
(2) Capital loss- is the loss incurred from the sale or exchange of capital assets.
(3) Net capital gain- is the excess of the gains from sales or exchanges of capital assets over the
losses from such sales or exchanges [Sec. 39(A)(2), NIRC of 1997].
(4) Net capital loss- is the excess of the losses from the sales or exchanges of capital assets over
the gains from such sales or exchanges [Sec. 39(3), NIRC of 1997].
(5) Ordinary gain- is the gain derived from the sale or exchange of ordinary assets. It includes
all gains other than capital gains, such as those derived from the performance of services,
whether personal or professional, and those accruing from business.
(6) Ordinary loss- is the excess of expenses and losses over the income of the taxpayer
excluding capital gains and capital losses or the loss incurred from the sale or exchange of an
ordinary asset.

Q. Explain the meaning of the two classes of capital gain (or loss).
Ans. They are:
(1) Short term capital gain (or loss)- the gain (or loss) arising from the sale or exchange of
capital assets held for not more than 12 months (i.e., less than one year).
(2) Long term capital gain (or loss)- the gains (or losses) arising from the sale or exchange of
capital assets held for more than twelve months [Sec.39(3), NIRC].
Note: Net capital loss carry over- the net capital loss in one year which cannot be deducted from
the ordinary income but which would be carried over to the next taxable year by a taxpayer (not
available to corporation but only to individuals) as a deduction against net capital gain up to an
amount equal to the net income before exemption in the year the loss was sustained.
Q. What are the requisites for the recognition of capital gain or loss?
Ans. The requisites are:
(1) The transaction must involve property classified as capital assets; and
(2) The transaction must be a sale or exchange or one considered as equivalent to a sale or
exchange.

Q. Differentiate capital gains from ordinary gains. Give examples of ordinary gains.
What is the difference between capital gains and ordinary gains?
Ans. Distinguishing the two:
(1) The source of capital gain is property not used in trade or business while the source of
ordinary gain is property used in trade or business;
(2) Some types of capital gains are adjusted by the holding period while the holding period does
not find application to ordinary gains.
(3) Capital losses may only be deducted from capital gain while from certain types of capital
gains there may be deducted ordinary losses.

Q. What are the basic rules on the recognition of capital gains or losses from the
disposition of personal property classified as capital asset where the taxpayer is an
individual.
Ans, The rules are:
First, The percentage of gain (or loss) to be taken into account shall be the following:
(1) 100%-capital assets held for 12 months or less;
(2) 50%- capital assets held for more than 12 months.
Second, capital loss shall be deducted to the extent only of the capital gains; hence, the net
capital loss is not deductible.
Third, A net capital loss in a taxable year in an amount not in excess of the net income before
exemption for that year shall be deducted from the net capital gains of the next succeeding
calendar year only.
Fourth, ordinary losses are deductible from capital gains.
Fifth, Gains or losses from short sales of property shall be considered as gains or losses from
sales or exchanges of capital assets.

NIRC Sec 22(Z) The term 'ordinary income' includes any gain from the sale or exchange of
property which is not a capital asset or property described in Section 39(A)(1). Any gain from
the sale or exchange of property which is treated or considered, under other provisions of this
Title, as 'ordinary income' shall be treated as gain from the sale or exchange of property which is
not a capital asset as defined in Section 39(A)(1). The term 'ordinary loss' includes any loss from
the sale or exchange of property which is not a capital asset. Any loss from the sale or exchange
of property which is treated or considered, under other provisions of this Title, as 'ordinary loss'
shall be treated as loss from the sale or exchange of property which is not a capital asset.

Q. Discuss this topic "income from sales or dealings in property."


Ans. Sales or dealings in property (real or personal ) may result either in gains or losses. The rule
is that the entire amount of gains or losses arising from such transaction shall be taxable or
deductible to some extent. When property is sold and the gain is measured by computing the
difference between the selling price and its cost less allowance for amortization. The rule is
applicable to sales of goodwill, patents, copyrights, and forced sales (i.e., expropriation).

NIRC Sec 24(C) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange.
The provisions of Section 39(B) notwithstanding, a final tax at the rates prescribed below is
hereby imposed upon the net capital gains realized during the taxable year from the sale, barter,
exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or
disposed of through the stock exchange.
Not over P100,000 5%
On any amount in excess of P100,000 10%

BIR ISSUANCES
REVENUE REGULATIONS NO. 006-08 April 22, 2008
Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or
Other Disposition of Shares of Stock Held as Capital Assets
Pursuant to Section 244, in relation to Sections 24 (C), 25 (A) (3), 25 (B), 27 (D) (2), 28 (A)
(7) (c), 28 (B) (5) (c), 34 (D) (4) (5), 38, 40, and Section 127 (A) and (B) of the 1997
National Internal Revenue Code (Tax Code), as amended, these Regulations are hereby
promulgated in order to harmonize and consolidate the rules relative to the imposition of tax for
the sale, barter, exchange or other disposition of shares of stock of domestic corporation that are
listed and traded through the Local Stock Exchange, or disposition of shares through Initial
Public Offering (IPO) or disposition of shares not traded through the Local Stock Exchange.

NIRC Sec 24(D) Capital Gains from Sale of Real Property


(1) In General The provisions of Section 39(B) notwithstanding, a final tax of six percent
(6%) based on the gross selling price or current fair market value as determined in accordance
with Section 6(E) of this Code, whichever is higher, is hereby imposed upon capital gains
presumed to have been realized from the sale, exchange, or other disposition of real property
located in the Philippines, classified as capital assets, including pacto de retro sales and other
forms of conditional sales, by individuals, including estates and trusts: Provided, That the tax
liability, if any, on gains from sales or other dispositions of real property to the government or
any of its political subdivisions or agencies or to government-owned or -controlled corporations
shall be determined either under Section 24(A) or under this Subsection, at the option of the
taxpayer;
(2) Exception The provisions of paragraph (1) of this Subsection to the contrary
notwithstanding, capital gains presumed to have been realized from the sale or disposition of
their principal residence by natural persons, the proceeds of which is fully utilized in acquiring or
constructing a new principal residence within eighteen (18) calendar months from the date of
sale or disposition, shall be exempt from the capital gains tax imposed under this Subsection:
Provided, That the historical cost or adjusted basis of the real property sold or disposed shall be
carried over to the new principal residence built or acquired: Provided, further, That the
Commissioner shall have been duly notified by the taxpayer within thirty (30) days from the date
of sale or disposition through a prescribed return of his intention to avail of the tax exemption
herein mentioned: Provided, still further, That the said tax exemption can only be availed of once
every ten (10) years: Provided, finally, That if there is no full utilization of the proceeds of sale
or disposition, the portion of the gain presumed to have been realized from the sale or disposition
shall be subject to capital gains tax. For this purpose, the gross selling price or fair market value
at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized
amount bears to the gross selling price in order to determine the taxable portion and the tax
prescribed under paragraph (1) of this Subsection shall be imposed thereon.

BIR ISSUANCES
REVENUE REGULATIONS NO. 14-00 November 20, 2000
Sale, Exchange or Disposition, by a Natural Person, of His "Principal Residence"
These regulations are hereby promulgated in order to streamline and make more efficient the
collection of the capital gains tax, if any, presumed to have been realized from the sale,
exchange or disposition, by a natural person, of his "Principal Residence."
REVENUE MEMORANDUM CIRCULAR NO. 45-02 October 14, 2002
Procedural Requirements for the Tax Exemption of Sale of Principal Residence.The concerned
Revenue District Officer shall see to it that if upon the lapse of thirty (30) days following the end
of the eighteen-month construction/acquisition period, there is no showing that the seller has
utilized the proceeds of sale, exchange or disposition of his old principal residence to acquire or
construct his new principal residence, said RDO shall forthwith initiate the assessment of the
deficiency capital gains tax and, thereafter, apply the escrowed bank deposit account against the
deficiency tax liability.

PASSIVE INVESTMENT INCOMES


Q. What is meant by dividends as used in the Tax Code?
Ans. Dividends means any distribution by a corporation out of its earnings or profits and payable
to its shareholders, whether in money or in other property.

Q. How is income from dividends treated for income purposes?


Ans. Taxable treatment depends upon the form of dividends:
(1) Cash dividend- it is paid to shareholders or members in cash and is taxable at 6%/8%/10%
beginning January 1,1998/1999/2000.
(2) Property dividend- paid in property of the corporation such bonds (also called bond
dividend) securities or stock investments held by the corporation paying the dividend and is
taxable at the same rate as cash dividend.
(3) Stock dividend- paid in stock and is not taxable unless it represents a distribution of earnings
or profits. (Sec 73(B),NIRC).
(4) Scrip dividend- it is issued in the form of a promissory note and is taxable at the same rate as
cash dividend.
(5) Liquidating dividend- it involves the distribution of assets by a corporation to its
stockholders upon dissolution and is taxable when gain is realized by the stockholder. [Sec.
73(A), NIRC].
(6) Indirect dividends-other payments or rights received by the taxpayer which are dividends.
Thus, if a corporation to which the stockholder is indebted forgives his debt, the transaction has
the effect of cash payment (Gutierrez v. Collector (CTA Case No. 65).

Discuss gross income derived from interest.


Ans. Interest income is only such interest arising from indebtedness; that is, compensation for the
use of money or forbearance. Interest received by a taxpayer, whether usurious or not, is
taxable[Sec.28 (b)(4) NIRC], unless the law specifically exempts such interest from tax [Sec.
2(d) Rev. Regs. 1-82] or such interest is subject to final tax (Sec. 2, Rev.Regs. 1-82).
. Thus, interest received from other sources shall form part of the taxpayer's net taxable income
under Sec. 24(A) or Sec. 27(A) of the Tax Code.

NIRC Sec 24 (B) Rate of Tax on Certain Passive Income:


(1) Interests, Royalties, Prizes, and Other Winnings A final tax at the rate of twenty percent
(20%) is hereby imposed upon the amount of interest from any currency bank deposit and yield
or any other monetary benefit from deposit substitutes and from trust funds and similar
arrangements; royalties, except on books, as well as other literary works and musical
compositions, which shall be imposed a final tax of ten percent (10%); prizes (except prizes
amounting to Ten thousand pesos (P10,000) or less which shall be subject to tax under
Subsection (A) of Section 24; and other winnings (except Philippine Charity Sweepstakes and
Lotto winnings), derived from sources within the Philippines: Provided, however, That interest
income received by an individual taxpayer (except a nonresident individual) from a depository
bank under the expanded foreign currency deposit system shall be subject to a final income tax at
the rate of seven and one-half percent (7 1/2%) of such interest income: Provided, further, That
interest income from long-term deposit or investment in the form of savings, common or
individual trust funds, deposit substitutes, investment management accounts and other
investments evidenced by certificates in such form prescribed by the BangkoSentralngPilipinas
(BSP) shall be exempt from the tax imposed under this Subsection: Provided, finally, That
should the holder of the certificate pre-terminate the deposit or investment before the fifth (5th)
year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the
depository bank from the proceeds of the long-term deposit or investment certificate based on the
remaining maturity thereof:
Four (4) years to less than five (5) years 5%;
Three (3) years to less than four (4) years 12%; and
Less than three (3) years 20%.
(2) Cash and/or Property Dividends A final tax at the following rates shall be imposed upon
the cash and/or property dividends actually or constructively received by an individual from a
domestic corporation or from a joint stock company, insurance or mutual fund companies and
regional operating headquarters of multinational companies, or on the share of an individual in
the distributable net income after tax of a partnership (except a general professional partnership)
of which he is a partner, or on the share of an individual in the net income after tax of an
association, a joint account, or a joint venture or consortium taxable as a corporation of which he
is a member or co-venturer:
Six percent (6%) beginning January 1, 1998;
Eight percent (8%) beginning January 1, 1999;
Ten percent (10%) beginning January 1, 2000.

Rental income
(1) Lease of personal property
(2) Lease of real property
(3) Tax treatment of
(a) Leasehold improvements by lessee
(b) VAT added to rental/paid by the lessee
(c) Advance rental/long term lease

EXCLUDED (NON-TAXABLE INCOME)


A. EXCLUDED INCOME
Q. Discuss briefly whether or not all income is taxable.
Ans. Generally, all income are taxable; however, some income are excluded or non-taxable and
they fall under the term "exclusion."

Q. What is exclusion?
Ans. Exclusions refers to income received or earned or capital items declared expressly by the
Tax Code or by special laws to be non-taxable.

Q. What are the types of exclusions?


Ans. They are:
(1) Substantive exclusions- receipts which are not considered as income and therefore not
taxable.
(2) Temporary exclusions- exclusions from gross income which results from a timing
recognition of income. In other words, these are income which are deferred recognition for
income tax purposes.

Q. What laws govern the exclusion of gross income?


Ans. Income or items not included in the gross income; hence, exempt from taxation or
considered as non-taxable are expressly provided by:
(1) National Internal Revenue Code of 1977/1997;
(2) The 1987 Constitution;
(3) Special laws and legislations;
(4) Presidential decrees and executive orders;
(5) Recent legislations of the Congress of the Philippines; and
(6) Judicial decisions.

Q. What income are excluded from gross income?


Ans. Under Sec 32(B) of the Tax Code the following items shall not be included in the gross
income and shall be exempt from taxation:
(1) Life insurance.
(2) Amount received by insured as return of premium;
(3) Gifts, bequests and devises;
(4) Interest on government securities;
(5) Compensation for injuries or sickness;
(6) Income exempt from treaty.
(7) Retirement benefits, pensions and gratuitous-
(a) Under reasonable benefit plan maintained by the employer;
(b) Received in consequence of separation from service due to death, sickness;
(c) Received from foreign government agencies;
(d) Benefits from US Veteran Administration
(e) Benefits under Social Security Act;
(f) Benefits under the GSIS [Sec. 32(B) (1) to (6) Tax Code].
(8) Miscellaneous items-
(a) Income received from certain investments;
(b) Income derived from public utility;
(c) Income derived as reward;
(d) Income earned from certain deposits under the expanded foreign currency deposit
system;
(e) Prizes and awards in recognition of religious, charitable, literary, civic
achievement,etc.

Q. What are the conditions for exclusion of life insurance proceeds from gross income?
Ans. The proceeds of life insurance policies must be paid to irrevocable beneficiaries upon the
death of the insured, whether in a single sum or otherwise, but if such amounts are held by the
insurer under an agreement to pay interest thereof, the interest payable shall be included in gross
income [Sec. 32(B)(11); 1.78.1(B)(7) ; Rev. Regs. No. 2-98].
The reason for such exclusion is that life insurance proceeds represent indemnity not income.

Q. Are amounts received by insured as return of premium to be excluded from the gross
income?
Ans. Yes, provided they are received by insured as a return of premiums paid by him under life
insurance, endowment or annuity contracts, either during the term or at maturity of the term
mentioned in the contract or upon surrender of the contract.87 The returned amount not an
income but a return of capital; hence, to be excluded. However, interest or earnings of premiums
returned are already income, not merely a return of capital so it must be included in the gross
income.

Q. Why are gifts, bequests, and devises exempt from income taxation?
Ans. Because they are subject to estate tax or donor's tax. However, income from property
acquired by gift, bequest, devise or descent, as well as gift, bequest, devise or descent of income
from any property (i.e., rentals, interest, disposition, etc.), in cases of transfer of divided interest
shall be included in gross income [Sec. 32(B)(3), NIRC of 1997].

Q. What is the gift tax test?


Ans. A gift is any transfer not in the ordinary course or business which will not be made for full
and adequate consideration in money or money's worth (Fraid-Ex--Sultaneth v. Commissioner,
150 F qd. 812(2nd Cir.) (NIRC Sec 100 )

Q. Discuss the basic distinction between compensation (income) and gift and their
corresponding tax treatment.
Ans. These distinctions and rules:
First, if the payment is intended to represent payment whether designated as compensation or
otherwise, for services rendered either in the past, present or future, the amount received will be
taxable income to the recipient.
Second, if the payments are made to show goodwill or a mere kindliness towards the recipients
and are not intended as a recompense for services rendered, then the payments represent gifts and
should be exempt.
Third, a payment made in satisfaction of a moral obligation or claim without legal obligation to
pay is not a gift and is subject to tax.

Q. Are compensation for injuries or sickness subject to exclusion or excluded from the
gross income?
Ans. Yes. Amounts received through Accident or Health Insurance or Workmen's Compensation
Act or as compensation for personal injuries or sickness plus the amount of damages received on
whether by suit or agreement on account of such injuries or sickness are excluded because they
are not income but compensation for such injuries or sickness suffered. However,
notwithstanding contrary view, compensation for unearned income as a result of such injuries or
sickness are taxable being replacement of income lost.

Q. Are moral damages awarded to a litigant for mental anguish or account of a libelous
article written about him taxable as income or not? Why?
Ans. Moral damages arising from mental anguish, not being moral damages arising from
physical injuries, are taxable as income. However, damages (moral or otherwise) received on
account of physical injuries are excluded from taxable income [Sec. 32(B)(4), NIRC of 1997].

Q. What is the rationale why income exempt under treaty are excluded from gross
income?
Ans. By the principle of reciprocity and comity among nations, income of any kind to the extent
required by any treaty obligation binding upon the Government of the Philippines are exempt
from the gross income [Sec 32(B) (5), NIRC of 1997; Sec. 2.78 (B)(10), Rev. Regs. No. 2-98].

Q. What are the retirement benefits, pensions, gratuities that are excluded from the gross
income?
Ans. They are:
(1) Retirement benefits received under RA No. 7641.
(2) Retirement received from reasonable private benefit plan after compliance with certain
conditions.
(3) Amounts received for separation beyond control of employee;
(4) Foreign social security, retirement gratuities, pension etc.
(5) US Veteran Administration benefits [Sec 32,B) , NIRC]; SSS benefits under Rep. Act No.
8282 [Sec. 34,B) (6),(d), NIRC]; and GSIS benefits under Rep. Act No. 8391[Rep. Sec. 32(b)
(6)(F), ; Sec. 2. 78.1 (B) (1)(f), Reg. No. 2-98].
The conditions for excluding benefits received under RA No. 7641 and those received by
officials and employees of private firms, whether, individual or corporate, in accordance with
employer's reasonable private benefit plan approved by the BIR; Retiring official or employee for
at least ten years, not less than 50 years of age at the time of retirement availed of the benefit of
exclusion only once.(Sec. 32(B) (6)(a), NIRC of 1997; lst par. Sec 2.78.1 (B)(1) Rev. Reg. No. 2-
98;
Reasonable private benefit plan means the pension, gratuity,stock bonus or profit sharing plan
maintained by an employee for the benefit of some or all of his officials or employees where
contributions are made by such employer for the officials or employees or both, for the purpose of
distributing to such official and employees the earnings and principal of the fund is 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 said officials
or employees [Sec. 32(B) (6)(a), NIRC of 1997];
Income received from investments in the Philippines in loans, stocks, bonds or domestic
securities, or from interest on their deposits in banks in the Philippines by foreign government,
financing institutions, owned, controlled or enjoying refinancing from them; and international or
regional financing institution established by governments [Sec.32(B) (7) NIRC of 1997

Q. What are the miscellaneous items excluded from gross income.


Ans. They are:
(1) Income derived by foreign government.
(2) Income from public or from the exercise of any essential governmental functions
accruing to the government or its political subdivision.
(3) Prizes and awards.
(4) Prizes and awards in sports competitions.
(5) 13th Month pay and other benefits.
(6) GSIS, SSS, Medicare , Pag-ibig contributions and union dues of individuals.
(7) Gains from the sale of bonds, debentures, or other certificates of indebtedness.
(8) Gains from redemptions of shares in mutual fund.
Prizes and awards made primarily in recognition of religious charitable, scientific, educational,
artistic, literary or civic achievement but only if: (1) The recipient was selected without any action
on his part to enter the contest or proceeding; and (2) The recipient is not required to render
substantial future services as a condition to receiving the prize or award [Sec. 32(B), (7) (c),
NIRC];
All prizes and awards granted to athletes in local and international sports tournaments and
competition whether held in the Philippines or abroad, and sanctioned by their national sports
association.(Sec. 32(B) (7) (d), NIRC of 1997;
Gross benefits received by officials and employees of public and private entities; Provided,
however, that the total exclusion shall not exceed P30,000.00 ( P 82,000 RA 10653) which shall
cover: (1) Benefits received by officials and employees of the national and local government
pursuant to RA No. 6686; (2) Benefits received by employees pursuant to PD No. 851 as amended
by Memorandum Order No. 28, dated August 12, 1986; (3) Benefits received by officials and
employees not covered by PD No. 851 as amended;(Sec. 2.78.1 (B) (11)(a), Rev. Regs. No. 2-
98;(4)Other benefits such as productivity incentives and Christmas bonus.(Sec.. 32(b)(7) (e) NIRC
of 1997; Sec. 2.78.1 (B) (11) (b), Rev. Regs. No. 2-98;

Q. Are separation pay to be excluded from gross income?


Ans. Yes, because any amount received by an official, employee or by his heirs from the
employer as a consequence of separation of such official or employee from the service of the
employer because of death, sickness or other physical disability or for any cause beyond the
control of the said official or employee [Sec. 32B) (6),(b), NIRC) such as retrenchment,
redundancy and cession of business [1st par. Sec. 2.78. 1(B) (1)(b), Rev. Regs. No. 2-98] are
excluded from gross income. Likewise payments received for involuntary separation are exempt
from income tax even if the official or employee at the time of separation had rendered less than
10 years of service and/or is below 50 years of age [3rd par. Sec. 2.78 (B) (1)(b), Rev. Regs. No.
2-98]. However, the following are taxable:
(1) Payment as a result of dismissal is taxable being considered compensation income [4th par.
Sec. 2.78 (B)(1) (B), Rev. Regs. No. 2-98].
(2) Back wages as a result of illegal termination is subject to tax (Escareal v. Court of Tax
Appeals, et. al CA-GR No SP No. 41989 prom .Sept. 30, 1998)

Q. Are there exclusions provided under special law?


Ans. Yes, like the following exclusions:
(1) Exemption of certain entities from taxation i.e., International Research Center; Deposit
Insurance Corporation, Philippine Postal Corporation (Sec. 14, RA No. 7354).
(2) Exemption of senior citizens of the payment of income taxes (Sec. 42, RA no. 7432 as
amended by RA 9994).
DEDUCTIONS
Q. Define deduction.
Ans. The items or amounts authorized by law to be subtracted from the pertinent items of gross
income to arrive at a taxable income (Sec. 34 , NIRC of 1997). Items which are allowed by law
to be deducted from the gross income are known as legal deductions. Items which are not
allowed by law to be deducted from the gross income are non-deductible items.

Q. What is meant by lesser deduction rule?


Ans. For income tax purposes, a taxpayer is free to deduct from his gross income a lesser amount
or not to claim any deduction at all (CIR v. Phoenix Assurance Co,. Ltd. L-19727 May 20, 1965,
14 SCRA 2).

Q. What is the nature of tax deductions?


Ans. The deductions partake of the nature of tax exemption and are to be construed strictissimi
juris against the taxpayer. The reasons for such strict interpretation are to safeguard government
revenue under the principle of "blood theory of taxation" (Commissioner of Internal Revenue v.
Algue, 158 SCRA 9). Consequently, deductions cannot be created by implication, there must be
a clear provision for such deduction (Basilan Estates Inc. v. Commissioner, 21 SCRA 17, Sept.
5, 1967; 61 SJS 1563).

Q. What are the deductions allowed under the Tax Code?


Ans. The allowable deductions are:
(1) Optional standard deduction (Sec. 34(L) NIRC of 1997).
(2) Itemized deductions [Sec. 34(A) to (K) and (M) NIRC of 1997].
(3) Personal and additional Exemptions (Sec. 35, NIRC of 1997).
(4) Extraordinary deductions such as
(a) Those allowed to insurance companies. ( Sec. 37, ibid).
(b) Deductions allowed to estates and trusts availing of itemized deduction of income
currently distributed to beneficiaries (Sec. 61, ibid);
(c) Losses from wash sales of stocks or securities (Sec. 38, ibid).
(d) Certain capital losses but only from capital gains (Sec. 39, ibid),

Q. Who has the burden of proving entitlement to such deduction?


Ans. The taxpayer has the burden of proving entitlement to a claimed deduction or refund (Paper
Industries Corp. of the Philippines v. Court of Appeals, 250 SCRA 434) in line with the rule of
strictissimi juris against taxpayer and liberally in favor of

Q. What are the requisites before deductions are allowed?


Ans. The requisites are:
(1)There must be a specific provision of law allowing the deduction since deductions do not exist
by implication.
(2) The requirements of deductibility must be met.
(3) There must be proof of entitlement to the deduction;
(4) The deductions must not have been waived.
(5) The withholding and payment of the tax required must be shown.
Misamis Oriental Association of Coco Traders Inc. v. Department of Finance Secretary, 238
SCRA 63. Atlas Consolidated Mining and Development Corporation v. Commissioner of
Internal Revenue L-16911,prom Jan 27, 1981 and Commissioner of Internal Revenue v. Atlas
Consolidated Mining and Development Corp et. al. 102 SCRA 246
Sec. 76 Rev. Re. No. 2; 38Sec. 34(K) and Secs. 58 and 81, NIRC of 1997. This is
additional requirement for deductibility. Any amount paid or payable which is otherwise
deductible from, or taken into account in computing gross income or for which depreciation or
amortization may be allowed shall be allowed as a deduction only if it is shown that the tax
required to be deducted and withheld there from has been paid to the BIR [Sec.34 (K) NIRC of
1997; lst par. Sec. 1.58.5 Rev. Regs. No. 2-98].
Q. Are there instances that the additional requirement of presenting the document
showing payment of withholding tax be dispensed with?
Ans. Yes. A deduction will also be allowed in the following cases when no withholding tax was
made:
(1) The payee reported the income and the withholding agent taxpayer pays the tax, including the
interest incident to the failure to withhold the tax and surcharges, if applicable, at the time of the
original audit and investigation;
(2) The recipient-payee failed to report the income due on due date thereof, but the withholding
agent/taxpayer pays the tax, including the interest incident to the failure to withhold the tax and
surcharges, if applicable, at the time of the original audit and investigation.
(3) The withholding agent erroneously under withheld the tax but pays the difference between
the correct amount and the amount withheld, including the interest incident to such error, and
surcharges, if applicable, at the time of the original audit and investigation (2nd par. Sec. 2.58.5
Rev. Regs. No. 2-98).

