Taxation Law Bar Questions

A. INTERNAL REVENUE LAWS, ORGANIZATION AND FUNCTIONS OF THE BIR

Interpretation of Tax Laws What is the general rule of statutory construction involving tax laws? What is the reason thereof? (1964) How are tax laws to be construed? Discuss briefly. (1966) State the rule on the construction or interpretation of laws imposing taxes. What is the rationale behind it? (1979) Tax laws are liberally construed in favor of the taxpayer and strictly against the government. The reason is that burdens are not to be imposed nor presumed beyond what the statutes expressly and clearly import. (MRR v. Collector of Customs, 52 Phil 950 reiterated in Republic v. intermediate Appellate Court, 196 SCRA 335) No person or property is subject to taxation unless they fall within the terms or plain import of a taxing statute. (Commissioner of Internal Revenue v. Court of Appeals, et al, 204 SCRA 182) Since taxation is a destructive power which interferes with the personal and property rights of the people and takes from them a portion of their property for the support of the government, tax statutes must be construed strictly against the government and liberal in favor of the taxpayer. (Mactan Cebu International Airport Authority v. Marcos et al., 261 SCRA 667) Revenue laws are in no just sense either remedial laws or laws founded upon a permanent public policy, and therefore they are not to be liberally construed. (Froehlich & Kttner v. Insular Collector of Customs, 18 Phil 462) What is the nature of our internal revenue laws? Explain briefly. (1979) Internal revenue laws are civil and not political (Hilado v, Collector of Internal Revenue, et al., 100 Phil 288). It does not deal with the organization and operation of the governmental organs of the state and neither do they define the relations of sate with the inhabitants of its territory. (People v. Perfecto, 43 Phil 887) Revenue laws are not classed as penal laws, although they prescribe penalties for violations. The reason is that they do not define crimes and provide for their punishment. (Republic v. Vda. de Fernandez, 99 Phil 935) Revenue laws are not part of remedial law because they do not provide the procedure for the protection or rights or the prevention or redress of wrongs. Revenue laws are special laws which prevail over general laws. (CIR v. Ilagan Electric and Ice Plant, September 30, 1969). Thus, prescriptive periods under the NIRC of 1997 takes precedence over the provisions of the Civil Code on prescriptions. How are grants of tax exemption construed in our jurisdiction? (1971) Explain the principle of strictissimi juris in connection with tax exemption? (1972)

State the rule on the construction or interpretation of laws granting tax exemptions or allowing tax deductions. What is the rationale behind it? (1979) Tax exemption should be construed in strictissimi juris against the taxpayer. One who claims to be exempted from payment of a particular tax must show exemption under clear and unmistakable terms found in the exempting statute. (Philippine Acetylene Co., v. CIR, 20 SCRA 1056) The power of taxation is a high prerogative of sovereignty. The relinquishment is never presumed. Any reduction or diminution thereof must be strictly construed, and the same must be couched in clear and unmistakable terms. Exemption cannot be allowed to exist upon a mere vague implication or inference. (Floro Cement Corporation v. Judge Gorospe and the Municipality of Lugait, 200 SCRA 480) The reasons for strictissimi juris interpretation of tax exemptions are (1) Under the lifeblood theory, that is, taxes are what we pay for civilized society (Mactan Cebu International Airport V. Marcos, et. al., 261 SCRA 667; (2) To minimize differential treatment and foster impartiality, fairness and equality of treatment among taxpayers, (Maceda v. Macaraig, Jr., 197 SCRA 771) and (3) Taxation is a high prerogative of the state whose relinquishment is never presumed. (Luzon Stevedoring Corporation v. CA, 163 SCRA 647) The rule that tax exemptions are to be strictly construed has certain exceptions. What are they? (1966) The exceptions to strictissimi juris interpretation of tax exemptions are: a. When the statute granting exemption provides for liberal construction thereof. b. In case of special taxes relating to special cases and affecting only special classes of persons. c. If exemptions refer to public property. d. In case of exemptions granted to charitable and educational institutions or their property. (Cooley) e. In cases of exemptions in favor of a government, political subdivision or instrumentality. (Maceda v. Macaraig, Jr., 197 SCRA 771) What is the effect of the repeal of a revenue law on a tax previously assessed and demandable? (1979) None. The previously assessed taxes may still be collected unless the repealing law is expressly made to be retroactive. (Intestate Estate of Jovito Co v. Collector, 100 Phil 464) National Internal Revenue Taxes Name five (5) kinds of taxes, fees and charges which are considered to be national internal revenue taxes. (1964) What are considered national internal revenue taxes? (1966) Taxes, fees and charges deemed to be national internal revenue taxes are:

a. b. c. d. e. f. g.

Income tax Estate and donor’s tax Value added tax Other percentage tax Excise tax Documentary stamp tax Such other taxes as are or hereafter may be imposed and collected by the BIR (Sec. 21, NIRC of 1997)

Authority of the CIR Can the CIR inquire into the bank deposits of a taxpayer? If so, does this power conflict with R.A. 1405 (Secrecy of Bank Deposit Law)? The power of the CIR does not conflict with R.A. 1405 because the same is an exception to the said law. Notwithstanding any contrary provision of R.A. 1405 and other general or special laws, the CIR is authorized to inquire into bank deposits of: a. A decedent to determine his gross estate; and b. Any taxpayer who has filed an application for compromise of his tax liability by reason of his financial incapacity to pay his tax liability. (1st par., Sec 6 (F) (1), NIRC of 1997) A Co., a Philippine corporation, is a big manufacturer of consumer goods. It has several raw materials. The BIR suspects that some of the suppliers are not properly reporting their income on their sales to A Co. The CIR therefore: 1. Issued an access letter to A Co. to furnish the BIR information on sales and payments to its suppliers. 2. Issued an access letter to bank (CX Bank) to furnish the BIR on deposits of some suppliers of A Co. on the alleged ground that the suppliers are committing tax evasion. A Co., X Bank and the suppliers have not been issued by the BIR letters of authority to examine. A Co. and X Bank believe that the BIR is on a “fishing expedition” and come to you for counsel. What is your advice? (1999) I would advise A Co. to supply the BIR with the information desired. The BIR is authorized under the NIRC of 1997 to secure information even from persons who are not under tax investigation. I would advise CX Bank to invoke the Bank Deposit Secrecy Law because there is no showing that there was an offer by the taxpayer to compromise his tax liability premised upon financial capacity to pay. A taxpayer is suspected not to have declared his correct gross income in his return for 1999. The examiner requested the Commissioner to authorize him to inquire into the bank deposits of the taxpayer so that he could proceed with the net worth method of investigation to establish fraud. May the examiner be allowed to look into the taxpayer’s bank deposits? In what cases may the

Commissioner or his duly authorized representative be allowed to inquire or look into the bank deposits of a taxpayer. (2000) No. There is no showing in the problem of the instances where the Commissioner or his representative is allowed to examine bank deposits as exception to the Bank Deposit Secrecy Law. The Commissioner is authorized to inquire into the bank deposit of: a. A decedent to determine his gross estate; and b. Any taxpayer who has filed an application for compromise of his tax liability by reason of his financial incapacity to pay his tax liability. (1st par., Sec 6 (F) (1), NIRC of 1997)

Other Duties, Powers and Authority of the Commissioner The Secretary of Finance, upon the recommendation of the Commissioner of Internal Revenue, issued a Revenue Regulation using gross income as the tax base for corporations doing business in the Philippines. Is the Revenue Regulation valid? (1994) No. The revenue regulation would have the effect of amending the NIRC of 1997. Administrative rules and regulations like revenue regulations issued by the Secretary of Finance, upon recommendation of the Commissioner of Internal Revenue, are intended to carry out and not to supplant or modify the law. An internal revenue officer, having been reliably informed from unimpeachable sources, that articles subject to excise taxes were kept in the house of Y, entered said house to look for and to seize the aforementioned articles over the objection of Y. Since said officer was not armed with a search warrant, Y invoked the sanctity of his home. Is the internal revenue officer’s actuation described above sanctioned by law or not? Why? (1996) Yes, the revenue officer’s actuation is sanctioned by law because articles on which excise taxes are due but not paid may be seized without need of a judicially issued search warrant. (1st par., Sec. 171, NIRC of 1997) This is so because of the application of the principle of primary jurisdiction. The determination of whether excise taxes are due requires the expertise, specialized skills and knowledge of the revenue officers because technical matters or intricate questions of fact are involved. Furthermore, the lifeblood theory of taxation which abhors any delay in the collection of taxes as a threat to the existence of the State supports the application of the principle of primary jurisdiction. The seizure without resort to the courts would hasten the tax collection effort. A store in the Cartimar market in Pasay City was discovered by the BIR agents selling luxury items worth about P500,000 suspected to have been smuggled into the country by the storeowner. May the Commissioner put under “preventive embargo” said luxury items? If so, what is the meaning of the said action and under what authority of law? (1975)

Yes, the Commissioner may place the luxury items under ―preventive embargo‖. ―Preventive embargo‖ refers to the power of Commissioner to place under constructive distraint the property of a delinquent taxpayer, or of any taxpayer who, in his opinion, performs any act tending to obstruct the proceeding for collecting the tax due or which may be due him. (1st par. Sec. 206, NIRC of 1997)

B. CONCEPTS OF INCOME AND INCOME TAXATION

Nature, Scope, Classification and Essential Characteristics of Income Define income for tax purposes. (1969) Income means all wealth which flows into the taxpayer other than as a mere return of capital. It includes the forms of income specifically described as gains and profits, including gains derived from the sale or other disposition of capital assets. (Sec. 36 Rev. Reg. No. 2) It is an amount of money coming to a person or corporation, whether as payment for services, interest or profit from investment. (Conwi et al v. CTA 213 SCRA 83) Income is a flow of service rendered by capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time. (Madrigal v. Rafferty 38 Phil 414) Income is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. (Fisher v. Trinidad 43 Phil 981).Thus, to tax a stock dividend would be to tax a capital increase rather than the income. (Commissioner v. CA, January 20, 1999) Income means earnings lawfully or unlawfully acquired, without consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition. (James v. US, 366 US 213) Distinguish income from capital (1965) How does “income” differ from “capital”? (1995) Capital is wealth or fund while income is profit or gain from the flow of wealth. (Commissioner v. CTA et at January 20, 1999) Capital is a fund of property existing at an instant of time while income is that flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time. Capital is wealth while income is the service of wealth. Capital is a tree, while income is the fruit. (Madrigal v. Rafferty, 38 Phil 414)

Define or explain the meaning of net taxable income of an individual or a corporation. (1971) In brief, what do you mean by net income for purposes of income tax? (1977) What is meant by taxable income? (2000) Taxable income means the pertinent items of gross income specified in the NIRC less the deductions and /or personal exemption and additional exemptions, if any, authorized for such types of income by the NIRC and other special laws. (Sec 31, NIRC) Mr. Cruz bought a residential house and lot in 1989 for P120,000. In 2002, curious as to how much his property then cost, he asked a real estate broker to reappraise the same. The real estate broker reported that the value of his property has increased to P1,800,000. Should Mr Cruz report the P1,680,000 increase in his income tax return for the year 2002? Reasons (1982) No. The P1,680,000 increase in the value of the residential house and lot is not considered as income reportable as income of Mr. Cruz because such increase has not yet been received by Mr. Cruz, either physically or constructively. Besides, capital gains of individuals on dispositions of real property are subject to a final tax, the presumed capital gain tax. Consequently, increases in valuation are not reported in the income tax return. Increases in valuation of real property are not subject to income tax, hence not reportable in the income tax return.

Romulus, 48 years of age and a retired employee had the following properties and transactions at the end of the 2002 taxable year: a) Shares of stock in Sabinian Corporation which he bought in 1998 for P50,000.00 and which were worth P70,000.00 as of the end of 2002. b) Shares of Visigoth Corporation which he bought for P40,000.00 in 1990 and which he sold for P100,000.00 in 2002. Are the above items subject to the regular tax rates found in the schedule under Section 24 (A) of the NIRC which states the tax rates on citizen and residents? Explain your answer. (1986) a. The shares of stock in Sabinian Corporation are not subject to the regular tax rates found in the schedule under Sec.24 (A) of the NIRC of 1997 because the shares have not been disposed of. Thus, there is no gain to be taxed. b. Assuming that the shares of Visigoth Corporation are capital assets of Romulus, not listed and traded through a local stock exchange, then the sale is not subject to the regular tax rates found in the schedule under Sec. 24(A) of the NIRC of 1997, because the actual gains derived from the sale are subject to the final tax provided under Sec. 21 (B) (C) of the NIRC of 1997. Manananggol, a lawyer, has among his clients a recruitment agency which pays him a monthly retainer of P10,000. In order to reduce his income tax liability, Manananggol arranged for the retainer to be paid directly to his

daughter, Christina. This year, Manananggol’s gross income from his law practice, exclusive of the P10,000 monthly retainer fee is P2,000,000. How mush gross income must Manananggol report this year? Explain your answer. (1986) The total amount of P2,120,000 which consists of the amount of P2,000,000 gross income from his law practice plus the total amount of P120,000 paid as a retainer fee to his daughter. This should be so because there was no visible service rendered by Christina to the recruitment agency. Hence, it is clear that said payment is a mere subterfuge on the part of Manananggol to avoid the taxes. In 1996, Corporation “X” had a capital stock of 1,000 shares without par value. At the time of its incorporation, the value of each no-par vvalue share was P10. In 2002, due to its profitable operations, the corporation earned a surplus of P200,000. The corporation’s board of directors increased the stated value of each share by P190 making each share worth P200. The BIR, for income tax purposes, assessed each stockholder for the P190 increase. Is the BIR correct. Explain. (1989) No. The stockholders have not physically or constructively received any income subject to tax. There was no change in the proportion of their ownership in the corporation considering that the shares of stock are without par value. Furthermore, there was no realization of the income through the change in the stated value. When the stockholders disposes of the shares, then the same would be subject to capital gains tax. “A” was engaged by Premiere Movies to perform A PANTOMIME ACT IN A MOVIE IT WAS MAKING. “A” was to be paid P20,000 for his performance and the parties signed the necessary contract. “A” then gratuitously assigned his rights under the contract to his son, “B”. “B” later on collected the P20,000 from the Premiere Movies. Is the P20,000 taxable to “A”? Reasons. (1989) Yes. The P20,000 A received for the performance is income from the practice of his profession as an artist. (Sec. 32 (A), NIRC of 1997).The fact that he gratuitously gave the same to his son does not detract from his (A’s) having received the income in exchange for his professional services. Since, there is no showing of other donations made by A, then the P20,000 is not subject to the donor’s tax because the first P100,000 net donation is exempt from donor’s taxes. (Sec. 99(A), NIRC of 1997) The employees of Travellers, Inc. satged a strike. X, a non-union member joined the strike and volunteered to picket the company premises from 8am to 5pm, Monday through Friday. Six months into the strike, X ran out of money and asked financial aid from the union since he has no other source of income and needed financial assistance in order to live. The union gave him P3,000 a month to take care of his food requirements plus P1,000 to take care of his monthly rent. When X filed his return, he excluded these benefits from his gross income. The exclusion was denied by the BIR. Decide. (1993)

