ACAS Taxation 2 (Income Tax - Full Midterm Coverage).docx

TAXATION 2

2nd Semester SY 2017-2018 San Beda College of Law - Alabang  Atty. Althea Barbara Barbara E. Acas

Income Tax

PART 1: INCOME TAX

Sections 23-59, 67-73 and 74-77 of the National Internal Revenue Code (NIRC) I.

BASIC PRINCIPLES OF INCOME TAX

 A. General Principles of Income Taxation Sec. 23 B. What is Ordinary Income? Sec. 22 (Z) C. What is Capital Gain? Sec. 25 (A)(3) D. What is Taxable Income? Sec. 31 II.

TAX ON INDIVIDUALS

 A.

Kinds of individual taxpayers Sec. 24, Sec. 25

B.

Definition of each kind of taxpayer Sec. 22 1. Resident citizens and resident aliens Taxation 2 – Outline | Page 1

2. Non-resident citizens 3. Non-resident aliens engaged in business in the Philippines 4. Senior Citizen Law, RA 7432, as amended by RA 9257 and RA 9994 Mercury Drug Corporation v. Commissioner of Internal Revenue. G.R. No. 164050. July 20, 2011 C.

Kinds of income and income tax of individuals 1. Income subject to ordinary income tax vs. Income subject to final income tax vs compensation income 2. Final Income Tax vs. Creditable Withholding Tax

D.

Personal Exemptions Sec. 35

E.

Premium payments on health and/or hospitalization insurance Sec. 34 (m)

F.

Estates and Trusts Sections 60-66 NIRC 1. General rule on taxability: fiduciary or beneficiary 2. Personal exemption allowed 3. Decedent’s estate administration; Revocable trusts 4. Income for benefit of grantor

III.

TAX ON CORPORATIONS

Taxation 2 – Outline | Page 2

 A. Definition of corporations Sec. 22 B. Classification of corporations and the tax rates 1. In general Sec. 27-28 a. Domestic b.

Resident

c. Non-resident 2. Special corporations a. Private educational institutions and non-profit hospitals Sec. 4 [3] Article XIV, Constitution b. Non-resident cinematographic film owner, lessor or distributor c. International carriers Commissioner v BOAC, ibid. United Airlines, Inc., v CIR, G.R. No. 178788, 29 September 2010 d. Non-resident owner of vessels e. Non-resident lessor of aircraft, machineries and other equipment f.

Foreign currency deposit system/Offshore banking units

g. Petroleum service contractor and sub-contractor PD 1354, PD 87 \

Taxation 2 – Outline | Page 3

h. Enterprise Registered under Bases Conversion and Development Act of 1992 and Philippine Economic Zone Act of 1995 i.

R.A. No. 9400 gives tax privileges to Clark & John Hay, R.A. No. 9399 Grants tax amnesty to locators of Clark & John Hay

C. Kinds of Taxes 1. Income subject to corporate income tax Commissioner of Internal Revenue v. Wander Phils. G.R. No. 68375. April 15, 1988 2. Income subject to final income tax D. Branch Profit Remittance Tax Sec. 28 (A)(5) E. Minimum Corporate Income Tax Sec. 27(e) and Sec. 28(A)(2) F. Improperly Accumulated Earnings Tax Sec. 29 Cyanamid Philippines, Inc. v. CA G.R. No. 108067. January 20, 2000 *Fringe Benefits Tax Sec. 33 IV.

INCOME TAX EXEMPT ENTITIES

 A. Partnership/joint ventures formed for the purpose of undertaking construction projects or engaging in energy operations

Taxation 2 – Outline | Page 4

Sec. 26 B. Professional partnership of real estate brokers exempt from income tax C. Co-ownership D. Section 30, NIRC Sec. 23-35, NIRC E. Under special laws 1. Omnibus Investment Code – income tax holiday incentive, as amended by EO 226 2. Special Economic Zone Act of 1995 (RA 7916) 3. Bases Conversion and Development Act (RA 7227, as amended) V.

