PM Reyes Notes on Taxation 1 - Income Tax (Updated 14 January 2013)
Ballpen example: w/ name — income to finder w/o name — no income to finder *Treasure Trove Test
PM REYES NOTES ON TAXATION I: INCOME TAX
Baseball Example: No Income because there is really no realization because there is no business transaction with a 3rd party. This militates agianst administrative convenience.
1 1. There is income, gain or profit (e.g. no reimbursement — medrep) Under “realization” there must be: 2. The income, gain or profit is received or realized Page | 1 2 1) change in substance during the taxable year; (known as the Q1.What is an income? 2) transaction with a 3rd party realization concept) and (supports Fisher v. Trinidad) 3. The income, gain or profit is not exempt from Income means the gain derived from capital, from 3 income tax. labor, or from both combined, including profits gained 4. Complete Dominion (CIR v. Glenshaw Glass Co.) from dealings in property or as well as any asset Q3.1. What is the difference between Income clearly realized whether earned or not. from capital income and capital? & labor? Is It refers to all wealth which flows into the taxpayer Income is distinct from capital. Income means all the this a other than as a mere return on capital. (RR No.2) wealth which flows into the taxpayer other than a requisite for mere return on capital while capital is a fund or what Q2.What is an income tax? constitutes property existing at one distinct point in time while income? income denotes a flow of wealth during a definite Income Tax is a tax on the net income or the entire NO. period of time. Income is gain derived and severed Because it income received or realized in one taxable year. It is from capital. (see CHAMBER OF REAL ESTATE AND can also levied upon corporate and individual incomes in BUILDER’S ASSOCIATION, INC. V. ROMULO [M ARCH 9, arise from excess of specified amounts, less certain deductions 2010]). WINDFALL. and/or specified exemptions permitted by law. (See CIR v. Income as contrasted with capital or property is to be Glenshaw & The final tax on certain passive incomes and the test. The essential difference between capital and Murphy v. withholding tax on income are embraced within the income is that capital is a fund; income is a flow. A IRS) term. fund of property existing at an instant of time is called capital. A flow of services rendered by that capital by Does it In CONWI V. CTA [AUGUST 31, 1992], the Supreme the payment of money from it or any other benefit have to be Court defined income tax as an amount of money rendered by a fund of capital in relation to such fund severed coming to a person or corporation within a specified through a period of time is called an income. Capital from the time, whether as payment for services, interest, or is wealth, while income is the service of wealth. A tax capital profit from investment. on income is not a tax on property. "Income," as here before it is used, can be defined as "profits or gains." (see considered As stated by the Supreme Court in REPUBLIC OF THE as income? M ADRIGAL VS. RAFFERTY [AUGUST 7, 1918]). PHILIPPINES VS. M ANILA ELECTRIC COMPANY NO. [NOVEMBER 15, 2002], income tax is imposed on an Q3.1.1 Are stock dividends income or (Hevering v. individual or entity as a form of excise tax or a tax on Bruun) capital? the privilege of earning income. In exchange for the protection extended by the State to the taxpayer, the Generally, stock dividends represent capital and do government collects taxes as a source of revenue to not constitute as income to its recipient. Mere finance its activities. issuance thereof is not yet subject to income tax as they are nothing but an enrichment through increase Q3.When is income taxable? (or what are the in value of capital investment. Such are considered elements of a taxable income?)
Gross Income (less) Deductions = Taxable Income Income, gain or profit is subject to income tax when the following conditions are present:
NOTE: Inter-corporate dividends are subject to 0% tax. 1
As opposed to mere reimbursements or return on capital. As opposed to the common examples of unrealized forex gains or mere revaluation increments. 3 Examples of those exempt from income tax: de minimis benefits and professional fees of GPPs. 2
PM REYES NOTES ON TAXATION I: INCOME TAX (Updated 14 January 2013) BY PIERRE M ARTIN DE LEON REYES This reviewer is a compilation of personal notes in Taxation One and notes and lectures from Atty. Gruba and Atty. Montero. References have also been made to the following books: DE LEON & DE LEON, JR. THE FUNDAMENTALS OF TAXATION (2012); DE LEON & DE LEON, JR. COMPREHENSIVE REVIEW OF TAXATION (2010); VITUG & ACOSTA. TAX LAW AND JURISPRUDENCE (2006); DOMONDON, TAXATION VOLUME II: INCOME TAX (2009); CO-UNTIAN, JR. TAX DIGEST (2009); MAMALATEO, PHILIPPINE INCOME TAX (2010); MAMALATEO, REVIEWER ON TAXATION (2008). This reviewer is best used with SACADALAN-CASASOLA, NIRC AND OTHER LAWS (2012). Possessors are granted the right to reproduce and distribute this reviewer as well as the right to convert the work to any medium for the purpose of preservation and/or continued distribution provided that the author’s name remains clearly associated with the work and that no alterations of the form and content are made.
The holder of stock dividend was not any poorer or richer when he received stock dividends (realization). There is also the idea of severance from capital which was been modified by Helvering v. Bruun. You have to be liquid to be taxed. You can’t pay stocks/ chickens to the BIR. This is why realization is a requisite for income. WHEN YOU REALIZE it is a different question.
Segues into the 3rd requisite. There may be an instance whereby those not considered as income will be such because the law says they are.
Stock dividends cannot comply with the requirement of “wherewithal” (i.e. the capacity to pay. — By taxing stock dividends, it is like asking the stockholder to sell his stock dividends to the BIR.
PM REYES NOTES ON TAXATION I: INCOME TAX
unrealized gain and cannot be subjected to income tax until that gain has been realized. As explained by the Supreme Court in FISHER V. TRINIDAD [OCTOBER 30, 1922], when a corporation issues stock dividends, it shows that the corporation’s accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution. The stockholder receives nothing out of the corporate assets for his separate use and benefit but a representation of his increased interest in the capital of the corporation. The capital still belongs to the corporation as there is no separation of interest.Receipt of stock dividends does not give rise to income However, stock dividends constitute as income if a corporation redeems stock issued so as to make a 4 distribution. This is essentially equivalent to the distribution of a taxable dividend the amount so distributed in the redemption considered as taxable income. (see COMMISSIONER VS. M ANNING [AUGUST 7, 1975])
Q3.2. Are money received as damages income?
Yes. In COMMISSIONER V. GLENSHAW GLASS CO. [348 U.S. 426], Glenshaw Co was engaged in a proracted litigation with Hartford-Empire Co where the former demanded exemplary damages for fraud and treble damages for injury to its business by reason of the latter’s violation of federal antitrust laws. The parties settled. Glenshaw did not report the money received as damages from the settlement in its income tax return. The Commissioner assessed Glenshaw for the deficiency. Glenshaw contended that punitive damages, as windfalls flowing from culpable conduct Tax Benefit of third parties are not taxable income. The US Rule - if Supreme Court held that money received as unable to damages must be reported as they constitute collect, you income. The mere fact that such payments were may report extracted from wrongdoers cannot detract from their it as loss. character as taxable income. The Court also stated But if after that punitive damages cannot be classified as gifts. such report, you receive payment for In MURPHY V. IRS [493 F.3d 170], the US Court of the debt, it Appeals (District of Columbia), held that the amount becomes received as compensatory damages for emotional income in distress and loss of reputation constitutes taxable your hands. income. In contrast, if you receive it 4 The exception to the rule that stock dividends do not constitute before loss income shall be discussed more extensively later. Knowing that report, its there is an exception exists will suffice for now. neutral. PIERRE MARTIN DE LEON REYES
Q3.3. What is the constructive receipt doctrine? The constructive receipt doctrine provides than an item is treated as income when it is credited to the account of the, or made unconditionally available to the taxpayer; no physical possession is required. Income is received not only when it is actually handed to a taxpayer but also when it is merely constructively received by him. In LIMPAN INVESTMENT V. CIR [JULY 26, 1966], the lessees opted to deposit their payments when the lessor refused to accept the same in 1957. The lessor did not report these payments in his 1957 income tax return. The Supreme Court held that the failure to report the said rental income is unjustified as, when the payments were deposited, the lessor was deemed to have constructive received such rentals.
Overview of the Philippine Income Tax System Q4.What are the features of the Philippine tax system? The Philippine tax system is: 5 1. Direct 6 2. Progressive 3. Semi-schedular, semi-global
Q4.1. What are the kinds of income tax systems? The types of income tax systems adopted are as follows: 1. Global Tax System – where the taxpayer is required to lump up all items of income earned during a taxable period and pay under a single set of income tax rates on these different items of income. (Simply put, varying taxes are imposed on passive income) 2. Schedular Tax System – where there are different tax treatments of different types of income so that a separate tax return is required to be filed for each type of income and the tax is computed on a per return or per schedule basis. 5
Direct taxes are those taxes wherein both the tax liability as well as the impact or burden of the tax falls on the same person 6 Progressive taxes are those taxes imposed where the tax rate increases as the tax base increases
PM REYES NOTES ON TAXATION I: INCOME TAX (Simply put, one rate for all types of gross income). 3. Semi-Schedular or Semi-Global Tax System – where the tax system is either (a) global (e.g. taxpayer with compensation income not subject to final withholding tax or business or professional income or mixed income – compensation and business or professional income) or (b) schedular (e.g. taxpayer with compensation, capital gains, passive income, or other income subject to final withholding tax) or (c) both global and schedular may be applied depending on the nature of the income realized by the taxpayer during the year.
Q4.2. How do you distinguish “schedular treatment from “global treatment” as used in income taxation?
6. Capital gains tax on sale or exchange of real property located in the Philippines and classified as a capital asset 7. Final withholding tax on certain passive investment incomes 8. Fringe benefit tax 9. Branch profit remittance tax; and 10. Tax on improperly accumulated earnings.
Definition of Terms Q5.Define the following terms: In Section 22(A) to (I), (Z), (GG), and (HH), Tax Code: Person Corporation
Under the schedular tax system, the various types of income (i.e. compensation; business/professional income) are classified accordingly and are accorded different tax treatments, in accordance with schedules characterized by graduated tax rates. Since these types of income are treated separately, the allowable deductions shall likewise vary for each type of income. On the other hand, under the global tax system, all income received by the taxpayer are grouped together, without any distinction as to type or nature of the income, and after deducting therefrom expenses and other allowable deductions, are subjected to tax at a graduated or fixed rate (see TAN VS. DEL ROSARIO [OCTOBER 3, 1994]).
Q4.3. What are the types of Philippine Income Tax (under Title II of the NIRC)? The types of Income tax under Title II of the NIRC are: 1. Graduated income tax on individuals 2. Normal corporate income tax on corporations 3. Minimum corporate income tax on corporations 4. Special income tax on certain corporations (e.g. private educational institutions, FCDUs, and international carriers) 5. Capital gains tax on sale or exchange of unlisted shares of stock of a domestic corporation classified as a capital asset
PIERRE MARTIN DE LEON REYES
General Professional Partnerships (GPPs)
Domestic (Corporation) Foreign (Corporation) Nonresident citizen
An individual, a trust, estate or corporation Includes partnerships, no matter how created or organized, jointstock companies, joint accounts, 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 and other energy operations pursuant to an operating agreement under a service contract with the Government 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 When applied to a corporation, means created or organized in the Philippines or under its laws When applied to a corporation, means a corporation which is not domestic The term means a citizen of the Philippines: 1. who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with intention to reside therein
Branch — not a separate entity from the Subsidiary — organized as a separate entity from the parent corp; head office; mere extension; you secure a relationship is based on equity (shareholding); considered as domestic registration establishing the branch. For tax corp. even if wholly owned by a foreign corporation. purposes is a resident foreign corp. PM REYES NOTES ON TAXATION
INCOME TAX Diff. bet. RC & NRC 2. who leaves the Philippines during the taxable year to is based on the reside abroad either as an physical presence and on the nature of immigrant or for employment the stay. on a permanent basis 3. 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. 4. who has been previously considered a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines with respect to his income derived from sources abroad until date of his arrival in the Philippines Resident alien
Nonresident alien Resident foreign corporation Nonresident Tokyo Shipping foreign case corporation Ordinary Income
Statutory Minimum Wage
Minimum Wage earner
Not subject to Income Tax
An individual whose residence is within the Philippines and who is not a citizen thereof An individual whose residence is not within the Philippines and who is not a citizen thereof A foreign corporation engaged in trade or business within the Philippines SEC Reg. A foreign corporation not engaged in trade or business within the Philippines Includes any gain from the sale or exchange of property which is not a capital asset or property 7 described in Section 39(A)(1) Refers to the rate fixed by the Regional Tripartite Wage and Productivity Boar, as defined by the Bureau of Labor and Employment Statistics (BLES) of DOLE. 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
In Section 31, 35(B), and 39(A), Tax Code: Taxable Income Income - Exclusions = Gross income Deductions/ Exemptions = Net Taxable Income Dependent
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 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 property held by the taxpayer (whether or not connected with his trade or business, EXCEPT: 1. 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 2. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business 3. Property used in trade or business of a character that is subject to allowance for depreciation
4. Real property used in trade or business of the taxpayer the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges
which defines what capital assets are and those which are not.
PIERRE MARTIN DE LEON REYES
PM REYES NOTES ON TAXATION I: INCOME TAX Q6.What are the kinds of income taxpayers?8
1. Those who are citizens of the Philippines at the time of the adoption of the Constitution 2. Those whose fathers or mothers are citizens of the Philippines 3. Those born before January 17, 1973 of Filipino mothers, who elect Philippine Citizenship upon reaching the age of majority; and 4. Those who are naturalized in accordance with law
The kinds of income taxpayers under Title II of the NIRC are: A. Individuals 1. Citizens (Section 24, NIRC) a. Resident Citizens b. Nonresident Citizens 2. Aliens a. Resident Aliens (Section 24, NIRC) b. Nonresident Aliens (Section 25, NIRC) i. Engaged in trade or business in the Philippines ii. Not engaged in trade or business in the Philippines 3. Estates and Trusts (Section 60, NIRC) a. Revocable trust b. Irrevocable trust B. Corporations 1. Domestic Corporations (Section 27, NIRC) 2. Foreign Corporations (Section 28, NIRC) a. Resident foreign corporations b. Nonresident foreign corporations 3. Partnerships a. Taxable partnership (Section 73(D), NIRC) b. Exempt partnership i. General Professional Partnership (Section 26, NIRC) ii. Joint venture or consortium undertaking construction activity or engaged in petroleum operations with operating contract with the government
Resident citizens and resident aliens Q7.Who are citizens of the Philippines?9 The following Philippines:
Before proceeding to income proper, it is important to know the different kinds of taxpayers first. This is because in analyzing any problem involving income taxation, the first thing to do is to determine who the taxpayer is. The only two exceptions where knowing the taxpayer is immaterial are where the transaction involves sales of shares of stock of a domestic corporation because it is subject to 1% of stock transaction tax or 5%/10% capital gains tax on net capital gain whether the seller is an individual, citizen or alien or a corporation, domestic or foreign and (2) where the real property sold is a capital asset located in the Philippines which is subject to 6% capital gains tax. 9 To determine if the taxpayer is a resident citizen, just refer to the enumeration of what constitutes a non-resident citizen.
PIERRE MARTIN DE LEON REYES
Q8.Who is a non-resident alien? A non-resident alien is an individual whose residence is within the Philippines and who is not a citizen thereof.
Q8.1. How is the residency of an alien determined? An alien is considered a non-resident if he stays here for a definite short period of time. An alien will be considered a resident if the stay here is either: 1. definite and extended; 2. indefinite In GARRISON V. CA [JULY 19, 1990], in resolving the contention of US nationals that they cannot be considered resident aliens as they intend to go back to the US on termination of their employment in the Philippines, the Supreme Court held that what the law requires is merely physical or bodily presence in a given place for a period of time, not the intention to make it a permanent place of abode. The Supreme Court further held that, as laid clearly in RR No. 2, whether an alien is a transient or not is determined by his intentions with regard to the length and nature of his stay. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him as a transient. If he lives in the Philippines and has no definite intention 10 as to his stay, he is a resident. One who comes to the Philippines for a definite purpose, which in its nature may be promptly accomplished, is a 11 transient. But if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien makes the 10 11
In other words, stay is indefinite. In other words, the stay is for a definite short period of time.
How to Determine if NRA or RA Relevant factors:(1) Duration & (2) Certainty/Definitie Short-Definite — NRA PM REYES NOTES ON TAXATION Short-Indefinite — Resident Long-Definite — Resident (e.g. Normal Black) INCOME TAX Long-Indefinite — Resident Philippines his temporary home, he becomes a resident, although he intends to return to his domicile 12 abroad.
Q8.2. When is the residence of an alien considered lost? RR 2 provides that an alien who has acquired residence in the Philippines retains his status as a resident until he abandons the same and actually departs from the Philippines. An intention to change his residence does not change his status as a resident alien to that of a nonresident alien.
Non-resident citizens Q9.Who is a non-resident citizen? The term “non-resident citizen” means a citizen of the Philippines: 1. who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with intention to reside therein 2. who is an one who leaves the Philippines during the taxable year to reside abroad either as an immigrant or for employment on a permanent basis 3. who is one 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. 4. who has been previously considered a nonresident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines with respect to his income derived from sources abroad until date of his arrival in the Philippines (See Section 22E, NIRC and Section 2, RR No. 0179 [January 8, 1979])
Q9.1. Should a non-resident citizen file an income tax return or information return covering his income earned abroad?
return. However, under RR 05-01 [July 31, 2001], non-resident citizens are no longer required to file the same on their income derived from sources outside the Philippines.
Q9.2. What is meant by the phrase The 183 day “most of the time” as used in qualification determining whether a citizen who is only to derives income from abroad and is qualify the “most of the physically present abroad is a time” non-resident? requirement
BUT this is RR No. 01-79 states that to be physically present not solely abroad most of the time during the taxable year, a controlling. contract worker must have been outside the RATHER Philippines for not less than 183 days during such Section 22. taxable year.This applies to a citizen who needs to be abroad for the most time but not a contract worker. Note: As can be seen from the wording of RR No.The moment 01-79, “most of the time” applies to a contract worker. you leave the In BIR Ruling 33-00 [September 5, 2000], however,Phils. you are the CIR held that for overseas contract workers, theconsidered an time spent abroad is not material as all that is NRC whether required is for the worker’s employment contract to or not you prove the pass through and be registered with the POEA. requisites.
Q9.3. Dual Citizens are treated as nonresident citizens of the Philippines
If a natural-born Philippine citizen who became a citizen of the United States is later on granted Philippine dual citizenship under RA 9225, is he required to pay taxes for income earned in the United States?
No. In BIR Ruling DA-095-05 [March 29, 2005], the CIR held that such a person would be a non-resident citizen, and hence, will not be required to pay Philippine tax for income earned in the United States.
Non-resident aliens engaged in business in the Philippines Q10.
Who is a non-resident alien?
A non-resident alien is an individual: 1. whose residence is not within the Philippines; and 2. who is not a citizen thereof
No. Previously, under RR No. 01-79, non-resident citizens were required to do so. In RR No. 9-99, nonresident citizens were required to file an information 12
In other words, the stay is definite but extended.
PIERRE MARTIN DE LEON REYES
PM REYES NOTES ON TAXATION I: INCOME TAX Q10.1. How do you determine if a nonresident alien is engaged in trade or business? Once a taxpayer is determined to be a non-resident alien, the test to determine whether the alien is a non-resident alien engaged in trade or business is whether his total aggregate stay for a taxable year exceeds 180 days. Once clasisified as NRA (S-D), further: < 180 days — Not engaged in business. Corporations — Back&Forth accumulated to 180 > 180 days — Engaged in business.
Differentiate the kinds of corporate taxpayers.
A corporation is itself a taxpaying entity and speaking generally, for purposes of income tax, corporations are classified into (a) domestic corporations and (b) foreign corporations. Foreign corporations are further classified into (1) resident foreign corporations and (2) non-resident foreign corporations. A domestic corporation is one created or organized in the Philippines or under its laws. A foreign corporation is one created or organized under the laws of a foreign country.
(see N.V. REEDERIJ “AMSTERDAM” VS. CIR [JUNE 23, 1988])
Is a partnership liable for income tax?
Yes. The term “corporations” includes partnerships, no matter how created or organized.
Q12.1. Is a GPP13 liable for income tax? No. A GPP is not considered a taxable entity for income tax purposes. Section 26 of the NIRC provides that persons engaging in business as partners in a GPP shall be liable for income tax only in their separate and individual capacities computed on their respective distributive shares of the partnership profit.
Q12.2. Distinguish between a GPP and an ordinary business partnership. A general professional partnership, unlike an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on their distributive shares of partnership profits (see CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES VS. DEL ROSARIO [OCTOBER 3, 1994])
A resident foreign corporation is a foreign corporation engaged in trade or business within the Philippines or having an office or place of business therein. A non- resident foreign corporation is a Q12.2.1. A and B, co-owners, bought 3 foreign corporation not engaged in trade or business within the Philippines and not having any office or Diff. bet. Co-Ownership and parcels of land in one transaction and bought 2 more Unregistered Partnership: place of business therein. parcels of land in another. Common Fund They decided to sell the 3 Intent to divide profits A domestic corporation is taxed on its income from parcels to C and the 2 parcels Habituality sources within and without the Philippines, but a to D. They realized a net profit foreign corporation is taxed only on its income from gain and paid CGT. CIR sources within the Philippines. However, while a assessed them for deficiency foreign corporation doing business in the corporate income tax. Is the Philippines is taxable on income solely from sources co-ownership taxable as a within the Philippines, it is permitted to deductions corporation? from gross income but only to the extent connected with income earned in the Philippines. On the other No. A Co-Ownership who own properties which hand, foreign corporations not doing business in produce income should not automatically be the Philippines are taxable on income from all considered partners of an unregistered partnership, sources within the Philippines, as interest, dividends, or a corporation, within the purview of the income tax rents, salaries, wages, premiums, annuities law. The essential elements of a partnership are two, Compensations, remunerations, emoluments, or namely: (a) an agreement to contribute money, other fixed or determinable annual or periodical or casual gains, profits and income and capital gains.” 13 General professional partnership (GPP) 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.
PIERRE MARTIN DE LEON REYES
PM REYES NOTES ON TAXATION I: INCOME TAX property or industry to a common fund; and (b) intent to divide the profits among the contracting parties. Here, there is no evidence that petitioners entered into an agreement to contribute money, property or industry to a common fund, and that they intended to divide the profits among themselves. The sharing of returns does not in itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest in the property. There must be a clear intent to form a partnership, the existence of a juridical personality different from the individual partners, and the freedom of each party to transfer or assign the whole property. (see OBILLOS v. CIR [OCTOBER 29, 1985] and PASCUAL V. CIR [OCTOBER 18, 1988]).
Q12.3. Are joint ventures taxable?
Generally, yes. However, a joint venture or In order to consortium undertaking construction projects or still fall w/in engaged in petroleum operations with an the NIRC, operating contract with the government are not they form a separate liable for income tax. entity A group of insurance companies in the Philippines Q12.3.1. What are the requirements in altogether decided to form a pool and This was made by the BIR order for a joint venture (instead of entered into a reinsurance because they cant amend the formed for construction JV) so that treaty with a non-resident NIRC. The RR requires that purposes be not liable for the distribution reinsurance company. Is such both parties in the JV must be income tax? of units is a pool subject to corporate merely In RR No. 010-12 [J UNE 1, 2012], a joint venture or taxes and withholding taxes dividends consortium formed for the purpose of undertaking on dividends paid to the nonconstruction projects which is not considered as a and not resident reinsurance taxable. taxable corporation should be: company?
Yes. Where several local insurance ceding companies enter into a Pool Agreement or an association that would handle all the insurance businesses covered under their quota-share reinsurance treaty and surplus reinsurance treaty with a non-resident foreign reinsurance company, the resulting pool having a common fund, and functions through an executive board and its work is indispensable, beneficial and economically useful to the business of the ceding companies and the foreign firm, such circumstances indicate a partnership or an association taxable as a corporation (see AFISCO INSURANCE CORPORATION VS. CIR [JANUARY 25, 1999])
heirs only as long as the inheritance or estate is no distributed, or, at least, partitioned. But the moment their respective known shares are used as part of the common assets of heirs to be used in making profits, it is but proper that the income from such shares should be considered as part of the taxable income of an unregistered partnership. (see ONA V. CIR [M AY 25, 1972]).
1. For the undertaking of a construction project; 2. Should involve joining or pooling of resources by licensed local contractors, licensed by the Philippine Contractors Accreditation Board (PCAB) of the DTI; 3. The local contractors are engaged in construction business; 4. The joint venture itself must likewise be duly licensed as such by the PCAB Absent one of the requirements, the joint venture formed for construction purposes shall be considered a taxable corporation.
Q12.3.2. A and B inherited properties. They did not partition the same and instead invested them to a common fund and divide the profits therefrom. Should they be classified as an unregistered partnership subject to corporate income tax?
Yes. The income from inherited properties may be considered as individual income of the respective
PIERRE MARTIN DE LEON REYES
May joint ventures involving foreign contractors be treated as a non-taxable corporation?
Yes, provided that the member foreign contractor is: 1. covered by a special license as contractor by the PCAB; and 2. construction project is certified by the appropriate government office as a foreign financed/internationally-funded project and that international bidding is allowed under the bilateral agreement between the Philippine government; and foreign/international financing institution.
PM REYES NOTES ON TAXATION I: INCOME TAX Q12.3.3.
Two local contractors entered into a joint development agreement to construct a residential subdivision. One local contractor shall contribute the parcel of land while the other shall contribute the construction and development of the parcel of land into a subdivision. Each shall receive an allocation of saleable house and lot units from the project. Is the joint venture liable for income tax?
No. In BIR Ruling No. 108-2010 [October 19, 14 2010], involving a joint venture between Avida and Aurora, the CIR held that the joint development agreement between the two is not subject to income tax because joint ventures formed by local contractors for construction purposes are deemed as not falling under the definition of a taxable corporation.
Income15 Statutory Inclusions Q13.
What are deemed included in (gross) income?
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 4. Interests Section 78: specific types of payment that 5. Rents are not considered as taxable income (e.g. 6. Royalties domestic labor) 7. Dividends
8. 9. 10. 11.
Annuities Prizes and winnings Pensions; and Partner’s distributive share from the net income of the GPP
(see Section 32(A), NIRC)
Q13.1. Is the enumeration provided in Section 32(A) exclusive? No. Section 32(A) does not intend the enumeration to be exclusive. It merely directs that the types of income listed therein be treated as income from sources within the Philippines (see CIR VS. AMERICAN AIRLINES [DECEMBER 19, 1989])
Compensation for services Q13.2. If an employer pays the income What is being taxes assessable against an taxed is the employee, is the payment by the employeeemployer employer taxable income on the relationship. part of the employee? Yes. In OLD COLONY TRUST CO. V. COMMISSIONER [279 U.S. 716], the US Supreme Court held that the payment of the tax by the employer was in consideration of services rendered by the employee. The payment constituted income to the employee. The Court also added that it cannot be argued that the payment was a gift. The payment for services, even though voluntary, was nevertheless compensation for services rendered.
Rents Q13.3. Are improvements made by lessees taxable as income on the part of the lessor? Yes, provided the such buildings or improvements are not subject to the removal by the lessee. The lessor may either: (1) report the improvements as income at the time when such improvements are completed based on its fair market value; or (2) spread the life of the lease the estimated depreciate value of the improvements at termination of the lease
It is also important to note in this BIR Ruling that the CIR held that the allocation of saleable units does not constitute as a taxable event as no income is actually realized by Avida or Aurora. 15 Previously, we looked into the types of taxpayers. Now, before proceeding to general principles and source of income rules, let us look into what is included in the term “income;;” and what is excluded therefrom.
PIERRE MARTIN DE LEON REYES
The above answer is the definition of gross income. This will be discusses in greater detail later. For now, we focus on determining what is considered income and what is not considered income or excluded therefrom.
PM REYES NOTES ON TAXATION I: INCOME TAX and report as income for each year of the lease an aliquot part thereof (Section 49, RR No. 2)
Q13.3.1. Should the improvement be capable of being separated from the land in order to be considered a taxable gain? No. The US Supreme Court in HELVERING V. BRUUN [309 US 461] stated that it is not necessary to recognition of taxable gain that the lessor be able to sever the improvement begetting the gain from his original capital.
Mere issuance/ declaration of stock dividends are doesn’t result to income
Dividends Q13.4. What are dividends? The term “dividends” means any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, 17 whether in money or in other property.
Q13.5. Are property dividends taxable? Yes. As provided in Section 251, RR No. 2, dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the full market value of such property when receivable by individual stockholders.
Q13.6. Are stock dividends subject to income tax? No. As discussed earlier, a stock dividend only represents the transfer of surplus to capital account and, as such, is not subject to income tax.
SD issued — bought by the Q13.6.1. What is the exception to company — ultimately the the rule that stock stockholder received cash. dividends are not Except that it was declared T subject to income tax? tax-free. — not legit bus. purpose Stock dividends constitute as income if a corporation redeems stock issued so as to make a distribution. This is essentially equivalent to the distribution of a taxable dividend the amount so distributed in the redemption considered as taxable income. (see 17
If in money, it is called a cash dividend. If it is in property, it is called a property dividend.
Tax rate for liquidating dividends is higher (32%) than ordinary dividends.
PIERRE MARTIN DE LEON REYES
COMMISSIONER VS. MANNING [AUGUST 7, 1975]) The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholder's separate property. Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. (see CIR VS. CA [JANUARY 20, 1999]) As provided in Section 252, RR No. 2: A stock dividend constitutes income if its gives the shareholder an interest different from that which is former stock holdings represented. A stock dividend does not constitute income if the new shares confer no different rights or interests that did the old.
Q13.7. Are liquidating dividends subject to income tax? Yes. Where a corporation distributes all of its property or assets in complete liquidation or 18 dissolution, the gain realized from the transaction by the stockholder, whether individual or corporate, is 19 taxable income or a deductible loss, as the case 20 may be.
“From whatever source” Q13.8. What is meant by the phrase “all income derived from whatever source" The phrase “all income derived from whatever source” encompasses all accessions to wealth, clearly realized, and over which the taxpayers have complete dominion. A gain constitutes taxable income when its recipient has such control over it that as a practical matter, he derives readily realizable economic value from it. 18
There must be a bona fide plan of liquidation involving the transfer of all assets. 19 If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible. 20 Previously, the CIR has ruled in BIR RULING 039-02 [NOVEMBER 11, 2002] and other previous rulings that the transfer by a liquidating corporation of its remaining assets to its stockholders and the receipt of the shares surrendered by the shareholder are not subject to income tax. However, in BIR RULING 479-11 [DECEMBER 5, 2011], the CIR reversed and set aside the abovecited ruling and all previous rulings to that effect. The rule now is that they are subject to income tax.