The denial of the inclusion is not valid. I would consider the amount given as a gift, which should be excluded from his gross income because there is no legally demandable obligation on the part of the union to give X money. The money was in the nature of a donated financial assistance and not compensation for having joined the picket. In 1999, X started constructing a commercial building with spaces for lease to the public. X required Y, a prospective lessee, to sign a pre-lease agreement, which principally provided; (a) that the lessee shall extend to the lessor a noninterest bearing loan of P100,000 payable within 12 months; and (b) that in consideration of the loan, the rentals shall not be increased while the loan remains unpaid. Upon completion of the building in 2002, Y extended the loan of P100,000 to X and he (X) was given a space in its ground floor. May the BIR consider the P100,000 as taxable income of X? Reasons. (1993) No. There was no gain realized by X whether as payment for services, interest or profit from investment because he is required to repay the P100,000 loan. A, an architect, owes Z, a businessman, the sum of P10,000. Z engaged the services of A to remodel his residence at Magallanes Village, Makati. The value of the services rendered by A is P100,000. Accordingly Z cancelled the debt of A. a. Is the P100,000 value of the services considered income subject to tax? Explain briefly. b. Under the same facts, suppose Z paid A P100,000 for the services rendered and at the same time condoned A’s indebtedness. Is the amount condoned considered income subject to tax? Explain briefly. (1978) a. Yes. Whether A uses the accrual method or cash method of accounting. If A uses the accrual method of accounting, then he has recognized income up to the total extent of P100,000 as there is now constructive receipt of income. On the otherhand, if he uses the cash method, he should be subject to tax only up to the extent of P10,000 the amount condoned. This is so because the condonation was in exchange of the services rendered. The P90,000 value of the services is not yet deemed collected. b. Yes. When Z pays A P100,000, then, the same is considered income from the exercise of A’s profession because of the physical receipt of the money. The amount of P10,000 condoned is considered as a gift because the cancellation was without consideration. Onesiphorous, a junior executive, owed his employer P4,000. The money was advanced to him to pay for his personal bills. Just recently, he submitted an excellent report to his employer who became very pleased because it attracted a big client to their company. The employer, therefore, decided to cancel the debt of Onesiphorous and, in addition, gave him a round trip ticket to Hongkong plus pocket money of P5,000.

How are the above items to be treated on the income return of Onesiphorous? The P4,000 is considered as part of the compensation income of Onesiphorous to be reported in his income tax return because the condonation was in exchange of services performed by him for his employer as a result of employeremployee relationship. The value of the round trip ticket to Hongkong including the pocket money may be treated as income to be reported in the income tax return if Onesiphorous is a rank and file employee, because income includes everything of value not necessarily in money. If Onesiphorous is not a rank and file employee, then the value of the round trip ticket to Hongkong including the P5,000 pocket money are fringe benefits taxable to the employer and not reportable by the employee in his income tax return. (Sec. 33, NIRC OF 1997) Mr. X asked you to prepare his income tax return. Is he required to include as part of the gross income his promissory note amounting to P10,000 which was condoned by his creditor? Give your reason. No. there is no showing in the facts that the condonation was in exchange of services rendered by Mr. X. the condonation amounts to a gift. Mr. Francisco borrowed P10,000 from his friend Mr. Gutierrez payable in one year without interest. When the loan became due, Mr. Francisco told Mr. Gutierrez that he (Mr. Francisco) was unable to pay because of business reverses. Mr. Gutierrez took pity on Mr. Francisco and condoned the loan. Mr. Francisco was solvent at the time he borrowed the P10,000 aand at the time the loan was condoned. Did Mr. Francisco derive any income from the cancellation or condonation of his indebtedness? Explain. No. Mr. Francisco did not derive income. It is clear that the creditor, Mr. Gutierrez, merely desired to benefit the creditor, Mr. Francisco, and without any consideration thereof cancelled the debt. The amount of the debt cancelled is a gift and not income. An insolvent company had an outstanding obligation of P100,000 from a creditor. Since it could not pay the debt, the creditor agreed to accept payment through dacion en pago a property which had a market value of P30,000. In the dacion en pago document, the balance of the debt was condoned. a. What is the effect of the discharge of the unpaid balance of the obligation on the debtor corporation? b. Insofar as the creditor is concerned, how is he affected taxwise as aa consequence of the transaction? (1997) a. The creditor corporation is deemed to have received a gift from its creditor to the extent of the difference, between the debt P100,000) and the value of the

property paid (P10,000), which is P70,000. It is clear that the creditor merely desires to benefit the debtor corporation and without any consideration thereof cancels the debt. (Sec. 50, Rev. Reg. 50). Thus, the amount foregone which is P70,000 is considered a gift and not to be reported as income in the corporation’s return. b. Since the P70,000 is considered a gift, the creditor shall be subject to appropriate rate for donor’s tax.

Gross Income What is “gross income” for purposes of the income tax? Except when otherwise excluded, ―gross income means all income derived from whatever source, including (but not limited to) the following items: (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions and other similar items; (2) Gross income derived from the conduct of trade or business of the exercise of a profession; (3) Gains derived from dealings in property; (4) Interests; (5) Royalties; (6) Dividends; (7) Annuities; (8) Prizes and winnings; (9) Pensions; and (10) Partner’s distributive share from the net income of the general professional partnership.‖ [Sec. 32 (A) of NIRC of 1997]

W was notified by her depository bank on June 3, 2000 that P50 million had been credited to her savings account because of the remittance of US$1 million through a US bank by her sister in the U.S. W lost no time in spending most of the money for various purposes, such as the purchase of luxurious condominium unit and a luxury car, money market placement gifts to relative, etc. Soon thereafter, the US bank discovered that W’s sister remitted only US$1,000 and not US$1 million. On or about June 29, 2000, the US bank filed a complaint for the recovery of the excess amount with the appropriate Manila court against W, as the remittance of so huge an amount arose from a clerical error. W was also charged with estafa on account of the same money. On March 15, 2001, W filed her income tax return for the calendar year 2000, without a declaration of the P50 million but with a footnote to the return which reads: “’Taxpayer was the recipient of some money from abroad which she presumed to be a gift but turned out to be an erroneous remittance and is now subject of litigation.”

In March 7, 2003, the Commissioner of Internal Revenue assessed W a deficiency income tax on the P40 million, imposed a 50% surcharge for filing a false and fraudulent return, and charged interest covering three years for late payment. W contented that the erroneous remittance is not “gross income” within the meaning of the Tax Code. She also disputed the imposition of the 50% surcharge. If you were the Judge, how would you rule on the legal points raised by W? (1984) W’s contention that the erroneous remittance is not ―gross income‖ is devoid of merit. It is considered under the NIRC of 1997 as falling within the ambit of ―income from whatever source derived‖ because it is income tax not expressly excluded or exempted from the class of taxable income. This is irrespective of the voluntary or involuntary action of W in producing the income. (Gutierrez v. Collector of Internal Revenue, CTA Case No. 65, August 31, 1965) As a matter of fact the source of the income may be legal or illegal. W was correct in her intention that she should not be subjected to the 50% surcharge. There was no actual and intentional fraud through willful and deliberate misleading of the Bureau of Internal Revenue. The government was not induced to give up some legal right and place itself at a disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities because W did not conceal anything. W’s notation on her income tax return was an ―error or mistake of fact or law‖ not constituting fraud. So also such notation was practically on invitation for investigation and that W literally ―laid cards on the table.‖ (Commissioner of Internal Revenue v. Javier, Jr., 199 SCRA 824) “X” issued a check drawn on a bank in which he has no funds. He negotiated the check and received P10,000. He tried his luck in a casino but lost. Thereafter, he was charged and convicted for passing a worthless check. The BIR wants to tax him for the P10,000 he got from negotiating the check. Decide. (1989) X should be taxed. The P10,000 is considered as his ―income from whatever source derived,‖ [Sec. 32 (A), NIRC of 1997]. The phrase is so broad that it includes all income not expressly excluded or exempted from the class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income. (Gutierrez v. Collector of Internal Revenue, CTA Case No. 65, August 31, 1965)

Mr. Lajojo is a big-time swindler. In one year he was able to earn P1 million from his swindling activities. When the Commissioner of Internal Revenue discovered his income tax from swindling, the Commissioner assessed him a deficiency income tax for such income. The lawyer of Mr. Lajojo protested the assessment on the following grounds:

a) The income tax applies only to legal income, not to illegal income; b) Mr. Lajojo’s receipts from his swindling, hence, his receipt from swindling was similar to a loan, which is not income, because for every peso borrowed he has a corresponding liability to pay one peso; and, c) If he has to pay the deficiency income tax assessment, there will be hardly anything left to return to the victims of swindling. How will you rule on each of the three grounds for the protest? Explain. (1995) a. The first ground should be denied for the reason that all incomes not expressly excluded or exempted from the class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income are subject to tax (Gutierrez v. Collector of Internal Revenue, CTA Case No. 65, August 31, 1965). There is no distinction whether the income may be legal or illegal. b. and c. The second and third grounds should be sustained. There is no income subject to tax for the reason that to collect a tax would give the government an unjustified preference as to the part of the money which rightfully and completely belongs to the victim. Furthermore, there is no income yet because under the claim of right doctrine in the determination of income, there is an obligation to return, hence Mr. Lajojo does not have a claim of right over the amounts swindled. NOTE NOT PART OF THE ANSWER: A contrary answer may be justified on the basis of the Gutierrez case and under the doctrine of control of income. Since, Mr. Lajojo has the unfettered ability to dispose of the amounts swindled, then it is income to him subject to tax. In order to facilitate the processing of its application for a license from a government office, Corporation A found it necessary to pay the amount of Php100,000 as a bribe to the approving official. Is the Php100,000 deductible from the gross income of Corporation A? On the other hand, is the Php100,000 taxable income of the approving official? (2001) The Php100,000 bribe is not allowed to be deductible from gross income because it is an illegal expenditure. [Sec. 34 (A) (1) (c), NIRC of 1997] The bribe is considered as income of the recipient subject to tax. All incomes not expressly excluded or exempted from the class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income are subject to tax (Gutierrez v. Collector of Internal Revenue, CTA Case. No. 65, August 31, 1965). There is no distinction whether the income may be legal or illegal.

Mr. Domingo owns a vacant parcel of land. He leases the land to Mr. Enriquez for ten years at a rental of P12,000.00 per year. The condition is that MR. Enriquez will erect a building on the land which will become the property of Mr. Domingo at the end of the lease without compensation or reimbursement whatsoever for the value of the building.

Mr. Enriquez erects the building. Upon completion, the building had a fair value of P1 million. At the end of the lease, the building is worth only P900,000.00 due to depreciation. Will Mr. Domingo have income when the lease expires and becomes the owner of the building with a fair market value of P900,000.00? How much income must he report on the building? Explain. (1995) Whether MR. Domingo, the lessor, will have income when the lease expires and he becomes the owner of the building depends upon the method of recognition he shall use. Mr. Domingo, the lessor may report as income the fair market value of the improvements at the time of completion of construction. In such a case, he need not report any income at the expiration of the lease. If Mr. Domingo, the lessor spreads over the life of the lease the estimated depreciated value of the improvement at the termination of the lease and report as income for each year of the lease an aliquot part thereof (Sec. 49, Rev. Regs. Nc. 2), he also need not report any income at the expiration of the lease. On the other hand, Mr. Domingo, may recognize as income the P900,000.00 fair market value of the building at the expiration of the lease, if he did not recognize income in the above described manner. Concepts of Income Taxation Discuss the meaning of the Global and Schedular systems of taxation. (1997) Global system of income taxation A system employed where the tax system views indifferently the tax base and generally treats in common all categories of taxable income of the individual. (Tan v. Del Rosario Jr. 237 SCRA, 324, 331) A system which taxes all categories if income except certain passive incomes and capital gains. It prescribes a unitary but progressive rate for the taxable aggregate incomes and flat rates for certain passive incomes derived by individuals. The apparent intent of current amendatory laws to the income tax law is to maintain, by and large, the global treatment on taxable corporations. (Tan, supra) NOTE: The global system of income taxation for all corporations is evident in the provisions of Chapter IV – Tax on Corporations, , Title II – Tax on Income, the NIRC of 1997 which imposes a tax of whichever is higher of a reduced rate of 32% on taxable income or a 2% minimum corporate income tax. This is irrespective of the tax base. Thus, whether the taxable income is P1,000.00, P10 million, or even higher, the tax rate is the same. In short, the tax on corporate income is not progressive in character. Schedular system of income taxation. A system employed where the income tax treatment varies and is made to depend on the kind or category of taxable income of the taxpayer. (Tan v. Del Rosario, Jr., 237 SCRA 324, 331) A system which itemizes the different incomes and provides for varied percentages of taxes, to be applied thereto. It is apparent intention of current amendatory laws to the income tax to increasingly shift the income tax system toward the schedular approach in the income taxation of individual taxpayers. (Tan, supra)

NOTE: Sec 24 (A) (1) (c). NIRC of 1997 provides for the application of the schedular system of income taxation to individuals. There is adoption of a progressive rate which taxes at 5% taxable incomes which do not go beyond P10,000.00, progressively increasing up to a high of 32% for taxable incomes exceeding P500,000.00.