Q. What are some of the basic principles underlying deduction?


Ans. The basic principles applicable to all taxpayers governing deductions from the gross income
are:
(1) The taxpayer seeking a deduction must point to some specific provisions of the statute
authorizing the deductions;
(2) The taxpayer must be able to prove that he is entitled to the deductions authorized or allowed
by law;
(3) No deductions are allowed to compensation income arising from personal services rendered
under the employer-employee relationship, except premiums paid for hospitalization or health
insurances.
(4) Deductions are not available to non-resident alien not engaged in trade or business in the
Philippines.
(5) Deductions applicable only to income connected from sources within the Philippines;
(6) Investment allowances and other incentives allowed as deduction from taxable income shall
be governed by the particular special law under which the incentive is claimed.

Q. What are the two classes of deductions available to individual taxpayer?


Ans. An individual taxpayer may choose either of the two kinds of alternative deductions
available to him.
(1) Itemized deductions; and
(2) Optional standard deductions.

Q. Who are the taxpayers that can avail of the deductions?


Ans. Deductions may be availed of by the following :
(1) Resident citizens;
(2) Non-resident citizens;
(3) Resident aliens.
(4) Nonresident aliens engaged in trade or business in the Philippines;
(5) Partner of a general partnership; and
(6) Estates and trust.

Q. What are the kinds of deductions from gross income authorized by the Tax Code?
Ans. They may be categorized as follows:
(1) Deductions from compensation income;
(2) Deductions from business and/or professional income.
(3) Deduction from corporate income.
(4) Specific deductions.
ITEMIZED DEDUCTIONS
NIRC CHAPTER VII Allowable Deductions

SECTION 34 Deductions from Gross Income Except for taxpayers earning compensation
income arising from personal services rendered under an employer-employee relationship where
no deductions shall be allowed under this Section other than under Subsection (M) hereof, in
computing taxable income subject to income tax under Sections 24(A); 25(A); 26; 27(A), (B)
and (C); and 28(A)(1), there shall be allowed the following deductions from gross income:

Q. What is the nature of itemized deductions?


Ans. Itemized deductions when available to a taxpayer must be proven and supported by the
taxpayer claiming as such.

Q. What are the allowable deductible items under the Tax Code?
Ans. They are:
(1) Expenses (ordinary/necessary/business).
(2) Interest
(3) Taxes
(4) Losses
(5) Bad debts
(6) Depreciation
(7) Depletion
(8) Charitable and other contributions;
(9) Research and development; and
(10) Contribution to pensions trust.
(11) Premium payments on health and/or hospitalization insurance subject to certain conditions
[Sec. 34 (A) to (M), NIRC of 1997].

Sec 34 (D) Losses

(1) In General Losses actually sustained during the taxable year and not compensated for by
insurance or other forms of indemnity shall be allowed as deductions:

(a) If incurred in trade, profession or business;

(b) Of property connected with the trade, business or profession, if the loss arises from fires,
storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.

The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to


promulgate rules and regulations prescribing, among other things, the time and manner by which
the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or
embezzlement during the taxable year: Provided, however, That the time limit to be so
prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety
(90) days from the date of discovery of the casualty or robbery, theft or embezzlement giving
rise to the loss.

(c) No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the
return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.

(2) Proof of Loss In the case of a nonresident alien individual or foreign corporation, the
losses deductible shall be those actually sustained during the year incurred in business, trade or
exercise of a profession conducted within the Philippines, when such losses are not compensated
for by insurance or other forms of indemnity. The Secretary of Finance, upon recommendation of
the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among
other things, the time and manner by which the taxpayer shall submit a declaration of loss
sustained from casualty or from robbery, theft or embezzlement during the taxable year:
Provided, That the time to be so prescribed in the rules and regulations shall not be less than
thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or
robbery, theft or embezzlement giving rise to the loss; and

(3) Net Operating Loss Carry-over The net operating loss of the business or enterprise for
any taxable year immediately preceding the current taxable year, which had not been previously
offset as deduction from gross income shall be carried over as a deduction from gross income for
the next three (3) consecutive taxable years immediately following the year of such loss:
Provided, however, That any net loss incurred in a taxable year during which the taxpayer was
exempt from income tax shall not be allowed as a deduction under this Subsection: Provided,
further, That a net operating loss carry-over shall be allowed only if there has been no substantial
change in the ownership of the business or enterprise in that

(i) Not less than seventy-five percent (75%) in nominal value of outstanding issued shares, if the
business is in the name of a corporation, is held by or on behalf of the same persons; or

(ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation, if the
business is in the name of a corporation, is held by or on behalf of the same persons.

For purposes of this Subsection, the term 'net operating loss' shall mean the excess of allowable
deduction over gross income of the business in a taxable year:

Provided, That for mines other than oil and gas wells, a net operating loss without the benefit of
incentives provided for under Executive Order No. 226, as amended, otherwise known as the
Omnibus Investments Code of 1987, incurred in any of the first ten (10) years of operation may
be carried over as a deduction from taxable income for the next five (5) years immediately
following the year of such loss. The entire amount of the loss shall be carried over to the first of
the five (5) taxable years following the loss, and any portion of such loss which exceeds the
taxable income of such first year shall be deducted in like manner from the taxable income of the
next remaining four (4) years.

BIR ISSUANCES

REVENUE REGULATIONS NO. 14-01 August 27, 2001

Implementing Section 34(D)(3) of the National Internal Revenue Code of 1997 Relative to the
Allowance of Net Operating Loss Carry-Over (NOLCO) as a Deduction from Gross Income to
govern the deduction from gross income of the Net Operating Loss Carry-Over (NOLCO)
pursuant to Section 34 (D) (3) of the Code, which provides:

"Net Operating Loss Carry-Over The net operating loss of the business or enterprise for any
taxable year immediately preceding the current taxable year which had not been previously
offset as deduction from gross income shall be carried over as a deduction from gross income for
the next three (3) consecutive taxable years immediately following the year of such loss:
Provided, however, That any net loss incurred in a taxable year during which the taxpayer was
exempt from income tax shall not be allowed as a deduction under this Subsection. Provided,
further, That a net operating loss carry-over shall be allowed only if there has been no
substantial change in the ownership of the business or enterprise in that

(i) Not less than seventy percent (75%) in nominal value of outstanding issued shares if the
business is in the name of a corporation is held by or on behalf of the same persons; or
(ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation if the
business is in the name of a corporation, is held by or on behalf of the same persons.

For purposes of this Subsection the term 'net operating loss' shall mean the excess of allowable
deduction over gross income of the business in a taxable year.

(4) Capital Losses

(a) Limitation Losses from sales or exchanges of capital assets shall be allowed only to the
extent provided in Section 39.

CASES DIGEST

Capital losses are deductible only to the extent of capital gains.

Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains derived
from the sale or exchange of capital assets, and not from any other income of the taxpayer.

China Banking Corp. vs. Court of Appeals, et al., G.R. No. 125508, July 19, 2000

(5) Losses From Wash Sales of Stock or Securities Losses from 'wash sales' of stock or
securities as provided in Section 38.

(6) Wagering Losses Losses from wagering transactions shall be allowed only to the extent of
the gains from such transactions.

(7) Abandonment Losses

(a) In the event a contract area where petroleum operations are undertaken is partially or wholly
abandoned, all accumulated exploration and development expenditures pertaining thereto shall
be allowed as a deduction: Provided, That accumulated expenditures incurred in that area prior to
January 1, 1979 shall be allowed as a deduction only from any income derived from the same
contract area. In all cases, notices of abandonment shall be filed with the Commissioner.

(b) In case a producing well is subsequently abandoned, the unamortized costs thereof, as well as
the undepreciated costs of equipment directly used therein, shall be allowed as a deduction in the
year such well, equipment or facility is abandoned by the contractor: Provided, That if such
abandoned well is reentered and production is resumed, or if such equipment or facility is
restored into service, the said costs shall be included as part of gross income in the year of
resumption or restoration and shall be amortized or depreciated, as the case may be.

LOSSES

Q. Define losses.
Ans. The term "losses" implies an intentional parting with something of value (1955CCH Fed.
Tax Course, par. 598). Loss occurs when the thing due perishes, goes out of commerce or when
it disappears in such a way that the existence is unknown or it cannot be recovered (Art. 1234,
Civil Code). Broadly, the term is to include all losses which are not general or natural to the
ordinary course of business and are not covered under some heading ,such as bad debts,
inventory losses, depreciation, etc.

Q. What losses may a taxpayer deduct from the gross income?


Ans. The taxpayer may deduct all losses actually sustained and charged off within the taxable
year and not compensated for by insurance or other forms of indemnity as follows:
(1) Those incurred in trade, business or profession in the Philippines; and
(2) Casualty losses of property connected with trade, business or profession in the Philippines
[Sec. 34(D) (1), NIRC of 1997].

Q. Classify deductible losses from the gross income.


Ans. Losses that can be deducted from the gross income of the taxpayer are classified as follows:
First, the ordinary losses, sub classified as:
(1) Losses incurred in trade or business.
(2) Losses incurred in profit-seeking transaction.
(3) Casualty losses due to casualty, robbery, theft or embezzlement.
Second, capital losses, such as:
(1) Losses from sales or exchanges of capital assets.
(2) Losses resulting from worthless securities.
(3) Losses from short sales of property.
Third, special losses such as-
(1) Losses from wash sales of stocks or securities
(2) Wagering losses;
(3) Abandonment losses;
(4) Losses due to voluntary removal of building, machinery, etc. incident to
renewals/replacements.
(5) Losses of the useful value of capital assets due to some change in business conditions.
(6) Losses from sales or exchanges of property between related taxpayers.

Q. What is meant by: (a) ordinary losses; and (b) net operating loss.
Ans. (a) Ordinary losses are losses that are incurred by a taxable entity as a result of its day to
day operations.
(b) Net operating loss is the excess of allowable deduction over gross income of the business
in a taxable year [4th par. Sec. 34(D) (3), NIRC of 1997].

Q. Give the concept of casualty, theft and embezzlement as deductible losses.


Ans. Casualty is the complete or partial destruction of property resulting from an identifiable
event of a sudden, unexpected or unusual nature. It denotes accident, some sudden invasion of
hostile agency and excludes progressive deterioration through steadily operating a cause
(Rev. Reg No.12-77,Sec. 1).Theft, generally, is the criminal appropriation of another's property
to the use of the taker (Sec. 1, Rev. Regs. 12-77). Finally, embezzlement is the fraudulent
expropriation of another' s property by a person to whom it has been entrusted or into whose
hands it has lawfully come (Sec. 1, Rev. Regs. No. 12-77).

Q. What is trading loss?


Ans. Trading loss is a cost of operation or service which may be allowed as a deduction from
gross income (Rizal Commercial Banking Corporation v. Commissioner, CTA Case No. 4672
prom. Feb. 12, 1996).

Q. Give the requisites for the deductibility of a loss.


Ans. The requisites for deductible losses are as follows:
(1) The loss must be that of the taxpayer;
(2) It must have been actually sustained or suffered during the taxable year;
(3) It must be evidenced by a closed and completed transaction;
(4) It must not be compensated by insurance or otherwise;
(5) The loss must not have been claimed as deduction for estate or inheritance tax purposes.
(6) The declaration of such loss must be submitted within the reglementary period set by the
Code or BIR regulations [1st Sentence Sec. 34(D) (2), NIRC of 1997].

Q. When shall be the proper time for declaring losses?


Ans. Following the reglementary period of 30-90 days authorized by the Tax Code [2nd
Sentence Sec. 34(C) (2) NIRC], the submission of sworn declaration of loss is now 45 days after
occurrence of casualty, robbery, theft or embezzlement.(Sec. 3, Rev. Regs. No. 12-77).

Q. Who are the persons entitled to claim deduction for losses.


Ans. The losses are deductible by:
(1) Individuals (resident citizen/resident alien)-
(a) Those incurred in trade or business;
(b) Those incurred in any transaction entered into for profit though not connected with trade
or business.
(c) Those involving property not connected with trade or business if the loss arises from fires,
storms, shipwrecks, or other casualty, or from robbery, theft or embezzlement.
Sec. 3, Rev. Regs. No. 12-77. The declaration of loss shall contain the following information:
(1) The nature of the event giving rise to the loss and the time of its occurrence; (2) A description
of the damaged property and its location; (3) The items needed to compute the loss; and (4) The
amount of insurance or other compensation received or receivable (Sec. 3 Rev.Regs. No. 12-77).

Q. What is the effect of a taxpayer's failure to record in his books the loss allegedly
suffered?
Ans. Such failure proves that the alleged loss had not been suffered and thus will not be allowed
as a deduction. (City Lumber v. Comm. L-18611, January 30, 1964).
Q. What are the basic rules on losses?
Ans. Some of the recognized rules/principles governing losses are:
(1) The loss to be deductible must be evidenced by a closed and completed transaction and must
not have been compensated by insurance or otherwise.
(2) Capital losses are deductible only from capital gains;
(3) If the capital assets sold have been held for more than one year, the loss shall be deductible
only to the actual extent of fifty (50%) percent
(4) Losses from wagering transaction shall be allowed only to the extent of the gains from such
transaction.
(5) Losses sustained in wash sales transaction are not deductible.
(6) Gains in illegal transaction are taxable; however, losses in illegal transaction are not
deductible;
(7) Loss deduction may be denied if there is a measurable right to compensation for the loss,
with ultimate collection reasonably clear
(Plaridel Surety & Insurance Co. v. Comm. L-21520, Dec. 11, 1967, 21 SCRA 187).

Q. What is the purpose why losses in transactions between related taxpayers are non-
deductible?
Ans. The purpose of the law is to prevent avoidance of income tax by taxpayers who take
advantage of deduction for losses by means of purported or simulated sales or exchanges to
members of their families/trusts. Accordingly, it is immaterial whether the sale is bona fide or
not (Madrigal v. Rafferty, 38 Phil. 444).

Sec 34 (B) Interest

(1) In General The amount of interest paid or incurred within a taxable year on
indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as
deduction from gross income: Provided, however, That the taxpayer's otherwise allowable
deduction for interest expense shall be reduced by forty-two percent (42%) of the interest income
subjected to final tax: Provided, That effective January 1, 2009, the percentage shall be thirty-
three percent (33%).

Forty-one percent (41%) beginning January 1, 1998;

Thirty-nine percent (39%) beginning January 1, 1999; and

Thirty-eight percent (38%) beginning January 1, 2000.

(2) Exceptions. No deduction shall be allowed in respect of interest under the succeeding
subparagraphs:

(a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an
indebtedness on which an interest is paid in advance through discount or otherwise: Provided,
That such interest shall be allowed as a deduction in the year the indebtedness is paid: Provided,
further, That if the indebtedness is payable in periodic amortizations, the amount of interest
which corresponds to the amount of the principal amortized or paid during the year shall be
allowed as deduction in such taxable year;

(b) If both the taxpayer and the person to whom the payment has been made or is to be made are
persons specified under Section 36(B); or

(c) If the indebtedness is incurred to finance petroleum exploration.

(3) Optional Treatment of Interest Expense. At the option of the taxpayer, interest incurred to
acquire property used in trade, business or exercise of a profession may be allowed as a
deduction or treated as a capital expenditure.

CASES DIGESTS

Interest paid for late payment of tax is deductible from gross income.

The term "indebtedness" as used in the Tax Code of the United States has been defined as an
unconditional and legally enforceable obligation for the payment of money. Within the meaning
of that definition, it is apparent that a tax may be considered an indebtedness. It follows that the
interest paid for the late payment of donor's tax is deductible from taxpayers gross income.

Commissioner of Internal Revenue vs. Consuelo L. vda.dePrieto, G.R. No.


L-13912, September 30, 1960

Definition of "theoretical interest"

"Theoretical interest" refers to interest "calculated" or computed (and not incurred or paid) for
the purpose of determining the "opportunity cost" of investing funds in a given business. Such
"theoretical" or imputed interest does not arise from a legally demandable interest-bearing
obligation incurred by the taxpayer who however wishes to find out, e.g., whether he would have
been better off by lending out his funds and earning interest rather than investing such funds in
his business.

Paper Industries Corp. of the Phil. vs. Court of Appeals, et al., G.R.
Nos. 106949-50, December 1, 1995

"Carrying charges" may be capitalized or deducted from gross income at the option of taxpayer

The "carrying charges" which may be capitalized under the U.S. Internal Revenue Code include,
interest on a loan "(but not theoretical funds)." Such "carrying charges" may, at the election of
the taxpayer, either be (a) capitalized in which case the cost basis of the capital assets, e.g.,
machinery and equipment, will be adjusted by adding the amount of such interest payments or,
alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to
deduct the interest payments against its gross income, the taxpayer cannot at the same time
capitalize the interest payments.In other words, the taxpayer is not entitled to both the deduction
from gross income and the adjusted (increased) basis for determining gain or loss and the
allowable depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction
of interest on a loan obtained for purchasing machinery and equipment against gross income,
unless the taxpayer has also or previously capitalized the same interest payments and thereby
adjusted the cost basis of such assets. prem08cd

Paper Industries Corp. of the Phil. vs. Court of Appeals, et al., G.R.
Nos. 106949-50, December 1, 1995

BIR ISSUANCES

REVENUE REGULATIONS NO. 13-00 November 20, 2000

Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for Deductibility of
Interest Expense from the Gross Income of a Taxpayer for deductibility of interest expense from
the gross income of a corporation or an individual engaged in trade, business or in the practice
of profession.

Requisites for Deductibility of Interest Expense. In general, subject to certain limitations, the
following are the requisites for the deductibility of interest expense from gross income, viz:

(a) There must be an indebtedness;


(b) There should be an interest expense paid or incurred upon such indebtedness;
(c) The indebtedness must be that of the taxpayer,
(d) The indebtedness must be connected with the taxpayer's trade, business or exercise of
profession;
(e) The interest expense must have been paid or incurred during the taxable year;
(f) The interest must have been stipulated in writing;
(g) The interest must be legally due;
(h) The interest payment arrangement must not be between related taxpayers as mandated in
Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997 ;
(i) The interest must not be incurred to finance petroleum operations; and
(j) In case of interest incurred to acquire property used in trade, business or exercise of
profession, the same was not treated as a capital expenditure.
Rules on the Deductibility of Interest Expense.

(a) General Rule. In general, the amount of interest expense paid or incurred within a
taxable year on indebtedness in connection with the taxpayer's trade, business or exercise of
profession shall be allowed as a deduction from the taxpayer's gross income.

(b) Limitation. The amount of interest expense paid or incurred by a taxpayer in


connection with his trade, business or exercise of a profession from an existing indebtedness
shall be reduced by an amount equal to the following percentages of the interest income earned
which had been subjected to final withholding tax depending on the year when the interest
income was earned, viz:
Forty-one percent (41%) beginning January 1, 1998;

Thirty-nine percent (39%) beginning January 1, 1999; and

Thirty-eight percent (38%).beginning January 1, 2000 and thereafter.

This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into
by the taxpayer or regardless of the date when the interest bearing loan and the date when the
investment was made for as long as, during the taxable year, there is an interest expense
incurred on one side and an interest income earned on the other side, which interest income had
been subjected to final withholding tax. This rule shall be observed irrespective of the currency
the loan was contracted and/or in whatever currency the investments or deposits were made.

INTEREST
Q. What is interest for tax purpose?
Ans. It is the compensation paid by a debtor to a lender for the use/forbearance of money.

Q. What interest is deductible from the gross income?


Ans. It is the amount of interest paid or incurred within the taxable year on indebtedness incurred
in connection with the taxpayer's trade, business or profession [Sec.34 (B),(1), NIRC].

Q. Pursuant to the National Internal Revenue Code, for interest to be deductible, what
are the requirements to be met? Give the requisites for the deductibility of interest from the
gross income.
Ans. They are:
(1) There must be an indebtedness incurred by the taxpayer in connection with the taxpayer's
trade, business or profession;
(2) The interest must have been paid or incurred within the taxable year [Sec. 34(B)(1) ibid]; and
(3) The interest must have been stipulated in writing (Art. 1956, Civil Code).

Q. What is meant by indebtedness and when is its interest deductible from the gross
income?
Ans. Indebtedness has been defined as something owed by one who is unconditionally obligated
or bound to pay (Comm. v. Prieto L-19313 Sept. 10, 1960). There must be real debt before the
interest deduction is allowed. The characteristics of the debt are:
(1) A definite obligor and obligee (either by name or designation);
(2) A definite ascertainable obligation;
(3) A time of maturity, either definite or that will become definite (Nolledo, p. 161). If there
exists no indebtedness or if the obligation is unenforceable, the interest paid is not deductible
[Page Oil Co. v. CTA 59 Af. 129 F. (2df) 402].

Q. Is interest for tax delinquency deductible?


Ans. Yes, as interest expense (but not as a tax). Although taxes are not considered debts, they
constitute indebtedness in favor of the government for purposes of deduction from gross income
of the interest paid. The tax being considered an indebtedness, it is immaterial whether the same
is deductible or not (Comm. v. Prieto L-13912, Sept. 30, 1960; Commissioner v. Palanca, L-
16626 Oct. 29, 1966).

Q. What is the rule on optional treatment of interest expense?


Ans. 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 [Sec.
34(B) (3) NIRC of 1997].

Q. What are the three cases when no deduction is allowed by law on the interest?
Ans. In the following instances:
(1) If within the taxable year an individual taxpayer respecting income on the cash basis
incurs an indebtedness on which interest is paid in advance through discount or otherwise, but
such interest shall be allowed as a deduction in the year the indebtedness is paid.
(2) If both the taxpayer and the person to whom the payment has been made or is to be made
are persons specified as related parties; and
(3) If the indebtedness is incurred to finance petroleum exploration [Sec. 34(B), NIRC of
1997].

Q. What transactions are considered as entered by related parties?


Ans. Interest on loans entered by related taxpayers:
(1) Between members of a family-i.e., to include brothers, sisters, spouses, ancestors and lineal
descendants; however, the interest payments made by affinity and collateral relatives (i.e.,
parents-in-law, brother/sisters-in-law, to all kinds of cousins, uncles and aunts) are deductible
from gross income.
(2) An individual and a corporation more than fifty percent in value of the outstanding stock of
which is owned directly or indirectly by or for such individual; or
(3) Between two corporations more than 50% in value of the outstanding stock of each of which
is owned, directly or indirectly, by or for the same individual; or
(4) The grantor and a fiduciary of any trust;
(5) Between the fiduciary of a trust and the fiduciary of another trust with the same grantor.
(6) Between a fiduciary of a trust and a beneficiary of such trust.

TAXES
Sec 34 (C)Taxes

(1) In General Taxes paid or incurred within the taxable year in connection with the taxpayer's
profession, trade or business, shall be allowed as deduction, except:

(a) The income tax provided for under this Title;

(b) Income taxes imposed by authority of any foreign country; but this deduction shall be
allowed in the case of a taxpayer who does not signify in his return his desire to have to any
extent the benefits of paragraph (3) of this Subsection (relating to credits for taxes of foreign
countries);

(c) Estate and donor's taxes; and


(d) Taxes assessed against local benefits of a kind tending to increase the value of the property
assessed.

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

(2) Limitations on Deductions In the case of a nonresident alien individual engaged in trade or
business in the Philippines and a resident foreign corporation, the deductions for taxes provided
in paragraph (1) of this Subsection (C) shall be allowed only if and to the extent that they are
connected with income from sources within the Philippines.

(3) Credit Against Tax for Taxes of Foreign Countries If the taxpayer signifies in his return
his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited
with:

(a) Citizen and Domestic Corporation In the case of a citizen of the Philippines and of a
domestic corporation, the amount of income taxes paid or incurred during the taxable year to any
foreign country; and

(b) Partnerships and Estates In the case of any such individual who is a member of a general
professional partnership or a beneficiary of an estate or trust, his proportionate share of such
taxes of the general professional partnership or the estate or trust paid or incurred during the
taxable year to a foreign country, if his distributive share of the income of such partnership or
trust is reported for taxation under this Title.

An alien individual and a foreign corporation shall not be allowed the credits against the tax for
the taxes of foreign countries allowed under this paragraph.

(4) Limitations on Credit The amount of the credit taken under this Section shall be subject to
each of the following limitations:

(a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed
the same proportion of the tax against which such credit is taken, which the taxpayer's taxable
income from sources within such country under this Title bears to his entire taxable income for
the same taxable year; and

(b) The total amount of the credit shall not exceed the same proportion of the tax against which
such credit is taken, which the taxpayer's taxable income from sources without the Philippines
taxable under this Title bears to his entire taxable income for the same taxable year.