PM REYES NOTES ON TAXATION I: INCOME TAX Validity of Q13.8.1. Is an unlawful gain subject the element to income tax? of complete dominion. Yes. In JAMES V. US [366 US 213], the Supreme Court ruled that embezzled money constitutes gross Tax you paid income. It opined that unlawful, as well, as lawful gain for are comprehended within the term “gross income.” embezzled The Court has given a liberal construction to “gross income is income” in recognition of the intent of Congress to tax nonall gains except those specifically exempted. refundable.
Gambler lost 3.4M but was only forgiveness of required to pay 0.5M. Is there taxable indebtedness amount to a income in his hands? The US-SC is gain subject to income tax? not income. For Yes. If, for example, an individual performs services discharge of for a creditor, who, in consideration thereof cancels debt to be the debt, income to that amount is realized by the applicable: debtor as compensation for his services. (see (1) liability Section 50, RR No. 2).21 (2) debtors holds Q13.8.3. Should taxes previously property. claimed and allowed as (e.g. the deductions but chips dont subsequently refunded or represent property. It is granted as tax credit be only an considered part of gross accounting income? mechanism) Yes. RMC No. 13-80 [April 10, 1980] provides that taxes previously claimed and allowed as deductions but subsequently refunded or granted as tax credit should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, taxes which are not allowable as deductions, when refunded or credited, are not 22 declarable for income tax purposes.
income of a taxpayer. If such is the determination, the taxpayer shall take inventories upon such basis as the Secretary of Finance, upon recommendation of the CIR, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.
Is there a particular method of valuing inventory that a taxpayer should follow?
No. The taxpayer may choose the method of valuding its inventory for any taxable year, and such method should be used in all subsequent years unless: 1. With the approval of the CIR, a change to a different method is authorized; or 2. The CIR finds that the nature of the stock on hand is such that inventory ains should be considered realized for tax purposes and therefore it is necessary to modify the valuation 23 method. Thus, in BIR RULING DA-128-08 [AUGUST 11, 2008], Pilipinas Shell requested to change its valuation method from the Weighted Average Method (WAVE) to the First-In-First-Out (FIFO) to conform with the adoption by a new computerized accounting system based on the Global Systems Application and Product Data Processing (GSAP) by its parent company and its affiliates, including Pilipinas Shell. They system uses FIFO. The CIR approved the shift to FIFO noting that the WAVE method is no longer compatible with the new accounting system to be introduced and to be consistent with the inventory method used by its parents company and affiliates all over the world.
What are “exclusions?”
Q13.9. Explain the use of inventories to determine the income of a taxpayer.
The term “exclusions” refers to items that are not included in the determination of gross income because:
For certain businesses, the use of inventories may be deemed necessary in order to determine clearly the
1. They represent return of capital or are not income, gain or profit (e.g. life insurance) 2. They are subject to another kind of internal revenue tax (e.g. gifts, bequests, devices) 3. They are income, gain or profits that are expressly exempt from income tax under the
If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. 22 The enumeration of taxes not allowable as deductions will be provided later.
PIERRE MARTIN DE LEON REYES
The CIR shall not exercise this authority more often than every 3 years.
PM REYES NOTES ON TAXATION I: INCOME TAX Constitution, tax treaty, Tax Code, or general or special law. (e.g. PEZA)
What are deemed excluded (gross) income?
1. Proceeds of life insurance, payable upon the death of the insured to the heirs or beneficiaries, but not the interest payments thereon if such amounts are held by the insurer under an agreement to pay interest. 2. Amounts received by the insured as return of premiums paid under life insurance, endowment or annuity contracts, either during the term or at the maturity of the contract or upon the surrender thereof. 25
3. Gifts, bequests, and devises but not the income from such property; if the amount received is on account of services rendered whether constituting a demandable debt or not such as remuneratory donations or the use or opportunity or use of capital, the receipt is income. 4. Compensation for injuries or sickness whether by suit or agreement including amounts received through accident or health insurance or under the Workmen’s compensation Act, but not damages or compensation recovered for loss of profit in loss or damage to property which would be taxable 5. Income exempt under treaty binding upon the Government of the Philippines.
It is considered as indemnity rather than income They are instead subject to estate or gift taxes (see PIROVANO VS. COMMISSIONER [JULY 31, 1965]) 26 Reasonable private benefit plan means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the 25
PIERRE MARTIN DE LEON REYES
That the benefits granted shall be availed of by an official or employee only once.
b. Any amount received by an official or 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. c. The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or non-resident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public. d. Payments of benefits due or to become due to any person (residing in the Philippines) under the laws of the United States administered by the United States Veterans Administration. e. Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282. f. Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and employees.
a. Retirement benefits received under RA 7641 and those received by officials and employees of private firms, whether individual or corporate, in accordance with a 26 reasonable private benefit plan maintained by the employer provided: 24
that the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement
Section 32(B) is an exclusive list As provided in Section 32(B), NIRC, the following items shall not be included in gross income and shall be exempt from income tax
6. Certain retirement benefits, gratuities, more particularly:
7. Miscellaneous including:
a. Income of foreign governments or financing institutions owned, controlled or enjoying refinancing from such foreign benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein its is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees.
PM REYES NOTES ON TAXATION I: INCOME TAX governments and of international or regional financial institutions established by foreign governments from their passive investments in the Philippines b. Income of the Philippine government and its political subdivisions derived from public utilities or in the exercise of essential governmental functions c. Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement but only if: i. The recipient was selected without any action on his part to enter the contest or proceedings; and ii. The recipient is not required to render substantial future services as a condition to receiving the prize or award d. All prizes and wards granted to Pacquiao is not exempt athletes in local and international sports under this because his competitions whether held in the “prizes” are contractual. Philippines or abroad. e. Gross benefits received by officials and employees of public and private entities provided, however, that the total exclusion shall not exceed P30,000 which shall cover: Bonuses i. Benefits received by officials and employees of the national and local government pursuant to RA 6686 ii. Benefits received by employees pursuant to PD 851 iii. Benefits received by officials and employees not covered by PD 851 iv. Other benefits such as productivity incentives and Christmas bonus provided that the ceiling of P30,000 may be increased through the rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year. f. GSIS, SSS, Medicare and Pag-ibig Supported by RMC 27-2011 contributions and union dues of individuals g. Gains from the sale of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years h. Gains from the redemption of shares of stock in a mutual fund company
PIERRE MARTIN DE LEON REYES
Also, under Section 33(C), NIRC, the following fringe 27 benefits are not taxable: 1. Fringe benefits authorized and exempted from tax under special laws; 2. Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization plans; 3. Benefits given to rank and file employees, whether granted under a CBA or not; 4. De minimis benefits.
Retirement benefits Q15.1. What are the requirements to exempt retirement benefits from income tax? For the retirement benefits to be exempt from income tax, the taxpayer is burdened to prove the concurrence of the following elements: 1. a reasonable private benefit plan is maintained by the employer; 2. the retiring official or employee has been in the service of the same employer for at least ten (10) years; 3. the retiring official or employee is not less than fifty (50) years of age at the time of his retirement; and 4. the benefit had been availed of only once 5. The retirement plan must be submitted to and approved by the BIR (see
INTERCONTINENTAL BROADCASTING CORPORATION VS. AMARILLA [OCTOBER 29, 2006]) Q15.2. An
It was the trust employees’ trust to provide pension, disability company's decision toretirement, invest, NOT payee/ benefits to its employees. The trust made investments and employer
earned therefrom interest income. Is it proper to subject the interest income to withholding tax?
No. As held by the Supreme Court in CIR V. CA & GCL RETIREMENT PLAN [M ARCH 23, 1992], said retirement benefits received by officials and 27
Fringe benefits means any goods, service or other benefit furnished or granted in cash or in kind by an employer to an individual employee (except rank and file employees). This will discussed more later.
PM REYES NOTES ON TAXATION I: INCOME TAX employees of private firms in accordance with a reasonable private benefit plan maintained by the employer shall be exempt from all taxes
Q15.3. A government employee, retired from service. Upon retirement, he received, among other benefits, terminal leave pay which the CIR withheld a portion allegedly representing income tax thereon. Is terminal leave pay considered part of gross income of the recipient? No. In COMMISSIONER OF INTERNAL REVENUE VS. CA & EFREN CASTANEDA [OCTOBER 17, 1991], the Supreme Court held that terminal leave pay received by a government official or employee is not subject to withholding (income) tax. The rationale behind the employee’s entitlement to an exemption from withholding tax on his terminal leave is that commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own. In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits. In fine, not being part of the gross salary or income of a government official or employee but a retirement benefit, terminal leave pay is not subject to income tax. (see RE: REQUEST OF ATTY. BERNANDINO ZIALCITA [OCTOBER 18, 1990]).
Q15.4. Are contributions to SSS, GSIS, PHIC and Pag-Ibig in excess of the mandatory contributions subject to income tax? Yes. Previously, SSS, GSIS, PHIC and Pag-Ibig contributions in excess of the mandatory contributions were considered exempt from income tax. However, because it was deemed to have been abused and the excess contributions are being made as a form of investment, RMC No. 027-11 [JULY 1, 2011] now considers the excess contributions as not excludible from gross income and not exempt from income and withholding tax.
PIERRE MARTIN DE LEON REYES
Income derived by foreign government Q15.5. A domestic corporation entered into a loan and sales contract with a foreign corporation where the latter shall extend a loan to the former and the former shall sell to the latter all copper concentrates to be produced from the machine to be purchased using the loaned amount. The foreign corporation applied for the loan from one of its government financing institutions. Is the interest income from the loans automatically exempt from withholding tax? No. As held in CIR V. MITSUBISHI METAL CORPORATION [JANUARY 22, 1990], the burden of proof rests upon the party claiming an exemption to prove that it is in fact covered by the exemption. In the said case, the Supreme Court found that the foreign government financing institution had nothing to do with the sales and loans agreement. It is the foreign corporation, not the foreign government financing institution that is the sole creditor of the domestic corporation.
De Minimis/PERA Q15.6. What are de minimis benefits? As defined by RR 3-98 [MAY 21, 1998], de minimis benefits are benefits of relatively small value offered or furnished by the employer to his/her employees as a means of promoting the health, goodwill, contentment, efficiency of his/her employees. These benefits are exempt from the withholding tax on compensation income, and consequently from income tax, regardless of whether or not the recipients of the benefits are managerial or rank-andfile employees.
What are deemed de minimis benefits?
As provided in RR No. 005-11 [March 16, 2011], as amended recently by RR No. 008-12 [M AY 11, 2012], the following shall be considered de minimis benefits not subject to income tax as well as withholding tax on compensation income of both managerial and rank and file employees:
PM REYES NOTES ON TAXATION I: INCOME TAX 1. Monetized unused vacation leave credits of private employees not exceeding ten (10) days 28 during the year; 2. Monetized value of vacation and sick leave credits paid to government officials and 29 employees; 3. Medical cash allowance to dependents of employees, not exceeding P750 per employee 30 per semester or P125 per month; 4. Rice subsidy of P1,500 or one (1) sack of 50 kg. rice per month amounting to not more than 31 P1,500; 5. Uniform and clothing allowance not exceeding 32 P5,000 per annum; 6. Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs, annual medical check-up, maternity assistance, and routine consultations, not 33 exceeding P10,000 per annum; 7. Laundry allowance not exceeding P300 per 34 month; 8. Employees achievement awards, e.g. for length of service or safety achievement, with an annual 35 monetary value not exceeding P10,000; 9. Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 36 per employee per annum; 10. Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of the 37 basic minimum wage per region basis.
Is the enumeration of de minimis benefits exclusive?
This was included in RR 3-98 and in RR 8-00 [August 21, 2000] but referred to employees in general. RR No. 005-11 [March 16, 2011] specifically provided “private” employees. 29 Introduced by RR 10-00 [December 14, 2000] 30 Provided under RR 3-98 and RR 8-00 [August 21, 2000] 31 Under RR 3-98, the amount was P350. RR 8-00 [August 21, 2000] increased this to P1,000 and added the alternative 1 sack of 50kg of rice. This was increased by RR 5-2008 [APRIL 17, 2008] to P1,500. 32 RR 3-98 did not provide for an amount. RR 8-00 [August 21, 2000] provided for an amount of P3,000. RR No. 005-11 [March 16, 2011] provided for an amount of P4,000. This was again increased by RR No. 008-12 [MAY 11, 2012] to P5,000. 33 RR 3-98 simply said “medical benefits” with no corresponding amount. RR 8-00 [August 21, 2000] provided the amount of P10,000 as the ceiling. 34 RR 3-98 provided for an amount of P150. RR 8-00 [August 21, 2000] increased it to P300. 35 RR 3-98 provided for a ceiling of ½ month of the basic salary of the employee. RR 8-00 [August 21, 2000] changed the ceiling amount to P10,000. 36 RR 3-98 did not provide for a ceiling amount. RR 8-00 [August 21, 2000] introduced the P5,000 ceiling. 37 Introduced by RR 8-00 [August 21, 2000].
PIERRE MARTIN DE LEON REYES
Yes. As provided in RR No. 005-11 [March 16, 2011], all other benefits given by employers which are not included in the enumeration shall not be considered de minimis benefits, and, hence, shall be subject to income tax as well as withholding tax on compensation income.
Q15.7. Is income earned by a contributor from the investments and reinvestments of his Personal Equity and Retirement Act (PERA) assets subject to income tax? No. As provided in RR No 017-11 [OCTOBER 27, 2011], implementing the tax provisions of RA 9505, otherwise known as the Personal Equity and Retirement Account (PERA) Act of 2008, investment income of a contributor consisting of all income earned from the investments and reinvestments of his PERA assets in the maximum amount allowed shall be exempt from the following taxes as may be applicable: 1. Final withholding tax on interest from any currency bank deposit, yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements, including a depository bank under the EFCDS; 2. Capital gains tax on the sale, exchange, retirement or maturity of bonds, debentures or other certificates of indebtedness; 3. 10% tax on cash and/or property dividends actually or constructively received from a domestic corporation, including a mutual fund company; 4. Capital gains tax on the sale, barter, exchange, or other disposition of shares of stock in a domestic corporation; 5. Regular income tax.
General Principles Q16. What are the general principles of income taxation in the Philippines (Section 23, Title II, NIRC)? Except as otherwise provided in this Code, the general principles are: Resident Citizen Non-Resident Citizen
taxable on all income derived from sources within and outside the Philippines taxable only on income derived from sources within the
The Tax Credit is 5% of the tax due from you which is substracted. So if the tax due from you (imposed on the net income) is 90k, and the tax credit rate is 5%, then the tax due would only be 85k
PM REYES NOTES ON TAXATION I: INCOME TAX Philippines [By definition of a non-resident citizen, this applies to an overseas contract worker (a citizen working and deriving income from abroad)] Alien (whether taxable only on income derived Alien resident or from sources within the whether engaged in non-resident) Philippines trade and Domestic taxable on all income derived business corporation from sources within and outside in the PH the Philippines or not. Foreign taxable only on income derived corporation from sources within the Whether resident or Philippines non-resident foreign (This applies whether the foreign corporation corporation is engaged or not in trade or business in the Philippines)
It is income within the Philippines if the residence of the obligor is in the Philippines. It is income without the Philippines if the residence of the obligor is abroad.
The exception to the general rule that dividends paid by a foreign corporation are from sources without the Philippines is when a foreign corporation derives 50 percent of its gross income from sources within the Philippines for a three-year period ending with the close of its taxable year preceding the declaration of its dividends
Additionally, it must be noted that only a nonresident alien not engaged in trade or business in the Philippines and non-resident foreign corporations are taxed on gross income while all other types of taxpayers are subject to tax on net income (i.e. may claim deductions).
Source of Income Rules38 Q17. What is meant by “source of income”?
The source of an income is the property, activity or service that produced the income. It is the physical source where the income came from. (see CIR VS. BAIER-NICKEL [AUGUST 29, 2006]).
Q18. What are the source of income rules in the Philippines? (Section 42, Title II, NIRC)
For the source of income rules, my reference IS MICHAEL J. MCINTYRE, INTERNATIONAL TAX: TEXT, CASES, PROBLEMS, AND QUESTIONS (2013). Most, if not all, of our tax books fail to sufficiently explain source of income rules and, thus, recourse to a foreign material is warranted. The rules are applicable as they are based on the US Tax Code, of which our own tax laws are modeled after.
PIERRE MARTIN DE LEON REYES
Generally, a dividend has its source in the country where the corporation paying the dividend is incorporated. Thus, if the dividend is received from a domestic corporation, it is income within the Philippines. If the dividend is from the foreign corporation, it is income without the Philippines.
Simply put, only resident citizens and domestic corporations are taxable on their worldwide income while the other types of individual and corporate taxpayers are taxable only on income derived from sources within the Philippines.
You need to first know what type of income you have, then the source and whether it would be taxable in the PH or not.
The source of an interest payment is the place of residence of the person obligated to make that payment (residence-of-the-obligor rule).
Income from services is sourced in the country where the services are performed. Thus, it is income within the Philippines if the service is performed in the Philippines. It is income without the Philippines if it is performed abroad.
Rents and Royalties Royalties — income from intangible prop.
Rents — income from tangible prop.
The rental income and royalty income derived from the use of property has its source in the country where the property is used. For tangible property, the place of use is the place where the tangible property is actually located.
PM REYES NOTES ON TAXATION I: INCOME TAX Thus, it is income within the Philippines if rents and royalties are derived from property located in the Philippines
Royalties — you pay depending on where the capital in used. So if you use the intellectual property (construct the design) here, then you have to pay taxes here. Sale of Real Property
Sale of Personal Property The execution/ signing of the contract is insignificant to determining where the sale of the property would be taxed.
For intangible property, the country of use is the country that protects the owner of that property against its unauthorized use by other 39 persons. Thus, it is income within the Philippines if it is used in the Philippines and the unauthorized use of such intangible property is protected by Philippine law. Income from the sale of real property is sourced in the country where the real property is located.
Q18.1. In CIR v. MARUBENI [DECEMBER 18, 2001], assuming that Marubeni was disqualified from availing of the income tax amnesty, would the income from the services rendered in connection with the turn-key projects constitute as income from Philippine sources? The answer is both yes and no. The answer is yes with regard to those services performed in the Philippines. The answer is, however, no with regard to those services rendered in Japan. Such services were rendered outside the taxing jurisdiction and thus constitute as income without the Philippines. Marubeni, being a foreign corporation, is taxable only on income within the Philippines and, hence, income from services rendered in the Philippines.
Q18.2. ABC Airways is a foreign airline.41 While it did not carry passengers and/or cargo to or from the Philippines, ABC maintains a general sales agent of its tickets in the Philippines. Is the sale of the tickets taxable as income from sources within the Philippines?
Thus, it is income within the Philippines if the real property is located in the Philippines. It is income without if the real property is located abroad. The income from the sale of personal property has its source in the country where the personal 40 property is sold. Thus, if the personal property is sold in the Philippines, it is income within the Philippines. If sold abroad, it is income without the Philippines. Note that gains from sale of shares of stock of a domestic corporation are treated as derived entirely from sources within the Philippines regardless of where the said shares are sold.
Yes. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In ABC’s case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands here in the country and the payments for fares were also made with Philippine currency. The site of the source of payments is the Philippines. The absence of flight operations to and from the Philippines is not determinative of the source of income/site of income taxation for the test of taxability is the “source.” (see CIR VS. JAPAN AIRLINES [MARCH 6, 1991]; CIR VS. BOAC [APRIL 30, 1987])
Q18.3. XYZ entered into reinsurance contracts with foreign insurance companies not doing business in 41
This is the generally accepted rule. In the US, the rule is that income from sale of personal property is sourced in the country where the seller is resident (residenceof-the-seller rule) 40
PIERRE MARTIN DE LEON REYES
It is a resident foreign corporation. In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. ABC maintained a general sales agent and it was engaged in selling or issuing tickets, which is considered the main lifeblood of an airline.
PM REYES NOTES ON TAXATION I: INCOME TAX the Philippines. XYZ was to cede portions of premiums underwritten in the Philippines to the foreign corporations in consideration for the assumption of risk. Is the cession of the premiums taxable as income from sources within the Philippines? Yes. “Sources” means the activity, property, or service giving rise to the income. The original insurance undertakings took place in the Philippines. It is not required that the foreign corporation be engaged in business in the Philippines. What is controlling is no the place of business, but the place of activity that created the income. Thus, the income is subject to income tax. (see PHILIPPINE GUARANTY V. CIR [APRIL 30, 1965] and HOWDEN & CO. V. CIR [APRIL 14, 1965]).
Q18.4. ABC, a domestic corporation, entered into a “Management Service Agreement” with XYZ, a non-resident foreign corporation under which the latter shall provide services for ABC’s US branch and advice on ABC’s corporate structure, all performed abroad. Is the compensation for services taxable as income from sources within the Philippines? Yes. The services covered by the management service agreement fall under the meaning of royalties. It is immaterial if the non-resident foreign corporation has no properties in the Philippines. The test of taxability is the source and the source of an income is that activity which produced the income. It is not the presence of any property from which one 42 derives rentals and royalties that is controlling, but rather as expressed under the expanded meaning of royalties, it includes “royalties for the supply of scientific, technical, industrial, or commercial, knowledge or information; and the technical advice, assistance or services rendered in connection with the technical management and administration of any scientific, industrial or commercial undertaking, venture, project or scheme. (see PHILAMLIFE V. CTA [CA-GR SP. NO. 31283, APRIL 25, 1995]). Philamlife discusses the difference between royalties and services. 42 This confirms the acceptance of the Philippine taxing jurisdiction of the rule that as to intangible property, the country of use is the country that protects the owner of that property against its unauthorized use by other persons.
PIERRE MARTIN DE LEON REYES
Q18.5. A, a non-resident citizen, was engaged by a domestic corporation as a commission agent. A will receive a sales commission on all sales actually concluded. A argues that the income is not taxable as A does not reside in the Philippines and that the place of payment of the income is outside the Philippines. Is A’s contention correct? No. The source of an income is the property,What she activity or service that produced the income. With failed to do respect of rendition of labor or personal service,was prove as in the instant case, it is the place where thethat the sale labor or service is performed that determines thewas source of income. There is therefore no merit in A’s consummated interpretation which equates source of income inin Germany labor or personal service with the residence of the payor or the place of payment of the income. (see 43 CIR VS. BAIER-NICKEL [AUGUST 29, 2006])
Q18.6. Quill Corp is an office supply Even in PH retailer with no physical presence tax treaties, in North Dakota but it has a the corp has licensed computer software to have program that its customers in physical North Dakota use for checking presence to be taxable by Quill’s current inventories and for the locality. placing orders directly. North Dakota attempted to impose a “use tax”44 on Quill. Is Quill liable for the tax? Yes. In QUILL CORP V. NORTH DAKOTA [504 US 298, M AY 26, 1992], the US Supreme Court ruled that there must be physical presence in a state for the corporation to be liable for sales and use taxes. It applied its ruling in NATIONAL BELLAS HESS V. DEPARTMENT OF REVENUE OF ILLINOIS [386 US 753] where it held that a seller whose only connection with customers in the State is by common carrier or the mail lacked the requisite minimum contacts with the 43
Note that in this case, Baier-Nickel argued that the services were done in Germany. However, she failed to prove hat such was the fact. Thus, the services were deemed performed in the Philippines, and, as such, is subject to income tax. 44 A use tax is a type of excised tax levied in the United States upon otherwise "tax free" tangible personal property purchased by a resident of the assessing state for use, storage or consumption of goods in that state (not for resale), regardless of where the purchase took place.
PM REYES NOTES ON TAXATION I: INCOME TAX State. Thus, such vendors are free from stateimposed duties to collect sales and use taxes. Nevertheless, the US Supreme Court opined that if interstate commerce would be subject to intolerable or undesirable burdens because of this, Congress has the power to legislate make such vendors liable 45 for sales and use taxes.
Q18.7. Vodafone International Holdings (VIH), a corporation in the What has to be the acquired a subject is the stocks of the Netherlands, controlling interest of CGP company and not the holdings, a company in the company itself. Cayman Islands. By virtue of this controlling interest, VIH acquired a 52% stake in Hutchinson Essar Limited (HEL)46 in India from Hutchinson Telecom International Limited (HTIL). Simply stated, VIH acquired control over CGP and its subsidiaries, including HEL. The Indian tax authorities contended that the transfer of shares was subject to income tax. VIH argues that the transfer of shares took place outside the Indian taxing jurisdiction, and, hence, is not taxable. Which contention is correct?
indirectly through transfer of capital assets situated in 48 India shall be deemed to accrue or arise in India. The Supreme Court stated that the section clearly applied to a transfer of capital asset situated in India and could not be expanded to cover indirect transfers of capital assets or property situated in India. The words “directly or indirectly” go with the income and 49 not with the transfer of a capital asset.
Q18.8. Is the gross income of branches of foreign corporations generated from solicitation of orders from local importers where the branches merely relay to its head office abroad said purchase orders and where the head office is the entity which actually consummates the sale liable for income tax? Yes. By virtue of RAMO No. 1-86 [April 25, 1986], an income tax is imposed on the gross income generated from “constructive” trading and commission income derived from brokering activities of Philippine branches of foreign corporations engaged in trading activities. RAMO No. 01-95 [March 21, 1995] expanded RAMO No. 1-86 to cover taxation of Philippine branches of foreign corporations engaged in soliciting orders, purchases, service contracts, trading, construction and other activities.
The contention of VIH was held to be correct. In VODAFONE INTERNATIONAL HOLDINGS B.V. V. UNION OF INDIA (SUPREME COURT OF INDIA, CIVIL APPEAL NO. 47 733 OF 2012, JANUARY 20, 2012), the Indian Supreme Court ruled that VIH had no liability to withhold tax as the transaction was between two nonresidents with no taxable presence in India. Under Section 9(1) of the Income Tax Act of India, all income accruing or arising, whether directly or 45
Note that, as of this updated version, the BIR plans to impose a sales tax on online retailers in the opinion that such sellers are no different from merchants who sell their goods in physical stores. A RR on the matter is forthcoming. 46 HEL was an Indian joint venture between HTIL, a corporation in Hong Kong, and Essar, an Indian corporation. 47 It is also important to note, that in this case, the Indian Supreme Court stated that, on the context of taxation of a holding company structure, the corporate veil may be lifted only if it is established that the transaction was a sham or there was abuse. In this case, the shares of CGP were transferred only for a commercial benefit and not with the object of tax evasion. The structure was in existence over a decade, it was not created or used as an instrument for tax avoidance, VIH was not a short-time investor and it did not introduce any new practice to grant itself a “controlling interest.”
PIERRE MARTIN DE LEON REYES
Q18.9. ABC, a multinational company, claimed as deduction from gross income its share of the overhead expenses of its foreign head office. Can these overhead expenses of the foreign head office be deducted from the gross income of the Philippine branch? It depends. Either it can be deducted in full or partly. Where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, 48
The Indian taxing authorities argued that this was a “lookthrough provision” a “look through” provision so that if there was a transfer, of a capital asset, situated in India, it meant income from capital gains accruing or arising outside India would be fictionally deemed to accrue or arise in India. 49 The Indian Supreme Court also noted that the existence of the Direct Tax Code Bill of 2010 which expressly stated that income accuring even from indirect transfer of capital assets situated in India would be deemed to accrue in India but this is not yet in force.
PM REYES NOTES ON TAXATION I: INCOME TAX 3. Individual earning compensation income (exception subsection M) rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment. However, where there are items included in the overhead expenses incurred by the parent company, all of which cannot be definitely allocated or identified with the operations of the Philippine branch, the company may claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational corporation. (see COMMISSIONER VS. CTA & SMITH KLINE [JANUARY 17, 1984]; see also RAMO 4-86 [April 5, 1986])
Deductions Q19. What are the kinds of deductions?
4. Resident citizen who opted OSD (Sec.34, par.1) 1. Nonresident aliens not engaged in trade or business; and 2. Nonresident foreign corporations or those corporations not engaged in trade or business in the Philippines
With respect to the itemized deductions, they cannot be availed by citizens and resident aliens whose income is purely compensation income from which only the personal and additional exemptions and premium payments on health and hospitalization insurance are deductible.
Sections 34 and 35, Tax Code Q20. What are the allowable and itemized deductions under the Tax Code? The allowable and itemized deductions include:
1. Deductions from compensation income – refers to the personal and additional exemptions in Section 35, NIRC and premium payments on health and/or hospitalization insurance which are allowed to be deducted by an individual taxpayer who receives income for personal services rendered under an employer-employee relationship
1. Business Expenses (Expenses in connection with taxpayer’s trade, business or profession) 2. Interest on Indebtedness 3. Taxes in connection with taxpayer’s business, trade or profession [except income taxes, estate and donor’s taxes, special assessments, and foreign income taxes (unless the taxpayer does not make use of the tax credit privilege)] 4. Losses 5. Bad debts 6. Depreciation 7. Depletion 8. Charitable and other contributions 9. Research and development expenditures 10. Contributions to pension trusts
2. Deductions from business and/or professional income – refers to the itemized deductions in Section 34 (A) to (M) including those deductible from compensation income, which a self-employed individual or professional engaged in the practice of a profession may deduct. 3. Deductions from corporate income – refers to the itemized deductions in Section 34 (A) to (J) which corporations (including partnerships other than GPPs) engaged in trade or business are authorized to claim 4. Special deductions – refer to the deductions allowed in addition to the itemized deductions allowable to corporations which may be availed of by insurance companies and proprietary educational institutions and non-profit hospitals as well as estates and trusts.
Q19.1. Who can avail of the deductions provided for under the law? All taxpayers except: Outright expense v. Capitalized expense: BOTTOMLINE IS BENEFIT — capitalized expenses may be spread out (e.g. adding a new floor, R&D). These are when the expenses will benefit the whole company in the long run beyond the current tax period. — outright expense thatDyou creditRthe expense the year it was spent. (e.g. PIERRErequires MARTIN E LEON EYES repairs and maintenance)
Business expenses Q21. What are the requisites for deductibility of business expenses?50 The requisites are: 1. The expense must be ordinary and necessary 2. Paid or incurred during the taxable year 3. In carrying on the trade or business of the taxpayer 4. Reasonable in amount 5. Substantiated by sufficient evidence “Substantiated” — — What if the income to be taxed comes from a drug cartel 50
This is the general rule which is to be followed for all business expenses. The enumeration provided in certain business expenses provide for additional requisites.
