TAXATION I

(INCOME TAXATION)

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Basis of Government’s right to impose tax on
income: Partnership theory

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 TAX ON INCOME

Income – (in the broad sense) all wealth which flows into the taxpayer
other than 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.
- it includes both taxable and non-taxable income.
Capital – is a fund or property existing at one distinct point of time.
- capital is wealth, while income is the service of wealth; capital is a
“tree” and income is the “fruit.”

Gross Receipts – receipts which may constitute capital as well as income

Revenue – refers to all funds/income derived by the government whether

from tax or other sources. Revenue is to the government as income is to
private persons or corporations.

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Income – is regarded as the best measure of taxpayer's ability to pay
tax. It is an excellent object of taxation in the allocation of government
costs.
– the tax concept of income is simply referred to as “gross income”
- the taxable item of income referred to as an “item of gross income”
or “inclusion in gross income.”

Taxability of income depends on the KIND OF TAXPAYER, SOURCE OF

INCOME, AND KIND OF INCOME.

“The essential difference between capital and income is that capital is a

fund; income is a flow. A fund of property existing at an instant of time is
called capital. A flow of services rendered by that capital by the payment of
money from it or any other benefit rendered by a fund of capital in relation
to such fund through a period of time is called an income. Capital is wealth,
while income is the service of wealth.” (Madrigal vs. Rafferty, G.R. No. L-
12287, August 7, 1918)
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“x x x income means money received, coming to a person or corporation for
services, interest, or profit from investments. We do not believe that the
Legislature intended that a mere increase in the value of the capital or
assets of a corporation, firm, or individual, should be taxed as "income."
Such property can be reached under the ordinary from of taxation.(Fisher
vs. Trinidad, G.R. No. L-17518, October 30, 1922

“x x x income may be defined as an amount of money coming to a person

or corporation within a specified time, whether as payment for services,
interest or profit from investment. Unless otherwise specified, it means
cash or its equivalent. 4 Income can also be though (sic) of as flow of the
fruits of one's labor. (Conwi vs. Cir, G.R. No. 48532 August 31, 1992)

“Income means "cash received or its equivalent"; it is the amount of money

coming to a person within a specific time ...; it means something distinct
from principal or capital. For, while capital is a fund, income is a flow. As
used in our income tax law, "income" refers to the flow of wealth.”
(Commissioner vs. BOAC, G.R. No. L-65773-74 April 30, 1987)
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 Sources of Income

• Property
• Labor (Service)
• Sale/exchange of capital asset and activity

For tax purposes, income from whatever

source forms part of the taxpayer’s income.

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"The words 'income from any source whatever' disclose a
legislative policy to include all income not expressly exempted
within the class of taxable income under our laws."
(Commissioner vs. BOAC)

The term “source of income” is not a place but the property,

activity or service that produced the income. In the case of
income derived from labor, it is the place where the labor is
performed; in the case of income derived from the use of
capital, it is the place where the capital is employed; and in
the case of profits from the sale or exchange of capital assets,
it is the place where the sale or transaction occurs.

The term ‘taxable income’ means the pertinent items of gross

income specified in this Code, less deductions, if any,
authorized for such types of income by this Code or other
special laws.” (Section 9, R.A. 10963) 7
Requisites for income to be taxable:

1. There must be gain or profit, whether in cash or its

equivalent. (Existence of income)
- the value received in the form of cash or its equivalent as a
result of rendition of service or earnings in excess of capital
invested.

2. The gain must be realized or received. Thus, not all

economic gains constitute taxable income. (Realization of
income)

Gen. Rule: A mere increase in the value of property

without actual realization, either through sale or other
disposition, is not taxable.
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Tests in determining Realization of Income:
a. Severance Test- Where there is no separation of
gain or profit, or separation of increase in value from
capital, there is no income subject to tax.
b. Realization Test – There is no taxable income until
there is a separation from capital of something of
exchangeable value, thereby supplying the realization or
transmutation which would result in the receipt of
income.
Gen. Rule: A mere increase in the value of property
without actual realization, either through sale or other
disposition, is not taxable.
A mere expectation of profits is not an income.
Exception: Economic benefit principle
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 With regard to the question of whether the appraisal
increase of property, plant and equipment of electric
utilities is taxable, the general rule is that, mere increase
in the value of property without actual realization, either
through sale or other disposition, is not taxable.
However, if by reason of appraisal, the cost basis of
property is increased and the resulting basis is used as
the new tax base for purposes of computing the
allowable depreciation expense, the net difference
between the original cost basis and new basis due to
appraisal is taxable under the economic benefit principle.
(BIR Ruling No. 029 – 98, March 19, 1998)

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The BIR revoked several rulings it issued including BIR Ruling Nos.
DA-413-04 and DA-416-04 and elucidated that acquisition cost less
any foreseeable salvage value shall be used in the computation of
depreciation expense of property, plant and equipment. Expounding
the clarification, it cited the case of Basilan Estates, Inc. vs. CIR, GR
No. L-22492, 5 September 1967, where the Supreme Court held that
the depreciation of an asset must be premised on its acquisition
cost, and not on its reappraised value. Income tax law does not
authorize the depreciation of an asset beyond its acquisition cost.
Further, Item IX of RAMO No. 1-00 dated 17 March 2000 states that
depreciation is not allowed on the appraisal increase of fixed assets.
(Revenue Memorandum Circular No. 70-2010, August 9, 2010)
Receipt of income may either be actual or constructive.
• Constructive receipt - Income which is credited to the account of or
set apart for a taxpayer and which may be drawn upon by him at
any time is subject to tax for the year during which so credited or
set apart, although not then actually reduced to possession.

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 - To constitute receipt in such a case, the income
must be credited to the taxpayer without any substantial
limitation or restriction as to the time or manner of
payment or condition upon which payment is to be
made. [Section 52, Revenue Regulations 2]
Example: Partner’s distributive share in the profits of
a general professional partnership is regarded as
received by the partner, although not yet distributed.
Presumptive receipt – it presumes the existence of
income on transactions supposedly not subject to tax.
(Sale of real property at a loss is still subject to capital
gains tax)
Income is not deemed realized until the fruit has been
plucked from the tree EISNERV.MACOMBER [252 US
426]
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Insofar as corporations are concerned, its liability to the capital gains
tax imposed on the presumed gains realized from the sale, exchange
or disposition of lands and/or buildings is governed by Section 27(D)
(5) of the Tax Code of 1997. Thus, for a corporation to be liable to
the tax, a true sale, exchange or disposition of capital assets must
have transpired. Unlike in transactions made by individuals under
Section 24(D)(1) of the Code, where all sales of real property
classified as capital assets, including pacto de retro or other forms of
conditional sales are subject to the capital gains tax, no similar
qualifications exist for capital asset transaction of a corporation.
Hence, the latter is subject to such tax only upon a close and
completed transaction in which income is realized.
Accordingly, this Office holds that only upon the executing of the
final or absolute deed of sale covering the properties of the bank
subject of the pacto de retro, will the payment of the 6% capital
gains tax apply. By the same token, since no actual conveyance of
real property is to be made, the stamp tax on deeds of sale and
conveyances of real property imposed under Section 196 shall not
apply. However,
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since the transaction is in the nature of an equitable
mortgage and made primarily as a security for the
payment of a pre-existing loan, the same is subject
instead to the rate of documentary stamp tax imposed
under Section 195. (BIR Ruling No. 091-99 dated July 8,
1999)

c. Economic Benefit Test/Doctrine of Proprietary

Interest – Income is earned when there is a substantial
alteration of the interest of a taxpayer, i.e. increase in
proportionate share of a stockholder in a corporation.
Where stock, options, shares of stock or other assets are
transferred by an employer to an employee to secure
better services they are plainly compensation which is
taxable income COMMISSIONER V. LABUE[351 US 243]
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 d. Claim of Right Doctrine – The power to dispose of
income is the equivalent of ownership of it. The exercise
of that power to procure the payment of income to
another is the enjoyment and hence the realization of
the income by him who exercises it. The dominant
purpose of the revenue laws is the taxation of income to
those who earn or otherwise create the right to receive
it and enjoy the benefit of it when paid HELVERING V.
HORST [311 U.S.112]
- a taxable gain is conditioned upon the presence of
a claim of right to the alleged gain and the absence of a
definite and unconditional obligation to return or repay.

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 CIR vs. Javier, G.R. No. 78953, July 31, 1991 - In this
case, the remittance was not a taxable gain, since it is
still under litigation and there is a chance that Javier
might have the obligation to return it. It will only
become taxable once the case has been settled because
by then whatever amount that will be rewarded, Javier
has a claim of right over it.
When a taxpayer receives funds (which represent
earnings) with a contingent obligation to repay, either
because the sum is disputed or mistakenly paid, and no
limitation on the use of the funds exists, those funds are
included in the taxpayer’s income in the year they are
received.

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 e. All events test- Income is reportable when all the
events have occurred that fix the taxpayer’s right to
receive the income and the amount can be determined
with reasonable accuracy. (CIR vs.ISABELA
CULTURALCORPORATION, G.R. NO. 172231, FEBRUARY
12, 2007)

f. Flow of Wealth Test - The test of taxability is the

source (the property, activity or service that produced the
income determines whether any gain was derived from
the transaction (COLLECTOR V. ADMINISTRATRIX OF THE
ESTATEOF ECHARRI, G.R. NO. 45544, APRIL25, 1939)

3. The gain must not be excluded by law or treaty from

taxation. (Recognition of Income)
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Are the following items income?
• Found treasure – YES
• Punitive damages representing profit loss– YES
• Damages for breach of promise or alienation of
affection - YES          
• Worthless debts subsequently collected – YES
(Recovery of bad debts previously allowed as
deduction in the preceding years shall be included as
part of the gross income in the year of recovery to the
extent of the income tax benefit of said deduction.)
• Tax refund – NO (but yes if the tax was previously
allowed as a deduction and subsequently refunded or
credited, as benefit accrued to the taxpayer; see
discussion on tax as a deductible item)
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• Non-cash benefits – YES
• Income from illegal sources – YES
• Psychological benefits of work – NO
• Give away prizes – YES
• Scholarships/fellowships – YES
• Stock dividends – NO
• Payment of usurious interest - YES

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• Cancellation of indebtedness

“SECTION 50.Forgiveness of indebtedness. — The

cancellation and forgiveness of indebtedness may amount
to a payment of income, to a gift, or to a capital
transaction, dependent upon the circumstances. If, for
example, an individual performs services for a creditor,
who, in consideration thereof cancels the debt, income to
that amount is realized by the debtor as compensation for
his services. If, however, a creditor merely desires to
benefit a debtor and without any consideration therefor
cancels the debt, the amount of the debt is a gift from the
creditor to the debtor and need not be included in the
latter's gross income. If a corporation to which a
stockholder is indebted forgives the debt, the transaction
has the effect of the payment of a dividend.” (RR. 02-40)
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Types of Income Tax System
1. Schedular System – different types of incomes are
subject to different sets of graduated or flat income tax
rates. Applicable tax rates will depend on the classification
of the taxable income and the basis could be gross income
(without deductions) or net income (deductions were
already subtracted).
- The schedular system is one where the income tax
treatment varies and is made to depend on the kind or
category of taxable income of the taxpayer.
- In a schedular system, income items are categorized into
schedules according to the type of activity which produced
them. Different tax rates are applied for each type of
income, one set of tax rates for salaries and wages, another
set of rates for business income and so on. Its main thrust is
the type of income than the characteristic of the taxpayer.
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 - the tax burden of a person does not correspond to
his income but rather fall fortuitously on the type of his
income. It is fixed and final.
2. Global System – the taxpayer is required to lump up
all items of income earned during a taxable period and
pay a single set of income tax rates on these different
items of income.
- The global system is one where the tax treatment
views indifferently the tax base and generally treats in
common all categories of taxable income of the taxpayer.
- A single tax is imposed on all income received or
earned by person irrespective of the activities which
produced the income.
- The burden of an individual is closely related to his
resources and ability to pay
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Income tax
– a tax on all yearly profits arising from property,
profession, trade or offices or as a tax on person’s
income, emoluments, profits and the like.

Nature of Philippine Income Tax:

It is a/an
a. direct tax - because the tax burden is borne by
the income recipient upon whom the tax is imposed
b. progressive tax (mainly) - since the tax base
increases as the tax rate increases. (ability to pay
principle)

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 c. excise tax

*It is based on income, either gross or net, realized in

one taxable year.

*It is the most comprehensive - by adopting the

citizenship principle, resident principle and the source
principle.

*It uses a semi-schedular and/or semi-global tax

system.

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Types of Philippine Income Tax
•  Net income tax
a. Graduated income tax on individuals
b. Normal corporate income tax on corporations
 
• Gross income tax
a. Minimum corporate income tax of 2% of the
gross income
b. Improperly Accumulated Earnings tax of 10%
on improperly accumulated earnings
c. Optional Corporate Income Tax of 15% on Gross
Income.

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 d. Gross Philippine Billings Tax
e. Gross onshore income Tax
f. Final withholding tax on passive income
g. Capital gains tax
 
• Fringe benefit tax
• Branch profit remittance tax

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Income Taxation Schemes
1. Final income taxation
2. Capital gains taxation
3. Regular/Normal income taxation

Items of
Gross Income

Capital gains Normal

Final tax
tax Income tax

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 The tax schemes are mutually exclusive. An
item of gross income that is subject to tax in one
scheme will not be taxed by the other schemes.
Similarly, items of income that are exempted in
one scheme are not taxable by the other
schemes.

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 Gross Income – means all income derived from whatever source,
including (but not limited to) the following items:

(1) Compensation for services in whatever form paid, including, but not
limited to fees, salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the
exercise of a profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general
professional partnership. (Sec. 32A, NIRC) 29
Exclusions (Sec. 32B):
1. Proceeds of life insurance policy -
NOTE: Proceeds of accident insurance: For
purposes of income tax, proceeds of accident
insurance are not income and not taxable as they are
merely reimbursements for the damage resulting
from the accident. In case of death however and for
purposes of estate tax, they are generally speaking
excluded from the computation of the gross estate
unless one of the risks insured against is the death of
the insured by accident in which case, the insurance
maybe considered as a life insurance. In this instance
also, for purposes of income tax, they shall still be
excluded from the computation of gross income. 30
Facts: X is the employee of Y. X insures his own life and pays premium of P5,000 annually.
Beneficiaries are his wife and children (W & C). Policy states that if X pays premium for the
next 20 years, he will get:
Proceeds: P1M; Interest 10%; and Return of Premium (ROP)
Tax Effects/Consequence:
1. Can X deduct premium from computation of gross income? No. X is a compensation
income earner and premium for life insurance is not among those allowed as deductions;

2. The policy states that if X survives to be 60 years old, he may receive the proceeds,
interest, and ROP.

a. If X survives, are the above-enumerated items considered as income? The proceeds of

P1M and the 10% interest are considered income. ROP, being mere return of capital, is
NOT INCOME.

Taxable? Only the 10% interest is taxable since proceeds of life insurance policies are
among the items of exclusions in Sec. 32(B), NIRC.
b. Assuming X dies and the proceeds are received by W & C, will this be considered as
income on their part? Yes, except for the ROP (Reason: If X had lived, he would have
received it as mere return of capital).

Included in the computation of gross income? Only the 10% interest is taxable since
proceeds of life insurance policies are among the items of exclusions in Sec. 32(B), NIRC.
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3. When X dies, will the above-enumerated items be
included in the computation of the gross estate? There are 2
sets of rules:

a. If the beneficiary is the EXECUTOR/ADMINISTRATOR of

the ESTATE, it will be INCLUDED in the computation of estate,
whether the assignment of beneficiary is revocable or not.

b. If the beneficiary is anyone other than those in (a):

•Revocable assignment- include in the computation of gross
estate
•Irrevocable assignment- exclude in the computation of
gross estate

As long as the decedent has control over the proceeds, it will

be included in the computation of the gross estate. 32
Facts: X is the employee of Y. Y insured X’s life. Premium was paid
by Y and he was also the beneficiary and will receive proceeds:
P1M +10% interest +ROP.
Tax Effects/Consequence:
1. Can Y deduct premium payments as business expense? No.
This is not a legitimate business expense. In addition Section
36, provides that premiums on life insurance taken by the
employer insuring the life of his employees wherein directly or
indirectly he is the beneficiary is NOT DEDUCTIBLE.

2. If X dies and Y gets proceeds, is this income on the part of

Y? Yes, except the ROP. However, only the 10% interest is
taxable. ROP and the amount of P1M are the first 2 items of
exclusion under Sec. 32 (B), NIRC.

3. Are the proceeds included in the computation of X’s gross

estate? No. X did not have any interest over the proceeds. In
fact, the only participation of X is his life. 33
Facts: X is the employee of Y. X took a life insurance but premium payments were made by Y.
X’s wife and children (W & C) were the assigned beneficiaries. Proceeds are as follows: P1M
+10% interest +ROP.
Tax Effects/Consequence:
1. Is it income on the part of X? Yes, the premium paid by employer Y is considered as
income on the part of X.
Is it taxable? If X is:
• Managerial/supervisory employee - Fringe benefit tax
• Rank and file employee - Net income tax

2. Can Y deduct the premium payments from the computation of gross income? No, unless
Y pays for the life insurance of ALL of his employees. If X gets singled out, Y can never deduct
because it is not a necessary business expense.
3. If X dies and the proceeds go to W & C, is this income on the part of W & C? Yes, except
for ROP. However, only the 10% interest is taxable (income tax).

Will this be included in the computation of the gross estate of X? Apply the rules on
revocable/irrevocable assignment of beneficiaries.

NOTE: Proceeds of accident insurance: For purposes of income tax, proceeds of accident
insurance are not income and not taxable as they are merely reimbursements for the
damage resulting from the accident. In case of death however and for purposes of estate
tax, they are generally speaking excluded from the computation of the gross estate unless
one of the risks insured against is the death of the insured by accident in which case, the
insurance maybe considered as a life insurance. In this instance also, for purposes of income
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tax, they shall still be excluded from the computation of gross income.
2. Amount received by the insured as return of
premium
3. Gift, bequest, devise, or descent
If however, the property received as a gift
realizes income, then the income of the property
forms part of the gross income of the taxpayer.
4. Compensation for injuries or sickness including
damages received
Damages - compensation for physical
injuries/disability or death, or for causes beyond
the control of the employee and only those actually
resulting therefrom are excluded from
computation of the gross income. 35
 Attorney’s fees and costs of suit are only excluded if
the amount awarded is equivalent to the actual
expense incurred. This shall not be considered as
income and not taxable because it is a mere
reimbursement of the expense. Any amount in excess
of the actual expense is considered taxable income.
Moral, exemplary, and any other type of damages are
taxable.

ONLY ACTUAL DAMAGES ARE EXCLUDED from the

computation of gross income. Other types of damages
are INCLUDED in the gross income and TAXABLE.
Rule: Any payment for reparation of damage is
excluded.
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5. Income exempt under treaty
6. Retirement benefits, pensions, gratuities, etc.
under certain conditions;
• If pursuant to a private retirement plan, retirement
benefits are not considered treated as compensation
and not subject to income tax provided that:
1. The employee is at least 50 years old;
2. Employed with the same employer for at least 10
years;
3. Private Retirement Plan is duly approved by the
BIR; and
4. The fund must be used for the benefit of the
employee and no other purpose.
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• Retirement benefits not pursuant to a private
retirement plan are not subject to income tax
provided that the employee is at least 60 years of
age and has rendered at least 20 years in service;

• All retirement benefits received by a government

employee including cash equivalent of all terminal
leave credits are income but not subject to tax;

• Benefits received from SSS, GSIS, Pag-Ibig and

PhilHealth , US Veteran’s Act are excluded.

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Example: The retirement plan provides that if the employee renders x no. of
years of service and he dies, he shall be considered as retired as if he retired
alive. The heirs will receive the retirement benefits.
Tax Treatment:
1. Is it income on the part of the heirs? Yes.
Is it taxable? No. The benefits are among the items of exclusions from gross
income.
2. Is it part of the employee’s gross estate? Yes, provided that it will later on be
deducted from the gross estate.

3. Why do we have to add first before we deduct? Gross estate is defined as the
value of ALL the property of the deceased, real or personal, tangible or
intangible.

NOTE: Benefits received from SSS, GSIS, Pag-Ibig and PhilHealth , US Veteran’s Act
• Not income
• Not compensation
• Not taxable

(The employees contributions are not deductible)

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7. Miscellaneous Items-
(a) Income Derived by Foreign Government. -
Income derived from investments in the
Philippines in loans, stocks, bonds or other
domestic securities, or from interest on
deposits in banks in the Philippines by
(i) foreign governments,
(ii) financing institutions owned, controlled, or
enjoying refinancing from foreign governments,
and
(iii) international or regional financial
institutions established by foreign governments;
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(b) Income Derived by the Government or its Political
Subdivisions. - Income derived from any public utility
or from the exercise of any essential governmental
function accruing to the Government of the
Philippines or to any political subdivision thereof.
(c)Prizes and Awards. - Prizes and awards made
primarily in recognition of religious, charitable,
scientific, educational, artistic, literary, or civic
achievement but only if:
(i) The recipient was selected without any action
on his part to enter the contest or proceeding; and
(ii) The recipient is not required to render
substantial future services as a condition to receiving
the prize or award.
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(d) Prizes and Awards in sports Competition. - All
prizes and awards granted to athletes in local and
international sports competitions and tournaments
whether held in the Philippines or abroad and
sanctioned by their national sports associations.

(e) 13th Month Pay and Other Benefits. - Gross

benefits received by officials and employees of public
and private entities: Provided, however, That the total
exclusion under this subparagraph shall not exceed
NINETY THOUSAND PESOS (P90,000) which shall
cover:

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(i) Benefits received by officials and employees of the
national and local government pursuant to Republic
Act No. 6686;
(ii) Benefits received by employees pursuant to
Presidential Decree No. 851, as amended by
Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not
covered by Presidential decree No. 851, as amended
by Memorandum Order No. 28, dated August 13,
1986; and
(iv) Other benefits such as productivity incentives and
Christmas bonus;

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1. Final Tax:
Income subject to final tax – income collected
through the withholding tax system. It is a final
settlement of the income tax due on said income.
- full taxes are withheld by the income payor at
source.
- the income tax payer does not need to file
income tax returns.
-applicable only on certain passive income
listed by the law. Not all passive income is subject
to final tax.
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Passive income vs. Active income

Passive income are earned with very minimal or

even without active involvement of the taxpayer
in the earning process.

Active or regular income arises from transactions

requiring a considerable degree of effort or
undertaking from the taxpayer.

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2. Capital Gains Tax:
– imposed on the gain realized on sale,
exchange, and other disposition of certain capital
assets.

- it is a final tax but it employs self-assessment

method.
- taxpayer files a tax return, report the gain and
pay the tax.

- it applies only to two (2) types of capital

assets: domestic stock and real property. 46
3. Normal Income Tax:
– the general rule in income taxation and covers
all other income.

- thus, it covers income such as:

a. Active income
b. other income
- gains from dealings in properties, not subject to
capital gains tax
- other passive income not subject to final tax.
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Taxability of income depends on the following:

1. SOURCE OF INCOME
2. KIND OF TAXPAYER, and
3. KIND OF INCOME

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Tax Situs - literally means the place of taxation, or
the country that has jurisdiction to levy a
particular tax on persons, property, rights or
business.

• The taxing power cannot go beyond the territorial

limits of the taxing authority. Basically, the state
where the subject to be taxed has a situs may
rightfully levy and collect the tax; and the situs is
necessarily in the state which has jurisdiction or
which exercises dominion over the subject in
question.

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The situs of taxation is determined by a number
of factors:
 
a) Subject matter- or what is being taxed. He
may be a person or it may be a property, an act
or activity;
b) Nature of tax- or which tax to impose. It
may be an income tax, an import duty or a real
property tax;
c) Citizenship of the taxpayer
d) Residence of the taxpayer.