(5) Adjustments on Payment of Incurred Taxes If accrued taxes when paid differ from the
amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the
taxpayer shall notify the Commissioner, who shall redetermine the amount of the tax for the year
or years affected, and the amount of tax due upon such redetermination, if any, shall be paid by
the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if
any, shall be credited or refunded to the taxpayer. In the case of such a tax incurred but not paid,
the Commissioner as a condition precedent to the allowance of this credit may require the
taxpayer to give a bond with sureties satisfactory to and to be approved by the Commissioner in
such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax
found due upon any such redetermination. The bond herein prescribed shall contain such further
conditions as the Commissioner may require.

(6) Year in Which Credit Taken The credits provided for in Subsection (C)(3) of this Section
may, at the option of the taxpayer and irrespective of the method of accounting employed in
keeping his books, be taken in the year in which the taxes of the foreign country were incurred,
subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the
taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued,
the credits for all subsequent years shall be taken upon the same basis, and no portion of any
such taxes shall be allowed as a deduction in the same or any succeeding year.

(7) Proof of Credits The credits provided in Subsection (C)(3) hereof shall be allowed only if
the taxpayer establishes to the satisfaction of the Commissioner the following:

(a) The total amount of income derived from sources without the Philippines;

(b) The amount of income derived from each country, the tax paid or incurred to which is
claimed as a credit under said paragraph, such amount to be determined under rules and
regulations prescribed by the Secretary of Finance; and

(c) All other information necessary for the verification and computation of such credits.

CASES DIGEST

Deductions from Gross Income

Fines and penalties paid for late payment of taxes are not deductible

Deductions from gross income are matters of legislative grace; what is not expressly granted by
Congress is withheld. Moreover, when acts are condemned by law and their commission is made
punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross
income, reduces, and so in part defeats, the prescribed punishment for the mandatory and timely
payment of taxes.

Lino Gutierrez, et al. vs. Collector of Internal Revenue, G.R. No.


L-19537, May 20, 1965

When distinction between "taxes" and "debts" are inconsequential


While "taxes" and "debt" are distinguishable legal concepts, in certain cases, on account of their
nature, the distinction becomes inconsequential. This qualification is recognized even in the
United States. Thus, the term debt is properly used in a comprehensive sense as embracing
not merely money due by contract, but whatever one is bound to render to another, either for
contract or the requirements of the law. Although what is involved in the Prieto case was donor's
tax while the present suit pertains to interest paid on the estate and inheritance tax,
interpretation placed upon the law was predicated on the congressional intent, not on the nature
of the tax for which the interest was paid.

Commissioner of Internal Revenue vs. Carlos Palanca, Jr., G.R. No.


L-16626, October 29, 1966

Q. Are taxes deductible from the gross income?


Ans. Taxes paid or accrued within the taxable year in connection with the taxpayer's profession,
trade or business are deductible [Sec. 34(C) (1), ibid].

Q. What are the taxes that are deductible from the gross income?
Ans. They are:
(1) Import duties paid to customs officers;
(2) Business taxes;
(3) Occupation taxes;
(4) License taxes;
(5) Privilege (excise) taxes;
(6) Documentary stamp taxes;
(7) Automobile registration fees;
(8) Any other taxes of every amount and nature paid directly to the government or any political
subdivision (Sec. 80,Rev. Regs. No. 2).

Q. What taxes are non-deductible from the gross income?


Ans. The following taxes are not deductible:
(1) Philippine income tax;
(2) Income, war profits, and excise profit taxes;
(3) Estate and gift taxes;
(4) Taxes assessed against local benefits (special assessments); and
(5) Electric energy consumption rate [Sec. 34(C) (1) NIRC of 1997].
Note: The taxes that are allowed as deductions when refunded or credited shall be included as
part of gross income in the year of receipt to the extent of income tax benefit of said deduction
[Sec. 34(C) (1) NIRC of 1997].

Q. What are the limitations on the deduction of taxes on the gross income?
Ans. The limitations are:
(1) For non-resident alien- deductible taxes must be connected with the income from sources
within the Philippines.
(2) For resident alien- the portion of the taxes paid to such foreign country which corresponds to
his taxable income. However, in the case of a resident alien whose income is derived solely
within the Philippines, neither tax declaration nor tax credit is allowed [Sec. 34(C) (2), NIRC of
1997].

Q. Give the concept and purpose of tax credit.


Ans. Tax credit refers to the taxpayer's right to deduct from the income tax due the amount of
the tax he has paid to a foreign country subject to specified limitations. Tax credit is aimed to
lessen the effect of international double or multiple income taxation. Tax credit is an amount
subtracted from an individual's or entity's tax liability to arrive at the total tax liability.
M.E. Holding Corporation v. Commissioner of Internal Revenue CTA Case No. 5414 prom.
August 17, 1998 citing Black's Law Dictionary 6th Ed.

Tax deductions (i.e., income, war profits taxes, excess profit taxes, taxes paid by authority
of foreign country) allowed upon the tax ascertained to be paid by a taxpayer who manifestly
expressed his intention to avail such benefit are known as tax credits. As previously pointed out,
the purposes of tax credit is to grant relief to the taxpayer of his burden of having to pay income
tax on the same income more than once.
War profit taxes are income taxes by reason or occasion of war in order to raise funds to
prosecute the war and reach income of war millionaires.
Excess profit taxes are income taxes imposed upon excessive earnings occurring during
garrison economic life in times of undeclared war.
Foreign country means any foreign state or political subdivision thereof, or any foreign
political entity which levies and collects income, war profits, or excess profit taxes and includes
the United States or any political subdivision thereof. (Sec. 85, Regs.).

Q. Who are the taxpayers entitled to claim tax credits?


Ans. May be claimed by the following:
(1) Citizens of the Philippines;
(2) Members of the general partnership;
(3) Beneficiary of estate and trust;
(4) Resident aliens when their country gives Filipinos reciprocal benefits.

Q. Who are not allowed to avail the deductible tax credit?


Ans. Tax credits not available to the following:
(1) Non-resident citizens;
(2) Non-resident aliens;
(3) Resident aliens whose income is derived solely from the sources within the Philippines (Last
par. Sec. 34(C) (3) (b) NIRC of 1997).

Q. Distinguish or differentiate tax credit from tax deduction.


Ans. Distinguishing the two:
(1) A tax credit reduces the taxpayer's liability dollar for dollar, compared to a deduction which
reduces taxable income upon which the tax liability is calculated.
(2) A tax credit differs from deduction to the extent that the former is subtracted from the tax
while the latter is subtracted from the income before the tax is computed.

Q. In claiming tax credit, what are the taxes for which credit may be taken?
Ans. They are income taxes paid or incurred during the taxable year to any foreign country/ies.

Q. What is the effect if a taxpayer signifies in his return his desire to claim a credit for
foreign taxes?
Ans. Such action will be considered to apply to income taxes paid to all foreign countries and no
portion of any such taxes shall be allowed as a deduction from gross income (Par. 2, Sec.87, Rev.
Regs, No.2).

Q. State the formula of tax credit.


Ans. The steps in computing income tax when one avails the deductibility of a tax credit are as
follows:
Gross Income (GI) less deductions equals Net Income (NI)
NI less Exemptions equals Taxable Net Income (TNI)
TNI multiplied by the tax rates equals Tax Due (TD)
Tax Due(TD) less Tax Credit(TC) equals Balance (B).

Q. What is the formula of determining Tax Credit?


Ans. Tax Credit may be determined by the following formula:
Taxable Income from Foreign Country
x Phil. Income tax = Tax Credit
Taxable Income From All Sources

Q. What is the limitation of tax credit?


Ans. The deductible tax is the computed tax credit or the actually paid in the foreign country
whichever is lesser.

Q. What is the tax credit rule on many incomes paid in foreign countries?
Ans. If the taxpayer has income from many countries, the formula:

Taxable Income from Foreign Country


x Phil. Income tax = Tax Credit
Taxable Income From All Sources

may be applied as "country limitation rule" and afterwards, compute for comparison the income
of all countries taken together under the so-called "over-all limitation rule" which can be arrived
at by the following formula:

NI From All Sources Outside


x Philippine Income Tax = Tax Credit Limit
Entire NI from All Sources
Q. In what particular year may a credit for foreign taxes be taken?
Ans. The Tax Code/BIR Regulations allow the taxpayer at his option and irrespective of the
method of accounting employed in keeping his books, to take such credit for taxes in the year in
which the taxes for the foreign country accrued. An election thus made must be followed in
returns for all subsequent years, and no portion of any such taxes would be allowed as a
deduction from gross income [Sec. 34(C) (6), NIRC; Sec. 89 Regs. No. 2].

Q. What should be the proper proof of tax credits?


Ans. The credit against tax for taxes paid to foreign countries shall be allowed only if the
taxpayer establishes to the satisfaction of the Commissioner of Internal Revenue:
(1) The total amounts of income derived from all sources without the Philippines;
(2) The amount of income derived from each country the tax paid or accrued to which is claimed
as a credit against tax for taxes of foreign countries, such amount to be determined under rules
and regulations prescribed by the Secretary of Finance; and
(3) All other information necessary for the verification and computation of such credits [Sec.
34(C) (7) NIRC of 1997].

Q. What are the administrative conditions for the allowance of tax credits?
Ans. The recognized conditions are:
(1) In the income tax return the taxpayer must signify his desire to claim tax credit.
(2) The return to be accompanied with the BIR prescribed form;
(3) The form must be carefully filled up with all the proper information and calculation to the
credits.
(4) Comply additional information as may be required by the Commissioner/BIR regulation.
(5) If credit is brought for taxes already paid, the form must have attached receipts for each tax
payment period. If sought for taxes accrued the return on which such accrued tax was based must
also be attached, as well as the bond [Sec.34(C), NIRC; Sec. 86, ibid].

Q. When may the Commissioner require a bond as a condition precedent to the allowance
of credit for foreign taxes?
Ans. In the case of a credit sought for a tax accrued but not paid [Sec. 34(C) (5), NIRC ; Sec. 86,
par. 2.]

Q. What are the governing rules on redetermination or adjustment of tax in case credit
for foreign taxes accrued proves incorrect or any tax payment credited is refunded?
Ans. The taxpayer is required to immediately notify the Commissioner who is authorized to
redetermine the amount of the tax of such taxpayer for the year or years for which such incorrect
credit was granted:
(1) The amount of tax if any, due upon such redetermination shall be paid by the taxpayer upon
notice and demand by the Commissioner.
(2) The amount of tax, if any, shown by such redetermination to have been overpaid shall be
credited or refunded to the taxpayer [Sec.34 (C) (5) NIRC; Sec. 87 Regs. No. 2].

Sec 34 (A) Expenses

(1) Ordinary and Necessary Trade, Business or Professional Expenses


(a) In General. There shall be allowed as deduction from gross income all the ordinary
and necessary expenses paid or incurred during the taxable year in carrying on or which are
directly attributable to, the development, management, operation and/or conduct of the trade,
business or exercise of a profession, including:

(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal
services actually rendered, including the grossed-up monetary value of fringe benefit furnished
or granted by the employer to the employee: Provided, That the final tax imposed under Section
33 hereof has been paid;

(ii) A reasonable allowance for travel expenses, here and abroad, while away from home in
the pursuit of trade, business or profession;

(iii) A reasonable allowance for rentals and/or other payments which are required as a
condition for the continued use or possession, for purposes of the trade, business or profession,
of property to which the taxpayer has not taken or is not taking title or in which he has no equity
other than that of a lessee, user or possessor;

(iv) A reasonable allowance for entertainment, amusement and recreation expenses during the
taxable year, that are directly connected to the development, management and operation of the
trade, business or profession of the taxpayer, or that are directly related to or in furtherance of the
conduct of his or its trade, business or exercise of a profession not to exceed such ceilings as the
Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the
Commissioner, taking into account the needs as well as the special circumstances, nature and
character of the industry, trade, business, or profession of the taxpayer: Provided, That any
expense incurred for entertainment, amusement or recreation that is contrary to law, morals,
public policy or public order shall in no case be allowed as a deduction.

(b) Substantiation Requirements. No deduction from gross income shall be allowed under
Subsection (A) hereof unless the taxpayer shall substantiate with sufficient evidence, such as
official receipts or other adequate records: (i) the amount of the expense being deducted, and (ii)
the direct connection or relation of the expense being deducted to the, development,
management, operation and/or conduct of the trade, business or profession of the taxpayer.

CASES DIGEST

Guiding principles in determining "ordinary and necessary" expenses.

This Court has never attempted to define with precision the terms "ordinary and necessary."
There are however, certain guiding principles worthy of serious consideration in the proper
adjudication of conflicting claims. Ordinarily, an expense will be considered "necessary" where
the expenditure is appropriate and helpful in the development of the taxpayers business. It is
"ordinary" when it connotes a payment which is normal in relation to the business of the
taxpayer and the surrounding circumstances. The term "ordinary" does not require that the
payments be habitual or normal in the sense that the same taxpayer will have to make them
often; the payment may be unique or non-recurring to the particular taxpayer affected.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

Intention of taxpayer may be the controlling factor in determining deductibility of ordinary and
necessary expenditures.

There is no hard and fast rule on the right to a deduction which depends in each case on the
particular facts and the relation of the payment to the type of business in which the taxpayer is
engaged. The intention of the taxpayer often may be the controlling fact in making the
determination. Assuming that the expenditure is ordinary and necessary in the operation of the
taxpayer's business, the answer to the question as to whether the expenditure is an allowable
deduction as a business expense must be determined from the nature of the expenditure itself,
which in turn depends on the extent and permanency of the work accomplished by the
expenditure.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

Expenses incurred by charitable institution for handling its dividends and interests are not
deductible as business expenses.

As the principle of allocating expenses is grounded on the premise that the taxable income was
derived from carrying on a trade or business, as distinguished from mere receipt of interests and
dividends from ones investments, said income should not share in the allocation of
administrative expenses. Thus, expenses incurred by a charitable institution for handling its
funds or income consisting solely of dividends and interests, are not expenses incurred in
"carrying on any trade or business," hence, not deductible as business or administrative
expenses.

Hospital de San Juan de Dios, Inc. vs. Commissioner of Internal Revenue, G.R.
No. 31305, May 10, 1990

What constitutes capital expenditures

Expenses relating to recapitalization and reorganization of the corporation, the cost of obtaining
stock subscription, promotions expenses and commission of fees paid for the sale of stock
reorganization are capital expenditures.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981
Questions in determining deductibility of compensation of corporate officers

Whenever a controversy arises on the deductibility, for purposes of income tax, of certain items
for alleged compensation of officers of the taxpayer, two (2) questions become material, namely:
(a) Have 'personal services been actually rendered' by said officers? (b) In the affirmative case,
what is the 'reasonable allowance' thereof?

Alhambra Cigar & Cigarette Manufacturing Company vs. Commissioner of Internal Revenue,
G.R. No. L-23226, November 28, 1967

Compensation to directors without relation to actual services cannot be regarded as ordinary


and necessary expenses.

The extraordinary and unusual amounts paid by the taxpayer to its directors in the guise and
form of compensation for their supposed services as such, without any relation to the measure of
their actual services, cannot be regarded as ordinary and necessary expenses within the meaning
of the law. This posture is in line with the doctrine in the law of taxation that the taxpayer must
show that its claimed deductions clearly come within the language of the law since allowances,
like exemptions, are matters of legislative grace.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

Improper payments of royalty are not deductible as legitimate business expenses.

Although the Tax Code allows payments of royalty to be deducted from gross income as business
expenses, it is CB Circular No. 393 that defines what royalty payments are proper. Improper
payments of royalty are not deductible as legitimate business expenses.

3M Philippines, Inc. vs. Commissioner of Internal Revenue, G.R. No. 82833, September 26, 1988

Conditions for deductibility of business expense

The statutory test of deductibility requires that to be deductible as a business expense, three
conditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be
paid or incurred within the taxable year, and (3) it must be paid or incurred in carrying on a
trade or business. In addition, not only must the taxpayer meet the business test, he must
substantially prove by evidence or records the deductions claimed under the law, otherwise, the
same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary
and necessary does not justify its deduction.

Esso Standard Eastern, Inc. vs. Commissioner of Internal Revenue, G.R. Nos. 28508-9, July 7,
1989

Requisites for deductibility of advertising expense.


To be deductible from gross income, advertising expense must comply with the following
requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or
incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade
or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent
papers.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc., G.R. No. 143672, April 24,
2003

Factors to consider in determining the reasonableness of an advertising expense

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an
advertising expense. There being no hard and fast rule on the matter, the right to a deduction
depends on a number of factors such as but not limited to: the type and size of business in which
the taxpayer is engaged; the volume and amount of its net earnings; the nature of the
expenditure itself; the intention of the taxpayer and the general economic conditions. It is the
interplay of these, among other factors and properly weighed, that will yield a proper
evaluation.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc., G.R. No. 143672, April 24,
2003

Two kinds of advertising.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise
or use of services and (2) advertising designed to stimulate the future sale of merchandise or use
of services. The second type involves expenditures incurred, in whole or in part, to create or
maintain some form of goodwill for the taxpayer's trade or business or for the industry or
profession of which the taxpayer is a member. If the expenditures are for the advertising of the
first kind, then, except as to the question of the reasonableness of amount, there is no doubt such
expenditures are deductible as business expenses. If, however, the expenditures are for
advertising of the second kind, then normally they should be spread out over a reasonable period
of time.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc., G.R. No. 143672, April 24,
2003

Protection of brand franchise is akin to acquisition of capital assets and therefore not business
expense.

The protection of brand franchise is analogous to the maintenance of goodwill or title to one's
property. This is a capital expenditure which should be spread out over a reasonable period of
time. Respondent corporation's venture to protect its brand franchise was tantamount to efforts
to establish a reputation. This was akin to the acquisition of capital assets and therefore
expenses related thereto were not to be considered as business expenses but as capital
expenditures.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc., G.R. No.
143672, April 24, 2003

To be considered ordinary, an expense must be reasonable in amount.

True, it is the taxpayer's prerogative to determine the amount of advertising expenses it will
incur and where to apply them. Said prerogative, however, is subject to certain considerations.
The first relates to the extent to which the expenditures are actually capital outlays; this
necessitates an inquiry into the nature or purpose of such expenditures. The second, which must
be applied in harmony with the first, relates to whether the expenditures are ordinary and
necessary. Concomitantly, for an expense to be considered ordinary, it must be reasonable in
amount.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc. G.R. No.
143672, April 24, 2003

Conditions for deductibility of employee bonuses

It is a general rule that bonuses to employees made in good faith and as additional compensation
for the services actually rendered by the employees are deductible, provided such payments,
when added to the stipulated salaries, do not exceed a reasonable compensation for the services
rendered. The conditions precedent to the deduction of bonuses to employees are: (1) the
payment of the bonuses is in fact compensation; (2) it must be for personal services actually
rendered; and (3) the bonuses, when added to the salaries, are 'reasonable . . . when measured
by the amount and quality of the services performed with relation to the business of the
particular taxpayer'

C. M. Hoskins & Co., Inc. vs. Commissioner of Internal Revenue, G.R. No.
L-24059, November 28, 1969

Factors in determining reasonableness of bonus as compensation

There is no fixed test for determining the reasonableness of a given bonus as compensation. This
depends upon many factors, one of them being 'the amount and quality of the services performed
with relation to the business.' Other tests suggested are: payment must be 'made in good faith';
'the character of the taxpayer's business, the volume and amount of its net earnings, its locality,
the type and extent of the services rendered, the salary policy of the corporation'; 'the size of the
particular business'; 'the employees' qualifications and contributions to the business venture';
and 'general economic conditions'. However, 'in determining whether the particular salary or
compensation payment is reasonable, the situation must be considered as a whole. Ordinarily,
no single factor is decisive. . . . it is important to keep in mind that it seldom happens that the
application of one test can give satisfactory answer, and that ordinarily it is the interplay of
several factors, properly weighted for the particular case, which must furnish the final answer."

C. M. Hoskins & Co., Inc. vs. Commissioner of Internal Revenue, G.R. No.
L-24059, November 28, 1969

Tax deductions must also be strictly construed.

It is a governing principle in taxation that tax exemptions must be construed in strictissimijuris


against the taxpayer and liberally in favor of the taxing authority; and he who claims an
exemption must be able to justify his claim by the clearest grant of organic or statute law. An
exemption from the common burden cannot be permitted to exist upon vague implications.
Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax
exemptions are strictly construed, then deductions must also be strictly construed.

Commissioner of Internal Revenue vs. General Foods (Phils.), Inc., G.R. No.
143672, April 24, 2003

Expenses to establish reputation are capital expenditures.

An expense incurred to create a favorable image of the corporation in order to gain or maintain
the publics and its stockholders patronage, does not make it deductible as business expense.
Efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses
related thereto are not business expense but capital expenditures.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

Listing fee is an ordinary and necessary business expense.

A listing fee is an ordinary and necessary business expense for the privilege of having its stock
listed.

Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

Litigation expenses incurred in defense or protection of title are capital in nature and not
deductible.

It is well settled that litigation expenses incurred in defense or protection of title are capital in
nature and not deductible, likewise, it was ruled by the U.S. Tax Court that expenditures in
defense of title property constitute a part of the cost of the property, are not deductible as
expense.
Atlas Consolidated Mining &Devt. Corp. vs. Commissioner of Internal Revenue, G.R. No. L-
26911, January 27, 1981

BIR ISSUANCES

REVENUE REGULATIONS NO. 10-02 July 10, 2002

Implementing the Provisions of Section 34(A)(1)(a)(iv) of the Tax Code of 1997, Authorizing the
Imposition of a Ceiling on "Entertainment, Amusement and Recreational Expenses" claimed by
individual taxpayers engaged in business or in the practice of their profession and of domestic or
resident foreign corporations, to arrive at the taxable income subject to income tax under
Sections 24(A); 25(A)(1); 26; 27(A), (B) and (C); 28(A)(1); 28(A)(6)(b) and Section 61 , of
the Tax Code of 1997.

These regulations shall cover entertainment, amusement and recreation expenses of the
following taxpayers:

a. Individuals engaged in business, including taxable estates and trusts;


b. Individuals engaged in the practice of profession;
c. Domestic corporations;
d. Resident foreign corporations;
e. General professional partnerships, including its members.
"Entertainment, Amusement and Recreation Expenses" includes representation expenses and/or
depreciation or rental expense relating to entertainment facilities, as described below.

The term "Representation Expenses" shall refer to expenses incurred by a taxpayer in connection
with the conduct of his trade, business or exercise of profession, in entertaining, providing
amusement and recreation to, or meeting with, a guest or guests at a dining place, place of
amusement, country club, theater, concert, play, sporting event, and similar events or places.
For purposes of these Regulations, representation expenses shall not refer to fixed
representation allowances that are subject to withholding tax on wages pursuant to appropriate
revenue regulations.

In the case particularly of a country, golf, sports club, or any other similar club where the
employee or officer of the taxpayer is the registered member and the expenses incurred in
relation thereto are paid for by the taxpayer, there shall be a presumption that such expenses are
fringe benefits subject to fringe benefits tax unless the taxpayer can prove that these are actually
representation expenses. For purposes of proving that said expense is a representation expense
and not fringe benefits, the taxpayer should maintain receipts and adequate records that indicate
the (a) amount of expense (b) date and place of expense (c) purpose of expense (d) professional
or business relationship of expense (e) name of person and company entertained with contact
details.
The term "Entertainment Facilities" shall refer to (1) a yacht, vacation home or condominium;
and (2) any similar item of real or personal property used by the taxpayer primarily for the
entertainment, amusement, or recreation of guests or employees. To be considered an
entertainment facility, such yacht, vacation home or condominium, or item of real or personal
property must be owned or form part of the taxpayer's trade, business or profession, or rented by
such taxpayer, for which the taxpayer claims a depreciation or rental expense. A yacht shall be
considered an entertainment facility under these Regulations if its use is in fact not restricted to
specified officers or employees or positions in such a manner as to make the same a fringe
benefit for purposes of imposing the fringe benefits tax.

The term "Guests" shall mean persons or entities with which the taxpayer has direct business
relations, such as but not limited to, clients/customers or prospective clients/customers. The term
shall not include employees, officers, partners, directors, stockholders, or trustees of the
taxpayer.

Exclusions The following expenses are not considered entertainment, amusement and
recreation expenses as defined under Section 2 hereof.

a. Expenses which are treated as compensation or fringe benefits for services rendered under
an employer-employee relationship, pursuant to Revenue Regulations 2-98 , 3-98 and
amendments thereto;
b. Expenses for charitable or fund raising events;
c. Expenses for bonafide business meeting of stockholders, partners or directors;
d. Expenses for attending or sponsoring an employee to a business league or professional
organization meeting;
e. Expenses for events organized for promotion, marketing and advertising including
concerts, conferences, seminars, workshops, conventions, and other similar events;
f. Other expenses of a similar nature.
Notwithstanding the foregoing, such items of exclusions may, nonetheless, qualify as items of
deduction under Section 34 of the Tax Code of 1997, subject to conditions for deductibility
stated therein.