To which system would you say the method of taxation under the National Internal Revenue Code belongs? (1997) a) Global System; and b) Schedular system. NOTE: The Philippines has adopted both of these systems. Distinguish between “schedular treatment from global treatment”: as used in income taxation. (1994) a) Under the schedular treatment there are different tax rates, WHILE under the global treatment there is unitary or single tax rate; b) Under the schedular treatment there are different categories of taxable income, WHILE under the global treatment there is no need for classification as all taxpayers are subjected to a single rate. c) The schedular treatment is usually used in the income taxation of individuals, WHILE the global treatment is usually applied to corporations. What are the basic features of the present income tax system? a) Progressive; b) Global system for taxable corporations and schedular for individuals; c) Uses gross compensation system.

Currently we hear of the system of income taxation by basing the tax on the gross rather than on the net income. What do you understand by “gross income taxation”? (1980) What is the system gross income taxation? Explain. (1983) In a broad sense, the tax base is the total gross income of an individual during the taxable year without any deductions allowed.

What are the advantages and disadvantages, if any, of an income tax based on gross over one based on net income? Explain your answer briefly. (1980) The advantages of gross income taxation are: a) The procedure for the computation of the tax is simpler than in the case of taxation based on net income;

b) Less discretion will be allowed on the tax examiners thereby minimizing graft; c) Examination and/or investigation of tax returns can be made faster; d) If coupled with an effective withholding tax system would provide more returns to the government. The disadvantages of gross income taxation are: a) A taxpayer may derive gross income but suffers a net loss; b) The rule of taxation may not be equitable and uniform if the gross income were the basis of the tax; c) If gross income were the basis, it may serve as a disincentive to further employment. NOTE: the 1987 Philippine Constitution requires that; ―The rule of taxation shall be uniform and equitable.‖ (Sec. 28 (1), Article VI)

General Principles of Income Taxation In general, on what does the taxability of income depends as regards individuals and corporations? Explain your answer, citing the income taxable under our Income Tax Law. (1970) The law, in levying the tax, adopts the most comprehensive tax situs of nationality and residence of the taxpayer (that renders resident citizens subject to income tax liability on their income from all sources) and of the generally accepted and internationally recognized income taxable base (that can subject non-resident aliens and foreign corporations to income tax on their income from the Philippine sources). (Tan v. Del Rosario, Jr. 237 SCRA 324, 334) What incomes are subject to tax under the National Internal Revenue Code? (1969) From what sources of income are the following persons/corporations taxable by the Philippine government? 1. Citizens of the Philippines residing therein; 2. Non-resident citizen; 3. An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker; 4. An alien individual, whether a resident or not of the Philippines; 5. A domestic corporation. (1998) The general principles of income taxation in the Philippines are: a) A citizen of the Philippines residing therein is taxable on all income derived from sources within and without the Philippines; b) A nonresident citizen is taxable only on income derived from sources within the Philippines; c) An individual citizen of the Philippines who is working and deriving income abroad as an overseas contract worker is taxable only on income from sources within the Philippines: Provided, That a seaman

who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker; d) An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from the sources within the Philippines; e) A domestic corporation is taxable on all income derived from sources within and without the Philippines; and f) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. (Sec. 23, NIRC of 1997, emphasis supplied)

Juan de la Cruz, a resident of the Philippines, left for Australia on August 24, 2002 to reside permanently thereat. During his stay in the Philippines, he received an income of P15,000.00 from January 1, 2002 up to the date of his departure. In Australia, he received during the remainder of the year 2002 an additional income of $10,000.00 from sources within that country. Are these two (2) incomes, P15,000.00 and $10,000.00 taxable in full and is Juan de la Cruz entitled to full personal exemptions and deductions allowed by our law? If Juan de la Cruz was not a citizen but a resident, on what amount is he taxable in full, and what deduction can he claim while in the Philippines? Explain fully your answer. (1979) Yes. The two incomes, P15,000.00 and $10,000.00 are taxable in full. Juan is considered as a resident citizen. The reason being that he stayed only in Australia for about four (4) months, from August to December, during the taxable year. To be considered as a non-resident citizen, Juan must have stayed in Australia most of the time during the taxable year. Since he is a resident citizen, his taxable income includes all income derived from sources within or without the Philippines. Juan is likewise entitled to full personal exemptions and deductions because he is considered as a resident citizen. If Juan is a resident alien, he shall be taxed only on all his income derived from sources within the Philippines. He shall also be entitled to the same deductions as a resident citizen. Mr. AD, a US citizen hired for five(5) years as plant manager of a local mining company, derives income from investments and real property he owes in the United States. Besides his salary and bonuses from the local mining company, he is provided with a house and allowances for the salaries of his driver and three maids. The mining company reimburses all his gasoline and oil expenses for the use of the company car, plus expenses for his grocery. a. What income items, if any, should he declare in the Philippine income tax return? Explain. b. Under the same facts, except that Mr. AD is a Filipino citizen working in Saudi Arabia and his investments and real property are located in the Philippines. What income items, if any, should he declare in his Philippine income tax return and at what rates is he taxed?

a. Only his income derived from sources within the Philippines such as his salary and bonuses from the local mining company and the expenses for his grocery. This is so because being a resident alien he shall be subject to tax only on the income derived from sources within the Philippines. The value of the use of the house, allowances for the salaries of his driver and the three maids, the value of the use of the company car, as well as the gasoline and oil, are considered as fringe benefits which are taxable to his employer. b. Since Mr. AD is an overseas contract worker taxable only on his income derived from sources within the Philippines. He is to be taxed only on his income derived from his investments and properties located in the Philippines. If the passive income, then he shall be subject to final taxes. If not, then to the schedular tax. Great Wall machineries Corporation (GWMC) is a corporation incorporated and operating under the laws of the People’s Republic of China. AGWMC and the Davao Ceramics Corporation (DCC) plan to enter into a US $1000,000 contract on C&F basis, whereby GWMC shall sell to DCC a GWMC-manufactured ball mill. Under the proposed contract which will be signed in Hongkong, GWMC will ship the ball mill from Shanghai to Davao City. GWMC will also send its Chinese technicians to Davao City to install the ball mill and to train DCC personnel on how to run the ball mill. The installation and the trainingwill take 30 days to complete. The airfare, hotel accommodation and salaries of GWMC who will be sent Davao City will be paid for by GWMC. The contract will be fully performed by GWMC within 65 days from the signing. Under the contract, DCC will remit payment in US dollars to GWMC’s bank account in Hongkong. This is the first contract that GWMC will sign with a customer in the Philippines. GMWC HAS NO OFFICE OR AGENT IN THE Philippines. /and GMWC has no intention of securing a license to do business in the Philippines. Will said GWMC personnel sent to Davao City be subject to Philippine income tax on their salaries while they work in Davao City? Explain. (1990) Yes, the foreign personnel are subject to Philippine income taxation. This is so because the personnel are considered as non-resident aliens not engaged in trade or business within the Philippines. They are not citizens of the Philippines aand they are not also residents of the Philippiens not having stayed therein for an aggregate period of more than 180 days during the calendar year. (Sec. 22 (G) and 25(A) (1), both of the NIRC of 1997). Consequently, they should be subject to income taxes on all income received within the Philippines which includes compensation. The tax imposed is 25% OF THE GROSS COMPENSATION INCOME RECEIVED. (Sec 25 (B), NIRC OF 1997) Newtex International (Phils. ) Inc. is an American firm duly authorized to engage in business in the Philippines as a branch office. In its activity of acting as a buying agent for foreign buyers of shirts and dresses abroad and performing liaison work between its home office and the Filipino garment manufacturers and exporters, Newtex does not generate any income. Tofinance its office expenses here, its head office abroad regularly remits to it the needed amount. To oversee its operations for two (2) years, the head office assigned three (3) foreign personnel.

Are the three foreign personnel subject to Philippine income tax? (1991) Yes, they are considered as resident aliens having stayed in the Philippines for more than two years. They shall be taxed on the incomes derived from sources within the Philippines. They Performed the service within the Philippines, hence taxable. Juan, a Filipino citizen, has emigrated to the United States where he is now a permanent resident. He owns certain income-earning property in the Philippines from which he continues to derive substantial income. He also receives income from his employment in the United States on which the US income tax is paid. On which of the above incomes is he taxable, if at all, in the Philippines, and how, in general terms, would such income or incomes be taxed? (1997) Juan is taxable only on his income derived from sources within the Philippines because he is a nonresident citizen. If the income is passive income, then he shall be subject to final taxes, if not, then to the schedular tax. HK Co. is a Hong Kong corporation not doing business in the Philippines. It holds 40% of the shares of A co., a Philippine company while the 60% is owned by P Co., a Filipino-owned Philippine corporation. HK also owns 100% of the shares of B Co., an Indonesian company which is a duly licensed Philippine branch. Due to the worldwide restructuring of the HK Co. group, HK Co. decided to sell all its shares in A and B Cos. The negotiations for the buy-out and the signing of the Agreement of Sale were all done in the Philippines. The agreement provides that the purchase price will be paid to HK Co.’s bank account in the US and the title to A and B Cos. Shares will pass from HK Co. to P Co. in HK where the stock certificates will be delivered. P Co. seeks your advice as to whether or not it will subject the payments of the purchase price to WT. Explain your advice. (1999) The payments for the purchase price are subject to WT because they are considered as income derived from sources within the Philippines. Since the shares of stock were sold in the Philippines, the income shall be treated as derived entirely from sources within the Philippines and correspondingly taxed therein. {2nd par., Sec 42 (E), NIRC OF 1997]

A Co., a Philippine corporation, has an executive (P) who is a Filipino citizen. A Co. has a subsidiary in Hong Kong (HK Co.) and will assign P for an indefinite period to work full time for HK Co. P will bring his family to reside in HK and will lease out his residence in the Philippines. The salary of p will be shouldered 50% by A Co. while the other 50% plus housing, cost of leaving and educational allowance of P’s dependents will be shouldered by the HK company. A Co. will credit the 50% of P’s salary to P’s Philippine bank

account. P will sign the contract of employment in the Philippines. P will also be receiving rental income for the lease of his Philippine residence. Are these salaries, allowances and rentals subject to Philippine income tax? (1999) The salaries and allowance of P are not subject to Philippine income tax because these are incomes from without the Philippines earned by P, who is an overseas contract worker. The rental income derived from his Philippine residence is considered as income derived from sources within the Philippines, hence subject to Philippine tax.

Mr. Cortex is a non-resident alien based in Hong Kong. During the calendar year 2000, he came to the Philippines several times and stayed in the country for an aggregate period of more than 180 days. How will Mr, Cortez be taxed on his income derived from sources within the Philippines and from abroad? (2000) Mr. Cortez being a non-resident alien engaged in trade in business in the Philippines is going to be taxes only on his income derived from sources within the Philippines [Sec. 25 (A) (1) in relation to Sec. 24, both of the NIRC of 1997] in the same manner as individual citizen and resident alien individuals and shall be subject to same exclusions, deductions and tax rates, except that taxes are allowed as a deduction only if and to the extent that they are connected from the sources within the Philippines. [Sec, 34 (C) (2), Ibid]. Furthermore, he is allowed to use only the itemized deductions but not the standard optional deduction. [Sec 34 (L), Ibid]. Finally Mr. Cortez is allowed to deduct personal exemptions only subject to reciprocity [ Sec 35 (D), Ibid] Mr. Sebastian is a Filipino seaman employed by a Norwegian company which is engaged exclusively in international shipping. He and his wife, who manages their business, filed a joint income tax return for 1998 on March 15, 1999. After an audit of the return, the BIR issued on April 20, 2002 a deficiency income tax assessment for the sum of p250,000, inclusive of interest and penalty. For failure of Mr. And Mrs. Sebastian to pay the tax within the period stated in the notice of assessment, the BIR issued on august 19, 20002 warrants of distraint and levy to enforce collection of taxes. What is the rule of income taxation with respect to Mr. Sebastian’s income in 1998 as a seaman on board the Norwegian vessel engaged in international shipping. Explain your answer. (2002) Mr. Sebastian is a seaman who is employed by a vessel exclusively engaged in international trade. Thus, his income as a seaman is considered as income derived from sources without the Philippines not subject to Philippine income taxation.