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 Situs of Income Taxation
(Comprehensive Tax Situs)

- it is determined by the nationality (Citizenship

Principle), residence of the taxpayer (Residence
Principle), and source of income (Source
Principle).

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Classification of Income as to Sources:

1. Income purely within

2. Income purely without
3. Income partly within and partly without

52
Determination of Source of Income (within or without)
 
Section 42 (E) of the NIRC provides:
 
Interests- Interest income is treated as income from within the
Philippines if the debtor or lender whether an individual or corporation is
a resident of the Philippines.

Dividends:
Dividends received from a domestic corporation are treated as income
from sources within the Philippines. 
Dividends received from a foreign corporation are treated as income
from sources within the Philippines, unless 50% of the gross income of the
foreign corporation for the three-year period preceding the declaration of
such dividends was derived from sources within the Philippines; but only
in an amount which bears the same ratio to such dividends as the gross
income of the corporation for such period derived from sources within the
Philippines bears to its gross income from all sources 53
 Services- Services performed in the
Philippines shall be treated as income from
sources within the Philippines
 
Rentals and Royalties- Gain or income from
property or interest located or used in the
Philippines is treated as income from sources
within the Philippines.

Sale of Real Property- Gain from sale of real

property located within the Philippines is
considered as income within the Philippines.
54
 Sale of Personal Property- Gain, profit or
income from sale of shares of stocks of a
domestic corporation is treated as derived
entirely from sources within the Philippines,
regardless of where the said shares are sold  
Gains from sale of other personal property can
be considered income from within or without or
partly within or partly without depending on the
rules provided in Sec. 42 E of the Tax Code.  
 

55
Rule:
a. personal property PURCHASED within and sold
without or purchased without and sold within – country
in which sold
b. personal property PRODUCED (in whole or part) by
the taxpayer within and sold without or produced (in
whole or part) without and sold within – sources partly
within and partly without the Philippines

Exception:

Sale of shares of stock in a domestic corporation shall

be treated as derived entirely from sources within the
Philippines regardless of where said shares are sold.
56
In the case of Commissioner vs. BOAC, the
Supreme Court declared that:

“The source of an income is the property,

activity or service that produced the income. For
the source of income to be considered as coming
from the Philippines, it is sufficient that the
income is derived from activity within the
Philippines.”
 
 

57
Factors in determining the source of income
(Source Rules)
1. Interests – residence of the debtor
2. Dividends – residence of the corporation paying
the dividend
3. Services – place of performance of the service
4. Mining income – location of the mines
5. Farming income – place of farming activities
6. Rentals and royalties – location of property or
interest in such property
7. Sale of real property – location of the property
8. Sale of personal property –
58
GENERAL CLASSIFICATION OF TAXPAYERS

Who is a taxpayer?
Under Sec 22(N), a taxpayer is any person subject
to [income] tax.

-The term ’person’ means an individual, a trust,

estate or corporation. (Sec. 22A, NIRC)

Income taxpayers, with distinction based on the

amount of income subject to tax, or the applicable
tax rates, or both, are classified as follows:
59
 Tax on Individuals
(Secs. 24-26, NIRC)

60
Kinds of INDIVIDUAL Taxpayers
A) Citizens
1) Resident citizens - Those residing in the Philippines unless he
qualifies as a non-resident under Sec. 22 (E)of the NIRC.

2) Non-resident citizens - Those not residing in the Philippines.

A “non-resident citizens” means

a.) One who establishes to the satisfaction of the Commissioner of

Internal Revenue (CIR) the fact of his physical presence abroad
with a definite intention to reside therein.
 
b.) A citizen of the Phils. who leaves the country during the
taxable year to reside abroad, either as immigrant or for
employment or on permanent basis.
61
 c.) A citizen of the Phils. who works and derive from
abroad and whose employment thereat requires him to be
physically present abroad most of the time during the
taxable year.

The phrase “most of the time” which is used in

determining when a citizen’s physical presence abroad will
qualify him as non-resident, shall mean that the said citizen
shall have stayed abroad for at least 183 days in a taxable
year [Section 2 (c), Revenue Regulation No. 1-79].

However, in 2011, the BIR issued BIR Ruling No. 517-

2011 stating that employees who rendered services for
more than 183 days in foreign countries were not
considered non-residents on the basis that:
62
 (1) the employee-employer relationship continued to exist
between the local company and employees; and

(2) the salaries of the employees were paid by the local

company. Section 2.78.3 of RR 2-98 states that an employee-
employer relationship exists when the person for whom the
services were performed has the right to control and direct the
individual who performs the services, not only as to the result
to be accomplished, but also as to the manner and means by
which such results are accomplished.

The same principle was applied in BIR Ruling No. 305-2016

where a government employee who was on assignment
abroad for three years was held to be a resident citizen for tax
purposes and as such, subject to tax on her worldwide income.
63
• In the ruling, the critical points raised by the BIR are the
temporary nature of the transfer (secondment) and the
continuing employee-employer relationship with the Philippine
employer.

• Based on the Memorandum of Agreement between the

government agency and the international organization, the
individual remained an employee of the government agency
during the period of secondment but was considered on leave
without pay. The government agency continued to pay for the
mandatory government contributions during the duration of her
secondment. As such, the employee does not qualify as a non-
resident citizen under Section 22(E)(3).
 
• Further, the individual did not have any intention to reside in the
foreign country either as an immigrant or on a permanent basis
to make her a non-resident citizen under Section 22(E). 64
d.) A citizen who has been previously considered as
non-resident citizen and who arrives in the Philippines
at any time during the taxable year to reside
permanently in the Philippines shall likewise be treated
as a nonresident citizen for the taxable year in which he
arrives in the Philippines with respect to his income
derived from sources abroad until the date of his arrival
in the Philippines.

e.) The taxpayer shall submit proof to the

Commissioner to show his intention of leaving the
Philippines to reside permanently abroad or to return
to and reside in the Philippines as the case may be, for
purposes of this Section.
65
• Further, Sec. 23 (C) of the NIRC provides that an individual citizen of the
Philippines who is working and deriving income from abroad as an
overseas contract worker (OCW) is taxable on income from sources
within the Philippines; Provided, That a seaman who is a citizen of the
Philippines who receives compensation for services rendered abroad as
a member of the complement vessel engaged exclusively in international
trade shall be treated as an overseas contract worker.

Sec. 2, Revenue Regulations No. 1-2011

- OCW refer to Filipino citizens employed in foreign countries,

commonly referred to as OFWs, who are physically present in a foreign
country as a consequence of their employment threat. Their salaries and
wages paid by an employer abroad ad is not borne by any entity or person
in the Philippines. To be considered as an OCW or OFW, they must be duly
registered as such with the Philippine Overseas Employment
Administration (POEA) with a valid Overseas Employment Certificate
(OEC).
66
 Seafarers or seamen are Filipino citizens who receive
compensation for services rendered abroad as a
member of the complement vessel engaged exclusively
in international trade. To be considered as an OCW or
OFW they must be duly registered as such with the
Philippine Overseas Employment Administration (POEA)
with a valid Overseas Employment Certificate (OEC) with
a valid Seafarers Identification Record Book (SIRB) or
Seaman’s Book issued by the Maritime Industry
Authority (MARINA).

67
B) Aliens

  1) Resident aliens - Those residing in the Philippines though not

a citizen thereof.
- Those who are actually present in the Phils. and who
are not mere transients or sojourners.

2) Non-resident aliens - Those not residing in the Phils. and who

is not a citizen thereof.
(a) Engaged in trade or business – comes and stays in the
Phils. For an aggregate period of more than 180 days during the
calendar year.
-includes performance of personal services within the
Phils.
(b) Not engaged in trade or business

68
 CITIZENS AND RESIDENT
ALIENS

69
 FINAL INCOME TAXATION
1. Final Tax on Certain Passive income Sec. 24 (B):
• Interest on bank deposits (peso currency): 20%
• Interest on bank deposits (foreign currency): 15%
• Interest on long term deposits not pre-terminated
for 5 years: EXEMPT,
If pre-terminated on the 4th year rate is 5%,
pre-terminated on the 3rd year rate is 12%, pre-
terminated prior to 3 years, back to regular rate of
20% on the entire income.
• Royalties: 20% except for literary and musical
compositions 10% 70
• Prizes exceeding Php10,000: 20%
• Prizes up to Php10,000: subject to normal income
tax or 8% optional rate
• Prizes and awards in sports competitions sanctioned
by the national sports commission; EXEMPT
• Prizes and awards made primarily in recognition of
religious, charitable, scientific, educational, artistic,
literary, or civic achievements but only if the
recipient was selected without any action on his part
to enter the contest or proceeding and the recipient
is not required to render substantial future services
as a condition to receiving the prize or award;
EXEMPT
71
• Winnings including PCSO/LOTTO winnings exceeding
Php10,000: 20%
• Winnings not exceeding Php10,000: subject to normal
income tax or 8% optional rate
• PCSO/LOTTO winnings not exceeding Php10,000:
EXEMPT;
• Cash and Property Dividends issued by Domestic
Corporation – 10%
• Cash and Property Dividends issued by Foreign
Corporation – subject to normal income tax or 8%
optional rate
• Share of an individual partner in the distributable net
income after tax of a partnership (except GPP) of: 10%
72
 All passive income received by a resident citizen
from outside of the Philippines are subject to Net
Income Tax (NIT) or 8% RATE , not FWT.

73
2. Fringe Benefits Tax:

Fringe benefits
Under labor laws, fringe benefits pertain to all
other benefits or incentives of employees other
than the basic pay. The basic pay is a fixed regular
salary or wages of employees every payroll period.

Under the NIRC the term “fringe benefits” was

defined to pertain to goods , services or other
benefits furnished by the employer to the
employees.

74
Tax treatment of fringe benefits:
1. Fringe benefits that are fixed every payroll are
considered regular compensation.
Example: fixed transportation allowance
2. Fringe benefits that are variable and
performance-based are considered supplemental
compensation.
Example: commission, profit sharing and
overtime pay
3. Fringe benefits in the form of incentives are
considered “13th month pay and other benefits”.
4. Fringe benefits furnished for the employer’s
convenience or necessity are exempt from income
tax. 75
Fringe benefits under Sec. 33(B) – refer to any good, service, or other
benefit furnished or granted in cash or in kind by an employer to
an individual employee (except rank and file employees as defined
herein) such as, but not limited to, the following:

a. Housing;
b. Expense account;
c. Vehicle of any kind;
d. Household personnel, such as maid, driver and others;
e. Interest on loan at less than market rate to the extent of the
difference between the market rate and actual rate granted;
f. Membership fees, dues and other expenses borne by the
employer for the employee in social and athletic clubs or other
similar organizations;
g. Expenses for foreign travel; h. Holiday and vacation expenses;
h. Educational assistance to the employee or his dependents; and
i. Life or health insurance and other non-life insurance premiums or
similar amounts in excess of what the law allows. 76
Rank and file employees shall mean all employees
who are holding neither managerial nor supervisory
position. Sec. 22 (AA)

Managerial employee – is one who is vested with

powers or prerogatives to lay down and execute
management policies and/or to hire, transfer,
suspend, lay-off, recall, discharge, assign or discipline
employees. (Labor Code)

Supervisory employees - those who, in the interest of

the employer, effectively recommend such managerial
actions if the exercise of such authority is not merely
routinary or clerical in nature but requires the use of
independent judgment. (Labor Code) 77
Fringe Benefits Tax – tax imposed on fringe benefits which are
granted or are paid by an employer to an employee occupying
managerial or supervisory position.

It is a tax on the income of the employee although paid by the

employer on behalf of the employee. The fringe benefit tax is a
final tax on the employee’s income to be withheld by the
employer. The withholding and remittance of FBT shall be made
on a quarterly basis.

The employer can claim the fringe benefit and the fringe
benefit tax as a deductible expense from his gross income.

Taxable fringe benefits exclude those items considered as

compensation income.

(Read Revenue Regulations 3-98, 8-2018) 78

 Tax Rate and Tax Base – [Generally] 35% of the grossed-up
monetary value (GMV)
GMV represents the whole amount of income realized by the
employee.

Special Cases:

• For fringe benefits received by non-resident alien not engaged

in trade of business (NRANETB), the tax rate is 25% of the
grossed-up monetary value (GMV).
• For fringe benefits received by alien individuals and Filipino
citizens employed by regional or area headquarters, regional
operating headquarters, offshore banking units (OBUs), or
foreign service contractor, the tax rate is 15% of the grossed-up
monetary value (GMV).

79
Classification of fringe benefits:
1. Fringe benefit to rank and file employees are taxable as
compensation income subject to normal tax rate, except

a. De minimis benefits, and

b. Benefits provided for the convenience of the employer

2. Fringe benefit to managerial employees are taxable with final fringe

benefit tax of 35%, except

a. De minimis benefits, and

b. Benefits provided for the convenience of the employer

3. Allowance which are fixed in amounts and are regularly received by the
employee as part of his monthly compensation income shall not be
treated as taxable fringe benefits but as compensation income.

80
Valuation of Fringe Benefits:
CONDITION VALUATION
Rule 1: If Fringe Benefit(FB) is • The value is the amount granted
granted in money, or is directly paid or paid for.
for by the employer.
Rule 2: If the FB is granted or • The value of the FB shall be
furnished by the employer in equal to the FMV of the property
property other than money and as determined in accordance
ownership is transferred to the with Sec. 6(E) of the Code
employee.
• The value of the FB is equal to
Rule 3: If the FB is granted or the depreciated value of the
furnished by the employer in property.
property other than money but
ownership is not transferred to the
employee.

81
1. Housing
Fringe Benefit Tax Base
(a) Lease of residential property for MV= 50% x rental payments
the use of the employee as his usual
place of residence.
(b) Residential Property owned by MV=[5%(FMV or ZV,
employer and assigned to employee whichever is higher) x 50%
as his usual place of residence.
(c) Residential property purchased by MV=5% x AC x 50%
employer on installment basis for the
use of employer as his usual place of
residence.
(d) Residential property purchased by MV=FMV or ZV, whichever is
ER and ownership is transferred to EE higher
as his usual place of residence.

82
Not taxable
a. Housing privilege of military officials of the
AFP located inside or near the military camps;

b. A housing unit which is situated inside or at

most 50 m from the perimeter of the business
premises;

c. temporary housing for an employee for 3

months or less;

83
2. Expense Account
Taxable
a. Expenses incurred by the employee which are
paid by his employer;
b. Expenses paid by the employee but reimbursed
by the employer. However, if the above
expenditures are duly receipted for and in the
name of the employer and these do not partake
the nature of a personal expense attributable to
the employee, the same shall not be subject to
fringe benefit tax; and
c. Personal expense of the employee an his family
which are paid or reimbursed by his employer w/n
supported by receipts in the name of the employer
d. Household expenses of the employee which are
borne by the employer.
84
Not taxable

a. Expenditures supported by receipts in the

name of the employer and expenditure that do
not partake the nature of a personal expense
attributable to the employee
b. Representation and Transportation
Allowances (RATA) that are fixed in amounts and
regularly received by the employees as part of
their monthly compensation income shall be
considered as taxable compensation income
subject to Withholding Tax on Wages.

85
3. Motor Vehicle
Fringe Benefit Tax Base
a. Purchase the motor vehicle in the name of MV=AC
the employee
b. Provides the employee with cash for the MV= Cash received by the
purchase of a motor vehicle in the name of the employee
employee

c. Shoulders a portion of the amount of the MV=Amount shouldered by the

purchase price of a motor vehicle in the name employer
of the employee

d. Purchases the car on installment in the name MV=AC/5

of the employee
e. Owns and maintains a fleet of motor vehicle MV=(AC/5) x 50%
not normally used in business
f. Leases and maintains a fleet of motor vehicles MV=50% X rental payments
not normally used in business
86
* How about use of aircraft (including
helicopters)?

The use of aircraft (including helicopters)

owned and maintained by the employer shall be
treated as business use and not be subject to
the fringe benefit tax.
The use of yacht whether owned and
maintained or leased by the employer shall be
treated as taxable fringe benefit. The value of
the fringe benefit shall be measured based on
the depreciation of a yacht at an estimated
useful life of 20 years. (Sec. 2.33 B, Rev. Regs.
No. 3-98)

87
 Not taxable
Motor vehicles used for sales, freight,
delivery service and other non-personal uses.
4. Interest on loan at less than market rate
Rules:
1. If the employer lends money to his employee
free of interest or at a rate lower than 12% per
year, such interest foregone by the employer of
the difference of the interest assumed by the
employee and the 12% rate shall be treated as
taxable fringe benefit.

88
2. The benchmark interest rate of 12% shall
remain in effect until revised by a subsequent
legislation
3. This regulation shall apply to installment
payments or loans with interest rate lower than
12% starting 1 January 1998.

89
Illustration:
In 2018, Mr. John Doe, owner of SMA
Supermarket, lends P100,000 to Jey, the
supermarket’s manager. It is stipulated in their
agreement that the amount should be paid in one
year with an annual interest of 5.5%.
FBT:
Interest at 12% P 12,000
Interest at 5.5% 5,500
Difference P 6,800
Divide by GMF 65%
GMV P 10,000
Multiply tax rate 35%
FBT due P 3,500
90
 5. Membership fees, dues and other expenses borne by
the employer for the employee in social and athletic
clubs or other similar organizations. The entire
expenditures shall be treated as taxable fringe benefits
of the employee in full.
6. Expenses for foreign travel
Except:
 
Where the expenses for foreign travel paid by the
employer for the employee are for the purpose of
attending business meeting or convention. The
exemption covers only the following expenses:
 
a) Inland travel expenses except lodging cost in hotel
averaging US$ 300 or less per day; and
91
b) Cost of economy or business class airline ticket.
Travel expenses should be supported by
documents proving the actual occurrences of the
meetings or conventions. Likewise, documents
and evidence showing the business purpose of the
employees’ travel must be presented otherwise,
the entire cost will be considered taxable fringe
benefit.

However, if the ticket is a first class one, 30% of

the cost of the ticket shall be subject to a fringe
benefit tax.

7. Holiday and vacation expenses

92
 8. Educational assistance
a. Education granted to employee
Except:
(1) Educational grant whereby the study is directly
connected with the trade, business or profession of the ER.
(2) And there is a written contract obligating the EE to
remain under the employment for a certain period.

b. Educational Assistance granted to the

dependents of the employee
Except:
Assistance provided through a competitive scheme
under a scholarship program of the company.
93
9. Life or health insurance and other non-life
insurance premiums or similar amounts in
excess of what the law allows.
Except:
a. Contribution of the employer for the
benefits of the employee pursuant to existing
laws. (SSS, GSIS, etc.)
b. The cost of premium borne by the
employer for the group insurance of his
employees.

94
 Benefits not subject to Fringe Benefits Tax:
1. Those that are exempted from income tax.
2. Contributions of the employer for the benefit
of the employee retirement, insurance, and
hospitalization benefit plans.
3. Benefits granted to the rank and file, whether
granted under a CBA or not.
4. De minimis benefits
5. Benefits granted to employees as required by
the nature of, or necessary to the trade,
business or profession of the employer.
6. Benefits granted for the convenience of the
employer. (Convenience of the Employer Rule)

95
 CAPITAL GAINS TAXATION

Capital assets (Sec. 39A, NIRC) - means property held

by the taxpayer (whether or not connected with
his trade or business) but does not include:

• Stock in trade;
• Property of a kind which would properly be included
in the inventory if on hand at the close of the
taxable year;
• Property held by the taxpayer primarily for sale to
customers in the ordinary course of trade or
business;
• Property used in trade or business which in subject
to the allowance for depreciation; and
• Real property used in trade or business. 96
1. Capital Gains tax on shares of stock treated as
capital assets Sec. 24 (C):
• Gains from Sale of capital shares of stocks - Capital
Gains Tax (CGT of 15%/FWT) if not traded thru the
local stock exchange. If traded thru the stock
exchange, .60 of 1% of the GSP (percentage tax under
Section 127 of the NIRC)

• Gains from Sale of shares of stocks classified as

ordinary asset – NIT OR 8% RATE

• If the transferor of the shares is an individual, the rule

on holding period and capital loss carry-over will not
apply, notwithstanding the provisions of Section 39 of
the Tax Code , as amended. (Rev. Reg. No. 6-2008)
97
 Stocks classified as capital assets are stocks and
securities held by a taxpayer other than dealers’ in
securities. If sold, these securities are subject to
capital gains tax (final tax).

The final tax is on a per transaction basis. The

return should be filed and paid within 30 days after
each sale and a final consolidated return of all
transactions during the taxable year on or before
the 15th day of the 4th month following the close of
the taxable year.
Holding period is not applicable on capital gains
of stock transaction because it has been subjected
to final tax.
98
2. Capital Gains tax on sale of real property Sec. 24
(D):

• If the property is within the Philippines and

capital in character whether sold at a gain or loss
- 6% CGT (FWT). Otherwise, NIT or 8% RATE if an
ordinary asset.
• If the property is outside the Philippines it is
always subject to NIT or 8% RATE whether
ordinary or capital asset.

99
 Sale or exchange of real property not used in
business is a capital asset transaction, hence,
subject to capital gains tax.
The sale or exchange of such real property is
subject to a capital gains tax of 6% based on the
selling price or zonal value, whichever is higher.
The payment of tax shall be on a per-transaction
basis. The computation of the tax disregards gain
or loss on the sale of real property. The 6% capital
gains tax on the sale of real property is a final tax
and not a creditable tax.

100
• If property (whether located within or outside of
the Philippines) is sold for insufficient
consideration and not property described in
Section 24(D), impose donor’s tax (Section 100)
or estate tax (Section 85g) subject to the rule on
bonafide sale lacking in donative intent;

Note that if the sale is bonafide sale and lacking

in donative intent, no donor’s or estate tax
component.

101
Exemption from CGT for sale of real property:
Requisites [Sec 24 (D)(2), NIRC]:

i. The real property must be the actual principal

residence of the taxpayer/seller;
ii. Seller must inform the BIR of his intention to avail of
the exemption (within 30 days from sale);
iii. Seller must build or purchase another principal
residence within 18 months from sale;
iv. Proceeds from the sale should be used in
building/purchasing new principal residence
v. 6% CGT will be applied proportionately to proceeds
not used for new principal residence.
*All kinds of individual taxpayers can avail of the exemption from payment of CGT
for sale of real property, except corporate taxpayers. 102
 NORMAL INCOME TAXATION
Tax schedule effective January 1, 2018 until December 31,
2022:
Not over Php250,000 0%
Over Php250,000 but not over 20% of the excess of Php250,000
Php400,000
Over Php400,000 but not over Php30,000 + 25% of the excess of
Php800,000 Php400,000
Over Php800,000 but not over Php130,000 + 30% of the excess of
Php2,000,000 Php800,000
Over Php2,000,000 but not Php490,000 + 32% of the excess of
over Php8,000,000 Php2,000,000
Over Php8,000,000 Php2,410,000 + 35% of the excess of
Php8,000,000

103
 - ALL income within and without other than
passive income under Sec. 24(B), Capital Gains on
sale of shares of stocks Sec. 24(C), and Capital
Gains on sale of real property Sec, 24(D) shall be
subject to the corresponding taxes as above
provided in Sec. 24 (A).
- applies on yearly profits o gains.
- imposed on the taxable income defined in
Sec. 31, NIRC:
Taxable Income means the pertinent items of
gross income specified in this Code, less
deductions, if any, authorized for such types of
income by this Code or other special laws.

104
 PERTINENT ITEMS OF GROSS INCOME

1. Compensation Income – means any remuneration

for rendering personal services. Generally, it is
obtained from an employer-employee relationship
between payor and recipient.