Requisites of Deductibility of "Entertainment, Amusement and Recreation Expense". The


following are the requisites for deductibility of entertainment, amusement and recreation
expense as defined above subject to the ceiling prescribed under Section 5 of these Regulations:

a. It must be paid or incurred during the taxable year;


b. It must be: (i) directly connected to the development, management and operation of the
trade, business or profession of the taxpayer; or (ii) directly related to or in furtherance of the
conduct of his or its trade, business or exercise of a profession;
c. It must not be contrary to law, morals, good customs, public policy or public order;
d. It must not have been paid, directly or indirectly, to an official or employee of the
national government, or any local government unit, or of any government-owned or controlled
corporation (GOCC), or of a foreign government, or to a private individual, or corporation, or
general professional partnership (GPP), or a similar entity, if it constitutes a bribe, kickback or
other similar payment;
e. It must be duly substantiated by adequate proof. The official receipts, or invoices, or bills
or statements of accounts should be in the name of the taxpayer claiming the deduction; and
f. The appropriate amount of withholding tax, if applicable, should have been withheld
therefrom and paid to the Bureau of Internal Revenue.
SECTION 5. Ceiling on Entertainment, Amusement, and Recreation Expense. There shall be
allowed a deduction from gross income for entertainment, amusement and recreation expense, as
defined in Section 2 of these Regulations, in an amount equivalent to the actual entertainment,
amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but
in no case shall such deduction exceed 0.50 percent (%) of net sales (i.e., gross sales less sales
returns/allowances and sales discounts) for taxpayers engaged in sale of goods or properties; or
1.00 percent (%) of net revenue (i.e., gross revenue less discounts) for taxpayers engaged in sale
of services, including exercise of profession and use or lease of properties. However, if the
taxpayer is deriving income from both sale of goods/properties and services, the allowable
entertainment, amusement and recreation expense shall in all cases be determined based on an
apportionment formula taking into consideration the percentage of the net sales/net revenue to
the total net sales/net revenue, but which in no case shall exceed the maximum percentage
ceiling provided in these Regulations.

(c) Bribes, Kickbacks and Other Similar Payments No deduction from gross income shall
be allowed under Subsection (A) hereof for any payment made, directly or indirectly, to an
official or employee of the national government, or to an official or employee of any local
government unit, or to an official or employee of a government-owned or -controlled
corporation, or to an official or employee or representative of a foreign government, or to a
private corporation, general professional partnership, or a similar entity, if the payment
constitutes a bribe or kickback.

(2) Expenses Allowable to Private Educational Institutions In addition to the expenses


allowable as deductions under this Chapter, a private educational institution, referred to under
Section 27(B) of this Code, may at its option elect either: (a) to deduct expenditures otherwise
considered as capital outlays of depreciable assets incurred during the taxable year for the
expansion of school facilities, or (b) to deduct allowance for depreciation thereof under
Subsection (F) hereof.

ORDINARY EXPENSES

Q. What are the expenses deductible under the Tax Code?


Ans. The expenses are:
(1) Business expenses; and
(2) Expenses allowable to private educational institutions.
Q. What are the requisites in order for business (ordinary and necessary) expenses to be
deductible?
Ans. The requisites for deductibility are:
(1) The expenses must be ordinary and necessary.
(2) They must be paid and incurred during the taxable year.
(3) They must be paid or incurred in carrying on the trade or business of the taxpayer;
(4) They must be supported by records of pertinent papers (i.e., receipts, vouchers);
(5) They must not be contrary to law or public policy.

ORDINARY EXPENSE- when it is reasonable and common to the particular business of the
taxpayer as distinguished from capital expenditures. It is ordinary when it connotes a payment
which is normal in relation to the business of the taxpayer and the surrounding circumstances. The
term "ordinary" does not require that payments be habitual or normal in the sense that the same
taxpayer will have to incur them often; the payment may be unique or non-recurring to the
particular taxpayer affected (Atlas Consolidated Mining Development Corp. v. Commissioner,L-
26911 January 27, 1981, Vol. 79 Jo. 4 p. 393'
NECESSARY EXPENSE- when it is useful or helpful to the business, it need not be essential
or indispensable to the business as distinguished from personal expenditure. Ordinarily, an expense
will be considered "necessary" where the expenditure is appropriate and helpful in the
development of taxpayer's business.(Sec. 34(A) (1) (a), NIRC].
The term paid if the taxpayer keeps his books on the cash receipts basis, expenses are
deductible in the year they are paid. Incurred if the taxpayer keeps his books on the accrual basis,
expenses are deductible in the year they are incurred, whether paid or not.
BONUSES to employees made as additional compensation are deductible provided such
payments when added to the stipulated salaries do not exceed a reasonable compensation for the
services rendered (Kuezzle & Steif, Inc. v. Commissioner of Internal Revenue (L-18840 May 29,
1961; 38 SCRA 366; G M. Hoskin & Co. Inc v. Commissioner of Internal Revenue L-249, March
18, 19658, 30 SCRA 1). The condition precedent to the deductibility of bonuses to employees are:
(1) The payment of the bonus is in fact a compensation; (2) The payment is made in good faith or
in compliance with law; (3) It must be for personal services actually rendered; (4) The bonuses
when added to the salaries are reasonable when measured to the business of the particular taxpayer
(C.M. Hoskin & Co. v. Commissioner, 30 SCRA 1).
COMPENSATION FOR SERVICES is deductible if reasonable and for personal services
actually rendered (Rev.Reg. 2, Sec. 80 (1); Commissioner of Internal Revenue v. Algue. etc., GR
No. L-29906. Feb. 17 1988). The factors to be considered in determining reasonableness of
compensation for services are: (1) Type and extent of services; (2) The payment must be made in
good faith; (3) The qualification of employees; (4) Volume or amount of taxpayer's earnings; (5)
The character of taxpayer's business; (6) The locality in which the business is in; (7) The
compensation policy of the taxpayer; and (8) The general economic conditions (BIR Ruling 1959).

Q. What are examples of business expenses?


Ans. Examples of business expenses that are deductible from the gross income as ordinary and
necessary expenses are:
(1)Wages, salaries, bonuses and other forms of services compensation and other benefits-
housing and meals
(2) Traveling expenses upon compliance of BIR requirements.
(3) Management expenses.
(4) Advertising and promotional expenses;
(5) Supplies.
(6) Incidental repairs;
(7) Labor;
(8) Rentals.
(9) Commissions;
(10) Insurance premium against fire, theft, etc.
(11) Operating expenses for transportation;
(12) Representation expenses.
TRAVELLING EXPENSES- include transportation expenses, meals and lodging. If the trip is
solely on business, the reasonable and necessary traveling expenses, including transportation
expenses, meals and lodging become business, instead of personal expenses
Traveling expenses to be deductible from the gross income must meet the following requisites:
(1) They must be reasonable and necessary; (2) They must be incurred away from home; (3) They
must be paid or incurred in the conduct of trade or business. The taxpayer claiming the benefit of
deductibility of traveling expenses must attach to his return a statement showing: (i) The nature of
the business in which he is engaged; (ii) The number of days away from home during the taxation
year on account of business; (iii) The total amount of expenses incident to meals and lodging while
absent from home and business during the taxable year; and (iv) The total amount of other
expenditures incident to travel and claimed as a deduction (Sec. 66, Rev. Regs,).
SUPPLIES- a professional may claim as deduction the cost of materials or supplies used by
him in the practice of profession. Deduction of supplies may either be effected by the method of
actual consumption or by total purchase. Additionally, a professional may incur professional
expenses, including repairs and expenses in maintaining his transportation equipment in making
professional calls, dues to professional societies, subscriptions to professional journals, office
rents, light, water, telephone, expenses amounts expended for books ,furnishings, etc.. and salaries
of the office personnel, etc .

Q. Define the following: (a) necessary expenses for tax purposes: (b) Ordinary expenses
for tax purposes.
Ans.
NECESSARY EXPENSE- when it is useful or helpful to the business, it need not be essential
or indispensable to the business as distinguished from personal expenditure. Ordinarily, an expense
will be considered "necessary" where the expenditure is appropriate and helpful in the
development of taxpayer's business.(Sec. 34(A) (1) (a), NIRC].
ORDINARY EXPENSE- when it is reasonable and common to the particular business of the
taxpayer as distinguished from capital expenditures. It is ordinary when it connotes a payment
which is normal in relation to the business of the taxpayer and the surrounding circumstances.
The term "ordinary" does not require that payments be habitual or normal in the sense that the
same taxpayer will have to incur them often; the payment may be unique or non-recurring to the
particular taxpayer affected (Atlas Consolidated Mining Development Corp. v. Commissioner,
L-26911 January 27, 1981)

Q. When can the business expenses be allowed and deducted?


Ans. The period for deducting expenses depends upon the method of accounting used by the
taxpayer. Thus, when-
(1) Taxpayer uses cash method of accounting, business expenses are deducted in the tax year
they are actually paid, even if they were incurred in an earlier year.
(2) Taxpayer uses accrual method of accounting, the business expenses are deductible when the
taxpayer becomes liable for them, whether or not they are paid in the same year. The propriety of
an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to
have known, at the closing of its books for taxable year.
Paramount Insurance Corporation v. Commissioner of Internal Revenue, CTA Case No. 4844,
prom. June 7, 1996;

Q. What are the three (3) essential conditions which must be satisfied in order that an
expense may be validly considered deductible for income tax purposes? State the essential
conditions which must be satisfied in order that an expense may be validly considered
deductible for income tax purposes.
Ans. The conditions are:
First, the business expenses must be paid or incurred within the taxable year;
Second, it must be an ordinary and necessary expense paid or incurred in carrying on a trade or
business.
Third, it must comply the substantiation rule with adequate evidence to support the deduction.

Q. Discuss "Substantiation Rule."


Ans. The taxpayer shall substantiate the expense being deducted with sufficient evidence, such
as official receipts or other adequate records by showing:
(1) The amount of the expense being deducted; and
(2) The direct connection or relation of the expense being deducted to the development
management, operation and/or conduct of the trade, business or profession of the taxpayer (Sec.
34(A)(1) (b), NIRC of 1997).
(3) Unless provided, substantiation -i.e.,
(a) Receipts or adequate records;
(b) Amount of expense;
(c) Date and place of expense;
(d) Purpose of expense;
(e) Professional or business relationship
(f) Must support each claim for business or professional expense otherwise it shall be
disallowed (Last Sentence, No. 2, Revenue Audit Memorandum Order No. 1-87).
As previously stated, a taxpayer has the burden of proving settlement to a claimed
deduction, testimonial and documentary evidence in the form of invoices and official receipts to
support the claimed deduction must be presented. However, under the law of evidence,
testimonial evidence standing alone is inadmissible and entitled to little, if any credence.
Commissioner of Internal Revenue v. Construction Resources of Asia, Inc. 2456 SCRA 671;
Atlas Consolidated Mining and Development Corporation v. Commissioner of Internal Revenue,
102 SCRA 246; Consolidated Mines v. Court of Tax Appeals, 58 SCRA 618' Paper Industries
Corporation of the Philippines v. Court of Appeals, et. al. and company cases, 250 SCRA 434;
Q. What are the requisites for bonus to employees to be deductible by employer as
business expense?
Ans. BONUSES to employees made as additional compensation are deductible provided such
payments when added to the stipulated salaries do not exceed a reasonable compensation for the
services rendered (Kuezzle & Steif, Inc. v. Commissioner of Internal Revenue (L-18840 May 29,
1961; 38 SCRA 366; G M. Hoskin & Co. Inc v. Commissioner of Internal Revenue L-249, March
18, 19658, 30 SCRA 1). The condition precedent to the deductibility of bonuses to employees are:
(1) The payment of the bonus is in fact a compensation; (2) The payment is made in good faith or
in compliance with law; (3) It must be for personal services actually rendered; (4) The bonuses
when added to the salaries are reasonable when measured to the business of the particular taxpayer
(C.M. Hoskin & Co. v. Commissioner, 30 SCRA 1).
Q. What are the requisites for traveling expenses to be deductible from the gross income?
Ans.. Traveling expenses to be deductible from the gross income must meet the following
requisites: (1) They must be reasonable and necessary; (2) They must be incurred away from home;
(3) They must be paid or incurred in the conduct of trade or business. The taxpayer claiming the
benefit of deductibility of traveling expenses must attach to his return a statement showing: (i) The
nature of the business in which he is engaged; (ii) The number of days away from home during the
taxation year on account of business; (iii) The total amount of expenses incident to meals and
lodging while absent from home and business during the taxable year; and (iv) The total amount
of other expenditures incident to travel and claimed as a deduction (Sec. 66, Rev. Regs,).

Q. Discuss the nature of entertainment or representation expenses.


Ans. These expenses are now available only to those taxpayers other than those receiving
compensation income. Representation expenses fall under the category of business expenses
which are allowable deductions (Zamora v. Collector L-152990 May 31, 1963, 8 SCRA 163).
They cannot be allowed as deductions in the absence of receipts, invoices or vouchers supporting
said expenses and in said cases the taxpayer cannot specify the items contributing said expenses.
Gangayco v. Collector, L-13325 April 20, 1961, 1 SCRA 980; Paramount Insurance
Corporation v. Commissioner of Internal Revenue CTA Case No. 4844 prom . June 7, 1996 citing
Collector of Internal Revenue v. Goodrich International Rubber Co. 2 SCRA 136;

Q. What are the requisites for entertainment or representation expenses to be deductible


from the gross income?
Ans. In order that representation expenses may be deducted:
(1) They must be ordinary and necessary expenses paid or incurred in carrying on any trade or
business;
(2) Should meet the further test of reasonableness in the amount incurred;
(3) They should be covered by supporting papers and in the absence thereof, the amount
deductible as representation expenses should be determined from all available data.
Zamora v. Collector, 8 SCRA 163; Roxas v. CTA L-15043 April 26, 1967, 23 SCRA 276;
Q. Give some of the factors that may be considered in determining the reasonableness of
the compensation paid for services?
Ans. COMPENSATION FOR SERVICES is deductible if reasonable and for personal
services actually rendered (Rev.Reg. 2, Sec. 80 (1); Commissioner of Internal Revenue v.
Algie.etc., GR No. L-29906. Feb. 17 1988). The factors to be considered in determining
reasonableness of compensation for services are: (1) Type and extent of services; (2) The payment
must be made in good faith; (3) The qualification of employees; (4) Volume or amount of
taxpayer's earnings; (5) The character of taxpayer's business; (6) The locality in which the business
is in; (7) The compensation policy of the taxpayer; and (8) The general economic conditions (BIR
Ruling 1959).

Q. May the cost of goods purchased for re-sale deductible from the gross income?
Ans. Yes, with proper adjustment for opening and closing inventories (Sec. 65, Regs. No. 2).

Q. What are the basic rules on the deductibility of cost of materials and supplies as a
business expense?
Ans. There are two methods that may be used in deducting this type of business expense:
(1) Actual consumption- This is computed by the inventory method. f the taxpayer keeps a
record of consumption of materials and supplies or takes physical inventories at the beginning
and end of the year, he should include as expenses, cost of materials and supplies actually
consumed and used during the year.
(2) Total purchases- If a taxpayer carries incidental materials or supplies on hand for which no
record of consumption is kept or of which no physical inventories are taken, it is permissible for
him to include in his expenses and deduct from gross income, the total of such supplies and
materials purchased during the year, provided the net income is clearly reflected in this method
(Sec. 67, Regs. No. 2 63Sec. 68, Regs. No. 2).

Q. What are the rules governing the deductibility of the cost of repairs as a business
expense?
Ans. The rules for this type of business expense are:
(1) Expenses for repairs are deductible if such repairs are incidental or ordinary; that is, made to
keep the property used in the trade or business of the taxpayer in an ordinarily efficient operating
condition (Sec. 67, Regs. No. 2 63Sec. 68, Regs. No. 2). such as repair of walls or roof to prevent
leaking.
(2) Repairs in the nature of replacement to the extent that they arrest deterioration and prolong
the life of the property are capital expenditures and should be debited against the corresponding
allowance for depreciation. So hollow block fences with iron grills around the house of the
taxpayer is disallowed because they prolong the life of property and materially increased its
value (Alhambra Cigar and Cigarettes Mfg. Co. v. Coll. 105 Phil. 1337; Comm. v. A. Soriano Y
Cia, CTA L-26793 March 21, 1971).

Q. (a) What is advertising? (b) Classify or state the kinds of advertising.


Ans. (a) Advertising is the use of the spoken or written word in printed matter, movies, radio and
television to acquaint the public with the taxpayer's merchandise or services General Foods
(Philippines) Inc. v. Commissioner of Internal Revenue, CTA Case No. 4386 prom. Feb.8,
1994).
(b) There are two kinds, namely:
(1) Advertising to stimulate the current sale of merchandise or use of services;
(2) Advertising designed to stimulate the future sale of merchandise or use of services.

Q. What is capital expenditure? Illustrate.


Ans. It is a cash outlay, or exchange of property, that does not decrease a taxpayer's asset but
merely changes its form. It is a payment which creates or enhances what is essentially a separate
and distinct asset. They are expenditures that result in obtaining benefits of a permanent in nature
such as lands, buildings and machineries [Sec. 36(A). (3)]. Hence, expenses for new buildings,
cost of defending and perfecting title to property (Sec. 120 Rev. Regs. No. 2)., architect fees,
expenditures for replacement alteration, improvements or additions , which either prolong the
life of the property or increase its value (Alhambra Cigar v. Collector, L-12126 and L-121231;
May 29, 1956; Commissioner v. Soriano A. Y Ca. L-24993, May 16, 1971) and cost of
topographical survey of boundary lines1 and amounts expended for maps, abstracts, recording
fees and surveys are capital in nature and not deductible from the gross income [Sec. 34(A)(2),
NIRC of 1997].

Q. Is there an instance when capital expenditures may be deducted as expense?


Ans. Yes. In addition to the expenses allowable as deductions, a private educational institution,
may at its option elect either:
(1) To deduct expenditures otherwise considered as capital outlays of depreciable assets
incurred during the taxable year for the expansion of school facilities, or
(2) To deduct allowances for depreciation thereof [Sec. 36(A)(3), NIRC of 1997].

Sec 34 (E) Bad Debts

(1) In General. Debts due to the taxpayer actually ascertained to be worthless and charged off
within the taxable year except those not connected with profession, trade or business and those
sustained in a transaction entered into between parties mentioned under Section 36(B) of this
Code: Provided, That recovery of bad debts previously allowed as deduction in the preceding
years shall be included as part of the gross income in the year of recovery to the extent of the
income tax benefit of said deduction.

CASES DIGEST

Requisites for deductibility of "bad debts"

For debts to be considered as "worthless," and thereby qualify as "bad debts" making them
deductible, the taxpayer should show that (1) there is a valid and subsisting debt; (2) the debt
must be actually ascertained to be worthless and uncollectible during the taxable year; (3) the
debt must be charged off during the taxable year; and (4) the debt must arise from the business
or trade of the taxpayer. Additionally, before a debt can be considered worthless, the taxpayer
must also show that it is indeed uncollectible even in the future.
Philippine Refining Company vs. Court of Appeals, et al., G.R. No.
118794, May 8, 1996

Criteria for ascertaining worthlessness of debts

The requirement of ascertainment of worthlessness requires proof of two facts: (1) that the
taxpayer did in fact ascertain the debt to be worthless, in the year for which the deduction is
sought; and (2) that, in so doing, he acted in good faith.

Collector of Internal Revenue vs. Goodrich International Rubber Co., G.R. No. L-
22265, December 22, 1967

BIR ISSUANCES

REVENUE REGULATIONS NO. 25-02 November 19, 2002


Implementing Section 34(E) of the Tax Code of 1997 on the Requirements for Deductibility of
Bad Debts from Gross Income on the requirements for deductibility of bad debts from the gross
income of a corporation, including banks and insurance companies, or an individual, estate and
trust that is engaged in trade or business or a professional engaged in the practice of his
profession.
Requisites for valid deduction of bad debts from gross income The requisites for deductibility
of bad debts are:
(1) There must be an existing indebtedness due to the taxpayer which must be valid and
legally demandable;
(2) The same must be connected with the taxpayer's trade, business or practice of profession;
(3) The same must not be sustained in a transaction entered into between related parties
enumerated under Sec. 36(B) of the Tax Code of 1997;
(4) The same must be actually charged off the books of accounts of the taxpayer as of the end
of the taxable year; and
(5) The same must be actually ascertained to be worthless and uncollectible as of the end of
the taxable year.
"Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to
demonstrate with reasonable degree of certainty the uncollectibility of the debt. The
Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the
collateral, if any, securing the debt and the financial condition of the debtor in determining
whether a debt is worthless, or the assigning of the case for collection to an independent
collection lawyer who is not under the employ of the taxpayer and who shall report on the legal
obstacle and the virtual impossibility of collecting the same from the debtor and who shall issue
a statement under oath showing the propriety of the deductions thereon made for alleged bad
debts. Thus, where the surrounding circumstances indicate that a debt is worthless and
uncollectible and that legal action to enforce payment would in all probability not result in the
satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the
worthlessness of the debt for the purpose of deduction.
In the case of banks, the Commissioner of Internal Revenue shall determine whether or not bad
debts are worthless and uncollectible in the manner provided in the immediately preceding
paragraph. Without prejudice to the Commissioner's determination of the worthlessness and
uncollectibility of debts, the taxpayer shall submit a BangkoSentralngPilipinas/Monetary Board
written approval of the writing off of the indebtedness from the banks' books of accounts at the
end of the taxable year.
"Also, in no case may a receivable from an insurance or surety company be written-off from the
taxpayer's books and claimed as bad debts deduction unless such company has been declared
closed due to insolvency or for any such similar reason by the Insurance Commissioner."

(2) Securities Becoming Worthless If securities, as defined in Section 22(T), are ascertained
to be worthless and charged off within the taxable year and are capital assets, the loss resulting
therefrom shall, in the case of a taxpayer other than a bank or trust company incorporated under
the laws of the Philippines a substantial part of whose business is the receipt of deposits, for the
purpose of this Title, be considered as a loss from the sale or exchange, on the last day of such
taxable year, of capital assets.

Requisites for capital gain or capital loss on securities transactions

Securities Becoming Worthless. If securities as defined in Section 22(T) become worthless


during the taxable year and are capital assets, the loss resulting therefrom shall, for purposes of
this Title, be considered as a loss from the sale or exchange, on the last day of such taxable year,
of capital assets.

The loss sustained by the holder of the securities, which are capital assets (to him), is to be
treated as a capital loss as if incurred from a sale or exchange transaction. A capital gain or a
capital loss normally requires the concurrence of two conditions for it to result: (1) There is a
sale or exchange; and (2) the thing sold or exchanged is a capital asset.

China Banking Corp. vs. Court of Appeals, et al., G.R. No. 125508, July 19, 2000

When securities become worthless, the law deems the loss as "a loss from the sale or exchange of
capital assets"

When securities become worthless, there is strictly no sale or exchange but the law deems the
loss anyway to be "a loss from the sale or exchange of capital assets." A similar kind of
treatment is given by the NIRC on the retirement of certificates of indebtedness with interest
coupons or in registered form, short sales and options to buy or sell property where no sale or
exchange strictly exists. In these cases, the NIRC dispenses, in effect, with the standard
requirement of a sale or exchange for the application of the capital gain and loss provisions of
the code.

China Banking Corp. vs. Court of Appeals, et al., G.R. No. 125508, July 19, 2000

BAD DEBTS
Q. Give the concept of deductible bad debts.
Ans. Debts are due to the taxpayer actually ascertained to be worthless and charged off within
the taxable year. A bad debt results from worthlessness or uncollectivity, in whole or in part of
accounts due the taxpayer by others, arising from money lent or from uncollectible amounts of
income from goods sold or services rendered.

Q. What is a bona fide debt?


Ans. A bona fide debt is one which arises from a debtor-creditor relationship based upon a valid
and enforceable obligation to pay a fixed or determinable sum of money.
Philex Mining Corp. v. Commissioner of Internal Revenue, CTA Case No. 5200 prom. August
21, 1997; citing Sec. 1166-1(c) of US Internal Revenue Code and Fisher v. Comm. 54 TC 905
(1970) and Goldstein v. Comm. TC Memor 1980-273;

Q. What are the requisites for deductibility of bad debts? or What are the requirements
before bad debts are allowed as deduction.
Ans. The requisites for deductibility of bad debts are:
(1) A valid and subsisting debt.
(2) Actually ascertained to be worthless and uncollectible during the taxable year;
(3) Must be charged off during the taxable year.
(4) The debt must arise from business or trade of the taxpayer.
(5) The debts are uncollectible despite diligent effort exerted by the taxpayer.
Philippine Refining Corporation v. Court of Appeals, et. al. 256 SCRA 667
(6) The debt must not be between that of a related party " [Sec. 34(E) (1), NIRC of 1997]

Q. (a) When is a debt considered worthless? (b) What are the circumstances indicative of
worthlessness?
Ans. (a) A debt is considered worthless, if under subjective circumstances at the time the
purported obligation is created, a "reasonable prudent person would not have expected
repayment from the debtor; that a taxpayer may exercise sound business judgment based upon
information reasonably obtainable in determining worthless debts; and that a taxpayer may not
postpone a bad debt deduction on the basis of a mere hope of ultimate collection (Philex Mining
Corp. v. Commissioner CTA No. 5200 prom. August 21, 1998).
(b) The circumstances indicative of worthlessness are:
(1) The flight or disappearance of the debtor;
(2) The insufficiency of collaterals;
(3) Bankruptcy or insolvency;
(4) Loss of evidence of indebtedness;
(5) Debt of debtor leaving no assets;
(6) Injury to debtor incapacitating him from work;
(7) Absence of visible properties of the debtor; and
(8) Fruitless efforts to collect small amounts from debtors scattered all over the country.