C. CLASSIFICATION OF TAXPAYERS AND TAXATION OF THEIR INCOME Trusts Mr. David created an irrevocable trust in favor of his two minor grandchildren. The trust stipulates that 50% of the net income should be distributed yearly to the grandchildren, share and share alike, the balance to accumulate for eventual distribution to the grandchildren at the age 25. The income for 2002 was P1 million. a) How will the income of the trust be taxable? b) Will your answer remain the same if the trust established by Mr. David is revocable? c) When is a trust considered revocable? (1980) a) The net income of the irrevocable trust amounting to P1 million should be reduced by the following: 1) The income given to the beneficiaries (Sec. 61 (A), NIRC of 1997); 2) P20,000.00 exemption (Sec. 62, Ibid) After the allowable deductions mentioned above, the taxable income shall be subjected to the same tax rates as individuals. (Sec. 61, Ibid.) b) No, because the income of such part of an irrevocable trust shall be included in computing the net income of Mr. David, the grantor. (Sec. 63, Ibid.) c) A trust is considered as revocable where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested 1) In the grantor either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or 2) In any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom. (Sec. 63, Ibid.) Oro, a millionaire with a wife and five (5) minor children has the following assets: Asset Amount a) Cash in money market P500,000 P75,000 or 15% return b) Stock investment in ABC Corp. P500,000 P100,000 or 20% return c) Stock investment in XYZ Corp. P500,000 P50,000 or 10% return d) Real Estate properties P1,500,000 P180,000 or 12% return TOTAL P3,000,000 P405,000 ==================== Oro thus earns an annual gross income of P405,000. He comes to you and says: “I want you to lessen the taxes my estate will have to pay, as well as lessen my current income tax. However, until my children reach 21 years of

age. I don’t want them to control any of my properties. At my age, I need a gross income of only P75,000 annually.” What would you do to reduce Oro’s estate taxes and his current income tax, and at the same time prevent his children from obtaining control of a substantial portion of his properties until they reach the age of 21? (1974) I would suggest the creation of an irrevocable trust over all the assets of Mr. Oro, except the cash in money market which earns P75,000.00, administered in the Philippines, registered with and approved by the Bureau of Internal Revenue subject to the following conditions: (a) The share of the children in the properties shall be transferred to each of them when they reach the age of 21; (b) All the income from the properties constituted into the trust, amounting to P330,000.00 should be divided among his five children, and no part of the income should go to Mr. Oro. The tax to be collected on the return from cash in money market, and the stack investments would be the same whether Mr. Oro constitutes a trust or not. All of these incomes would be subject to final taxes. However, there would be tax savings with respect to the P180,000.00 return from the real properties. If Mr. Oro does not constitute a trust, the P180,000.00 shall be taxed on the portion above P140,000.00 in the amount of P22,500.00 and the excess over P140,000.00 shall be taxed at the rate of 25% or P40,000 x .25 = P10,000.00. The total tax due from Mr. Oro is P32,500.00. On the other hand, if an irrevocable trust is so constituted as above – mentioned, the income of P180,000.00 shall be divided among the five (5) children who shall each have income subject to tax in the amount P36,000.00. Each child shall pay an income tax on his share computed on the basis of P2,500.00 on the amount that does not exceed P30,000.00 and 15% on the excess over P30,000.00 or P6,000.00 x .15 = P900.00. Thus, the tax due from each child is P2,500.00 + P900.00 = P3,400.00. The total tax due from all the five (5) children is P3,400.00 x 5 = P17,000.00. The savings is computed as: tax paid by Mr. Oro on the P180,000.00 income from real properties is P32,500 LESS taxes to be paid by his five (5) children amounting to P17,000.00 = P15,500.00 Corporations Define or explain the meaning of corporation for income tax purposes? (1971) Corporation for income tax purposes includes partnership, no matter how created or organized, joint stock companies, joint accounts (cuentas en participacion) associations or insurance companies. It does not include general professional partnerships, joint venture or consortium formed for the purposes of undertaking construction projects engaging in petroleum, coal, geothermal, and other energy operations, pursuant to an operation of consortium agreement under a service contract with the Government. [1 st sentence, Sec. 22 (B), NIRC of 1997]

Partnerships Taxed as Corporations

E died in December 2000 leaving to his three (3) sons A, B, and C an apartment building. They decided not to partition the property and just divided the rentals among themselves for the year 2001. Was a partnership formed which id subject to the corporate income tax for the year 2001? In 2002, A, B and C did not divided the income from the apartment building; instead they invested the same in the purchase of a house to be rented out. What is the status of their enterprise for income tax purposes for the year 2002? Explain your answer. (1972) There was no partnership formed subject to the corporate income tax for the year 2001, when the three (3) sons did not partition the apartment they inherited. However, with respect to the house they purchased in 2002 from the common fund, there was formed a partnership. Co-heirs who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would subject the income of all coownership of inherited properties to the tax on corporations resulting in oppressive taxation and confirm the dictum that the power to tax involves the power to destroy. This eventuality should be obviated. Article 1769(3) of the Civil Code provides that ― the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common fight or interest in any property from which the returns are derived‖. There must be an unmistakable intention to form a partnership or joint venture. (Obillos, Jr. v. CIR, 139SCRA 440).Such is not present in the case at bar. For tax purposes, the purchase of a house t be rented out is in fact a contribution of the incomes of A, B and C to a common fund for the purposes of dividing the rentals earned among themselves. With respect to the purchase of a house, a partnership was thus formed in 2002, subjecting them to corporate income tax rates. (Evangelista v. Collector, 102 Phil 140)

Mrs. Carmen Reyes died in 1996 leaving as heirs her husband, Pedro Reyes, and six (6) children. She left real properties in Manila, Pasay City and Quezon City, with a total value of P50,000.00. The husband was appointed administrator of the estate. In 2001 the project of partition was approved by the court and upon satisfaction that the estate and inheritance taxes had already been paid, the special proceedings on the estate of the deceased was closed and terminated. However, Mr. Reyes continued to administer the properties with the consent of his children. He leased some of the properties, the rental income of which he accumulated and later used in the purchase of other properties. By 2002, he and his children had acquired real property with a total value of P2,000,000.00. Investigation revealed that during the period 2001 to 2002, the annual rental income of the properties administered by Mr. Reyes was P120,000.00. He reported half of said annual income in his income tax return, while each of his children added to his income the amount of P10,000.00, as his share in the rental income of the properties.

If you were the Commissioner of Internal Revenue, how would you tax the yearly rental income of P120,000.00? What in your opinion should be the tax status of Mr. Reyes and his children? Explain, citing the legal basis for your conclusion. (1973) As the Commissioner of Internal Revenue, I would determine which portion of the yearly income of P120,000.00 is attributable to the inherited properties and the portion coming from the properties from the accumulated rentals of the inherited properties. The income from the inherited properties should be taxed as income from the separate properties of Mr. Reyes and his children. They should be taxed separately as they are merely co-owners of the properties. The income from the properties purchased from the rental income of the properties is partnership income taxable like corporations. With respect to the purchased properties, the tax status of Mr. Reyes and his children is a taxable partnership. Co-heirs who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise would subject the income of all coownership of inherited properties to the tax on corporations resulting in oppressive taxation and confirm the dictum that the power to tax involves the power to destroy. This eventually should be oviated. Article 1769(3) of the Civil Code provides that ―the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common fight or interest in any property from which the returns are derived.‖ There must be an unmistakable intention to form a partnership or joint venture. (Obillos, Jr. v. Commissioner of the Internal Revenue, 139 SCRA 440) such is not present in the instant case. For tax purposes the purchase income generating real property is in fact, a contribution of the incomes of Mr. Reyes and his children to a common fund for the purpose of dividing the rentals earned among themselves. Thus, a partnership was thus formed in 2002, subjecting them to corporate income tax rates. (Evangelista c. Collector, 102 Phil.)

Rosa Arroyo died in 2000. His heirs executed a project partition of her estate which was approved by the Court. However, Rosa’s estate was not actually distributed among the heirs but remained under the management of their father (widower-spouse) who used the properties in business and so their value increased yearly. The profits were credited on the books of account of the common fund to the heirs in proportion to their respective hereditary shares. The heirs allowed their father to continue using their shares for his ventures, although they paid income taxes on their respective shares of the profits of their common business. Is there a partnership here subject to corporate income tax under the Tax Code? Why? (1975) There was no partnership formed subject to the corporate income tax, when her widower-spouse and heirs did not partition the estate they inherited from Rosa. However, when the heirs allowed their father (the widower spouse) to continue using

their shares for his ventures, resulting in a common business, there was formed partnership. Co-heirs who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would subject the income of all coownership of inherited properties to the Article 1769(3) of the Civil Code provides that ―the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common fight or interest in any property from which the returns are derived.‖ There must be an unmistakable intention to form a partnership or joint venture. (Obillos, Jr. v. Commissioner of the Internal Revenue, 139 SCRA 440) such is not present in the instant case. For tax purposes the purchase income generating real property is in fact, a contribution of the incomes of Mr. Reyes and his children to a common fund for the purpose of dividing the rentals earned among themselves. Thus, a partnership was thus formed in 2002, subjecting them to corporate income tax rates. (Evangelista c. Collector, 102 Phil.)

EL, GL, and XL all of legal age, inherited from their parents, who both died in a car accident on January 1, 1997, a ten (10) door apartment building situated on a 2,500 square meter lot (apartment building) in Pasay City. The estate proceedings with the Regional Trial Court (RTC) of Pasay City were terminated on 31 December 1998 with the three (3) sisters remaining equal and proindiviso co-owners of the apartment building. The rent was divided equally among the three sisters after deducting the expenses (like real estate taxes and major repairs) on the apartment building. The three sisters then reported their shares of the net income in their individual income tax returns from 1999 to 2002. Now, a buyer has offered to purchase the apartment building for P10 million. a. Were the three sisters correct in reporting their shares of said net income in their respective tax returns from 1999 to 2002? Explain. b. If the three sisters decide to sell the apartment building, how will they be taxed on the sale? Explain (1990) a. Yes. Co-heirs who inherited properties which produce income should not automatically be considered as partners of an unregistered partnership or corporation subject to tax. The reason is that sharing of gross returns does not by itself establish a partnership. There must be an unmistakable intention to form a partnership or joint venture. There is no contribution or investment of additional capital to increase or expand the inherited properties, merely continuing the dedication of the property to the use to which it had been put by their forebears. (Obillos, Jr. v.CIR, 139 SCRA 436) b. They shall be taxed on their ordinary income from the sale. The properties are not capital assets because they are used in trade or business. Mr. Santos died intestate in 2000 leaving his spouse and five children as the only heirs. The estate consisted of a family home and a four-door apartment

which was being rented to tenants. Within the year, an extrajudicial settlement of the estate was excuted among the heirs, each of them receiving his/her due share. The surviving spouse assumed administration of the property. Each year, the net income from the rental of the property was distributed to all, proportionaely, on which they paid respectively, the corresponding tax. In 2003, the income tax returns of the heirs were examined and deficiency income tax assessment were issued against each of them for the years 2000 to 2002, inclusive, as having entered into an unregistered partnership. Were the assessment justified? (1997) No. Co-heirs who inherited properties which produce income should not automatically be considered as partners of an unregistered partnership or corporation subject to tax. The reason is that sharing of gross returns does not by itself establish a partnership. There must be an unmistakable intention to form a partnership or joint venture. There is no contribution or investment of additional capital to increase or expand the inherited properties, merely continuing the dedication of the property to the use to which it had been put by their forebears. (Obillos, Jr. v.CIR, 139 SCRA 436) Roberto Ruiz and Conrado Cruz bought three(3) parcels of land from Rodrigo Sabado on 4 May 1994. Then on 8 July 1995, they bought two(2) parcels of land from Miguel Sanchez. In 2000, they sold the first three parcels of land to Central Realty Inc. In 2002, they sold the two parcels to Jose Guerrero. Ruiz and Cruz realized a net profit of P100,000 for the sale in 2000 and P150,000 for the sale in 2002. The corresponding capital gains taxes were individually paid by Ruiz and Cruz. On 20 September 2002 however, Ruiz and Cruz received a letter from CIR assessing them deficiency corporate income taxes for the years 2000 and 2002 because, according to the CIR, during said years they as co-owners in the real estate transactions formed an unregistered partnership or joint venture taxable as a corporation and that the unregistered partnership was subject to corporate income tax, as distinguished from profits derived from the partnership by them, which is subject to individual income tax. Are Roberto Ruiz and Conrado Cruz liable for deficiency corporate income tax? No. Roberto Ruiz and Conrado Cruz have not formed a partnership subject to corporate tax rates. Mere sharing of gross returns does not of itself establish a partnership (Art. 1769-3, Civil Code). There must be an unmistakable intention to form a partnership or joint venture. (Obillos, Jr. v.CIR, 139 SCRA 436). There is no showing that the joint purchase was for the purpose of earning profits to be divided among them. Noel Langit and his brother, Jovy, bought a parcel of land which they registered in their names as pro indiviso owners (Parcel A). Subsequently, they formed a partnership duly registered with the SEC, which bought another

parcel of land (Parcel B). Both parcels of land were sold, realizing a net profit of P1,000,000 for Parcel A and P500,000 for Parcel B. a. The BIR claims that the sale of Parcel A should be taxed as a sale of an unregistered partnership. Is the BIR correct? b. The BIR also claims that the sale of Parcel B should be taxed as a sale by a corporation. Is the ABIR correct? (1994) a. No. The brothers have not formed a partnership subject to corporate tax rates. Mere sharing of gross returns does not of itself establish a partnership (Art. 1769-3, Civil Code). There must be an unmistakable intention to form a partnership or joint venture. (Obillos, Jr. v.CIR, 139 SCRA 436). There is no showing that the joint purchase was for the purpose of earning profits to be divided among them. b. Yes, because the Parcel B was brought after the brothers have formed a taxable partnership. Registration of the partnership with the SEC is a manifest showing of the brother’s intention to engage in business together and divide the profits.

General Professional Partnerships

Distinguish the income tax liability of X, a general professional partnership engaged in the practice of law, and Y, a general partnership engaged in the operation of logging concession. (1981) A general professional partnersip is 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 while a general partnership is formed by persons for the sole purpose of engaging in any trade or business. A general professional partnership is not a taxable entity hence its income is not taxable as such while a general partnership is considered as a corporation hence a taxable entity and its income is taxable as such. A general professional partnership not being a taxable entity does not need to file an income tax return but an information return while a general partnership being a taxable entity should file an income tax return. The partners in a general professional partnership are not subject to double taxation being taxed only once while a general partnership is taxed once on its income and the share in the profits of the partners are again taxed as dividends. X, Y, Z & Associates is a partnership of new lawyers belonging to the same law class and fraternity. The BIR District Officer is requiring them to register their firm name with the Bureau of Domestic Trade before the Revenue Distrcit Office will allow the registration of books, receipts and other records of the law firm. Is the law firm subject to pay income tax as well as the requirement to file an income tax return? Explain (1988)

The firm is not subject to pay income tax as it is a general professional partnership for the sole purpose of exercising their common profession, no part of the net income of which is derived from engaging in any trade or business. The parties shall be liable for income tax only in their individual capacity. The firm is required to file in duplicate a return of its income, except income exempt under Sec 32 (B) of the NIRC of 1997 (exclusion from gross income), setting forth the items of the gross income and deductions allowed and the names, TINs, addresses and shares of each of the partners. (Sec. 55, NIRC of 1997) A partner in a general law partnership incurs expenses that are not passed on to the partnership such as: he buys his own law books; he entertains clients without passing the bills to the partnership; he pays his own dues to professional organization; and he buys a car for use in law practice. The partnership does not advance the purchase price or take title to the car. May he deduct the above-mentioned expenses from his distributive share in the net profits of said partnership? Why? (1999 No, because these are incurred in the exercise of the profession which are properly deductible by the general professional partnership in order to arrive at the net distributive shares of the individual partners. Atty. MA and Atty. PL were classmates in law school. After passing the bar in 1999, they joined separate law firms in Makati. In 2000, they resigned from their respective law firms and formed a law partnership under the firm name of A & L, with office address at Ayala Avenue, Makati City. In January, 2002, being particularly a good year, the partnership anticipates a net income of P2.0 million. a. Is the said law partnership a taxable entity for income tax purposes? Explain. b. If the two partners decide to reinvest P1.5 million into the partnership to buy an office condominium and distribute as dividends only P0.50 million, how much of the partnership’s 2002 net income will be subject to income tax? Explain. (1990) a. No, because it is a general professional partnership organized for the conduct of a profession. (Sec. 22 (B) and 26, NIRC OF 1997) b. None, because the net income of a general professional partnership is not subject to income taxation.