- is considered as having been earned in the place

where the service was rendered and not
considered as sourced from the place of origin of
the money;

- Payment for services, other than compensation

income, is considered as having been earned at
the place where the activity or service was
performed;
105
Classification of Compensation Income:
1. Basic salary or wage
2. Honoraria
3. Fixed or variable allowances
4. Commission
5. Fees
6. Tips and gratuities
7. Hazard or emergency pay
8. Retirement pay
9. Separation pay

106
10.Pension
11.Vacation and sick leave
12.13th month pay and other benefits
13.Fringe benefits and de minimis
14.Overtime pay
15.Profit sharing
16.Awards for special services
17.Beneficial payments
18.Other forms of compensation

107
• INFORMER’S REWARD: Forms part of the gross income
of the taxpayer informant and subject to income tax;

• TIPS AND GRATUITIES PAID BY CLIENTS and NIGHT SHIFT

DIFFERENTIAL:
1. If paid directly by clients to employees, considered as
income and subject to tax on the part of employee but
cannot be subjected to withholding tax by the employer;
2. If paid to the employer by reason of service rendered
by employees, income, taxable on the part of the
employee but subject to withholding by the employer;
3. Night shift differential, are considered as income and
subject to tax on the part of the employee who is not an
MWE but subjected to withholding tax by the employer;

108
• COMPENSATION FOR DEATH, PHYSICAL INJURIES, PHYSICAL
DISABILITY PAID BY EMPLOYER TO EMPLOYEE OR HIS HEIRS, OR
FOR CAUSES BEYOND THE CONTROL OF EMPLOYEE
1. Not income as mere compensation for the damage, injury,
sickness, or loss of life;
2. Separation pay for retrenchment, redundancy, or any labor
saving device is income but not subject to tax due to causes
beyond control of employee;
3. Backwages in case of illegal dismissal, income and subject to
tax;
4. Separation pay in case of non-reinstatement of employee
due to strained relation between employer and employee after
illegal dismissal, income but not taxable for causes beyond the
control of the employee;
5. Award of moral, exemplary and nominal damages in illegal
dismissal cases, are income and should be subject to tax.

109
• SPECIAL ALLOWANCE OF THE JUDICIARY (SAJ) (withholding
taxes) ( RMC 58-2014)
a. SAJ of judges of equivalent rank of RTC and CA;
b. Special Allowance in an amount equivalent to SAJ not
included in number 1;
c. Additional allowance given to judiciary and employees;
• Payouts of Employee Pension Plans ( RMC 39-2014)
Income of pension plans ( distributed as pension, as stock bonus,
or pension) :
-all dividends received by employee are subject to income tax;
Payouts representing share of employees: not taxable- just a
return of capital;

110
• STOCK OPTION PLANS ( RMC 79-2014)

KINDS:
a. Equity Settlement Option: option to purchase shares of stocks at a
specific price and specific date or period;
b. Cash Settlement Option: no actual shares of stocks transferred but
a person is given the right to obtain the difference between the actual
FMV and the nominal value of the shares at a specific date or period;
RULES:
1. If with Employer-employee relationship: -
-Without payment of price: employer cannot claim as deduction;
-With payment of price: treated as taxable capital gains on the part
of employer;
-Subject to DST;

2. Sale, Barter, or Exchange of Option:

- Treated as sale, barter, or exchange of stocks untraded thru the
local stock exchange subject to CGT;
- If sold, bartered, or exchanged w/o consideration, treated as
donation subject to donor’s tax;
111
3. Exercise of the Option by the Employees:
a. Rank and File: Difference between book value/FMV
(whichever is higher) at exercise of option AND price at grant
date, is treated as compensation subject to income tax and
withholding taxes;
b. Supervisory/ Managerial Employees: Difference between
book value/FMV (whichever is higher) at exercise of option AND
price at grant date, is treated as fringe benefit subject to FBT;
c. Difference between book value/FMV (whichever is higher)
at exercise of option AND price at grant date, is treated as
additional consideration subject to withholding taxes;

4. If granted not to an employee or a supplier of goods/services:

Equity Settlement Option: difference between book value/FMV
(whichever is higher) at exercise of option AND price at grant
date, is treated as donation subject to donor’s tax;

112
Valuation of Compensation:

1. Cash – face amount

2. In kind - @FMV
3. Services rendered at stipulated price – price
will be presumed to be the FMV of the
remuneration received
4. Corporation’s own stock - @FMV of the stock
at the time the services were rendered.
5. Promissory note – fair discounted value.

113
 EXCLUSIONS FROM GROSS COMPENSATION INCOME

1. Remuneration received as incidents of employment

a. Exempt retirement benefits under RA 7641
including exempt retirement gratuities to government
officials and employees
b. Exempt termination benefits
c. Benefits under the United States Veterans
Administration
d. Social security, retirement gratuities, pensions,
and similar benefits from foreign government agencies
and other institutions private public
e. Benefits from SSS, under the SSS Act of 1954, as
amended
f. Benefits from GSIS under the GSIS Act of 1937,
amended

114
2. De minimis benefits - Facilities or privileges are of
relatively small value which are offered or furnished by
the employer merely as a means of promoting the
health, goodwill, contentment or efficiency of his
employees.

DE MINIMIS BENEFITS (DMB) (TRAIN LAW AND RR 11-2018)

MONETIZED UNUSED VL (private sector) NOT EXCEEDING 10 DAYS

MONETIZED VL/SL (government) no limit

MEDICAL CASH ALLOWANCE TO DEPENDENTS OF EMPLOYEES NOT EXCEEDING P 1,500/EMPLOYEE/SEM

OR P 250/MO
RICE SUBSIDY P 2,000 OR ONE SACK OF RICE OF 50KG/MO
( P 2,000.00)
UNIFORM/CLOTHING ALLOWANCE P 6,000/YEAR (RR 11-2018)

ACTUAL MEDICAL ASSISTANCE NOT EXCEEDING P 10,000/YEAR

LAUNDRY ALLOWANCE NOT EXCEEDING P 300/MO

ACHIEVEMENT AWARDS ( in the form of tangible personal NOT EXCEEDING P 10,000/YEAR

property other than cash or gift certificate) received by an
employee under an established written plan which does not
discriminate in favor of highly paid employees)
115
GIFTS GIVEN DURING CHRISTMAS/MAJOR ANNIVERSARY NOT EXCEEDING P 5,000/EMPLOYEE/YEAR
CELEBRATIONS
DAILY MEAL ALLOWANCE FOR OT/NIGHT/GRAVEYARD SHIFT NOT EXCEEDING 25% OF BASIC MINIMUM

BENEFITS RECEIVED BY AN EMPLOYEE PURSUANT TO CBA AND NOT EXCEEDING P10,000.00/YR/EMPLOYEE

PRODUCTIVITY INCENTIVE SCHEME (PER RR 1-2015)
NOTE: IF NOT PART OF ABOVE LIST NOT DE MINIMIS, IE, TAXABLE/SUBJECT TO
WT

The amount of ‘de minimis’ benefits conforming to the ceiling herein prescribed
shall not be considered in determining the P 90,000.00 ( amount as amended by RA
10653 February 2015) ceiling of ‘other benefits’ excluded from gross income under
Section 32(b)(7)(e) of the Code. Provided that, the excess of the ‘ de minimis’
benefits over the irrespective ceilings prescribed by these regulations shall be
considered as part of ‘other benefits’ and the employee receiving it will be subject to
tax only on the excess over the P90,000.00 ceiling. Provided, further , that MWEs
receiving ‘other benefits’ exceeding the P 90,000.00 limit shall be taxable on the
excess benefits.
Any amount given by the employer as benefits to its employees, whether
classified as “ de minimis” benefits or fringe benefits, shall constitute as deductible
expense upon such employer. Where compensation is paid in property other than
money, the employer shall make necessary arrangements to ensure that the amount
of the tax required to be withheld is available for payment to the BIR. 116
 3. 13th month pay and other benefits not exceeding P90,000

“13th month pay and other benefits” includes:

a. 13th month pay
b. Other benefits
-Christmas bonus of private employees
-Cash gifts other than Christmas or anniversary gifts of private employees (RR2-
98, as amended by RR5-2011)
- Additional compensation allowance (ACA) of government personnel (RR8-2000)
- 14th month pay, 15th month pay, etc.
- other fringe benefits of rank and file employees

4. Compensation Income shall not include remuneration paid for:

i. agricultural labor paid entirely in products of the farm where the labor is
performed; or
ii. Domestic service in a private home; or
iii. Casual labor not in the course of the employer’s trade or business; or
iv. Services by a citizen or resident of the Philippines for a foreign
government of an international organization. Sec. 78 (A)
117
5. Benefits, privileges, and facilities which are given to employees for
the exclusive benefit or convenience of the employer. (Convenience
of the Employer Rule) (Revenue Audit Memo No. 1-87, 23 April 1987)

a. Work-related mobile phone allowance and transportation

allowance particularly to employees of call centers which are
operated on a 24-hour basis where employees are required to be
available always for assignment and consultation (BIR Ruling DA-
233-07)
b. Outstation allowance for employees who will be out from office
site at least 8 hours to visit lotto franchise holders for repairs
and/or inspection of equipment leased by the employer (BIR Ruling
No. 013-02)
c. Grant of housing privilege to employees working at distant or
remote facilities even if the dwelling is distanced from the facility in
compliance to labor safety standards (BIR Ruling No. 055-99)
d. Car incentives to employed on-call medical doctors
e. Scholarship grants to employees under contract to remain in
service for a specified period upon completion of the study
118
 6. Anyone earning at least the minimum wage in
his/her region will not pay income tax. (Sec. 6 of
R.A. 9504)
Statutory Minimum Wage (SMW) shall refer to the rate fixed by
the Regional Tripartite Wage and Productivity Board (RTWPB), as
defined by the Bureau of Labor and Employment Statistics (BLES)
of the Department of Labor and Employment (DOLE). The RTWPB
of each region shall determine the wage rates in the different
regions based on established criteria and shall be the basis of
exemption from income tax for this purpose. Holiday pay, overtime
pay, night shift differential pay and hazard pay earned by the
aforementioned MWE shall likewise be covered by the above
exemption. Other benefits in excess of P 90,000.00 shall be subject
to tax;

119
 MWEs receiving other income, such as income from the
conduct of trade, business, or practice of profession, except
income subject to final tax, in addition to compensation income
are not exempted from income tax on their entire income FROM
OTHER SOURCES earned during the taxable year. This rule,
notwithstanding, the SMW, Holiday pay, overtime pay, night shift
differential pay and hazard pay shall still be exempt from
withholding tax.
Previously under RR10-2008, a minimum wage earner loses
the special privilege of tax exemption if they derive other taxable
income. However, this rule was nullified by the Supreme Court in
Serrano et. al. Vs. Secretary of Finance and CIR, G.R. No. 184450,
24 January 2017.
Consequently, the MWE is still exempt from income tax from
the foregoing benefits even if they received other taxable
compensation. However, they may be subjected to tax if their
other taxable income exceeds P250,000 for the year.
120
7. Benefits exempt under treaty or international agreements
- Employee benefits of non-Filipino nationals and/or non-
permanent residents of the Philippines from foreign
governments, embassies or diplomatic missions, and
international organizations in the Philippines are exempt from
income tax.

Exemption from withholding tax does not mean income tax

exemption
- Foreign government embassies, diplomatic missions and
international organizations are immune from income tax
including the obligation to withhold income tax by virtue of
international comity as embodied in several international
agreements to which the Philippines is a signatory.
However, this exemption from the obligation to withhold tax does
not mean income tax exemption of their Filipino employees.

121
Filipino employees of foreign governments, international
missions and organizations are taxable as a rule except only
to employees of the following organizations:

a. United Nations (UN)

b. Specialized Agencies for International Development
c. Australian Agency for International Development (AUSAID)
d. Food and Agriculture Organization (FAO)
e. World Health Organization (WHO)
f. United Nations Development Programme (UNDP)
g. International Organization for Migration (IOM)
h. International Seabed Authority (ISA)

These organizations have exemption provisions that extend

even to their Filipino employees. Other aid agencies or
international organizations may have tax free provisions in
their articles of agreement for Filipino employees. 122
 The exemption of Filipino employees is not
automatic, Filipinos claiming exemptions under the
terms of international agreements or under provisions
of special laws granting privileges to international
organizations shall file an application for confirmation
of tax exemption with the BIR’s International Tax
Affairs Division (ITAD). The confirmation serve as proof
of exemption. Without the confirmation certificate,
the employee is taxable.

Employees working in Philippine embassies or

Philippine consulate offices are not considered non-
resident citizens and are subject to Philippine income
tax.

123
Summary of Rules:
Foreign embassy, Philippine embassy or
missions, or organization consulate office
In the Philippines
- Filipino citizens Taxable* N/A
-Aliens Exempt N/A
Abroad
- Filipino citizens Exempt Taxable
-Aliens Exempt Exempt

* Taxpayer must prove if there is an exemption grant

under contract or special law.

124
8. Compensation and/or business income earned
outside the Philippines by a Filipino Overseas
Contract Worker, nonresident Filipino Citizen,
resident alien and foreign corporation. (Sec. 23, NIRC)

8. Salaries and stipends in dollars received by non-

Filipino citizens serving as staff of the IRRI and the
Ford Foundation. (R.A. 2707)

9. Benefits required by the nature of, or necessary to

the trade, business or profession of the employer.

10. Tax exemptions of allowance paid to military

personnel

125
• Withholding Taxes – is a systematic way of
collecting taxes at source, an indispensable
method of collecting taxes to ensure adequate
revenue for the government.
Withholding tax at source – is that part of tax
system which collects through withholding agents
(payor) the appropriate income taxes due as they
are earned before earnings are paid to the payees.
The primary objective of the system is to
ensure accurate payment of taxes and to be able
to use taxes collected at an earlier time to finance
the operations and projects of the government.

126
Types of withholding at source:
1) Final Withholding Tax; and
Under the final withholding tax system the
amount of income tax withheld by the
withholding agent is constituted as a full and final
payment of the income due from the payee on
the said income. [1st sentence, 1st par., Sec. 2.57
(A), Rev. Regs. No. 2-98]

The liability for the payment of the tax rests

primarily on the payor as a withholding agent.
Thus, in case of failure to withhold or in case of
under withholding, the deficiency tax shall be
collected from the payor/withholding agent.
127
The payee is not required to file an income tax return for
the particular income, the final tax on which has been
withheld. (Sec. 79 B, NIRC)
The finality of the withholding tax is limited only to the
payee or the recipient’s income tax liability on said
income, such as when the said income is further subject
to a percentage tax. (Rev. Reg. No. 2-98)
The final taxes withheld are reported in the following BIR
Forms:
a. BIR Form No. 1601-F, for reporting the monthly
remittance of final income taxes withheld on various
income.
b. BIR Form No. 1602, on interest paid on deposits and
yield on deposit substituted.
c. BIR Form No. 1603, Quarterly Remittance Return of
Final Income Taxes Withheld on Fringe Benefits Paid to
Employees other then Rank and File 128
 2) creditable withholding tax
Under the creditable withholding tax system,
taxes withheld on certain income payments are
intended to equal or at least approximate the
tax due from the payee on the said income.
The income recipient is still required to file an
income tax return and/or pay the difference
between the tax withheld and the tax due on
the income. [1st and 2nd sentences, Sec. 257(B),
Rev. Regs. No. 2-98]

A tax withheld on income payments covering

the expanded withholding tax from
compensation income is creditable in nature.
(Sec 57 B, NIRC)
129
The creditable taxes withheld are reported in the
following BIR Forms:
a. BIR Form No. 1601 C, Monthly Remittance Return of
Income Taxes Withheld on Compensation.
b. BIR Form No. 1601 E, Monthly Remittance Return of
Creditable Expanded Income Taxes Withheld.
c. BIR Form No. 1606, Withholding tax Remittance
Return.

Kinds of creditable withholding taxes:

(a) taxes withheld on income payments covered by the
expanded withholding tax; and

(b) taxes withheld on compensation income.

130
 Basic Rules on Compensation Withholding Taxes

As a general rule, all salaries earned by persons as

government or non-government employees are subject to
withholding tax, except of the ff. items:

1. Commission paid by an insurance agent to his sub-agents

2. Compensation for services by a citizen or resident of the
Phils. for a foreign government or an international
organization.
3. Remuneration for casual labor not in the course of the
employer’s trade/ business
4. Remuneration for private service performed by maids,
cooks, gardener, family drivers and the like
5. Remuneration paid to agricultural labor and paid entirely
in products of the farm.
6. Minimum wage earners
131
 The following persons who are hereby constituted
as withholding agents for purposes of the
creditable taxes that are required to be withheld
on income payments:

1. In general, any juridical person, whether or not

engaged in business or trade;
2. Any individual, with respect to payments made
in connection with his trade or business.
However, insofar as taxable sale, exchange or
transfer of real property is concerned, individual
buyers who are not engaged in trade or business
are also constituted as withholding agents; and
3. All government offices including GOCCs, as well
as provincial, city and municipal governments.
132
 Every person who makes payment or expects
to make payment of compensation in an
amount exceeding the statutory minimum wage
to any single employee shall register by filing in
duplicate, with the RDO of the City or
Municipality where his legal residence or place
of business is located, an Application for
Registration as a withholding agent using the
form prescribed by the BIR not later than ten
(10) days after becoming an employer. (Sec. 4,
Rev. Reg. No. 1-2006; Rev. Regs. 10-2008)

133
Time of withholding
The obligation of the payor arises at the time an income is paid
or becomes payable; whichever comes first. The term “payable”
refers to the date the obligation becomes due , demandable or
legally enforceable.
Exemption from Withholding

The creditable withholding tax shall not apply to income

payments made to the following:
1. Compensation income of individuals that do not exceed the
statutory minimum wage and amount of de minimis received
within the prescribed ceiling provided by law;
2. Compensation income of employees of the government of the
Philippines, or any of its political subdivisions, agencies or
instrumentalities, with salary grade 1 to 3;
3. The National Government and its instrumentalities, including
provincial, city or municipal governments;
4. Persons enjoying exemption from payment of income taxes
pursuant to the provisions of any law, general or special.
134
Where and When to file
- it shall be paid upon filing a return in duplicate
with the authorized agent banks located within the
RDO having jurisdiction over the residence or
principal place of business of the withholding
agent.
- the tax return shall be filed and payments
should be made within ten (10) days after the end
of each month except for taxes withheld for the
months of December of each year, which shall be
filed on or before January 15 of the following year.

135
Meaning of Large Taxpayer
A taxpayer who satisfies any of the following criteria is a
large taxpayer:

1. Value Added Tax (VAT) – business establishment with

VAT paid or payable of at least one hundred thousand
pesos (P100,000) for any quarter of the preceding
taxable year;
2. Excise Tax – business establishment with excise tax paid
or payable of at least one million pesos (P1,000,000) for
the preceding taxable year;
3. Corporate Income Tax – business establishment with
annual income tax paid or payable of at least one million
pesos (P1,000,000) for the preceding taxable year; and
4. Withholding tax - Tax – business establishment with
withholding tax payment or remittance of at least one
million pesos (P1,000,000) for the preceding taxable
year.
136
 -If the employee has other items of income that
are subject to regular income tax such as income
from business or profession, income from other
employment or casual income, he must file a
consolidated income tax return to include such
items of income for the entire taxable year. The
withholding tax on compensation is credited
against the total tax due in the consolidated tax
return.

Substituted filing of tax return

Under the substituted filing system, the
employer files the income tax return of the
employee. If the amount of tax correctly withheld
by the employer, the employee no longer needs to
file an annual income tax return.
137
 2. Income derived from the conduct of trade or
business or the exercise of a profession

Business - any commercial activity engaged in as

a means of livelihood or profit of an individual
or group of individuals.
Profession – for tax purposes, it is primarily any
endeavor or work requiring specialized training
in the field of learning, art, or science engaged
in as a means of livelihood or profit of an
individual or group of individuals.

138
Income from Business - Gains or profits derived
from rendering services, selling merchandise,
manufacturing products, farming and long- term
construction contracts.

Professional Income - Any other income that is

not derived from personal services or not
related to an employer – employee relationship
and is generally subject to tax on net income
basis.

- The value derived from an exercise of

profession, business or utilization of capital
assets.
139
EXCLUSIONS FROM GROSS BUSINESS INCOME

1. Income earned by Barangay Micro Business

Enterprises (BMBE) are exempt from income
taxation and exempt from the coverage of
minimum wage law (R.A. 9178)
2. Income earned by Government educational
institutions and nonstick and nonprofit educational
institutions and used actually, directly or exclusively
related to educational purposes.
3. Income earned by duly registered cooperatives
dealing/transacting business with members only.
4. Income earned by duly registered cooperatives
dealing/transacting business with both members
and non-members are exempted on their
transactions to members only.
140
 Barangay Micro Business Enterprise (BMBE)
refer to any business entity or enterprise engaged in
the production, processing or manufacturing of
products or commodities, including agro-processing,
trading and services, whose total assets including
those arising from loans but exclusive of the land on
which the particular business entity’s office, plant
and equipment are situated, shall not be more than
Three Million Pesos (P3,000,000)
A registered BMBE shall be issued a Certificate
of Authority as proof of registration, which will be
effective for a period of two (2) years, renewable for
another period of two (2) years, thereafter.

141
 CLASSIFICATION OF GROSS INCOME FROM
BUSINESS/PROFESSION:

1. Manufacturing, merchandising, and servicing

2. Farming
3. Long term contract

* The term “trade or business” includes the

performance of the functions of a public
office. [Section 22(S), NIRC]

142
 In case of manufacturing, merchandising or mining
business, GROSS INCOME shall mean gross sales less
sales returns, discounts and allowances and cost of
goods sold [ Sec. 27(A)] plus any income from
investment and other incidental or outside operations or
sources (Sec. 43, Rev. Regs. No. 2).

In determining gross income, subtractions should not

be made for depreciation, depletion, selling expenses or
losses for items not ordinarily used in computing the
Cost of Goods sold.

In the case of taxpayers engaged in the sale of

service, gross income is based on gross receipts less
returns, allowances, discounts.

143
 "Cost of goods sold' shall include all business
expenses directly incurred to produce the
merchandise to bring them to their present
location and use.

Cost of Sales of a business may be classified as

follows:

1. Cost of goods manufactured and sold of

manufacturing concern;
2. Cost of goods sold of trading or merchandising
concern; and
3. Cost of service of servicing concern

144
• For a manufacturing concern, 'cost of goods
manufactured and sold' shall include all costs of
production of finished goods, such as raw materials
used, direct labor and manufacturing overhead,
freight cost, insurance premiums and other costs
incurred to bring the raw materials to the factory or
warehouse.

• For a trading or merchandising concern, 'cost of

goods' sold shall include the invoice cost of the
goods sold, plus import duties, freight in
transporting the goods to the place where the
goods are actually sold, including insurance while
the goods are in transit.

145
• For a servicing concern, ‘cost of services’ shall include
the direct costs and expenses necessarily incurred to
provide the services required by the customers and
clients which include the following items:

1. Salaries;
2. Benefits of personnel, consultants and specialists
directly rendering the service;
3. Cost of facilities directly utilized in providing the
service such as depreciation or rental of equipment
used and cost of supplies; and
4. In the case of banks, costs of services shall include
interest expense.