“Reasonable” (Kuezle & Aguinaldo) — if the amount was indicative of being a dividend, then it is not deductible. Another form (deductible) is if the amount was compensation, but this is hard to defend if the 20 amount is too huge or bloated. This veil of reasonableness is to protect the government from tax evasion by the taxpayer who may shift all income to the income tax-exempt entitty. (p.24)
Expenses: Not necessary — would never be deductible. Extraordinary — may be capitalized (deductible but spread through a period of time) from a case to case basis. Usually these are necessary on top of being extraordinary. (Re: #7) As to withholding tax, the tax must PM REYES NOTES ON TAXATION I: be withheld first before it can be deducted INCOME TAX because there is a presumption that if such was not withheld, another taxing jurisdiction 3. Reasonable allowance for rentals and or 6. Must not be against law, morals, public is claiming it. policy, or public order other payments required for the continued Ex: VP of use or premium of the property for the 7. Must be paid to the BIR the corp. purpose of the trade or business and to Q21.1. What is meant by ordinary and borrowed which property the taxpayer has not taken or necessary expenses? money from is not taking title or in which he has no the 51 equity. employees. An expense is 'ordinary' when it connotes a 4. Reasonable allowance for entertainment, The VP payment which is normal in relation to the business of amusement and recreation expenses died, so the the taxpayer and the surrounding circumstances. provided that they are connected to the P took Ex: Pet shop incident where the snake bit the client — necessary company development and operation of the trade, An expense will be considered 'necessary' where funds to business or profession and that it is not the expenditure is appropriate and helpful in the repay the development of the taxpayer's business contrary to law, morals, public policy or public debts. This Ex: insuring the president is not related to the business. order. is an extraQ21.2. What is meant by “paid or incurred ordinary Q21.4. Is the enumeration of business during the taxable year?” expense, but expenses provided in the Tax not Code exclusive? deductible. Paid or incurred during the taxable year means that the deduction shall be taken for the taxable year in Rather, it No. A taxpayer is entitled to deduct the ordinary and which paid or accrued or paid or incurred dependent was necessary expenses paid in carrying on his business capitalized. on the accounting method in which net income is from his gross income from whatever source. computed Q21.2.1.
ABC Corp failed to claim expenses for professional services that accrued in past years. May ABC Corp still claim these expenses as deductions?
No. In COMMISSIONER OF INTERNAL REVENUE VS. ISABELA CULTURAL CORPORATION (FEBRUARY 12, 2007), Isabela Corp failed to claim the expenses for professional services that accrued in 1984 and 1985 during the said years. Instead, it sought to claim them as deductions during the taxable year of 1986. The Supreme Court held that one of the requisites for the deductibility of a business expenses is that it must have been paid or incurred during the taxable year. Hence, the professional fees should have been claimed as deductions during the years where they were paid or incurred.
1. Republic Act 10028 (Expanded Breastfeeding Promotion Act) The law provides that the expenses incurred by a private health and non-health facility, establishment or institution, in complying with the provisions of this Act, shall be deductible expenses for income tax purposes up to twice the actual amount incurred provided: 1. That the deduction shall apply for the taxable period when the expenses were incurred 2. That all health and non-health facilities, establishments and institutions shall comply with the provisions of this Act within six (6) months after its approval 3. That such facilities, establishments or institutions shall secure a "Working MotherBaby-Friendly Certificate" from the Department of Health to be filed with the Bureau of Internal Revenue, before they can avail of the incentive.
Q21.3. What are the types of business expenses specifically included in the Tax Code as deductions? As provided in Section 34(A)(1)(a), these are:
Donations to Yolanda are deductible
1. Reasonable allowance for salaries or other compensation for personal services actually rendered to the taxpayer 2. Reasonable allowance for travel expenses in the pursuit of trade, business or profession
PIERRE MARTIN DE LEON REYES
Name some special laws which provide for deductible business expenses.
2. Republic Act Development Act) 51
In the latter case, he may claim depreciation allowance
US deductible — housing amortization is deductible whereas, such is not deductible in the Philippines.
PM REYES NOTES ON TAXATION I: INCOME TAX The law provides for a deduction from taxable income of fifty percent (50%) of expenses incurred in training schemes in connection with the Act and which shall be deductible during the financial year the expenses were incurred. 3. Republic Act 8525 (Adopt a school act) The law provides for a deduction from the gross income equivalent to fifty percent (50%) of expenses incurred in connection with the said act. 4. Republic Act 9999 (Free Legal Assistance Act) The law provides that a lawyer or professional partnerships rendering actual free legal services, as defined by the Supreme Court, shall be entitled to an allowable deduction from the gross income, the amount that could have been collected for the actual free legal services rendered or up to ten percent (10%) of the gross income derived from the actual performance of the legal profession, whichever is lower Q21.4.2.
Name some revenue regulations implementing special laws which provide for deductible business expenses.
1. RR 1-2009 [December 9, 2008]
arguing that the advertising expenses are not business expenses but capital expenditures. The Supreme Court ruled in favor of the CIR. 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 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. 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. The advertising expense incurred by General Foods fall under the second type. Q21.4.4.
The RR provides that sales discounts given to persons with disabilities shall be deductible from gross income subject to certain conditions.
ABC Corporation paid a PR firm to campaign for the sale of ABC’s additional capital stock. Is the compensation paid to the PR firm deductible as a business expense?
2. RR 7-2010 [July 20, 2010] The RR provides that discounts given to senior citizens on certain goods and services shall be deductible from gross income. Also, private establishments employing senior citizens shall be entitled to additional deductions from gross income equivalent to fifteen (15%) of the total amount paid as salaries and wages to senior citizens. Q21.4.3.
Are “advertising expenses” deductible from gross income?
It depends on the nature of the advertising expense. In COMMISSIONER OF INTERNAL REVENUE VS. GENERAL FOODS (PHILS.) INC. [APRIL 24, 2003], General Foods claimed as deductions its advertising expenses for its product “Tang.” The CIR disallowed the deduction
PIERRE MARTIN DE LEON REYES
No. In ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE (JANUARY 27, 1981), the Supreme Court held that this is not deductible because it is a capital expenditure. Expenses relating to the recapitalization and reorganization of the corporation, promotion expenses and commission or fees for the sale of stock reorganization are capital expenditures. Q21.4.5.
Are litigation deductible as a expense?
No. As held in ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE (JANUARY 27, 1981), litigation expenses incurred in defense or protection of title are capital in nature and not deductible.
PM REYES NOTES ON TAXATION I: INCOME TAX A, a hotel owner, claimed as deduction promotion expenses incurred by his wife for the promotion of the hotel. Half of the said expenses were disallowed as deductions because on the finding that his wife went abroad on a combined business and medical trip. Is the disallowance proper?
Commission. The Supreme Court held that the police protection fees were not deductible as they are illegal since it was consideration for the performance of functions required of policemen by law. As to the gifts and parties, they were deemed excessive considering that the purpose of the exhibition was for a charitable cause.
Yes. In ZAMORA VS. COLLECTOR OF INTERNAL REVENUE [MAY 31, 1963], Zamora, a hotel owner,
The test of deductibility in the case of compensation payments is whether they are reasonable and payments purely for the personal services actually rendered.
Q21.4.6. REPRESENTATION EXPENSE: — a deductible expense on the part of the employer. But it is not considered as income on the part of the employee. — In representation expense, there must be some benefit to the business of the taxpayer (e.g. dining out of office guests/clients). — v. Fringe Benefits — deductible expense and income.
claimed as deduction promotion expenses incurred by his wife for the promotion of the hotel. On appeal, the CTA only allowed 50% of the promotional expenses as deductions because it was found in the Central Bank dollar allocation that his wife went abroad on a combined business and medical trip. The Supreme Court stated that promotional expenses are deductible but must be substantiated. When some of the representation expenses claimed by the taxpayer were evidenced by vouchers or chits, but others were without vouchers or chits, documents or supporting papers; that there is no more than oral proof to the effect that payments have been made for representation expenses allegedly made by the taxpayer and about the general nature of such alleged expenses; that accordingly, it is not possible to determine the actual amount covered by supporting papers and the amount without supporting papers, the court should determine from all available data, the amount properly deductible as representation expenses. In view of this, the Supreme Court held CTA did not commit error in allowing as promotion expenses in A’s income tax returns at merely one-half. Q21.4.7.
Are police protection fees and gifts for an exhibition for charitable purposes deductible as a business expense?
No. In CALANOC VS. COLLECTOR OF INTERNAL REVENUE [NOVEMBER 29, 1961], at issue in this case is the deductibility of the expenses incurred for police protection and for gifts and parties in connection with the boxing and wrestling exhibition that Calanoc financed and promoted whose proceeds would be given to the orphans and destitute children of the Child Welfare Workers Club of the Social Welfare
PIERRE MARTIN DE LEON REYES
Q21.5. What is the rule on the deductibility of compensation payments?
A, an experience realtor, was paid supervision fees in the amount of P100,000 annually by XYZ Corporation for a three-year project, an amount when combined with his salary and bonuses is double the XYZ’s income. Are the supervision fees deductible?
No. In C.M. HOSKINS & CO., INC. VS. COMMISSIONER OF INTERNAL REVENUE [NOVEMBER 28, 1969], Hoskins & Co. claimed as deductions the payment of P100,000 to its founder and controlling stockholder, Hoskins representing 50% of the 8% supervision fees the company received as managing agent for Paradise Farms. In this case, the Supreme Court held that such was not deductible for failing to pass the reasonableness test. If allowed, Hoskin would be receiving on his salary, bonus, and supervision fees at total of P185,000 which is double the company’s reported net income. The Supreme Court stated that if it was a one-time payment, it could have been deducted since Hoskin was an experienced realtor. However, the P100,000 supervision fee was being paid every year (for three years) for the entire duration of the company’s project with Paradise Farms.
Q21.6. Are salaries deductible? Yes provided that they comply with the following requisites: 1. The expense must be both ordinary and necessary 2. The salaries must be paid or incurred within the taxable year
PM REYES NOTES ON TAXATION I: INCOME TAX 3. The salaries must be incurred in carrying on a trade or business 4. The salaries must be for personal services actually rendered 5. The salaries must be reasonable in amount.
Q21.7. Are bonuses to employees allowable deductions from gross income? Yes provided that: 1. They are made in good faith 2. They are given for personal services actually rendered 3. They do not exceed a reasonable compensation for the services rendered when added to the stipulated salaries. Q21.7.1.
Can a bonus given to corporate officers be deducted from gross income from the sale of one of its properties on the representation that corporate officers, by virtue of their positions, contributed to the consummation of the sale?
No. In AGUINALDO INDUSTRIES CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE [FEBRUARY 25, 1982], Aguinaldo Industries sought to claim as deductions the bonuses given to its corporate officers from the sale of one of its properties.The Supreme Court held that the said bonuses cannot be deducted because there is no evidence that the said officers did any work which would be the basis of the grant of the bonuses. One of the requisites for the deductibility of bonuses is that they are given for personal services actually rendered. Q21.7.2.
ABC Corporation claimed as deductions bonuses it gave to its non-resident president and vice-president and the bonuses it gave to its resident officers and employees. The company gave its resident officers and employees much more. The deductions for bonuses given to resident officers and employees were disallowed for being excessive and for no special reason. Is the disallowance proper?
PIERRE MARTIN DE LEON REYES
It would depend on the nature, extent, and quality of the services actually rendered by the resident officers and employees. In KUENZLE & STREIFF, INC. VS. COLLECTOR OF INTERNAL REVENUE [OCTOBER 20, 1959], the Supreme Court held that the bonuses to its resident officers and employees were reasonable taking into account the situation at the time when the services were rendered: unsettling conditions after the war, the imposition of controls on exports and imports, and he use of foreign exchange which resulted in diminution of the amount of business.
Q21.8. What are some factors that may be considered in determining the reasonableness of the compensation paid for services? They are: 1. 2. 3. 4. 5. 6. 7. 8.
The payment must be made in good faith The character of the taxpayer’s business The volume and amount of its net earnings The locality in which the business is in The type and extent of the services rendered The salary policy of the corporation The size of the particular business The employee’s qualifications and business venture 9. The general economic conditions There is no fixed test in determining the reasonableness of a given bonus as compensation. This depends on many factors and the situation must be considered as a whole.
Q21.9. What is the rule on the deductibility of representation or entertainment, amusement and recreation expenses? Such expenses must: 1. be directly related to or in furtherance of the conduct of the trade, business or exercise of the profession 2. not be contrary to law, morals, public policy or public order 3. not exceed such ceilings prescribed by the Secretary of Finance. Q21.9.1.
Is there a ceiling on entertainment, amusement and recreational expenses?
Yes. RR 10-2002 [JULY 10, 2002] provides that sellers of goods or properties are allowed to deduct
PM REYES NOTES ON TAXATION I: INCOME TAX 0.5% of their net sales as representation expenses while sellers of services are granted 1% of their net revenues as representation expenses. However, when supporting documents reflect a lower amount, then such lower amount shall be used.
not precluded thereby from claiming said interest payment as deduction under Section 34(B) of the same Code. It is a well-settled rule that tax obligations constitute indebtedness for purposes of deduction from gross income of the amount of interest paid on indebtedness.
Q24.2. Are there any additional requisites provided for revenue regulations for the deductibility of interest expenses?
Interest (as amended by Republic Act 9337) Q22. How is interest defined under the Tax Code? Interest shall refer to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. It includes the amount paid for the borrower’s use of money during the term of the loan, as well as for his detention of money after the due date for its repayment.
Q23. What is indebtedness? Indebtedness is something owned by one who is unconditionally obligated or bound to pay
Q24. What are the requisites for the deductibility of interest expenses from gross income? The requisites are: Loan agreement 1. There must be indebtedness provides an 2. The indebtedness must be connected with interest between the taxpayer’s trade, business or exercise of X and Y (corps). profession Is the interest 3. The interest must be legally due deductible? Depends. If X 4. The interest expense must have been paid or incurred during the taxable year. and Y are 5. The interest must have been stipulated in individuals, it is writing deductible. + (6) not related parties and (7) interest arbitrage Lender has to be Q24.1. Do tax obligations constitute an individual and must own at indebtedness? least 50% of the entities. Yes. In COMMISSIONER OF INTERNAL REVENUE VS. VDA. DE PRIETO [SEPTEMBER 30, 1960], Vda. de Prieto conveyed real property by way of gifts to her four children. She was assessed for donor’s gift taxes including interests due thereon. She claimed as deduction the total interest on account of the delinquency. She contends that the interests due from her tax obligations are deductible from gross income. The Supreme Court held that although interest payment for delinquent taxes is not deductible as tax under Section 34(C) of the Tax Code, the taxpayer is
PIERRE MARTIN DE LEON REYES
Yes. RR 13-2000 [NOVEMBER 20, 2000] provides three more, namely: 1. the interest payment arrangement must not be between related taxpayers 2. the interest must not be incurred to finance petroleum operations 3. 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 The RR also provides for a limitation in that 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 38% of the interest income earned which had been 52 subject to final withholding taxes.
Q24.3. What are the rules on the deductibility of Interest expenses? The general rule is that 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 provided that the taxpayer’s otherwise allowable deduction for interest expense shall be reduced by 38% of the interest income subject to final tax. The exceptions (where interest expense is not deductible from gross income) are: 1. If within the taxable year an individual reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise. Such interest shall be allowed as a deduction in the year the indebtedness is paid. If the 52
This will be further discussed under tax arbitrage.
PM REYES NOTES ON TAXATION I: INCOME TAX indebtedness is payable in periodic amortization, 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. 2. If both the taxpayer and the person to whom the payment has been made or is to be made are “related” persons specified under Section 36(B). 3. If the indebtedness is used to finance petroleum exploration. Q24.4.1.
Enumerate the cases when no deduction is allowed because the loan is between related taxpayers.
1. Between members of the family 2. Between an individual and a corporation – where the individual paid interest on a loan granted by the corporation more than 50% of the capital stock of which is owned by the individual 3. Between two corporations – where one corporation owns more than 50% of the 53 other 4. Between a grantor and fiduciary of a 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
Q25. May the taxpayer choose to treat interest expense as capital expenditure? Yes. Section 34(B)(3) provides that 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. However, should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments because that would constitute double tax benefits which is not authorized by law
The case of a parent company-subsidiary loan will not be disallowed because it does not refer to a case of a commonlyowned entity (commonly owned at 50%) but one where one entity owns the other.
PIERRE MARTIN DE LEON REYES
In PAPER INDUSTRIES CORPORATION OF THE
PHILIPPINES VS. COURT OF APPEALS [DECEMBER 1, 1995], Paper Industries claimed as deductions against gross income interest payments on loans for the purchase of machinery and equipment. The CIR disallowed the deduction on the ground that because the loans had been incurred for the purchase of machinery and equipment, the interest payments on the said loans should have been capitalized instead and claimed as a depreciation deduction taking into account the adjusted basis of the machinery and equipment (original acquisition cost plus interest charges) over the useful life of such assets. The Supreme Court ruled that Paper Industries is entitled to its claimed deduction for interest payments on loans for, among other things, the purchase of machinery and equipment. The general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. In this case, the CIR does not dispute that the interest payments were made on loans incurred in connection with the carrying on of the registered operations of Paper Industries, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Paper Industries. Neither does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by Paper Indusries during the tax year. The CIR has been unable to point to any provision of the Tax Code or any other Statute that requires the disallowance of the interest payments made by Paper Industries. The general rule that interest payments on a legally demandable loan are deductible from gross income must be applied.
Interest arbitrage Q26. What is interest arbitrage? Interest arbitrage results in the reduction of the interest expense by a percentage of the interest income subject to final tax. It is also defined as a circumstance which is presumed to exist because by putting excess funds in deposits/securities subject to 20% withholding, taxpayers are able to avoid the 32% tax which will happen if the same funds are invested in revenue-generating activities. Another illustration of this is when a taxpayer borrows money from the bank (interest payments on which
PM REYES NOTES ON TAXATION I: INCOME TAX can then be claimed as expense and thus a 32% benefit) then deposits it in a bank (and subsequently suffers only a 20% final withholding tax) thus benefiting by 12% representing the difference the 32% deduction and the 20% withholding tax. It does not matter if the taxpayer actually intended to save taxes.
claimed are connected with income from sources within the Philippines. Also, to be deductible, the taxes must be imposed by law on, and payable by the taxpayer. Thus, a VAT is not deductible by the customer upon whom the burden of the tax is shifted by the seller (on whom the tax is imposed by law).
In BIR RULING NO. 006-00 [JANUARY 5, 2000], PNB requested the BIR to exclude the interest income derived by it from treasury bonds in the determination of the interest expense not allowable as deduction as gross income. PNB argues that the said bonds were given by the Government for payment for its liabilities to PNB and hence, it has not engaged in a tax arbitrage scheme. Although as a general rule, the amount of interest expense paid or incurred by a taxpayer within a taxable year on indebtedness in connection with his trade, business or exercise of profession shall be allowed as a deduction from his gross income, the said interest expense, however, shall be reduced if the taxpayer has derived certain interest income which had been subject to final withholding tax. The CIR ruled that this limitation on the deductibility of interest expenses applies whether or not a tax arbitrage scheme was entered into by the taxpayer.
Taxes Q27. Are all taxes deductible from gross income? No. Section 34(C)(1) provides that all taxes, national or local, paid or accrued during the taxable year in connection with the trade or business or profession of the taxpayer are deductible from gross income except:
Q27.1. May a resident alien deduct from their gross income income taxes they paid to their government? Generally, the answer is no. In COMMISSIONER OF 54 INTERNAL REVENUE VS. LEDNICKY [JULY 31, 1964], US citizens residing in the Philippines who derives income wholly from sources within the Philippines, sought to deduct from their gross income the income taxes they have paid to the US government. The Supreme Court held that to allow an alien resident to deduct from his gross income whatever taxes he pays to his own government is incompatible with the status of the Philippines as a sovereign state. This is because the foreign government will have the power to reduce the tax income of the Philippine government simply by increasing their tax rates. Also important is this case is the statement made by the court on the exception: a taxpayer may only be allowed to deduct from his gross income, taxes paid to a foreign country when such taxpayer is entitled to a foreign tax credit and he does not choose to exercise such right. The right to deduct foreign tax paid is only an alternative to the taxpayer’s right to the foreign tax credit.
Q28. What is the rule on credit for taxes? 1. Philippine income tax 2. Foreign income taxes unless the taxpayer does not make use of the tax credit privilege under Section 34(C)(3) 3. Estate and donor’s taxes 4. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed (special assessments) 5. VAT In the case of nonresident alien individual or a foreign corporation, deduction is only allowed if and to the extent that the taxes for which deduction is
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If the taxpayer signifies in his return his desire to claim a credit for taxes, the basis of such credit, in the case of a resident citizen of the Philippines, and in the case of a domestic corporation is as follows: a. The amount of income taxes paid or incurred during the taxable year to any foreign country b. An individual’s proportionate share of any such taxes of which he is a partner or of an 54
Note that at the time this case was decided, resident aliens were still allowed to claim a tax credit. The present rule is that only resident citizens and domestic corporations can claim a tax credit. Also, in this case, their net income for foreign sources was zero and, thus, there was no need to apply the tax credit.
PM REYES NOTES ON TAXATION I: INCOME TAX estate or trust of which he is a beneficiary paid or accrued 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 Title II. Only those subject to tax on worldwide income (resident citizen and domestic corporations) may avail of tax credits because they pay taxes for foreign sources income twice (in the Philippines and abroad) and the tax credit is meant to lessen the impact of double taxation,
Q28.1. What are the limitations on credit for foreign taxes? The amount of the credit shall be subject to the following limitations:
Rationale for 1. allowing foreign income taxes to be deductible: To prevent double taxation. HOWEVER, only citizens and domestic corporations are 2. allowed to claim to tax deductions because they are the only ones taxed globally (e.g. Pacquiao)
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. 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.
In mathematical terms, this can be expressed as:
2. Those incurred in any transaction entered into for profit, although not connected with the trade or business 3. Casualty losses that arise from fire, storm, shipwreck, or other casualty, or from theft or robbery, even though not connected with the trade or business of the taxpayer.
Q30. What are the conditions for deductibility of losses? In order that losses may be allowed as deductions, the following conditions must concur: 1. The losses must actually be sustained and charged off within the taxable year 2. Evidenced by a closed and completed transaction 3. Loss is not compensated by insurance or otherwise 4. In the case of an individual, the loss must have been incurred in the business, trade or profession of the taxpayer or incurred in any transaction entered into for profit though not connected with his trade or business 5. In the case of casualty loss, declaration of loss is filed within 45 days from the occurrence of the casualty loss
Q30.1. How shall the amount of the loss deductible be determined? The amount of loss deductible is limited to the difference between the value of the property immediately preceding the loss and its value immediately thereafter but shall not exceed an amount equal of the cost or other adjusted basis of the property, or depreciated cost reduced by any 55 insurance or other compensation received.
Thus, the tax payable is whichever comes out from this formula or the actual foreign taxes paid, whichever is lower.
Q30.2. What are the special rules on losses? Certain special rules on losses are: 1. Losses are deductible only by the person sustaining them. They are purely personal and cannot be used as deductions by another
Q29. How are losses classified under the Tax Code? Losses are generally classified into: 55
1. Those incurred in a trade or business for profit
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For example, you purchased a piece of machinery for the value of 200,000 to be depreciated for 20 years. On the 10th year, it was lost due to fire and for the loss, you received P50,000 from your insurance. How much can you deduct? Get the depreciated cost which is now 100,000 and deduct the insurance received. The amount that can be deducted is then 50,000.
PM REYES NOTES ON TAXATION I: INCOME TAX 2. Net Operating Loss Carry Over (NOLCO) can be availed of by any taxpayer engaged in trade, business, or practice of profession. Net Operating loss of business for any taxable year, which refers to the excess of allowable deduction over gross income, can be carried over as deduction for the next three consecutive taxable years immediately following the year of such loss. NOLCO shall be allowed only if there has been no substantial change in the ownership of the business or enterprise. 3. Capital losses may not be deducted from ordinary gains; such capita losses may only be deducted from capital gains unless a final tax on the capital transaction is imposed. 4. Losses from wagering transaction shall be allowed only to the extent of the gains from such transactions. 5. In the case of petroleum operations which are abandoned, wholly or partially, accumulated exploration and development expenditures to a certain extent may be allowed as deduction as abandonment losses. 6. Losses on account of the shrinkage in value of securities or shares of stock are not deductible until after the loss would have been actually sustained by the disposition of the said securities. When, however, such securities become worthless during the taxable year and are capital assets the loss thereform shall be considered as a loss from the sale or exchange on the last day of such taxable year, of capital assets. 7. Voluntary advances to a corporation made without expectation of repayment do no warrant, upon on-payment, a deduction for losses 8. Losses from investments are not deductible as ordinary losses or as bad debts from other income. Shares of stock becoming worthless in the hands of an investor are capital assets, as such capital losses are allowed to be deducted only to the extent of capital gains.
Q30.3. What is the rule with respect to loss resulting from shrinkage in the value of the stock
A person cannot deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of such stock through fluctuations of the market or otherwise.
Q30.4. What is the rule with respect to loss resulting from stocks becoming worthless? If the securities become worthless during the taxable year and are capital assets, the loss resulting therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
Q30.5. What are the substantiation requirements for losses arising from casualty, robbery, theft, or embezzlement? Generally, under RR 12-77 [OCTOBER 6, 1977], the substantiation requirements are: 1. A declaration of loss filed with the CIR or his deputies within a certain period as prescribed in the RR after the occurrence of the casualty, robbery, theft, or embezzlement 2. Proof of the elements of the loss claimed
RMO 31-2009 [OCTOBER 16, 2009] provides for policies and guidelines for the reporting of casualty losses.
Section 38, Tax Code Q31. Define Wash sale. Wash sale is a sale or other disposition of stock or securities where substantially identical securities are acquired or purchased within a 61-day period, beginning 30 days before the sale and ending 30 days after the sale.
Q31.1. Are losses deductible?
No. This is an exception to the general rule that losses from sales or exchanges of stock or securities are deductible as losses from sales or exchange of property. This will not apply to a loss incurred by a dealer in securities.
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PM REYES NOTES ON TAXATION I: INCOME TAX NOLCO Q32. What is a net operating loss? Net Operating loss refers to the excess of allowable deduction over gross income of a business for any taxable year.
Q32.1. What are the rules on the carryover of net operation loss by a taxpayer? 1. 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 3 consecutive taxable years immediately following the year of such loss 2. Any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction 3. 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 – (a) not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation is held by or on behalf of the same persons; or (b) Not less than 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.
Q32.2. XYZ entered into a merger agreement with ABC. Under this agreement, the rights, properties, privileges, powers and franchises of the said ABC were to be transferred, assigned and conveyed to XYZ as the surviving corporation. Before merger, the company had over preceding years accumulated losses. XYZ claimed these losses as a deduction against its gross income. Should the deduction be allowed?
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No. In PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES VS. COURT OF APPEALS [DECEMBER 1, 1995], the Supreme Court ruled that the deduction was improper. NOLCO of the taxpayer shall not be transferred or assigned to another person, whether directly or indirectly, such as, but not limited to, the transfer or assignment thereof through merger, consolidation or any form of business combination of such taxpayer with another person. To allow the deduction claimed by the surviving corporation would be to permit one corporation or enterprise to benefit from the operating losses accumulated by another corporation or enterprise.
Q32.3. If a corporation has paid its MCIT, will the three-year reglementary period on the carry-over of NOLCO continue to run? Yes. RR 14-01 [AUGUST 27, 2001] provides that that the three-year reglementary period on the carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its income tax under the MCIT computation
Q32.4. If several corporations enter an agreement to integrate their respective businesses, can each of the corporations continue to carry-over their respective net operating losses? It depends on the nature of the integration plan. In BIR RULING 30-00 [AUGUST 10, 2000], three cement companies (Republic, Fortune and Blue Circle) sought the opinion of the CIR on the tax implications of their integration plan. With regard to NOLCO, the CIR held that since, under the plan, the corporation are not dissolved but merely integrated for a specific bona fide purpose, the net operation losses of each of the cement corporations are preserved after the proposed share swap and may be carried over and claimed as a deduction from their respective gross income because there is no substantial change in the ownership of either of the three cement companies.
Forex losses Q33. Are foreign deductible?
No. In BIR RULING 206-90 [OCTOBER 30, 1990] and BIR RULING NO. 144-85 [AUGUST 26, 1985], the CIR
PM REYES NOTES ON TAXATION I: INCOME TAX held that, with regard to foreign exchange losses, the annual increase in value of an asset is not taxable income because such increase has not yet been realized, The increase in value could only be taxed when a disposition of the property occurred which was of such a nature as to constitute a realization of such gain. The same conclusion obtains to losses. The annual decline in the value of property is not normally allowable as a deduction. Hence, to be allowable the loss must be realized.
Bad Debts Q34. What are bad debts? Bad debts shall refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or form uncollectable amounts of income from goods sold or services rendered.
Q34.1. How do you distinguish bad debts from loss? Voluntary cancellation or forgiveness of a debt does not give rise to a deductible loss. However, if the debt is actually worthless, there may be a bad debt deduction. That deduction would be allowed because the debt was worthless, not because it was forgiven.
Q34.2. What are the conditions for bad debts to be deductible? As provided in RR 5-99 [March 10, 1999], 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 4. The same must actually be charged-off within the taxable year 5. The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.
RR 5-99 [March 10, 1999] provides for two exceptions to requisite no. 5, namely: 1. The BSP, through the Monetary Board, shall ascertain the worthlessness and uncollectibility of
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the bad debts and it shall approve the writing off of the said indebtedness from the banks; books of accounts at the end of the taxable year. 2. 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 In both cases, requisites nos. 1-4 should still be complied with,
Q34.3. What is meant by “actually ascertained to be worthless?” The phrase means that a debt is not worthless simply because it is of doubtful value or difficult to collect. Conclusive evidence must be presented to show that the taxpayer’s receivable from a debtor has definitely become worthless.