Q. What are the steps to be undertaken by the taxpayer to prove undertaking of diligent
efforts to collect the debts?
Ans. The recognized steps are:
(1) Sending of statement of accounts;
(2) Sending of collection letters;
(3) Giving account to a lawyer for collection;
(4) Filing a collection case in court (Philippine Refining Corporation v. Court of Appeals, et. al.
256 SCRA 667).

Q. Discuss the extent of debt deductibility


Ans. The amount of the bad debt is not necessarily also the amount deductible as illustrated by
the following cases:
(1) A worthless debt partially secured by a mortgage may be written off as that portion not
covered by the mortgage (Philippine Trust Co. v. Collector , CTA Case No. 367 January 30,
1961).
(2) Compromised debt may be deducted to the extent of the amount not paid anymore provided
the debtor is insolvent (i.e. ,P10,000.00 being paid by P3,000.00; so, P7,000.00 is deductible),
(3) Only the difference between the amount received in distribution of the assets of a bankrupt
and the amount of the claim may be deducted as bad debt (Sec. 103 Regs.).

Q. What is the status of subsequently collected debts?


Ans. A debt which was previously found to be worthless and written off in a prior year and
subsequently collected does not render the deduction unallowable and illegal (Philippine Trust
Co. v. Collector, supra). However, any amount subsequently received on account of bad debts
previously charged off and allowed as deduction for income tax purposes must be included in the
gross income for the taxpayer in which received (Par. 1, Sec. 102 Rev. Regs.).

Sec 34 (F) Depreciation

(1) General Rule There shall be allowed as a depreciation deduction a reasonable allowance
for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property
used in the trade or business. In the case of property held by one person for life with remainder to
another person, the deduction shall be computed as if the life tenant were the absolute owner of
the property and shall be allowed to the life tenant. In the case of property held in trust, the
allowable deduction shall be apportioned between the income beneficiaries and the trustees in
accordance with the pertinent provisions of the instrument creating the trust, or in the absence of
such provisions, on the basis of the trust income allowable to each.

(2) Use of Certain Methods and Rates The term 'reasonable allowance' as used in the
preceding paragraph shall include, but not limited to, an allowance computed in accordance with
rules and regulations prescribed by the Secretary of Finance, upon recommendation of the
Commissioner, under any of the following methods:

(a) The straight-line method;

(b) Declining-balance method, using a rate not exceeding twice the rate which would have been
used had the annual allowance been computed under the method described in Subsection (F)(1);

(c) The sum-of-the-years-digit method; and


(d) Any other method which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner.

(3) Agreement as to Useful Life on Which Depreciation Rate is Based Where under rules and
regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner,
the taxpayer and the Commissioner have entered into an agreement in writing specifically
dealing with the useful life and rate of depreciation of any property, the rate so agreed upon shall
be binding on both the taxpayer and the National Government in the absence of facts and
circumstances not taken into consideration during the adoption of such agreement. The
responsibility of establishing the existence of such facts and circumstances shall rest with the
party initiating the modification. Any change in the agreed rate and useful life of the depreciable
property as specified in the agreement shall not be effective for taxable years prior to the taxable
year in which notice in writing by certified mail or registered mail is served by the party
initiating such change to the other party to the agreement:

Provided, however, That where the taxpayer has adopted such useful life and depreciation rate
for any depreciable asset and claimed the depreciation expenses as deduction from his gross
income, without any written objection on the part of the Commissioner or his duly authorized
representative, the aforesaid useful life and depreciation rate so adopted by the taxpayer for the
aforesaid depreciable asset shall be considered binding for purposes of this Subsection.

CASES DIGEST

Definition of "depreciation"

Depreciation is the gradual diminution in the useful value of tangible property resulting from
wear and tear and normal obsolescence. The term is also applied to amortization of the value of
intangible assets, the use of which in the trade or business is definitely limited in duration.

Basilan Estates, Inc. vs. Commissioner of Internal Revenue, et al., G.R. No. L-22492, September
5, 1967

Depreciation commences with the acquisition of the property.

Depreciation commences with the acquisition of the property and its owner is not bound to see
his property gradually waste, without making provision out of earnings for its replacement. It is
entitled to see that from earnings the value of the property invested is kept unimpaired, so that at
the end of any given term of years, the original investment remains as it was in the beginning. It
is not only the right of a company to make such a provision, but it is its duty to its bond and
stockholders, and, in the case of a public service corporation, at least, its plain duty to the
public. Accordingly, the law permits the taxpayer to recover gradually his capital investment in
wasting assets free from income tax.
Basilan Estates, Inc. vs. Commissioner of Internal Revenue, et al., G.R. No.
L-22492, September 5, 1967

The law does not authorize depreciation of an asset beyond its acquisition cost.

The income tax law does not authorize the depreciation of an asset beyond its acquisition cost.
Hence, a deduction over and above such cost cannot be claimed and allowed. The reason is that
deductions from gross income are privileges, not matters of right. They are not created by
implication but upon clear expression in the law. Moreover, the recovery, free of income tax, of
an amount more than the invested capital in an asset will transgress the underlying purpose of a
depreciation allowance. For then what the taxpayer would recover will be, not only the
acquisition cost, but also some profit. Recovery in due time thru depreciation of investment made
is the philosophy behind depreciation allowance; the idea of profit on the investment made has
never been the underlying reason for the allowance of a deduction for depreciation.

Basilan Estates, Inc. vs. Commissioner of Internal Revenue, et al., G.R. No.
L-22492, September 5, 1967

Depreciation of building is based on construction cost, not on its assessed value.

Where a building acquired by a corporation from the vendors in exchange for shares of its stocks
is revalued on the basis of its construction cost, which revaluation imports an obligation of the
corporation to pay the vendors the difference between the assessed value and the revalued
construction cost, it is held that the depreciation logically has to be on the basis of the
construction cost and not on the assessed value of the building, since the corporate investment
would ultimately be the construction cost.

Commissioner of Internal Revenue vs. Priscila Estate, Inc., et al., G.R. No.
L-18282, May 29, 1964

Findings of tax court on depreciation of assets should not be disturbed.

Depreciation is a question of fact, and where the appellant does not claim that the tax court, in
applying certain rates and basis to arrive at the allowed amounts of depreciation, was arbitrary
or had abused its discretion, the findings of the tax court on the depreciation of assets should not
be disturbed.

Commissioner of Internal Revenue vs. Priscila Estate, Inc., et al., G.R. No. L-
18282, May 29, 1964

Depreciation of residence not used in trade or business is not deductible.

The claim for depreciation of taxpayer's residence is not deductible where such residence was
not used in his trade or business. A taxpayer may deduct from gross income reasonable
allowance for deterioration of property arising out of its use or employment in business or trade.
Lino Gutierrez, et al. vs. Collector of Internal Revenue, G.R. No.
L-19537, May 20, 1965

When purchase of domestic goods and services considered as "capital goods or properties"

For petitioner's purchases of domestic goods and services to be considered as "capital goods or
properties," three requisites must concur. First, useful life of goods or properties must exceed
one year; second, said goods or properties are treated as depreciable assets under Section 34 (f)
and; third, goods or properties must be used directly or indirectly in the production or sale of
taxable goods and services. From petitioner's evidence, the account vouchers specifically
indicate that the disallowed purchases were recorded under inventory accounts, instead of
depreciable accounts. That petitioner failed to indicate under its fixed assets or depreciable
assets account, goods and services allegedly purchased pursuant to the rehabilitation and
maintenance of Malaya Power Plant Complex, militates against its claim for refund. As correctly
found by the CTA, the goods or properties must be recorded and treated as depreciable assets
under Section 34 (F) of the NIRC.

Kepco Phil. Corp. vs. Commissioner of Internal Revenue, G.R. No.


179356, December 14, 2009

(4) Depreciation of Properties Used in Petroleum Operations An allowance for depreciation in


respect of all properties directly related to production of petroleum initially placed in service in a
taxable year shall be allowed under the straight-line or declining-balance method of depreciation
at the option of the service contractor.

However, if the service contractor initially elects the declining-balance method, it may at any
subsequent date, shift to the straight-line method.

The useful life of properties used in or related to production of petroleum shall be ten (10) years
or such shorter life as may be permitted by the Commissioner.

Properties not used directly in the production of petroleum shall be depreciated under the
straight-line method on the basis of an estimated useful life of five (5) years.

(5) Depreciation of Properties Used in Mining Operations An allowance for depreciation in


respect of all properties used in mining operations other than petroleum operations, shall be
computed as follows:

(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or

(b) Depreciated over any number of years between five (5) years and the expected life if the
latter is more than ten (10) years, and the depreciation thereon allowed as deduction from taxable
income: Provided, That the contractor notifies the Commissioner at the beginning of the
depreciation period which depreciation rate allowed by this Section will be used.
(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or Resident
Foreign Corporations In the case of a nonresident alien individual engaged in trade or
business or resident foreign corporation, a reasonable allowance for the deterioration of property
arising out of its use or employment or its non-use in the business, trade or profession shall be
permitted only when such property is located in the Philippines.

DEPRECIATION

Q. What is meant by "depreciation" as used in the Tax Code?


Ans. Depreciation is the reasonable allowance for exhaustion, wear and tear and obsolescence4
of the property used in trade or business (Sec, 195, Revenue Regulations No. 2). The term is also
applied to amortization of the value of intangible assets, the use of which in the trade or business
is definitely is limited duration (i.e., incorporation expenses- see Estates Inc. v. Commissioner of
Internal Revenue, 21 SCRA 17).

Q. Why is there a need for a depreciation allowance?


Ans. Because depreciation allowance provides for a source of funds to replace an asset. By using
the property, a gradual sale is made of it; and the depreciation charged is the measure of the cost
which has been sold. When the property is disposed of after years of use, it is no longer the
whole thing originally used (US v. Ludey, 274 T.J.S. 295; also Basilan Estates v. Comm. Ibid).

Q. What depreciation are allowed as deduction? Or What is the proper allowance for
depreciation of any property used in trade or business?
Ans. The term "reasonable allowance" as used shall include (but not limited to) an allowance
computed in accordance with regulations prescribed by the Secretary of Finance upon
recommendation of the Commissioner under certain methods. There shall be allowed as a
depreciation deduction a reasonable allowance for the exhaustion, wear and tear and
obsolescence of property used in trade or business:
(1) In the case of property held by one person for life with remainder to another person,
(a) The deduction shall be computed as if the life tenant were the absolute owner of
the property; and
(b) Shall be allowed to the life tenant.
(2) In case of property held in trust,
(a) The allowable deduction shall be apportioned between the income beneficiaries
and the trustees;
(b) In accordance with the provisions of the instrument creating the trust; or
(c) In the absence of such provisions, on the basis of the trust income allowable to
each [Sec. 234 (F) (1), NIRC of 1997].

Q. How is depreciation measured?


Ans. Depreciation is a question of fact and is not measured by theoretical yardstick but should be
determined by a consideration of actual facts (Commissioner v. Prescilla Estate Inc. L-18282,
May 29, 1964). The reasonableness of any claim for depreciation shall be determined upon the
conditions known to exist d at the end of the period for which the return is made (Sec. 109, Regs.
NO. 2).

Q. What are the requisites for deductibility of depreciation?


Ans. Depreciation is deductible from the gross income if the following requisites are being
complied with:
First, It must arise out of the use or employment in business or out of its not being used;
Second, It must be reasonable, using certain methods and rates such as the following:
(1) Straight line method;
(2) Declining balance method;
(3) Year-digits method;
(4) Other prescribed methods such as:
(a) Apportionment to units of production;
(b) Revaluation method;
(c) Sinking fund method.
(5) Conventional (agreement ) depreciation method.
STRAIGHT LINE METHOD, under which the cost or other basis of the property less its
estimated salvage value is deductible in equal annual amounts over the period of the estimated
useful life of the property (Holsman, FEDERAL INCOME TAXATION, pp. 10-13). The periodic
charge is computed by relating the cost of the asset less any scrap, residual/salvage to the service
life expressed in either months or years.(see par. 20 a). Statement of Financial Accounting
Standard No. 6). Cost less salvage over service life equals depreciation charge per period.
Assuming that a machine cost P10,000.00 and had an estimated salvage value of P500.00 and a
service life of 10 years, the annual depreciation charge would be: P10,000.00 less P500.00 divided
by 10 years.
DECLINING BALANCE METHOD- under which a uniform rate is applied each year to the
unrecovered cost or other basis of property. This method produces results similar to the sum of the
year's digest method. However, this method arrives at a depreciation charge by multiplying a fixed
rate times a declining rate times a fixed balance, when the calculated rate is multiplied by the net
book value at the beginning of the period (without regard to salvage value) the annual depreciation
charge will write down the assets to its salvage value, the rate may not exceed twice the straight
line rate thus,, its tax designation as double declining balance method, it may happen that after the
midpoint of service life, the taxpayer may shift to a straight line basis.(see Par. 20 d. Statement of
Financial Accounting Standards No. 6).
SUM OF THE YEARS-DIGESTS METHOD, under which an annual allowance for
depreciation is computed by applying changing fractions to the cost or other basis of property
reduced by estimated salvage. The numerator of the fraction changes each year to a number which
corresponds to the remaining useful life of the asset (including the year for which the allowance is
being computed) and the denominator (which remains consistent) is the year's digest
corresponding to the estimated useful life of the asset (Holzman, supra). This method of decreasing
charges is based on applying a decreasing rate of depreciation of a constant depreciable cost. The
denominator of the rate fraction is equal to the sum of the digests in reverse order. For example, if
an asset had an estimated service life of five(5) years, the denominator would be 15 calculated as
follows: 1+2+3+4+5= 15. In the first year, the rate fraction would be 5/15; in the third year,
3/15,etc. The rate fraction is multiplied by the depreciable cost (cost less salvage) to obtain each
year's charge to expense.
Units of production and hours of use method- these methods relate depreciation to the estimated
production capability of an asset and is expressed in a rate per unit of product or hour of use. They
are used in situations where the usage of the depreciable asset varies considerably from period to
period, and in those circumstances in which the service life is more a function of use than passage
of time (Par. 20, b. Statement of Financial Accounting Standards No. 6).
Where under regulations prescribed by the Secretary of Finance, upon recommendation of
the Commissioner of Internal Revenue, the taxpayer and the Commissioner of Internal Revenue
have entered into an agreement in writing specifically dealing with the useful life and rate of
depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer and the
National Government in the absence of facts and circumstances not taken into consideration in the
adoption of such agreement. The responsibility of establishing the existence of such facts and
circumstances shall rest with the party initiating the modification. Any change in the agreed rate
and useful life specified in the agreement shall not be effective for taxable years before the taxable
year in which notice in writing by certified mail or registered mail is served by the party to the
agreement initiating such change. Provided, however, that where the taxpayer has adopted such
useful life and depreciated rate for any depreciable asset and claimed the depreciation expenses as
deduction from his gross income, without any written objection on the part of the Commissioner
of Internal Revenue or his duly authorized representatives, the aforesaid useful life and
depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be considered
binding [Sec. 34 (f) (3), NIRC of 1997].

Third, not exceeding the capital invested.


Fourth, in case of non-resident aliens only if the property is located within the Philippines. [Sec.
34(F) (5), NIRC of 1997].
Fifth, depreciable life must extend one year.
Sixth, two more additional requisites:
(1) It must be charged off during the taxable year; and
(2) Statement on the allowance must be attached.

Q. What are the properties subject to depreciation?


Ans. While some properties may not be depreciated (not subject to depreciation) the following
may be subject to depreciation:
(1) Tangible property.
(2) Intangible property.
(3) Properties used in petroleum operation (Sec. 34(F), (5), NIRC of 1997).
TANGIBLE PROPERTY- that which is subject to wear and tear, decay or decline from natural
causes, to exhaustion to obsolescence due to the normal profess of the art as where machinery or
other property must be replaced by a new invention, or due to the inadequacy of the property to
the growing needs of the business(Sec. 106, Regs, supra,)
INTANGIBLE PROPERTY that the use of which in the trade or business is definitely limited
in duration , like patents, copyrights, and franchises.(Secs. 10, 111, Regs., ibid.) This allowance in
property is called amortization.
Q. (a) May depreciation deduction be allowed in case of property which has been amortized
to its scrap value and is no longer in use?(c) What is the capital sum recoverable through
depreciation allowance? (c) May depreciation deduction be allowed beyond the
capital invested in the assets being depreciated?

Ans. (a) No, not allowed (Sec. 108 Regs. No. 2).
(b) The capital sum to be replaced by depreciation allowances is the cost or the basis of property
in respect of which the allowance is made. To this amount should be added from time to time,
the amount or cost of improvement, addition and betterment and from it should be deducted from
time to time, the amount of any definite loss or damage sustained through casualty as
distinguished from the gradual exhaustion of its utility which is the basis of the depreciation
allowance (Sec. 180, Regs. No. 2)
(c) No, otherwise, the deduction may extend already to profits (Gutierrez v. Comm. L-
19587, May 20, 1965).

Q. What properties are not subject to deductible depreciation?


Ans. They are:
(1) Inventories or stocks-in-trades;
(2) Lands, apart from the improvement or physical development added to it;
(3) Bodies of minerals which through the process of removal suffer depletion as they are subject
to depletion allowance;
(4) Automobiles and the transportation equipment based solely by the taxpayer for pleasure;
(5) Building used solely by taxpayer as his residence;
(6) Furniture and furnishing used in the said buildings;
(7) Personal effects or clothing except properties or costumes used exclusively in the business
such as theatrical business;
(8) Intangibles, the use of which in business or trade is not of limited duration;
(9) Incidental repairs.

Q. Who are the persons entitled to depreciation?


Ans. The following are entitled:
(1) Resident Filipino citizens and resident aliens.
(2) Nonresident aliens.
(3) Resident foreign corporations.
(4) Service contractors related to petroleum production [Sec. 34(F)(4)(5), NIRC of 1997].

Q. What is the annual depreciation of a depreciable fixed asset with a cost of


P100,000.00 and an estimated useful life of 20 years and salvage value of P10,000.00 after
its useful life?
Ans. The annual depreciation is P4,500.00 computed as follows:
P100,000.00 -cost
- 10,000.00 -salvage value
P90,000.00 divided by 20 years lifetime =P4,500.00 (annual depreciation)

Sec 34 (G) Depletion of Oil and Gas Wells and Mines


(1) In General In the case of oil and gas wells or mines, a reasonable allowance for depletion
or amortization computed in accordance with the cost-depletion method shall be granted under
rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the
Commissioner: Provided, That when the allowance for depletion shall equal the capital invested
no further allowance shall be granted: Provided, further, That after production in commercial
quantities has commenced, certain intangible exploration and development drilling costs: (a)
shall be deductible in the year incurred if such expenditures are incurred for non-producing wells
and/or mines, or (b) shall be deductible in full in the year paid or incurred or, at the election of
the taxpayer, may be capitalized and amortized if such expenditures incurred are for producing
wells and/or mines in the same contract area.

Intangible costs in petroleum operations' refers to any cost incurred in petroleum operations
which in itself has no salvage value and which is incidental to and necessary for the drilling of
wells and preparation of wells for the production of petroleum: Provided, That said costs shall
not pertain to the acquisition or improvement of property of a character subject to the allowance
for depreciation except that the allowances for depreciation on such property shall be deductible
under this Subsection.

Any intangible exploration, drilling and development expenses allowed as a deduction in


computing taxable income during the year shall not be taken into consideration in computing the
adjusted cost basis for the purpose of computing allowable cost depletion.

(2) Election to Deduct Exploration and Development Expenditures In computing taxable


income from mining operations, the taxpayer may, at his option, deduct exploration and
development expenditures accumulated as cost or adjusted basis for cost depletion as of date of
prospecting, as well as exploration and development expenditures paid or incurred during the
taxable year: Provided, That the total amount deductible for exploration and development
expenditures shall not exceed twenty-five percent (25%) of the net income from mining
operations computed without the benefit of any tax incentives under existing laws. The actual
exploration and development expenditures minus twenty-five percent (25%) of the net income
from mining shall be carried forward to the succeeding years until fully deducted.

The election by the taxpayer to deduct the exploration and development expenditures is
irrevocable and shall be binding in succeeding taxable years.

"'Net income from mining operations', as used in this Subsection, shall mean gross income from
operations less 'allowable deductions' which are necessary or related to mining operations.
'Allowable deductions' shall include mining, milling and marketing expenses, and depreciation of
properties directly used in the mining operations. This paragraph shall not apply to expenditures
for the acquisition or improvement of property of a character which is subject to the allowance
for depreciation.
In no case shall this paragraph apply with respect to amounts paid or incurred for the exploration
and development of oil and gas.

The term 'exploration expenditures' means expenditures paid or incurred for the purpose of
ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, and
paid or incurred before the beginning of the development stage of the mine or deposit.

The term 'development expenditures' means expenditures paid or incurred during the
development stage of the mine or other natural deposits. The development stage of a mine or
other natural deposit shall begin at the time when deposits of ore or other minerals are shown to
exist in sufficient commercial quantity and quality and shall end upon commencement of actual
commercial extraction.

(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien Individual or
Foreign Corporation. In the case of a nonresident alien individual engaged in trade or business
in the Philippines or a resident foreign corporation, allowance for depletion of oil and gas wells
or mines under paragraph (1) of this Subsection shall be authorized only in respect to oil and gas
wells or mines located within the Philippines.

CASES DIGEST

The burden of justifying the allowance of deduction based on depletion rests on taxpayer.

As an income tax concept, depletion is wholly a creation of the statute "solely a matter of
legislative grace." Hence, the taxpayer has the burden of justifying the allowance of any
deduction claimed. As in connection with all other tax controversies, the burden of proof to show
that a disallowance of depletion by the Commissioner is incorrect or that an allowance made is
inadequate is upon the taxpayer, and this is true with respect to the value of the property
constituting the basis of the deduction. This burden-of-proof rule has been frequently applied
and a value claimed has been disallowed for lack of evidence.

Consolidated Mines, Inc. vs. Court of Tax Appeals, et al., G.R. Nos. L-
18843 & 18844, August 29, 1974

Differences between "depletion" and "depreciation"

Both depletion and depreciation are predicated on the same basic premise of avoiding a tax on
capital. The allowance for depletion is based on the theory that the extraction of minerals
gradually exhausts the capital investment in the mineral deposit. The purpose of the depletion
deduction is to permit the owner of a capital interest in mineral in place to make a tax-free
recovery of that depleting capital asset. A depletion is based upon the concept of the exhaustion
of a natural resource whereas depreciation is based upon the concept of the exhaustion of the
property, not otherwise a natural resource, used in a trade or business or held for the production
of income. Thus, depletion and depreciation are made applicable to different types of assets. And
a taxpayer may not deduct that which the Code allows as a deduction of another.

Consolidated Mines, Inc. vs. Court of Tax Appeals, et al., G.R. Nos.
L-18843 & 18844, August 29, 1974

DEPLETION
Q. What is meant by deductible depletion?
Ans. Depletion is the reduction during the taxable year of oil, gas or other deposits or reserves as
a result of production. Depletion is the exhaustion of natural resources like mines and oil and gas
wells as a result of production and severance from such mines or wells (1965 CCH Fed. Tax
Courses, par. 1201).

Q. What is the theory and purpose of depletion allowances?


Ans. The theory of the allowance for depletion, as in the case of depreciation, is that, as the
product of the mine is sold, a gradual sale is being made of the taxpayer's capital interest in the
property. Depletion allowance enables the taxpayer to recover that capital interest free of income
tax, at its cost or on some other basis (1965 CCH Fed, Tax Course, par. 1201).

Q. What is a wasting asset?


Ans. An asset that is exhaustible, non-replaceable and non-repairable. Examples: natural
resources like mines, oil and gas wells.

Q. Distinguish depletion from depreciation.


Ans. The asset subject to depletion could not be replaced while that subject to depreciation could
be replaced.

Q. What are the items that are subject to depletion?


Ans. They are:
(1) Depletion of oil and gas wells and mines.
(2) Intangible exploration and development drilling cost;
(3) Intangible costs in petroleum operation.
(4) Optional deduction of exploration expenditures and development expenditures under the Tax
Code.

Q. What is meant by: intangible costs in petroleum operations, exploration expenditures


and development expenditures?
Ans. Defining them:
(1) Intangible costs in petroleum operations- any cost incurred in petroleum operations which
is itself has no salvage value and which is incidental to and necessary for the drilling of wells and
preparation of wells, for the production of petroleum. Provided, that said costs shall not pertain
to the acquisition or improvement of property of a character subject to the allowance for
depreciation except that the allowances for depreciation on such property shall be deductible
under this subsection [3rd par. Sec. 34(G)(1), NIRC of 1997].
(2) Exploration expenditures- expenditures paid or incurred for the purpose of ascertaining the
existence, location, extent, or quality of any deposit or ore or other mineral, and paid or incurred
before the beginning of the development stage of the mine or deposit [5th par. Sec. 34(G) (2),
NIRC of 1997].
(3) Development expenditures- expenditures paid or incurred during the development stage of
the mine or other natural deposits. The development stage of a mine or other natural deposit shall
begin at the time when deposits of one or other minerals are shown to exist in sufficient
commercial quantity and quality and shall end upon commencement of actual commercial
extraction [6th par. Sec. 34 (G), (2), NIRC of 1997].