146
Gross Income from Farming
Income from farming refers to earnings derived
from its operation by a person. It includes the
following:

1. Gross receipts from sale of livestock and

products purchased from others;
2. Cash received from sale of products raised in the
farm;
3. Gains from sale of work animals and farm
equipment; and
4. Miscellaneous income such as rent received on
crop shares, proceeds of insurance on growing
crops, etc.
147
Comparative presentation:
TAX CODE GAAP

Sales P xxx Sales P xxx

Less: Cost of Sales xxx Less: Cost of Sales xxx
Business Income P xxx Gross Profit P xxx
Less: Allowed Deductions xxx Less: Operating Expenses xxx
Income before personal exemptions P xxx Net Income before tax P xxx
Less: Personal Exemptions xxx
Net Taxable Income P xxx

148
• Real Estate Service Practitioners and Other Professionals (RR 10-2013)

CWT: 15% if the gross income for the current year exceeds P720,000;
and 10%, if otherwise, on professional fees, talent fees, etc., for services
rendered by individuals engaged in the practice of profession or callings,
such as:

• Designers;
• Real estate service practitioners (i. e. real estate consultants, real estate
appraisers and real estate brokers) requiring government licensure
examination given by the Real Estate Service pursuant to Republic Act No.
9646;
• All other profession requiring government licensure examination regulated by
the Professional Regulations Commission, Supreme Court, etc. xxx” ( i.e.
lawyers, doctors, dentists )

CWT: 10% on gross commissions of

• customs;
• insurance;
• stock;
• immigration,
• commercial brokers;
• agents of professional entertainers;
149
•WT for Medical Practitioners ( RR 14-2013)
“Medical Practitioners” include doctors, nurses, medical technologists, allied
health services, dentists, and other practitioners who are not under an
employer-employee relationship;
• Paid by Hospitals/HMO’s to medical practitioners: 15% WT if the income
payments for current year exceeds P 720,000; 10%, if otherwise;
•Duty of Hospitals/Clinics/HMO’s: withhold all the taxes due;
•Hospitals/Clinics/HMO’s should not allow practitioners to directly accept
payments from patients who were confined to hospitals. All payments of
professional fees are coursed thru the hospital; Exception:

- If there is proof that no fee was charged and paid by patient;

- Joint sworn declaration by practitioner and patient (forming part of
records of hospital);
- Administrator of hospital informs RDO that practitioner refuses to
execute sworn statement;
• Hospitals are required to submit list of practitioners who did not charge any
fee from patients and whose charges are paid by patients directly to
hospitals;

•Hospital is required to submit to RDO, sworn statement executed by the

president/managing partner of the corporation/company/hospital/clinic as to
the complete and updated list of medical practitioners accredited with them.
150
• “TIANGGES” or “Privilege Stores” (RR 16-2013)
“Privilege Store” Defined:
• stall not permanently fixed to the ground;
• normally set up in places like shopping malls, hospitals, office buildings, hotels, villages or
subdivisions, churches, parks, streets and other public places;
• Purpose is selling a variety of goods/services for short durations of time or during special
events (including festivals, fiestas, etc.);
• If any business activity is for a cumulative period of more than fifteen (15) days: NOT
CONSIDERED AS “PRIVILEGE STORE” and treated as an individual habitually engaged in t/b
should be registered as regular TXs’ with invoices/receipts;
Parties and Obligations:

a. “Exhibitor” or “Organizer” - primary lessee of the entire space where the operations of
privilege stores are held by virtue of a lease contract and who subsequently sub-leases the
same to the privilege store operators;

Obligations:
1. 5% expanded WT on rentals; remitted 10th day of ff month;
2. Keep Books of Accounts and Issue Receipts ( if sales do not exceed P 50,000.00 –
simplified bookkeeping)
(3). Submit List of Sales within Five (5) Days after the privilege store operation

151
b. “Privilege Store Operator” - individual leasing from the lessor/owner or subleasing from
the “exhibitor” or “organizer” a space upon which privilege stores are erected;
Obligations:
(1) Deduct EWT (5%) on rental payments;
(2) File ITR (15 April);
(3) Submit Information Statement on Privilege Store Activities.
(4) Keep Books of Accounts and Issue Receipts/Sales or Commercial Invoices. If less
than P 50,000.00 simplified bookkeeping;
(5) Submit List of Sales on Privilege Store Activities to the Exhibitor/Organizer ( within 5
days from operations);
c. IF NOT CLASSIFIED AS “Privilege Stores Operators” (Regular Taxpayers):
Obligations:
(1). EWT on Rental Payments to Exhibitor/Organizer for Sub-Leased Spaces or
Lessor/Owner of Leased Property;
(2) Keep Books of Accounts and Issue Receipts/Sales or Commercial Invoices;
(3) File Income, Withholding, Business (Percentage or Value Added) and Other Tax
Returns, and Pay the Correct Amount of Taxes;
(4) File Other Information Returns and include CWT on rentals;

152
Association Dues/HOAs (Villages and Subd’s) (MC 9-2013)
RA 9904: Income and dues of HOAs are tax exempt provided they are used in providing for
cleanliness, safety, security, and other basic services of members including maintenance of
facilities;
New Rule: Income and dues of HOAs are exempt from income tax, VAT, and % tax, provided:

(1). HOA is duly constituted as defined under RA 9904;

(2). LGU issues a certificate stating the basic community services and facilities supplied
by HOA and that LGU’s lack of resources to provide, such as basic services which redound
to the benefit of all HOA members, ie, security, street and vicinity lights , maintenance,
repairs and cleaning of streets, garbage collection/disposal;
(3). HOA shows proof that income and dues are used for basic services;
Gratuitous Donations to HOA’s (MC 53-2013): SUBJECT to Donor’s Tax; NOT SUBJECT to
Income Tax;
Onerous Donations in Exchange for Goods, Services or Use or Lease of Properties: (MC 53-
2013)
TREATMENT: charges from activity in exchange for the performance of a service, use of
properties or delivery of an object are SUBJECT to INCOME TAX and VAT or % TAX;
NOTE: SECTIN 109 (Y), NIRC, ALREADY EXEMPTS FROM VAT, THE DUES AND FEES PAID TO
HOAs and CONDOMINIUM CORPORATIONS

153
• On-line Stores (MC 55-2013)
Kinds (as to their participating parties):
1. Business to Consumer (“B2C”): selling goods and services to final consumers;
2. Consumer to Consumer (“C2C”); and
3. Business to Business (“B2B”): job recruitment, online advertising, credit, sales, market
research, technical support, procurement and different types of training.
Common Types:
1. Online shopping or online retailing – sale directly to consumers over the internet
without an intermediary service;
2. Online intermediary service – 3rd party that offers intermediation services between two
trading parties receiving commission. Intermediary service provider (ISP) is a
merchandiser/retailer if:
• ISP controls such collection of buyers’ payments, and receives commission from the
merchant/retailer;
• ISP markets multiple products for its own account;

3. Online advertisement/classified ads – uses internet to deliver marketing messages to

attract customers;
4. Online auction –conducted through the internet via an online service provider; the
seller sells the product or service to the person who bids the highest price.
Requirements:
1. Register the business at the Revenue District Office (RDO);
2. Secure ATP;
3. Register books of accounts;
4. Issue OR’s and invoices; 154
• Marginal Income Earners ( MC 7-2014)
Marginal Income Earner (MIE) : individual (self-employed without any compensation income) whose
business does not realize gross sales or receipts exceeding P100,000in any I2-month period;
Activities are principally for subsistence or livelihood, such as but not limited to:
– Agricultural
– Growers/produce(farmers/fishermen selling directly to consumers);
– Small sari-sari stores;
– Carinderias;
– Drivers/operators of single unit tri-cyle;
– Excluding licensed professionals, consultants, artists, sales agents, brokers;

• Requirements/Rules:
Registration with BIR (Form 1901);
Sworn Statement of Income for the year;
NSO Certified or local civil registry BC;
Exempt from Annual Registration Fee;
Registration of books of account ( simplified);
Issuance of principal registered receipts;
Filing of ITR and Payment of annual income tax;
Exemption from business taxes;

155
 3. Gains derived from dealings in property

- includes all gains derived from the disposition of

property (real, personal or mixed) for money in
case of sale, or for property in case of exchange,
or from a combination of both sale and exchange.
- The general rule is that the entire amount of the
gain or loss arising there from is a taxable gain or
deductible loss.
- “dealings in property” refers to the disposal
through sale or exchange of (a) ordinary assets, or
(b) capital assets.

156
1. Gain from sale, exchange, or other disposition
of real property classified as ordinary assets
(although subject to creditable withholding
tax)
2. Gain from sale, exchange or other disposition
of personal property classified as ordinary
assets.
3. Gain from sale, exchange or other disposition
of other personal property classified as capital
asset.
4. Gains realized from sale, exchange or other
disposition of real property not located in the
Philippines, regardless of classification, by
resident citizens.

157
• Measurement of gain/loss [Section 40(A)]
“gain” - excess of the amount realized from the sale or
other disposition of property over the basis or adjusted
basis.
“loss” - excess of the basis or adjusted basis over the
amount realized.

• Amount realized = sum of money received plus the fair

market value of the property (other than money)
received [Sec. 40 (A)]

• Basis of property [Sec. 40 (B)]

– depends primarily on the manner in which the

taxpayer acquired the property.
158
1. By purchase:
a.) acquired before 1 March 1913 – FMV on such
date
b.) acquired on or after 1 March 1913 – Cost plus
expenses of acquisition (Sec. 136, Rev. Reg. No. 2)

- The acquisition cost and incidental expenses

related to the acquisition of asset are to be
capitalized;
- The adjusted cost and the expenses related to the
disposition of asset are treated as reduction from
the selling price.

159
Example:
After using the delivery truck in business for 2
years, Mr. B sold it for P150,000. The sale was
subject to 5% agent commission and 10%
processing expenses based on selling price.
The truck was previously purchased for a list
price of P90,000. Other expenses related to the
acquisition of the truck are P7,000 reconditioning
cost and P3,000 testing cost. The truck has a 5-
year estimated useful life.

160
The adjusted cost and expenses related to the sale of the truck
would be:
List price P 90,000
Add: Incidental costs:
Reconditioning cost P 7,000
Testing cost 3,000 10,000
Total cost capitalized P 100,000
Less: Cost of expired life [(P100,000/5)x2] 40,000
Adjusted cost or book value P 60,000
Add: Sales expenses:
Processing expense P 15,000
Commission expense 7,500 22,500
Total adjusted cost and expenses P 82,500

Sales price P 150,000

Less: Adjusted cost and expenses 82,500
Gain (loss) on sale P 67,500
161
2. Included in the inventory – latest inventory value
(Sec. 136, Rev. Reg. No. 2)
3. By devise, bequest or inheritance – FMV or value
of such property at the time of the acquisition
(death of decedent) (Sec. 139, Rev. Reg. No. 2)
Example:
Mr. F sold his inherited land for P100,000. The
land has a FMV of P150,000 when inherited and
has a FMV of P90,000 when sold.

Sales price P 100,000

Less: FMV when inherited 150,000
Gain (loss) on sale (P 50,000)
162
4. By gift – same basis as it would have been in the
hands of the donor or the last preceding owner
by whom it was not acquired by gift, except that
if such basis is greater than the FMV of the
property at the time of the gift, then for the
purpose of determining loss shall be such fair
market value.
Example:
Mr. G received an antique painting as a gift from
Ms. R. Ms. R acquired the painting for P100,000
but its FMV was P80,000 when it was given to
Mr. G which he subsequently sold to Mr. J for
P150,000.

163
Sales Price P 150,000
Less: Cost of Sale 80,000
Gain (loss) on sale P 70,000
5. Acquired (other than capital assets) for less than
an adequate consideration in money or money’s
worth – amount paid by the transferee
Example:
Mr. J sold a portion of lot with a cost of P500,000
to Ms. E for P200,000. Subsequently, Ms. E sold
the same to Mr. T for P290,000.
Sales Price P 290,000
Less: Amount paid by transferee 200,000
Gain (loss) on sale P 90,000
164
6. Stock or security or property received if the
exchange is one where gain/loss may be
recognized – same as the basis of the stock, or
security or property given in exchange
7. Stock or security or property received if the
exchange is one where the gain, if any, but not the
loss is to be recognized- basis of the property,
stock or security given in exchange less cash and
FMV of property given in exchange add dividend
and/or gain recognized
8. Property transferred in the hands of transferee if
the exchange is one where the gain, if any, but not
the loss is to be recognized – same basis as it
would be in the hands of transferor increased by
the amount of gain recognized to the transferor
on the transfer. 165
 EXCLUSIONS FROM GROSS INCOME
[Sec. 40 (C)(2)]
1. Exchange solely in kind in legitimate mergers and consolidation which
includes:

a. Between corporation which are parties to a merger or

consolidation (property for stock)
b. Between a stockholder of a corporation party to a merger or
consolidation and the other party corporation (stock for stock)
c. Between a security holder of a corporation which is a party to a
merger or consolidation and the other corporation (securities for
securities or stock)
2. Transfer or exchange of property for stock resulting in acquisition of
corporate control (Property for stock)
[Sec. 40 (C)(2)]
3. Sale/disposition of principal residence [Sec.24 (D)(2)]
4. Shares listed and traded in the stock exchange – subject to stock
transaction tax

166
Types of Gains from dealings in property

(1) Ordinary gain vis-à-vis Capital gain

Ordinary gain – is the gain derived from the sale or exchange of

ordinary assets including gains from performance of services and
business. There is an ordinary gain if the business income is greater
than the business operating expenses.
  Ordinary loss – is the excess of business expenses and losses over
the business income of the taxpayer derived from the sale or
exchange of ordinary assets.

Capital gain – is the excess of value received over the determined

cost from the sale or exchange of a capital asset. On the other hand, a
capital loss refers to the excess of the determined cost over the value
received from the sale or exchange of a capital asset.

167
(2) Net capital gain, Net capital loss

Net Capital gain is the excess of the gains from sales or

exchange of capital assets over the losses from such sales
or exchanges.

Net capital Loss is the excess of the losses from sales or

exchanges of capital assets over the gains from such sales
or exchanges.
Preferential Tax Treatment of Capital Gain (Loss)
• Net capital gain is added to ordinary gain but net capital
loss is not deductible from ordinary gain.
• Net ordinary loss is deductible from net capital gain.
• Capital losses are deductible only to the extent of the
capital gain. 168
• For the individual the reportable percentages of capital
gain or loss shall be:
100% if the capital asset is held for one year or less than
one year (short term)
50% if the capital asset is held for more than one year
(long term)
• There is a net capital loss carry-over on the net capital
asset’s loss in a taxable year which may be deducted as a
short-term capital loss from the net capital gain of the
subsequent taxable year; provided that the following
conditions shall be observed:
- the taxpayer is other than a corporation
- the amount of loss does not exceed the income before
exemptions at the year when the loss was sustained
- the holding period should not exceed 12 months. 169
Example:
Mr. R, sold various properties as follows in 2019:
Items sold Date acquired Date sold Gain (loss)
Car 8/14/2017 2/14/2019 P 100,000

Office supplies 6/1/2018 12/5/2019 20,000

Laptop 4/5/2018 4/5/2019 80,000

Home appliances 7/21/2018 8/24/2019 ( 160,000)
Books 12/28/2018 11/26/2019 ( 30,000)

Vacant lot 2/14/2018 12/3/2019 250,000

170
The net capital gain or loss shall be computed as follows:

Items sold Holding Gain (loss) % Gain (loss)

period
Car Long-term P 100,000 50% P 50,000
Laptop Short-term 80,000 100% 80,000
Home appliances Long-term (160,000) 50% ( 80,000)

Books Short-term (30,000) 100% ( 30,000)

Net capital gains P 20,000

171
• Net capital loss carry over

Individual taxpayers are allowed to carry-over net capital loss as a

deduction against net capital gain of the following year subject to the
following limits:
Limit 1 – the amount of net income in the year the net capital loss
was sustained, and
Limit 2 – the available net capital gain in the following year

In other words, the amount of the net capital loss carry over shall
be whichever is the lowest of the actual loss, Limit 1, and Limit 2.

Note that the net capital loss carry over is strictly for one year only
and is applicable only to individual taxpayers. Corporate taxpayers are
not allowed under the NIRC to carry over net capital loss.

172
Willy reported the following in 2018 and 2019:

2018 2019
Net income before dealings in property P 70,000 P 300,000

Dealings in ordinary assets:

Ordinary gains P 40,000 P 30,000

Ordinary losses ( 80,000) ( 50,000)

Dealings in capital assets:

Capital gains P 20,000 P 80,000

Capital losses ( 60,000) ( 30,000)

Net capital gains or (loss) (P 40,000) P 50,000

173
The net income before dealings in capital assets should be determined
first. Thus,
2018 2019
Net income before dealings in property P 70,000 P 300,000
Ordinary gains 40,000 30,000
Ordinary losses ( 80,000) ( 50,000)
Net income before dealings in capital assets P 30,000 P 280,000

The net capital gain in 2019 shall be computed as follows:

2018 2019
Net capital gains or (loss) (P 40,000) P 50,000
Carry over: lowest of 30k, 40k and 50k 30,000 (30,000)
Net capital gain P 20,000

174
• There is no capital loss cavy-over hen the taxpayer incurs a net
operating loss in the period the net capital loss as sustained and
when the following year results to a net capital loss.
• The amount of capital loss carry-over shall not exceed the net
income before dealings in capital assets in the year the net capital
loss as sustained. This rule is anchored on the tax benefit rule.
• The amount of capital loss carry-over shall not exceed the net capital
gain in the following year.
• When the capital gain or capital loss is sustained by a corporation,
the following rules shall be observed:

1. There is no holding period; hence, there is no net capital loss

carry-over
2. Capital gains and losses are recognized to the extent of capital
gains.
3. Net capital losses are not deductible from ordinary gain or income
but ordinary losses are deductible from net capital gains.
175
• Treatment of Losses and Gains from Wash Sale

1. As a general rule, losses from wash sale are not deductible while
gains from wash sale are taxable.
2. If the number of securities sold is more than the number of
securities purchased within the sixty-one day period, then:

a. No loss shall be recognized on the acquisitions within the sixty-one day period which
are matched with a number of shares or securities disposed of; and
b. A capital loss shall be recognized on the number of shares or securities disposed of
which cannot be matched with acquisitions within the sixty-one day period.

3. If the number of securities sold is less than the number of

securities purchased within the sixty-one day period, then:
a. The stocks or securities disposed of will be matched with an equal number of shares
of sock or securities acquired in accordance with the order of acquisition beginning
with the earliest acquisition.

176
Example:

Mr. Y had the following transactions with DEF Corporation’s ordinary

shares classified as capital asset:

Jan. 10, 2020 – purchased 10,000 shares @ P50/share

Jan. 20, 2020 - purchased 4,000 shares @ P50/share
Feb. 10, 2020 - purchased 3,000 shares @ P48/share
Feb. 14, 2020 – sold 10,000 shares @ P45/share
- from Jan. 10, 2020

Compute for:
1. Deductible and nondeductible loss on Feb. 14, 2020
2. New cost of Jan. 20 and Feb. 10 purchases
3. If on Feb. 25, Mr. Y sold 4,000 shares @ P60/share, how much is
the capital gain (loss)? 177
1. Sales P 450,000
Less: Cost of sales 500,000
Capital gain (loss) (P 50,000)

Nondeductible loss (P50,000 x 7/10) – wash sales P35,000

Deductible loss (P50,000 x 3/10) P15,000
2. Jan. 20 Feb. 10
Original cost P200,000 P144,000
Add: Nondeductible loss
Jan. 20 (P35,000 x 4/7) 20,000
Feb. 10 (P35,000 x 3/7) ________ 15,000
New cost P220,000 P159,000
3. Sales P240,000
Less: Cost of sales 220,000
Capital gain P 20,000
178
 4. Rents
- Refers to earning derived from leasing real estate
as well as personal property. It includes all other
obligations assumed to be paid by the lessee to
the third party in behalf of the lessor (examples
are interest, taxes, loans, insurance premiums and
others.
- Rental income is generally determined by gross
receipts for the year, (earned and unearned under
accrual basis) because the nature of business
involved is service.
* Tax treatments of leasehold improvements, advance rent and
taxes paid by lessee to or for a lessor?
179
Illustration:
KCZ Bazaar leases a portion of its commercial
space to Mr. D with the agreement that Mr. D
should be responsible to pay the ff:
a. Advanced rental of P100,000;
b. Monthly rental of P25,000;
c. Annual insurance premium of P5,000;
d. Annual interest expense of P3,000; and
e. Real estate tax, P2,000.

180
Rules:
1. If the advance payment is a prepaid rental received
without restriction as to its use, the entire amount is
taxable in the year it is received whether the lessor
uses cash or accrual method of accounting.
2. If he advanced payment is a security which restricts
the lessor as to its use, then such amount should be
excluded in the determination of rental income.
3. If the advance payment is a loan deposit, or option
money for the property, or a security deposit for the
faithful compliance of the lessee of the lease contract,
such advance payment is not an income to the lessor.
The income to the lessor inures when the lessee
violates the terms of the contract. (acceleration
clause)
181
4. When the lessee erected or built permanent
improvements on the leased property which will
become the property of the lessor upon the
expiration of the lease, the value of the
improvements should be reported as income of the
lessor using either outright method or spread out
method.
Outright method – the income from leasehold
improvement shall be recognized when the
improvement is completed at its fair market value.
Spread-out – the estimated BV of the leasehold
improvement at the end of the lease is spread over the
term of the lease and is reported as income for each
year of the lease an aliquot part thereof.
182
Illustration:
ZC, Inc. leases its lot to Mrs. Tan for a term of 3
years with an annual rental of P50,000. As of
January of year 1, Mrs. Tan completed the
construction of an improvement on the lot with a
value of P1,500,000 with an estimated useful life 5
years.
The leasehold contract stipulates that the
improvement will belong to ZC, Inc. after the term if
the lease.

183
Outright method:
Value of the building P 1,500,000
Add: Annual rental per agreement 50,000
Total lease income to be reported P 1,550,000
Spread-out method:
Cost of the building P 1,500,00
Less: Accumulated depreciation
at the end of the lease
(P1,500,000/5 yrs.)3 yrs. 900,000
Book value of improvement at the
end of the lease P 600,000
Divide by the term of the lease 3
Annual income on leasehold improvement P 200,000
Add: Annual rental 50,000
Total lease income to be reported P 250,000
184
 5. Interests
- An earning derived from depositing or lending of
money, goods or credits.
 
General rule: Interest received by a taxpayer, whether
usurious or not, is subject to income tax.

Except: When interest income is exempted by law

from income tax.
Part of the Pertinent items of Gross Income

-Interests on bonds, notes or other interest-bearing

obligation of residents, corporate or otherwise
185
 EXCLUSIONS FROM GROSS INCOME

1. Interest income from long-term deposit or investment in the

form of savings, common or individual trust funds, deposit
substitutes, investment management accounts and other
investments evidenced by certificates in such form
prescribed by the BSP. [Sec. 24(B)(1)] Provided:

- These must have a maturity period of not less than five years
and must be issued by banks in denominations of P10,000.

- Applicable only to individual taxpayers, except nonresident

aliens not engaged in trade or business in the Philippines

- The deposit or investment must be evidenced by certificates

conforming to the BSP prescribed form.
186
2. Interest earned is exempted from income tax if
received from:

a. Members of a duly-registered cooperative;

b. Expanded foreign currency deposit system by
nonresident citizens/aliens; and
c. A tenant who paid to a landowner on the price of
land under a tenant-purchaser agreement as part of
CARP.

187
 6. Royalties
- These are the compensations or payments for
the use of property and are paid to the owner of a
right.

Part of the Pertinent items of Gross Income

- Royalties paid by a foreign corporation

188
7. Dividends – a form of earnings derived from the distribution made
by a corporation out of its earnings or profits payable to its
stockholders, whether in money or other property.
(1) Cash dividend - A dividend paid in cash and is taxable to the
extent of the cash received.

(2) Stock dividend - Involves the transfer of a portion of retained

earnings to capital stock by action of stockholders. it simply means
the capitalization of retained earnings.

(3) Property dividend - A dividend paid in property of a corporation

such as stock investment, bands or securities held by the corporation
and to the extent of the FMV of the property received at the time of
the distribution.

(4) Liquidating dividend - A dividend distributed to the shareholders

upon dissolution of the corporation.
189
 
General rule: A mere issuance of stock dividends is not subject to
income tax, because it merely represents capital and it does not
constitute income to its recipient. Before disposition thereof,
stock dividends are nothing but a representation of interest in
the corporate entity.