D. EXCLUSION FROM GROSS INCOME Exclusion from Gross Income, in General

Discuss briefly whether or not all income is taxable. (1988) Not all income are taxable. Some incomes are excluded from gross incomes in the determination of taxable income, and others are subject to tax exemptions. Exclusions from gross income distinguished from deductions from gross income. a) Exclusions from gross income refer to a flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons: 1) it is exempted by the fundamental law; 2) it is exempted by statute; and 3) it does not come within the definition of income (Sec. 61, Rev, Regs. No. 2), WHILE deductions are the amounts which the law allows to be subtracted from gross income in order to arrive at net income. b) Exclusions pertain to the computation of gross income, WHILE deductions to the computation of net income. c) Exclusions are something received or earned by the taxpayer which do not form part of gross income, WHILE deductions are something spent or paid in earning gross income. An example of exclusion from gross income are life insurance proceeds, and an example of a deduction are ordinary and necessary expenses.

Distinguish “Exclusion from Gross Income” from “Deductions from Gross Income”. Give an example of each. a) Exclusions from gross income refer to a flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons: 4) it is exempted by the fundamental law; 5) it is exempted by statute; and 6) it does not come within the definition of income (Sec. 61, Rev, Regs. No. 2), WHILE deductions are the amounts which the law allows to be subtracted from gross income in order to arrive at net income. b) Exclusions pertain to the computation of gross income, WHILE deductions to the computation of net income. c) Exclusions are something received or earned by the taxpayer which do not form part of gross income, WHILE deductions are something spent or paid in earning gross income. An example of an exclusion is life insurance proceeds while an example of deduction is depreciation. Life Insurance Proceeds

“X” Corporation took a keymen insurance of the life of its President, Mr. Rodel Cruz. The policy designated Mr. Cruz’s wife as its revocable beneficiary in the event of death of Mr. Cruz. Will the insurance proceeds be treated as income subject to tax by the wife?(1980) No. Proceeds of life insurance policies paid to the beneficiary, in this case the wife, upon the death of the insured are excluded from gross income. [Sec. 32 (B) (1), NIRC of 1997]. The reason is that life insurance proceeds represents indemnity not income. Mr. X received the following income and you were asked to prepare his income tax return. Is he required to include as part of gross income the proceeds from a life insurance policy received from the estate of his deceased parents? Give your reasons. (1988) No. Life insurance proceeds are excluded from gross income. [Sec. 32 (B) {1}, NIRC of 1997], being compensation or indemnity for loss and not income. Returned Premiums A took out a life insurance policy for P1,000,000.00 naming his wife as beneficiary. Under the terms of the policy, the insurer will pay A the amount of P1,000,000.00 after the 20th year of the policy, and his beneficiaries, should he died before that date. A outlived the policy and received P1,000,000.00. The premiums paid on the policy was P250,000.00. Is the P1,000,000.00 received by A subject to tax? Explain your answer. (1978) No, not all of the P1,000,000.00 is subject to tax. The amount of P250,000.00 is not subject to tax because it is the amount received by A, as a return of the premiums paid by him under a life insurance contract at the maturity of the term mentioned in the contract. [Sec. 32 (B) (2), NIRC of 1997]. The premiums returned are not income but return of capital. They represent earnings which were previously taxed. On the other hand, the amount of P750,000.00 is subject to tax because it represents income being interest or earnings of the premium and not return of capital. (Ibid)

Linus purchased a life annuity for P500,000 which will pay him P120,000 a year. The life expectancy of Linus is 12 years. Under Section 32 of NIRC of 1997, which of the following will Linus be able to exclude from his gross income: a. P940,000 b. P500,000 c. P1,440,000 Choose one of the above answers and explain your choice. (1986)

P500,000. the said amount represents a return of premiums paid by Linus which is not income but return of capital. They represent earnings which were previously taxed. [Sec (B) (2), NIRC of 1997] Born of a poor family on 14 February 1952, Mario worked his way through college. After working for more than 12 years in X Manufacturing Corporation, Mario decided to retire and avail of the benefits under the very reasonable retirement plan maintained by his employer. On the day of his retirement on 30 April 2002, his endowment insurance policy, for which he was paying an annual premium of P1,520 since 1982 also matured. He was then paid the face value of his insurance policy in the amount of P50,000. Is his P50,000 insurance proceeds exempt from income taxation? (1991) Not all of the P50,000 would be exempt. Only the amount of P30,400 considered as a return of premiums would be exempt while the balance of P19,600 representing the interest or earnings of the premium would be subject to tax. The amount of P30,4000 represents a return of premiums paid by Marcelo which is not income but return of capital. They represent earnings which were previously taxed. [Sec.32 (B) (2), NIRC of 1997] Gifts, Bequests and Devises Explain whether or not the following taxpayer is subject to income tax on her described item received: Mrs. Y, wife of a deceased employee, received financial benefits voluntarily voted upon by the Board of Directors of the employer-company in recognition of her husband’s long and loyal service and primarily to help her meet financial needs. (1988) Mrs. Y is not subject to income tax on the financial benefits she received because there were no services rendered by Mrs. Y. It could not also be considered as income of the deceased employee because the giving was not in payment for services rendered. Since there was no consideration given, it is a gift and not income. Mr. Osorio, a bank executive, while paying golf with Mr. Perez, a manufacturing firm executive, mentioned to the latter that his (Osorio’s) bank had just opened a business relationship with a big foreign importer of goods which Perez’ company manufactures. Perez requested Osorio to introduce him to this foreign importer and put in a good word for him (Perez), which Osorio did. As a result, Perez was able to make a profitable business deal with the foreign importer. In gratitude, Perez, in behalf of his manufacturing firm, sent Osorio an expensive car as a gift. Osorio called Perez and told him that there was really no obligation on the part of Perez or his company to give such expensive gift.

But Perez insisted that Osorio keep the car. The company of Perez deducted the cost of the car as a business expenses. The Commissioner of Internal Revenue included the fair market value of the car as income of Osorio who protested that the car was a gift and therefore excluded from income. Who is correct, the Commissioner or Osorio? Mr. Osorio is correct. Where the taxpayer receives a car from a corporation for furnishing the names of potential customers, the same is a gift excluded from income taxation.(Duberstein v. Commissioner of Internal Revenue F2d 28, CCA 6 th0 Mr. Rodrigo, an 80-year old retired businessman, fell in love with a 20-year old Tetchie Sonora, a nightclub hospitality girl. Although she refused to marry him, she agreed to bbe his “live in” partner. In gratitude, Mr. Rodrigo transferred to her a condominium unit, where they both live, under a deed of salee for P10 million. Mr. Rodrigo paid the capital gains tax of 6% of P10 million. The Commissioner found that the property was transferred to Tetchie Sonora by Mr. Rodrigo because of the companionship she was providing him. Accordingly, the Commissioner made a determination that Sonora had compensation income of P10 million in the year the condominium was transferred to her and issued a tax deficiency income tax assessment. Tetchie Sonora protests the assessment and claims that the transfer of the condominium unit was a gift and therefore excluded from income. How will you rule on the protest of Tetchie Sonora? Explain. (1995) Protest granted. There was no legally demandable obligation on the part of Sonora to get the condominium unit. This is because there was no consideration she gave to Mr. Rodrigo in exchange for the condominium unit. The giving stemmed from a pure act of liberality on the part of Mr. Rodrigo which is a gift excluded from gross income. X, a multinational corporation doing business in the Philippines, donated to Mr. Y, its resident manager in the Philippines. Assuming the shares of stock were given to Mr. Y in consideration of his services to the corporation, what is the tax implication? Explain. (1996) The value of the shares shall be taxable as a compensation income because it was paid as a result of employer-employee relationship. Compensation for Injuries or Sickness Are moral damages awarded a litigant for mental anguish on account of a libelous article written about him taxable as income or not? Why? (1964)

Moral damages are taxable as income. Mental anguish is not physical injuries, therefore moral damages awarded due to moral anguish are not excluded from income. Amount received as a compensation for personal injuries plus amounts of any damages received on account of such injuries are excluded from taxable income if the personal injuries are physical in character. Exclusions from taxable income are considered as exemptions from taxation, hence to be interpreted in strictissimi juris against the taxpayer. The words ―personal injuries‖ should be given a restrictive meaning to refer only to physical injuries. This interpretation finds basis in Sec. 32 (B) (4), NIRC of 1997 which refers to ―Accident or Health Insurance or under Workmen’s Compensation Acts, both of which refers to ―physical injuries or sickness‖. This could only mean physical injuries. In a certain civil case, plaintiff was awarded damages by the court in the sum of P20,000 representing profit he failed to realize on account of defendant’s failure to comply with his obligation to said plaintiff. Are those damages taxable against him? (1967) Yes, because damages which are excluded from gross income are only those that paid as a result of injuries or sickness. Furthermore, since this is ―unearned income‖ than he would have paid income taxes on the income if he was not previously deprived of such income. It is only just that upon recovery he should pay income taxes on the same. An accident solely attributable to the criminal negligence of the driver of B Bus Company resulted in the death of X’s wife, physical injuries to X that prevented him from working for a month, and the total wreck of X’s brand new car which he had bought for P400,000. In the action for damages filed by X against B Bus Company, the court awarded the following; p30,000 for X’s injuries consisting mainly in the loss of his right hand; P25,000 for X’s loss of one month salary; P25,000 for the death of his wife and P100,000 moral damages on account of such loss; and P800,000 for the loss of X’s car, the value of which had in the meantime doubles on account of inflation. How would you treat each of the above items of damages for income tax purposes? Explain (1984) The amount of P30,000 for X’s injuries consisting in the loss of his right hand, P25,000 for the death of his wife, and the P100,000 moral damages arising from the death of X’s wife are all excluded from gross income. They represent amounts of damages received by suit as compensation for injuries. Consequently, such amounts are not considered income. [Sec. 32 (B) (4), NIRC of 1997] The P800,000 is partly taxable. The first P400,000 representing the value of the damaged car is not taxable because it is merely compensation or replacement of what X lost. Consequently, there is no income. The increase in value of the car in the amount of P400,000 is taxable income because it was a damage payment arising

from the destruction of the car and not from the physical injuries arising from sickness or accident. The P25,000 award representing salary not earned as a result of the accident is taxable because it is merely a replacement of income that is taxable if earned. Exclusions are to be strictly construed as they constitute tax exemptions. The widow and children of a passenger who died in an airplane crash were paid P1,200,000 by the airline. This figure was reached after negoatiation between the heirs of the deceased and the insurer of the airline, the latter having received indubitable evidence that the deceased had a net income of P120,000 at the time of his death, and that 10 productive years would have insured financial stability to his family. Should the heirs declare this amount in their income tax returns. State your answer. (1970) No, the amount of P1,200,000 should not be declared in the heir’s income tax returns. The amount represents damages received on account of personal injuries (which includes death) by agreement hence to be excluded from gross income. [Sec. 32 (B) (4) NIRC of 1997]. The reason for the exclusion is that the payment is mere compensation for injuries suffered and not income. Furthermore, the amounts were not existing at the time of the death of the decedent. Patroclus was injured in a vehicular accident in 1999. He incurred and paid medical expenses of P10,000 and legal fees of P5,000 during the year. In 2002, he recovered P35,000 as settlement from the insurance company which insured the car owned by the other party involved in the accident. From the above payments and transactions, the amount taxable to Patroclus in 20002 is: a. P20,000 b. P25,000 c. P30,000 d. P35,000 e. None of the above. Choose one of the above answers and give reasons for your choice. (1986) None of the above. All of the recovered amounts are not income because they are merely compensation for actual losses suffered. They do not constitute taxable gain as they were not received as payment for services, interest or profit from investment. Mr. Infante was hit by a wayward bus while on his way to work. He survived but had to pay P400,000 for his hospitalization. He was unable to work for six (6) months which meant that he did not receive his usual salary of P10,000 a month or a total of P60,000. He sued the bus company and was able to obtain a final judgment awarding him P400,000 as reimbursement for his hospitalization, p60,000 for the salaries he failed to receive while hospitalized, P200,000 as moral damages for his pain and suffering, and P100,000 as exemplary damages. He was able to collect in full from the judgment. How much income did he realize when he collected on the judgment? Explain. (1995)

P60,000 because this amount is merely a replacement of income which should have been subjected to tax if earned. All of the other receipts are excluded from gross income. They represent amounts of damages received by suit as compensation for injuries. Consequently, such amount are considered as income. [Sec. 32 (B) (4), NIRC of 1997] Retirement Benefits, Gratuities, Pension, Etc

RSV was retired by his employer corporation in 1997 and paid P100,000 as a retirement gratuity without any deduction of withholding tax. The corporation subsequently became bankrupt. Can the BIR subject the P100,000 retirement gratuity to income tax? Discuss. No. It is clear that ―RSV was retired by his employer xxx.‖ The only conclusion that could be drawn is that he was separated beyond his control. Thus, the retirement gratuity he received is excluded from gross income and not subject to income tax. Romulus, 48 years of age and a retired employee had among his properties and transactions at the end of the 1998 taxable year: Retirement benefits in the amount of P200,000.00 received by him in 2002 under a qualified retirement plan maintained by his former employer company. Romulus voluntarily retired after 20 years of service. Is the above item subject to the regular tax rates found in the schedule under Section 24 (A) of the NIRC, which states that the tax rates on citizens and residents? Explain your answer. Yes, because it is not among excluded incomes. There is no showing that Romulus retirement was compulsory, hence it could not be said that his separation was beyond his control. The amount of P200,000.00 could not also be considered as tax-exempt retirement because Romulus is only 48 years which is below 50 years. Neither is there a statement in the facts that he has worked for the same employer for at least ten (10) years or that he has not previously enjoyed tax-free retirement benefits. Explain whether or not the following taxpayer is subject to the income tax on the described item received: Retiree from AG&P receiving retirement benefits from the company retirement plan, qualified by the BIR. (1988) The retirement benefits would be subject to tax because there is no showing that the retiree is a qualified tax-free retiree. The problem does not show that the retiree is above 50 years, that he has served his employer for more than 10 years and that he has not previously availed of tax-free retirement. Furthermore, there is no showing that the separation through retirement wass beyond the retiree’s control.