Q34.4. What is meant by “actually charged off?” The phrase means that the amount of money lent by the taxpayer to his debtor has been recorded in his books of account as a receivable that has actually become worthless of as of the end of the taxable year, that the said receivable has been cancelled and written-off from the said taxpayers books of account.
Q34.5. ABC mining entered into a management contract with XYZ mining. ABC made advances of cash and property. However, XYZ’s mine suffered continuing losses which led to ABC;s withdrawal as manager and cessation of mine operations. ABC and XYZ entered into two compromises: the first involved alleged indebtedness by XYZ from the advances of ABC and the second involved long-term loans guaranteed by ABC. ABC deducted the amounts as bad debt. Is the deduction proper? No. In PHILEX MINING CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE [APRIL 16, 2008], the Supreme Court held that Philex cannot deduct the amounts as bad debt. The agreement
PM REYES NOTES ON TAXATION I: INCOME TAX provided for a distribution of assets of the mine upon termination, a provision that is more consistent with a partnership than a creditor-debtor relationship. In this connection, there is no contractual basis for the execution of the two compromise agreements in which Baguio Gold recognized a debt in favor of Philex. Philex’s advances should be treated as investments in a partnership. The advances were not "debts" of Baguio Gold to Philex inasmuch as the latter was under no unconditional obligation to return the same to the former. As for the amounts that Philex paid as guarantor to Baguio Gold’s creditors, the debts were not yet due and demandable at the time that Philex paid the same. Philex cannot claim the advances as a bad debt deduction from its gross income. Deductions for income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed. In this case, Philex failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could be deducted from its gross income. Consequently, it could not claim the advances as a valid bad debt deduction.
Q34.6. Is the declaration by the taxpayer that a debt is worthless sufficient for it to claim a bad debt deduction? There should have been diligent efforts from the taxpayer in trying to collect the debt.
No. In PHILIPPINE REFINING COMPANY VS. COURT OF APPEALS [M AY 8, 1996], at issue was PRC’s (now Unilever) claimed of bad debt deduction. On appeal, the CTA disallowed the same as there was no iota of documentary evidence to prove the worthlessness of the debts sought to be deducted. The Supreme Court stated that before a debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future. PRC here failed to prove the worthlessness of the amounts receivable.
Q34.7. ABC, an investment company made advances to XYZ under an agreement that a portion of its net profits would go to ABC. XYZ suffered substantial losses but continued to operate. ABC made a partial write-off of the losses and deducted the amount in its return. Is the deduction proper?
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No. In FERNANDEZ HERMANOS, INC. VS. COMMISSIONER OF INTERNAL REVENUE [SEPTEMBER 30, 1969], the Supreme Court held that the deduction was improper. The Court opined that assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of paying the debt, the debt is still not deductible as a worthless debt because the debtor was still in operation. It has been held that if the debtor corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is not considered worthless and therefore not deductible.
Q34.8. What is the Tax Benefit Rule? Under the Tax Benefit Rule or Equitable Doctrine of Tax Benefit, the recovery of amounts deducted in previous 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. If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction if the said bad debt written-off, then his subsequent recovery shall be treated as a mere recovery or a return of capital, hence, not treated as receipt of realized taxable income.
Depreciation Q35. What is depreciation? Depreciation is the gradual diminution in the useful 56 value of tangible property resulting from wear and tear and normal obsolescense. The term is also applied to amortization of the value 57 of intangible assets, the use of which in the trade or business is definitely limited in duration.
Q35.1. What is the depreciation?
Depreciation commences with the acquisition of the property and its owner is not bound to see his property gradually waste, without making provision 56
Not all tangible property can be depreciated. Land, for example, cannot be depreciated because its value continues to increase. 57 Like those with limited duration
PM REYES NOTES ON TAXATION I: INCOME TAX out of earnings for its replacement. It is entitled to see to it 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
Capital Recovery Concept — you should be able to recover your 1. capital during the time that 2. you’re using your asset. 3. Such asset can either be tangible or 4. intangible (e.g. patents).
Q35.2. What are the requisites for the deductibility of a depreciation expense? The allowance for depreciation must be reasonable It must be for property used in the trade, business, or profession It must be charged off during the taxable year; and A statement on the allowance must be attached to the return Q35.3. Can an asset be depreciated beyond its acquisition cost?
No. In BASILAN ESTATES, INC. VS. COMMISSIONER OF INTERNAL REVENUE [SEPTEMBER 5, 1967], Basilan Estates claimed deductions for the depreciation of its assets up to 1949 on the basis of their acquisition cost. In 1950, however, it changed the depreciable value of the assets by increasing it to conform with the increase in cost of their replacement. Accordingly, in 1950 to 1953, the company deducted from gross income the value of the depreciation based on this reappraised value. The Supreme Court held that such value cannot be deducted from gross income as it was beyond the acquisition cost. Depreciation as a deduction is allowed so that the owner of the assets can set aside some money to buy a replacement or, in other words, to gradually recover the acquisition cost. The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. The reason is that deductions from gross income are privileges, not matters of right. More importantly, the recovery, free of income tax, of an amount more than the invested capital in an asset will run counter to the purpose of a depreciation allowance. For then, the taxpayer can not only recover the acquisition cost, but also make some profit. Recovery in due time through 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.
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Q35.4. The BIR found that ABC claimed excessive depreciation of its buildings. In its defense, ABC Limpan argued that that some of its buildings are old and out of style; hence, they are entitled to higher rates of depreciation than those adopted by the BIR in its assessment. On appeal, the CTA found that the depreciation was excessive. Should the findings of the CTA be affirmed? Yes provided there no arbitrariness and abuse of discretion on the part of the CTA. In LIMPAN INVESTMENT CORPORATION VS. COMMISSIONER OF INTERNAL REVENUE [JULY 26, 1966], the Supreme Court opined that depreciation is a question of fact and is not measured by theoretical yardstick, but should be determined by a consideration of actual facts. The findings of the tax court in this respect should not be disturbed when not shown to be arbitrary or in abuse of discretion. Limpan has not shown any arbitrariness or abuse of discretion on the part of the CTA. In fact, the CTA applied rates of depreciation in accordance with Bulletin F of the US Federal Internal Revenue Service, which the Supreme Court, has pronounced as having strong persuasive effect.
Q35.5. What are the special rules on deductibility of depreciation on vehicle expenses? RR 12-2012 [OCTOBER 12, 2012] provides for the following rules: 1. Only one vehicle for land transport is allowed for the use of an official or employee 2. The value of which should not exceed P2,400,000 3. It must be substantiated with sufficient evidence, such as official receipts or other adequate records; and 4. There is a direct connection or relation of the vehicle to the development, management, operation, and/or conduct of the trade or business or profession of the taxpayer Generally, no deduction in the gross income shall be allowed for depreciation of the following:
PM REYES NOTES ON TAXATION I: INCOME TAX 1. Yachts, helicopters, airplanes, and/or aircrafts; and 2. Land vehicles with a value of more than P2,400,000 Exception: the taxpayer is in the business of transport operations or lease of transportation equipment and the vehicles purchased are used in such operations. In addition, the following shall be disallowed as deductions in the gross income: 1. All maintenance expenses on account of nondepreciable vehicles; 2. Input taxes on the purchase of non-depreciable vehicles and all input taxes on maintenance expenses.
Depletion Q36. What is depletion? Depletion is the exhaustion of natural resources like mines and opil and gas wells as a result of production or severance from such mines or wells.
Q36.1. Who may avail of the cost of depletion? Annual depletion deductions are allowed only to persons who own an economic interest in the property that are entitled to depletion allowance.
Q36.2. What is the difference 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.
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Q36.3. What is the rule on depletion? A reasonable allowance for depletion or amortization, under a cost depletion method, shall be allowed for oil and gas wells and mines. The allowance is deductible from the net taxable income. However, when the allowance for depletion has equal the capital invested, no further allowance shall be granted
In CONSOLIDATED MINES, INC. VS. COURT OF TAX APPEALS [AUGUST 29, 1974], the BIR among other disallowances claimed that the depletion expense deductions of Consolidated Mines have been overcharged. Thus, Consolidated was assessed for income tax deficiency. The CIR and Consolidated differed with regard to the cost of the mining property as well as the estimated ore deposit. On appeal to the CTA, the CTA ruled in favor of the CIR on the issue of depletion deductions. Consolidated contested the rate of mine depletion adopted by the CTA in arriving at its conclusion. In depletion, evidence must be shown to show the produce mined and for how much they were sold during the year for which the return or computation were made. This is necessary in order to determine the amount of depletion that can be legally deducted from gross income. Given the evidence presented, the Supreme Court held that the CIR was correct as to the cost of the mining property but both the CIR and Consolidated were wrong as to estimated ore deposit.
Charitable and other contributions Q37. What are the conditions for deductibility of charitable contributions? The requisites are: 1. Actually paid or made to the Philippine Government or any political subdivision thereof, or any of the domestic corporation or association specified in the Tax Code 2. Made within the taxable year 3. Not exceeding 10% (individuals) or 5% (corporations) of the taxpayer’s taxable income before charitable contributions 4. Evidenced by adequate receipts or records
PM REYES NOTES ON TAXATION I: INCOME TAX Q37.1. What contributions are deductible in full? Donations to the following institutions are deductible in full: 1. Donations to the Government, its entities, political subdivisions or fully owned corporations exclusively for undertaking priority activities in accordance with the national priority plan to be determined by NEDA 2. Donations to foreign institutions or international organizations pursuant to agreements, treaties entered into by Government or special laws 3. Donations to accredited Non-Government Organizations (non-profit domestic 58 corporation)
Q37.2. When are donations subject to limitations? When the donation is made to: 1. The government for public purposes 2. Accredited domestic corporations for religious, charitable, scientific, etc. purposes 3. Social welfare institutions 4. NGOs (not accredited) The limitations are 10% of net income for individual taxpayers and 5% of net income for corporate taxpayers.
Q37.3. What is a organization?
Is an international NGO qualified to be granted accreditation?
NGOs are accredited by the PCNC (Philippine Council for NGO Certification)
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Research and Development Q38. What is the rule on the deductibility of expenses for research and development? 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.
Q38.1. When is the inapplicable?
The rule does not apply to: 1. 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 2. Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, quality of any deposit of ore or other mineral, including oil or gas.
A non-government organization shall refer to a non-stock, non-profit domestic corporation 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. Q37.3.1.
No. In BIR RULING 19-01 [M AY 10, 2001], at issue was whether or not international organizations with home offices based abroad are qualified to be granted done institution status (accreditations as NGO), the CIR ruled that a non-stock, non-profit corporation or organization must be created or organized under Philippine laws and that an NGO must be a non-profit domestic corporation, a foreign corporation whether resident or non-resident cannot be accredited as a done institution.
In 3M PHILIPPINES, INC. VS. COMMISSIONER OF 59 INTERNAL REVENUE [SEPTEMBER 26, 1988], 3M Philippines, a subsidiary of 3M (nonresident foreign corporation based in the US), claimed as deductions the entire amount paid by 3M Philippines to 3M for royalties and technical services. The Supreme Court ruled that the entire amount is not deductible. Improper payments of royalty are not deductible as legitimate business expenses. Proper reference must be given to CB Circular 393 which provides that 59
Note, however, that during this time, there was a 5% threshold for royalty payments.
Gross Receipts — Gross Sales — Gross Income —
PM REYES NOTES ON TAXATION I: INCOME TAX CB Circular is no longer present, so the standard is “reasonable ness”
royalties shall be paid only on commodities manufactured by the licensee under the royalty agreement. In this case, there were some finished products imported by the licensee from the licensor. No royalty is payable on the wholesale price of such imported finished products.
Q38.2. May the taxpayer elect to amortize/capitalize its research and development expenses?60 Yes. The taxpayer may elect to amortize the following research and development expenditures: 1. Paid or incurred by the taxpayer in connection with his trade, business, or profession 2. Not treated as research and development expenses (not capitalized) 3. Chargeable to capital account but not chargeable to property of a character which is subject to depreciation or depletion.
Additional requirements for deductibility Q39. What are the additional requirements for deductibility of deductions? ALTERNATI Any amount paid or payable which is otherwise VE: Go to deductible from or taken into account in computing the BIR and gross income or for which depreciation or show that amortization may be allowed shall be allowed as a the payee deduction ONLY if it is shown that the tax required to reported it be deducted and withheld therefrom has been paid to as income. the BIR in accordance with: You show BIR the 1. Section 34, Section 58 (on returns and payment of income tax taxes withheld at source); and return of the other party 2. Section 81 (on filing of return and payment of taxes from which withheld) . you should have RMO 38-83 [NOVEMBER 14, 1983] provides for the withheld. guidelines for allowance of deductions for certain income payments.
Q40. What is meant by “Optional Standard deduction?” Section 34(L) provides that in lieu of the itemized deductions, an individual subject to tax excluding a nonresident alien may elect a standard deduction of not exceeding 40% of his gross sales or gross receipts, as the case may be. In the case of a domestic corporation and a resident foreign corporation, it may elect a standard deduction in an amount not exceeding 40% of its gross income. A non-resident alien (whether engaged or not) and a non-resident foreign corporation cannot claim OSD. The election to use OSD when made in the return shall be irrevocable for the taxable year for which the return is made.
Q40.1. What are the rules in the determination of the amount of OSD? RR 16-2008 [NOVEMBER 26, 2008] provides for the following rules: 1. For individuals a. If on accrual basis of accounting, the OSD shall be based on gross sales b. If on cash basis of accounting, the OSD shall be based on gross receipts c. Cost of sales and cost of services are not allowed to be deducted for purposes of determining the basis of the OSD 2. For corporations a. It shall be based on gross income
Q40.2. What are the rules in the determination of the amount of OSD of GPPs? RR 2-2010 [FEBRUARY 18, 2010] amended Sections 6 to 7 of RR 16-2008 with respect to the determination of the OSD of GPPs.
Optional Standard Deduction Section 34 (L), Tax Code as amended by Republic Act 9504
This is similar to interest expense where you can capitalized.
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A GPP is not subject to income tax but 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. 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. The
PM REYES NOTES ON TAXATION I: INCOME TAX GPP may claim itemized deductions or in lieu thereof may opt to avail of the OSD allowed to corporations. The net income determined by either claiming the itemized deductions or OSD from the GPP’s gross income is the distributable net income from which the share of each partner is determined. If the GPP availed of the itemized deductions in computing its net income, a partner may still claim itemized deductions from his share in the net income of the partnership. However, if the GPP availed of the OSD in computing its net income, the partner can no longer claim further deduction from his share in the said net income.
Premium payments on health and/or hospitalization insurance Q41. May a taxpayer deduct from his gross income premium payments for health and hospitalization insurance? Yes. An individual taxpayer can claim as deduction from his gross income the premium payment for health and/or hospitalization insurance for an amount not exceeding P2,400 per family during the taxable year provided the gross family income does not exceed P250,000 for the taxable year. Only one spouse claiming the additional exemption for dependents shall be entitled to this deduction.
Non-deductible expenses Section 36, Tax Code
Q42. What items are not deductible from gross income? No deduction shall in any case be allowed in respect to: 1. Personal, living or family expenses
3. Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made (capitalized interest) 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 5. Losses from sales or exchanges of property directly or indirectly between related persons a. Between members of a family b. Between an individual and a corporation more than 50% in value of the outstanding stock of which is owned by such individual (except in the case of distributions in liquidation) c. Between two corporations more than 50% in value of the outstanding stock of each of which is owned by the same individual if either one of the companies is a holding company d. Between the grantor and a fiduciary of any trust e. Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust f. Between a fiduciary of a trust and a beneficiary of such trust.
Section 119-122, RR 2 reiterates the enumeration provided above.
Q42.1. Are margin fees business 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. (Capital expenditures)
No. In ESSO STANDARD EASTERN, INC. VS. COMMISSIONER OF INTERNAL REVENUE [JULY 7, 1989], Esso made profit remittances to its New York Head Office. Esso claims that the margin fees it paid to the Central Bank on the remittances are ordinary and necessary expenses and should be deducted from its gross income.
They are not deductible because the taxpayer is already given a personal exemption of P50,000 regardless of status and gender, plus an additional exemption of P25,000 foe each dependent, not exceeding 4, as defined by law
The Supreme Court held that margin fees are not necessary and ordinary expenses. The margin fees are not expenses in connection with the production or earning of petitioner's incomes in the Philippines..
PIERRE MARTIN DE LEON REYES
PM REYES NOTES ON TAXATION I: INCOME TAX Since the margin fees in question were incurred for the remittance of funds to petitioner's Head Office in New York, which is a separate and distinct income taxpayer from the branch in the Philippines, for its disposal abroad, it can never be said therefore that the margin fees were appropriate and helpful in the development of petitioner's business in the Philippines exclusively or were incurred for purposes proper to the conduct of the affairs of petitioner's branch in the Philippines exclusively or for the purpose of realizing a profit or of minimizing a loss in the Philippines exclusively
Determining Net Income Tax Payable62 Section 31, 32(A), NIRC
Q43. What is taxable income? As defined in Section 31, 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.
Q44. What is gross income?
Q45. Is income subject to final tax included in the taxpayer’s taxable income? No. Under the Tax Code, "taxable income" does not include passive income subjected to final withholding taxes. The definition of gross income is broad enough to include all passive incomes subject to specific rates or final taxes. However, since these passive incomes are already subject to different rates and taxed finally at source, they are no longer included in the computation of gross income, which determines taxable income (see CIR VS. PHILIPPINE AIRLINES [OCTOBER 9, 2006]). Such income is no longer “returnable,” meaning it will no longer be declared as income in the income tax return and, hence, will not be subject to the schedular income tax rates on individuals or the corporate income tax rate.
Q46. How is net determined?
In all cases, other than when a final tax is imposed or when the gross compensation income tax system applies, the income tax is imposed on the net taxable income computed as follows:
As provided in Section 32(A), gross income means all income derived from whatever source, including, but not limited to, the following items:
(1) All income minus exclusions equals gross income; (2) Gross income less allowable deductions equals net income (in case of corporations, 63 this is already the taxable net income) (3) Net income less personal and additional exemptions (when applicable) equals taxable net income (4) Taxable net income times income tax rates (on the graduated basis) equals net income tax due (5) Income tax less creditable withholding tax and/or tax credit equals net income tax payable.
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. Interests 5. Rents 6. Royalties 7. Dividends 8. Annuities 9. Prizes and winnings 10. Pensions; and 11. Partner’s distributive share from the net income of the GPP
The next three parts will be on Individuals, Corporations, and Withholding Tax. This part provides the key terms and an overview of how net income tax payable for individuals and corporations are determined.
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Simply multiply it with the corporate income tax rate.
PM REYES NOTES ON TAXATION I: INCOME TAX Further, their holiday pay, overtime pay, night shift differential pay, and hazard pay received by them shall likewise be exempt from income tax.
Individuals Ordinary and Passive Income Q47. Differentiate ordinary passive income.
Ordinary income is income other than capital gain and those incomes which fall under the category of passive income. On the other hand, if the income is generated in the active pursuit and performance of the corporation’s primary purposes, the same is not passive income. Generally, passive income is income generated by the taxpayer’s assets. These assets can be in the form of real properties that return rental income, shares of stock in a corporation that earn dividends or interest income received from savings.
Q47.1. What is the income tax rate imposed on ordinary income? It shall be subject to the graduated income tax with 64 rates from 5% to 32%. In relation to Section 23 of the NIRC, the taxable income derived for each taxable year: 1. From all sources within and without the Philippines by resident citizens; 2. From all sources within the Philippines only by a non-resident citizen including overseas contract workers; 3. From all sources within the Philippines only, by a resident alien or a non-resident alien engaged in trade or business in the 65 Philippines; shall be subject to the graduated income tax in accordance with the following schedule provided under Section 24 (see Tax Rates Table annexed to this reviewer) Q47.1.1.
Is the income of minimum wage earners be subject to the graduated income tax rates?
No. Minimum wage earners shall be exempt from the payment of income tax on their taxable income. 64
For ordinary income over P10,000 but not over P30,000 and upper brackets, a fixed amount is added to the taxable amount subject to the graduated income tax rate. 65 Only difference really is the source of income
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Q47.2. What is the income tax rate imposed on passive income? Passive incomes are subject to different final taxes. As stated earlier, since they are already subject to different rates and taxed finally at source, they are no longer included in the computation of gross income, which determines taxable income.
Q47.3. What are the incomes subject to final tax rates? As a general rule, income, gain or profit derived by an individual during the taxable year shall be subject to the graduated income tax rates. As exceptions, certain incomes subject to tax are not subject to the graduated tax rates and are instead subject to final tax rates. They are: 1. Tax on certain passive income under Section 24(B) a. Interests, royalties, prizes and other winnings under Section 24(B)(1) b. Cash and/or property dividends under Section 24(B)(2) 2. Capital gains from sale of shares of stock not traded in the Stock exchange under Section 24(C) 3. Capital gains from sale of real property under Section 24(D) 4. Compensation income of alien and Filipino employees of a. Regional or area headquarters and regional operating headquarters of MNCs under Section 25(C) b. Offshore Banking Units under Section 25(D) c. Foreign petroleum service contractors and sub-contractors under Section 25(E)
What is the proper tax treatment on individual taxpayers of income derived from royalties, prizes and other winnings?
Royalties (except books, literary works, musical compositions), prizes amount to more than P10,000 and other winnings (except PCSO and Lotto)
PM REYES NOTES ON TAXATION I: INCOME TAX Q47.3.4.
Final tax in case of citizens (whether resident or nonresident), resident aliens and non-resident aliens engaged in trade or business is 20%. In case of non-resident aliens not engaged in trade or business, the amount received shall form part of their gross income subject to a flat 25%. (see Section 25(B)) Exceptions: 1. For royalties from books, literary works, musical compositions, the final tax is 10%. 2. Prizes amounting to P10,000 or less shall form part of ordinary taxable income and, subject, to the graduated income tax rates. 3. PCSO and Lotto Winnings are tax-exempt.
What is the proper tax treatment on individual taxpayers of income derived from dividends?
Dividends from domestic corporations and shares in net profits of taxable partnerships received by citizens (whether resident or nonresident) or resident aliens are subject to 10%.
As provided in RR 14-2012 [NOVEMBER 7, 2012]: 1. Interest from Philippine currency bank 1- 4 are deposits and yield from deposit substitute derived from and from trust funds or similar dealings with banks not arrangements interest Final tax in case of citizens, resident aliens and non- income resident aliens engaged in trade or business is derived by banks. 66 20%. In case of non-resident aliens not engaged in trade or business, the amount received shall form part of their 67 gross income subject to flat 25% income tax. 2. Interest income derived from government debt instruments and securities They are considered “deposit substitutes.” same tax treatment as above is applied. 3. Interest derived from long deposits or investments
What are deposit substitutes? An alternative form of obtaining funds from the public (the term public means borrowing from 20 or more individual or corporate lenders at any one time), other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower’s own account for purposes of re-lending or purchasing receivables and other similar obligations, or financing their own needs or the needs of their agent or dealer
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a. Depositor is an individual citizen (resident or non-resident), a resident alien or a nonresident alien engaged in trade or business in the Philippines; b. The long-term deposit or investment certificates under name of the individual; c. The long-term deposits or investments must be in the form of savings, common or individual trust funds, deposit substitutes, etc evidences by certificates in the BSPprescribed form d. The long-term deposits or investments must be issued by banks only; e. The long-term deposits or investments must have a maturity period of not less than 5 years
As for non-resident aliens not engaged in trade or business, it shall form part of their taxable gross income subject to flat rate of 25%.
They are exempt from tax, provided the following requisites are met:
In the case of non-resident aliens engaged in trade or business, it is 20%.
What is the proper tax treatment on individual taxpayers of income derived from interests
Same rate applies to domestic and resident foreign corporations. A non-resident foreign corporation is subject to a FWT of 30%. Irrespective of the number of lenders at the time of origination if such debt instrument and securities are to be traded or exchanged in the secondary market. 67 68
Interest bearing bond v. Zero-coupon bank
PM REYES NOTES ON TAXATION I: INCOME TAX f.
The long-term deposits or investments must be in the denominations of P10,000 and other BSP-prescribed denominations g. The long-term deposits or investments should not be pre-terminated. h. Except those specifically exempted by law, any other income such as gains from trading, foreign exchange gain shall not be covered by income tax exemption. If the deposit or investment is pre-terminated, a final tax shall be imposed on the entire income. Four years to less than five year – 5%. Three years to less than four years – 12% If less than three years – 20%. 4. Interest income derived from a depository bank under the expanded foreign currency deposit system (EFCDS)
banks, the interest income shall be subject to 10% 6. Interest income instruments
Q48. Define the following terms. Section 22(Z) and 39(A) Tax Code Ordinary Income
a. The interest income must be derived by residents. Interest income from foreign currency loans granted by such depository banks under the EFCDS other than OBUs shall be subject to a final tax of 10%. b. Any income of non-residents, whether individuals or corporations, shall be tax-exempt. 5. Interest income derived from offshore banking units of OBUs a. Income derived by OBUs from foreign currency transactions with nonresidents, other OBUs, and local commercial banks are tax-exempt. b. If the foreign currency transactions are with residents other than OBUs and local commercial
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Capital Gains Tax70
Derived by FCDUs:
Domestic and resident foreign corporations are also subject to the final tax of 7.5%. Nonresident foreign corporations are exempt.
Any other debt instrument not within the coverage of deposit substitutes shall be subjected to a creditable withholding tax of 20%.
Derived from FCDUs: a. The interest income must be derived by residents. If the interest income is derived by a resident individual taxpayer, it shall be subject to 69 a final tax of 7 ½%. b. Any income of non-residents, whether individuals or corporations, shall be tax-exempt. c. If the bank account is jointly in the name of a non-resident and a resident, 50% shall be treated as exempt and the remaining 50% shall be subject to the final tax of 7 ½.
Any gain from the sale or exchange of property which is not a capital asset or property described in Section 39(A)(1) (which defines what capital assets are and those which are not) Includes any loss from the sale or exchange of property which is not a capital asset Means property held by the taxpayer (whether or not connected with his trade or business) but does not include: 1. Stock in trade of the taxpayer or other property of a kind which would properly be include in the inventory of the taxpayer if on hand at the close of the taxable year 2. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business 3. Property used in the trade or business of a character which is subject to the allowance for depreciation 4. Real property used in trade or business of the taxpayer Means the excess of the gains from sales of exchanges of capital assets over the losses from such sales or exchanges Means the excess of the losses from sales or exchanges of capital
This will be discussed in greater detail in the section on Capital Gains and Losses.
PM REYES NOTES ON TAXATION I: INCOME TAX assets over the gains from such sales or exchanges Section 22(T) to (X), Tax Code Securities
Non-bank financial institution
Means share of stock n a corporation and rights to subscribe for or to receive such shares A merchant of stocks or securities, whether an individual, partnership or corporation, with an established place of business, regularly engaged in the purchase of securities and the resale thereof to customers Every banking institution as defined in RA 337 as amended by RA 8791 (General Banking Act of 2000) A financial intermediary as defined in RA 337 as amended by RA 8791 (General Banking Act of 2000) authorized by the BSP to perform quasi-banking activities Means borrowing funds from 20 or more personal or corporate lenders at any one time, through the issuance, endorsement, or acceptance of debt instruments of any kind other than deposits for the borrower’s own account or through the issuance of certificates of assignments or similar instruments, with recourse, or of purchase agreements for purposes of re-lending or purchasing receivables and other similar obligations
Q49. What is a capital gains tax? A capital gains tax is a tax on capital gains, the profit realized from the sale of capital assets.
Q49.1. If the asset sold is not a capital asset, what tax will be imposed? If the asset is an ordinary asset, any gain from the sale thereof shall form part of the ordinary income which shall be subject either to graduated income tax rates (if individual) or corporate income tax (if corporation).
Q49.2. What capital gains are subject to As far as the taxing capital gains tax?
authority is concerned, 1. Capital gains from the sale of shares of stock no the seller is trade in the stock exchange liable for the 2. Capital gains from the sale of real property tax. EXCEPT for Q49.3. From the above transactions, who mortgage are the individual taxpayers whose where the transactions would be subject to mortgagee capital gains tax? is the statutory The capital gains tax shall be imposed on such seller. transactions by any individual taxpayer, whether 71 citizen or alien.
Q49.4. Is the capital gain from the sale or exchange of a capital asset always taxable in full? No. In the case of a taxpayer other than a corporation, the following percentages of the gain upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain: 1. 100% if the capital asset has been held for not more than 12 months 2. 50% if the capital asset has been held for more than 12 months
Capital Gains Tax with respect to shares of stock Q50. What are stocks classified as capital assets? Stocks classified as capital assets mean all stocks and securities held by taxpayers other than dealers in securities.
Q51. What is the rule on capital gains from sales of shares of stock? Capital gains tax shall be 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 through the stock exchange. The final tax imposed shall be: 71
Note that any corporate taxpayer, domestic or foreign as well as all other taxpayers may be subjected to pay capital gains tax on stock or real property transactions
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PM REYES NOTES ON TAXATION I: INCOME TAX Capital gains not over P100,000 – 5% Capital gains over P100,000 – 10%
from said transactions (see COMPAGNIE FINANCIERE SUCRES ET DENREES VS. CIR [AUGUST 28, 2006])
The tax base shall only be the gain on the sale and such sale will always be subject to capital gains tax without any exemption. The capital gains tax must be paid within 30 days following each sale or disposition. In case of installment sale, the return shall be filed within 30 days following the receipt of the first down payment and within 30 days following the subsequent installment payments. (See RR 06-2008 [APRIL 22, 2008])
Q51.1. If the share of stock is traded through the stock exchange, what tax is applicable? A percentage tax of ½ of 1% is imposed on the gross selling price of shares of stock if they are listed and sold, exchanged or transferred through the facilities of the local stock exchange.(see Section 127(A) and RR 06-2008 [APRIL 22, 2008]) However, even if trade through the stock exchange, a sale of shares by companies not complying with the 10% minimum public float shall be subject to capital gain tax (see RR 16-2012 [November 7, 2012])
Q51.2. What are exempted from capital gains tax on stock transactions? 1. Gains derived by dealers in securities 2. Gains from sales of stock to the extent invested in new shares of stocks in banks, financial intermediaries, and corporations organized primarily to hold equities in banks 3. All other gains which hare specifically exempt from income tax under existing investment incentives and other special laws.