Exceptions: When stock dividends are subject to tax;

a) These shares are later redeemed for a consideration by the

corporation or otherwise conveyed by the stockholder to the
extent of such contribution. Under the NIRC, if a corporation,
after the distribution of a non-taxable stock dividend, proceeds
to cancel or redeem its stock at such time and in such manner as
to make the distribution and cancellation or redemption
essentially equivalent to the distribution of a tax of a taxable
dividend, the amount received in redemption
190
  or cancellation of the stock shall be treated as a taxable
dividend to the extent that it represents a distribution of
earnings or profits. (Sec.73 (B), NIRC). Depending on the
circumstances, corporate earnings may be distributed
under the guise of initial capitalization by declaring the
stock dividends previously issued and later redeem or
cancel said dividends by paying cash to the stockholder.
This process amounts to distribution of taxable dividends
which is just delayed so as to escape the tax. (CIR vs. CA,
301 SCRA 152)
b) The recipient is other than the stockholder.
(Bachrach vs. Seifert, 57 PHIL 483)
c) A change in the stockholder’s equity results by
virtue of the stock dividend issuance.
191
 EXCLUSIONS FROM GROSS INCOME
1. Pure stock dividends, dividends received from
cooperative, and pure liquidating dividends, and
2. Inter-corporate dividends

Part of the Pertinent items of Gross Income

- Dividends received from a foreign
corporation
- Distributive shares of a partner in a
general professional partnership

192
 8. Prizes and awards
- a reward for a contest or a competition. It
represents remuneration for an effort reflecting
one’s superiority.

Part of the Pertinent items of Gross Income

1. Prizes of P10,000 and below

2. Prizes won abroad

193
 EXCLUSIONS FROM GROSS INCOME
1. Prizes and awards received in recognition of religious,
charitable, scientific, educational, artistic, literary or civic
achievements are exclusions from gross income if:
 
a. The recipient was selected without any action on his part to
enter a contest or proceedings; and

b. The recipient is not required to render substantial future

services as a condition to receiving the prize or award. [Sec.
32 (B)(7)(c)]
 
2. Prizes and awards granted to athletes in local and int’l sports
competitions and tournaments held in the Philippines and
abroad and sanctioned by their national associations. [Sec. 32
(B)(7)(d)]
194
 9. Winnings - a reward for an event that depends on
chance.

Part of the Pertinent items of Gross Income

- Winnings won outside of the Philippines

EXCLUSIONS FROM GROSS INCOME

1. PCSO/LOTTO winnings not exceeding Php10,000

195
“Other sources of income” – they are generally
incidental earnings or not common source
earnings. Usually these income are, but not limited
to, the following:

1. Annuities;
2. Bad debt recovery;
3. Tax refund or credit;
4. Damages recovery; and
5. Income from whatever source

196
 10. Annuities, Proceeds from life insurance or
other types of insurance

Annuities – are amounts payable yearly or at other regular

intervals for a certain or uncertain period. They also
represent as installment payments for life insurance sold
by insurance companies.
If the part of annuity payment represents interest,
then it is taxable income. If the annuity is a return of
premium, it is not taxable.

Part of the Pertinent items of Gross Income

- Any excess of the return of premiums
197
 11. Pensions retirement benefit, or separation
pay

- Pension refers to allowance paid regularly to a

person on his retirement or to his dependents on
his death, in consideration of past services,
meritorious work, age, loss or injury.

Part of the Pertinent items of Gross Income

- Pensions that do not comply with the requirements for

exemption provided under [Sec. 32 (6)]

198
Tax Benefit Rule – is a general principle in taxation
which states that if a taxpayer deducted an item
on his income tax return and enjoyed a tax benefit
(reduced his income tax) thereby, and in a
subsequent year recovers all or part of that item,
he will recognize gross income in the year the
deducted item is recovered.
- this rule has both an inclusionary and an
exclusionary component, i.e., the recovery is
included in the taxpayer’s gross income to the
extent that the taxpayer obtained a tax benefit
from the prior year’s deduction, and the recovery
is excluded to the extent that the prior year’s
deduction did not provide a tax benefit. 199
 12. Bad debt recovery – when a written off
receivable has been recovered in the succeeding
year, the recovered amount must be included in
the gross income during the taxable year of
recovery. However, under the doctrine of
equitable benefit, the amount recovered is only
taxable to the extent of the tax benefit in the year
the account was written off.

Illustration: In 2018, C wrote off a worthless

account receivable-trade amounting to P50,000. If
C has bad debts recovery for P30,000 in 2018,
such amount will be included as part of his 2018
taxable income from business. 200
 12. Tax refund or credit – is subject to the tax
benefit rule which states that the refund of tax
would only be subjected to tax if such tax was
previously deducted from gross income resulting
in the reduction of reportable taxable income.

As a general rule, refunds from taxes paid are

taxable except for the following:

a. Estate or donor’s tax;

b. Philippine income tax;
c. Stock transaction tax; and
d. VAT, claimed as input tax. 201
Illustration:
D, Company, a domestic corporation, paid the
following taxes during the year.
2017 2018
Gross income P250,000 P400,000
Allowable deductions (130,000) (250,000)
Income before taxesP120,000 P150,000
Taxes paid:
Community tax deficiency (2,000)
Income tax deficiency ________ (5,000)
Net income per GAAP P118,000 P145,000
Net income per ITR P118,000 P150,000 202
Supposing that the tax deficiencies were refunded
in year 2019, what would be the reportable
taxable income if the 2019 data of business were
as follows:
Gross income P 500,000
Allowable deductions 300,000
Gross income-business P 500,000
Add: Tax refund 2,000
Total P 502,000
Allowable deductions (300,000)
Taxable income P 202,000
203
 13. Damages recovery – is an amount received by
an injured person as payment for loss income or
payment to compensate damage to property,
injury to person, or loss of life.
As a rule, recoveries of damage representing
compensation for loss of profit or income are
taxable.
Recoveries that are to compensate for damages
to property, injury to person, or loss of life are not
taxable.

204
 ALLOWED DEDUCTIONS
In general, deductions or allowed deductions are
business expenses and losses incurred which the law allows
to reduce gross business income to arrive at net income
subject to tax.
Sec. 34 of the NIRC pertains only to items related to the
trade/business of the taxpayer
Deductions are strictly construed against the taxpayer.
They are not presumed but allowable only by reason of
specific provisions of law and not under any general
equitable or Constitutional concept.
The taxpayer seeking a deduction must be able to prove
that he is entitled to the deduction which the law allows.
The purpose of deductions from gross income is to
provide the taxpayer a just and reasonable taxable amount
as the basis of income tax. 205
Two major classifications of business expenditures:
1. Revenue expenditures – are ordinary recurring
expenditures that provide benefits to the current
accounting period. They are charged to expense as
incurred, and are deductible from gross income if they
satisfy the conditions as prescribed by the Tax Code.
2. Capital expenditures – are nonrecurring expenditures
related to the acquisition of depreciable assets to be
used in the business, but not for sale, having a useful
life of several years. The cost incurred for acquiring
such assets is capitalized and not immediately
expensed. They are gradually expended from period to
period in the form of depreciation or amortization
within their estimated useful life.
206
 Costs after the acquisition of plant assets shall be
capitalized when any of the following conditions are met:

1. Increase in useful life

2. Increase in capacity
3. Increase in efficiency

If neither the condition is met, the expenditures intended

only to sustain the ordinary level and quality or services to
be provided by the plant assets. Thus, expenditures should
be designated as revenue expenditures.

Capital expenditures are not deductible, in lieu thereof,

depreciation expense of the asset is allowed
207
Situs of Expenses
The place of business becomes the basis if
business expenses are deductible from Philippine
income tax purposes.
As a rule, business expenses deductible only if
they are incurred in relation to the business income
taxable in the Philippines (except when the
taxpayer is a resident Filipino or a domestic
corporation). If a business expense could not be
traced whether incurred within or not, such
expense shall be allocated based on the gross
income within and without.
208
• Allowed deductions from gross
business/professional income –
Kinds of Deductions:
1. Itemized deductions
2. Optional standard deduction (OSD)
3. Special allowable itemized deductions

209
The following are not allowed to claim any kind of
deduction:
1. Taxpayers whose income is subject to Gross
Income Tax (GIT)
2. Taxpayers whose Income is subject to Final
Withholding Tax

*If taxpayer is subject to 8% optional rate, no

deductions however, tax is imposed on the amount
in excess of P 250,000.00.

210
Itemized deductions – are allowed deductible
ordinary and necessary business expenses paid
or incurred during the taxable year. As a rule,
these deductions require supporting documents
to justify the reduction from gross income. [Sec
34 (A-M)]
- Compensation income is not allowed to be reduced by
OSD or itemized deductions
- Each spouse may either use OSD or itemized
deductions

211
Requisites of Deductibility of Items under Section 34 of
the Tax Code:
1. Necessary in Trade or Business of the taxpayer;
- Deductions must be paid or incurred in connection with
the taxpayer’s trade, business or profession
- It must be directly connected with trade or business
or profession of the taxpayer.

2. Actually paid or incurred;

3. Reasonable in amount; and
4. Supported by documents.
- The claimed deduction must be evidenced by
official receipts or other adequate records.
212
 In accordance with the principles for claiming
deductions, the burden of proof is on a 
taxpayer when claiming business deductions under
Section 162(a).
However, a deduction is not denied for otherwise
allowable business expenses where there is a failure
of strict proof, i.e., records of expenses for certain
transactions.
When proof of detail or itemization is lacking,
automatic disallowance for business expenses is not
the general rule.

213
 The evidence must establish the ff:

a) the amount of expenses being deducted

b) the direct relation of such to the

development, management, operation, and/or
conduct of the trade, business or profession of
the taxpayer.

Note: Cohan Rule Principle

214
COHAN RULE
Leorge Cohan was a well known Broadway star
in the early 1900s (his most famous
performance is Give my Regards to Broadway).
Interestingly, his legacy is also closely connected to
tax law. Cohan was audited by the IRS and was told
that he was not allowed to deduct many of his
business and entertainment related expenses
because he did not keep all of the necessary
receipts. Mr. Cohan appealed this ruling and the
courts actually sided with him, forcing the IRS to
accept estimates of his expenses.

215
 The Cohan Rule is now a law that allows
taxpayers to deduct some of their business related
expenses even if the receipts have been lost or
misplaced so long as they are reasonable and
credible

A common law rule whereby taxpayers, when unabl
e to produce records of actual expenditures, may
rely on reasonable estimates provided there is
some factual basis for it.

216
 “Absolute certainty in such matters is usually
impossible and is not necessary; the Board should
make as close an approximation as it can, bearing
heavily if it chooses upon the taxpayer whose
inexactitude is of his own making.”
(Cohan v. Commissioner of Internal Revenue, 39 F.2d 540, 2 U.S. Tax
Cas. (CCH) P 489, 8 A.F.T.R. (P-H) P 10552 (C.C.A. 2d Cir. 1930))

217
Income Subject to Itemized Deductions:
1. Business/professional income derived within and
outside the Phils. by a resident citizen;
2. Business/professional income derived within the Phils.
by a nonresident citizen, a resident alien and a
nonresident alien;
3. Business/professional income of general co-partnership;
4. Business income derived within and outside the Phils. by
a domestic corp.
5. Business income derived of proprietary educational
institution and nonprofit hospitals
6. Business income of proprietary GOCCs; and
7. Business income within the Phils. earned by a foreign
corporation
218
• ITEMIZED DEDUCTIONS

I. Expenses
II. Interest
III. Taxes
IV. Losses
V. Bad debts
VI. Depreciation
VII. Depletion of oil and gas wells and mines
VIII. Charitable and other contributions
IX. Research and Development
X. Pension and trust
219
I. Expenses
Requisites for deductibility
 
1. BUSINESS TEST:
a) must be ordinary and necessary,
- “Ordinary” means commonly incurred, “Necessary”
means appropriate and helpful to the taxpayer or intended
to realize profit or to minimize loss.

b) must be paid or incurred during the taxable year,

Cases: Hospital De San Juan De Dios vs. CIR (10 May 1990);
ESSO Standard Eastern Inc. vs. CIR (175 SCRA 158-159);
CIR vs. Isabela Cultural Corporation (12 February 2007)
c) must be paid or incurred in carrying on or which
are directly attributable to the development,
management, operation and/or conduct of the
trade, business or exercise of a profession,
d) must be reasonable, and
e) must not be against public policy, public moral
or law
- Illegal expenses are not deductible whether
business is legal or illegal;
- Legitimate expenses whether business is legal or
illegal are deductible

f) Withheld with tax and paid to the BIR, if

required such as salary expense
 2. SUBSTANTIATION TEST:

It must be substantiated with sufficient

evidence, such as official receipts or other
adequate records, showing:
 
i. the amount of the expense being deducted, and
ii. the direct connection or relation of the expense
being deducted to the development, management,
operation and/or conduct of the trade, business or
profession of the taxpayer.

222
Business expenses include a reasonable allowance for the
following:

1. Salaries, wages, management expenses,

commissions, and labor;
2. Supplies, and repairs and maintenance,
and other incidental expenses;
3. Operating expenses of transportation
equipment used in the trade, profession
or business;
4. Rental for the use of business property;

223
5. Advertising expenses designed to
stimulate the current sale of merchandise or
use of services are deductible business
expenses;
6. Travelling expenses while away from home
solely in the pursuit of trade, profession or
business; and
7. Insurance premiums against fire, storm,
theft, accident, or other similar losses in the
trade or business.

224
Salaries and Wages

- Salaries and wages and other forms of compensation

for personal services actually rendered;
- including the grossed-up monetary value (GMV) of
fringe benefits furnished or granted by the employer
to the employee;
- Generally, salaries are allowed as deductions from
gross business income only if the corresponding
withholding tax has been deducted and remitted to
the BIR;
- it must be reasonable in amount.
Materials and Supplies
- they are deductible when consumed or used in the
business operation during the taxable period. 225
Rentals
- required as a condition for the continued use or
possession, for purposes of the trade, business or
profession, or property to which the taxpayer has not
taken or is not taking title or which he has no equity
other than that of a lessee, user or possessor.
- Rentals on lease of property are deductible provided
taxpayer does not acquire interest other than as a
mere possessor, thus rentals on lease to own scheme
are not deductible as they are capital expenditures
already
- advance rental payment is not deductible expense of
the lessee until the period is used, although the lessor
may be required to report the amount when received.
226
- Real estate tax on the property leased and
shouldered by the lessee is deductible expense on the
part of the lessee BUT treated as taxable income on
the part of the lessor.

- Cost of major improvements introduced by lessee in

an ordinary asset are not deductible expense on the
part of the lessee as these are capital investment on
his part but maybe depreciated by the lessee.

- Cost of minor improvements are deductible

227
Traveling expense

Requisites
- it must be reasonable and necessary,
- it must be incurred while away from home, here or
abroad,
- it must be paid or incurred in the conduct of trade or
business.
“Away from home” – means away from the taxpayer’s tax
home.
Tax home – refers to the location of the employee’s
principal place of employment regardless of where the
family residence is maintained.

228
Representation expense

- these are entertainment, amusement and recreation

(EAR) expenses incurred or paid during the taxable
year that are directly connected to the development,
management and operation of the trade, business or
profession of the taxpayer.

Ceilings prescribed by law:

1. ½% of net sales for taxpayers engaged in sale of
goods/properties, or
2. 1% of net revenue for taxpayers engaged in sale of
services, including exercise of profession and use/lease
of properties. (Rev. Regs. 10-2002)

229
 - if the taxpayer derives income both sales of
goods/properties and services, the allowable EAR
expense shall in all cases determined based on an
apportionment formula, but which I no case shall
exceed the maximum percentage ceiling.
Requisites:
1. It must not be contrary to law, morals, public policy or
public order;
2. It must be substantiated with sufficient evidence such as
receipts an or adequate records;
3. It must be limited to the ceiling requirement;
4. There must be some definite reasonable purpose
connected with one’s business.

230
- Mere giving of parties to entertain one’s employees
and personnel does not indicate a definite business
purpose.

- Bribes, kickbacks and similar payments are not

allowed as a deduction, however expenses incurred
in an illegal activity are generally deductible if they
are ordinary, necessary, and reasonable.
- NOLCO and any item of incentive deduction
allowable under any special law are not part of the
itemized deductions. (Rev. Reg. 14-2001)

- NOLCO is not part of itemized deductions because

such loss was not incurred during the taxable year.
231
Examples of non-deductible expenses:

1. compensation to public relations firm for

services rendered in carrying on
campaign to sell additional capital stock;
2. expenses relating to recapitalization and
reorganization of corporation;
3. promotion or marketing expenses which
are tantamount to purchase of goodwill;
(Atlas Mining and Development Corp. vs. CIR, G.R. No. L-
26911, G.R. No. L-26924, January 27, 1981)
4. bribes and kickbacks;
232
5. expenses for major repairs are not
deductible but expenses for minor repairs
are deductible;

6. personal and living expenses of the

taxpayer;

7. advertising expenses/marketing expenses

designed to stimulate the future sale of
merchandise or use of services as these are
already considered as capital outlay;
233
8. Any amount paid out for new buildings or for
permanent improvements, or betterments made to
increase the value of the property or estate.

9. Any amount expended in restoring property for

which an allowance is or has been made.

10. Premiums paid on any life insurance policy

covering the life of any officer or employee, or of
any person financially interested in any trade or
business carried on by the taxpayer, when the
taxpayer is directly or indirectly a beneficiary under
such policy.
234
11. Transactions between related taxpayers
resulting to losses from sales or exchanges of
property, interest expense or bad debts.

12. Donations made to employees and others,

which do not have in them the element of
compensation or are excess of reasonable
compensation for services.

235
II. Interest – the cost of money incurred within a taxable year on
indebtedness in connection with the taxpayer’s profession, trade
or business.

Requisites for deductibility

a) There must be an indebtedness stipulated in writing;
b) The indebtedness must be that of the taxpayer;
c) The indebtedness must be connected with the trade, business or
profession of the taxpayer;
d) The interest must have been paid or incurred during the taxable
year;
e) The deduction for interest expense shall be reduced by an
amount equal to 33% of the interest income subject to final tax.
(tax arbitrage)
f) The interest payment arrangement must not be between
related taxpayers as mandated in Sec. 34(B)(2)(b), in relation
to Sec. 36(B), both of the Tax Code of 1997.
236
 *Interest between related taxpayers:
• Members of the family
• Individual and corp. of which such individual own more than 50%
• Between corps. where the same individual owns more than 50%
in each corp.
• Grantor and fiduciary (trustee) of any trust.
• Fiduciary and another fiduciary – same grantor
• Fiduciary and beneficiary or such trust

g) The interest must not be incurred to finance petroleum

operations.
h) In case of interest incurred to acquire property used in
trade, business or exercise of profession, the same was not
treated as a capital expenditure.

*Optional treatment 237

Interest Expense Deductible in full:
1. The business has no interest income subjected to 20%
final tax; or
2. The interest expense is paid in favor of the government.
(Rev. Reg. No. 13-2000)
- Interest on delinquent taxes is deductible.
- Interest paid to the government shall not be reduced by
tax differential because the beneficiary of such interest is
the government itself.
- However, fines and penalties for late payment of taxes are
not deductible.

238
Non deductible interest expenses
• Interest payment on indebtedness not business related
[Section 34(B)(2)]
• Interest payment in favor of a relative (related debtor
and creditor);
• Interest paid in advance
• Interest paid on preferred stock which is considered
interest on capital by virtue of RMC 17-71
• Interest on undrawn salaries and bonuses
• Interest on capital for cost keeping
• Interest paid where parties provide no stipulation to pay
interest in writing
• Interest on indebtedness if incurred to finance petroleum
239
Facts: X borrowed P100,000 from Y with 10% interest
per annum. Total amount due is P110,000.

1. X paid Y P110, 000. Is it income on the part of Y?

Only the 10% interest is income and taxable.

Can X deduct the 10% as interest on loan?

Yes, provided that the loan was in relation to X’s

trade or business and subject further to the 33%
limitation of the interest earnings of the said debtor;

240
 2. X was not able to pay Y. Tax consequence?

Y may declare the P110,000 as bad debt.

It will be deductible if:
(1) Y is engaged in trade/business and
(2) the amount of bad debt is in relation to his trade or business.

There are no tax consequences on X if after the deduction of bad

debt, the same was recovered, we apply the tax benefit rule
which means that the amount of debt subsequently recovered up
to the extent of the income tax benefit received by the taxpayer
when the same was claimed as deduction and subsequently
recovered, SHALL FORM part of the gross income of taxpayer;

NOTE: There can be no deduction if X and Y are related to each

other under Sec. 36(B), NIRC.
241
3. If debtor X dies before paying his debt. Tax
consequences?

Y will have to file a claim during settlement of X’s

estate. It will be considered as a claim against the
estate (CAE) and the entire amount may be deducted
from the estate whether or not the loan is in
connection with X’s trade or business.
On the part of Y, the same shall be deductible from
gross income as bad debt expense.

242
4. If the estate subsequently pays Y, is it income on his
part?

Only the interest is income and taxable.

What if prior to X’s death, Y claimed the debt as a

deduction (bad debt) and during the settlement of the
estate, the court ordered that Y be paid the amount of
the loan + interest?

Apply the tax benefit rule.

243
4. If creditor Y dies before X pays the debt. Tax
consequences?

a. The estate of Y should include the debt as part of Y’s

gross estate (a debt is an intangible personal property,
hence should be included in the gross estate as provided
under Section 85 of the NIRC)

b. The debt is an allowable deduction from the gross

estate of Y as a claim against an insolvent person (CAIP)
If the estate of Y is allowed to deduct and X
subsequently pays the debt + interest, the tax benefit
rule cannot be applied. The payment will form part of
the income of the estate subject to Net Income Tax.
Remember that the estate is considered as a taxpayer.
244
III. Taxes
Requisites for deductibility

1. It must be paid or incurred within the taxable year.

2. It must be paid or incurred in connection with the
taxpayer’s trade, profession or business.
3. The tax must be imposed directly upon the taxpayer.
Examples:
a) Import duties f) Excise tax
b) Local Business taxes g) DST
c) Occupation taxes h) Community tax
d) Privilege and license taxes i) Municipal tax
e) Automobile registration fees j) income tax paid to foreign
country if not claimed as tax 245
credit
- the amount of deductible taxes is limited to the basic
tax and shall not include the amount for any surcharge
or penalty on delinquent taxes.

Limitation: In the case of a nonresident alien

individual engaged in trade or business (NRAETB)
and a resident foreign corporation (RFC), the
deductions for taxes shall be allowed only if and to the
extent that they are connected with income from
sources within the Philippines.

246
Non-deductible taxes

1. Foreign income tax, if claimed as tax credit

2. Final Taxes
3. Estate and donor’s taxes
4. Stock transaction tax on the sale, barter or exchange of
s/s listed and traded through the local stock exchange.
5. Taxes assessed against local benefits tending to increase
the value of the property
6. Taxes which are not in connection with the trade,
business or profession of taxpayer.
7. Income tax imposed by the Philippine gov’t.
8. Value – added Tax (VAT)
9. Energy Taxes
247
 Tax Credit
-- deducted from Philippine income tax
-- only foreign income taxes may be claimed as
credits

Tax deduction
-- deducted from the gross income
-- all taxes are allowed to be deducted with the
exception of the taxes expressly excluded

248
IV. Losses – represent reduction of resources due to
unintended destruction or deprivation of things.
In general, theses losses shall be allowed as
deductions from gross income if related to business,
actually sustained during the taxable year and not
compensated for by insurance or other forms of
indemnity.
Kinds of Losses:
1. Ordinary losses – generally deductible from gross
income.
2. Capital losses-deductible only from capital gains.
3. Special kinds of losses – losses incurred not
related to ordinary business transactions or capital
asset transactions. 249
Examples:
a. losses from sales or exchange of property between related
taxpayers.
b. wagering losses
c. losses due to voluntary removal of property such as building,
machinery, etc.