INCLUSIONS AND EXCLUSIONS FROM GROSS INCOME

Sec. 32, NIRC  A. Definition of Gross Income B. Exclusions from Gross Income Items of income which are not included in the taxable income. These are the items of income which are excluded by the Constitution, by tax treaties, by the Tax Code itself, and by special tax laws from the gross income and considered as exempt from income tax. Said income should be excluded in the determination of the taxable income in the income tax returns of taxpayers, whether individual or corporation, unless required to be reported in the same return or in certain information returns as required by regulations. Sec. 61-64 RA 4917 - An Act Providing That Retirement Benefits Of Employees Of Private Firms Shall Not Be Subject To Attachment, Levy, Execution, Or Any Tax Whatsoever. RA 7641 – An Act granting retirement benefits to private sector employees in absence of qualified plan C. Exclusion of 13th Month Pay and Bonuses Up to A Certain Threshold

Taxation 2 – Outline | Page 5

D.  Article III, Section 5 and 6 - RA 7459 Inventors and Invention Incentives Act of the Philippines E. Tax Treaties Deutsche Bank v. Collector of Internal Revenue, G.R. No. 188550, August 19, 2013

VI.

ITEMS OF GROSS INCOME

Sec. 32  A. Compensation for personal services 1. In money 2. In kind cf. “Convenience-of-the-employer rule” VII.

INTEREST INCOME

 A. Taxable (Section 24B) B. Not taxable C. Imputed interest on inter-company loans/Advances Sec. 50 VIII.

INCOME UNDER LEASE AGREEMENTS

Sec. 49  A. Rent B. Obligations of lessor to third parties assumed and paid by lessee C.  Advance rental D. Leasehold improvements. Options to report income for right of reversion of improvements to lessor: a. Option 1 – Report fair market value upon completion

Taxation 2 – Outline | Page 6

b. Option 2 – Report over remaining life of lease depreciated value after expiration of lease period

IX.

DIVIDEND INCOME

Sec. 73  A. Kinds of dividends recognized in law 1. Cash 2. Property 3. Stock B. Measure of income in cash and property dividend C. Stock dividend mmm 1. When taxable a. Measure of income 2. When not taxable a.  Adjusted cost per share 3. Liquidating “dividend” X.

INCOME FROM ANY SOURCE WHATSOEVER

 A. Bad debt recovery Sec. 50 B. Forgiveness of indebtedness Sec. 50

Taxation 2 – Outline | Page 7

C. Tax refunds D. Damage recovery E. Prizes and winnings F. Income from any source whatsoever XI.

Classes of Deductions

Sec. 34 (L), NIRC 

Optional standard deduction - who may avail



Itemized deductions



Items not deductible o

Personal, living or family expenses

o

 Amount paid for new buildings or for permanent improvements (capital expenditures)

o

 Amount expended in restoring property

o

Interest expense bad debt and losses from sales from sales of property between related parties

 A. Expenses in General Sec. 65-76 

Requisites for deductibility (ordinary, necessary business expenses) o

Should relate to business

o

Complies with substantiation requirements

o

Must be a legitimate and legal expenditure

Taxation 2 – Outline | Page 8

o

Must be reasonable in amount (limitations on entertainment expenses, interest income)

"Business expenses" are expenditures related to the conduct of the business of the taxpayer and deductible in the year incurred. While "Capital expenses" are expenditures that improve or add to the value of the property or equipment of the business. They are not immediately deductible, but may be deducted overtime in the form of "Allowance for depreciation."



Salaries, wages, compensation for services rendered; pensions, compensation for injuries; commissions



Benefits to employees, including "de minimis benefits'" and the grossed-up monetary value of fringe benefits subject to FBT



Traveling expenses (here and abroad) while away from home solely in the pursuit of a trade or business



Rentals for the use of business property



Entertainment, amusement and recreation expenses



Incidental repairs

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Cost of materials and supplies

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 Advertising expense and other selling expenses

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Professional services



Insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business

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Equipment used in the trade or business

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Organizational and operating expenses