“A” worked for “Z” from 1970 to 2002. Beginning 2003 “A’s” employment was terminated as he could no longer perform his duties. “A” was informed by “Z” that he will get a pension of P5,000.00 a month for the rest of his life. “Z” has neither standardized pension plan nor a qualified pension plan. “A’s” pension was paid from “Z’s” operating revenues and “Z” deducted the payments as necessary and ordinary business expense. On the part of “A”, must he treat his pension as income? Reasons. (1989) No, because they are amounts received by ―A‖ from his employer as a consequence of his termination from the service for a cause beyond his control. The pension is excluded from gross income. Born of a poor family on 14 February 1954, Mario worked his way through college. After working for more than 12 years in X Manufacturing Corporation, Mario decided to retire and avail of the benefits under the very reasonable retirement plan maintained by his employer. On the day of his retirement on 30 April 2002 he received P400,000.00 as retirement benefit. Is Mario’s P400,000.00 retirement benefit subject to income tax? Yes. Mario’s retirement benefits are subject to income tax as he was only 48 years old at the time of his retirement. For retirement to be excluded from gross income, hence not subject to tax, the retiree must be above 50 years. Pedro Reyes, an official of Corporation X, asked for an “earlier retirement because he was emigrating to Australia. He was paid P2,000,000.00 as separation pay in recognition of his valuable services to the corporation. Juan Cruz, another official of the same company, was separated for occupying a redundant position. He was given P500,000.00 as separation pay. Jose Bautista was separated due to his failing eyesight. He was given P500,000.00 as separation pay. All the three (3) were not qualified to retire under the BIR-approved pension plan of the corporation. a) Is the separation pay given to Reyes subject to income tax? b) How about the separation pay received by Cruz? c) How about the separation pay received by Bautista? (1994) a) Yes. The voluntary action on the part of Pedro Reyes, is not considered as a cause beyond his control, the separation is not excluded from gross income. It is included for tax purposes. He does not qualify for tax-free retirement because there is no showing that he is 50 years or over, that he has rendered at least 10 years of service with Corporation X, and that he has not previously availed of the tax-free retirement. b) No, because Cruz was separated for a reason beyond his control as a result of redundancy. c) No. The separation pay received by Bautista was due to his failing eyesight, a cause beyond his control. Mr. Jacobo worked for a manufacturing firm. Due to this business reverses the firm offered a voluntary redundancy program in order to reduce overhead

expenses. Under the program, an employee who offered to resign would be given separation pay equivalent to his three months’ basic salary for every year of service. Mr. Jacobo accepted the offer and received P400,000.00 as separation pay under the program. After all the employees who accepted the offer were paid, the firm found its overhead still excessive. Hence, it adopted another redundancy program. Various unprofitable departments were closed. As a result, Mr. Kintanar was separated from the service. He also received P400,000.00 as separation pay. a) Did Mr. Jacobo derive income when he received his separation pay? Explain. b) Did Mr. Kintanar derive income when he received his separation pay? Explain. (1995) a) Yes. Mr. Jacobo voluntarily resigned hence the separation pay he received, not being for a cause beyond his control, is not excluded from gross income. Furthermore, the separation pay is not also considered as tax-free retirement because there is no showing that he is 50 years or over, that he has rendered at least 10 years service with his employer, and he has not previously availed of the tax-free retirement. b) No, because Mr. Kintanar was separated for a reason beyond his control which is redundancy. The amount he received is excluded from gross income, hence, not taxable. Mr. Quiroz worked as chief accountant of a hospital for forty-five years. When he retired at 65, he received a retirement pay equivalent to two months salary for every year of service as provided in the hospital’s retirement plan in view of his loyalty and invaluable services for forty-five years; hence, it resolved to pay him a gratuity of P1 million over and above his retirement pay. The Commissioner of the Internal Revenue taxed the P1 million as part of the gross compensation income of Quiroz who protested that it was all excluded from income because (a) it was retirement pay and (b) it was a gift. a) Is Mr. Quiroz correct in claiming that the additional P1 million was retirement pay and therefore excluded from income? Explain. b) Is Mr. Quiroz correct in claiming that the additional P1 million was a gift and therefore excluded from income? Explain. (1995) a) No, because the P1 million was beyond the amount paid from the reasonable retirement plan. b) Yes. The P1 million was given on the basis of the pure act of liberality on the part of the hospital. There was no obligation on the part of the hospital to give the amount. X, an employee of ABC Corporation, died. ABC Corporation gave X’s widow an amount equivalent to X’s salary for one year. Is the amount considered taxable income to the widow? Why? (1996) The amount given is not considered taxable income to the widow because it is among the exclusions from gross income.

The amount received by the heirs of an employee as a consequence of separation of such employee from the service of the employer because of death is excluded from gross income. The money given to X’s heir, his widow because of X’s death the amount is not income. (Sec. 32 (B) (6) (b), NIRC of 1997) A Co., a Philippine corporation, has two divisions- manufacturing and construction. Due to the economic situation, it had to close its construction division and lay-off the employees in that division. A Co., has a retirement plan approved by the BIR, which requires a minimum of 50 years of age and 10 years of service in the same employer at the time of retirement. There are 2 groups of employees to be laid off: (a) Employees who are at least 50 years of age and has 10 years of service at the time of termination of employment. (b) Employees who do not meet either the age or length of service A Co., plans to give the following: For category (A) employees - the benefits under the BIR approved plan plus an ex gratia payment of one month for every year of service. For category (B) employees - one month for every year of service. A Co., seeks your advice as to whether or not it will subject any of these payments to WT. Explain your advice. (1999) The payments should not be subject to withholding tax (WT). The separation, due to the economic situation, is one which is beyond the employees control, hence excluded from gross income and not subject to income taxation. To start a business of his own, Mr. Mario de Guzman opted for an early retirement from a private company after ten (10) years of service. Pursuant to the company’s qualified and approved private retirement benefit plan, he was paid his retirement benefit which was subjected to withholding tax. a) Is the employer correct in withholding the tax? Explain. b) Under what conditions are retirement benefits received by officials and employees of private firms excluded from gross income and exempt from taxation? (2000) a) Yes. Mario is not entitled to a tax-free retirement because he has not complied with the requirements, specifically the absence of showing that he is at least fifty 50) ears of age at the time of retirement and that he has not previously availed of the tax-free retirement. b) Retirement benefits received under Republic Act No. 7614 and those received by officials and employees of private firms, whether, individual or corporate, in accordance with employer’s reasonable private benefit plan approved by the BIR, are excluded from gross income and exempt from income taxation if the retiring official or employee was: 1) In service of same employer for at least ten (10) years. 2) Not less than fifty (50) years of age at time of retirement; 3) Availed of the benefit of exclusion only once. [Sec. 32 (B) (6) (a), NIRC of 1997] The retiring official or employee should not have

previously availed of the privilege under the retirement plan of the same or another employer. [1st par., Sec. 2.78 (B) (1), Rev. Regs. 2-98] Maribel Santos, a retired public school teacher, relies on her pension form the GSIS and the interest income from a time deposit of P500,000.00 with ABC Bank. Is Miss Santos liable to pay any tax on her income? (1994) Her pension is not subject to tax as it is an exclusion from income. The interest from the time deposit is subject to the final tax of 20% as passive income. Mr. Javier is a non-resident senior citizen. He receives a monthly pension from the GSIS, which he deposits with the PNB-Makati Branch. Is he exempt from income tax and therefore not required to file an income tax return? (2000) Yes. Mr. Javier does not have any income which is required to be reported in the income tax return. His pension is not subject to tax as it is an exclusion from income. The interest form the time deposit is subject to the final tax of 20% as passive income, and therefore not required to report in an income tax return. Miscellaneous Items Excluded From Gross Income

Evelyn is a graduate student of U.P. In January, 2002, she won the Palanca Award for an outstanding short story she wrote. The award was P25,000.00 in cash. In February, 2002, she was also named most Valuable Player of the Varsity Volleyball Team and she was given a trophy plus P10,000.00. Finally, in March, 2002, she received a Fellowship Award from the University of California to pursue a master’s degree in American Literature. The fellowship is for $10,000.00 plus free board and lodging fro two (2) semesters. Should Evelyn include these awards and fellowship in her gross income? Reasons. (1993) All of the awards and monetary value of her fellowship are excluded from her gross income. The awards were made primarily in recognition of her educational and literary achievements. There is no showing in the problem that Evelyn was selected due to any action on her part to join the contest. And that she is required to render substantial future services as a condition to receiving the prize or award. [Sec. 32 (B) (7) (c), NIRC of 1997] Jose Miranda, a young artist and designer, received a prize of P100,000.00 fro winning in the on-the-spot peace poster contest sponsored by a local Lions Club. Shall the award be included in the gross income of the recipient for tax purposes? Explain. (2000) Yes. It is apparent from the nature of an on-the-spot poster contest that there was action on the participant’s part to enter the contest. [Sec. 32 (B) (7) (c), NIRC of 1997], hence the prize is not excluded from income taxation.

Onyok, an amateur boxer, won in a boxing competition sponsored by the Gold Cup Boxing Council, a sports association duly accredited by the Philippine Boxing Association. Onyok received the amount of P500,000 as his prize which was donated by Ayala Land Corporation. The BIR tries to collect income tax on the amount received by Onyok who refuses to pay. Decide. (1996) The P50,000 prize is subject to tax. The prize was granted to Onyok, an athlete, in a local or international sport tournament, but there is no showing in the problem that the Philippine Boxing Association, is the national sports associations for boxing duly accredited by the Philippine Olympic Committee. (Sec. 32 (B) (7) (d), NIRC of 1997) In June 2002, the Sangguniang Bayan authorized a mid-year bonus of P3,000, a cash gift of P5,000 and transportation and representation allowance of P6,000 for each of the municipal employees. a. Is the midyear bonus subject to any tax? b. How about the cash gift? c. How about the transportation and representation allowance? Since the total amounts do not exceed P30,000 for the year, then they are excluded from gross income. (Sec. 32 (B) (7) (e), NIRC of 1997) E. PASSIVE INCOME SUBJECT TO FINAL TAX Passive Income in General What is mean by income subject to “final tax”? Give at least two examples of income of resident individuals that is subject to final tax. (2001) Income subject to final tax refers to an income collected to through the withholding tax system. The payor of the income withholds the tax and remits it to the government as a final settlement of the income tax due to said income. The recipient is no longer required to include the income subject to a final tax as part of his gross income reportable in the annual income tax return. Among the examples of income subject to final tax are dividends, interest on bank deposits, royalties, etc. Taxation of Passive Income Mr. Juan, while relaxing in his living room, picked up the telephone which had just rung. The voice at the other end, after asking for the name and address of Mr. Juan, announced that he, Mr. Juan, had just won a prize of P5,000. Within the week, his prize arrived through mails. The program was sponsored by a manufacturing company. The choice of Mr. Juan was done by the announcer who picked up the telephone directory, flicked to a page theein and ran down his fingers to the 29 th name on the page.