Some recognized losses

 
1. Ordinary losses/business losses
2. Casualty losses
3. Capital losses
  4. Net operating loss carryover (NOLCO)
5. Securities becoming worthless
  6. Losses from wash sales or stock or securities 
7. Wagering losses
  8.  Abandonment losses
250
Requisites for deductibility
a) The loss must be that of the taxpayer.
b) There must be an actual loss suffered in a closed
and completed transaction.
c) The loss must be connected with the taxpayer’s
trade, business or profession.
d) The loss must not be compensated for by insurance
or otherwise.
e) The loss results from casualty, robbery, theft or
embezzlement, the loss must be reported to the BIR
from 30 days to 90 days from the date of its discovery.
f) The loss must not be claimed as deduction for
estate tax purposes in the estate tax return.
251
Losses not allowed by law as deductions:
1. Loss on voluntary removal of building on land purchased
with a view to erect another building.
2. Gambling losses not covered by gambling gains.
3. Capital losses not covered by capital gains.
4. Losses from exchanges of property in corporate
readjustments.
5. Losses from illegal transactions.
6. Losses from exchanges of property where the property
received is not substantially different from the property
disposed.
7. Losses not incurred in trade, profession or business or in
any transaction entered into for profit.
8. Losses from sales/exchanges of property between related
taxpayers.
252
Classification of deductible losses:
1. Business losses such as losses incurred in
trade or profession;
2. Casualty losses such as losses due to storms,
fires, shipwreck or other casualties or
property connected with profession, trade or
business;
3. Losses of business property due to theft,
robbery or embezzlement;
4. Net operating loss carry-over (NOLCO) –
special deduction

253
Illustration:
Percy Co. incurred the following losses for the year 2013:

a. Building razed by fire, costing P5,000,000;

accumulated depreciation P3,000,000, insurance
payment received P1,600,000, salvage value
P250,000.
b. Loss of P50,000 due to cash shortage embezzled by
the cashier who absconded.
c. Loss on robbery of computers costing P70,00;
accumulated depreciation , P25,000, insurance
recovered P25,000.
How much should Percy Co. claim as deductible loss?

254
Loss on fire-building
Cost P5,000,000
Less: Accumulated depreciation P3,000,000
Insurance recovery 1,600,000
Salvage value 250,000 4,850,000 P150,000
Loss on embezzlement 50,000
Loss on robbery-computers
Cost P70,000
Less: Accumulated depreciation P25,000
Insurance recovery 25,000 50,000 20,000
Total deductible loss: P220,000

255
Partial loss – the deductible loss is the lower amount of the replacement
cost or the book value of the asset’s damaged portion. At the time of
loss, such amount shall be reduced by the amount of insurance
recovery.
Illustration:
Choki, Inc. sustained fire loss on its machine in 2013. The machine,
however, is partially damaged. Choki, Inc. spent P90,000 for major
repair. Prior to fire, documents reveal that the machine had an
acquisition cost of P300,000 and accumulated depreciation of
P180,000.

The deductible loss would be:

Replacement cost P90,000
Compare with book value:
Acquisition cost P300,000
Less: accumulated depreciation 180,000 120,000
Deductible loss (replacement cost, lower) P90,000
256
 V. Bad debts - Debts due to the taxpayer when
actually ascertained to be worthless and charged-off
within the taxable year.
Requisites for deductibility
1) There must be a valid and subsisting debt.
2) The same must be connected with the taxpayer’s
trade, business or practice of profession.
3) The same must not be sustained in a transaction
entered into between related parties enumerated
under Sec. 36 (B) of the NIRC.
4) The same must be actually charged-off the books
of accounts of the taxpayer as of the end of the
taxable year.
257
Valuation of Bad debts
1. Actual amount paid – an accounts receivable
acquired by purchase which becomes
uncollectible can be deducted from gross
income at the actual amount paid.
Illustration:
Z sold its P250,000 accounts receivable for P100,000 to X
without recourse

Assume that the latter cannot collect from the client of the
former despite efforts made, the actual amount paid which is
P100,000 is the allowed deductible bad debt expense of X.

258
2. Original amount – if receivables are acquired
through sale of goods or services, the original
amount of receivable is deductible, but the
related interest thereof, not reported as
income, is not deductible.
Illustration:
J sold its goods on installment for P100,000 with the ff. terms:
50% down payment; the remaining balance is payable in five (5)
annual installment. The cash price for goods sold is P70,000.
Assuming that the remaining balance becomes uncollectible and
was written off, the amount of bad debts that can be deducted from
gross income is P20,000 computed as follows:
Cash price P 70,000
Less: Down payment received 50,000
Deductible bad debts expense P 20,000
259
3. Proportionate amount – if receivable becomes
uncollectible due to debtor’s bankruptcy, the
allowed deduction is the proportionate amount
uncollectible over the total claims of ordinary
debtor’s creditors.
Illustration:
D, Co. has P50,000 collectibles from Mr. S who died with the
following assets and liabilities:
Assets Liabilities
Total P500,000 P900,000

Liabilities are composed of the following:

Unpaid income tax P 100,000
Various creditors 800,000
Total liabilities P 900,000 260
Total assets of Mr. S P 500,000
Less: Payment to preferred creditor-Government 100,000
Assets available to ordinary creditors P 400,000
Less: Total liabilities to various creditors 800,000
Total Indebtedness that cannot be paid 400,000

Collectibles of Mr. S P 50,000

Multiplied by percentage of uncollectibility 50%
Deductible bad debts expense P 25,000

261
- Bad debts computed using the allowance
method are not acceptable for taxation
purposes. The only acceptable method to record
bad debts for tax purposes is the direct or actual
method.

- A cash basis taxpayer generally reports income

of principal business activities upon collection.
Consequently, such taxpayer cannot deduct
worthless accounts from his gross receipts
because income is reported only when collected.

262
VI. Depreciation - The gradual diminution in the
useful value of tangible property used in trade or
business resulting from exhaustion, wear and tear,
and normal obsolescence.
- an annual reasonable allowance to reduce the
useful value of the tangible fixed assets resulting
from wear and tear and normal obsolescence is
allowed as a deduction from gross income to
enable taxpayers to recover acquisition cost of the
property used in the practice of profession,
business or trade. (Sec.34 F)

263
 The term is also applied to amortization of
value of intangible assets the use of which in trade
or business is definitely limited in duration.
(Basilan Estates, Inc. vs. Comm., 5 September
1967)

Depreciation is allowed only for taxpayers

engaged in trade or business . Depreciation
period for personal properties is five (5) years
while the period for real properties ranges from
15 to 25 years depending on the economic or
useful life of the asset.

264
Requisites for deductibility

• The allowance for depreciation must be reasonable

• It must be for property arising out of its use or employment in

the business or trade, or out of its not being used temporarily
during the year

• It must be charged-off during the taxable year;

• A statement on the allowance must be attached to the return.

• The property must have a limited useful life.

• The depreciable asset must be located in the Philippines if the

taxpayer is a nonresident alien or a foreign corporation.
265
- Only one vehicle for land transport is allowed for
the use of an official or employee, the value of
which should not exceed P2,400,000.

- No depreciation shall be allowed for yachts,

helicopters, airplanes, and/or aircrafts, and land
vehicles which exceed the above threshold
amount, unless the taxpayer’s main line of
business is transport operations or lease of
transportation equipment and the vehicle
purchased are used in said operations.

266
- All maintenance expenses on account of non-
depreciation vehicles for taxation purposes are
disallowed on its entirety.
- A taxpayer who is purely earning purely
compensation income is not allowed to claim
depreciation as a deduction.
- In case a taxpayer purchases an asset used in his
trade or business, he is not entitled to claim the
amount as deductible business expense
considering that the same is a capital
expenditure, but the taxpayer is allowed to claim
depreciation of the asset as a deduction
267
- Under a Build Operate Transfer agreement, the
builder is allowed to depreciate the asset until the
time of transfer and after transfer, the transferee
can also claim depreciation of the asset based on
the FMV of the property at the time of acquisition;

- Under a lease agreement with provision that all

permanent improvements shall accrue to the
lessor upon end of lease contract, the lessee who
is engaged in t/b can claim depreciation of the
improvements while the lessor can claim
depreciation of the leased property excluding the
improvements;
268
- Under a lease to own contract, the lessee who introduces
the improvements shall have the right to claim
depreciation of the improvements only while the lessor
claims depreciation of the leased property only. The
lessee cannot claim rentals for the lease as deductible
business expenses because he acquires interest other
than as a mere possessor of the property; Upon
expiration of the contract, the lessee owns the property
in full and lessor loses all rights over the property;
- When TX incurs capital expenditure, business expense is
not allowed as deduction and in lieu thereof, TX claims
depreciation of the asset as deduction. If the asset while
being subjected to depreciation is lost ( casualty loss),
stop depreciation expense as deduction and in lieu
thereof claim casualty loss as deduction;
269
VII. Depletion of oil and gas well and mines

Depletion is the exhaustion of natural resources

due to production. It is the reduction of cost or
value of natural resources such as oil and gas wells
and mines as the resources are converted into
inventories.

Limitation: A reasonable allowance for depletion

computed using the cost-depletion method shall
be granted provided that the allowance for
depletion shall not exceed the capital invested.
270
VIII. Charitable and other contributions

- is a non-operating expense, but the law allows some

contributions or gifts given within the taxable year as
deductions from gross income. (Sec. 34 H)

- the amount of any charitable contribution of property

other than money shall be based on the acquisition cost of
said property.

271
Requisites for deductibility
• The taxpayer making the charitable contribution must be
engaged in a profession, trade or business;

• There must be actual payment of contribution or gift;

• The net income of the institution must not inure to the

benefit of any individual or private stockholder;

• It must be made within the taxable year;

• It must be evidenced by adequate records or receipts.

272
• The contribution must actually be paid or made to the
Phil. Government or any of its agencies or political
subdivision or to any domestic corporations or
associations specified by the Tax Code or other entities as
allowed by the Tax Code and existing special laws; and
• It must not exceed 10% of the individual’s taxable income
and 5% of the corporation’s taxable income before
deducting the contribution (applicable only to
contributions with limit).

273
The following are subject to limit:

• Donations to the Philippine government or any of its

agencies or any political subdivision thereof exclusively
for public purposes;
 
• Donations to accredited domestic corporations or
associations organized and operated exclusively for:

• Religions;
• Charitable;
• Scientific;
• Youth and sports development;
• Cultural; or
274
 • Educational purposes; or for the
• Rehabilitations of veterans; and
 
• Donations to social welfare institutions or to non-
government organizations in accordance with rules and
regulations promulgated by the Secretary of Finance
provided, no part of the net income of which inures to
the benefit of any private stockholders or individual.

275
Contributions deductible in full under the Tax Code:

• Donations to the government of the Philippines or to any

of its agencies or political subdivisions including fully-
owned government corporations exclusively to finance,
to provide for, or to be used in undertaking priority
activities in: 

• Education;
• Health;
• Youth and sports development;
• Human settlements;
• Science and culture; and
• Economic development  
276
 
• According to the national priority plan determined by
NEDA provided, that donations not in accordance with
the said annual priority plan shall be with limit;

• Donations to foreign institutions or international

organizations in pursuance or compliance with
agreements, treaties, or commitments entered into by
the government of the and the foreign laws or
international organizations or in pursuance of special
laws, and
 
• Donations to certain accredited non-government
organization.
277
IX. Research and development - are for
improvements of processes and formulas as well
as the development of improved or new
products. As a general rule, R&D only extends
from the laboratory or drawing board to
prototype status; i.e., so long as an activity still
contains an element of uncertainty/technical
risk, it is within the realm of R&D.

278
R&D expenditures which are paid or incurred by a
taxpayer during the taxable year in connection with his
trade, business or profession may be treated EITHER as:

1. Ordinary and necessary expenses allowed as

deduction during the taxable year when paid or
incurred (i.e., as an outright deduction for the full
expenditure), or

2. Deferred asset (or deferred expense) which is

periodically subject to amortization – over a period of
not less than 60 months beginning with the month in
which the taxpayer first realizes benefits from such
expenditures.
279
Limitations on Deduction: The above tax treatment of
R&D expenses does NOT apply to:

1. Any expenditure for the acquisition or improvement

of land or the improvement of depreciable property,
used in connection with research and development.

2. Any expenditure incurred in ascertaining the

existence, location, extent, or quality of any deposit of
ore or other mineral, including oil or gas.

280
X. Pension trust

- a pension plan comprises of a fund intended

to provide retirement benefits to the
employees. It is usually set up after some years
of operations when the employer can already
provide benefits to employees.
- an employer is allowed to deduct from
business gross income contributions or
payments made to pension trust in accordance
with a “reasonable private benefit plan”

281
Requisites for deductibility

• The employer must have established a pension or retirement plan to

provide for the payment of reasonable pensions to its employees;

• The pension plan is reasonable and actuarially sound;

• The plan must be approved by the BIR;

• It must be funded by the employer; i.e., the employer contributes

cash to the plan;

• The amount contributed must no longer be subject to its control or

disposition; and

• The payment has not therefore been allowed as a deduction.

282
The Tax Code provides that the allowance
deduction as pension trust is equal to the
provision for the payment of reasonable
pensions to employees (based on the normal or
actuarian valuation) or actual contribution to the
plan whichever is lower, and the excess of the
actual contribution over the actuarian valuation
is to be amortized over the period of 10 years.

NOTE: PERSONAL EXEMPTIONS/ADDITIONAL

EXEMPTIONS/ PREMIUMS ON HEALTH AND OR
HOSPITALIZATION INSURANCE (PHHI) ARE
COMPLETELY REMOVED UNDER THE TRAIN LAW;
283
• OPTIONAL STANDARD DEDUCTION as amended by
R.A. 9504
- may be taken by a taxpayer, in lieu of itemized
deductions
REQUISITES:
a. Available only to citizens, resident aliens, domestic
corporations and resident foreign corporations;
b. The standard deduction is optional;
i.e., unless the taxpayer signifies in his return his
intention to elect this deduction, he is considered as
having availed of the itemized deductions.
284
 c. Such election, when made by the qualified taxpayer, is
irrevocable for the taxable year in which made; however,
he can change to itemized deductions in succeeding years.

*Since an individual in business or in the practice of

profession is required to file quarterly income tax returns,
can he choose the OSD in his quarterly returns and then
choose the itemized deductions in his annual income tax
return, or vice versa?

YES, the OSD or Itemized Deductions is against the gross

income of the year. Quarterly income tax returns are only
interim computations on the taxable income for the year

285
d. The amount of standard deduction is limited to
forty percent (40%) of:

Gross income – DC and RFC

Gross sales or receipts – RC, NRC, RA

[However, OSD is not available against compensation

income arising out of an employer-employee
relationship.]

*NOTE: The “cost of sales” in case of individual seller of goods, or the “cost of
services” in the case of individual seller of services, is not allowed to be
deducted for purposes of determining the basis of the OSD.

286
 e. Proof of actual expenses is not required, but the taxpayer should
keep records pertaining to his gross income during the taxable year.
• Special Deductions
1. Adopt-a-School Program under R.A. 8525;
2. Fifteen percent (15%) additional deduction of salaries/wages paid to
senior citizens;
3. Senior Citizen Discount under R.A. 9257;
4. Rooming-in and Breast-feeding Practices under R.A. 7600;
5. Free Legal Assistance under R.A. 9999;
6. Income currently distributed to beneficiaries under estates and
trusts. [Sec. 61 (A)];
7. Special deductions allowed to insurance companies such as:
a. Net additions to reserve funds within a year;
b. Premium deposits returned to their policyholders;
c. Actual deposit of sums with the officers of the Government of the Philippines.
8. NOLCO;
9. Personal Exemptions (deleted)
287
Net operating loss – shall mean the excess of
allowable deductions over gross income of the
business in a taxable year.
- for tax purposes, the net operating loss
comprises only of operating expenses and losses
that are allowed by the law as deduction from
gross income.
- estimated losses or expenses re not allowed
for ta purposes

288
Illustration:

Assume the following expenses of ABC, Enterprises:

Service revenue P 400,000

Gain from life insurance 300,000
Salary expense, tax withheld and paid 240,000
Estimated warranty expense 50,000
Insurance expense of employee – beneficiary is employer 100,000
Rent expense 120,000
Depreciation expense 60,000
Bad debts (of which 30% written off) 30,000

289
 ACCOUNTING TAXATION
Salary expenses P 240,000 P 240,000
Estimated warranty expense 50,000
Insurance expense 100,000
Rent expense 120,000 120,000
Depreciation expense 60,000 60,000
Bad debts 30,000 9,000
Total deductions allowed P 600,000 P 429,000

ACCOUNTING TAXATION
Service Revenue P 400,000 P 400,000
Gain from life insurance 300,000
Total revenue P 700,000 P 400,000
Deductions allowed (600,000) (429,000)
Net income (loss) P 100,000 P (29,000)

290
Net operating loss carry-over
- is not part of the itemized deductions.
- it shall be carried over as a special deduction
from gross income for the next three (3)
consecutive taxable years immediately following
the year of the loss.
- a taxpayer who claims OSD shall not
simultaneously claim deduction of the NOLCO. The
three-year reglementary period shall continue to
run notwithstanding the fact that the aforesaid
taxpayer availed of the OSD during the said period.

291
 - Domestic and resident foreign corporation
taxed during the taxable year with MCIT cannot
enjoy the benefit of NOLCO. Nevertheless, the
running of the three (3) year period for the expiry
of the NOLCO is not interrupted by the fact that
such corporation is subject to MCIT.
-NOLCO shall be availed of on a “first-in, first-
out” basis.

-It shall be allowed as deduction in computing

the taxpayer’s income taxes per quarter and
annual final adjustment income tax.

292
Illustration: 2009 2010 2011 2012 2013
Jey,Business
Gross single, reported
Income the following
P 200,000 P 250,000
income and expenses:
P 340,000 P 400,000 P 600,000

Business deductions 350,000

2009 200,000 2011
2010 300,000 2012
380,000 400,000
2013
Salary
Incomeas from business P 180,000
professor
(loss) (P150,000) P 190,000
P 50,000 P 200,000
P40,000 P 210,000
P 20,000 P P200,000
210,000
Gross Business Income 200,000 250,000 340,000 400,000 600,000
Less: Applicable NOLCO (50,000) (40,000) (20,000) -
Business deductions 350,000 200,000 300,000 380,000 400,000
How much is the
Net Business Income (loss)
taxable income
(P150,000) 0 before0 personal 0 P200,000
exemption
Salary as professor of Mr. Jey for the190,000
180,000 taxable years
200,0002009 to 2013?
210,000 210,000

Taxable income before P180,000 P190,000 P200,000 P210,000 P410,000

personal exemption

293
Taxpayers entitled to deduct NOLCO
1. Individual taxpayers engaged in trade or
business or in the exercise of his profession.
2. Domestic and resident foreign corporations
subject to normal income tax.
3. Special corporation subject to preferential tax
rates such as private educational institutions,
hospitals, and regional operating headquarters.

NOLCO incurred or sustained prior to 01 January

1998 shall not qualify for purposes of NOLCO.

294
Persons not entitled to deduct NOLCO
As a rule, any loss incurred in a taxable year
during which the taxpayer was exempt from income
tax shall not be allowed as a deduction.

Any person, natural or juridical, enjoying

exemption from income tax pursuant to the
provisions of the Tax Code and any special law shall
not be entitled to deduct NOLCO from gross
income.

295
Entities not allowed NOLCO
1. OBUs of a foreign banking corporation, and FCDU
of a domestic or foreign banking corporation duly
authorized as such by the BSP.
2. An enterprise registered with the Board of
Investments with respect to its BOI-registered
activity enjoying the Income Tax Holiday incentive.
Its accumulated net operating losses incurred or
sustained during the period of such Income Tax
Holiday shall not qualify for purposes of the
NOLCO.
3. An enterprise registered with PEZA
4. Enterprises registered under R.A. 7227
5. Foreign corporations engaged in international
shipping or air carriage business in the Philippines.
296
COMPARISON BETWEEN NET CAPITAL LOSS CARRY OVER (NCLCO) AND
NET OPERATING LOSS CARRY OVER ( NOLCO)

Rules:
(1). NOLCO refers to net operating loss carry over which is applicable only
to a corporate taxpayer. If a corporate taxpayer has more deductions than
gross income, the corporation sustains net operating losses which maybe
carried over for three years. Consequently, if during the succeeding year,
the taxpayer realized taxable net income, this maybe reduced by the net
operating loss carried over from the previous year;

(2). NCLCO refers to net capital loss carry over which is applicable only to
individual taxpayers. This results from exchanges of capital assets wherein
gains and losses have been recognized such that during the taxable period,
after charging all capital losses from the capital gains, the taxpayer may
either realize net capital gains (included in the gross income therefore
taxable) OR net capital loss ( which maybe carried over for the next year);

(3). NOLCO pertains to expenses and deductions from gross income while
NCLCO pertains to losses sustained in exchanges of capital assets;

(4). Both NOLCO and NCLCO are not applicable to a pure compensation income earner;
297
COMPARISON BETWEEN NET CAPITAL LOSS CARRY OVER (NCLCO)
AND NET OPERATING LOSS CARRY OVER ( NOLCO)
Rules:
(1). NOLCO refers to net operating loss carry over which is applicable
only to a corporate taxpayer. If a corporate taxpayer has more
deductions than gross income, the corporation sustains net operating
losses which maybe carried over for three years. Consequently, if
during the succeeding year, the taxpayer realized taxable net income,
this maybe reduced by the net operating loss carried over from the
previous year;

(2). NCLCO refers to net capital loss carry over which is applicable only
to individual taxpayers. This results from exchanges of capital assets
wherein gains and losses have been recognized such that during the
taxable period, after charging all capital losses from the capital gains,
the taxpayer may either realize net capital gains (included in the gross
income therefore taxable) OR net capital loss ( which maybe carried
over for the next year);

(3). NOLCO pertains to expenses and deductions from gross income

while NCLCO pertains to losses sustained in exchanges of capital
assets; 298
 NON-RESIDENT ALIENS
(Sec. 25, NIRC)

299
Non-Resident Alien ETB (NRAETB)
• Taxability is the same as non-resident citizen except for Dividends from a
domestic corporation which is subject to 20% FWT; COMPENSATION
INCOME is not applicable to a NRAETB;

• A nonresident alien individual who shall come to the Philippines and stay
therein for an aggregate period of more than one hundred eighty (180)
days during any calendar year shall be deemed a 'nonresident alien doing
business in the Philippines’.

Indicators that an alien is engaged in Trade or Business in the Philippines:

• stay in the Philippines for an aggregate period of more than 180 days in a
calendar year;
• principle of habituality in entering into commercial transactions in Phils;
• appointment of agents in the Phils;
• hiring of employees in the Phils;
• putting up a branch in the Phils;
300
Non-Resident Alien Not ETB (NRANETB)

• All income plus PI are subject to GIT (Final Tax) of 25%. For
aliens employed in OBUs, MNCs, and petroleum service
contractors ( Section 25 C,D,E), the preferential tax
treatment of GIT 15% IS NO LONGER APPLICABLE under
the TRAIN LAW. Their compensation income and other
employee benefits shall be subject to NIT rates;
• CGT on sale of SoS and CGT on sale of RP, same as other
individual taxpayers;

301
 INCOME NOT SUBJECT TO INCOME TAX
GENERAL RULE: ALL income subject to income tax
Exception: unless specifically excluded from computation of
gross income or exempted by law;
a. income from without of NRC, NRAETB, NRANETB, RFC,
AND NRFC;
b. income of GPP’s, Joint venture or consortium formed for
the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy
operations pursuant to an operating consortium
agreement under a service contract with the Government;
c. gains from sale of assets (capital or ordinary) of
NRC,NRAETB,NRANETB,RFC,NRFC which properties are
located outside of the Philippines;
302
d. Sale of real property located in the Philippines treated as
capital asset shall be exempt from CGT of 6%, provided the ff
requisites are complied with:

• The real property sold must be the actual principal residence of

the taxpayer/seller;
• Seller must inform the BIR of his intention to avail of the
exemption (within 30 days from sale);
• Seller must build or purchase another principal residence within
18 months from sale;
• Proceeds from the sale should be used in building/purchasing
new principal residence x. 6% CGT will be applied proportionately
to proceeds not used for new principal residence.