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Management expenses

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Training expenses



Other necessary expenses

B. Interest Taxation 2 – Outline | Page 9



Interest deductible from gross income



Interest not deductible from gross income



Prepaid interest of individual on cash method of accounting



Reduction of interest expense on interest income subjected to final tax



Requirement for deductibility of interest expense

C. Taxes Sec. 80-82 

Deductible from gross income



Not deductible from gross income



Meaning of the term “taxes”



Tax Credits v. Tax Deduction (cf Mercury Drug Corporation vs CIR)



Fines and penalties

D. Losses Sec. 93-101 

Kinds of taxpayers and their losses



Completed transactions



Special rules on losses a. Voluntary removal of buildings b. Lose of useful value of assets c. Shrinkage in value of stocks

Taxation 2 – Outline | Page 10

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Wagering losses

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Requirements for Substantiation of losses – must be documented



Foreign exchange losses - Revenue Memorandum Circular No 26-85, July 15, 1985, interbank guiding rate

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 Abandonment losses Net operating loss carry-over a. Three-year period b. No substantial change in ownership (75% rule)

E. Bad Debts Sec. 102-104 

Requirements for deductibility



Tax Benefits Rule (RR 25-2002)



Bad debts between related parties Sec. 36 [B], NIRC 

Requirements for deductibility of bad debts including banks



Philex Mining v. Commissioner of Internal Revenue G.R. No. 148187. April 16, 2008

F. Depreciation (Sec. 105-115) 

Depreciation base



Methods of depreciation (straight line, declining balance, sum of the digits)



Depreciation Rates

G. Depletion (Sec. 34 (g))

Taxation 2 – Outline | Page 11

H. Pension Trust (Sec. 118) I.

Charitable and Other Contributions 

Fully deductible



Deductible, subject to limitations a. Corporation b. Individuals c. Section 34(H), RA 8424 “deductibility by actually paid or made to accredited donee institution”

J. Research and Development Expenses Sec. 34, NIRC 



When paid or incurred; or  Amortized for 60 months

K. Imposition of Ceilings on Deductions by the Secretary of Finance 

Sec. 34, last par., NIRC

L.  Additional requirement for Deductability 

Sec. 34 [k] NIRC (must pay withholding tax otherwise disallowed per RR 12-2013)

M. Items Not Deductible 



Sec. 36 NIRC (Sec. 119-122, RR 2-98 as amended)  Atlas Consolidated v. Commissioner of Internal Revenue G.R. No. L-26911. January 27, 1981

N. Sale or Exchange of Property

Taxation 2 – Outline | Page 12



Capital assets Sec. 38 (Sec. 132-135) a. Definition of capital asset (RR 7-2003, February 11, 2003) b. Guidelines in determining whether a real property is capital or ordinary asset c. Definition of ordinary income Sec. 22 (Z) d. Net capital gain, net capital loss e. Ordinary loss f.

Percentage taken into account (long term; short term) by taxpayers other than a corporation

g. Limitation on capital loss h. Meaning of sale or exchange – requirement for capital gain 

Determination of gain or loss from sale or transfer of property Sec. 40 NIRC (Sec. 136-143) a. Computation of gain or loss CIR v. Aquafresh Seafood, Inc., G.R. No. 170389, 20 October 2010 b. Cost or basis for income tax purposes c. Exchange of property – tax-free exchange Sec. 40(c)(2), -

Merger or consolidation – i.

BIR Ruling 383-87, November 25, 1987

ii.

Commissioner of Internal Revenue v Vicente Rufino G.R. No. L-33665-68. February 27, 1987

-

Transfer of “substantially all” the assets

Taxation 2 – Outline | Page 13

-

Transfer of property for shares of stocks

-

 Administrative requirements in case of tax-free exchanges

-

De facto merger

d. Cost basis in tax-free exchanges e.  Assumption of liability in tax-free exchanges f. 

Business purpose

Losses from wash sales of stocks or securities Sec. 32, Sec. 131



Exemption from capital gains tax of certain individuals from the sale or exchange of principal residence Sec. 24, (D)(2



RR 6-2008, Taxation of Shares of Stocks (April 22, 2008), as amended by RR 16-2012 and RR 6-2013

Taxation 2 – Outline | Page 14

Taxation 2 – Outline | Page 15