Is the amount he received considered part of taxable income as this term is defined in Sec. 31 of the NIRC? Reason out your answer. (1979) Yes. The amount of the prize being less than P10,000 shallnot be subject to final tax. (Sec. 24 (B) (1), NIRC OF 1997) but shall be included in the gross income less the deductions and/ or personal and additional exemptions, if any (Sec. 31, Ibid.), then subjected to the schedular rate. (Sec. 24 (A) (1) (c), Ibid) Mr. X received income and you were asked to prepare his income tax return. Is he required to include as part of gross income proceeds from his winnings from the gambling casino? Give your reason. (1998) No. If the winnings exceed P10,000, they shall be subject to a final tax of 20% hence not to be included in the income tax return. (Sec. 24 (B) (1), NIRC of 1997) What are disguised dividends in income taxation? (1994) These are payments, usually for services, made in the form of dividends in order to evade the higher taxes imposed on gross income. They are not dividends in legal contemplation because they are not return from investments. May a stock dividend constitute taxable income to the shareholder who receives it? Why? (1977) During the year, a domestic corporation derived dividends from its stock investments in domestic corporations. In preparing the corporate income tax return, what should be the tax treatment? (1997) No. A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. (1st sentence, Sec 73 (B), NIRC OF 1997) Stock dividends are unrealized gain and cannot be subject to income tax until the gains have not been realized. Stock dividends represent capital and do not constitute income to its recipients. The mere issuance thereof is not subject to income tax as they are nothing but an ―enrichment through the increase in value of capital investment‖. As capital, stock dividends postpone the realization of profits because the ―fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution.‖ Before realization, stock dividends are nothing but a representation of an interest in the corporate peoperties. As capital, it is not yet subject to income tax. (CIR v. CA, et al., January 20, 1999) From the following list of taxpayer’s receipts during a taxable year, select and write down all the items that would fall under his taxable income under Sec. 31 of the NIRC; as well as what falls under gross compensation income: a. Salaries received from a private frim; b. Proceeds from life insurance; c. Sweepstakes prize; d. Annual bonus; e. Christmas bonus;

f. Per diems; g. Dividends on life insurance; h. Rentals; i. Government backpay under RA 304; j. Compensation for his injuries; k. Sale of crops; l. Interest on money loaned. Explain your answer briefly. (1966) The following falls under the taxpayer’s taxable income, having been earned from trade or business: (h) Rentals, (k) Sale of crops, and (l) Interest of money loaned. Comprising his compensation income, which was earned as a result of employer-employee relationship are: (a) Salaries received from a private firm, (d) Annual bonus (e) Christmas bonus, and (f) Per diems, provided that for (d), (e) and (f), only the amount exceeding P30,000 should be includible in his compensation income. It should be noted that items (b) Proceeds from life insurance and (j) Compensation for injuries, are not included as income hence part of the exclusions from gross income. Items (c) sweepstakes prize, (g) dividends on life insurance, and (i) Government backpay under RA 3O4 are exempt from income taxation. Romulus, 48 years of age and a retired employee had the following properties and transactions at the end of the 2002 taxable year: a. Cash dividends received by Romulus from Sabinia Corp. during 2002 in the amount of P5,000. b. Interest on time deposits with United Banana Bank received in 2002 in the amount of P80,000. Are the above items subject to the regular rates found in the schedule under Sec. 24 of the NIRC, which states the tax rates on individual citizens and individual resident aliens in the Philippines? Explain your answer. (1986) a. No. the cash dividends received by Romulus are not subject to the regular rates. They are subject to the regular rates. They are subject to final tax of 10% on the gross amount of the dividends. b. No, because the interest on bank deposits are subject to final tax on 20% on the gross interest earned. (Sec. 24 (B) (1), Ibid) During the year, a domestic corporation derived the following items of revenue: (a) gross receipt from as trading business; (b) interest from money placement in the banks; (c) dividends from its stock investments in domestic corporations; (d) gains from stock transactions through the Philippine stock Exchange; (e) proceeds under an insurance policy on the loss of goods. In preparing the corporate income tax return, what should be the tax treatment on each of the above items?

Only the gross receipts from a trading business should be included as part of gross income reportable in the corporate return. The proceeds under an insurance policy should not be included as it is not income being merely compensation for the loss suffered. All the other items are subject to a final tax and should not be reportable. F. CAPITAL GAINS TAX Capital Gains Taxation, In General When may a capital gain be exempt from tax? (1976) a. Sale, exchange or other disposition of real property. 1. Presumed capital gains realized from the disposition of their principal residnce by natural persons, the proceeds of which are fully utilized in acquiring or constructing a new principal residence subject to certain conditions. (sec. 24 (D) (2), NIRC of 1997). This exemption is availbe only to resident individuals, whether citizens or aliens. 2. Sales under the Community Mortgage Program (1st par. Sec. 3, Rev. Regs. No. 17-2001) 3. Foreclosure sale 4. Consolidation of more than one title owned by the same owner into one mother title. 5. Sale by a trustee of land owned by the tax-exempt pension plan. (BIR Ruling, June 9, 1998) 6. Transfer of land from one government agency to another for development into a social housing community to be disposed of to bonafide residents. (BIR Ruling, November 14, 1989) 7. Conveyance of common areas by developer-owner to the condominium corporation without consideration after uits therein have been sold. (BIR Ruling, September 10, 1991) 8. Adjudication of real property to an heir in a partition not being sale, exchange or disposition thereof. (BIR Ruling, December 3, 1991) 9. Transfer of real property to trustee under a revocable trust. (BIR Ruling, March 19, 1992) 10. Sale by a religious organization of a land and its improvements used for religious purposes, if the proceeds thereof shall be used to purchase a new church site and construction of a church building thereon. (BIR Ruling, April 2, 1992) b. Certain types of exchanges solely in kind 1. Exchange in pursuance of a consolidation or merger subject to certain conditions (Sec.40 (B) (2), NIRC of 1997) 2. The exchange results to control of the corporation together with others not exceeding four (4) persons. (last par., Sec.40 (B) (2), NIRC of 1997)

What is capital asset? Illustrate with an example? (1988) The term ―capital assets‖ means property held by the taxpayer (whether or not connected with his trade or business), but does not include: a. Stock in trade, or b. Other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or c. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or d. Property used in the trade or business, of a character which is subject to the allowance for depreciation; or real property used in the trade or business of the taxpayer. (Sec. 39 (A) (1), NIRC OF 1997) Examples of capital assets are: a. Stock and securities held by taxpayers other than dealers in securities. b. Jewelry not used for trade and business c. Residential houses and lands owned and used as such d. Automobiles not used in trade or business e. Paintings, sculptures, stamp collections, objects of arts which are not used in trade or business In 1993, Mr. Naval bought a lot for P1,000,000 in a subdivision with the intention of building his residence on it. In 2002, he abandoned his plan to build his residence on it because the surrounding area became a depressed area and land values in the subdivision went down; instead he sold it for P800,000. Is the land a capital asset or an ordinary asset? (1994) The land is a capital asset. It is not used for trade and business because it was intended for Mr. Naval’s residence. (Sec. 39 (A). NIRC of 1997) An individual taxpayer who own a ten (10) door apartment with a monthly rental of P10,000 each residential unit, sold this property to another individual taxpayer. Is the seller liable to pay the capital gains tax? (1998) No. The seller is not liable to pay the capital gains tax. The tax is imposed only upon the disposition of a capital asset, which is one not used in trade or business. (Sec. 24 (D) (1), NIRC of 1997) Since the (ten) 10-door apartment is being rented out on a regular basis, it is used in trade or business. Thus, it is an ordinary asset and any gains derived there from the disposition shall not be subject to capital gains taxation but to ordinary income taxation. Perlas inherited from his parents large parcels of undeveloped land acquired by them years ago at the total cost of P500,000. Perlas now sells all of these parcels for P2,000,000. How much of the gains should he report for income tax purposes? (1974) None. He need not report any gains in his income tax return. The sale is subject to the final tax of 6% on the presumed capital gains derived from the sale because the property is a capital asset not used in trade or business.

Supposed that when Perlas inherited these parcels, they were already fully developed real estate subdivisions, with small lots being sold on installment basis. He now sells all these parcels for P4,000,000. How much of the gain should he report for income tax purposes? (1974) The gain Perlas should report for income tax purposes should be his taxable ordinary income which results after deducting deductions and/or personal and additional exemptions allowed under the law from his gross income of P4,000,000. Since the properties are fully developed real estate subdivisions, these are ordinary assets being properly held by Perlas, the taxpayer, primarily for sale to customers in the ordinary course of his trade or business (Sec. 39 (A) (1), NIRC of 1997). The properties being ordinary assets, the gains should not be subject to the final tax imposed on the disposition of capital assets. What is ordinary gains? Give examples. (1989) What does the term “ordinary income” include? (1998) Ordinary gain is any gain from the sale or exchange of property which is not a capital asset or property. (Sec. 22 (Z), NIRC of 1997) Examples or ordinary gains include, among others, the gains derived from the sale of real property used in trade or business such as a building being rented out on a regular basis; sale or items held for sale in the ordinary course of business, such as the gains from the sale of automobiles by a car dealer; sale of equipment subject to depreciation, such as the sale by a pharmaceutical firm of its medicine manufacturing equipment. Differentiate capital gains from ordinary gains. (1974) How would you differentiate capital gains from ordinary gains? (1989) What is the difference between capital gains and ordinary gains? (1998) a. The source of capital gain is property not used in trade or business while the source of ordinary gain is property used in trade or business. b. Some types of capital gains are adjusted by the holding period while the holding period does not find application to ordinary gains. c. From certain types of capital gains may be deducted ordinary losses while only ordinary loss may be deducted from ordinary gains. d. The concept of net loss carryover applies to capital gains taxation, while the concept of net operating loss carryover applies to ordinary gains taxation e. Generally no deductions are allowed from capital gains while deductions are usually allowed for ordinary gains. Aristarchus is engaged in business as an art dealer. His inventory of paintings includes several masterpieces which he acquired ten years ago. Aristarchus invests part of his savings in private corporations belonging to his friends. The shares of these corporations are not traded in the stock market. Among his existing investments are shares of stock of Crescent Corporastion and Ethereal Corporation. Consider the following transactions of Aristarchus during the taxable year 2002.

1. In May 2002, Aristarchus sold his shares in Ethereal Corporation which he held since 1999. His original purchase price for these shares was P100,000. He sold them for P200,000. 2. In September 2002, Aristarchus sold one of his Manansala masterpieces for P2,000,000. The buyer gave him a manager’s check which Aristarchus can deposit anytime. However, Aristarchus foresaw that his income for 2002 will be substantially higher than he wanted it to be. He therefore plans to wait until 2003 before depositing the manager’/s check. Aristarchus acquired the painting in 1992 for P100,000. 3. In addition to the above transactions, Aristarchus has also been thinking of disposing of his Crescent Corporation shares. He bought the said shares in 1995 for P400,000. They are presently worth only P200,000. The son of Aristarchus is getting married in 2002 and Aristarchus is thinking of selling the Crescent shares for P200,000 and donating the proceeds of the sale to his son. After mulling this over, Aristarchus decided to sell the Crescent shares and donate the cash proceeds to his son. What types of gains or losses will Aristarchus realize in transactions 1, 2 and 3 above for the taxable years 2002 and 2003, if any? Explain your answer. (1986) 1. In the taxable year 2002, Aristarchus realized a capital gain from the disposition of the shares of Ethereal Corporation because his selling price is higher that his acquisition price. Aristarchus is not engaged in the business of buying and selling shares of stock, neither is there showing in the problem that the shares are listed and traded in the local stock exchange, hence the Ethereal shares are capital assets. He realized the gain in 2002 because it was at that time the shares were sold. 2. Aristarchus had an ordinary gain in 2002. Aristarcus is an art dealer engaged in the business of buying and selling paintings. There is a gain because the selling price was higher than the acquisition price.When the manager’s check was given to Aristarchus in 2002, he had full disposition of the same, hence it was in 2002 that he realized the income. The date of the deposit in 2003, has no effect on the realization of the income. 3. In taxable year 2002, Aristarchus incurred a capital loss froom the disposition of the shares in Crescent Corporation because his selling price is lower than is acquisition price. Aristarchus is not engaged in the business of buying and selling of shares of stock, neither is there any showing in the problem that the shares are listed and traded in the stock exchange, hence the Crescent shares are capital assets. He incurred the loss in 2002 because it was at that time the shares were sold. Tax Treatment of Disposition of Real Property Deemed Capital Assets

X-land Condominium Corporation was organized by the owners of units in Xland Building in accordance with the Master Deed with Declaration of Restrictions. The X-land Building Corporation, the developer of the building, conveyed the common areas in favor of the X-Land Condominium. Is the conveyance subject to any tax? (1994) No. There was no separate sale, exchange or other disposition that is taxable. When the owners purchased their units, the common areas were already included in the sales prices that were already subject to income taxes. A corporation engaged in real state development, executed deeds of sale on various subdivided lots. One buyer, after going around the subdivision, bought a corner lot with a good view of the surrounding terrain. He paid P1.2 million, and the title to the property was issued. A year later, the value of the lot appreciated to a market value of P1.6 million, and the buyer decided to build his house thereon. Upon inspection, however, he discovered that a huge tower antennae had been erected on the lot frontage totally blocking his view. When he complained, the realty company exchanged his lot with another corner lot with an equal area but affording a better view. Is the buyer liable for capital gains tax on the exchange of the lots? (1997) Yes. The buyer who exchanged his lot is subject to the presumed capital gains tax as he is considered the seller in the exchange. The transaction subject to the 6% presumed capital gains taxes includes not only sales but exchanges of property [Sec. 24 (D) (1), NIRC] The rea property of Mr. Pedro Cruz was expropriated yt he government in 2002. He acquired said property in 1985 for only P50,000, but the government paid him P1,000,000 which was the market value at the time of the appropriation. How shall Mr. Cruz be taxed on the expropriation proceeds? Explain. (1973) The tax liability, if any, on the gains from sales or other dispositions of real property, classified as capital assets, to the government or any of its political subdivisions or agencies or to government owned or controlled corporations shall be determined, at the option of the taxpayer, in either of the following: a. Included as part of gross income to be subject to the allowable deductions and/or personal and additional exemptions, then subject to the schedular rate [Sec. 24 (D) (1), in relation to Sec 24 (A) (1), NIRC] b. The final tax of six (6) percent imposed on the presumed capital gain whichever is higher of the gross selling price, or the current fair market value as determined below: 1. the fair market of real properties located in each zone or area as determined by the Commissioner after consultation with competent appraisers both from the private and public sectors; or 2. the fair market value as shown in the schedule of values of the Provincial and City Assessors. [Sec. 24 (D) (1) in relation to Sec 6 (E), NIRC]

Juan Panalo won a damage suit for P500,000 agaist Juan Talo. Panalo got a writ of execution and made a levy on the lot of Talo. The lot was sold at public auction where Panalo was the highest for P500,000. Panalo refused to pay any capital gains tax on his purchase of said lot. Your opinion. (1993) Panalo is correct in refusing to pay the capital gains tax. The tax is to be paid by the seller, in this case Talo, not the buyer Panalo. [Sec. (D) (1), NIRC] X bought a house and lot on March 19, 1993 for P900,000. He sold the same property on April 10, 2002 for P2,000,000. How much is the taxable income on his capital asset transaction that should be reported by X? Reason (1976) There is no taxable income to be reported in the annual income tax because the transaction is subject to the 6% presumed capital gains tax. There is no showing that the house and lot is used in X’s trade or business or that he is engaged in the realty business.The property is thus classified as capital asset. X purchased a house and lot in 1995 for P1,000,000. Five years later, X fenced the whole premises, constructed an annex to the house and put up a swimming pool, which cost him a total of P1,000,000. X sold the property in 2002 for P3,000,000. Assessment was issued against X for a capital gain based on P1,000,000. Is the assessment correct? Explain briefly. (1981) No. It appears that the house and lot is a capital asset because it is bot used in trade or business. Thus, it is subject to the 6% presumed capital gains tax which does not consider the actual gain realized. CD purchased a parcel of land in 1963 for P10,000. He died in 1981. In his will, he devised the aforesaid parcel to a fried of his, MN, obtained title thereto in 1983 after CD’s estate has been settles. On August 30, 20002, MN received a P1,000,000 cash offer for the said lot. He now would like your advice as to the taxes he will have to pay should he actually sell. State your opinion on the matter with legal support. (1985) The parcel of land is a capital asset since there is no showing that it is used in trade or business. As such if sold, the seller shall be subject to the 6% presumed capital gains tax based on whichever is the higher of the gross selling price, the fair market value determined by the Commissioner, or the valuation of the provincial or city assessor. In 1993, Mr. Naval bought a lot for P1,000,000 in a subdivision with the intention of building his residence on it. In 2002, he abandoned is plan to build his residence on it because the surrounding area became a depressed area and land values in the subdivision went down. Instead he sold it for P800,000. At the time of the sale, the zonal value was P500,000. is there any income tax due on the sale? (1994)