The exemption applies to all kinds of individual taxpayer only, not to

corporate taxpayer.

303
e. interest on time or long term bank deposits in local
banks which taxpayer did not pre-terminate for a
period of five(5) years), applicable only to individuals;
f. PCSO/LOTTO winnings not exceeding P 10,000.00;
g. Prizes and awards in sports competitions sanctioned
by the national sports commission;
h. Prizes and awards made primarily in recognition of
religious, charitable, scientific, educational, artistic,
literary, or civic achievements but only if the recipient
was selected without any action on his part to enter
the contest or proceeding and the recipient is not
required to render substantial future services as a
condition to receiving the prize or award;

304
i. Dividends issued by a DC in favor of another DC;
j. Dividends issued by a DC in favor of a RFC;
k. Proceeds of Life Insurance policy received by the insured,
heirs, beneficiary but interest shall be subject to IT;
l. Proceeds of property insurance to reimburse damage to
property;
m. Proceeds of medical, health and accident insurance to
reimburse hospitalization expenses, sickness, or injury
sustained;
n. Return of premium;
o. Gifts, bequests, devises, but the same shall be subject to
ET or DT depending on the mode of transfer;
p. Income exempt under a treaty;

305
q. Actual damages as compensation for death, sickness, or
injury. All other damages shall be subject to IT;
r. Statutory minimum wage of Minimum Wage Earners
(MWE); SMW of employees including HP,HP, OP, NSD shall be
exempt from income tax. The law is very clear on its intent
without any further qualifications, thus, the BIR Issuance,
providing that a MWE who receives other benefits in excess
of P 82,000.00 OR deriving income from other sources, is
NULL AND VOID. Soriano et.al. vs DOF and CIR, et.al.
( 184450/184508/184538/185234), 24 January 2017
s. Managerial/supervisory employees for DMB within limits
and 13th month pay and other benefits not exceeding P
90,000.00 ;
t. Employee benefits furnished by the employer for the
convenience of the employer or necessary for the trade of
business of the employer;
306
u. Separation pay for causes beyond the control of the
employee ( redundancy, retrenchment, illegal dismissal
and in lieu of reinstatement); backwages, and damages in
labor cases are subject to IT; compensation of loss of
earning capacity, subject to IT;
v. Retirement benefits from GSIS, SSS, US Veterans Act;
w. Retirement benefits from private retirement plan
maintained by the employer provided employee is at least
50 yrs old, with continuous service of 10 yrs, avails of
retirement only once with the employer, the retirement
plan is approved by BIR;
x. Retirement benefits if without retirement plan
maintained by the employer provided employee is at 60
yrs old with continuous service of 20 yrs;

307
y. Benefits received from Pag-ibig and
Philhealth;
z. Campaign contributions received by
political parties or candidates ( winning or
losing) if fully utilized by the party or
candidate;
aa. Association dues paid by homeowners in a
subdivision: exempt from IT provided the
following requisites are complied with:
(1). HOA is duly constituted as defined
under RA 9904;
308
 (2). LGU issues a certificate stating the basic
community services and facilities supplied by HOA and
that LGU’s lack of resources to provide, such as basic
services which redound to the benefit of all HOA
members, ie, security, street and vicinity lights ,
maintenance, repairs and cleaning of streets, garbage
collection/disposal;
(3). HOA shows proof that income and dues are used
for basic services; But association dues paid by
homeowners in a condominium corporation are subject to
IT;

bb. De Minimis Benefits (DMB) within limits received by all

kinds of employees;

309
8% INCOME TAX OPTION:
The TRAIN law introduced a new tax scheme for individual taxpayer – the
8% optional income tax. The option to be taxed at 8% must be indicated in
the first quarter income tax return or in the first quarter percentage tax
return. When made, the option shall be irrevocable for the calendar year.
Nature:
1. A bundled tax – it is in lieu of:
a. Regular income tax, determined through the income tax table
b. 3% general percentage tax
2. An annual option
- It is valid for as long the taxpayer remained as a non-VAT taxpayer during the year. It ill be
invalidated in favor of the regular income tax once the taxpayer becomes a VAT taxpayer
during the year.
3. Paid quarterly and annually

Scope:
a. pure business or professional income earners
b. mixed income earners
310
Rules on tax credit for taxes paid to foreign country:

1. An alien individual shall not be allowed credits for the

taxes paid to foreign countries. It is because he shall be
taxed on income derived within the Philippines only.
2. At the option of the taxpayer, the income tax paid by
resident citizen to any foreign country may be treated as
an item of deduction or tax credit.
3. The total amount of the credit shall not exceed the
proportion of the tax against which such credit is taken,
which the taxpayer’s income from sources without the
Philippines taxable under this Title bears to his entire
taxable income for the same taxable year.

311
Limit of tax credit paid to foreign country:
One foreign country
Tax credit = Taxable income from foreign country x Philippine Income tax
Taxable income from all sources

Two or ore foreign countries - the same tax formula is used

as that of one foreign country except that the allowable
tax credit will be lower of the following:

1. Actual tax paid to foreign country

2. Limit on tax credit computed using individual taxable
income from foreign country (as numerator); or
3. Limit on tax credit computed using total taxable income
from foreign country (as numerator).
312
Illustration:
Assume that Mr. V, head of the family and a resident citizen,
derived income from sources within and outside the
Philippines.
SOURCES OF INCOME TAXABLE INCOME INCOME TAX PAID
PHILIPPINES P220,000 P 15,000
JAPAN 200,000 70,000
USA 500,000 175,000
HONGKONG (120,000) -

- The income tax paid in the Philippines is only partial

payment as reflected in the quarterly income tax.

313
Computation of Philippine Income tax before tax credit:
Taxable income from all sources:
Philippines P 220,000
Japan 200,000
USA 500,000
Hongkong (120,00)
Taxable income P 800,000
Less: Personal exemption 50,000
Taxable income P 750,000

Tax on P500,000 P 125,000

Tax on excess 80,000
Philippine income tax before tax credit P 205,000
314
Determination of allowable tax credit:
Limit 1: Actual tax paid-foreign P245,000

Limit 2: Individual taxable income-foreign

Japan (P200,000/800,000) x P205,000 P51,250
USA (P500,000/800,000) x P205,000 128,125 P179,375

Limit 3: Total taxable income-foreign

[(P200,000+500,000-P120,000)/P800,000]xP205,000 P148,625

Philippine income tax before credit P205,000

Less: Tax credit
Foreign P148,625
Local 15,000 163,625
Philippine income tax still due P 41,375

315
Individuals required to file Income Tax Returns (ITR) in
triplicate:
1. Resident Filipino Citizen on his income from all sources
a) Individuals deriving compensation income from 2 or more employers,
concurrently or successively at anytime during the taxable year;
b) Employees deriving compensation income regardless of eh amount,
whether from single or several employers during the calendar year, the
income tax of which has not been withheld correctly resulting to collectible
or refundable return;
c) Employees whose monthly gross compensation income does not exceed
the statutory minimum wage and opted for non-withholding of tax on said
income;
d) Individuals deriving other non-business, non-professional related income in
addition to compensation income not otherwise subject to a final tax; and
e) Individuals receiving purely compensation income from a single employer,
although the income of which has been correctly withheld, but whose
spouse is not entitled to substituted filing.

316
2. Nonresident Filipino Citizen on his income derived
within the Philippines.
3. Resident alien on his income derived within the
Philippines
4. Every nonresident alien engaged in trade or business or
profession in the Philippines.

Exempt:
5. Minimum wage earners;
6. If his gross income does not exceed his total personal
and additional exemptions;
7. Earning purely compensation income and income tax
has bee correctly withheld;
8. Individuals whose sole income has been subjected to
final tax.
317
Financial Statements attached to ITR:
1. Statement of net worth and operations – if the gross
sales, receipts or output from business do not exceed
P50,000, in any quarter.
2. Balance sheet and Profit-and-loss statements - if the
gross sales, receipts or output from business in any one
quarter exceed P50,000 but do not exceed P150,000.
3. Other statements - if the gross sales, receipts or output
from business in any one quarter exceeds P150,000
a) Balance sheet and profit-and loss statements certified by an
independent CPA.
b) Comparative profit-and loss statements of the current and
preceeding years.
c) Schedule of income producing properties and corresponding
income therefrom.
318
Annual declaration and quarterly payments of income tax:

Quarters Specific Dates

First April 15 of the current taxable year
Second August 15 of the current taxable year
Third November 15 of the current taxable year
Fourth April 15 of the following calendar year when
final adjusted income tax return is due for
filing.

319
Installment payment of tax:
Individual taxpayers are allowed installment payment of
their income taxes when the tax due exceeds P2,000.
The taxpayer other than a corporation may elect to pay
the tax in two (2) equal installments in which case the tax
installment dates are as follows:

1. April 15 – 1st installment payment on the required date

of filing and payment.
2. July 15 – 2nd installment payment
3. If any installment us not paid on or before the date fixed
for its payment, the whole amount of the tax unpaid
becomes due and payable together with the penalty on
delinquency.
320
 Primary Sub-classification/s
Classification

Residents of the Philippines (20%-35%)

Citizens of the
Philippines
Not residents of the Philippines (20%-35%) Sec. 22(E)

Residents of the Philippines (20%-35%) Sec. 22(F)

Engaged in Trade or Business in the

Philippines (20%-35%) Sec. 25A
Aliens
Not Residents of the Philippines
Sec. 22 (G)
Not engaged in Trade or Business in the
Philippines (25%)
Individuals

Individual Employed by Regional or Area Headquarters and Regional

Operating Headquarters of Multinational Companies
(15% of Compensation income)

Individual Employed by Offshore Banking Units

(15% of compensation income) including Filipinos occupying the same
Special classes of position
Individuals (Aliens)

Individual Employed by a foreign service contractor or by a foreign service

subcontractor engaged in petroleum operations in the Philippines
(15% of compensation income)

321
 Category of Income Resident Nonresident
CITIZEN ALIEN CITIZEN NRAEBT NRANEBT
all sources Within Within Within within
Compensation,
Business/Profession
GIW 25%
Prizes of P10,000 or less
Proprietary, Schedular Normal Tax Rate
educational/Hospital N/A
Cinematographic Film and the
like GIW 25%

Interest, Royalty,
Winnings/Prizes of P10,000 & 20% FINAL WITHHOLDING TAX (FWT)
below

Royalties-books, literary, GIW 25%

musical 10% FINAL WITHHOLDING TAX (FWT)

Interest (long term investment)

EXEMPT

Cash/Property dividends 6%(1998); 10%(2000), FWT GIW 20%

Interest (Foreign currency
deposit sys.) GIW 7.5% FWT EXEMPT

Capital gains on sale of shares

5% (not over P100,000); 10% (in excess of P100,000) FWT on net capital gains

Sale of shares EXEMPT

Capital gains on sale of
real property 6% FWT of Gross Selling Price or FMV whichever is higher

Winnings on Phil.
Sweepstakes/Lotto EXEMPT
 Kinds of income and taxes

Source CG ON SALE CG ON SALE

ALL INCOME OTHER THAN PASSIVE OF S OF S OF RP
Taxpayer (B), ( C ), (D) INCOME (not traded) (located in
the Phils)

w/in w/out A B C D

INDIVIDUALS (including estates and trusts)

RC *CIE: NIT; FWT FWT FWT

* SEP/SEI w/ GR/GS not more than
3M: NIT or 8% of GR/GS in excess of P
250,000.00 at the option of TX;
* SEP/SEI w/ GR/GS exceeding 3M:
NIT
* MIE on CI: NIT
MIE on income from T/B or EP w/
GR/GS not more than 3M: NIT or 8%
of GR/GS at the option of TX;
MIE w/ GR/GS exceeding 3M: NIT

NRC SAME FWT FWT FWT

RA SAME FWT FWT FWT
NRAETB SAME FWT FWT FWT
NRANETB GIT/FT (25%) FWT FWT
323
*Legend:
RC – resident citizen SEP – individual engaged exercise of
NRC – nonresident citizen profession
RA – resident alien SEI – individual engaged in trade or
NRA – nonresident alien business
NRAETB – nonresident alien GR – gross receipts
engaged in trade/business GS – gross sales
NRANETB– nonresident alien not NIT – net income tax
engaged in trade/business MIE - mixed income earner
DC – domestic corporation CI – compensation income
RFC – resident foreign corporation T/B – trade/business
NRFC – nonresident foreign EP - exercise of profession
corporation TX – taxpayer
CG – capital gains FWT – final withholding tax
S of S – Shares of stock GIT/FT – gross income tax/final tax
CIE – compensation income earner

324
• Summary of rules on individual taxpayers:

a. Among all individual taxpayers, only RC is taxable for

income within and outside the Phils;
b. All kinds of taxpayers are similarly taxed for income
within EXCEPT:
• NRA engaged in t/b - 20% Final tax on cash and property dividends
• NRA not engaged in t/b are taxed on the gross income;
c. All kinds of individual taxpayers are subject to CGT on
sale of shares of stock;
d. All kinds of individual taxpayers may be exempt from
6% CGT on sale of real property;

325
 Tax on Corporations
(Secs. 27-30, NIRC)

326
Corporations, as used in income taxation, includes
partnerships, no matter how created or organized,
joint stock companies, joint accounts (cuentas en
participacion), and associations or insurance
companies.

However, it does not include: 

1.       a general professional partnership; and
  2.       a joint venture or consortium formed for the
purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other
energy operations pursuant to an operating or
consortium agreement under a service contract with the
government.
327
Kinds of Corporate Taxpayers

1) Domestic corporations - Those created or organized in the Phils.

or under its laws.

2) Foreign corporations - Those created, organized or existing

under any laws other than those of the Phils.

  a. Resident - Those foreign corporation engaged in trade or

business within the Phils.

b. Non-resident - Those foreign corporation not engaged in trade

or business within the Phils.

328
Corporations may be subjected to the following income
taxes:

1. Normal Corporate Income Tax (NCIT) – 30% or

Minimum Corporate Income Tax (MCIT) – 2% or
Gross Income Tax (GIT) – 15%
2. Improperly Accumulated Earnings Tax (IAET) – 10%
3. Brach remittance profit
4. Capital Gains Tax – on sale of real property or on sale
of shares of stock
5. Final tax on passive income

329
The Normal Corporate Income Tax
BIR Form 1702 lays out the general format for income tax
computation on business income:
Sales/revenues/receipts/fees from within and without Pxxx
Less: Sales returns, allowances, and discounts (if any) Pxxx
Cost of Sales xxx xxx
Gross income from operation Pxxx
Add: Non-operating and other income not subject to
final tax or capital gains tax xxx
Gross income Pxxx
Less: allowable itemized deductions or OSD xxx
Net taxable income Pxxx
Multiply by normal corporate income tax rate 30%
Normal corporate income tax Pxxx

330
 Minimum Corporate Income Tax (MCIT) – domestic and
resident foreign corporations shall be taxed with 2%
based on gross income and not on taxable income after
operating expenses if they have:
1. Been in their fourth year of operation, and
2. Incurred a net loss or zero taxable income, or a normal
income tax that is lesser than MCIT.
For purposes of MCIT, passive income that has been
subjected to a final tax shall not be included as a part of
gross income.
Any excess of the MCIT over the normal tax shall be
carried forward and credited against the normal tax
immediately for 3 succeeding taxable years.
331
Formula:
Gross income from operation P xxx
Add: Non-operating and other income not
subjected to final/capital gains tax xxx
Total gross income subject to MCIT P xxx
Multiply by MCIT tax rate 2%
MCIT P xxx

332
Carry Forward of Excess MCIT

Illustration: HKML Corp. has been operating since 1 Jan.

2008. Data pertinent to its operations covering 2010 to
2012 are as follows:
2010 2011 2012
Gross sales P3,080,000 P4,100,00 P5,200,000
Sales returns, discounts/allowances 80,000 100,000 200,000
Cost of sales 1,500,000 2,000,000 2,500,000
Operating expenses 1,450,000 1,900,000 2,100,000

333
1. Computation of Normal Corporate Income Tax (NCIT)
2010 2011 2012
Gross sales P3,080,000 P4,100,00 P5,200,000
Sales returns, discounts/allowances 80,000 100,000 200,000
Net sales P3,000,000 P4,000,000 P5,000,000
Cost of sales 1,500,000 2,000,000 2,500,000
Gross Income P1,500,000 P2,000,000 P2,500,000
Operating expenses 1,450,000 1,900,000 2,100,000
Net taxable income P 50,000 P 100,000 P 400,000
Multiply by normal corporate tax 30% 30% 30%
NCIT P 15,000 P 30,000 P 120,000

334
2. Computation of Minimum Corporate Income Tax (MCIT)
2011 2012
Gross sales P4,100,00 P5,200,000
Sales returns, discounts/allowances 100,000 200,000
Net sales P4,000,000 P5,000,000
Cost of sales 2,000,000 2,500,000
Gross Income P2,000,000 P2,500,000
Multiply by minimum corporate tax 2% 2%
3. Determination
MCIT of income tax due and Ppayable:
40,000 P 50,000

2010 2011 2012

NCIT or MCIT, whichever is higher P15,000 P40,000 P120,000
Less: excess of MCIT over NCIT - - 10,000
Income tax due and payable P15,000 P40,000 P110,000

335
*The Secretary of Finance is authorized to suspend the
imposition of the minimum corporate income tax on any
corporation which suffers LOSSES:

-on account of prolonged labor dispute (losses from a strike

staged by employees that lasts for more than 6 months
and caused the temporary shutdown of operations), or

-because of force majeure (acts of God and other calamity;

includes armed conflicts like war or insurgency), or

-because of legitimate business reverses (substantial losses

due to fire, robbery, theft or other economic reasons).

336
Gross Income Tax (GIT)
- The President, upon the recommendation of the Secretary of
Finance, may allow domestic corporations the option to be taxed
at fifteen percent (15%) of gross income, after the following
conditions have been satisfied:
Tax effort ratio 20% of GNP
Ratio of IT collection to total tax revenue 40%
VAT tax effort 4% of GNP
Ratio of Consolidated Public Sector Financial Position (CPSFP) to 0.90%
GNP
Ratio of the Corporation’s Cost of Sales to Gross Sales Does not 55%
exceed

- The election of the gross income tax option by the corporation

shall be irrevocable for three (3) consecutive taxable years during
which the corporation is qualified under the scheme.

337
- the option to be taxed based on gross income shall be
available only to firms whose ratio of cost of sales to
gross sales or receipts from all sources do not exceed
55%.
For purposes of gross income tax, gross income
should be the same as gross income for purposes of
MCIT in cases of trading, merchandising and
manufacturing concern business. However, for service
enterprises, gross income means gross receipts less sales
returns, discounts, allowances and cost of services.

338
Illustration: F, Corp.’s information regarding its 2013
operation is as follows:
Gross sales P 3,700,000
Cost of sales 2,000,000
Operating expenses 1,000,000

NCIT MCIT GIT

Gross sales P3,700,000 P3,700,000 P3,700,000

Less: Cost of sales 2,000,000 2,000,000 2,000,000

Gross income 1,700,000 1,700,000 1,700,000

Less: Operating expenses 900,000

Net income 800,000

Multiply by tax rate 30% 2% 15%

Income tax P240,000 P34,000 P255,000

339
 Improperly Accumulated Earnings Tax (IAET)

There is imposed for each taxable year, in addition

to other taxes, a tax equal to 10% of the improperly
accumulated taxable income of domestic and closely
held corporations formed or availed of for the purpose
of avoiding the income tax with respect to its
shareholders or the shareholders of any other
corporation, by permitting the earnings and profits of
the corporation to accumulate instead of dividing them
among or distributing them to the shareholders.

- Only domestic and closely-held corporations/family

corporations are liable for IAET.

340
Exception:
The use of undistributed earnings and profits for the
reasonable needs of the business would not generally
make the accumulated or undistributed earnings
subject to the tax. What is meant by “reasonable needs
of the business” is determined by the IMMEDIACY TEST.

Immediacy Test - It states that the “reasonable needs of

the business” are the

1) immediate needs of the business; and

2) reasonably anticipated needs.

341
Exempt Corporations:

1. Banks and other non-bank financial intermediaries;

2. Insurance companies;
3. Publicly-held corporations;
4. Taxable partnerships;
5. General professional partnerships;
6. Non- taxable joint ventures; and
7. Enterprises that are registered:
a. with the Philippine Economic Zone Authority (PEZA) under R.A.
7916;
b. pursuant to the Bases Conversion and Development Act of
1992 under R.A. 7227; and
c. under special economic zones declared by law which enjoy
payment of special tax rate on their registered operations or
activities in lieu of other taxes, national or local. 342
Tax base – is determined by adding to the year’s taxable
income the following:
1. Income exempt from tax;
2. Income excluded from gross income;
3. Income subject to final tax;
4. NOLCO deducted;

The sum of the above shall be reduced by the sum of:

5. Income tax paid or payable for the taxable year;
6. Dividends actually or constructively paid/issued from the
applicable year’s taxable income; and
7. Amount reserved for the reasonable needs of the
business as defined, emanating from the covered year’s
taxable income.
343
Illustration: La Vista, Corp. a closely-held corporation,
reported the following during the taxable year:
Accumulated retained earnings P 3,000,000
Paid-up share capital 2,000,000
Income tax payable on interest income 900,000
20% final tax on interest income 60,000
Dividend income 200,000
Gain on life insurance 1,000,000
Dividend declared and paid 300,000
Reserved for plant expansion 200,000
Investment in bonds 2,000,000

344
Improperly Accumulated Earnings tax:

Taxable income (P900,000/30%) P3,000,000

Add: Gain on life insurance P1,000,000
Interest income 300,000
Dividend income 200,000 1,500,000
Total P4,500,000
Less: Income tax due and payable P900,000
Dividend declared and paid 300,000
Reserved for plant expansion 200,000
Final tax on interest income 60,000 1,460,000
Improperly Accumulated earnings P3,040,000
Multiplied by IAET rate 10%
Improperly Accumulated earnings tax P 304,000
345
Branch Profit Remittance Tax

Tax base: Profits applied or earmarked for

remittance
Tax Rate: 15% final tax
Condition: Branch profits are effectively connected
with the conduct of its trade or business in the
Philippines.
Exempt:
1. Profits remitted derived from activities registered
with the Philippine Economic Zone Authority (PEZA)
2. Passive income gains and profits received not
directly connected with the conduct of is trade or
business in the Philippines.
346
a. MCIT is in lieu of 30% corporate net income tax while IAET is in addition to all
other taxes imposed upon the corporation. MCIT is imposed beginning the 4th year
following the commencement of its operations;

b. MCIT is imposed beginning the 4th taxable year immediately following the
commencement of operations provided that the 2% on the gross income is higher
than the NIT of 30%;

c. Prizes and Winnings of DC, if any, are subject to NIT and considered as income in
the ordinary course of its trade or business. Note however that generally juridical
entities do not have winnings in games of chances;

d. Unlike individuals, interest income from long term deposits of DC are not exempt
from FWT;

e. Dividends received by a DC from another DC are exempt from tax. These are called
Inter-corporate dividends;

f. IAET is in addition to corporate taxes and imposed on corporations which retain

earnings beyond reasonable business needs; 347
Tax Exempt Corporations (NIRC):

1. Labor, agricultural or horticultural organization not organized

principally for profit;

2. Mutual savings bank not having a capital stock represented by

shares, and cooperative bank without capital stock organized
and operated for mutual purposes and without profit;

3. A beneficiary society, order or association, operating for the

exclusive benefit of the members such as a fraternal
organization operating under the lodge system, or mutual aid
association or a non-stock corporation organized by employees
providing for the payment of life, sickness, accident, or other
benefits exclusively to the members of such society, order, or
association, or non-stock corporation or their dependents;

4. Cemetery company owned and operated exclusively for the

benefit of its members;
348
5. Nonstock corporation or association organized and
operated exclusively for religious, charitable, scientific,
athletic, or cultural purposes, or for the rehabilitation
of veterans, no part of its net income or asset shall
belong to or inures to the benefit of any member,
organizer, officer or any specific person;

6. Business league chamber of commerce, or board of

trade, not organized for profit and no part of the net
income of which inures to the benefit of any private
stock-holder, or individual;
7. Civic league or organization not organized for profit
but operated exclusively for the promotion of social
welfare;

8. A nonstock and nonprofit educational institution; 349

9. Government educational institution;

10. Farmers' or other mutual typhoon or fire insurance

company, mutual ditch or irrigation company, mutual
or cooperative telephone company, or like
organization of a purely local character, the income of
which consists solely of assessments, dues, and fees
collected from members for the sole purpose of
meeting its expenses; and
11. Farmers', fruit growers', or like association organized
and operated as a sales agent for the purpose of
marketing the products of its members and turning
back to them the proceeds of sales, less the necessary
selling expenses on the basis of the quantity of
produce finished by them;
350
 Notwithstanding the provisions in the preceding paragraphs, income of
whatever kind and character of the foregoing organizations from any of
their properties, real or personal, or from any of their activities
conducted for profit regardless of the disposition made of such income,
shall be subject to tax imposed under this Code.