Q51.3. Is an assignment of deposits on stock subscriptions subject to capital gains tax? YES. The assignment of the deposits on stock subscriptions results in a net gain. A tax on the profit of sale on net capital gain is the very essence of the net capital gains tax law. To hold otherwise will ineluctably deprive the government of its due and unduly set free from tax liability persons who profited
PIERRE MARTIN DE LEON REYES
Q51.4. What is the effect of non-payment of capital gains tax on stock transactions? As provided in Section 11 of RR 06-2008, no sale, exchange, transfer or similar transaction intended to convey ownership of, or title to any share of stock shall be registered in the books of the corporation unless the receipts of payment of the tax herein imposed is filed with and recorded by the stock transfer agent or secretary of the corporation. RMC 37-2012 [AUGUST 3, 2012] clarified RR 06-2008 in stating that a Certificate Authorizing Registration [CAR] is still necessary before any transfer of shares of stock not traded in the Stock Exchange may be transferred in the books of a corporation.
Capital Gains Tax with disposition of real property
to For there to
be capital gains tax, the property Q52. What is the rule on capital gains from should be a dispositions of real property? capital asset “PRESUMED GAIN” — you always assume they sell for gain (property not The rate of 6% shall be imposed on capital gains used in the presumed to have been realized by the seller from business & the sale, exchange, or other disposition of real not principal properties located in the Philippines classified as residence) capital assets, including pacto de retro sales and other forms of conditional sales based on the gross selling price or fair market value as determined by the CIR, whichever is higher.
The tax base shall be the entire selling price. The capital gains tax must be paid within 30 days following each sale or disposition. In case of installment sale, the return shall be filed within 30 days following the receipt of the first down payment and within 30 days following the subsequent installment payments.
Q52.1. What is the special rule for disposition of real property made by an individual to the government? As provided in RR 8-98, in case of disposition of real
PM REYES NOTES ON TAXATION I: INCOME TAX When government or to any of its political subdivisions or included as agencies or to government-owned or controlled income, corporations, the seller may elect to: there may be deductions you can avail 1. compute the tax on the gain derived from such sale under the normal income tax rates; or of. 2. under a final capital gains tax of 6%.
Q52.2. What are the conditions for the exemption of capital gains tax on the sale by a natural person of his principal residence? As provided in RR 13-99 [JULY 26, 1999], as 72 amended by RR 14-2000 [NOVEMBER 20, 2000]: 1. The 6% capital gains tax otherwise due shall be deposited in cash or manager’s check in an interest-bearing account with an authorized agent bank under an Escrow Agreement. 2. He shall file his Capital Gains Tax Return 3. The proceeds from the sale, exchange or disposition must be fully utilized in acquiring or constructing his new principal residence within 18 calendar months from date of its sale. To ensure compliance, he must within 30 days from the lapse of the said period the required documents to prove full utilization. 4. Upon a showing that the proceeds of the sale, exchange or disposition have been fully utilized, the escrow on the bank deposit shall be released. 5. The tax exemption may be availed of only once every 10 years 6. The historical cost or adjusted basis of his old principal residence sold, exchanged disposed shall be carried over to the cost basis of his new principal residence 7. If he fails to submit the required documents within 30 days after the lapse of the 18-month period, it shall be presumed that he did not fully utilize the proceeds of the sale, exchange or disposition of his old principal residence, and shall be assessed deficiency capital gains tax. The escrow shall be 73 applied in payment of this. 8. If there is no full utilization of the proceeds of sale, exchange or disposition of his old principal residence, he shall be liable for deficiency capital gains tax, inclusive of 20% interest per annum, 72
RR 14-2000 added the escrow agreement requirement and conditions relating thereto. 73 If the same is insufficient to cover the entire amount assessed, he shall remain liable for the remaining balance of the assessment. The excess of the deposit in escrow, if any, shall be returned to him.
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computed from the 31st day after the date of sale or disposition of the said old principal residence.
Q52.3. Who is liable to pay the capital gains tax? The seller is liable to pay the capital gains tax. As provided in RR NO. 8-98 [AUGUST 25, 1998], the capital gains tax return will be filed by the seller within 30 days following each sale or disposition of real property. Q52.3.1.
Can the buyer pay the capital gains tax?
Yes. The buyer can retain the amount for the capital 74 gains tax and pay it upon authority of the seller, or the seller can pay the tax, depending on the agreement of the parties.
Q52.4. Is the payment of the capital gains tax a pre-requisite to the transfer of ownership to the buyer? No. Payment of the capital gains tax, however, is not a pre-requisite to the transfer of ownership to the buyer. The transfer of ownership takes effect upon the signing and notarization of the deed of absolute sale. (see Chua v. CA [APRIL 9, 2003])
Q52.5. If a mortgagee foreclosed the mortgaged property but the mortgagor exercises his right of redemption within the applicable period, will capital gains tax still be imposed on the foreclosure sale? RR 4-99 [M ARCH 9, 1999] provides that in case the mortgagor exercises his right of redemption within 75 one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. If the mortgagor does not exercise his right of redemption, 74
The buyer has more interest in having the capital gains tax paid immediately since this is a pre-requisite to the issuance of a new Torrens title in his name. 75 Note Section 47 of the General Banking Act, judicial persons whose property is being sold pursuant to an extrajudicial foreclosure shall have the right to redeem the property until, but not after, the registration of the certificate of foreclosure sale with the Register of Deeds which in no case shall be more than 3 months after foreclosure
PM REYES NOTES ON TAXATION I: INCOME TAX capital gains tax on the foreclosure sale shall become due. Q52.5.1. ABC Company took out a loan from XYZ bank and mortgaged one of its properties as collateral. ABC was unable to pay so XYZ extrajudicially foreclosed the property and bought it. Before the expiration of the one-year redemption 76 period, the mortgagor notified the bank of its intention to redeem the property. Is XYZ liable to pay the capital gains tax as a result of the foreclosure sale? No. In foreclosure sale, there is no actual transfer of the mortgaged real property until after the expiration of the one-year period and title is consolidated in the name of the mortgagee in case of non-redemption. This is because before the period expires there is yet no transfer of title and no profit or gain is realized by the mortgagor.
Q52.6. If title to property is transferred to one spouse as a result of a court decision in an annulment case, is the transfer subject to capital gains tax? No. In BIR Ruling DA-029-08 [JANUARY 23, 2008], title to a house and lot was transferred to the husband by virtue of a decision of the court declaring his marriage with his wife null and void. In BIR Ruling DA 287-07 [M AY 8, 2007], title to a condominium unit was transferred to the wife as a result of an agreement to distribute communal property executed in the course of annulment proceedings. In both BIR Rulings, the CIR held that the transfer of the title of the subject properties are not subject to capital gains tax, as such transfers are equivalent to a conveyance but without monetary consideration, made in accordance with the Court's Decision granting parties agreement for the distribution of communal property.
The foreclosure sale in the case on which the question is based took place prior to the effectivity of the Act.
PIERRE MARTIN DE LEON REYES
Q53. What are the requirements for OCWs and seafarers or seamen to be considered OCWs for taxation purposes? To be considered as an OCW, they must be duly registered as such with the POEA with a valid Overseas Employment Certificate (OEC). In the case of seafarers or seamen, they must be duly registered with the POEA with a valid OEC and with a valid Seafarers Identification Record Book or Seaman’s book issued by the MARINA. (see RR NO. 001-11 [FEBRUARY 24, 2011]).
Q53.1. What is the tax treatment of OCWs for purposes of income tax? An OCW’s income arising out of his overseas employment is exempt from income tax. If he has income earnings from business activities or properties within the Philippines, such income earnings are subject to Philippine income tax.
Q53.2. Are OCWs and seafarers exempt from the 7.5% final tax on interest income from a depository bank under the EFCDS? No, because OCW and seamen are non-residents. As such, they are exempt from the final tax. To avail of the tax exemption, they must present proof of nonresidency such as their OEC or Seaman’s book. However, if the account is jointly in the name of the OCW and an individual living in the Philippines, half of the interest income will be treated as tax-exempt and the remaining half shall be subject to the final tax. (see RR NO. 001-11 [FEBRUARY 24, 2011]).
Q54. What is the tax treatment of senior citizens for purposes of income tax? Generally, qualified senior citizens deriving returnable income during the taxable year, whether from compensation or otherwise, are required to file their income tax return and pay the tax. However, he shall be exempt under the following cases: 1. The returnable income is in the nature of compensation income but he qualifies as a minimum wage earner; and 2. If the aggregate amount of gross income earned by the Senior Citizen during the taxable year
PM REYES NOTES ON TAXATION I: INCOME TAX does not exceed the amount of his personal exemptions (basic and additional) Note that the exemption of senior citizens from income tax does not extend to all types of income earned during the taxable year such as those subject to final taxes. (see RR No. 007-10 [JULY 20, 2010].)
Q54.1. Is the 20% sales discount granted by establishments to qualified senior citizens considered a tax credit or a tax deduction? In M.E. HOLDING CORPORATION V. COURT OF APPEALS [M ARCH 3, 2008], the Supreme Court noted that under RA 9257 or the Expanded Senior Citizens Act of 2003, starting taxable year 2004, the 20% sales discount shall be treated as a tax deduction and no longer as a tax credit. Q54.1.1.
What is the difference between a tax credit and tax deduction?
A tax credit is a peso-for-peso deduction from the taxpayer’s tax liability or a full recovery while a tax deduction only benefits the taxpayer to the extent of a percentage of the amount granted as a discount. (See CARLOS SUPERDRUG CORP. V. DSQS [JUNE 29, 2007] and M.E. HOLDING CORPORATION V. COURT OF APPEALS [M ARCH 3, 2008])
Q55. Can a benefactor77 of a PWD whose civil status is single avail of the “head of family” status to be entitled to personal exemption? It is no longer necessary. RA 9442, which amends RA 7277 or the Magna Carta for Persons with Disability, provides that a benefactor of a PWD whose civil status is single shall be considered as “head of family” and, as such, shall be entitled to personal exemption. However, the terms “head of family” and “his/her dependents” for purposes of availing personal exemption have been eliminated in view of an amendment brought about by RA 9504. The rule is that individual taxpayers regardless of status are entitled to the personal exemption. [see RR NO. 001-09 [DECEMBER 9, 2008].
A benefactor refers to any person, whether related or not to the person with disability, who takes care of him/her as a dependent
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Q56. What is the rationale behind personal and additional exemptions under the Tax Code? Exemptions are fixed at arbitrary amounts intended to substitute for the disallowance of personal or living expenses as deductible items from the taxable income of certain individual taxpayers. The amounts represent roughly the equivalent of the taxpayer’s minimum subsistence and those of his dependents.(see PANSACOLA V. CIR [NOVEMBER 16, 2006])
Q56.1. Which kinds of individual taxpayers can avail of personal and additional exemptions? Citizens and resident aliens are allowed personal and additional exemptions; nonresident aliens engaged in trade or business in the Philippines are entitled to personal exemptions only by way of 78 reciprocity but not to additional exemptions.
Q56.2. How should these exemptions be credited? These exemptions must first be credited against gross compensation income; the excess, if any, can be used to offset taxable net income.
Q57. What is personal exemption allowed to individual taxpayers? 79
All individual taxpayers, regardless of status, shall be allowed a basic personal exemption of P50,000.
Thus, for a nonresident alien, his entitltment to personal and additional exemption depends on whether he is engaged in trade or business and his country of residence allows exemption to Filipinos. If not engaged, he will not be allowed the exemption. Note as well that employees of ROHQs, OBUs, and FCDUs are not entitled to personal and additional exemptions as they are subject to tax on gross income without the benefit of deductions/ exemptions. 79 Note that, previously, the amount of personal exemption depended on the status of the individual taxpayer. It was P20,000 for single individuals, P32,000 for legally married and P25,000 for head of a family. As amended by RA 9504, all individuals, regardless of status, are entitlted to a basic personal exemption of P50,000.
PM REYES NOTES ON TAXATION I: INCOME TAX Q57.1. What is the individuals?
Living — those who are living away by “force”, are still entitled to claim exemptions.
In the case of married individuals where only one spouse is deriving gross income, only such spouse shall be allowed the personal exemption.
Yes. RA 10165 or “The Foster Care Act of 2012” amended the NIRC to include a “foster child” in the term “dependent.” Thus, foster parents may claim an addition exemption of P25,000 for each dependent (which includes the foster child) not exceeding 4.
Q58. What are the additional exemptions allowed to individual taxpayers?
Q58.2. What is the rule for spouses and legally separated spouses?
There shall be allowed an additional exemption of 80 P25,000 for each dependent not exceeding four.
The additional exemption for dependents can be claimed by only one of the spouses. In the case of legally separated spouses, additional exemptions may be claimed only by the spouse who has custody of the child or children.
Q58.1. Who is a “dependent” under the Tax Code? 81
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 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. Q54.1.2.
Are illegitimate considered for exemptions?
Yes. By express wording of the law, a dependent includes an illegitimate child. Q54.1.3.
R.A. No. 9504 — there are no longer heads of families.
May parents and siblings be considered as additional exemptions?
No. parents and siblings are considered dependents only for purposes of qualifying an individual to become head of a family but not for purposes of additional exemptions. Q54.1.4.
Are senior citizens supported and living with a taxpayer considered as additional tax exemptions?
No. The word “dependent” does not include senior citizens. Q54.1.5.
Is a foster child considered a dependent?
Q59. What is the “status-at-the-end-of-theyear” rule or the “change-of-status” rule with respect to personal and additional exemptions? This means that whatever is the status of the taxpayer at the end of the calendar year shall be used for purposes of determining his personal and additional exemptions. As held in PANSACOLA V. CIR [NOVEMBER 16, 2006], 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. A change of status of the taxpayer during the taxable 82 year generally benefits, but does not prejudice him. In the following cases, the rule is applied as follows: 1. If the taxpayer marries or should have additional dependents during the taxable year, he may claim the corresponding additional exemption in full for such year. 2. If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions for himself and his dependents as if he died at the close of such year. 3. If the spouse or any of the dependents dies or if any such dependent marries, becomes 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 oth e dependents died, or if such dependents married,
Previously, the amount was P8,000. Note that Illegitimate children are included in the definition of dependents and in the entitlement for additional exemption. 81
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The rule of thumb is that which will be beneficial to the taxpayer.
PM REYES NOTES ON TAXATION I: INCOME TAX became 21 years old or became gainfully employed at the close of such year.
Q60. What is the tax treatment of PERA investment income with respect to income tax? The investment income of a contributor consisting of all income earned from the investments and reinvestments of his PERA assets in the maximum amount allowed shall be exempt from income tax provided that: 1. Each of the investment products must be approved by the concerned regulatory authority 2. Non-income taxes, if applicable, relating to the above investment income, shall remain imposable.
Q62. May GPPs claim OSD? Yes. RR 2-2010 [FEBRUARY 18, 2010] provides for the rules in the determination of the OSD of GPPs. Refer to Q40.1.
Corporations Q63. Define taxable income and gross income for purposes of corporate income taxes. Taxable Income
Partnerships (GPPs)83 Q61. What is the tax treatment of a GPP? The GPP as an entity is not liable for income tax. However, the persons engaging in business as partners in a GPP shall be liable for income tax only in their separate and individual capacities for their respective distributive share in the net income of the GPP.
Q61.1. How is the distributive share of the partners computed? The net income of the GPP 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.
Q61.2. When is the net income of a partnership deemed constructively received by partners? The taxable income declared by a partnership which is subject to corporate income tax, after deducting the said corporate income tax, shall be deemed to have been actually or constructively received by the partners in the same taxable year and shall be taxed to them in their individual capacity, whether actually distributed or not.
means the pertinent items of gross income specified in the Code, less the deductions and/or personal and additional exemptions, if any authorized for such types of income by the Code or other special laws. For corporations, taxable income would mean net income. Net income and taxable income is used interchangeably when it comes to corporations. Shall mean gross sales less sales returns, discounts, allowances and cost of goods sold.
Q63.1. Why is the distinction of the two relevant for purposes of corporate income tax? 1. For domestic corporations and resident foreign corporations, Regular Corporate Income Tax (RCIT) is imposed on taxable income. For nonresident foreign corporations, RCIT is imposed on its gross income. 2. When applicable, MCIT is imposed on the gross income of domestic and resident foreign corporations.
Domestic Corporations Ordinary Income Q64. What is the regular corporate income tax imposed on corporations? The rate of RCIT imposed on corporations is 30%.
Previously, we have said that a partnership is liable for income tax as the term “corporations” includes partnerships no matter how created or organized except GPPs. In this, GPPs will be discussed instead.
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Note that it was 35% effective November 1, 2005 but on January 1, 2009, the effective rate is now 30%.
Between resident citizen and domestic receives dividends from foreign corps: RC - 10% D - 0%
PM REYES NOTES ON TAXATION I: INCOME TAX
For domestic corporations: 1. The rate is imposed on taxable income from sources within and without the Philippines. 2. Different rates of tax apply on certain passive incomes.
As a general rule, all domestic corporations are subject to the RCIT. As exceptions, certain domestic corporations are subject to final tax rates. They are: 1. Proprietary education institutions and hospitals 2. Foreign currency deposit unit of a local universal or commercial bank 3. Firms that are taxed under a special income tax regime 4. Private educational institutions 5. Hospitals
For resident foreign corporations: 1. The rate is imposed on taxable income from sources within the Philippines. 2. Different rates of tax apply on certain passive incomes. For nonresident foreign corporations: 1. The rate is imposed on gross income from all sources within the Philippines. 2. The gross income includes those income sourced from certain passive incomes including capital gains. 3. However, capital gains from sales of shares of stock not traded in the stock exchange are, not included in the gross income as well as interest from foreign loans and intercorporate dividends which are subject to final tax rates.
Q65. May the President allow domestic and resident foreign corporations the option to be taxed on their gross income? Yes. As provided under Section 27(A)(1) and Section 28(A)(1), the President upon recommendation of the Secretary of Finance may allow domestic and resident foreign corporations the option to be taxed at 15% of gross income after the following conditions have been satisfied: 1. a tax effort ratio of 20% of the GNP 2. a ratio of 40% of income tax collection to total tax revenues 3. a VAT tax effort of 4% of GNP 4. a 0.9% ratio of Consolidated Public Sector Financial Position (CPSFP) to GNP
Q67. Are GOCCs income tax?
As a general rule, yes. As provided under Section 27(C), the provisions of special or general laws to the contrary notwithstanding, all corporations, agencies or instrumentalities owned or controlled by the Government, except the GSIS, SSS, Philhealth, and the PCSO, shall pay such rate of tax upon their taxable income as imposed by this section upon corporations or associations engaged in a similar business, industry or activity.
Passive Income Q68. What are some of the certain passive incomes received by corporations? 1. Interests from Deposits and Yield or any other Monetary Benefit from Deposit Substitutes and from Trust Funds and Similar Arrangements and Royalties 2. Income derived under the Expanded Foreign Currency Deposit System 3. Intercorporate Dividends 4. Capital gains from sale of shares of stock not traded in the Stock exchange under 85 5. Capital gains from sale of real property
This option is available to firms whose ratio of cost of sales to gross sales or receipts from all sources does not exceed 55%. Upon election of the gross income tax option, it shall be irrevocable for 3 consecutive taxable years during which the corporation is qualified.
Q66. What domestic corporations are subject to preferential tax rates?
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Note that this is not considered a passive income for foreign corporations, whether resident or nonresident. The simple reason is because of the prohibition imposed by the Constitution on foreign ownership of lands.
PM REYES NOTES ON TAXATION I: INCOME TAX Q68.1. What is the tax treatment on corporations of income derived from dividends? 1. If the dividends corporation:
Domestic and resident foreign corporations are taxexempt as they are treated as inter-corporate dividends. However, for resident foreign corporations, they are subject to the 15% branch profit remittance tax. For non-resident foreign corporations, the dividend is subject to: 1. Tax treaty rate, if applicable 2. 15% if no tax treaty but satisfies the tax-sparing provision 3. 30% if no tax treaty and does not comply with the tax-sparing provision 2. If the dividends are from a foreign corporation: The income shall form part of the gross income of the corporation but the situs of the income becomes material except for a domestic corporation which is taxed on worldwide income.
Q68.2. What is the tax treatment on corporations of interest income from Deposits and Yield or any other Monetary Benefit from Deposit Substitutes and from Trust Funds and Similar Arrangements and Royalties? If the tax 1. Domestic and resident foreign corporations are rate for subject to a final tax of 20%. something 2. Subject to a final withholding tax of 30% if is not received by a foreign nonresident corporation, specifically unless the interest income is from foreign loans stated, it contracted on or before August 1, 1986, in which does not case it is subject to a FWT of 20% mean it is exempt. Q68.3. What is the tax treatment on Rather, it corporations of income derived will form under the EFCDS? part of your regular income 1. Domestic and resident foreign corporations are subject to subject to a final tax of 7.5%. Any income of non30% tax residents, whether individuals or corporations, shall be tax-exempt.
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2. Income derived by a depository bank under the EFCDS from foreign currency transactions with non-residents, OBUs in the Philippines, local commercial banks, including branches of foreign banks and other depository banks under the EFCDS shall be exempt from all taxes. 3. Interest income from foreign currency loans granted by such depository banks under the EFCDS other than OBUs shall be subject to a final tax of 10%.
Capital Gains Tax86 Q69. Is the assignment and delivery of the developed units to joint owners in a Build-To-Own (BTO) scheme subject to capital gains tax? In a BTO, the developer makes it appear that it merely manages the construction of the condominium project, and that the funds as contributed by the individual investors are pooled in a bank with the developer, as project manager, receiving a project management fee, In that scheme, it is claimed that the assignment and delivery to the individual investors of the developed units is not taxable as it is merely a transfer of property held in trust by the Trustee for the individual trustors. Previous BIR rulings have exempted the assignment from capital gains tax. In In BIR RULING DA-455-07 [AUGUST 17, 2007], the conveyance of the condominium units by the trustee to the individual trustors pursuant to the terms of the BTO contract and without consideration was held not subject to capital gains tax. However, in RMC NO. 055-10 [JUNE 28, 2010], the CIR nullified all BIR Rulings exempting the scheme from capital gains tax. Thus, the present rule is that the assignment and delivery in BTO schemes are subject to capital gains tax. Semi-global aspect of taxation — Section 24(A) — because it Resident Foreign Corporations just states all the income that are taxable and provides a fixed You dont need to be In general registered as long as you tax rate. are “engaged in business”
Q70. What is the difference between a branch and a subsidiary? For purposes of taxation, a subsidiary is considered a domestic corporation while a branch is a resident foreign corporation.
Domestic v. Resident Foreign Corp. differ in treatment of the ff: — Royalties, capital gains on disposition of property, prizes, dividends 86
Same rates and rules as in the case of individual taxpayers. Refer to that discussion in the reviewer.
Domestic v. Resident Foreign Corp. Q: Sells at a price lower than acquisition A: D would be taxed under presumed gain. RFC 50 would not be taxed since “no gain” would reflect in their taxable income.
PM REYES NOTES ON TAXATION INCOME TAX
R.A. No. 10378 — the airline would be exempt from tax if the PH has a counterpart in their jurisdiction which enjoys similar I:exemption. — This affects the UA v. CIR decision, although not the focus.
Q71. What resident foreign corporations are subject to preferential tax rates?
taxed on the income they derive from Philippine sources.
As a general rule, all resident foreign corporations are subject to the RCIT. As exceptions, certain resident foreign corporations are subject to final rates. They are:
For an international air carrier, Gross Philippine Billings refers to the amount of gross revenue derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document.
1. Regional or area headquarters (RHQ) (a branch established in the Philippines by MNCs and which does not earn or derive income from the 87 Philippines and whose role is supervisory) 2. Representative office (a branch in the Philippines of a MNC whose activities are limited to information dissemination, product promotion) 88 3. International carriers by air or water 89 4. Offshore Banking Units 5. Foreign Currency deposit Unit (FCDU) in the 90 Philippines of a foreign bank 91 6. Regional Operating Headquarters (ROHQ) 7. Branch of foreign corporation with respect to profit remittances to head office. 8. Branch of foreign corporations registered with PEZA, SBMA, CDA, CDJHA. 9. Qualified service contractor or subcontractor engaged in petroleum operations in the Philippines
Just because International Carrier you have landing rightsQ72. For purposes of income taxation, what does not is an international carrier? mean you are “engaged in business” An International carrier shall refer to a foreign airline corporation doing business in the Philippines having If you sell been granted landing rights in any Philippine port to international air transportation tickets in the perform services/activities or flight operations anywhere in the PH automatically world (see RR NO. 15-2002) make you engaged in Q73. What is Gross Philippine Billings? business. The 2.5% tax on gross Philippine billings is an income tax levied on the presumed gain of the airline and shipping companies. It ensures that they are
For International Shipping, Gross Philippine Billings means gross revenue whether for passenger, cargo or mail originating from the Philippines up to final destination, regardless of the place of sale or payments of the passage or freight documents
Q73.1. ABC Shipping is a foreign corporation. XYZ chartered one of ABC’s ships to load raw sugar in the Philippines. Upon arriving at the port, the vessel found no sugar for loading. The ship sailed back without carrying any sugar. Is ABC Shipping liable for gross Philippine billings tax? No. A resident foreign corporation engaged in the transport of cargo is liable for taxes depending on the amount of income it derives from sources within the Philippines. ABC derived no receipt from its charter agreement with XYZ. The vessel arrived in the port on but found no raw sugar to load and returned without any cargo laden on board (see CIR vs. Tokyo Shipping [M AY 26, 1995])
Q73.2. What is the tax treatment of an international air carrier with flights originating from Philippine ports? RR No. 15-2002 provides that such an international air carrier, irrespective of the place where passage documents are sold or issued, is subject to the Gross Philippine Billings tax unless subject to a different tax rate under the applicable tax treaty to which the Philippines is a signatory.
They are tax-exempt. An international carrier doing business in the Philippines shall pay a tax of 2.5% on its Gross Philippine Billings 89 Income derived by OBUs from foreign currency transactions with nonresidents, other OBUs, and local commercial banks are taxexempt.If the foreign currency transactions are with residents other than OBUs and local commercial banks, the interest income shall be subject to 10% 90 See Q68.3. 91 They shall pay a tax of 10% of their taxable income 88
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Q73.3. What is the tax treatment of foreign airline companies who do not have flights from or passing through any point in the Philippines but have a branch
Subsidiary v. Branch — Subsidiary is a domestic corporation whose equity ownership may be wholly PM REYES NOTES ON TAXATION I: foreign — Branch and its foreign head office is one and the same, with the branch being a INCOME TAX resident foreign corp. registered with the (see CIR V . BOAC [A PRIL 30, 1987], AIR NEW office or a sales agent in the Z EALAND V . CIR [CTA C ASE , J ANUARY 30, 2008] and Philippines which sells tickets? UNITED AIRLINES V. CIR [SEPTEMBER 29, 2010]) RR No. 15-2002 provides that such off-line airline is not considered engaged in business as an international air carrier and is, therefore, not subject to the Gross Philippine billings tax.
However, the sale of tickets is taxable as income from sources within the Philippines.
Q74. What is a branch profit remittance tax?
Q73.4. ABC Airlines is an off-line international carrier selling passage documents through an independent sales agent in the Philippines. Is ABC engaged in trade or business in the Philippines and, as such, subject to the corporate income tax on resident foreign corporations? In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. Here, ABC maintained a general sales agent and it was engaged in selling or issuing tickets, which is considered the main lifeblood of an airline. The absence of flight operations to and from the Philippines is not determinative of the source of income for purposes of ascertaining income tax liability. It is sufficient that the income is derived from activity within the Philippine territory. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In ABC’s case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands here in the country and the payments for fares were also made with Philippine currency. The site of the source of payments is the Philippines. If an international air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2.5% of its Gross Philippine billings, while international air carriers that do not have flights to and from the Philippines but nonetheless earn income from other activities in the country will be taxed at the corporate income tax rate. Here, ABC earns income from the sale of tickets.
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Single-entitty Rule — the head and branch is one and the same. Passive income items Branch Profit Remittance Tax do not form part of the income items subject to BPRT. Any profit remitted by a branch to its head office shall be subject to a tax of 15% which shall be based on the total profits applied or earmarked for remittance without any deduction for the tax component thereof except those activities which are registered with the PEZA.
Q74.1. What is the purpose of the branch profit remittance tax? The purpose of a branch profit remittance tax is to equalize the tax burden on foreign corporations maintaining on one hand, local branch offices, and organizing, on the other hand, a subsidiary domestic corporation where at least majority of all the latter’s stocks are owned by such foreign corporations. As explained in the case of BANK OF AMERICA VS. COURT OF APPEALS [JULY 21, 1994], prior to amendment, local branches were made to pay only the usual corporate income tax of 25% to 35% then on net income applicable to resident foreign corporations while Philippine subsidiary corporations were subject to the same rate on their net income but their dividend payments were additionally subjected to a 15% withholding tax. Thus to eliminate this unequal tax treatment, a branch profit remittance tax was imposed on local branches on their remittance of profits abroad.
Q74.2. What is the correct tax base for computing the branch profit remittance tax? Is it the “profit actually remitted” or “the amount actually applied for”? The correct tax base is the amount actually applied for by the branch with the Central Bank as profit to be remitted abroad. In BANK OF AMERICA VS. COURT OF APPEALS [JULY 21, 1994], the Supreme Court held that the the tax base 92
Refer to questions on the tax treatment of interest income derived from transactions with OBUs and FCDUs as provided in RR 14-2012.
When the PEZA is the one remitting, it will not be subject to BPRT.
PM REYES NOTES ON TAXATION I: INCOME TAX upon which the 15% which the 15% branch profits remittance tax shall be imposed is the profit actually remitted abroad and not the total branch profits out of which the remittance is to be made. We note, however, that the applicable law for the branch profit remittance tax specifies the tax base to be on the profit remitted abroad. In COMPANIA GENERAL V. CIR [CTA CASE NO. 4141 AUGUST 23, 1993], Compania General contended that the correct tax base for computing the branch profit remittance tax is the profit actually remitted abroad given its reliance on previous BIR rulings and the case of CIR v. Burroughs. On the other hand, the CIR contends that, because of RMC Circular No. 8-82 [March 17, 1982], the tax base should be the amount actually applied for by the branch with the Central Bank of the Philippines as profit to be remitted abroad. The CTA ruled in favour of the CIR as the branch profit remittance taxes were paid after the effectivity of RMC No. 8-82.