Q. Who are entitled to depletion allowance?


Ans. Depletion deductions are allowed only to the owner of an economic interest to mineral
deposits. An economic interest is possessed in every case in which the taxpayer has acquired (by
investment or otherwise) a capital interest in mineral in place and secures by any form of legal
relationship, income derived from the severance or sale of mineral to which they must look for
the return of his capital. The holder of a royalty interest is deemed to have an interest in oil in
place which depleted by severance (Revenue Reg. No 5, 76. April 1,1976; Gen. Circ. No V-332,
Jan. 6, 1961).

Q. In general, how shall depletion allowance be computed?


Ans. It shall be computed under the cost depletion method. The cost depletion method being
the following: (1) In the case of oil and gas wells and mines, a reasonable allowance for depletion
or amortization computed in accordance with the cost depletion method shall be granted under
rules and regulations prescribed by the Secretary of Finance. (2) When the allowance for depletion
shall be equal the capital invested, no further allowance shall be granted. (3) After production in
commercial quantities has been commenced, certain intangible exploration and development
drilling costs: (a) shall be deductible in the year incurred if such expenditures are incurred for non-
producing wells and/or mines; or (b) shall be deductible in full in the year paid and/or incurred, or,
at the producing wells and /or mines in the same contract area. (4) Any intangible exploration,
drilling and development expenses allowed as a deduction in computing taxable income during the
year shall not be taken into consideration in computing the adjusted cost basis for the purpose of
computing allowable cost depletion [Sec. 34(G),(1), NIRC of 1997].

Q. What are the essential facts in determining the amount of cost depletion to be allowed ?
Ans. The essential facts in determining the allowable depletion are:
(1) The basis of the property;
(2) The estimated total recoverable units in the property; and
(3) The number of units recovered during the taxable year.

Q. When may allowances for depletion allowable to nonresident aliens?


Ans. In case of nonresident alien individuals, allowances for depletion of oil and gas wells or
mines shall be authorized only in respect to oil and gas wells or mines located within the
Philippines [Sec. 34(G) (3), NIRC of 1997].
Sec 34 (J) Pension Trusts An employer establishing or maintaining a pension trust to provide
for the payment of reasonable pensions to his employees shall be allowed as a deduction (in
addition to the contributions to such trust during the taxable year to cover the pension liability
accruing during the year, allowed as a deduction under Subsection (A)(1) of this Section) a
reasonable amount transferred or paid into such trust during the taxable year in excess of such
contributions, but only if such amount: (1) has not theretofore been allowed as a deduction, and
(2) is apportioned in equal parts over a period of ten (10) consecutive years beginning with the
year in which the transfer or payment is made.

CASES DIGEST

Income of pension trust is likewise tax-exempt

It is evident that tax exemption is likewise to be enjoyed by the income of the pension trust.
Otherwise, taxation of those earnings would result in a diminution of accumulated income and
reduce whatever the trust beneficiaries would receive out of the trust fund. This would run afoul
of the very intendment of the law. The tax advantage in Rep. Act No. 1983, Section 56(b), was
conceived in order to encourage the formation and establishment of such private Plans for the
benefit of laborers and employees outside of the Social Security Act.

Commissioner of Internal Revenue vs. Court of Appeals, et al., G.R.


No. 95022, March 23, 1992

PENSION TRUSTS
Q. Discuss briefly pension trust as deductible item.
Ans. An employer establishing or maintaining a pension trust to provide for the payment of
reasonable pensions to his employees shall be allowed as a deduction, in addition to the
contributions to such trust during the taxable year to cover the pension liability accruing during
the year, allowed as a deduction, a reasonable amount transferred or paid into such trust during
the taxable year in excess of such contribution, but only if such amount:
(1) Has not therefore been allowable as a deduction; and
(2) Is apportioned in equal parts over a period of 10 consecutive years beginning with the year in
which the transfer or payment is made.

Q. What are the deductible payments in connection with the pension trust?
Ans. The payments to employer's pension trusts which are deductible are:
(1) Amounts contributed by the employer during the taxable year into the pension plan to cover
the pension liability accruing the year;
(2) One-tenth of the reasonable amount paid by the employer to cover pension liability
applicable to the years prior to the taxable year, or so paid to place the trust, in a sound financial
basis (Sec. 118, Regs. NO. 2; Teodoro and De Leon, supra, p. 181).

Q. How is the income from the pension plan treated for income tax purposes?
Ans. Such income is not taxable to the plan if it is actually distributed or made available to the
employees who shall be taxable as to the respective amounts received by them (BIR Ruling No.
20, 1956).

Q. What are the requirements or requisites to be complied with by the employer in order
to validly deduct the payment to pension trusts?
Ans. The requisites are:
(1) The employer must have established a pension or retirement plan to provide for the payment
of reasonable pensions to his employees.
(2) The pension plan is reasonable and actually sound (Sec. 118, Regs. No. 2).
(3) It must be funded by the employer-i.e.., the employer contributes cash to the plan;
(4) The amount contributed must not be subject to control or disposition; and
(5) The payment has not yet been allowed as a deduction.

Q. What are the requisites of a reasonable retirement plan.


Ans. Under the implementing regulations, the requisites are:
(1) It must be a definite written program setting forth all provisions essential for qualification;
(2) It must be a permanent and continuing program unless sooner terminated by virtue of a valid
business reason;
(3) It must cover at least 70% of all officials and employees. If the plan provides eligibility
requirements and at least 70% of all officials and employees meet the eligibility requirements, at
least 80% of those eligible must be covered.
(4) It must provide for the non-diversion of the corpus (principal) or income of the trust fund to
any purpose other than for the exclusive benefit of the officials and employees.
(5) It must provide for discrimination in contributions or benefits in favor of officials and
employees who are officers, shareholders, supervisors or highly compensated officers.
(6) It must provide for the contribution to the trust fund by the employer of officials and
employees, or both for the purpose of distributing to the officials and employees or their
beneficiaries the corpus and income of the fund accumulated by the trust in accordance with the
plan; and
(7) It must provide for non-forfeitable right, that is, upon the termination of the plan or upon the
complete discontinuance of contributions under the plan, the rights of each officials or employer
to benefits accrued to the date of such termination, to the extent then funded, or the rights of each
employer to the amounts credited to his account at such time are non-forfeitable (Sec.118, Rev.
Regs. 2).

Sec 34 (M) Premium Payments on Health and/or Hospitalization Insurance of an Individual


Taxpayer The amount of premiums not to exceed Two thousand four hundred pesos (P2,400)
per family or Two hundred pesos (P200) a month paid during the taxable year for health and/or
hospitalization insurance taken by the taxpayer for himself, including his family, shall be
allowed as a deduction from his gross income: Provided, That said family has a gross income of
not more than Two hundred fifty thousand pesos (P250,000) for the taxable year: Provided,
finally, That in the case of married taxpayers, only the spouse claiming the additional exemption
for dependents shall be entitled to this deduction.
Notwithstanding the provisions of the preceding Subsections, the Secretary of Finance, upon
recommendation of the Commissioner, after a public hearing shall have been held for this
purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized
deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of
determining such ceilings or limitations, the Secretary of Finance shall consider the following
factors: (1) adequacy of the prescribed limits on the actual expenditure requirements of each
particular industry; and (2) effects of inflation on expenditure levels: Provided, further, That no
ceilings shall further be imposed on items of expense already subject to ceilings under present
law.

RESEARCH & DEVELOPMENT


Sec 34 (I) Research and Development.

(1) In General A taxpayer may treat research or development expenditures which are paid or
incurred by him during the taxable year in connection with his trade, business or profession as
ordinary and necessary expenses which are not chargeable to capital account. The expenditures
so treated shall be allowed as deduction during the taxable year when paid or incurred.

(2) Amortization of Certain Research and Development Expenditures At the election of the
taxpayer and in accordance with the rules and regulations to be prescribed by the Secretary of
Finance, upon recommendation of the Commissioner, the following research and development
expenditures may be treated as deferred expenses:

(a) Paid or incurred by the taxpayer in connection with his trade, business or profession;

(b) Not treated as expenses under paragraph (1) hereof; and

(c) Chargeable to capital account but not chargeable to property of a character which is subject to
depreciation or depletion.

In computing taxable income, such deferred expenses shall be allowed as deduction ratably
distributed over a period of not less than sixty (60) months as may be elected by the taxpayer
(beginning with the month in which the taxpayer first realizes benefits from such expenditures).

The election provided by paragraph (2) hereof may be made for any taxable year beginning after
the effectivity of this Code, but only if made not later than the time prescribed by law for filing
the return for such taxable year. The method so elected, and the period selected by the taxpayer,
shall be adhered to in computing taxable income for the taxable year for which the election is
made and for all subsequent taxable years unless, with the approval of the Commissioner, a
change to a different method is authorized with respect to a part or all of such expenditures. The
election shall not apply to any expenditure paid or incurred during any taxable year prior to the
taxable year for which the taxpayer makes the election.
(3) Limitations on Deduction This Subsection shall not apply to:

(a) Any expenditure for the acquisition or improvement of land, or for the improvement of
property to be used in connection with research and development of a character which is subject
to depreciation and depletion; and

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

Sec 34 (H) Charitable and Other Contributions

(1) In General Contributions or gifts actually paid or made within the taxable year to, or for
the use of the Government of the Philippines or any of its agencies or any political subdivision
thereof exclusively for public purposes, or to accredited domestic corporations or associations
organized and operated exclusively for religious, charitable, scientific, youth and sports
development, cultural or educational purposes or for the rehabilitation of veterans, or to social
welfare institutions, or to nongovernment organizations, in accordance with rules and regulations
promulgated by the Secretary of Finance, upon recommendation of the Commissioner, no part of
the net income of which inures to the benefit of any private stockholder or individual in an
amount not in excess of ten percent (10%) in the case of an individual, and five percent (5%) in
the case of a corporation, of the taxpayer's taxable income derived from trade, business or
profession as computed without the benefit of this and the following subparagraphs.

(2) Contributions Deductible in Full Notwithstanding the provisions of the preceding


subparagraph, donations to the following institutions or entities shall be deductible in full:

(a) Donations to the Government Donations to the Government of the Philippines or to any of
its agencies or political subdivisions, including fully-owned government corporations,
exclusively to finance, to provide for, or to be used in undertaking priority activities in education,
health, youth and sports development, human settlements, science and culture, and in economic
development according to a National Priority Plan determined by the National Economic and
Development Authority (NEDA), in consultation with appropriate government agencies,
including its regional development councils and private philanthropic persons and institutions:
Provided, That any donation which is made to the Government or to any of its agencies or
political subdivisions not in accordance with the said annual priority plan shall be subject to the
limitations prescribed in paragraph (1) of this Subsection;

(b) Donations to Certain Foreign Institutions or International Organizations Donations to


foreign institutions or international organizations which are fully deductible in pursuance of or in
compliance with agreements, treaties, or commitments entered by the Government of the
Philippines and the foreign institutions or international organizations or in pursuance of special
laws;
(c) Donations to Accredited Nongovernment Organizations The term 'nongovernment
organization' means a nonprofit domestic corporation:

(1) Organized and operated exclusively for scientific, research, educational, character-building
and youth and sports development, health, social welfare, cultural or charitable purposes, or a
combination thereof, no part of the net income of which inures to the benefit of any private
individual;

BIR ISSUANCES

REVENUE REGULATIONS NO. 13-98 December 8, 1998

Deductibility of Contributions or Gifts Actually Paid or Made to Accredited Donee Institutions


in Computing Taxable Income.

Donations to accredited non-stock, non-profit corporations/NGOs shall be entitled to the


following benefits:

(1) Limited Deductibility. Donations, contributions or gifts actually paid or made within
the taxable year to accredited non-stock, non-profit corporations shall be allowed limited
deductibility in an amount not in excess of ten percent (10%) for an individual donor, and five
percent (5%) for a corporate donor, of the donor's income derived from trade, business or
profession as computed without the benefit of this deduction.

(2) Full Deductibility. Donations, contributions or gifts actually paid or made within the
taxable year to accredited NGOs shall be allowed full deductibility, subject to the following
conditions:

(i) The accredited NGO shall make utilization directly for the active conduct of the activities
constituting the purpose or function for which it is organized and operated, not later than the
fifteenth (15th) day of the third month after the close of the accredited NGOs taxable year in
which contributions are received, unless an extended period is granted by the Secretary of
Finance, upon recommendation of the Commissioner.

For this purpose, the term "utilization" shall have the meaning as defined under Sec. 1(c) of
these Regulations.

(ii) The level of administrative expenses of the accredited NGO, shall, on an annual basis,
not exceed thirty percent (30%) of the total expenses for the taxable year;

(iii) In the event of dissolution, the assets of the accredited NGO, would be distributed to
another accredited NGO organized for similar purpose or purposes, or to the State for public
purpose, or purposes, or to the state for public purpose, or would be distributed by a competent
court of justice to another accredited NGO to be used in such manner as in the judgment of said
court shall best accomplished the general purpose for which the dissolved organization was
organized.

(iv) The amount of any charitable contribution of property other than money shall be based
on the acquisition cost of said property

(v) All the members of the Board of Trustees of the non-stock, non-profit corporation,
organization or NGO do not receive compensation or remuneration for their service to the
aforementioned organization.

(3) Exemption from Donor's Tax Donations and gifts made in favor of accredited non-
stock, non-profit corporations/NGOs shall be exempt from donor's tax: Provided, however, That
not more than thirty percent (30%) of the said donations and gifts for the taxable year shall be
used by such accredited non-stock, non-profit corporations/NGOs institutions qualified-donee
institution for administration purposes pursuant to the provisions of Section 101 (A)(3) and
(B)(2) of the Tax Code .

(2) Which, not later than the 15th day of the third month after the close of the accredited
nongovernment organizations taxable year in which contributions are received, makes utilization
directly for the active conduct of the activities constituting the purpose or function for which it is
organized and operated, unless an extended period is granted by the Secretary of Finance in
accordance with the rules and regulations to be promulgated, upon recommendation of the
Commissioner;

(3) The level of administrative expense of which shall, on an annual basis, conform with the
rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the
Commissioner, but in no case to exceed thirty percent (30%) of the total expenses; and

(4) The assets of which, in the event of dissolution, would be distributed to another nonprofit
domestic corporation organized for similar purpose or purposes, or to the state for public
purpose, or would be distributed by a court to another organization to be used in such manner as
in the judgment of said court shall best accomplish the general purpose for which the dissolved
organization was organized.

Subject to such terms and conditions as may be prescribed by the Secretary of Finance, the term
'utilization' means:

(i) Any amount in cash or in kind (including administrative expenses) paid or utilized to
accomplish one or more purposes for which the accredited nongovernment organization was
created or organized.

(ii) Any amount paid to acquire an asset used (or held for use) directly in carrying out one or
more purposes for which the accredited nongovernment organization was created or organized.
An amount set aside for a specific project which comes within one or more purposes of the
accredited nongovernment organization may be treated as a utilization, but only if at the time
such amount is set aside, the accredited nongovernment organization has established to the
satisfaction of the Commissioner that the amount will be paid for the specific project within a
period to be prescribed in rules and regulations to be promulgated by the Secretary of Finance,
upon recommendation of the Commissioner, but not to exceed five (5) years, and the project is
one which can be better accomplished by setting aside such amount than by immediate payment
of funds.

(3) Valuation The amount of any charitable contribution of property other than money shall
be based on the acquisition cost of said property.

(4) Proof of Deductions Contributions or gifts shall be allowable as deduction only if verified
under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of
the Commissioner.

CASES DIGEST

Charitable institution remains tax-exempt although it derives income from paying patients for its
hospital operations

As a general principle, a charitable institution does not lose its character as such and its
exemption from taxes simply because it derives income from paying patients, whether out-
patient, or confined in the hospital, or receives subsidies from the government, so long as the
money received is devoted or used altogether to the charitable object which it is intended to
achieve; and no money inures to the private benefit of the persons managing or operating the
institution.

Lung Center of the Phil. vs. Quezon City, et al., G.R. No. 144104, June 29, 2004

Rationale for tax exemption of charitable institutions

An institution does not lose its charitable character, and consequent exemption from taxation, by
reason of the fact that those recipients of its benefits who are able to pay are required to do so,
where no profit is made by the institution and the amounts so received are applied in furthering
its charitable purposes, and those benefits are refused to none on account of inability to pay
therefor. The fundamental ground upon which all exemptions in favor of charitable institutions
are based is the benefit conferred upon the public by them, and a consequent relief, to some
extent, of the burden upon the state to care for and advance the interests of its citizens.

Lung Center of the Phil. vs. Quezon City, et al., G.R. No. 144104, June 29, 2004

CHARITABLE CONTRIBUTONS
Q. Classify or What are the kinds of charitable and other contributions?
Ans. Contributions under the Tax Code as amended are:
(1) Ordinary contributions- those which are subject to limitations(i.e. 10% for individuals/5%
for corporations) as to the amount deductible from the gross income.
(2) Special contributions-Those which are deductible in full from the gross income.

Q.What are the ordinary donations/gifts/ contributions that are deductible when actually
paid in taxable year?
Ans. When made or paid:
(1) To or for the use of Government of the Philippines or any of its agencies /political
divisions for exclusively public purposes.
(2) To domestic corporations organized/operated exclusively for religious, charitable,
scientific [and research, basic research, applied research, youth and sport development, cultural,
or Educational or rehabilitation of veterans health purposes, etc.
(3) To social institutions when no part of the net income inures to the benefit of any
stockholder/individual.

RELIGIOUS PURPOSES means the promotion, propagation, and accomplishment of any


form of religion, creed, or belief recognized by the Government of the Philippines (Sec. 34(H),
NIRC; Sec. 2(G),BIR-NEDA Regulations No. 1-8, as amended);
CHARITABLE ACTIVITY -extending relief to the poor, distressed and under privilege and
shall include fighting against juvenile delinquency and community deterioration (Sec. 1(f), Rev.
Rev. No. 13-98;
SCIENTIFIC AND RESEARCH PURPOSE- undertaking or assisting in pure or basic, applied
and scientific research in the field of agriculture, forestry, fisheries, industry, engineering, energy
development, food and nutrition, medicine, environment and biological, physical and natural
sciences for the public interest (1st par. Sec. 2(g) Rev. Regs. No. 13-98).
BASIC RESEARCH- an experimental or theoretical work undertaken primarily to acquire new
knowledge of the underlying foundation of phenomena and observable facts without any particular
application or use in view. It analzes properties, structures or relationships with a view of
formulating and testing hypothesis, theories or laws. The result of basic research are not generally
sold but are usually published in scientific journals or circulars to interested colleagues (Sec. 1(g)
(i) Rev.Regs. No. 13-98).
APPLIED RESEARCH-an original investigation undertaken in order to acquire new
knowledge. It is directed primarily towards a specific practical aim or objective. It is undertaken
either to determine possible uses for the findings of basic research or to determine new methods
or way of achieving some specific and predetermined objectives. It involves the consideration of
the available knowledge and its extension in order to solve particular problems. Applied research
develop ideas into operational form (Sec. 1(g) (ii) Rev. Regs. No. 13-98).
CHARACTER BUILDING AND YOUTH AND SPORT DEVELOPOMENT PURPOSES-
includes:(a) conducting basic and applied research on youth development; (b) initiating and
establishing youth organizations to promote and develop youth activities including establishment
of summer camps or centers for leadership training and youth activities; (c) Conducting a program
of physical fitness and amateur sports development for the country; (d) Developing and
maintaining recreational facilities, playground and sports centers; and (d) Conducting training
programs for the development of youth and athletes for national and international competition
(Sec. 24(j) BIR-NEDA Regulation No. 1-8).
CULTURAL ACTIVITY- the term shall refer to and include undertaking and/or assisting in
research activities on all aspects of history, social system, customs and traditions, developing,
enriching and preserving Filipino arts and culture, developing and promoting the visual and
performing arts; and participating in vigorous implementation of bilingual policy through
translation and wider use of technical scientific and creative publications, development of an
adapted technical dictionary and use of Filipino as the medium of instruction (Sec. 21(j) Rev.
election of the taxpayer, may be capitalized and amortized, if such expenditures incurred are for
Regs. No. 13-98).
EDUCATIONAL ACTIVITY- shall refer to and include the granting of scholarships to
deserving students and professional chairs for the enhancement of professional courses, and
instructing or training of individuals either through formal and informal methods (1st par. Sec. (i)
Rev. Regs. No. 13-98)
REHABILITATION OF VETERANS- this shall include services extended to Philippine
veterans ad members of their families because of financial difficulties and attendant problems,
and services extended to disabled veterans toward productive life (Sec. 1(k) Rev. Regs. No. 13-
98);
HEALTH PURPOSES- to include the pursuit of the following:(a) control, prevention
treatment of communicable and degenerative diseases, accidents and other health disabilities; (b)
Family planning program designed to indicate knowledge and understanding of population, human
growth and development of family life; (c) environment sanitation, such as public sewage system
and sanitary toilets; and (d) nutrition which aims to reduce the prevalence or malnutrition and
increase the energy and protein intake among households [Sec.1(m) Rev. Regs. No. 13-98]..
SOCIAL WELFARE PURPOSES- shall refer to and include (a) undertaking and/or assisting
in the amelioration of the living conditions of distressed citizens particularly those who are
handicapped by reasons of poverty, youth, physical and mental disability, illness, old age and
natural disasters, including assistance to cultural minorities; (b) pursuing a program for the
protection and development of children and youth, such as providing services for drop-outs, pre-
school children of low-income working mothers, and physical handicapped children; (c) providing
for the rehabilitation of the youth and disabled adults, released prisoners, drug addicts, alcoholic,
mentally retarded, hansenites and similar cases; and (d) providing for services to squatter families
and to displaced workers [Sec. 1 (1) Rev. Regs. No. 13-98].

Q. For ordinary contributions/donations to be deductible, what requisites must be


complied with/present?
Ans. The following requisites:
(1) The contribution must actually be paid or made to the government/political subdivisions or
agencies to any domestic corporations specified by the Tax Code.
(2) It must be made within the taxable year;
(3) Must not exceed 10% of the taxpayer's net income determined without the benefit of the
contribution.
(4) Must be evidenced by adequate records/receipts.
(5) The donees must be accredited by an accrediting entity.
Q. May deduction of contributions be allowed even in the absence of supporting receipts?
Ans. Yes, provided the taxpayer may be able to prove it under the rules of evidence (Ramirez v.
Comm. CTA Case No. 544, Sept. 14, 1959; Nava v. Comm. CTA Case No. 568, Sept. 25,
1961)..

Q. What donations (special) are deductible in full and not within the creditable
limitations of 10%/5%?
Ans. They are:
(1) Donations to the government [Sec. 34(H) (2), NIRC of 1997].
(2) Donations to foreign institutions or international organizations.
(3) Donations to certain private foundations and/or donations to accredited non-governmental
organizations [Sec. 34(H) (2), NIRC of 1997].
(4) Donations of prizes and awards to athletes (Sec. 1, Rep Act No. 7549).

Q. What is an accrediting entity?


Ans. Accrediting entity- shall refer to a non-stock, non-profit organization composed of NGO
networks duly designated by the Secretary of Finance to establish and operationalize a system of
accreditation to determine the qualification of non-stock, non-profit corporations or organization
and NGOs for accreditation as qualified donee institutions [1st Sentence, Sec. 1(d), Rev.Regs.
No. 13-98].

Q. What is the present accrediting entity?


Ans. The Philippine Council for NGO Certification, Inc. (PCNC), a non-stock, non-profit
corporation which was established by several NGO networks has been duly designated by the
Secretary of Finance as an Accrediting Entity pursuant to Memorandum of Agreement dated
January 29, 1998 between Secretary of Finance and PCNC's Interim Chairman [Last par. Sec.
4(4) Rev. Regs. No. 13-98].

Q. Are contributions to a candidate in an election subject to donor's tax? On the part of


the contributor, is it allowable as a deduction from the gross income?
Ans. No, not within the enumerated deductible donations and contributions.

Q. In the conduct of his business in 2015, X found it necessary to give gifts to the
government officials with whom he had official dealings. He deducted the costs of these gifts
as representation expenses in his income tax return. Are the deductions valid? Reasons,
Ans. No. Under the Tax Code no deduction from gross income shall be allowed for any payment
directly or indirectly to an official or employer of the national government, or to an official or
employee of any local government unit, or to an official or employee of a government-owned or
controlled corporation, or to an official or employee or representative of a foreign government,
or to a private corporation, general professional partnership or a similar entity, if the payment
constitutes a bribe or a kickback [Sec. 34(A)(1)(c), NIRC of 1997].

Q. Are the following expenses deductible from the gross income: (1) Employer's
contribution to the Christmas fund of his employees; (2) Contribution to the construction of
a chapel of a university that declare dividends to its stockholders; (3) Premiums paid by the
employer for the life insurance of his employees; (4) Contribution to a newspaper fund for
needy families when such newspaper organizes a group of civic spirited citizens solely for
charitable purposes; (5) Interest on taxes?
Ans. (1) Item (1) is deductible under No. 2.7 RAMO NO. 1-87 being part of the necessary and
ordinary expenses. inures to the benefit of private stockholder [Sec.34(H), (1)NIRC of 1997)].
(2) Not deductible because part of the net income of the university
(3) And (4). Not deductible per Sec. 36(A) (4), NIRC of 1997;
(5) Interest on taxes are deductible as they are deemed indebtedness and not as taxes
(Comm. v. Prieto, 109 Phil. 592; Comm. v. Palanca, Jr. 18 SCRA 496).