In determining entitlement to tax exemption, two tests are applied:

organizational test and operational test.

• Organizational test requires that the corporation or association’s

constitutive documents exclusively limit its primary purpose to
those described in Sec. 30 of the 1997 Tax Code.
• Operational test requires that the regular activities of the
corporation or association be exclusively devoted to the
accomplishment of the purpose specified in Sec. 30 of the 1997 Tax
Code. "A corporation or association fails to meet this test if
substantial part of its operation are considered "activities conducted
for profit."
351
Tax Exempt GOCCs:

1. GSIS
2. SSS
3. PHILIPPINE HEALTH INSURANCE CORP.
4. PCSO

Tax Exempt Corporations under Special laws:

1. Cooperatives (Rev. Mem. Cir. 48-91)
2. Foundation created for scientific advancement (Sec.
24, R.A. 2067)

352
APPLICATION TAX EXEMPTIONS OF VARIOUS
INSTITUTIONS
FACTS: Institution occupies real property. Part of the
property is leased to KFC/MCDONALD’S.

1. GOVERNMENT AGENCIES (Example: PNP)

• General Rule: Government agencies are exempt from
payment of taxes as long as they are directly performing
government functions
• Exception: If income of agency is in the exercise of proprietary
functions, it is subject to tax and treated as an ordinary
corporation subject to corporate income tax of 30%. GOCC’s
are considered as ordinary corporations and subject to tax,
except SSS, PHIC, PCSO, GSIS, and Local Water Districts;

353
Example:

• PNP earns money from collection of license fees.

a. Is this income? Yes.
b. Is this taxable? No.

• Rentals paid by KFC.

a. Is this income? Yes.
b. Is this taxable? Yes. This is considered as income from proprietary
functions of the government.

• X donates P500,000 to PNP.

a. Is this income on the part of PNP? Yes, but it is not subject to income
tax [Sec 32 (B)(3), NIRC excludes gifts, bequests, devises from gross income].

b. Is the donation subject to estate/donor’s tax? No. Transfers for public use
are exempt from estate or donor’s tax ( Sections 86 and 101 of the Tax Code)

c. Can X deduct the donation from gross income

354
 - If X were a compensation income earner, he cannot claim as deduction. CIEs are no
longer entitled to claim any deduction under the TRAIN LAW;

- If X were an individual engaged in trade or business, the entire amount may be deducted,
provided priority project of the government. If not priority project, then donor can claim as
deduction up to 10% of its taxable income prior to this deduction ( if individual) or 5% of its
taxable income prior to this deduction ( if corporation) (Section 34h, NIRC);

• Should PNP decide to deposit in a bank the funds from license fees, rentals, and the gift of P
500,000.00, thereby earning interest income of 2% per annum, is the interest from bank
deposit income and taxable?

Is it income? YES.
IS IT TAXABLE? YES, last paragraph of Section 30 NIRC states that income of whatever kind
and character from an activity conducted for profit shall be subject to income tax (FWT of
20%);

Real Property Tax - government agencies directly performing government functions are
exempt. Under Section 234, Local Government Code of 1991, real properties owned by the
government and any of its agencies or instrumentalities shall be exempt from real property tax
except when the beneficial use thereof pertains to non-exempt entity for a consideration. NOTE:
It is the beneficial use of the property that exempts the government agency from payment of
tax. Thus, PNP is exempt from RPT as provided in the Local Government Code of 1991.

355
2. GOVERNMENT EDUCATIONAL INSTITUTIONS (GEI) such as public elementary
school, public high school, state colleges (Example: PUP)
• PUP earns money from tuition fees.
a. Is it income? Yes
b. Is it taxable? No. Sec. 30, NIRC exempts from tax, income by the institution
when it is “realized as such.”

• Rental fee received from KFC

a. Is it income? Yes.
b. Is it taxable? Yes. Last paragraph of Sec. 30, NIRC provides that income from
any activity conducted for profit regardless of the disposition shall be subject to
tax.

• X donated P500,000 to PUP.

a. Is it income on the part of PUP? Yes, but not subject to income tax. (same
reason as government agencies).
b. Is it subject to estate/donor’s tax? No. Section 86/101 of the tax code
on transfer for public use; 356
• Can X deduct the donation from gross income? Same rules as government
agencies.
• Should GEI decide to deposit in a bank the funds from tuition fees, rentals, and
the gift of P 500,000.00, thereby earning interest income of 2% per annum, is the
interest from bank deposit income and taxable?
a. Is it income? YES.
b. IS IT TAXABLE? YES, last paragraph of Section 30 NIRC states that income of
whatever kind and character from an activity conducted for profit shall be subject
to income tax;

Real Property Tax (RPT) - As long as the property is ACTUALLY, DIRECTLY and
EXCLUSIVELY used for educational purpose, it is exempt from payment of RPT.
Under the Local Government Code of 1991, real properties actually, directly and
exclusively used for educational, religious, and charitable purpose shall be exempt
from real property tax. Real properties owned by the government and any of its
agencies or instrumentalities shall be exempt from real property tax except when
the beneficial use thereof pertains to non-exempt entity.

357
• 3. NON-STOCK, NON-PROFIT EDUCATIONAL INSTITUTIONS (NSNPEI)
A. Previous Rules:
• All income from facilities within campus operated and maintained
by the school shall be exempt from tax ( canteen, dormitory, and
bookstore as ancillary services). However, they shall be subject to
internal revenue taxes on income from trade, business or activity,
the conduct of which is not related to the exercise or performance
by such institutions of their educational purposes or functions ( ie.
Rental payment from their building/premises).

• The interest income from currency bank deposits and yield from
deposit substitutes instruments actually, directly, and exclusively in
pursuance of their purposes as an educational institution are
exempt from the 20% final tax and 7 ½ % tax on interest income
under the expanded foreign currency deposit system upon
compliance of certain conditions;

358
B. AS OF JULY 26, 2016 :
• Revenues pursuant to educational purpose and used ADE for
educational purpose ARE EXEMPT; MEANING SOURCE IS
IMPORTANT;
• RMO 44-2016 issued on July 26, 2016; CIR vs St. Paul College of
Makati (GR 215383, 08 March 2017): It is clear and unmistakable
from the constitutional provision that NSNPEIs are constitutionally
exempt from tax on all revenues derived in pursuance of its
purpose as an educational institution and used actually, directly
and exclusively for educational purposes. This constitutional
exemption gives the non-stock, non-profit educational institutions a
distinct character. And for the constitutional exemption to be
enjoyed, jurisprudence and tax rulings affirm the doctrinal rule that
there are only two requisites: (1) The school must be non-stock and
non-profit; and (2) The income is actually, directly and exclusively
used for educational purposes. There are no other conditions and
limitations.

359
• C. AS OF 09 NOVEMBER 2016:
• REGARDLESS OF SOURCE AS LONG AS REVENUES ARE ADE USED FOR EDUCATIONAL PURPOSE,
EXEMPT FROM TAX. SECTION 30 (in so far as NSNPEI) is declared CONTRARY TO CONSTITUTION

G.R. No. 196596, November 09, 2016 – CIR v. DE LA SALLE UNIVERSITY, INC.; G.R. No. 198841 - DE LA
SALLE UNIVERSITY INC., v. CIR; G.R. No. 198941 – CIR v. DE LA SALLE UNIVERSITY, INC., Respondent.

• ISSUE: (1) income tax on rental earnings from restaurants/canteens and bookstores operating within
the campus; (2) value-added tax (VAT) on business income; and (3) documentary stamp tax (DST) on
loans and lease contracts.
• When a NSNPEI proves that it uses its revenues actually, directly, and exclusively for educational
purposes, it shall be exempt from income tax, VAT, and LBT. When it also shows that it uses its assets in
the form of real property for educational purposes, it shall be exempt from RPT.
• So long as the Assets or Revenues are used actually, directly and exclusively for educational purposes,
they are exempt from duties and taxes. The Constitution DOES NOT require that the revenues and
income must be sourced from educational activities or activities related to the purposes of an
educational institution. The phrase all revenues is unqualified by any reference to the source of
revenues. So long as the revenues and income are used actually, directly and exclusively for
educational purposes, then said revenues and income shall be exempt from taxes and duties.
• For NSNPEI, the last paragraph of Section 30 of NIRC is without force and effect for being contrary to
the Constitution insofar as it subjects to tax the income and revenues of non-stock, non-profit
educational institutions used actually, directly and exclusively for educational purpose. We make this
declaration in the exercise of and consistent with our duty to uphold the primacy of the Constitution.
THIS RULING APPLIES ONLY TO NSNPEI as provided in the Constitution, AND DOES
NOT COVER the other exempt organizations under Section 30 of the Tax Code.
360
 PREVIOUS RULES CURRENT RULES
Type of Income Taxability
Tuition Fees Income as such, NO TAX (Sec 30) ALL THESE TYPES OF INCOME
ARE NOT SUBJECT TO TAX.
Rental Income NIT ( last par Sec 30) THE CONSTITUTION
PROVIDES THAT ALL
Income from operating a canteen For the operation of a canteen inside REVENUES AND ASSETS,
the campus, the income therein being
incidental to the operations of the LAND, BUILDINGS, AND
school is exempt; IMPROVEMENTS OF NSNPEI
ACTUALLY, DIRECTLY AND
Income from bookstore Not subject to income tax since EXCLUSIVELY USED FOR
operation from bookstore is an ancillary
activity the conduct of which is carried EDUCATIONAL PURPOSE
out within the school premises SHALL BE EXEMPT FROM
TAX;
Not subject to income tax provided the
IN SO FAR AS NSNPEI IS
Income from dormitories
dormitory is within the campus as the CONCERNED, SECTION 30 IS
same is an ancillary activity. However, DECLARED
income from dormitory located outside UNCONSTITUTIONAL.
of school premises shall be subject to
income tax already. THUS, SECTION 30 DOES NOT
APPLY TO NSNPEI;
Income from concessionaires of These are already subject to income tax
the canteen and operators of the and treated as income from an activity
conducted for profit pursuant to the
dormitory. last paragraph of Section 30, NIRC.

Interest Income on bank deposits FWT (last par Sec 30)

361
• X donated P500,000 to NSNPEI:
a. Is it income on the part of the institution? Yes but it is not subject to tax
[Sec. 32 (B)(3), NIRC]

b. Is it subject to estate/donor’s tax? No, provided that not more than 30% is
used for administration purposes. . (Section 87 and 101 of the Tax Code)

c. Can X deduct the amount of the donation from gross income?

i. If X were a compensation income earner, he cannot claim as deduction. CIEs are

no longer entitled to claim any deduction under the TRAIN LAW;
ii. If X were an individual engaged in trade or business, up to the extent of 10% of
the amount of taxable income prior to this deduction may be deducted;
iii. If X were a corporation, up to the extent of 5% of the amount of taxable income
prior to this deduction may be deducted

• Real Property Tax - Such institution is exempt from payment of RPT (BASIS: LGC
and Constitution) Under the Local Government Code of 1991, real properties
actually, directly and exclusively used for educational, religious, and charitable
purpose shall be exempt from real property tax. 362
4. PROPRIETARY EDUCATIONAL INSTITUTIONS
a. Income tax: General Rule: Proprietary Educational institutions
are not exempt from tax unless there is a law providing for an
exemption. Sec 27(B) NIRC in relation to the Constitution: If the
income from unrelated trade/activity (ut/a) exceeds 50% of the total
income, it is treated as an ordinary corporation taxable at the rate of
30%. Otherwise, it is subject to a preferential rate of 10%.

NOTE: The exemption from income tax is not absolute but dependent
on the income from unrelated trade or activity.
b. If X donates P500,000 to the institution:
i. Is it income on the part of the institution? Yes, but not
included in computation of the gross income, therefore not
taxable. [Sec. 32 (B)(3), NIRC]
ii. Is it subject to estate/donor’s tax? No, provided that not
more than 30% is used for administration purposes.

363
c. Can X deduct the amount of the donation from gross income?
i. If X were a compensation income earner, he cannot claim as deduction.
CIEs are no longer entitled to claim any deduction under the TRAIN LAW;
ii. If X were an individual engaged in trade or business, up to the extent of 10%
of the amount of taxable income prior to this deduction may be deducted;
iii. If X were a corporation, up to the extent of 5% of the amount of taxable
income prior to this deduction may be deducted

d. Should PEI decide to deposit in a bank the funds from tuition fees, rentals, and the
gift of P 500,000.00, thereby earning interest income of 2% per annum, is the interest
from bank deposit income and taxable?
i. Is it income? YES.
ii. IS IT TAXABLE? YES, applying Section 27, the entire income from these
activities maybe taxed at 30% or 10%. 30% if income from uta exceeds 50% of its
total income and 10% if uta does not exceed 50% of its total income;

e. Real Property Tax - The institution is exempt from payment of RET (Local
Government Code of 1991). Under the Local Government Code of 1991, real
properties actually, directly and exclusively used for educational, religious, and
charitable purpose shall be exempt from real property tax.
364
5. CHARITABLE/ RELIGIOUS INSTITUTIONS

NOTE: The Constitutional provision regarding charitable/religious institutions is

limited only to exemption from RET. The exemption is based on the ACTUAL,
DIRECT, AND EXCLUSIVE USE of the property not ownership.
• The term “educational” does not refer to those managed by the religious
institutions but to the carrying on by these institutions of educational purpose
incidental to its primary purpose. (i.e. catechism, church daycare centers, etc.)

1. Money received as a charitable/religious institution

a. Is it income? Yes.
b. Is it taxable? No. Sec. 30, NIRC exempts income by the institution if it is
“realized as such.”

2. Rental fee received from KFC

a. Is it income? Yes.
b. Is it taxable? Yes. The last paragraph of Sec. 30, NIRC provides that income
from any activity conducted for profit regardless of the disposition shall be
subject to tax.
365
3. X donated P500,000 to the institution.
a. Is it income on the part of the institution? Yes, but it is not subject to tax
as gift, bequests and devises are items of exclusions.[Sec. 32 (B)(3), NIRC]
b. Is it subject to estate/donor’s tax? No, provided that not more than 30% is
used for administration purposes.
c. Can X deduct the amount of the donation from his gross income?

i. If X were a compensation income earner, he cannot claim as

deduction. CIEs are no longer entitled to claim any deduction under the
TRAIN LAW;
ii. If X were an individual engaged in trade or business, up to the
extent of 10% of the amount of taxable income prior to this deduction
may be deducted;
iii. If X were a corporation, up to the extent of 5% of the amount of
taxable income prior to this deduction may be deducted

Real Property Tax - The institution is exempt from payment of RET (Local
Government Code of 1991). Under the Local Government Code of 1991, real
properties actually, directly and exclusively used for educational, religious, and
charitable purpose shall be exempt from real property tax. 366
REQUIREMENTS FOR EXEMPTION under Section 30 (e):
1. Organization must be a non-stock corporation or association organized and operated
exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the
rehabilitation of veterans;

2. It should meet the ff tests:

• Organizational Test - corporation’s documents exclusively limit its purposes to par e of Section
30;
• Operational Test - regular activities of the corporation be exclusively devoted to the
accomplishment of the purposes in par (e), Section 30;

3. All the net income or assets of the corporation or association must be devoted to its purpose/s
and no part of its net income or asset accrues to or benefits any member or specific person;

4. It must not be a branch of a foreign non-stock non-profit corporation.

Validity of Tax Exemption/Revalidated Exemption:

- 3 years from date of effectivity specified in the certificate/ruling;
- Renewable in nature subject to submission of documents and approval of BIR;
- Failure to file ITR results to cancellation of tax exemption certificate beginning the
taxable year when ITR was not filed; 367
DEFINITIONS: NON-STOCK NON-PROFIT/INUREMENT under Section 30 NIRC
• “Non-stock”: no part of income is distributed as dividends and any profit as
incident of operations, shall be used for furtherance of its purpose;
• “Non- profit”: no net income or asset accrues to or benefits any member, with all
net income or asset devoted to purpose and all its activities conducted not for
profit;
NOTE: For exemption to apply as NSNP corporation under Section 30, NIRC, its
earnings/assets “shall not INURE to the benefit of any trustee, officer, member, or
specific person”
Considered as “INUREMENT”
1. Payment of compensation, salaries, honorarium to trustees or organizers;
2. Payment of exorbitant or unreasonable compensation to employees;
3. Provision of welfare aid/financial assistance to members;
4. Donation to any person/entity;
5. Purchase of goods/services in excess of FMV from an entity where trustee,
officer has an interest;
6. Upon dissolution, assets are distributed to trustees, organizers, officers,
members

368
1. A foreign corporation is not subject to CGT on sale of real property because
under the Constitution, they are not allowed to own real property in the Philippines.
2. Indicators that a FC is engaged in Trade or Business in the Philippines:
• principle of habituality in entering into commercial transactions in Phils;
• appointment of agents in the Phils;
• hiring of employees in the Phils;
• putting up a branch in the Phils;

• NRFC is taxable on the gross income and subject to Final Tax of 30%;
• All income and PI are subject to Final Tax of 30%;
• Inter-corporate dividends received by a NRFC from DC are subject to
FT of 15%;
• MCIT and NIT are not applicable to NRFC;
• CGT on sale of real property is not applicable to NRFC;
• All taxes due from NRFC are final taxes;

369
Corporate Income Tax Returns:
Every corporation subject to the tax herein imposed,
except foreign corporations not engaged in trade or
business in the Philippines, shall render, in duplicate, a
true and accurate quarterly income tax return (BIR Form
1702Q) and final or adjustment return (BIR Form 1702)

The return shall be filed by the president, vice president

or other principal officers and shall sworn to by such
officer and by the treasurer or assistant treasurer.

A corporation may employ either a calendar or fiscal

year as a basis for filing its annual income tax return. A
corporation shall not change the accounting period
employed without prior approval from the CIR.
370
Rules:

1. The corporate quarterly income tax shall be filed within

sixty (60) days following the close of each of the first
three quarters of the taxable year;
2. The income tax due on the corporate quarterly returns
and final adjusted income tax returns computed in
accordance with Sec. 75 and 76 shall be paid at the time
the declaration or return is filed;
3. The final adjustment return shall be filed on or before
the 15th day of April or on or before the 15th day of the
fourth month following the close of the fiscal year, as
the case may be.

371
Exercise:
Spartan Corp., a domestic corporation, has the following data in
2013:
 
Gross Income (gross of WT of 1%) P1,500,000
Business expense 600,000
Gain on sale of business asset 60,000
Interest on deposit with Metrobank, net of tax 5,000
Sale of shares of stocks, not listed and traded
Selling price P150,000
Cost 115,000
Dividends from domestic corporation 35,000
Dividends paid during the year 120,000
Reserved for building aquisition 300,000

In 2012, the corporation suffered an operating loss of

P130,000.
372
Estates and
Trusts

Domestic Corporations Sec. 22 (C ) – 30% on Taxable Income

Foreign Resident Foreign Corporations Sec. 22 (H) - 30% on Taxable Income

Corporations
Sec. 22(D)
Non-resident Sec. 22 (I) - 30% on Gross Income
Proprietary educational institutions and non-profit hospitals – 10% of their taxable
income

Domestic Depositary Bank (Foreign Currency Deposit Units) – 10% of gross onshore
income

Resident international carriers – 2.5% Gross Philippine Billings

Corpo- Offshore Banking Units – 10% of gross onshore income

rations
Resident Depositary Bank (Foreign Currency Deposit Units) - 10% of gross onshore
income
Special Classes
of Corporations
Regional or Area Headquarters Sec. 22( DD) and Regional Operating Headquarters Sec.
22 (EE) of Multinational Companies

Non-resident cinematographic film owners, lessors or distributors - 25% final tax

Non-resident owners or lessors of vessels chartered by Philippine Nationals – 4.5% final

tax

Non-resident lessors of aircraft, machinery and other equipment - 7.5% final

373 tax
Taxation of Partnerships

Rules:

1. The partnership is subject to the same rules on corporations

(capital gains tax, final tax on passive income, normal tax, minimum
corporate income tax [MCIT] and gross income tax [GIT]), but is not
subject to the improperly accumulated earnings tax [IAET]. The
partnership must file quarterly and year-end income tax returns.
2. The taxable income of the partnership, less the normal corporate
income tax thereon, is the distributable net income of the
partnership.
3. The share of a partner in the partnership’s distributable net
income of a year shall be deemed to have been actually or
constructively received by the partners in the same taxable year
and shall be taxed to them in their individual capacity, whether
actually distributed or not. Such share will be subjected to a final
tax of 10% to be withheld by the partnership.
374
Taxation of General Professional Partnerships
Rules:
1. A GPP as such shall not be subject to the income tax.
2. The partners shall only be liable for income tax only in
their separate and individual capacities.
3. For purposes of computing the distributive share
of the partners, the net income of the GPP shall be
computed in the same manner as a corporation.
4. Each partner shall report as gross income his
distributive share, actually or constructively received, in
the net income of the partnership.
 
• The share of a partner shall be subject to a creditable
withholding income tax of 15%.
375
Taxation on Estates and Trusts
a) Application: The tax imposed upon individuals shall apply to the
income of estates or of any kind of property held in trust,
including:

1. Income accumulated in trust for the benefit of unborn or

unascertained person or persons with contingent interests, and
income accumulated or held for future distribution under the terms
of the will or trust;
2. Income which is to be distributed currently by the fiduciary to
the beneficiaries, and income collected by a guardian of an infant
which is to be held or distributed as the court may direct;
3. Income received by estates of deceased persons during the
period of administration or settlement of the estate; and
4. Income which, in the discretion of the fiduciary, may be either
distributed to the beneficiaries or accumulated.

376
b) Exception
 
The tax shall not apply to employee's trust which forms part of a
pension, stock bonus or profit-sharing plan of an employer for the benefit
of some or all of his employees:
 
i. if contributions are made to the trust by such employer, or employees,
or both for the purpose of distributing to such employees the earnings and
principal of the fund accumulated by the trust in accordance with such
plan, and
 
ii. if under the trust instrument it is impossible, at any time prior to the
satisfaction of all liabilities with respect to employees under the trust, for
any part of the corpus or income to be used for, or diverted to, purposes
other than for the exclusive benefit of his employees.

377