Yes. The income tax due on the sale is the presumed capital gains tax. [Sec. 24 (D) (1), NIRC]. This is so because the property is a capital asset not used in trade or business. A, a doctor by profession, sold in the year 2002 a parcel of land which he bought as a form of investment in 1992 for P1million. The land was sold to B, his colleague, at a time when the real estate prices had gone down and so the land was sold for P800,000 which was then the fair market value of the land. He used the proceeds to finance his trip to the United States. He claims that he should not be made to pay the 6% final tax because he did not have any actual gain on the sale. Is his contention correct? Why? (2001) No. Dr. A’s contention is not correct. The 6% final tax is a ―presumed capital gains tax‖ which is based on whichever is higher of the gross selling price, the current fair market value as determined by the BIRT Commissioner, or the valuation of the city/provincial assessor. It is imposed irrespective of whether there is a gain or a loss from the sale. [Sec. 24 (d) (1), NIRC] XYZ, a corporation not engaged in the realty business, bought a piece of land in 2001 which it sold to another corporation one year later. It realized a net profit of P1,000,000. What income tax rate would it be subject to and why? (1988) Assuming that XYZ is a domestic corporation, it shall be subject to the 6% presumed capital gains tax. There is no showing in the problem that the piece of land is used in its trade or business, hence it is classified as a capital asset. ABC, s domestic corporation, sold in 2002 two (2) condominium units of Legaspi Toower in Roxas Blvd. For P8,158,142. Taxpayer corporation declared in its income tax return for taxable year 2002 its gains derived from the sale of the two (20)condominium units as follows: UNIT A UNIT B (316.5 sq. ft.) (322 sq. ft) Proceeds from sale P3,933,679 P4,224,463= P8, 158,142 Less: a. Acquisition cost 1,501,295 1, 529,755= 3,031,050 (Deed of sale, 9/9/97) b. Payment of realty tax 49,248 53,412 = 104,661 Total (a) and (b) P1,550,543 P1,565,168= P3,135,711 Gains P2,383,136 P2,639,295= P5,022,431 Without going into computations, answer the following question: Since ABC derived gains from the sale of the condominium units, should it pay the 6% capital gains tax because the corporation is not a real estate dealer? Discuss. (1992) Yes. ABC should pay the 6% capital gains tax because there is no showing in the problem that the properties are used in its trade or business.

X sold a piece of land to the United Church of Christ of Quezon City, Inc. the land is to be devoted strictly for religious purposes by the Church. When the Church tried to register the title of the land, the Register of Deeds refused claiming that the capital gains tax was not paid. Is the transaction exempt from the capital gains tax? Reason. (1993) No. The capital gains tax is due from X, the seller. Neither X nor the united church of Christ of Quezon City, is exempt from the capital gains tax. The tax exemption of a religious institution applies only to real property taxes, and on certain kinds of income. Mar and Joy got married in 1993. A week before their marriage, Joy received, by way of donation, a condominium worth P750,000 from her parents. After marriage, some renovations were made at a cost of P150,000. In 2002, they sold the condominium unit and bought a new unit. What is the income tax implications of the sale? (1997) The sale is subject to the 6% presumed capital gains tax. There is no showing that the condominium is used in trade or business. The sale is not exempted from capital gains taxes because the problem does not show that the condominium unit is the principal residence of Mar and Joy. Tax Treatment of Sale, Exchange or Other Disposition of Shares of Stock Not Listed and Traded in the Stock Exchange that are Considered as Capital Assets

In June, 2002, A, a Filipino, sold for P5,000,000 a 500 sq. m. lot that he bought in 1990 for P50,000. His brother B sold in the same year at P1.00 per share 500,000 shares of stock of Black Gold Corporation whose shares were being traded at the Makati Stock Exchange. B bought the shares two years before at P0.10 each. What would be the respective income tax liabilities of the two brothers? A. would be subject to the 6% presumed capital gains tax because the property is considered as a capital asset not used in trade or business. B would be subject to the transfer tax of ½ of 1% on the gross selling price since the shares were traded in the stock exchange. Whether the shares are capital assets or not, as well as the holding period does not apply to sales of shares of stock in the stock exchange. Romulus, 48 years of age and a retired employee had the following properties and transactions at the end of the 2002 taxable year: c) Shares of stock in Sabinian Corporation which he bought in 1998 for P50,000.00 and which were worth P70,000.00 as of the end of 2002. d) Shares of Visigoth Corporation which he bought for P40,000.00 in 1990 and which he sold for P100,000.00 in 2002.

Are the above items subject to the regular tax rates found in the schedule under Section 24 (A) of the NIRC which states the tax rates on citizen and residents? Explain your answer. (1986) a. No. There is no income yet that has been realized which could be subject to taxation. Mere increments in value without realization are not taxable. b. No. If Visigoth Corporation is a domestic corporation and the shares are traded through the local stock exchange, they shall be subject to a final tax, hence not to the regular tax rates. If traded, the sale shall be subject to the transaction tax of ½ of 1%, which is also a final tax. If Visigoth Corporation is not a domestic corporation, then the proceeds of the sale shall be included in the annual income tax return subject to the rates on ordinary income. Three brothers inherited in 1997 a parcel of land valued for real estate purposes at P3.0 million which they held in co-ownership. In 2000, they transferred the property to a newly organized corporation as their equity which was placed at a zonal value of P6.0 million. In exchange for the property, the three brothers thus each received shares of stock in the corporation with a total par value of P2.0 million or, altogether, a total of P6.0 million. No business was done by the corporation, and the property remained idle. In the early part of 2002, one of the brothers, who was in dire need of funds, sold his shares to the two brothers for P2.0 million. Is the transaction subject to any internal revenue tax other than the documentary stamp tax? (1997) The transaction shall be subject to the capital gains tax on the sale of shares of stock in domestic corporation outside of the stock exchange, if there is a taxable gain. Tax Treatment of Other Capital Assets that are Not Real Property or Shares of Stock Not Listed and Traded in the Stock Exchange Mrs. G received as gift from her mother several pieces of jewelry purchased ten years ago for P100,000. At the time of the gift, the jewelry had a fair market value of P2.0 million. After possessing the jewelry for 18 months. Mrs. G sold them for P2.5 million. 1) What are the tax consequences? Discuss without need of making computations. 2) Suppose Mrs. G received a piece of land as a gift from her mother. Under the same set of facts described above, what are the tax consequences of the sale of the land? Explain. (1987) 1. Mrs. G shall determine her capital gain after applying the holding period. The capital gain is then included in the annual income tax return, subject to the schedular rate. 2. Mrs. G shall be subject to the 6% presumed capital gains tax without regard to the holding period. This is so because the property is classified asset, there being no showing that it is used in trade or business.

Taxation of Exchanges of Property When may capital gains be exempt (1976) No capital gains or loss shall be recognized if in the 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; or b. A shareholder exchanges stock in a corporation which is a party to the merger or consolidation solely for the stock of another corporation, also a party to the merger or consolidation; c. A security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation solely for stock or securities in another corporation, a party to the merger or consolidation; or 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 other, not exceeding four (4) persons gain control of said corporation: Provided, that stocks issued for services shall not be considered as issued in return for property. [Section 40 (C), NIRC} Don Juan is engaged in extensive farming activities on his 50-hectare farm in Tanauan, Batangas. He bought his farm in 1994 for only P50,000. On September 11, 2002, it has a fair market value of P5,000,000. Don Juan now intends to transfer his 50-hecatre farm to X, Inc. , an existing domestic corporation in which Don Juan already owns 95% of the stockhildings. He would like to transfer his farm to X, for P4,500,000 worth of shares of stock (of X, Inc.) and P500,000 in cash. Don Juan consults you concerning the tax consequence of his proposed transaction. Explain his tax liability. (1968) The exchange is one that is not a tax-free exchange because it is not one solely in kind (a portion was cash), and that the exchange did not result to control as Don Juan was already in control. Don Juan has a tax liability on his realized gain. He acquired the property for P50,000 but he was able to get in exchange P4,500,000 worth of shares and P500,000 cash. He is to be taxed on the P450,000 cash exceeding his acquisition of P50,000. He is going to be taxed on the shares of stock only when he disposes of them. Cebu Development, Inc. (CDI) has an authorized capital stock of P5,000,000 divided into 50,000 shares with a par value of P100.00 per share. Of the authorized capital stock, 25,000 shares have been subscribed. M. Jun Legaspi is a stockholder of CDI where he has his subscription amounting to 13,000 shares. To fully pay his unpaid subscription in the amount of P950,000, Mr Legaspi transferred to the corporation a parcel of land that he owns by virtue of a Deed of Assignment. Upon investigation, the BIR discovered that Mr. Legaspi acquired said property for only P500,000. Is Mr Legaspi liable for any taxable gain? Is CDI liable for any taxable gain? (1991)

Both Mr. Legaspi and CDI are not liable for any taxable gain. The transaction is an exchange solely in kind. Thus, no gain is recognized as the property transferred to CDI by Mr. Legaspi in exchange for the shares of stock resulted in Mr. Legaspi’s gaining control of CDI because he acquired ownership of 13,000 or more than 50% of the total authorized shares of 25,000. Dimas owns a parcel of land worth P5,000,000 which he inherited from his father in 2002 when it was worth P3,000,000. His father purchased the property in 1988 for P1,000,000. a. If Dimas transfers this parcel of land to his wholly owned corporation, Dimasalang Corporation, in exchange for shares of stock of said corporation worth P4,500,000, Dimas will have a taxable gain of : 1. Zero 2. P500,000 3. P2,000,000 4. P3,500,000 5. P4,000,000 6. None of the above Choose one of the above answers and explain the reason for your choice. (1986) P3,500,000. The exchange is not one solely in kind which is subject to tax exemption. To be exempt, the exchange must be for the purpose of obtaining control which is not present in this case. b. Dimasalang Corporation ion the above situation would have a taxable gain of: 1. Zero 2. P500,000 3. P1,500,000 4. P3,500,000 5. None of the above Choose one of the above answers and explain the reason for your choice. (1986) P500,000. Dimasalang parted with as asset worth of P4,500,000, with another with a value of P5,000,000. The exchange is not exempt because Dimas already controls the corporation. In a tax-free exchange the purpose must be for controlling the corporation. c. As a result of the transaction above-mentioned, the aggregate basis of Dimas for all his Dimasalang corporation shares is: 1. P1,000,000 2. P3,000,000 3. P4,500.000 4. P5,000,000 5. None of the above Again, choose one of the above answers and explain the reason for your choice. (1986)

P300,000. This is the fair market value price or value of the property as of the date the property was acquired through inheritance. d. Going back to the transaction in question no. 2, if instead of inheriting the parcel of land from his father, Dimas received it as a gift, the aggregate basis of Dimas for all his Dimasalang Corporation shares would be: 1. P1,000,000 2. P3,000,000 3. P4,500.000 4. P5,000,000 5. None of the above Again finally, choose one of the above answers and explain the reason for your choice. (1986) P1,000,000 which was the value at the hands of his father.

In a qualified tax-free exchange of property for shares under Section 40 (C) (5) of the Tax Code, what is the tax basis for computing the capital gains on : a) the sale of the assets received by the corporation; and b) the sale of the shares received by the stockholders in exchange of the assets? (1994) a. With respect to the asset received by the corporation, the tax basis should be the original historical cost of the property exchanged for the shares of stock increased by the amount of the gain recognized by the transferor on the transfer. [Sec. 40 (C) (5) (b), NIRC] b. The basis of the shares received in exchange for the property, is the same as the value of the property exchanged decreased by (1) the money received, and (2) the fair market value of the other property received, and increased by (a) the amount treated as dividend, and (b) the amount of any gain that was recognized on the exchange. [Sec. 40 (C) (5) (a), NIRC] In a qualified merger under Section 40 (C) (2) of the Tax Code, what is the tax basis for computing the capital gains on : (1) the sale of the assets received by the surviving corporation from the absorbed corporation; and (2) the sale of the shares of stock received by the stockholders from the surviving corporation? (1994) The same answer as above.

G. PERSONAL EXEMPTIONS

Basic Personal Exemptions

H. DEDUCTIONS FROM GROSS INCOME I. COMPENSATION INCOME OF INDIVIDUALS J. INDIVIDUALS: TAXATION OF SELF-EMPLOYMENT INCOME, INCOME FROM TRADE AND BUSINESS OR PROFESSION K. ESTATES AND TRUSTS L. TAXATION OF CORPORATION M. TAXATION OF GENERAL PROFEWSSIONAL PARTNERSHIPS, JOINT VENTURE NOT TAXABLE AS A CORPORATION N. WITHHOLDING OF TAX O. INCOME TAX RETURNS, INFORMATION RETURNS AND ELECTRONIC FILING OF TAX RETURNS P. COLLECTION AND PAYMENT OF INCOME TAXES, PENALTIES AND SURCHARGES Q. ADMINISTRATIVE AND COMPLIANCE REQUIREMENTS R. INCOME TAX EXEMPTIONS, SPECIAL INCOME TAX SYSTEM AND TAX TREATIES