Q. In his income tax return for the year 2016, Mr. Cecilio Sison claimed the following
items as deductions from his gross income. (1) Real estate tax paid on his lot and house;(2)
Depreciation of the car he used in going to and from office; (3) Interest paid on a loan the
proceeds of which he used in the construction of his house; (4) Amount paid to the LTO for
the registration of his car. (5) Contribution paid to a religious organization; (6) The amount
of P10,000.00 he paid to a doctor who operated on him for appendectomy; (7) Tuition fee for
a son in a high school at St. Mary's college in California, USA; (8) Loss of wife's jewelry
through robbery.
The income of Mr. Sison was derived solely from his employment as an executive of a
private bank. Which of the items mentioned may be allowed or disallowed as deduction from
his gross income?
Ans. All items enumerated are non-deductible and if included in the return, they are disallowable
because Mr. Sison is only allowed personal and additional exemptions being a compensation
income earner under an employer-employee relationship.

Sec 34 (K) Additional Requirements for Deductibility of Certain Payments Any amount paid
or payable which is otherwise deductible from, or taken into account in computing gross income
or for which depreciation or amortization may be allowed under this Section, shall be allowed as
a deduction only if it is shown that the tax required to be deducted and withheld therefrom has
been paid to the Bureau of Internal Revenue in accordance with this Section, Sections 58 and 81
of this Code.

Sec 34 (L) Optional Standard Deduction In lieu of the deductions allowed under the
preceding Subsections, an individual subject to tax under Section 24, other than a nonresident
alien, may elect a standard deduction in an amount not exceeding forty percent (40%) of his
gross sales or gross receipts, as the case may be. In the case of a corporation subject to tax under
Sections 27(A) and 28(A)(1), it may elect a standard deduction in an amount not exceeding forty
percent (40%) of its gross income as defined in Section 32 of this Code. Unless the taxpayer
signifies in his return his intention to elect the optional standard deduction, he shall be
considered as having availed himself of the deductions allowed in the preceding Subsections.
Such election when made in the return shall be irrevocable for the taxable year for which the
return is made: Provided, That an individual who is entitled to and claimed for the optional
standard deduction shall not be required to submit with his tax return such financial statements
otherwise required under this Code: Provided, further, That except when the Commissioner
otherwise permits, the said individual shall keep such records pertaining to his gross sales or
gross receipts, or the said corporation shall keep such records pertaining to his gross income as
defined in Section 32 of this Code during the taxable year, as may be required by the rules and
regulations promulgated by the Secretary of Finance, upon recommendation of the
Commissioner.

BIR ISSUANCES
February 18, 2010 REVENUE REGULATIONS NO. 002-10

SUBJECT : Amendment to Sections 6 and 7 of Revenue Regulations No. 16-2008


with Respect to the Determination of the Optional Standard Deduction (OSD) of General
Professional Partnerships (GPPs) and the Partners Thereof, as well as the Manner and
Period for Making the Election to Claim OSD in the Income Tax Returns

TO : All Revenue Officers and Others Concerned

SECTION 1. Scope. Pursuant to the provisions of Sec. 244, in relation to Sec. 3 of


Republic Act No. 9504 (RA 9504) amending Sec. 34 (L) of the Tax Code of 1997 (Code), as
amended, these Regulations are hereby promulgated to amend certain provisions of Revenue
Regulations No. 16-2008 to further clarify the manner of claiming the OSD by General
Professional Partnerships and the partners comprising them and the manner of manifesting
the election to use OSD for the taxable year concerned by all taxpayers entitled to it.

SECTION 2. Sec. 6 of Revenue Regulations No. 16-2008 is hereby amended to read as


follows:

"SEC. 6. Determination of the Optional Standard Deduction for General Professional


Partnerships (GPPs) and Partners of GPPs. Pursuant to Sec. 26 of the Code, a GPP is
not subject to income tax imposed under Title II thereof. However, the partners shall be
liable to pay income tax on their separate and individual capabilities for their respective
distributive share in the net income of the GPP.

Sec. 26 of the Code likewise provides that "For purposes of computing the distributive
share of the partners, the net income of the GPP shall be computed in the same manner as a
corporation." As such, a GPP may claim either the itemized deductions allowed under
Section 34(A) to (J) of the Code or in lieu thereof, it can opt to avail of the OSD allowed to
corporations in claiming the deductions in an amount not exceeding forty percent (40%) of
its gross income. The net income determined by either claiming the itemized deduction or
OSD from the GPP's gross income is the distributable net income from which the share of
each partner is to be determined. Each partner shall report as gross income his distributive
share, actually or constructively received, in the net income of the partnership.

The GPP is not a taxable entity for income tax purposes since it is only acting as a "pass-
through" entity where its income is ultimately taxed to the partners comprising it. In
computing taxable income defined under Section 31 of the Code, all expenses which are
ordinary and necessary, incurred or paid for the practice of profession, are allowed as
deductions. Since the taxable income is in the hands of the partner, as a rule apart from the
expenses claimed by the GPP in determining its net income, the individual partner can still
claim deductions incurred or paid by him that contributed to the earning of the income
taxable to him. The following rules shall govern the claim of the partners of deductions from
their share in the net income of the partnership, viz.:

1. If the GPP availed of the itemized deduction in computing its net income, the partners
may still claim itemized deductions from said share, provided, that, in claiming itemized
deductions, the partner is precluded from claiming the same expenses already claimed by the
GPP. In fine, if the GPP claimed itemized deductions the partners comprising it can only claim
itemized deductions which are in the nature of ordinary and necessary expenses for the practice
of profession which were not claimed by the GPP in computing its net income or distributable
net income during the year. Examples of these are representation expenses incurred by the
partner where the covering invoice or receipt is issued in his name; travelling expenses while
away from home, which were not liquidated by the partnership; depreciation of a car used in the
practice of profession where said car is registered in the name of the partner; and similar
expenses.

Hence, if the GPP availed of itemized deductions, the partners are not allowed to claim the OSD
from their share in the net income because the OSD is a proxy for all the items of deductions
allowed in arriving at taxable income. This means that the OSD is in lieu of the items of
deductions claimed by the GPP and the items of deduction claimed by the partners.

2. If the GPP avails of OSD in computing its net income, the partners comprising it can no
longer claim further deduction from their share in the said net income for the following reasons:

i. The partners' distributive share in the GPP is treated as his gross income not his gross
sales/receipts and the 40% OSD allowed to individuals is specifically mandated to be deducted
not from his gross income but from his gross sales/receipts; and,

ii. The OSD being in lieu of the itemized deductions allowed in computing taxable income as
defined under Section 31 of the Tax Code, it will answer for both the items of deduction allowed
to the GPP and its partners.

3. Since one-layer of income tax is imposed on the income of the GPP and the individual
partners where the law had placed the statutory incidence of the tax in the hands of the latter,
the type of deduction chosen by the GPP must be the same type of deduction that can be availed
of by the partners. Accordingly, if the GPP claims itemized deductions, all items of deduction
allowed under Section 34 can be claimed both at the level of the GPP and at the level of the
partner in order to determine the taxable income. On the other hand, should the GPP opt to
claim the OSD, the individual partners are deemed to have availed also of the OSD because the
OSD is in lieu of the itemized deductions that can be claimed in computing taxable income.

4. If the partner also derives other gross income from trade, business or practice of
profession apart and distinct from his share in the net income of the GPP, the deduction that he
can claim from his other gross income would follow the same deduction availed of from his
partnership income as explained in the foregoing rules. Provided, however, that if the GPP opts
for the OSD, the individual partner may still claim 40% of its gross income from trade, business
or practice of profession but not to include his share from the net income of the GPP.

SECTION 3. Sec. 7 of Revenue Regulations No. 16-2008 is hereby amended to read as follows:

"SEC. 7. Other Implications of the Optional Standard Deduction. A taxpayer who


elected to avail of the OSD not exceeding forty percent (40%) of gross sales or gross receipts, in
case of an individual taxable under Secs. 24(A) and 25(A)(1) of the Tax Code, or forty percent
(40%) of gross income, in case of a corporation subject to tax under Sec. 27(A) or 28(A)(1) of
the same Code shall signify in his/its return such intention, otherwise he/it shall be considered as
having availed himself of the itemized deductions allowed under Sec. 34 of the Code. Once the
election to avail of the OSD or itemized deduction is signified in the return, it shall be
irrevocable for the taxable year for which the return is made.

The election to claim either the OSD or the itemized deduction for the taxable year must be
signified by checking the appropriate box in the income tax return filed for the first quarter of
the taxable year adopted by the taxpayer. Once the election is made, the same type of deduction
must be consistently applied for all the succeeding quarterly returns and in the final income tax
return for the taxable year. Any taxpayer who is required but fails to file the quarterly income
tax return for the first quarter shall be considered as having availed of the itemized deductions
option for the taxable year.

Thus, a taxpayer who avails of the OSD in the first quarter of its/his taxable year shall have to
claim the same OSD in determining its/his taxable income for the rest of the year, including the
final income tax return which is due to be filed on or before the 15th day of the fourth month,
following the close of the taxable year. Likewise, a taxpayer who avails of the itemized deduction
in the first quarter of its/his taxable year or fails to file an income tax return for the first quarter
of the taxable year, shall have to claim the itemized deduction in determining the taxable income
for the rest of the year, including the final income tax return which is due to be filed on or before
the 15th day of the fourth month, following the close of the taxable year.

An individual taxpayer who is entitled to and claimed the OSD shall not be required to submit
with his tax return such financial statements otherwise required under the Code. Provided, that,
except when the Commissioner otherwise permits, the said individual shall keep such records
pertaining to his gross sales or gross receipts. In the case of a corporation, however, said
corporation is still required to submit its financial statements when it files its annual income tax
return and to keep such records pertaining to its gross income as herein defined."

SECTION 4. Repealing Clause. All revenue issuances or portions thereof which are
inconsistent with the provisions of these Regulations are hereby amended, modified or repealed
accordingly.
SECTION 5. Effectivity Clause. These regulations shall take effect 15 days following its
publication in newspaper of general circulation.

(SGD.) MARGARITO B. TEVES

Secretary of Finance

Recommending Approval:

(SGD.) JOEL L. TAN-TORRES

Commissioner of Internal Revenue

REVENUE REGULATIONS NO. 016-08 November 26, 2008

Implementing the Provisions of Republic Act No. 9504 (Minimum Wage Law), Dealing on the
Optional Standard Deduction (OSD) Allowed to Individuals and Corporations in Computing
Their Taxable Income in lieu of the itemized deductions.

Determination of the Amount of Optional Standard Deduction for Individuals The OSD
allowed to individual taxpayers shall be a maximum of forty percent (40%) of gross sales or
gross receipts during the taxable year. If the individual is on the accrual basis of accounting for
his income and deductions, the OSD shall be based on the gross sales during the taxable year.
On the other hand, if the individual employs the cash basis of accounting for his income and
deductions, the OSD shall be based on his gross receipts during the taxable year.

It should be emphasized that the "cost of sales" in case of individual seller of goods, or the "cost
of services" in the case of individual seller of services, are not allowed to be deducted for
purposes of determining the basis of the OSD inasmuch as the law (RA 9504) is specific as to the
basis thereof which states that for individuals, the basis of the 40% OSD shall be the "gross
sales" or "gross receipts" and not the "gross income".For other individual taxpayers allowed by
law to report their income and deductions under a different method of accounting (e.g.
percentage of completion basis, etc.) other than cash and accrual method of accounting, the
"gross sales" or "gross receipts" pursuant to this Section shall be determined in accordance with
said acceptable method of accounting.

Determination of the Amount of Optional Standard Deduction for Corporations In the case of
corporate taxpayers subject to tax under Sections 27 (A) and 28 (A) (1) of the Code, as
amended, the OSD allowed shall be in an amount not exceeding forty percent (40%) of their
gross income.

For purposes of these Regulations, "Gross Income" shall mean the gross sales less sales returns,
discounts and allowances and cost of goods sold. "Gross sales" shall include only sales
contributory to income taxable under Sec. 27 (A) of the Code. "Cost of goods sold" shall include
the purchase price or cost to produce the merchandise and all expenses directly incurred in
bringing them to their present location and use.

For trading or merchandising concern, "cost of goods sold" means the invoice cost of goods
sold, plus import duties, freight in transporting the goods to the place where the goods are
actually sold, including insurance while the goods are in transit.

For manufacturing concern, "cost of goods sold" means all costs incurred in the production of
the finished goods such as raw materials used, direct labor and manufacturing overhead, freight
cost, insurance premiums and other costs incurred to bring the raw materials to the factory or
warehouse. The term may be used interchangeably with "cost of goods manufactured and sold".

In the case of sellers of services, the term "gross income" means the "gross receipts" less sales
returns, allowances, discounts and cost of services. "Cost of services" means all direct costs and
expenses necessarily incurred to provide the services required by the customers and clients
including (a) salaries and employee benefits of personnel, consultants and specialists directly
rendering the service, and (b) cost of facilities directly utilized in providing the service such as
depreciation or rental of equipment used and cost of supplies: Provided, however, that "cost of
services" shall not include interest expense except in the case of banks and other financial
institutions. The term "gross receipts" as used herein means amounts actually or constructively
received during the taxable year. However, for taxpayers engaged as sellers of services but
employing the accrual basis of accounting for their income, the term "gross receipts" shall mean
amounts earned as gross revenue during the taxable year.

The items of gross income under Section 32 (A) of the Code, as amended, which are required to
be declared in the income tax return of the taxpayer for the taxable year are part of the gross
income against which the OSD may be deducted in arriving at taxable income. Passive incomes
which have been subjected to a final tax at source shall not form part of the gross income for
purposes of computing the forty percent (40%) optional standard deduction.

Q. What is meant by gross income of the taxpayer ?


Ans. The E-VAT Law gives this definition: . For purposes of this section, the term gross
income derived from business shall be equivalent to gross sales less sales returns, discounts and
allowances and cost of goods, sold. (Sec. 27(A), (4); Sec. 27(D)(4) as amend by Sec. 1, RA No.
9337).

Q. What is meant by cost of goods sold ?


Ans. It means
(1) Generally, cost of goods sold shall include all business expenses directly incurred to
produce the merchandise to bring them to their present location and use (Sec. 27, as amended
ibid).
(2) For trading or merchandising concerned cost of goods sold shall include the invoice cost of
the goods sold, plus import duties, freight in transporting the goods to the place where the
goods are actually sold including insurance while the goods are in transit (Ibid).
(3) For manufacturing concern, costs of goods manufactured and sold, shall include all cost of
production of finished goods, such as raw materials, seeds, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to
the factory or warehouse (ibid).

Q. For those taxpayer engaged in sale services, what is meant by gross income?
Ans. In the case of taxpayers engaged in the sale services, gross income means gross receipts
less returns, allowances, discounts and cost of services.
Q. What is meant by cost of services?
Ans. Under E-VAT (RA No. 9337), Cost of services shall mean all direct costs and expenses
necessarily incurred to provide services required by the customers and clients including
(1) salaries and employee benefits of personnel, consultants and specialists directly rendering
the services:
(2) cost of facilities directly utilized in providing the services such as depreciation, rental of
equipment used and cost of supplies; Provided, that in the case of banks, cots services shall
include interest expense(Sec. 1, RA No. 9337, amending Sec. 27, Tax Code).

OPTIONAL STANDARD DEDUCTION


Q. What is an optional standard deduction?
Ans. It is a fixed percentage deduction which is allowed to certain taxpayers without regard to
any actual expenditures. It is an amount not exceeding FORTY percent (40%) of the gross income
of the qualified taxpayer [Sec. 34 (L), NIRC].
Q. What is the purpose of optional standard deduction?
Ans. To facilitate the audit or review of the tax returns

Q. Who can avail optional standard deduction?


Ans. Only resident citizens deriving business/professional income and resident alien individuals
on their gross income derived from employer-employee relationship [Sec. 34(L); Sec. 24, NIRC
of 1997] and corporations under Rep Act 9540.

Q. When taxpayer may avail of the optional standard deduction?


Ans. Unless the taxpayer signifies in his income tax return his intention to elect the optional
standard deduction, he shall be considered as having availed himself of the itemized deduction
allowed under the Tax Code. Such election when made in the income tax return shall be
irrevocable for the taxable year in which the income tax return is made [Sec. 34(L); Sec. 24,
NIRC of 1997].

Q. What are the characteristics of this alternative deduction known as optional standard
deduction?
Ans. This type of deduction is the method of deduction based on a flat percentage of the gross
income in lieu of the itemized deductions. Optional standard deduction has five (5)
characteristics:
(1) This deduction is given only to resident citizens and resident aliens with taxable income and
corporations.
(2) This is optional; hence, the taxpayer has to signify in his return of the intention to elect this
deduction; otherwise, he shall be considered part of the administrative taxing personnel to
determine which items are allowed to be deducted or considered to have adopted the itemized
deductions;
(3) The election is irrevocable for that taxable year;
(4) The amount is limited to 40% of the gross income.
(5) No need of any proof for this deduction.

Q. Give the rule on the ceiling for deductible amounts.


Ans. The Secretary of Finance may prescribe regulations limiting the amount of claimed
deduction/s subject to the following conditions:
(1) Previous recommendation by the Commissioner of the Internal Revenue;
(2) Consideration of the following factors:
(a) Adequacy of the prescribed limits on the actual expenditure
requirements of each particular industry.
(b) Effect of inflation on expenditure levels.
(3) No ceiling shall further be imposed on items of expenses already subject to ceilings under
existing laws.

Q. Give the summary of deductions allowed to different kinds of taxpayers.


Ans. As summarized.
First, on compensation income of resident citizens, derived from sources within or without the
Philippines, and compensation income of nonresident citizens and resident alien individuals
derived from sources within the Philippines:
(1) Deductions for premium payments on health and/or hospitalization insurance;
(2) Personal and additional exemptions.
Second, Resident citizens, on incomes (other than compensation income) derived from sources
within and without the Philippines, subject to the schedular tax on income:
(1) Optional standard deduction; or
(2) Itemized deductions; and
(3) Personal and additional exemptions;
Third, Resident alien individuals from their income (other than compensation income) derived
from sources within the Philippines:
(1) Optional standard deduction; or
(2) Itemized deductions; and
(3) Personal and additional exemptions;
Fourth, Nonresident citizens and nonresident alien individuals engaged in trade, business or
profession in the Philippines from their income derived from sources within the Philippines:
(1) Itemized deductions; and
(2) Personal and additional exemptions and in the case of nonresident aliens only subject to
reciprocity;
Fifth, Nonresident alien individuals not engaged in trade or business in the Philippines from their
income derived from sources within the Philippines (whether compensation or other income) are
subject to tax on their gross income; hence, no deduction or exemption allowed.
Sixth, Estates or trusts, deduction allowed similar to individuals except with respect to the
exemption allowed which is not categorized as personal and additional exemption but referred to
only as exemption in the amount of P20,000.00.(Domondon, supra, pp.298-299).
Seventh, Corporations
(1) Optional standard deduction; and
(2) Itemized deductions;

NON-DEDUCTIBLE ITEMS AND EXEMPTIONS


A. NON-DEDUCTIBLE ITEMS
Q. Enumerate the non-deductible items from the gross income?
Ans. The following are the non-deductible items from the gross income:
(1) Personal, living and family expenses.
(2) Capital investments;
(3) Expenses for restoration of property under capital investments;
(4) Premiums paid on life insurance taken by employer covering life of his employees;
(5) Losses between relatives [Sec. 36, (A), NIRC of 1997].

Q. Discuss some rules or jurisprudence relative to personal, living and personal expenses.
Ans. The following, by leading jurisprudence/established rules, are non-deductible from the
gross income
(1) Insurance paid on dwelling owned and occupied by taxpayer;
(2) Allowances of minor children;
(3) Travelling expenses to and from one's office (BIR Ruling Nov. 24,1962).
(4) Expenses for light and water not incurred in connection with taxpayer's business ( BIR
Ruling (January16, 1961);BIR Ruling , July 24, 1962).
(5) Amounts expended for birthdays and wedding gifts,etc.
EXEMPTIONS
Q. What is Wisconsin plan?
Ans. It is a system which allows the deduction from gross income of arbitrary amounts for
personal, living or family expenses of the taxpayer. Briefly, the system which allows personal
exemption as deduction from the gross income of the taxpayer.

Q. What is the meaning or concept of exemption?


Ans. Personal exemptions are arbitrary amount allowed in the nature of a deduction from the net
income for personal, living or family expenses of an individual taxpayer (Sec. 9, Rev. Regulation
No. 2). The personal exemptions provided by law in income tax are roughly equivalent to the
minimum subsistence of a taxpayer (Madrigal v. Rafferty, 38 Phil. 414).

Q. How is deduction distinguished from exemption?


Ans. Distinguishing the two:
(1) A deduction is a subtraction while exemption is an immunity or privilege, a freedom from a
charge or burden to which others are subjected (Flores v. Sheridan, 137 Ind. 28, 36 NE 365).
(2) Exemptions are generally receipts which are excluded from the taxable income while
deductions are not receipts but are generally expenditures which are permitted to be subtracted
from income to determine the amount subject to tax (22 American Jurisprudence, 93).
(3) Personal exemptions are the theoretical personal, family, and living expenses of an
individual, while deductions are reduction of wealth which helped earn the income subject to tax