Q74.3. Norway and the Philippines entered into a tax treaty. Article 25 of the Convention provides for equal treatment between nationals of the two countries and as between a Norwegian enterprise in the Philippines and a domestic enterprise. Det Norske Philippines, a local branch of De Norske, a Norwegian enterprise, invokes Article 25 for the non-imposition of the branch profits remittance tax. Is its contention valid? No. In ITAD BIR RULING NO. 018-09 [JUNE 23, 2009], the CIR ruled that the principle of equal treatment in Article 25 does not prevent the imposition of the branch profit remittance tax. First, the principle of equal treatment is limited to nationals of the Philippines and of Norway who are both residents of the Philippines. While indeed Det Norske is a national of Norway, it is not a resident of the Philippines. Second, while the treaty lays down a principle of equal treatment between a Norwegian enterprise in the Philippines and a domestic enterprise, as long as the aggregate taxes imposed by the Philippines on such Norwegian enterprise is not greater than the taxes imposed by the Philippines on a domestic enterprise, it cannot be considered that such Norwegian enterprise is treated less favourably in the Philippines than the domestic enterprise.
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Q75. Define regional or area headquarters and a regional operating headquarters. Regional or area headquarters (RHQs) Limited acts allowed. Exempted from tax since the things it does don’t generate income. Regional Operating Headquarters (ROHQs)
Shall mean a branch established in the Philippines by MNCs and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets Shall mean a branch established in the Philippines by multinational companies which are engaged in any of the following services: general administration; business planning and coordination; sourcing and procurement of raw materials and components; corporate finance advisory services; marketing control and sales promotion; training and personal management; logistic services; research and development services and product development; technical support and maintenance; data processing and communications; and business development
Q75.1. What is the tax treatment of RHQs and ROHQs? RHQs are not subject to income tax while ROHQs shall pay a tax of 10% of their taxable income
Q75.2. What is the tax treatment of the income derived by alien individuals and qualified Filipino personnel employed by RHQs and ROHQs? A FWT of 15% shall be withheld from the gross income derived by every alien individual occupying managerial and technical positions in RHQs and ROHQs and representative offices established in the Philippines multinational companies as salaries, wages, annuities, compensation, remuneration, and other emoluments, such as honoraria and
PM REYES NOTES ON TAXATION I: INCOME TAX allowances, except income which is subject to fringe benefits tax, from such regional or area headquarters and regional operating headquarters. The same tax treatment shall apply to Filipinos employed and occupying the same positions as those aliens employed by RHQs and ROHQs of multinational companies, regardless of whether or not there is an alien executive occupying the same position. (see RR 11-2010 [October 26, 2010]) Q75.2.1.
Can the Filipino employee opt to be taxed at the regular income tax rate?
Yes, such Filipinos employed by RHQs and ROHQs in a managerial or technical position shall have the option to be taxed at either 15% of gross income or at the regular rate on their taxable income in accordance with the Tax Code if the RHQ or ROHQ 93 is governed by Book III of E.O. 226, as amended by R.A. No. 8756. (see RR 11-2010 [October 26, 2010]) Q75.2.2.
If the Filipino is not a managerial or technical employee, can he avail of the 15% final income tax rate?
No. As clarified by RR 11-2010 [October 26, 2010], all other employees other than those in managerial or technical positions are considered as regular employees who are subject to the regular income tax rate on their taxable compensation income. Q75.2.3.
What are the requirements in order for a Filipino to be THREE-FOLD TEST applicable to deemed occupying a FIlipinos managerial or technical 1. Function position the same as that of an 2. Compensation alien employed in an ROHQs 3. Exclusivity or RHQ? 1. Position and Function Test — The employee must occupy a managerial position or technical position AND must actually be exercising such managerial or technical functions pertaining to said position; 2. Compensation Threshold Test — In order to be considered a managerial or technical employee for income tax purposes, the employee must have received, or is due to receive under a contract of employment, a gross annual taxable 93
Book III of EO 226 (or the Omnibus Investments Code) refers to Incentives to MNCs establishing RHQs and ROHQs in the Philippines
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compensation of at least PhP975,000.00 9495 (whether or not this is actually received); 3. Exclusivity Test — The Filipino managerial or technical employee must be exclusively working for the RHQ or ROHQ as a regular employee and not just a consultant or contractual personnel. Exclusivity means having just one employer at a time.
Nonresident Foreign Corporations In general Q76. XYZ Corporation is a domestic corporation which entered into a license agreement with ABC Corporation, a non-resident foreign corporation based in the US pursuant to which the former was granted the right to use trademark, patents and technology owned by the latter. For such use, XYZ paid royalties to ABC and subjected the same to the 25% withholding tax on royalty payments. XYZ claimed for a refund and argues that the withholding tax should only be 10% pursuant to the most-favoured nation clause of the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty. Is XYZ’s contention correct? No. In CIR V. S.C. JOHNSON AND SONS, INC. [JUNE 25, 1999], the Supreme Court held that the concessional tax rate of 10% provided for in the RP-Germany Tax Treaty could not apply to taxes imposed upon royalties in the RP-US Tax Treaty since the two taxes imposed under the two tax treaties are not paid under similar circumstances and do not contain similar provisions on tax crediting. It is not proved that the RP-US Tax Treaty grants similar tax reliefs to residents of the US in respect of the taxes imposable upon royalties earned from sources within the Philippines as those allowed to their German counterparts. Further, the RP-Germany Tax Treaty allows for crediting against German income and 94
If there is a change in compensation as a consequence of which, such employee subsequently receiving less than the compensation threshold, the employee shall be subject to the regular income tax rate for the calendar year when the change becomes effective. 95 Beginning December 31, 2013 and on December 31 every three years thereafter, the compensation threshold shall be adjusted to its present value using the Philippine Consumer Price Index (CPI), as published by the National Statistics Office.
PM REYES NOTES ON TAXATION I: INCOME TAX corporate tax of 20% of the gross amount of royalties paid under the law of the Philippines. On the other hand, the RP-US Tax Treaty does not provide for the similar crediting of 20% of the gross amount of royalties paid. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment. since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as allowed under the RPWest Germany Tax Treaty, XYZ cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances.
Q77. ABC Corporation, a foreign corporation in Japan and licensed to do engage in business in the Philippines (hence, a resident foreign corporation) has equity investments in XYZ Company, a domestic corporation. XYZ declared and paid cash dividends to ABC. XYZ directly remitted the cash dividends to ABC’s head office in Japan (hence, a non-resident foreign corporation) net not only of the 10% final dividend tax but also of the withheld 15% profit remittance tax based on the remittable amount after deducting the final withholding tax of 10%. ABC argues that following the principal-agent relationship theory, ABC is a resident foreign corporation subject only to the 10 % intercorporate final tax on dividends received from a domestic corporation. Is ABC correct?
Marubeni wanted to be an RFC because the tax was lower than if it was classified as an NRFC, in which case the dividends are taxes at 15%.
No. The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal agent relationship theory. It is understood that the branch becomes its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not of the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch
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office, the latter becomes the taxpayer, and not the foreign corporation. (see MARUBENI CORPORATION VS. CIR [SEPTEMBER 14, 1989]).
Q78. XYZ is a foreign shipping company. It does not have a branch office in the Philippines and it made only two calls in Philippine ports. What kind of foreign corporation is XYZ? XYZ is a foreign corporation not authorized or licensed to do business in the Philippines. In order that a foreign corporation may be considered engaged in trade or business, its business transactions must be continuous. A casual business activity in the Philippines by a foreign corporation does not amount to engaging in trade or business in the Philippines for income tax purposes. Accordingly, its taxable income for purposes of our income tax law consists of its gross income from all sources within the Philippines. (see N.V. REEDERIJ “AMSTERDAM” VS. CIR [JUNE 23, 1988])
Special nonresident foreign corporations Q79. Enumerate
the non-resident foreign corporations whose income is subject to preferential tax rates.
As a general rule, the gross income of a non-resident foreign corporation is subject to the flat rate tax of 30%. As exceptions, the following are subject to final tax rates and final withholding taxes: 1. Income of a non-resident cinematographic film 96 owner, lessor or distributor 2. Income of a non-resident owner or lessor of 97 vessels chartered by Philippine nationals 3. Income of a non-resident owner of aircraft, 98 machineries and other equipment
Mo MCIT for these special corporations
Such corporation shall pay a tax of 25% of its gross income from sources within the Philippines 97 Such corporation shall be subject to a tax of 4.5% of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations, as approved by the Marina 98 Such corporations shall be subject to a tax of 7.5% of gross rentals of fees
PM REYES NOTES ON TAXATION INCOME TAX Tax on Certain Incomes of Non-resident Foreign Corporations Q80. Enumerate the incomes of non-resident foreign corporations subject to preferential tax rates 1. Interest income on foreign loans contract on or after August 1, 1986. 2. Intercorporate dividends received from a domestic corporation 3. Income covered by Tax Treaties
Q80.1. What is the tax treatment on interest income on foreign loans from a non-resident foreign corporation? If the foreign loan is contracted on or after August 1, 1986, it shall be subject to a FWT at the rate of 20%.
Q80.2. What is the tax treatment on dividends received from a domestic corporation by a nonresident foreign corporation?
The Philippines has to provide the lower tax rate, and the US has to provide the tax sparing provision. I: The providing state provides the “deemed paid” status to preserve the benefit trying to be given by the developing state.
exempted or reduced are considered as having been fully paid. In the Philippines, the 15% tax on dividends received by a non-resident foreign corporation from a domestic corporation is imposed subject to the condition that the country in which the nonresident foreign corporation is domiciled shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 15%, which represents the different between the regular income tax of 30% and the 15% 100 tax on dividends. Q80.2.2.
Illustrate the application of the tax-sparing provision by 101 providing an example.
1. "X" Foreign Corp. Tax Liability with no preferential rates "X" Foreign Corporation income 102 Foreign Tax rate (50%) 103 RP Tax Rate (30%) Foreign Tax Credit 104 "X" tax payable to Foreign "X" tax payable to RP
400 200 120 120 80 120
For non-resident foreign corporations, the dividend is subject to:
Here, the total tax payable of the foreign corporation is 200.
1. Tax treaty rate, if applicable 2. 15% if no tax treaty but satisfies the tax-sparing provision 3. 30% if no tax treaty and does not comply with the tax-sparing provision
2. "X" Foreign Corp. Tax Liability with Preferential Rate and without Tax Sparing
What is provision?
As explained in the case of CIR V. PROCTER & GAMBLE PHILIPPINES [DECEMBER 2, 1999]: A more general way of mitigating the impact of double taxation is to recognize the foreign tax as a tax credit. However, the principal defect of the tax credit system is when low tax rates or special tax concessions are granted in a country for the obvious reason of encouraging foreign investments. For instance, if the usual tax rate is 35 percent but a concession rate accrues to the country of the investor rather than to 99 the investor himself. To obviate this, a tax sparing provision may be stipulated. With tax sparing, taxes 99
This means that, at the end of the day, the foreign investor would be paying the same total amount of taxes due to the foreign country and the Philippines.
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"X" Foreign Corporation income Foreign Tax rate (50%) RP Tax Rate (15%) Foreign Tax Credit "X" tax payable to Foreign "X" tax payable to RP
400 200 60 60 140 60
Here, the total tax payable of the foreign corporation is still the same at 200.
Note that previously, it was 20% which represents the difference between the RCIT of 35% and the 15% tax on dividends. 101 The example provided in the case of CIR v. Procter & Gamble uses the old rates. This example modifies the example provided in the case and uses the current rates effective January 1, 2009. Note that the foreign tax rate and the foreign corporation income are hypothetical. 102 Income (400) x Foreign Tax Rate (50%) = 200 103 Income (400) x RP Tax Rate (30%) = 120 104 [Income (400) x Foreign Tax Rate (50%)] – Foreign Tax Credit (120) = 80
PM REYES NOTES ON TAXATION I: INCOME TAX 3. "X" Foreign Corp. Tax Liability with Preferential Rate and with Tax Sparing "X" Foreign Corporation income Foreign Tax rate (50%) RP Tax Rate (15%) Foreign Tax Credit "X" tax payable to Foreign "X" tax payable to RP
400 200 60 105 120 80 60
The CTA, applying the ruling in CIR V. PROCTER & GAMBLE PHILIPPINES [DECEMBER 2, 1999], concluded that if the country of domicile of the recipient corporation allows a credit against the tax imposable 106 by it an amount equivalent to 20% of the dividends remitted from a Philippine domestic corporation to corporations domiciled therein, the dividends remitted are subject to FWT at the preferential rate of 15% in accordance with Section 28 (b)(5)(b) of the Tax Code of 1997, as amended.
The total tax payable of the foreign corporation is now 140. Q80.2.3.
Is it required that the foreign country must give a “deemed paid” tax credit for the dividend tax waived by the Philippines making applicable the preferred dividend tax rate of 15%?
As ruled in CIR V. PROCTER & GAMBLE PHILIPPINES [DECEMBER 2, 1999], the Tax Code does not require that the foreign country’s tax laws deemed the parent-corporation to have paid the dividend tax waived by the Philippines. The Code only requires that the foreign country shall allow the corporation a “deemed paid” tax credit in an amount equivalent to the percentage points waived by the Philippines. Q80.2.4.
When does a non-resident foreign corporation become entitled to the 15% FWT?
In INTERPUBLIC GROUP OF COMPANIES, INC. VS. COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO. 7796 DATED FEBRUARY 21, 2011], a US Corporation, who owns 30% of the total and outstanding voting capital stock of a Philippine advertising company filed a claim for the refund or issuance of a TCC for overpaid FWT on dividends withheld and remitted by the Philippine company. In the administrative claim, the US corporation alleged that, as a non-resident foreign corporation, it may avail of the preferential FWT rate of 15% on cash dividends received from a domestic corporation during the taxable year 2006. The CIR, in response, raised the question of whether the US corporation is entitled to the FWT at the rate of 15% or the rate of 20% in accordance with the RPUS Tax Treaty.
The additional 60 will be considered as tax deemed paid or also known as the “phantom tax.” It is the foreign jurisdiction that will allow the “deemed paid” tax credit.
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Is there a need for a prior ruling from the BIR in order to avail of the benefit?
In INTERPUBLIC GROUP OF COMPANIES, INC. VS. COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO. 7796 DATED FEBRUARY 21, 2011], the CIR also contended that the US company’s transactions were bereft of any tax treaty relief application with the International Tax Affairs Division (ITAD). On this point, the CTA ruled that the same is not 107 necessary. Q80.2.6.
If the foreign country does not impose a tax on the dividend, is the dividend received by the non-resident foreign corporation subject to the 15% FWT?
Yes. In BIR RULING DA-145-07 [M ARCH 8, 2007], SM Investments asked for the BIR’s opinion on whether the cash dividends declared by them to Asia Opportunities Limited, a corporation organized and existing under the laws of the British Virgin Islands are subject to 15% FWT. The CIR noted that the International Business Companies Ordinance of the Territory of the British Virgin Islands does not impose any tax on dividends from foreign sources, which logically would include those received from Philippine corporations. As such, the dividend is subject only to the FWT of 15%.
Q80.3. To avail the benefits of a tax treaty provision, must it be preceded by an application for a tax treaty relief with the International Tax Affairs Division (ITAD)?
Now, 15% effective January 1, 2009. This is subject to debate. This case implies that the benefit is automatic without need for a TTRA. 107
If the payor is liable on the Tax Treaty, he won’t be liable in the Tax Code provisions. — You will make a decisions based on whether or not the other country has a tax credit provision.
PM REYES NOTES ON TAXATION INCOME TAX
Yes. As provided in RMO 072-10 [AUGUST 25, 2010], the ITAD is the sole office charged with the receiving of tax treaty relief applications (TTRA). All tax treaty relief applications relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). All rulings relative to the application, implementation and interpretation of the provisions of Philippine tax treaties shall emanate from ITAD. In MIRANT V. CIR [CTA CASE NO. 7796, FEBRUARY 21, 2011], Mirant made income payments to VHL enterprises, a US nonresident foreign corporation and to WES World, a UK nonresident foreign corporation. It accordingly withheld the tax due on these interest payments. Thereafter, Mirant filed for a refund contending that the two foreign corporations have created “permanent establishments” in the Philippines and thus making applicable the lower withholding tax rate under the RP-UK and RP-US tax treaties. The CTA noted that under those treaties, VHL and WES World, while not having a fixed place of business have established “permanent establishments” in the Philippines because they have “furnished services through their employees or other personnel for a period or periods the aggregate of which is more than 183 days in a twelve-month period." However, under RMO 01-2000, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). A foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation.The CTA noted that Mirant did not make such application. Thus, the CTA finally held that the income payments of Mirant to VHL and WES, which are both non-resident foreign corporations, are 108109 subject to the final tax of 32%.
Q80.4. What is the meaning of mostfavoured nation (MFN) and how is it applied to applications for tax treaty reliefs? 108
Note that the applicable tax rate is now 30%. Note, however, that in INTERPUBLIC GROUP OF COMPANIES, INC. VS. COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO. 7796 DATED FEBRUARY 21, 2011], the CTA, by way of obiter, stated that, even with respect to the applicability of the 20% FWT under the RP-US Tax Treaty, a tax treaty relief application “is not made a condition precedent by law.” 109
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Deutsche Bank AG Manila Branch v. CIR (G.R. No. 188550) — you can take the benefit of the 20% even without a tax ruling the other country does not have a tax I: ifcredit system and you are left with a 30% (NIRC provision for NRFC) or 20% (treaty provision).
The most-favoured nation simply means that a country which is the recipient of this treatment must, receive equal advantages as the "most favoured nation" by the country granting such treatment. Most tax treaties would have a MFN clause making a benefit which is more advantageous accorded to one country demandable. In ITAD RULING 102-02 [M AY 28, 2002], Energizer Philippines claims that its royalty payments to Eveready Battery are subject to the preferential tax rate of 15% pursuant to the MFN clause of the RPUS Tax Treaty in relation to the RP-Netherlands Tax Treaty. The CIR applied the ruling in CIR V. S.C. JOHNSON AND SONS, INC. [JUNE 25, 1999], where the Supreme Court interpreted the MFN clause, or the phrase “paid under similar circumstances” as referring to the manner of payment of taxes and not the subject matter of the tax which is royalties. The CIR found that the RP-US and RP-Netherland tax treaties show a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. Thus, the royalty payments by Energizer to Eveready are subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to the "most-favored-nation" provision of the RP-US tax treaty in relation to the RP-Netherlands tax. Withholding tax is a direct tax. However, if the Withholding Tax agent is the one who shoulders the penalties in case of non-payment, isn’t it an indirect tax?
In general Q81. What is the withholding tax system? The withholding tax system is a procedure through which taxes (including income taxes) are collected.
Q81.1. Who is the withholding agent? The withholding agent is the one who has control, custody, or receipt of the funds that is subject to income tax and to be withheld and remitted to the BIR. The withholding agent holds the amount withheld from the income of another person in trust for the government until paid. The duty to withhold is different from the duty to pay income tax. The obligation to withhold is imposed upon the buyer-payor of income but the burden of tax is really upon the seller-income earner. The obligation to withhold is compulsory as it makes such withholding agent personally liable for payment
PM REYES NOTES ON TAXATION I: INCOME TAX of the tax. Such liability of the withholding agent is direct and independent from the liability of the income recipient.
Q81.2. Who are required by law to withhold on income payments? 1. Agents or employees of withholding agents 2. Persons having control of the payment and claiming the expense 3. Payor having control of the payment where payment is made thru brokers
If you’re Q81.3. When does the obligation to already withhold arise? recognizing Ex: debt was due on Feb. 17, but was paid 15th. the paid When is the tax due? 15th since it was paid Either when: amount as a then, but if it wasn’t paid on the 15th nor 17th, deduction in then tax is due by the 17th. 1. It is paid your books, 2. It becomes payable (i.e. it is legally due, you will have demandable, or enforceable) to withhold such at the 3. It is accrued as an asset or expense end of the In FILIPINAS SYNTHETIC FIBER CORPORATION V. CA [OCTOBER 12, 1999], the Supreme Court stated that quarter. the Tax Code is silent as to when the duty to withhold taxes arises. In this case, to determine when the duty to withhold the taxes arose, the Court inquired into the nature of accrual method of accounting, the procedure used by the taxpayer, and to the modus vivendi of withholding tax at source come. It noted that under the accrual basis method of accounting, income is reportable when all the events have occurred that fix the taxpayer’s right to receive the income and the amount can be determined with reasonable accuracy. Such method is allowed by law in reporting incomes.
Q81.4. May a withholding agent file a claim for tax refund? Generally, the person entitled to claim a tax refund is the taxpayer. However, if the taxpayer does not file the claim, the withholding agent may file the same. In CIR V. SMART COMMUNICATIONS [AUGUST 25, 2010], it was submitted that rule allowing the withholding agent to file the claim is applicable only when the withholding agent and the taxpayer are related parties. The Supreme Court disagreed and stated that such relationship is not required. A withholding agent has a legal right to file a claim for refund. First, he is considered a taxpayer under the Tax Code as he is personally liable for the withholding tax as well as for deficiency assessments, surcharges, and penalties, should the amount withheld be finally found
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to be less than the amount that should have been withheld. Second, as an agent of the taxpayer, his authority to file the income tax return and remit the tax withheld to the government includes the authority to file a claim for refund and to bring an action for recovery of such claim.
Q81.5. Is the withholding agent who filed the claim for tax refund obliged to remit the same to the taxpayer? Yes. In CIR V. SMART COMMUNICATIONS [AUGUST 25, 2010], the Supreme Court ruled that while the withholding agent has the right to recover the taxes erroneously or illegally collected, he nevertheless has the obligation to remit the same to the principal taxpayer under the principle of unjust enrichment. Q81.6. What are the three categories of income subject to withholding tax? Under Section 57 of the Tax Code, the types of income subject to withholding tax are divided into three categories: 1. withholding of final tax on certain incomes; 2. withholding of creditable tax at source and 3. tax-free covenant bonds.
Q81.7. What are the three withholding tax?
1. Final withholding tax (FWT) 2. Creditable Withholding Tax (WT) 3. Withholding Tax on Wages
Q82. Differentiate final withholding tax (FWT) from creditable withholding tax (CWT). The differences are as follows: FWT The amount of income tax withheld by the withholding agent is constituted as a full and final payment of the income tax due from the payee on the said income. The liability for payment
CWT Taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. Payee
PM REYES NOTES ON TAXATION I: INCOME TAX of the tax rests primarily on the payor as a withholding agent.
The payee is not required to file an income tax return for the particular income.
required to report the income and/or pay the difference between the tax withheld and the tax due on the income. The payee also has the right to ask for a refund if the tax withheld is more than the tax due. The income recipient is still required to file an income tax return, as prescribed in Sec. 51 and Sec. 52 of the NIRC.
(see Section 2.57(A) and (B), RR 2-98 [April 17, 1998] and CHAMBER OF REAL ESTATE AND BUILDER’S ASSOCIATION, INC. V. ROMULO [M ARCH 9, 2010])
Final Withholding Tax at Source Q83. What is meant by withholding tax at source? Since the withholding taxes are deducted by the withholding agent when the income payments are paid or payable, they are described as “withholding taxes-at-source.” This means that the income tax of the recipient of income is withheld and deducted at the source and at the time of accrual or payment of the expense by the withholding agent-payer of income.
Q83.1. What are the four general types of income payments subject to FWT? 1. Passive Incomes 2. Income payments to entities where their gross income is subject to tax (i.e. non-resident aliens not engaged in trade or business, non-resident foreign corporations, special aliens) 3. Fringe Benefits 4. Informer’s Reward to Persons Instrumental in the Discovery of the Violations of the Tax Code. (see Section 2.57.1, RR 2-98 [April 17, 1998])
Creditable Withholding Tax Q84. What is meant by creditable withholding tax?
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Under the CWT tax system, taxes withheld on certain payments are but intended to approximate the tax due from the payee. The withheld taxes remitted to the BIR are treated as deposits or advances on the actual tax liability of the taxpayer, subject to adjustment at the proper time when the actual tax liability can be fully and finally determined.
Q84.1. What are the three general types of creditable withholding taxes? The three types of creditable withholding taxes are: 1. Expanded withholding tax on certain income payments made by private persons to resident taxpayers (e.g. professional fees, income payments to brokers, income payments to partners of GPPs, etc) 2. Withholding tax on compensation income for services done in the Philippines 3. Withholding tax on money payments made by the government
Q84.2. What is the rule on creditable withholding of income payments to medical petitioners as laid down in RR 13-98 [August 14, 1998]? It shall be presumed that the hospital or clinic has collected the professional fee of the said medical practitioner and shall, accordingly, be liable for the withholding of the tax vis-a-vis each and every patient admitted into the hospital or clinic under the care of the said medical practitioner. However, the withholding tax shall not apply whenever there is proof that no professional fee has in fact been charged by the medical practitioner and paid by his patient,
Return and Payment of Tax Withheld at Source Q85. Who is obliged to file the return and pay the tax withheld? The withholding agent shall file the return and pay the tax: 1. FWT - within 25 days from the close of each calendar quarter for FWT 2. CWT - not later than the last day of the month following the close of the quarter during which withholding was made. (see Section 58(A), Tax Code)
PM REYES NOTES ON TAXATION I: INCOME TAX Q85.1. What are the other obligations of the withholding agent with respect to the return and payment of the tax withheld? 1. He shall furnish the recipient of the income a written statement showing the income or other payments made by him during such quarter or year, and the amount of the tax deducted and withheld therefrom. 2. He shall submit an annual information return containing the list of payees and income payments, amount of taxes withheld for each payee and other pertinent information. (see Section 58(B) and (C), Tax Code)
Q85.2. Since CWT is but an approximation, what happens if there is excess payment or deficiency in payment?
2. Compensation income of government employees with salary grades 1 to 3.
Q87. Who is obliged to deduct, withhold, file the return and pay the tax upon wages? Every employer making payment of wages shall deduct and withhold upon such wages the applicable 110 tax except in the case of minimum wage earners. (see Section 79(A), Tax Code) The return shall be filed and the payment made within 25 days from the close of each calendar quarter (see Section 81, Tax Code) However, if the employer is the Government or any political subdivision, agency, or instrumentality, the return of the amount deducted and withheld upon any wage shall be made:
The excess of the amount of tax so withheld over the tax due on his return shall be refunded.
1. by the officer or employee having control over the payment of such wage, or 2. by any officer duly designated for the purpose (see Section 82, Tax Code)
If the income tax collected at source is less than the tax due on his return, the difference shall be paid. (see Section 58(D), Tax Code)
Q87.1. What are the other obligations of the employer with respect to the withholding of tax on wages?
Q85.3. What is the effect of non-payment of CWT to the transfer of real property?
1. Every employer shall furnish to each such employee a written statement confirming wages paid by the employer during the calendar year and the amount of tax deducted and withheld
No registration of any document transferring real property shall be effected by the Register of Deeds unless the CIR or his duly authorized representative has certified that such transfer has been reported and the capital gains or CWT, if any, has been paid. (see Section 58(E), Tax Code)
Withholding on Wages
2. Every employer shall submit to the CIR an annual information return containing a list of employees, the total amount of compensation income of each employee, the total amount of taxes, accompanied by copies of the written statements, and other information as may be deemed necessary.
Q87.2. Who is liable if there is a failure to withhold and remit the correct amount of tax?
Q86. What income payments are exempted from the requirement of withholding tax on compensation? As provided in SECTION 2.78, RR 2-98 [APRIL 17, 1998], as amended by RR 1-2006 [DECEMBER 29, 2005]: 1. Compensation income of individuals that do not exceed the statutory minimum wage or P5,000 pesos per month, whichever is higher.
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The employer shall be liable. If he fails to withhold and remit the correct amount, such tax shall be collected from him together with penalties or additions to the tax otherwise applicable (see Section 80(A), Tax Code)
Minimum wage earners are exempt from income tax.
PM REYES NOTES ON TAXATION I: INCOME TAX Q87.3. What is the consequence if the employer fails to deduct and withhold the tax but the tax against which such tax may be credited is paid (the tax is paid by the recipient)/employee)? If the employer fails to deduct and withhold the tax and thereafter the tax against which such tax may be credited is paid, the tax so required to be deducted and withheld shall not be collected from the employer. The employer shall not be relieved of liability for any penalty for non-compliance (see Section 79(A), Tax Code)
Q87.4. What is the rule when there is an overpayment of tax withheld on wages by the employer? If the overpayment was not deduced and withheld by the employer, he shall be given a refund or credit. If the overpayment was deducted and withheld by the employer, the employee shall be allowed a credit.
Q87.5. How can employees avail of personal and additional exemptions given that their compensation is subjected to withholding? On or before the date of commencement of employment with the employer, the employee shall submit to the employer a signed withholding exemption certificate relating to the personal and additional exemptions to which he is entitled. If there is a change of status, he may file a new exemption certificate within 10 days from such change. (see Section 79(D)(2), Tax Code)
Q87.6. What is the consequence if an employee fails or refuses to file an exemption certificate or wilfully supplies false or inaccurate information? The tax shall be collected from the employee including penalties or additions to the tax. Further, excess taxes withheld by the employer shall not be refunded to the employee but shall be forfeited to the government
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Q87.7. What is the withholding treatment when the husband and the wife each are recipients of wages? 1. The husband shall be deemed the head of the family and proper claimant of the additional exemption unless he explicitly waives this right in favor of his wife 2. Taxes shall be withheld from the wages of the wife with the schedule for zero exemption
Q88. Are backwages, allowances and benefits awarded in a labor dispute subject to withholding tax? Yes. Backwages, allowances, and benefits awarded in a labor dispute constitute remunerations for services that would have been performed by the employee in the year when actually received, or during the period of his dismissal from the service which was subsequently ruled to be illegal. The said back wages, allowances and benefits are subject to withholding tax on wages. (see RMC 39-2012 [August 3, 2012])
Q88.1. Who should withhold the tax due thereon? The employers are mandated to withhold taxes on wages and this includes those backwages, allowances, and benefits awarded in a labor dispute.