SECTION 35 Allowance of Personal Exemption for Individual Taxpayer


(A) In General For purposes of determining the tax provided in Section 24(A)
of this Title, there shall be allowed a basic personal exemption amounting to Fifty
thousand pesos (P50,000) for each individual taxpayer.
In the case of married individuals where only one of the spouses is deriving gross
income, only such spouse shall be allowed the personal exemption.
(B) Additional Exemption for Dependents. There shall be allowed an
additional exemption of Twenty-five thousand pesos (P25,000) for each dependent
not exceeding four (4).
The additional exemption for dependents shall be claimed by only one of the
spouses in the case of married individuals.
In the case of legally separated spouses, additional exemptions may be claimed
only by the spouse who has custody of the child or children: Provided, That the
total amount of additional exemptions that may be claimed by both shall not
exceed the maximum additional exemptions herein allowed.
For purposes of this Subsection, a 'dependent' means a legitimate, illegitimate or
legally adopted child chiefly dependent upon and living with the taxpayer if such
dependent is not more than twenty-one (21) years of age, unmarried and not
gainfully employed or if such dependent, regardless of age, is incapable of self-
support because of mental or physical defect.
(C) Change of Status If the taxpayer marries or should have additional
dependent(s) as defined above during the taxable year, the taxpayer may claim the
corresponding additional exemption, as the case may be, in full for such year.
If the taxpayer dies during the taxable year, his estate may still claim the personal
and additional exemptions for himself and his dependent(s) as if he died at the
close of such year.
If the spouse or any of the dependents dies or if any of such dependents marries,
becomes twenty-one (21) years old or becomes gainfully employed during the
taxable year, the taxpayer may still claim the same exemptions as if the spouse or
any of the dependents died, or as if such dependents married, became twenty-one
(21) years old or became gainfully employed at the close of such year.
CASES DIGEST
Tax due is determined by the individual taxpayer's status and qualified dependents at the
close of the taxable year.
What the law should consider for the purpose of determining the tax due from an
individual taxpayer is his status and qualified dependents at the close of the taxable year
and not at the time the return is filed and the tax due thereon is paid. Emphasis must be
made that Section 35 (C) of the NIRC allows a taxpayer to still claim the corresponding
full amount of exemption for a taxable year, e.g. if he marries; have additional
dependents; he, his spouse, or any of his dependents die; and if any of his dependents
marry, turn 21 years old; or become gainfully employed. It is as if the changes in his or
his dependents' status took place at the close of the taxable year.
Carmelino F. Pansacola vs. CIR, G.R. No. 159991, November 16, 2006
Tax due is determined by the individual taxpayer's status and qualified dependents at the
close of the taxable year.
FACTS: On April 13, 1998, petitioner Carmelino F. Pansacola filed his income tax
return for the taxable year 1997 that reflected an overpayment of P5,950. In it he claimed
the increased amounts of personal and additional exemptions under Section 35 4 of the
NIRC, although his certificate of income tax withheld on compensation indicated the
lesser allowed amounts on these exemptions. He claimed a refund of P5,950 with the
BIR, which was denied. Later, the CTA also denied his claim because according to the
tax court, "it would be absurd for the law to allow the deduction from a taxpayer's gross
income earned on a certain year of exemptions availing on a different taxable year. . ."
Petitioner sought reconsideration, but the same was denied.
On appeal, the Court of Appeals denied his petition for lack of merit. The appellate court
ruled that the NIRC took effect on January 1, 1998, thus the increased exemptions were
effective only to cover taxable year 1998 and cannot be applied retroactively.
ISSUE: Could the exemptions under Section 35 of the NIRC, which took effect on
January 1, 1998, be availed of for the taxable year 1997?
HELD: No. Prefatorily, personal and additional exemptions under Section 35 of the
NIRC are fixed amounts to which certain individual taxpayers (citizens, resident aliens)
12 are entitled. Personal exemptions are the theoretical personal, living and family
expenses of an individual allowed to be deducted from the gross or net income of an
individual taxpayer. These are arbitrary amounts which have been calculated by our
lawmakers to be roughly equivalent to the minimum of subsistence, taking into account
the personal status and additional qualified dependents of the taxpayer. They are fixed
amounts in the sense that the amounts have been predetermined by our lawmakers as
provided under Section 35 (A) and (B). Unless and until our lawmakers make new
adjustments on these personal exemptions, the amounts allowed to be deducted by a
taxpayer are fixed as predetermined by Congress.
A careful scrutiny of the provisions of the NIRC specifically shows that Section 79 (D)
provides that the personal and additional exemptions shall be determined in accordance
with the main provisions in Title II of the NIRC. Its main provisions pertain to Section 35
(A) and (B).
Section 35 (A) and (B) allow the basic personal and additional exemptions as deductions
from gross or net income, as the case may be, to arrive at the correct taxable income of
certain individual taxpayers. Section 24 (A) (1) (a) imposed income tax on a resident
citizen's taxable income derived for each taxable year.
Section 31 defines "taxable income" as the pertinent items of gross income specified in
the NIRC, less the deductions and/or personal and additional exemptions, if any,
authorized for such types of income by the NIRC or other special laws. As defined in
Section 22 (P), "taxable year" means the calendar year, upon the basis of which the net
income is computed under Title II of the NIRC. Section 43 also supports the rule that the
taxable income of an individual shall be computed on the basis of the calendar year. In
addition, Section 45 provides that the deductions provided for under Title II of the NIRC
shall be taken for the taxable year in which they are "paid or accrued" or "paid or
incurred."
Moreover, Section 79 (H) requires the employer to determine, on or before the end of the
calendar year but prior to the payment of the compensation for the last payroll period,
the tax due from each employee's taxable compensation income for the entire taxable
year in accordance with Section 24 (A). This is for the purpose of either withholding from
the employee's December salary, or refunding to him not later than January 25 of the
succeeding year, the difference between the tax due and the tax withheld.
Therefore, as provided in Section 24 (A) (1) (a) in relation to Sections 31 and 22 (P) and
Sections 43, 45 and 79 (H) of the NIRC, the income subject to income tax is the
taxpayer's income as derived and computed during the calendar year, his taxable year.
Clearly from the abovequoted provisions, what the law should consider for the purpose of
determining the tax due from an individual taxpayer is his status and qualified
dependents at the close of the taxable year and not at the time the return is filed and the
tax due thereon is paid. Now comes Section 35 (C) of the NIRC which allows a taxpayer
to still claim the corresponding full amount of exemption for a taxable year, e.g. if he
marries; have additional dependents; he, his spouse, or any of his dependents die; and if
any of his dependents marry, turn 21 years old; or become gainfully employed. It is as if
the changes in his or his dependents' status took place at the close of the taxable year.
Consequently, his correct taxable income and his corresponding allowable deductions
e.g. personal and additional deductions, if any, had already been determined as of the
end of the calendar year.
In the case of petitioner, the availability of the aforementioned deductions if he is thus
entitled, would be reflected on his tax return filed on or before the 15th day of April 1999
as mandated by Section 51 (C) (1). Since the NIRC took effect on January 1, 1998, the
increased amounts of personal and additional exemptions under Section 35, can only be
allowed as deductions from the individual taxpayer's gross or net income, as the case
may be, for the taxable year 1998 to be filed in 1999. The NIRC made no reference that
the personal and additional exemptions shall apply on income earned before January 1,
1998. Carmelino F. Pansacola vs. C I R, G.R. No. 159991, November 16, 2006
(D) Personal Exemption Allowable to Nonresident Alien Individual A
nonresident alien individual engaged in trade, business or in the exercise of a
profession in the Philippines shall be entitled to a personal exemption in the
amount equal to the exemptions allowed in the income tax law in the country of
which he is a subject or citizen, to citizens of the Philippines not residing in such
country, not to exceed the amount fixed in this Section as exemption for citizens or
residents of the Philippines: Provided, That said nonresident alien should file a true
and accurate return of the total income received by him from all sources in the
Philippines, as required by this Title.

Q. State the basis for personal exemption.


Ans. The allowance for personal exemption is based:
(1) Essentially, on the economic and political grounds that persons whose income is small
should be exempted from income taxation.
(2) Consistently, with the principle that the burden of taxation should be adjusted accordingly, to
the "capacity to pay."

Q. Classify the various classes/kinds of exemptions.


Ans. Exemptions under the Tax Code are classified as:
(1) Basic personal exemption;
(2) Additional exemption for qualified dependent;
(3) Special personal exemption for non-resident ; and
(4) Special additional personal exemption.

Q. Discuss the extent of the basic personal exemption.


Ans. The taxpayer's (filer's) civil status shall be indicated by checking the appropriate box in the
tax return. The amount of personal exemption are as follows:
(1) P50,000.00 for single individual or married individual judicially decreed as legally separated
with no qualified dependents.
(2) P50,000.00 for head of the family; and
(3) P50,000.00 for each married individual. In case of married individuals where only one of the
spouses deriving gross income, only such spouse shall be allowed the personal exemption [Sec.
35(A) NIRC of 1997]. Republic Act 9504.

Q. What is a head of a family for purposes of basic personal exemption?


Ans. Head of a family is a unmarried man or legally separated man or woman-
(1) With one or both parents living with and dependent upon him or
(2) With one or more brothers or sisters, living with and dependent upon him or her for chief
support; or
(3) With one or more legitimate, illegitimate, recognized natural or her for their chief support; or
legally adopted children living with and dependent for chief support, where such brothers or
sisters or children
(a) are not more than 21 years of age, unmarried and not gainfully employed.
(b) where such children, brothers or sisters, regardless of age, are incapable of support
because of mental or physical defect.
(4) and being a benefactor of a qualified senior citizen whether such senior citizen being cared for
is related or not [Sec. 5(a), RA No. 7432].
Q. Explain the meaning of living with?
Ans. "Living with the person giving support" does not necessarily mean actual and physical
dwelling together at all times and under all circumstances.. Dependent absence on business or
child away at school or for a visit, as long as common home is maintained. However, a resident
alien with children abroad is not entitled to credit as head of family (Par. 2, Sec. 11 Rev. Regs.
No. 2).

Q. What is meant by Chief support ?.


Ans. "Chief support" means principal or main support (i.e., paying for the rent and spending
for the food, clothing of the dependent) more than 50% of the support required; however, partial
support not amounting to chief support will not entitle the taxpayer to claim exemption as head of
a family.
Sec.5, RA No. 7432; Baybay v. Commissioner of Internal Revenue, CTA Case No. 5280,
prom. Dec. 20, 1998; Par.2, Sec. 11, Rev. Regs. No. 2.

Q. Discuss additional exemption for dependents.


Ans. There shall be allowed an additional exemption of P25,000.00 for each dependent not
exceeding four. This exemption can be claimed only by one spouse who has the custody of the
child or children. The husband is the proper claimant of this exemption, unless he waives his
right in favor of his wife in the application for registration (BIR Form No. 1902) or in the
withholding exemption certificate (BIR Form No. 1905). Republic Act 9504

Q. For purposes of income taxation and as deductible exemption, what is meant by


dependent?
Ans. "Dependent" means a legitimate, illegitimate or legally adopted child chiefly dependent
upon and living with the taxpayer if such dependent is not more than 21 years of age, unmarried
and not gainfully employed, or if such dependent regardless of age, is incapable of self-support
because of mental or physical defect [Sec. 35 NIRC of 1997].

Q. Discuss the special personal exemption to nonresident alien individual.


Ans. Nonresident alien individual when engaged in trade, business or exercised of his profession,
shall be entitled to a personal exemption in the amount equal to the exemption allowed in the
income tax return in the country of which he is subject or citizen of the Philippines not residing
in the Philippines, not to exceed the amount fixed in this section or residents of the Philippines
provided he filed true and correct return [Sec. 35(D), Tax Code].

Q. Who are the taxpayers who are enjoying and availing personal exemption?
Ans. They are:
(1) Resident citizens;
(2) Resident aliens;
(3) Nonresident alien taxable under adjusted gross income.
(4) Nonresident alien qualified under Sec. 35(D) NIRC of 1997.

Q. Who are the taxpayers who could not deduct exemption?


Ans. They are:
(1) Income, compensation income or otherwise received by nonresident aliens not engaged in
trade or business or in the exercise of a profession in the Philippines.
(2) Compensation income received by resident aliens and Filipinos employed by:
(a) Regional or area headquarters or regional operating headquarters of multi-national
corporations established in the Philippines;
(b) Offshore banking units established in the Philippines.
(c) Petroleum service contractors and subcontractors in the Philippines.

Q What are the basic rules governing change of status?


Ans. The basic rules are:
(1) If the taxpayer marries or should have additional dependent/s as defined, during the taxable
year, the taxpayer may claim the corresponding additional exemptions, as the case may be in full
for such year.
(2) If the taxpayer dies during the taxable year, his estate may still claim the personal and
additional exemption for himself and his dependents as if he died at the close of such year [2nd
par. Sec. 35 , NIRC].
(3) If the spouse or any of the dependents dies or if any of such dependents marries, becomes
21 years old, or becomes gainfully employed during the taxable year, the taxpayer may still
claim the same exemptions as of the spouse or any of the dependents died, or as if such
dependents married, became 21 years old or became gainfully employed at the close of such year
[3rd par. Sec. 35(C), NIRC of 1997].

NIRC SECTION 36 Items not Deductible


(A) General Rule In computing net income, no deduction shall in any case be allowed in
respect to
(1) Personal, living or family expenses;
(2) Any amount paid out for new buildings or for permanent improvements, or betterments made
to increase the value of any property or estate;
This Subsection shall not apply to intangible drilling and development costs incurred in
petroleum operations which are deductible under Subsection (G)(1) of Section 34 of this Code.
(3) Any amount expended in restoring property or in making good the exhaustion thereof for
which an allowance is or has been made; or
(4) Premiums paid on any life insurance policy covering the life of any officer or employee, or of
any person financially interested in any trade or business carried on by the taxpayer, individual
or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy.
(B) Losses from Sales or Exchanges of Property. In computing net income, no deduction shall
in any case be allowed in respect of losses from sales or exchanges of property directly or
indirectly
(1) Between members of a family. For purposes of this paragraph, the family of an individual
shall include only his brothers and sisters (whether by the whole or half-blood), spouse,
ancestors, and lineal descendants; or
(2) Except in the case of distributions in liquidation, between an individual and a corporation
more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or
indirectly, by or for such individual; or
(3) Except in the case of distributions in liquidation, between two corporations more than fifty
percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly,
by or for the same individual, if either one of such corporations, with respect to the taxable year
of the corporation preceding the date of the sale or exchange was, under the law applicable to
such taxable year, a personal holding company or a foreign personal holding company;
(4) Between the grantor and a fiduciary of any trust; or
(5) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a
grantor with respect to each trust; or
(6) Between a fiduciary of a trust and a beneficiary of such trust.

Q. Enumerate the non-deductible items from the gross income?


Ans. The following are the non-deductible items from the gross income:
(1) Personal, living and family expenses.
(2) Capital investments;
(3) Expenses for restoration of property under capital investments;
(4) Premiums paid on life insurance taken by employer covering life of his employees;
(5) Losses between relatives [Sec. 36, (A), NIRC of 1997].

Q. Discuss some rules or jurisprudence relative to personal, living and personal expenses.
Ans. The following, by leading jurisprudence/established rules, are non-deductible from the
gross income
(1) Insurance paid on dwelling owned and occupied by taxpayer;
(2) Allowances of minor children;
(3) Travelling expenses to and from one's office (BIR Ruling Nov. 24,1962).
(4) Expenses for light and water not incurred in connection with taxpayer's business ( BIR
Ruling (January16, 1961);BIR Ruling , July 24, 1962).
(5) Amounts expended for birthdays and wedding gifts,etc.

Q. What is capital expenditure? Illustrate.


Ans. It is a cash outlay, or exchange of property, that does not decrease a taxpayer's asset but
merely changes its form. It is a payment which creates or enhances what is essentially a separate
and distinct asset. They are expenditures that result in obtaining benefits of a permanent in nature
such as lands, buildings and machineries [Sec. 36(A). (3)]. Hence, expenses for new buildings,
cost of defending and perfecting title to property (Sec. 120 Rev. Regs. No. 2)., architect fees,
expenditures for replacement alteration, improvements or additions , which either prolong the
life of the property or increase its value (Alhambra Cigar v. Collector, L-12126 and L-121231;
May 29, 1956; Commissioner v. Soriano A. Y Ca. L-24993, May 16, 1971) and cost of
topographical survey of boundary lines1 and amounts expended for maps, abstracts, recording
fees and surveys are capital in nature and not deductible from the gross income [Sec. 34(A)(2),
NIRC of 1997].

Q. Is there an instance when capital expenditures may be deducted as expense?


Ans. Yes. In addition to the expenses allowable as deductions, a private educational institution,
may at its option elect either:
(1) To deduct expenditures otherwise considered as capital outlays of depreciable assets
incurred during the taxable year for the expansion of school facilities, or
(2) To deduct allowances for depreciation thereof [Sec. 36(A)(3), NIRC of 1997].
Q. What is the purpose why losses in transactions between related taxpayers are non-
deductible?
Ans. The purpose of the law is to prevent avoidance of income tax by taxpayers who take
advantage of deduction for losses by means of purported or simulated sales or exchanges to
members of their families/trusts. Accordingly, it is immaterial whether the sale is bona fide or
not (Madrigal v. Rafferty, 38 Phil. 444).

Q. What is the purpose why losses in transactions between related taxpayers are non-
deductible?
Ans. The purpose of the law is to prevent avoidance of income tax by taxpayers who take
advantage of deduction for losses by means of purported or simulated sales or exchanges to
members of their families/trusts. Accordingly, it is immaterial whether the sale is bona fide or
not (Madrigal v. Rafferty, 38 Phil. 444).

FINAL TAX AND PASSIVE INCOME

Q. Classify income according to tax rates.

Ans. They are:


(1) Income subject to schedular rates; and
(2) Income subject to final tax.

Q. What are the incomes that are subject to final tax?


Ans. They are:
(1) Certain passive income;
(a) Interests, royalties, prizes and other winnings [Sec.24 (B)(1), NIRC of 1997].
(b) Cash and /or property dividends [Sec. 24(B)(2), NIRC of 1997]. (2) Capital gains
from sales of shares of stock not traded in the stock exchange [Sec. 24 (C) NIRC of 1997].
(3) Capital gains from sales of real property [Sec. 24(D), NIRC of 1997].

Q. What is meant by passive income?


Ans Income derived from any activity in which the taxpayer does not materially participate.
Material participation is the taxpayer's involvement in the activity on a regular, continuous and
substantial basis. A taxpayer who puts his money in investment management accounts and whose
only involvement consists of making additions or withdrawals to the account from time to time
would not satisfy the material participation standard. So also a taxpayer who earns interest from
his bank deposits.

Q. What are the tax rates of the final taxes imposed on passive income?
Ans. They are: 25%, 20%, 12%%,10%, 7-1/2% and 5%.

Q. When is 25% final tax on passive income applicable or imposable?


Ans. Passive income derived from sources within the Philippines (other than capital gains from
sales of shares of domestic corporation, not traded in the stock exchange or from sales of real
property located in the Philippines), by a nonresident alien individual not engaged in trade or
business within the Philippines is subject to a gross rate of 25%.

Q. What are the passive incomes of citizens and resident alien individual who are subject
to final tax of 20%?
Ans. They are:
(1) Interest from any Philippine currency bank deposit, yield or monetary benefits from deposit
substitutes and from trust funds and similar arrangement.
(2) Royalties (except on books, literary works and musical compositions) which shall be
imposed only 10%).
(3) Prizes (except prizes amounting to P10,000.00 or less which shall be subject to taxes on
ordinary income); and
(4) Other winnings (except Philippine Charity Sweepstakes and Lotto winnings) [Sec. 24(B)(1)
NIRC of 1997].

Q. What passive income derived from sources within the Philippines, received by citizens
or alien individuals (resident or not) may be subject to 10% final tax?
Ans. Royalties from books, as well as other literary works and musical compositions [Sec. 24(B
(1); Sec. 25(A) (2), NIRC of 1997].

Q. What are the basic rules on the treatment of prizes?


Ans. The rules are:
First, it is subject to final tax of 20% under these conditions:
(1) The prize must have been derived from sources within the Philippines.
(2) The prize exceeds P10,000.00;
(3) The winner must be a citizen or alien resident or nonresident alien engaged in trade, business
or exercise of a profession in the Philippines.
Second, the prize is subject to ordinary income tax when these conditions are present:
(1) The prize does not exceed P10, 000.00.
(2) The prize was derived from sources without the Philippines;
(3) The winner is nonresident alien or a resident alien not engaged in trade, business or exercise
of a profession in the Philippines, in which case the tax is 25%.
Third, athletes prizes and awards are exempt from final income tax.

Q. Are there interest income that are exempted from the 20% final tax on passive
income?
Ans. Yes, in the following cases. From long-term deposit or investment is in the form of:
(1) Savings
(2) Common on individual trust funds
(3) Deposit substitutes.
(4) investment management accounts;
(5) Other investments evidenced by certificates in such form prescribed by the Bangko Sentral
ng Pilipinas. [Sec. 24(B)(1) and Sec 25 (A) (2), NIRC of 1997].
LONG-TERM DEPOSIT OR INVESTMENT CERTIFICATES- certificate of time deposit or
investment in the form of savings, common or individual trust funds, deposit substitutes,
investment management accounts and other investments with a maturity period of not less than
five years, the form of which shall be prescribed by the Bangko Sentral ng Pilipinas (BPS) and
issued by banks only (i.e., by nonbank financial intermediaries and finance companies) to
individuals in denominations of ten thousand pesos (P10,000.00) and other denominations as may
be prescribed by Central Bank [Sec. 22(FF) NIRC of 1997].
COMMON TRUST FUND- A fund maintained by a trust corporation, bank or investment
house authorized to performed trust functions under a written and formally established plan,
exclusively for the collective investment and reinvestment of certain monies, representing
participations in the plan received by it in its capacity as a trustee.
DEPOSIT SUBSTITUTES- An alternative form of obtaining funds from the public, other than
deposits, through the issuance, endorsement or acceptance of debt instruments for the borrower's
over account for the purpose of relending or purchasing of receivables and other obligations or
financing their own needs or the needs of their agent or dealer (Sec. 22 (Y), NIRC of 1997
INVESTMENT MANAGEMENT ACCOUNT-The investible funds or any investment
portfolio handled by a bank or an investment house in a representative capacity as financial or
managing agent, adviser, consultant or administrator of financial or sold or transferred or in any
manner conveyed to another person or entity with or without recourse.

Q. When may long-term deposits or investments be subject to final tax of varied rates?
Ans. In case of pre-termination of long term deposit or investment in which case it is subject
to final rates of 5%, 12% and 20%. Should the holder of the certificate evidencing the long-term
deposit or investment pre-terminate the deposit or investment before the 5th year, a final tax shall
be imposed on the entire income and shall be deducted and withheld by the depository bank from
the proceeds of the long-term deposit or investment certificate based on the remaining maturity
thereof according to the following rates: (a) Four (4) years to less than five(5)years.... 5%; (b)
Three (3) years to less than four (4) years.... 12%; and (c) Less than three (3) years.... 20% (Sec.
24 (B)(1) and Sec. 15)A,(2), NIRC of 1997).

Q. What is meant by: (1) Public; (2) Money market; (3) Money market instruments; (4)
Repurchase agreement; and (5) Reverse repurchase agreement.
Ans. Defining them:
(1) Public- for purposes of defining deposit substitutes, public means borrowing from twenty
(20) or more individuals or corporate lenders at any one time [Sec. 22 (Y) NIRC of 1997].
(2) Money market- a market dealing in standardized short term credit instruments (involving large
amounts) where lenders and borrowers do not deal directly with each other but through a
middleman or dealer in the open market. It involves "commercial papers". Its fundamental function
is to "match and bring together in a most impersonal manner both the fund users and the fund
suppliers. It is an "impersonal market, free from personal considerations" and is intended as a
market mechanism to prove quick mobility of money and securities.
Paper Industries of the Philippine Corporation (PICOP) v. Court of Appeals,et. a. GR Nos.
106949-50 and companion cases, prom. Dec. 1, 1995 citing Perez v. Court of Appeals, 127 CRA
636, 643; Sesbreno v. Court of Appeals, 222 SCRA 466.
(3) Money market instruments- they are by custom and usage of the financial markets, short-
term instruments with tenor of one (1) year or less. They are commercial papers which are
issued, endorsed, investment management, advisory, consultancy or any similar arrangement
which does not create or result in a trusteeship.
(4) Repurchase agreement- a sale of securities to a buyer with the firm commitment by the
seller to buy back or repurchase the same securities from the buyer at a specified future date and
at a pre-agreed price.
(5) Reverse repurchase agreement- an arrangement where the Bangko Sentral ng Pilipinas
(BSP) sells a group of securities in a broker-dealer under the provision that the customer will buy
them back at a predetermined date for a specific price. As distinguished from a repurchase
agreement which has only two-parties, a reverse repurchase agreement has three parties: the
Bangko Sentral, the broker-dealer and the customer.

Q. What are considered deposit substitutes instruments?


Ans. The following are considered or examples of deposit substitute instruments: banker's
acceptances; promissory notes; repurchase agreements including reverse repurchase agreements
entered into between Bangko Sentral ng Pilipinas) and any authorized agent bank; certificates of
assignment or participation and similar instruments with recourse [Sec. 22) NIRC of 1997];

Q. What debt instruments not considered deposit substitute debt instruments


Ans, Debt instruments not considered deposit substitutes debt instruments are:
(1) Those issued for interbank call loans with maturity of not more than (5) days to cover
deficiency or reserves against deposit liabilities including Those between or among banks and
quasi-banking institutions [Sec. 22(Y), NIRC of 1997]l
(2) T-Bills and Central Banks bills issued under Rep. Act No. 245 as amended and pursuant to
Central Bank Act is not deposit but certificates of indebtedness. Asian Basmk Corporation v.
Commission, CTA Case No. 4720).They are in the nature of promissory notes distinct and
separate from that issued by the Central Bank (BPI Family Bank v. Commissioner, A-GR SPNo.
29853, Sept.. 19, 1994).

Taxation of resident citizens, non-resident citizens, and resident aliens


a) General rule that resident citizens are taxable on income from all sources within and
without the Philippines
(i) Non-resident citizens
b) Taxation on compensation income
(i) Inclusions
(a) Monetary compensation
(1) Regular salary/wage
(2) Separation pay/retirement benefit not otherwise exempt
(3) Bonuses, 13th month pay, and other benefits not exempt
(4) Directors fees
(b) Non-monetary compensation
(1) Fringe benefit not subject to tax
(ii) Exclusions
(a) Fringe benefit subject to tax
(b) De minimis benefits
(c) 13th month pay and other benefits, and payments specifically excluded
from taxable compensation income
(iii) Deductions
(a) Personal exemptions and additional exemptions
(b) Health and hospitalization insurance
(c) Taxation of compensation income of a minimum wage earner
(1) Definition of statutory minimum wage
(2) Definition of minimum wage earner
(3) Income also subject to tax exemption: holiday pay, overtime pay, night-
shift differential, and hazard pay
c) Taxation of business income/income from practice of
profession
d) Taxation of passive income
(i) Passive income subject to final tax
(a) Interest income
(i) Treatment of income from long-term
deposits
(b) Royalties
(c) Dividends from domestic corporations
(d) Prizes and other winnings
(ii) Passive income not subject to final
tax
e) Taxation of capital gains
(i) Income from sale of shares of stock of a Philippine corporation
(a) Shares traded and listed in the stock exchange
(b) Shares not listed and traded in the stock exchange
(ii) Income from the sale of real property situated in the Philippines
(iii) Income from the sale, exchange, or other disposition of other
capital assets
11. Taxation of non-resident aliens engaged in trade or
business
a) General rules
b) Cash and/or property
dividends
c) Capital gains
[Exclude: non-resident aliens not engaged in trade or business]
12. Individual taxpayers exempt from income
tax
a) Senior citizens
b) Minimum wage earners
c) Exemptions granted under international agreements

BIR ISSUANCES
REVENUE REGULATIONS NO. 007-10 July 20, 2010
Implementing the Tax Privileges Provisions of Republic Act No. 9994, Otherwise Known as the
"Expanded Senior Citizens Act of 2010", and Prescribing the Guidelines for the Availment
Thereof in order for the ff:
1. The availment of the income tax exemption of Senior Citizens;
2. The value-added tax exemption privileges granted to VAT-registered taxpayers selling
goods and services identified in the Act to Senior Citizens;
3. The tax privileges granted to establishments giving discount on their sale of goods and
services to Senior Citizens;
4. The tax implication of taking care and supporting senior citizens by their benefactors;
and,
5. The tax privileges granted to private entities who engage Senior Citizens as their
employees.

REVENUE REGULATIONS NO. 001-09 December 9, 2008


Regulations Implementing Republic Act No. 9442, entitled "An Act Amending Republic Act 7277,
Otherwise Known as the Magna Carta for Persons with Disability", Relative to the Tax
Privileges of Persons with Disability and Tax Incentives for Establishments Granting Sales
Discount