Q88.2. If the backwages, allowances, disputes are received by virtue of a labor dispute award through garnishment of debts due to the employer and other credits to which the employer is entitled to subject to withholding tax? In RMC 39-2012 [August 3, 2012], the CIR answered this question in the affirmative. Persons having control of the payment of wages or salaries are authorized to deduct and withhold upon such wages or salaries the withholding tax due thereon. In this case, the garnishees are the persons owning debts due to the employer or in possession or control of credits to which the employer are entitled. Accordingly, they are in control of the payment of backwages, allowances and benefits. Thus, in order to ensure the collection of the appropriate withholding taxes on wages, garnishees of a judgment award in a labor dispute are constituted as withholding agents
PM REYES NOTES ON TAXATION I: INCOME TAX with the duty of deducting the corresponding withholding tax on wages due thereon in an amount equivalent to five percent (5%) of the portion of the judgment award representing the taxable backwages, allowances and benefits.
Q89. What income payments made by the government are subject to withholding? Income payments, except any single purchase which is P10,000 and below, which are made by a government office, national or local, including 111 GOCCs, on their purchases of goods from local suppliers shall be subject to a withholding tax of 1%. (see Section 2.57.2(N), RR 2-98 [April 17, 1998])
Special Rules Minimum Corporate Income Tax Q90. What is the minimum corporate income tax (MICT?) A minimum corporate income tax of 2% of gross income shall be imposed on a domestic corporation and resident foreign corporation beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations when: 1. the MCIT is greater than the RCIT for the taxable year. 2. such operation has zero or negative taxable income (see Section 27(E), Section 28(A)(2), Tax Code and RR 9-98 [August 5, 1998], as amended by RR 122007 [October 10, 2007])
Q90.1. What is the purpose of MCIT? As held in the case of CHAMBER OF REAL ESTATE AND BUILDER’S ASSOCIATION, INC. V. ROMULO [M ARCH 9, 2010]), the primary purpose of any legitimate business is to earn a profit. Continued and repeated losses after operations of a corporation or consistent reports of minimal net income render its financial statements and its tax payments suspect. For sure, 111
A GOCC which is listed as one of the top 5,000 corporations shall withhold the tax in its capacity as a GOCC rather than as one of the top 5,000 corporations.
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certain tax avoidance schemes resorted to by corporations are allowed in our jurisdiction. The MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax evasion and minimizes tax avoidance schemes achieved through sophisticated and artful manipulations of deductions and other stratagems. Since the tax base was broader, the tax rate was lowered.
Q90.2. Is MCIT a tax on capital and an additional tax imposition? The Supreme Court in CHAMBER OF REAL ESTATE AND BUILDER’S ASSOCIATION, INC. V. ROMULO [M ARCH 9, 2010] answered this in the negative. The MCIT is imposed on gross income which is arrived at by deducting the capital spent by the corporation in the sale of its goods, i.e. the cost of goods and other direct expenses from gross sales. Thus, the capital is not being taxed. Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the RCIT.
Q90.3. What is the difference between RCIT and MCIT? The tax base of RCIT is taxable income while the tax base of MCIT is gross income. In COMMISSIONER VS. PAL [JULY 7, 2009], PAL under PD 1590 (its franchise) was liable only for basic corporate income tax or franchise tax, whichever is lower and this is in lieu of all other taxes, except real property. The CIR contends that PAL is subject to MCIT while it was the contention of PAL that the MCIT was included in the “in lieu of all other taxes” provision. The Supreme Court noted there is a distinction between taxable income, which is the basis for basic corporate income tax; and gross income, which is the basis for the MCIT under Section 27(E). The two terms have their respective technical meanings, and cannot be used interchangeably. Hence, the basic corporate income tax cannot cover MCIT since the basis for the first is the annual net taxable income; while the basis for the second is gross. Thus, MCIT is included in “all other taxes” from which PAL is exempted.
Q90.4. For purposes of MCIT, what is gross income? As provided in RR 9-98 [August 5, 1998], as amended by RR 12-2007 [October 10, 2007]:
PM REYES NOTES ON TAXATION I: INCOME TAX For purposes of MCIT, the term "gross income" means gross sales less sales returns, discounts, and allowances and cost of goods sold, in case of sale of goods, or gross revenue less sales returns, discounts, allowances and cost of services/direct cost, in case of sale of services. Note that “cost of goods sold” shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use while “cost of services” shall mean all direct costs and expenses necessarily incurred to provide 112 the services required by the customs and clients. As noted by the Supreme Court in COMMISSIONER VS. PAL [JULY 7, 2009], inclusions and exclusions/deductions from gross income for MCIT purposes are limited to those directly arising from the conduct of the taxpayer’s business. It is thus more limited than the gross income used in the computation of basic corporate income tax. Q90.4.1.
What if apart from the income from core business activities, other items of gross income are realized or earned by the corporation, are these items included as part of gross income?
Yes. If apart from deriving income from these core business activities there are other items of gross income realized or earned by the taxpayer during the taxable period which are subject to the normal corporate income tax, the same items must be included as part of the taxpayer's gross income for 113 computing MCIT.
Q90.5. Explain the carrying forward of excess MCIT against normal income tax. Any excess MCIT against the normal income tax is creditable within the next three (3) years from payment thereof. To illustrate: Year
Excess MCIT against RCIT
This only shows that deductions are not taken into account in MCIT. 113 This means that the term "gross income" will also include all items of gross income enumerated under Section 32(A) of the Tax Code, as amended, except income exempt from income tax and income subject to final withholding tax
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100,000 (tax to be 115 paid)
75,000 (tax to be 114 paid) 100,000 (tax to be paid) 60,000
In the year 2000, since the RCIT is greater than MCIT, the firm will have to pay the RCIT of P100,000. To this amount, the corporation can credit the excess MCIT is has so far which totals 65,000. The amount of income tax payable now becomes 35,000. Note that with respect to the excess MCIT of 25,000, that can be claimed as tax credit against the normal income tax up to the year 2001 or three years from payment of the MCIT in 1998 and only when the RCIT is greater than MCIT. You cannot credit the MCIT against the MCIT or other losses.
Q90.6. Can the imposition of MCIT be suspended? Yes, the Secretary of Finance can suspend its imposition on any corporation which suffers losses on 116 account of prolonged labor dispute, or because of 117 force majeure, or because of legitimate business 118 reverses.
Improperly Accumulated Earnings Tax (IAET) Q91. What is an improperly accumulated earnings tax? This is the income tax imposed on a corporation if its earnings and profits are accumulated (undistributed) instead of being divided and distributed to its stockholders. An improperly accumulated earnings tax (IAET) equal to 10% is imposed for each taxable year on the
This is the tax to be paid because MCIT > RCIT This Is the tax to be paid because MICT < RCIT Defined as losses arising from a strike staged by the employees which lasted for more than six (6) months within a taxable period and which has caused the temporary shutdown of business operations. 117 It means a cause due to an irresistible force as by "Act of God" like lightning, earthquake, storm, flood and the like. This term shall also include armed conflicts like war or insurgency. 118 It shall include substantial losses sustained due to fire, robbery, theft or embezzlement, or for other economic reason as determined by the Secretary of Finance. 115 116
PM REYES NOTES ON TAXATION I: INCOME TAX improperly accumulated taxable income of each corporation. It is imposed on domestic corporations which are 119 classified as closely-held corporations.
Q91.1. Define “improperly accumulated taxable income.” The term “improperly accumulated taxable income” means taxable income adjusted by: 1. 2. 3. 4.
Income exempt from tax Income excluded from gross income Income subject to final tax; and The amount of net operating loss carry-over deducted; and 5. Reduced by the sum of: a. dividends actually or constructively paid; and b. income tax paid for the taxable year c. amount reserved for the reasonable needs of 120 the business In relation to 5(c), RMC 35-2011 [March 14, 2011] states that the amount that may be retained, taking into consideration the reasonable needs of the business shall be 100% of the paid-up capital or the amount contributed to the corporation representing the par value of the shares of stock. Any excess 121 capital over and above the par shall be excluded.
Q91.2. What is the purpose and nature of IAET? The imposition of IAET discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed (see CYNAMID PHILIPPINES INC VS. CA [JANUARY 20, 2000])
Closely-held corporations are those corporations at least fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than twenty (20) individuals. Domestic corporations not falling under the aforesaid definition are, therefore, publicly-held corporations. 120 Added by RR 2-01. 121 For example, if only Dec 31, 2010, you have a paid-up capital of 100,000. You can only retain up to 100,000. A subsequent infusion of capital of 500,000 a week later cannot be considered.
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The IAET is being imposed in the nature of a penalty to the corporation for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by the corporation (see RR 2-01 [FEBRUARY 12, 2001]).
Q91.3. What corporations are subject to IAET? As a general rule, the IAET shall apply to every corporation formed or availed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits accumulate instead of being divided or distributed. As exceptions, the IAET shall not apply to: 1. Publicly-held corporations 2. Banks and other non-bank financial intermediaries; and 3. Insurance companies 4. GPPs 5. Non-taxable joint ventures 6. Enterprises registered under SEZs (see RR 2-01 [FEBRUARY 12, 2001]).
Q91.4. What is the main factor to consider in holding a corporation liable for IAET? The touchstone of the liability is the purpose behind the accumulation of the income and not the consequences of the accumulation. Thus, if the failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or undistributed earnings subject to the tax. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, the 10% improperly accumulated earnings tax shall be imposed. [see RR 2-01 [FEBRUARY 12, 2001]).
Q91.5. What circumstances are indicative of a purpose to avoid the income tax with respect to shareholders? The fact that any corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. (see Section 29(C)(1), Tax Code)
PM REYES NOTES ON TAXATION I: INCOME TAX Moreover, the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs (including reasonably anticipated needs) of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by the clear preponderance of evidence shall prove the contrary (see Section 29(C)(2), Tax Code) In CIR v. TUASON [M AY 15, 1989], the CIR assessed Tuason, Inc. for IAET. The CIR presumed that when Tuason, Inc. accumulated profits, the purpose was to avoid the income tax on its shareholders on the finding that it was a mere holding or investment company. Tuason contended it was for the purpose of expanding their business as a real estate broker. The Supreme Court ruled that Tuason was liable for IAET. Tuason was a mere holding company as it was not involved itself in the development of the subdivisions but merely subdivided its own lots and sold them for bigger profits. It derived its income from interest, dividends, and rental from the sale of realty. The touchstone of liability is the purpose behind the accumulation of the income and not the consequences of the accumulation. The company's failure to distribute dividends to its stockholders was clearly for reasons other than the reasonable needs of the business.
Q91.6. What is the “Immediacy Test?” In order to The Immediacy Test is used to determine the escape IAET, “reasonable needs” of business” in order to justify an dividends accumulation of earnings. Under this test, the term must be "reasonable needs of the business" are hereby declared construed to mean the immediate needs of the within 1yr business, including reasonably anticipated needs. from the The corporation should be able to prove an close of the immediate need for the accumulation of the earnings fiscal year. and profits, or the direct correlation of anticipated Otherwise, needs to such accumulation of profits. Otherwise, you will have to justify the such accumulation would be deemed to be not for the accumulation reasonable needs of the business, and the penalty tax would apply. In M ANILA WINE MERCHANTS V. CIR [FEBRUARY 20, 1984], Manila Wine Merchants (MWM) invested in several companies and bought shares in Wack Wack Golf and Country Club and likewise acquired US Treasury Bills. CIR found that MWM had unreasonably accumulated a surplus. On appeal, the CTA ruled that the purchase of shares were harmless. However, the CTA also ruled that the purchase of US Treasury Bills was in no way related to the business of importing and selling wines and
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ordered MWM to pay IAET on the said treasury bills. One of the contentions of MWM was that it will be used to aid its importations The Supreme Court ruled against MWM. It noted that the bonds were bought in 1951 and until 1961;; it was never used to aid MWM’s importations. To justify an accumulation of earnings and profits for the reasonably anticipated future needs, such accumulation must be used within a reasonable time after the close of the taxable year. In CYNAMID V. CA [JANUARY 20, 2000], Cynamid argued that the increase of working capital by a corporation justifies accumulating income. It invoked the Bardahl Formula which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the company though one operating cycle and pay all of its current liabilities and any extraordinary expenses reasonably anticipated. The Supreme Court ruled that, as stressed by American authorities, the formula is used only for administrative convenience and not a precise rule. The Court found that in companies where the formula was applied, they had operating cycles shorten than that of Cynamid. The ratio of current assets to current liabilities should be used to determine the sufficiency of working capital which ideally should be 2:1. Cyanamid’s ratio is 2.21:1 and, thus, there was no need to infuse working capital.
Q91.7. In determining if profits are reasonably accumulated for business needs, the intention of the taxpayer is reckoned at what time? It is reckoned at the time of accumulation. In M ANILA WINE MERCHANTS V. CIR [FEBRUARY 20, 1984], one of the contentions of MWM was that it held on to said bonds for several years to wait for 60% of its stock to be owned by Filipinos so it can purchase its own lot and building. The Supreme Court stated that to determine if profits are reasonably accumulated for business needs, the controlling intention is that manifested at the time of accumulation and not later ones. The second reason given by MWM was too indefinite and was a mere afterthought.
Q91.8. Are there ways by which to avoid liability from IAET? Yes, when the accumulation is justified by reasonable needs of the business such as: 1. Accumulation up to 100% of the paid-up capital
PM REYES NOTES ON TAXATION I: INCOME TAX 2. For definite corporate expansion projects or programs 3. For buildings, plants or equipment acquisitions 4. For compliance with a loan covenant or preexisting obligation under a legitimate business agreement 5. When there is a legal prohibition for its distribution 6. In the case of Philippine subsidiaries of foreign corporations, undistributed earnings intended or reserved for investments within the Philippines
Q91.9. Abbot-Phils, a domestic corporation, is a wholly owned The subsidiaries of foreign corporations are exempt subsidiary of Abbot-US, a nonfrom IAET provided that resident foreign corporation. after applying the Abbot-Phils claims that by virtue grandfather rule, they are of this, it is exempt from the IAET. not closely-held Is this contention correct? corporations. Yes. In BIR RULING 25-02 [JUNE 25, 2002], the CIR ruled that Abbot-Phils was exempt from IAET. Since Abbott-Phils. is a wholly-owned subsidiary of AbbottUS, such shares will be considered as being owned proportionately by the Abbott-US shareholders. The ownership of a domestic corporation for purposes of determining whether it is a closely held corporation or a publicly held corporation is ultimately traced to the individual shareholders of the parent company. Thus, where at least 50% of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote in a corporation is owned directly or indirectly by at least 21 or more individuals, the corporation is considered publiclyheld corporation. As of the year-end 2000, Abbott-US had 101,272 shareholders holding a combined 1,545,934,133 shares of common stock and the twenty largest shareholders of Abbott-US as of September 30, 2001 own an aggregate of 30.1 percent of Abbott-US' issued and outstanding shares. Thus, Abbot-Phils is a publicly-held corporation exempt from IAET.
Fringe Benefit Tax Q92. What is a fringe benefit tax? The State imposes a final tax of 32% effective January 1, 2000 on the grossed-up monetary value of fringe benefit furnished or granted to the employee except rank and file employees by the employer, whether an individual, professional partnership or a corporation regardless of whether
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the corporation is taxable or not, or the government and its instrumentalities except when: 1. The fringe benefit is required by the nature of or necessary to the trade, business or profession of the employer; or 2. When the fringe benefit is for the convenience or advantage of the employer (see Section 33, Tax Code and RR 3-98 [JANUARY 1, 1998])
Q92.1. What is a fringe benefit? As defined by Section 33(B), the term “fringe benefit” means 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 as defined herein) such as, but not For educ. limited to, the following: discounts given to 1. Housing; — for short-term only ø teachers for 2. Expense account; their 3. Vehicle of any kind; 4. Household personnel, such as maid, driver and children, the general rule others; is that it is 5. Interest on loan at less than market rate to the not FB if extent of the difference between the market rate such and actual rate granted; scholarship 6. Membership fees, dues and other expenses was given borne by the employer for the employee in social by virtue of a and athletic clubs or other similar organizations; screening 7. Expenses for foreign travel;— trade related ø and because 8. Holiday and vacation expenses; of the 9. Educational assistance to the employee or his employee — connected to trade + service contract ø dependents; and 10. Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.
Q92.2. What is the rationale behind the Fringe Benefits Tax? As a general rule, the income recipient is the person liable to pay the income tax. In order to improve collection of income on the compensation income of employees, the State requires the employer to withhold the tax upon payment of the compensation income. However, it has been observed that many of the fringe benefits paid by the employer to his employees are not subjected to income tax and withholding tax on compensation. To plug this loophole, RA 8424 was passed. It imposed a fringe benefits tax on the fringe benefits received by
PM REYES NOTES ON TAXATION I: T INCOME TAX FB no longer form part of the income of the employee since FBT is a final tax for which the employer is paying already.
supervisory and managerial employees. The law mandates that the employer shall assume the fringe benefits tax imposed on the taxable fringe benefits of 122 123 the managerial or supervisory employees, but allows the employer to deduct such fringe benefit tax as a business expense from its gross income. However, the fringe benefits of rank-and-file 124 employees are treated as part of his compensation income, which must be withheld and deducted by his employer from the compensation income of the employee.
Q92.3. What is meant by “grossed-up monetary value of the fringe benefit?” As defined in RR 3-98 [JANUARY 1, 1998], the grossed-up monetary value of the fringe benefit represents the whole amount of income received by the employee which includes the net amount of money or net monetary value of property which has been received plus the amount of the fringe benefit tax thereon otherwise due from the employee, but paid by the employer for and in behalf of his 125 employee. Q92.3.1. How is the grossed-up The tax paid is the difference monetary value of the fringe between the monetary value and the benefit determined? gross monetary value. The formula It is determined by dividing the actual monetary value is applied in of the fringe benefit by 68% (effective January 1, order to 2000.) preserve the full value of Q92.3.2. Is the above formula absolute? the fringe benefits and No. In the case of non-resident aliens not engaged in at the same trade or business and alien and Filipino individuals time satisfy employed in RHQs, ROHQs of MNCs, OBUs and the tax petroleum subcontractors, the grossed-up value of liability (e.g. the fringe benefit shall be determined by dividing the you cannot actual monetary value of the fringe benefit by the give a car difference between one hundred percent (100%) and and tell the employee to under their respective rates of income tax.
Q92.4. Are all fringe benefits subject to FBT? No. The following fringe benefits are not taxable: 1. Fringe benefits exempted by law 2. Benefits required by the business or for the convenience of the employer 3. Benefits given to the rank and file employees; and 126 4. De minimis benefits This holds true only when both are related parties. Transfer Pricing However, where A is not subject to income (e.g. tax holiday), then overpricing becomes an issue.
Q93. What is transfer pricing?
The principle behind TP is It is the power of the CIR to distribute, apportion, that you allocate, and shift income and expenses between want what is related taxpayers to reflect their true taxable income an or to prevent evasion of taxes. acceptable tax between At present, the Philippines does not have any the parties. guidelines on transfer pricing unlike in other jurisdictions. RMC 026-08 [March 24, 2008] states that while the BIR is still revising the final draft of the RR on transfer pricing, the BIR as a matter of policy subscribes to the OECD Transfer Pricing Guidelines in the interim.
Q93.1. GSK purchase a pharmaceutical ingredient from Adechsa, a related non-residency company for between $1,512 and $1,651 per kg. During the same period, two Canadian pharmaceutical companies purchase the same ingredient for between $194 and $304 per kg from arm’s length suppliers. Canada’s minister for internal revenue reassessed GSK because the prices it paid for the ingredient were greater than an amount that would have been reasonable in the circumstances had they been dealing at arm’s length. GSK argues the License and Supply Agreement it entered with Adechsa should be considered in determining if it is an arm’s length transaction. Is GSK’s contention correct?
leave behind three 122 A managerial employee refers to one who is vested with powers or prerogatives to lay down and execute management policies wheels to pay for the and/or to hire, transfer, suspend, lay-off, recall, discharge, assign or discipline employees tax.) 123 A supervisory employee is one who, in the interest of the employer, effectively recommends such managerial actions if the exercise of such authority is not merely routinary or clerical in nature but requires the use of independent judgment. 124 A rank-and-file employee means all employees who are holding neither managerial or supervisory position 125 The purpose of getting the grossed-up monetary value is to preserve the benefit to the employer as a whole.
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For the discussion of this, see Q15.6
RR — Advance Pricing Agreement — get someone to say that the amount (though seemingly overpriced) is acceptable because of certain circumstances; Doctrine of HM v. PM GlaxoSmithKline
REYES NOTES ON TAXATION I: INCOME TAX Q93.1.1.
Yes. As held by the Supreme Court of Canada in HM V. GLAXOSMITHKLINE [2012 SCC 52, OCTOBER 18, 2012], a proper application of the arm’s length principle requires that regard be had for the “economically relevant characteristics” of the arm’s length and non-arm’s length circumstances to ensure they are “sufficiently comparable.” The “economically relevant characteristics of the situations being compared” may make it necessary to consider other transactions that impact the transfer price under consideration. Such circumstances will include agreements that may confer rights and benefits in addition to the purchase of property where those agreements are linked to the purchasing agreement. The objective is to determine what an arm’s length purchaser would pay for the property and the rights and benefits together where the rights and benefits are linked to the price paid for the property. In this case, GSK was paying for at least some of the rights and benefits under the Licence Agreement as part of the purchase prices for ranitidine from Adechsa. As such, the Licence Agreement could not be ignored in determining the reasonable amount paid to Adechsa which applies not only to payment for goods but also to payment for services.
Q93.2. What is the “arm’s length bargaining standard” with respect to the determination of the taxable income on inter-company loans or advances in relation to transfer pricing? RMC 026-08 [M ARCH 24, 2008] adopts the arm’s length standard as the ultimate test for determining the fairness of related party transactions. The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm’s length with another uncontrolled taxpayer. Basically two unrrelated parties selling similar Thus, where a member of a group of controlled entities makes a loan or advances directly or indirectly or becomes a creditor of another member of such group and charges no interest, or chargest interest at a rate which is not equal to an arm’s-length 127 rate, the CIR may make appropriate allocations to reflect an arm’s length interest rate for use of such loan or advance.
The arm's length interest rate shall be the rate of interest which was charged or would have been charged at the time the indebtedness arose in independent transaction with or between unrelated parties under similar circumstances.
Filinvest Development Corporation (FDC) extended advances in favour of its affiliate. The BIR assesses FDC for deficiency income by unilaterally imputing an “arm’s length” interest rate on its advances. FDC disputes this by saying the CIR lacks authority to impute theoretical interest and the rule is that interests cannot be demanded in the absence of a stipulation to that effect. Is FDC’s contention correct?
Yes. According to the case of CIR V. FILINVEST DEVELOPMENT CORPORATION [JULY 19, 2011], Despite the seemingly broad power of the CIR to distribute, apportion and allocate gross income under Section 50, the same does not include the power to impute theoretical interest even with regard to controlled taxpayers’ transactions. This is true even if the CIR is able to prove that the interest expense was in fact claimed by FDC. The term in the definition of gross income that even those income “from whatever source derived” is covered still requires that there must be actual or at least probable receipt or realization of the time of gross income sought to be apportioned, distributed or reallocated. Finally, under the Civil Code, no interest shall be due unless 128 expressly stipulated in writing.
Q93.3. Is transfer pricing applicable only to taxable entities No. Section 50 does not apply only to taxable entities. Reallocation may also apply to tax-exempt organizations. (see RMC 026-08 [M ARCH 24, 2008])
Special Entities Proprietary Educational Institutions and Hospitals Q94. What is the tax treatment of proprietary education institutions and hospitals which are non-profit?
Reconcile Sec.30 (activity for profit) & Article XIV of the Constitution (utilization) — harmonized in the sense that your activity is for the benefit of profit-making and not exclusively for educational/charitable purposes. However, if it was income from profit, then there would be contradiction with C.
The case would have been decided differently if we had an RR on Transfer Pricing.
100M derived from the education business. 60% is dedicated for non-educational purposes. Under Sec.27, the 50% rule applies on (1) non-stock, proprietary schools PIERRE MARTIN DE LEON REYES and (2) non-stock, non-proprietary hospitals. 69 — The source has to arise from the primary purpose. Income should be generated by the educational purpose. Otherwise, it is not shielded by the 10% benefit.
PM REYES NOTES ON TAXATION I: INCOME TAX Section 27(B) of the Tax Code provides that they shall pay a tax of 10% on their taxable income except: 1. Certain passive incomes subject to final tax 2. If the gross income from unrelated trade, 129 business, or other activity exceeds 50% of the total gross income derived by such 130 proprietary educational institution and hospital which are non-profit from all sources, the tax shall be imposed on the entire taxable income.
Q94.1. What is meant by the terms “proprietary” and “non-profit?” Proprietary means private while non-profit means no net income or asset accrues to or benefits any member or specific person, with all the net income or asset devoted to the institution’s purposes and all its activities. As noted by the Supreme Court IN CIR V. ST. LUKES MEDICAL CENTER [SEPTEMBER 26, 2012], ―non-profit‖ does not necessarily mean ―charitable.‖
Q94.2. St. Lukes Medical Center is a hospital organized as a non-stock and non-profit corporation. It admits both paying and nonpaying patients. The CIR claimed that St. Lukes was liable for income tax at 10% as provided under Section 27(B)131 of the NIRC. St. Lukes argues that it is a nonstock, non-profit institution for charitable and social welfare purposes exempt from income tax under Section 30(E) and (G) of the NIRC.132 Decide.
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. 130 Is any private schoolm maintained and administered by private individuals or groups with an issued permit to operation from the Department of Education or CHED, or TESDA, as the case may be 131 Section 27(B) provides that proprietary educational institutions and hospitals which are non-profit shal pay a tax of ten percent (10%) on their taxable income 132 Section 30(E), NIRC provides that a non-stock corporation or association organized and operated exclusively for charitable purposes is exempt from income tax while Section 30(G) provides that a civic league or organization not organized for profit but operated exclusively for the promotion of social welfare is likewise exempt.
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In CIR V. ST. LUKES MEDICAL CENTER [SEPTEMBER 26, 2012], the Supreme Court ruled that St. Lukes cannot claim full tax exemption under Section 30 because it has paying patients and this is notwithstanding the fact that it is a non-profit hospital. For Section 27(B) to apply, the hospital must be nonprofit which means that no net income or asset accrues to or benefits any member or specific person and all the activities of the hospital are non-profit. On the other hand, Section 30(E) and (G), while providing for an exemption is qualified by the last paragraph which, in turn, provides that activities conducted for profit shall be taxable. Section 30(E) and (G) requires that an institution be operated exclusively for charitable purposes to be completely exempt from income tax. In this case, however, St. Lukes is not operated exclusively for charitable purposes insofar as its revenues from paying patients are concerned. Such revenue is subject to income tax at 10% under Section 27(B).
Q94.3. Reconcile the tax treatment of proprietary educational institutions and hospitals which are non-profit under Section 27(B) and non-stock, non-profit charitable institutions under Section 30(E) and (G). To be exempt from income taxes, Section 30(E) requires that the charitable institution must be organized and operated exclusively for charitable purpose. It is nevertheless allowed to engage in ―activities conducted for profit‖ without losing its taxexempt status for its not-for-profit activities. The consequence, however, is that such income from activities conducted for profit, regardless of the disposition made of such income, shall be subject to tax. For proprietary educational institutions and hospitals which are non-profit, to avail of the preferential tax rate, no net income or asset accrues to or benefits any member or specific person, with all the net income or asset devoted to the institution’s purposes and all its activities. Thus, in CIR V. ST. LUKES MEDICAL CENTER [SEPTEMBER 26, 2012], while the St. Lukes did not qualify as a non-profit, non-stock charitable institution under Section 30(E) as it was not operated exclusively for charitable purposes, it remains to be a proprietary non-profit hospital under Section 27(E) as long as it does not distribute any of its profits to its
General Rule: non-stock, proprietary hospital, exempt from tax. Exception: You will be subject to 10% if you do things outside of your essential function (educ/ PM charity). — 30% imposed if more than 50% of your income arises from unrrelated business.
REYES NOTES ON TAXATION I: INCOME TAX
members and such profits are reinvested pursuant to its corporate purposes. St. Lukes, as a proprietary non-profit hospital, is entitled to the preferential tax rate of 10% on its net income from its for-profit activities.
GOCCs Q95. Are GOCCs, agencies and instrumentalities owned and control by the government liable to pay income tax? Passive income is not part of the exempted income. All corporations, agencies, or instrumentalities owned or controlled by the government shall pay such rate of tax upon their taxable income except: 1. 2. 3. 4. 5.
GSIS SSS Phil Health 133 Local Water Districts PCSO
(see Section 27(C), Tax Code)
Q95.1. Is RA 9337 constitutional insofar as it excluded PAGCOR from the enumeration of GOCCs exempt from the payment of corporate income tax? Yes. In PAGCOR V. BIR [M ARCH 15, 2011], the Supreme Court held that the original exemption of PAGCOR from corporate income tax was not made pursuant to a valid classification based on substantial distinction so that the law may operate only on some and not on all. Instead, the same was merely granted to the acquiescence of the House Committee on Ways and Means to the request of PAGCOR. The argument that the withdrawal of the exemption violates the non-impairment clause will not hold since any franchise is subject to amendment, alteration or 134 repeal by Congress.
Inserted by RA 10026. The Court, however, made clear that PAGCOR remains to be exempt from indirect taxes. 134
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Exempt Corporations Q96. What are the exempt corporations enumerated in Section 30 of the Tax Code? 1. Labor, agricultural or horticultural organization not organized principally for profit 2. Mutual savings bank not having a capital stock represented by shares and cooperative bank without capital stock organized and operated for mutual purposes and without profit 3. A beneficiary society, order or association, operating for the exclusive benefit of the members such as a fraternal organization operating under the lodge system, or a mutual aid association or a non-stock corporation organized by employees providing for the payment of life, sickness, accident, or other benefits exclusively to the members of such society, order, or association, or non-stock corporation or their dependents 4. Cemetery company owned and operated exclusively for the benefit of its members 5. Non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inure to the benefit of any member, organizer, officer or any specific person 6. Business league, chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual 7. Civil league or organization not organized for profit but operated exclusively for the promotion of social welfare 8. A non-stock and non-profit educational institution 9. Government educational institution 10. Farmers or mutual typhoon or fire insurance company, mutual ditch or irrigation company, mutual or cooperative telephone company or like organizstion of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses; and 11. Farmers, fruit growers, or like association organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity of produce finished by them.
PM REYES NOTES ON TAXATION I: INCOME TAX Q96.1. Are recreational from income tax?
No. As clarified by RMC 35-2012 [AUGUST 3, 2012], clubs which are organized and operated exclusively for pleasure, recreation, and other non-profit purposes (hereinafter referred to as "recreational clubs") are not exempt from income tax. The provision in the National Internal Revenue Code of 1977 which granted income tax exemption to such recreational clubs was omitted in the current list of tax exempt corporations under National Internal Revenue Code of 1997, as amended.
No. In CIR V. G. SINCO EDUCATIONAL CORP [OCTOBER 23, 1956], the Supreme Court held that the amount of fees charged by the school depends upon the policy and a given administration at a given time and is not conclusive of the purposes of the institution. It does not in itself make a school a profit-making enterprise. Q96.1.2.
Q96.2. A credit cooperative was assessed deficiency withholding tax on interest from savings and time deposits of its members. The CTA ruled against the credit cooperative stating that withholding tax on income payments subject to FWT includes said interests as “interests from similar arrangements.” Is CTA’s ratio correct? No. Since interest from any Philippine currency bank deposit yield or any other monetary benefit from deposit substitutes are paid by banks, other entities such as cooperative are not required to withhold the corresponding tax on the interest from savings and time deposits of its members. The fact that “similar arrangements” is preceded by banking terms means that those subject to withholding must have deposit peculiarities. This is also consistent with the preferential treatment accorded to members of cooperatives who are exempt in the same way as the cooperative themselves. (see DUMAGUETE CREDIT COOPERATIVE V. CIR [JANUARY 22, 2010]).
Q96.3. Are all the activities of corporations enumerated in Q90 exempt from tax? No. Notwithstanding that they are exempt corporations, the income of whatever kind and character of the organizations mentioned above from any of their properties, real or personal, or form any of their activities conducted for profit regardless of the disposition made of such income shall be subject to tax imposed under the Code.
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If a non-stock, non-profit educational institution charges tuition and other fees for the different services it renders, does the institution lose its tax-exempt status?
What is the difference in tax treatment on interest income from currency bank deposits and yield, etc and on interest income from a depository bank under the EFCDS of nonstock, non-profit corporations and non-stock, non-profit educational institutions?
As provided in RMC 76-03 [November 14, 2003]: For non-stock non profit corporation, their interest income from currency bank deposits and yield or any other monetary benefit from deposit substitute instruments and from trust funds and similar arrangement, and royalties derived from sources within the Philippines are subject to the 20% final withholding tax and interest income derived by them from a depository bank under the expanded foreign currency deposit system shall be subject to 71/2% final withholding tax. Unlike non-stock, non-profit corporations, their interest income from currency bank deposits and yield from deposit substitute instruments used actually, directly and exclusively in pursuance of their purposes as an educational institution, are exempt from the 20% final tax and 7 ½% tax on interest income under the expanded foreign currency deposit system imposed provided they submit on an annual basis submit to the Revenue District Office concerned an annual information return and duly audited financial statement together with the following: 1. Certification from their depository banks as to the amount of interest income earned from passive investment not subject to the 20% final withholding tax and 7 ½% tax on interest income
PM REYES NOTES ON TAXATION I: INCOME TAX under the expanded foreign currency deposit system. 2. Certification of actual utilization of the said income; and 3. Board Resolution by the school administration on proposed projects to be funded out of the money deposited in banks or placed in money markets, on or before the 14th day of the fourth month following the end of its taxable year.
Q96.4. Enumerate some special laws granting exempt status to certain types of corporations 1. Executive Order 226 (Article 39) or the Omnibus Investment Code
thereof, 5% of the gross income earned by all business enterprises within the ECOZON shall be paid and remitted as follows: i. 3% to the National Government ii. 2% to the Treasurer’s office of the municipality of city where the enterprise is located. 3. RA 9178 or the Barangay Micro Business Enterprises Act Final tax on certain passive income is not exempt. All BMBEs shall be exempt from tax for income arising from the operations of the enterprise.
4. RA 9593 (Section 4 & 86, 88) or Tourism Act
Registered Enterprises are granted an Income Tax Holiday as follows:
a. New enterprises in Greenfield and Brownfield 137 Tourism Zones shall, from the start of business operations, be exempt from tax on income for a period of six (6) years. This income tax holiday may be extended if the enterprise undertakes a substantial expansion or upgrade of its facilities prior to 138 the expiration of the first six (6) years. b. These enterprises shall likewise be allowed to carry over as deduction from the gross income for the next six (6) consecutive years immediately following the year of the loss, their net operating losses for any taxable year immediately preceding the current taxable year which had not been previously offset as deduction from gross income. c. An existing enterprise in a Brownfield Tourism Zone shall be entitled to avail of a non-extendible income tax holiday if it undertakes an extensive expansion or 139 upgrade of facilities. d. In lieu of all other national and local taxes, license fees, imposts and assessments, except real estate taxes and such fees as may be imposed by the TIEZA, a new
a. For six (6) years from commercial operation for pioneer firms and four (4) years for nonpioneer firms, new registered firms shall be fully exempt from income taxes levied by the National Government. This tax exemption will be extended for another year in each of the following cases: i. the project meets the prescribed ration of capital equipment to number of workers set by the BOI ii. utilization of indigenous raw materials at rates set by the BOI iii. the net foreign exchange savings or 135 earnings amount b. For a period of three (3) years from commercial operation, registered expanding firms shall be entitled to an exemption from income taxes levied by the National 136 Government. 2. RA 7916 (Sections 23 to 25) or the Special Economic Zone Act 137
a. Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu
A “Greenfield Tourism Zone” refers to a new or pioneer development, as determined by the TIEZA (Tourism Infrastructure and Enterprise Zone Authority) while a “Brownfield Tourism Zone” refers to an area with existing infrastructure or development as determined by the TIEZA. 138
No registered pioneer firm may avail of this incentive for a period exceeding eight (8) years. 136 During the period within which this incentive is availed of by the expanding firm it shall not be entitled to additional deduction for incremental labor expense.
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This extension shall consider the cost of such expansion or upgrade in relation to the original investment, but shall in no case exceed an additional six (6) years. 139 Such an income tax holiday shall consider the cost of such expansion or upgrade in relation to the original investment, but shall in no case exceed six (6) years to be counted from the time of completion of the expansion or upgrade.
Homeowners Association qualifications to be exempt from tax (Section 30).
PM REYES NOTES ON TAXATION I: INCOME TAX enterprise shall pay a tax of five percent (5%) on its gross income earned, which shall be distributed as follows: i. 1/3 to be proportionally allocated among affected LGUs ii. 1/3 to the National Government; and iii. 1/3 to the TIEZA
5. RA 9856 or the Real Estate Investment Trust (REIT) Act 140
A REIT shall be subject to income tax on its taxable net income defined in the Act as the pertinent items of gross income less all allowable deductions, less the dividends distributed by the REIT out of its 141 distributable income. In no case, shall the REIT be subject to MCIT. Note, however, that if the REIT (1) fails to maintain its status as a public company as defined in the Act; (2) fails to maintain the listed status of the investor securities on the Exchange; and (3) fails to distribute at least 90% of its distributable income, the income tax shall be imposed on taxable net income not as defined in the Act but as defined in the Tax Code.
Capital assets/income Assets/income
Q97.1. What are capital assets? The term capital assets means property held by the taxpayer (whether or not connected with his trade or business, except: 1. 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 2. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business 3. Property used in trade or business of a character that is subject to allowance for depreciation 4. Real property used in trade or business of the taxpayer (see Section 39 Tax Code, and Section 132, RR 2)
(see RR 13-2011 [JULY 25, 2011]) Q97.1.1.
If the gain is Capital Gains and Losses not covered by a specific Q97. What is the importance of knowing if an final tax, asset/income is capital or ordinary such gain or loss will constitute The tax treatment will vary depend on the nature of part of your the asset. For example, if real property is a capital gross incomeasset, the gain from the sale thereof shall be subject subject to to the final capital gains tax of 6%. If it is an ordinary income tax. asset, any gain from the sale thereof shall form part of the ordinary income which shall be subject either to graduated income tax rates (if an individual) or corporate income tax (if a corporation). CAPITAL LOSS CARRY-OVER — When you sell an asset below its value or the value your acquired it, it is considered a loss which can be carried over for the next 3 years.
A REIT is a stock corporation established principally for the purpose of owning income - generating real estate assets. 141 Dividends are allowed deductions.
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A inherited from his father an agricultural land. He had the land surveyed and subdivided into lots. Improvements, such as good roads, concrete gutters, drainage and lighting system, were introduced to make the lots saleable. Soon after, the lots were sold to the public at a profit. The Revenue examiner adjudged A as engaged in business as real estate dealers and required him to pay the real estate dealer’s tax and assessed a deficiency income tax on profits derived from the sale of the lots based on the rates for ordinary income and not as capital gains at capital gain rates. Is the Revenue Examiner correct?
Yes. The statutory definition of capital assets is negative in nature. If the asset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets. And
Shares of stock is different from stock in trade.
PM REYES NOTES ON TAXATION I: INCOME TAX necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the kind of asset involved in the transaction. In this case, the activities of A are indistinguishable from those invariably employed by one engaged in the business of selling real estate. One strong factor is the business element of development which is very much in evidence. A did not sell the land in the condition in which he acquired it. In the course of selling the subdivided lots, A engaged in the real estate business and accordingly, the gains from the sale of the lots are ordinary income taxable in full (see CALASANZ VS. COMMISSIONER [OCTOBER 9, 1986])
Q97.2. What are ordinary assets? The statutory definition of capital assets is negative in nature. If the asset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets Q97.2.1.
Y inherited from his mother several tracts of land. When his mother was still alive, these lands were subdivided into lots and leased. Y sold the leased lots to the occupants except for one lot which needed filling because of low elevation. Said lot was filled and subdivided into smaller lots and sold to the public. Y reported his income from the sales as long-term capital gains. The CIR denied this and ruled that Y was engaged in the business of leasing the lots and the subsequent sale are sales of real property used in trade or business of the taxpayer. Is the CIR correct?
Yes. In this case, the properties should be regarded as ordinary assets. When Y obtained by inheritance the parcels in question, transferred to him was not merely the duty to respect the terms of any contract thereon, but as well the correlative right to receive and enjoy the fruits of the business and property which the decedent had established and maintained. Under the circumstances, Y’s sales of the several lots forming part of his rental business cannot be characterized as other than sales of ordinary assets. The sales concluded on installment basis of the subdivided lots comprising the last lot do not deserve
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a different characterization for tax purposes. The following circumstances in combination show unequivocally that the petitioner was, at the time material to this case, engaged in the real estate business (see TUASON VS. LINGAD [JULY 31, 1974])
Q97.3. What is the tax consequence if the property is sold by a sellercorporation engaged in real estate business? 142
It depends. In BIR RULING 27-02 [JULY 15, 2002], the CIR was asked to rule on the tax consequences of certain transactions involving a seller that is engaged n real estate business but without any specification as to whether the property is capital or ordinary. The CIR stated that it is necessary to first determine the character of the real property being sold.
If the real property is a land or building which is not actually used in the business of the seller-corporation and is treated as a capital asset, , then a final tax of six percent (6%) shall be imposed on the gain presumed to have been realized on its sale, exchange or disposition of such land or building based on the gross selling price or fair market value, whichever is higher of such land and/or building. This rule applies, whether or not the seller-corporation is engaged in real estate business. If the real property being sold is an ordinary asset, withholding tax rates shall apply. The rate of withholding tax will depend on whether, first, the seller is exempt or taxable; second, whether the seller is habitually engaged in real estate business or not; and third, if the seller is habitually engaged in real estate business, the gross selling price.
Q97.4. Is an equity investment a capital asset? Yes. As ruled by the Supreme Court in CHINABANK V. CA [JULY 19, 2000], an equity investment is a capital, not ordinary, asset of the investor the sale or exchange of which results in either a capital gain or a capital loss.
This ruling also stated that registration with the HLURB or HUDCC shall be sufficient for a seller/transferor to be considered as habitually engaged in the real estate business. If the seller/transferor is not registered with HLURB or HUDCC, he/it may prove that he/it is engaged in the real estate business by offering other satisfactory evidence
PM REYES NOTES ON TAXATION I: INCOME TAX Net capital gain, net capital loss
Q97.5. Define net capital gain and net capital loss. Net Gain
the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges
Percentage taken into account PERIOD RULE
Q97.6. Is the capital gain from the sale or exchange of a capital asset always taxable in full? No. In the case of a taxpayer other than a 143 corporation, the following percentages of the gain upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain: 1. 100% if the capital asset has been held for not more than 12 months 2. 50% if the capital asset has been held for more than 12 months
Limitations on capital loss Q97.7. What is the allowable extent of losses from sales or exchanges of capitals assets? Losses from sales of exchanges of capital assets shall be allowed to be deducted only to the extent of the gains from such sales or exchanges. In CHINABANK V. CA [JULY 19, 2000], Chinabank made a 53% equity investment in the First CBC Capital (Asia) Ltd, a Hong Kong subsidiary. First CBC became insolvent. With BSP approval, Chinabank wrote-off the investment in its ITR as a bad debt or as an ordinary loss deductible from its gross income. The BIR disallowed the deduction on the basis that the debt was not worthless. The Supreme Court ruled that the equity investment is not indebtedness in the first place but rather capital, not an ordinary, asset. Shares of stock would be ordinary assets only to 143
The holding period is material only if the capital asset is sold by an individual. This does not apply to corporations.
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a dealer in securities or a person engaged in the purchase and sale of, or an active trader (for his own account) in, securities. In the hands, however, of another who holds the shares of stock by way of an investment, the shares to him would be capital assets. When the shares held by such investor become worthless, the loss is deemed to be a loss from the sale or exchange of capital assets. The Court further stated that assuming that the equity investment of CBC has indeed become "worthless," the loss sustained is a capital, not an ordinary, loss. The rule thus is that capital loss can be deducted only from capital gains. The capital loss sustained by CBC can only be deducted from capital gains if any derived by it during the same taxable year that the securities have become "worthless.
Determination of Gains or Loss from Sale or Transfer of Property Computation of Gain or Loss Q98. How is gain or loss from the sale or other disposition of property computed? The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain. The loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized.
Q98.1. Define “amount realized” Amount realized
the sum of the money received plus the fair market value of te property (other than money received).
Q98.2. When is gain or loss realized? Gain or loss arising from the acquisition and subsequent disposition of property is realized only when as the result of a transaction between the owner and another person the property is converted into other property that: 1. is essentially different from the property disposed of, and 2. has a market value.
PM REYES NOTES ON TAXATION I: INCOME TAX The requirement that the property received in exchange must be "essentially different from the property disposed of" implies that there must be a change in substance and not merely a change in 144 form. The term "market value" means the fair value of the property in money as between one who wishes to purchase and one who wishes to sell. It
Basis of Stocks and Securities acquired in Wash Sales
Cost or basis for determining gain or loss Q99. Define “basis” Basis
1. The cost thereof in the case of property acquired on or after March 1, 1913, if such property was acquired by purchase; 2. The FMV as of the date of acquisition if the same was acquired by inheritance 3. If the property was acquired by gift, the basis shall be the same as if it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift except if such basis is greater than FMV of the property at the time of the gift then, for purpose of determining loss, the basis shall be such FMV; 4. If the property was 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 5. The basis as defined in paragraph (C)(5) of Section 40 if the property was acquired in a transaction where the gain or loss is not recognized under paragraph (C)(2) of Section 145 40.
By way of illustration, if a taxpayer owning ten shares of stock exchanges his stock certificate for a voting trust certificate, no income is realized. 145 This refers to the basis used in tax-free exchanges
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[see Section40(B) Tax Code and RR-2] The basis of the substantially identical stock so sold or disposed of, increased or decreased, as the case may be, by the difference, if any, between the price at which the stock or securities was acquired and the price at which such substantially identical stock or securities were sold or otherwise disposed of. [see Section 143, RR 2]
Exchange of Property Exchanges) A — (6M) B — (10M) C
Under 40(c), the transactions are all not in cash. This is
Definitions not taxable to the extent that taxpayer does not have the wherewithal to pay.
Q100. For purposes of Section 40, define the following terms: Securities
Merger or Consolidation
Means bonds and debentures but not notes of whatever class or duration Shall be understood to mean (i) the ordinary merger or consolidation or (ii) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock. For a transaction to be regarded as a merger or consolidation under Section 40: 1. It must be undertaken for a bona fide business purpose and not solely for escaping the burden of taxation 2. In determining if a bona fide transaction exists, the whole transaction or series of transactions shall be treated as a single unit and every step of the transaction shall be considered 3.In determine if the property transferred constitutes a
PM REYES NOTES ON TAXATION I: INCOME TAX
substantial portion of the property of the transferor, property shall be taken to include cash assets Means ownership or stocks in a corporaion possessing at least 51% of the total voting power of all classes of stock entitled to vote
Q101. What are considered exchanges?
As a general rule, the entire amount of the gain or loss shall be recognized upon the sale or exchange of property The exceptions (tax free exchanges) are: 1. No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation: a. A corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation, which is a party to the merger or consolidation b. A shareholder exchanges stock in a corporation, which is a party to a merger or consolidation solely for the stock of another corporation also a party to a merger or consolidation c. A security holder of a corporation, which is a party to a merger or consolidation, exchanges his securities in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation 2. No gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation of which as a result of such exchange, said person, alone or together with others, not exceeding four (4) persons gains control of said corporation provided that stocks issued for services shall not be considered as issued in return for property.
Merger or Consolidation Q101.1. A, B, C were majority stockholders of ABC Theatrical
PIERRE MARTIN DE LEON REYES
CIR v. Rufino — there must be a business purpose. There has to be a time deferential between the exchange of shares of two companies, and the distribution of such shares to the shareholder.
Co. They were also majority stockholders of XYZ Theatrical Co which was engaged in the same business. ABC and XYZ agreed to merge. Under the agreement, all business, property, assets and goodwill of ABC will be transferred to XYZ in exchange for XYZ stocks for each stock held in ABC. Is the exchange subject to capital gains tax?
No. As held in CIR v. RUFINO [FEBRUARY 27, 1987], It is well established that where stocks for stocks were exchanged, and distributed to the stockholders of the corporations, parties to the merger or consolidation, pursuant to a plan of reorganization, such exchange is exempt from capital gains tax. The basic consideration, of course, is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The criterion laid down by the law is that the merger" must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation." It is clear, in fact, that the purpose of the merger was to continue the business of the Old Corporation, whose corporate life was about to expire, through the New Corporation to which all the assets and obligations of the former had been transferred. The exemption from the tax of the gain derived from exchanges of stock solely for stock of another corporation was intended to encourage corporations in pooling, combining or expanding their resources conducive to the economic development of the country. The merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the letter and intendment of the NIRC exempting from the capital gains tax exchanges of property.
Transfer of property for shares of stock Q101.2. Filinvest Development Corporation (FDC), a holding company, is the owner of 80% of the outstanding shares of Filinvest Alabang, Inc. (FAI) and 67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). FDC and FAI entered into a Deed of Exchange with FLI
UPSTREAM MERGER — treated as a donation.
PM REYES NOTES ON TAXATION I: INCOME TAX whereby the former both transfer in favor of the latter parcels of land in exchange for shares of stock of FLI. The CIR argues that the taxable gain should be recognized for the exchange as FDC’s controlling interest in FLI was decreased as a result of the exchange. Is the CIR’s contention correct? No. The Supreme Court in CIR V. FILINVEST DEVELOPMENT CORPORATION (JULY 19, 2011] stated that the requisites for the non-recognition of gain or loss of a transfer of property for shares of stock are as follows: (a) the transferee is a corporation; (b) the transferee exchanges its shares of stock for property/ies of the transferor; (c) the transfer is made by a person, acting alone or together with others, not exceeding four persons; and, (d) as a result of the exchange the transferor, alone or together with others, not exceeding four, gains control of the transferee. Rather than isolating FDC, the shares issued to FDC should be appreciated in combination with the new shares issued to FAI. Together, FDC and FAI’s shares add to 70.99% of FLI’s shares. Since the term "control" is clearly defined as "ownership of stocks in a corporation possessing at least fifty-one percent of the total voting power of classes of stocks entitled to one vote, “ the exchange of property for stocks between FDC-FAI and FLI clearly qualify as a tax-free transaction.
Q101.3. ABC is a domestic corporation. Shareholders transferred their real property in exchange for more shares in the corporation. In effect, they gained control of more than 51% of the shares of the corporation entitled to vote. Is the exchange tax-exempt? 146
It depends. In BIR Ruling 274-87, the CIR ruled that no gain or loss would be recognized if property is transferred to a corporation by a person in exchange for stock in such a corporation of which as a result of such exchange, said person alone or together with others, not exceeding four persons, gains control of said corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of 146
stocks entitled to vote. In determining the 51% stock ownership, only those persons who transferred property for stock in the same transaction may be counted up to a maximum of five.
Transfer of “substantially all” the assets Statutory Q101.4. What is a de facto merger?
To constitute a de facto merger, the following de facto elements must concur: merger — always a 1. There must be a transfer of all or corporation. substantially all of the properties of the transferor corporation solely for stock, and 2. It must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation. (see RMC 1-02 [April 25, 2002])
Q101.5. What is meant by “substantially all”? As provided by RR 2, "substantially all" means the acquisition by one corporation of at least 80% of the assets, including cash, of another corporation, which has the element of permanence and not merely momentary holding
Q101.6. What are the differences between a de facto merger and a statutory (ordinary) merger? In a de facto merger, the Transferor is not automatically dissolved unlike in the case of a statutory merger. Likewise, there is no automatic transfer to the Transferee of all the rights, privileges, and liabilities of the Transferor in the case of de facto merger.
Q101.7. What are the similarities and differences between a de facto merger and a transfer of property for shares under Section 40(C)(2) of the Tax Code? De facto merger is in procedure similar to a transfer to a controlled corporation under the same Section 40(C)(2) of the Tax Code of 1997, except that at least 80% of the Transferor's assets, including cash, are transferred to the Transferee, with the element of permanence and not merely momentary holding.
Note that in this BIR Ruling, there were 6 transferors,
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merger — control requirement
PM REYES NOTES ON TAXATION I: INCOME TAX However, a de facto merger and a transfer to a controlled corporation are different in that, (1) the Transferor in a de facto merger is a corporation, while in a transfer to a controlled corporation, the Transferors may either be a corporation or an individual, and (2) in a de facto merger, there is no requirement that the transferor gains control (that is, 51% of the total voting powers of all classes of stocks of the Transferee entitled to vote) of the Transferee as a prerequisite to enjoying the benefit of nonrecognition of gain or loss. What is essential in a de facto merger is that the Transferee acquires all or substantially all of the properties of the Transferor. (see RMC 1-02 [April 25, 2002])
Administrative Requirements in case of tax-free exchanges Q101.8. What are the administrative requirements in case of tax-free exchanges? 1. The parties who are applying for confirmation that the transaction is indeed a tax-free exchange shall submit the following: a. A sworn certification on the basis of the property to be transferred b. Certified true copies of the TCT and/or CCT of real properties transferred c. Certified true copies of the corresponding latest Tax Declaration of the real properties to be transferred d. Certified true copies of the certificates of stocks evidencing shares of stocks to be transferred e. Certified true copy of the inventory of other property/ies to be transferred/ 2. The BIR shall issue a certification or ruling confirming that an exchange of property for shares complies with the requisites for it to be tax-free. The certification or ruling shall contain the substituted basis of the properties. 3. The Certificate Authorizing Registration (CAR) or Tax Clearance (TCL) shall be issued by the RDO/Authorized Internal Revenue Officer on the basis of the BIR certification or ruling 4. The information that the transaction is a tax-free exchange and the substituted basis of the properties shall be annotated in the TCT and/or CCT. 5. The applicant/taxpayer shall pay the processing and certification fee of P5,000 for each
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application not involving more than 10 real properties and/or certificates of stock. An additional P100 shall be paid for every TCT/CCT and/or certificate of stock in excess of 10. 6. Every official, agent, or employee of the Registry of Deeds and corporate secretary or the duly authorized officer of the corporation who fails to annotate the information shall be subject to a penalty.
Exchange not solely in kind Q101.9. What is the effect if the tax-free exchange is not solely in kind? 1. If an individual, shareholder, security holder or corporation receives money and/or property in addition to the stock, the gain, but not the loss, shall be recognized but in amount not in excess of the sum of the money and the fair market value of such other property received. 2. As to the shareholder, if the money and/or property has the effect of a distribution of a taxable dividend, there shall be taxed an amount of the gain recognized not in excess of his proportionate share of the undistributed earnings and profits of the corporation; the remainder, if any, shall be treated as capital gain. 3. If the transferor corporation receives money and/or property in addition to the stock, then: a. If the corporation distributes it in pursuance of the plan of merger or consolidation, no gain shall be recognized b. If the corporation does not distribute it, the gain, if any, but not the loss shall be recognized but not in an amount not in excess of the sum of such money and the fair market value of the property so received.
Q101.10. What is the effect of the assumption of the transferee of the liabilities of the transferor in addition to the transfer of property?
PM REYES NOTES ON TAXATION INCOME TAX Section 40(C)(4) provides that if the taxpayer receives the stock as if it were the sole consideration, and, as part of the consideration, another party to the exchange assumes a liability of the taxpayer or acquires property subject to a liability, such assumption or acquisition shall not be treated as money and/or property and shall not prevent the exchange from being tax-free. However, if the amount of liabilities assumed plus the amount of liabilities to which the property is subjected to exceed the total adjusted basis of the property, then such excess shall be considered either a capital gain or ordinary gain, as the case may be.
Q101.11. What is the cost or basis in taxfree exchanges? The basis of the stock or securities shall be the same as the basis of the property, stock, or securities exchanged: 1. minus the money received 2. minus the fair market value of the property received 3. plus the amount treated as dividend of the shareholder 4. plus the amount of any gain that was recognized on the exchange. Note that the assumption or acquisition of liability shall be treated as money and/or property received if as part of the consideration to the transferor, the transferee of the property assumes a liability of the transferor or acquires from the latter property subject to a liability. The basis of the property transferred in the hands of the transferee shall be the same as it would be in the hands of the transferor increased by the amount of the gain recognized to the transferor on the transfer.
Business Purpose Q101.12. A owns all the stock of ABC Corp. ABC Corp. had 1,000 shares of XYZ Corp. A formed a new corporation called DEF Corp. A had ABC transfer all 1,000 XYZ shares to DEF. She then dissolved DEF and liquidated the assets (the XYZ shares). A then sold the XYZ
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G v. H — tax avoidance. The shares sold by new company to P is lower value than if such shares had been declared as dividends. New has lower value shares because it was I: corp. new. As such, the dividends it declares at liquidation has lower value subject to taxation; step-transaction doctrine/collapse
shares and paid the corresponding CGT based on a lower cost basis. Is the transfer valid? .
No. As held in GREGORY V. HELVERING [293 US 465, JANUARY 7, 1935], a transfer of assets by one corporation to another must have a business purpose. Here, it was a mere device which followed the form of a corporate reorganization to conceal its real character which was a transfer of stock of XYZ shares to A.
Rulings Q101.13. Is there a prescriptive period for rulings issued in connection to tax-free exchanges? Yes. RMC 40-2012 [August 3, 2012] provides that rulings issued under Section 40 (C) (2) of the NIRC, as amended, shall be valid only for ninety (90) days counted from the date of receipt of the ruling by any of the parties to the exchange transaction. The properties and shares of stocks involved in the transfer should be conveyed to the transferee/s and transferor/s, respectively, within this period.
Losses from Wash Sales of Stocks or Securities Q101.14. What is a Wash sale? Wash sale is a sale or other disposition of stock or securities where substantially identical securities are acquired or purchased within a 61-day period, beginning 30 days before the sale and ending 30 days after the sale.
Q101.15. Are losses from wash sales deductible? No. This is an exception to the general rule that losses from sales or exchanges of stock or securities are deductible as losses from sales or exchange of property. This will not apply to a loss incurred by a dealer in securities. A loss incurred by a dealer in securities with respect to a transaction made in the ordinary course of the business of such dealer is deductible.
PM REYES NOTES ON TAXATION I: INCOME TAX Example: A, whose taxable year is the calendar year, on December 1, 2012, purchased 100 shares of common stock in the ABC Company for P100,000 and on December 15, 2012, purchased 100 additional shares for P80,000. On January 2, 2012, he sold the 100 shares purchased on December 1, 2012, for P80,000. Because of the provisions of Section 38, no loss from the sale is allowable as a deduction. (see Section 38, Tax Code and Section 131, RR 2)
Administrative Provisions Accounting Methods Q102. What are accounting methods that may be used by taxpayers? The methods are: 1. Cash Method – a method of accounting whereby all items of gross income received during the year shall be accounted for in such taxable year and that only expenses actually paid shall be claimed as deductions during the year 2. Accrual Method – method of accounting for income in the period it is earned, regardless of whether it has been received or not. Expenses are accounted for in the period they are incurred and not in the period they are paid. 3. Installment Method – method of accounting considered appropriate when collections of the proceeds of sales and incomes extend over relatively long periods of time and there is strong possibility that full collection will not be paid. As customers make installment payments, the seller recognizes the gross profit on sale in proportion to the cash collected during the year. (see Section 49, Tax Code) 4. Percentage of Completion Method – method of accounting applicable in the case of a building, installation or construction contract covering a period in excess of one year, whereby gross income derived from such contract may be reported upon the
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basis of percentage of completion. (see Section 48, Tax Code) 5. Crop Year Basis – method of accounting applicable only for farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal of the harvest. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops is realized.
Hybrid Method Q102.1. Can a taxpayer use a combination of two or more methods of accounting? No. The rule is that a taxpayer may use any one method of accounting but not a combination of two or more methods of accounting for each type of business during the taxable year. The use of a hybrid method of accounting is not allowed (see CONSOLIDATED MINES VS. CTA [AUGUST 29, 1974])
Percentage of Completion Method Q102.2. Can gross income be instead reported when the long term contract is finally completed? Yes. Section, 44, RR 2 provides that gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice to so treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of the completion.
Installment Basis Q102.3. A sold lots to ABC Corp and was
The law expressly paid less than 25%, the balance excludes Evidence Of was covered by 4 checks. On the Indebtedness from the same day, the checks were compuation of whether