PM REYES NOTES ON TAXATION I: INCOME TAX PM REYES NOTES ON TAXATION I: INCOME TAX (Updated 14 January 2013) BY PIERRE MARTIN DE LEON REYES This reviewer is a compilation of personal notes in Taxation One and notes and lectures from Atty. Gruba and Atty. Montero. References have alsobeenmadetothefollowingbooks:DELEON&DELEON,JR.THEFUNDAMENTALSOFTAXATION(2012);DELEON&DELEON,JR. COMPREHENSIVE REVIEW OF TAXATION (2010); VITUG & ACOSTA. TAX LAW AND JURISPRUDENCE (2006); DOMONDON, TAXATION VOLUME II: INCOME TAX (2009); CO-UNTIAN, JR. TAX DIGEST (2009);MAMALATEO, PHILIPPINE INCOME TAX (2010);MAMALATEO, REVIEWER ON TAXATION (2008). This reviewer is best used with SACADALAN-CASASOLA, NIRC AND OTHER LAWS (2012). Possessorsaregrantedtherighttoreproduceanddistributethisrevieweraswellastherighttoconverttheworktoanymediumforthe purposeofpreservationand/orcontinueddistributionprovidedthat theauthorsnameremains clearlyassociatedwiththeworkandthatno alterations of the form and content are made.Page | 1 In general Q1. What is an income? Incomemeansthegainderivedfromcapital,from labor, or from both combined, including profits gained fromdealingsinpropertyoraswellasanyasset clearly realized whether earned or not. Itreferstoallwealthwhichflowsintothetaxpayer other than as a mere return on capital. (RR No.2) Q2. What is an income tax? IncomeTaxisataxonthenetincomeortheentire income received orrealized in one taxableyear.It is levieduponcorporateandindividualincomesin excess of specified amounts, less certain deductions and/or specified exemptions permitted by law. Thefinaltaxoncertainpassiveincomesand withholdingtaxonincomeareembracedwithinthe term. InCONWIV.CTA[AUGUST31,1992],theSupreme Courtdefinedincometaxasanamountofmoney comingtoapersonorcorporationwithinaspecified time,whetheraspaymentforservices,interest,or profit from investment. AsstatedbytheSupreme CourtinREPUBLICOFTHE PHILIPPINESVS.MANILAELECTRICCOMPANY [NOVEMBER15,2002],incometaxisimposedonan individual or entity as a form of excise tax or a tax on theprivilegeofearningincome. Inexchangeforthe protection extended by the State to the taxpayer, the government collects taxesas asource of revenueto finance its activities. Q3. When is income taxable? (or what are the elements of a taxable income?) Income,gainorprofitissubjecttoincometaxwhen the following conditions are present: 1.There is income, gain or profit1 2.The income, gain orprofit is received orrealized duringthetaxableyear;2(knownasthe realization concept) and 3.Theincome,gainorprofitisnotexemptfrom income tax.3 Q3.1.Whatisthedifferencebetween income and capital? Income is distinct from capital. Incomemeans all the wealthwhichflowsintothetaxpayerotherthana merereturnoncapitalwhilecapitalisafundor propertyexistingatonedistinctpointintimewhile incomedenotesaflowofwealthduringadefinite periodoftime.Incomeisgainderivedandsevered fromcapital.(seeCHAMBEROFREALESTATEAND BUILDERSASSOCIATION,INC.V.ROMULO[MARCH9, 2010]). Income as contrasted with capital or property is to be the test. The essential difference between capital and incomeisthatcapitalisafund;incomeisaflow.A fund of property existing at an instant of time is called capital. A flow of services rendered by that capital by thepaymentofmoneyfromitoranyotherbenefit rendered by a fund of capital in relation to such fund through aperiodof time is called an income. Capital is wealth, while income is the service of wealth. A tax on income is not a tax on property. "Income," as here used,canbedefinedas"profitsorgains."(see MADRIGAL VS. RAFFERTY [AUGUST 7, 1918]). Q3.1.1 Arestockdividendsincomeor capital? Generally,stockdividendsrepresentcapitalanddo notconstituteasincometoitsrecipient.Mere issuancethereofisnotyetsubjecttoincometaxas they are nothing butan enrichment throughincrease invalueofcapitalinvestment.Suchareconsidered

1 As opposed to mere reimbursements or return on capital.2 As opposed to the common examples of unrealized forex gains or mere revaluation increments.3 Examples of those exempt from income tax: de minimis benefits and professional fees of GPPs.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES2unrealizedgainandcannotbesubjectedtoincome tax until that gain has been realized. AsexplainedbytheSupremeCourtinFISHERV. TRINIDAD[OCTOBER30,1922],whenacorporation issues stock dividends, it shows that the corporations accumulated profits have been capitalized, instead of distributed to the stockholders orretainedas surplus availablefordistribution.Thestockholderreceives nothingoutofthecorporateassetsforhisseparate use and benefit but a representation of his increased interestinthecapitalofthecorporation.Thecapital stillbelongstothecorporationasthereisno separation of interest. However,stockdividendsconstituteasincomeifa corporationredeemsstockissuedsoastomakea distribution.4Thisisessentiallyequivalenttothe distributionofataxabledividendtheamountso distributedintheredemptionconsideredastaxable income. (see COMMISSIONER VS. MANNING [AUGUST 7, 1975]) Q3.2.Aremoneyreceivedasdamages income? Yes. InCOMMISSIONERV.GLENSHAWGLASSCO.[348 U.S. 426], Glenshaw Co was engaged in a proracted litigationwithHartford-EmpireCowheretheformer demandedexemplarydamagesforfraudandtreble damagesforinjurytoitsbusinessbyreasonofthe lattersviolationoffederalantitrustlaws.Theparties settled.Glenshawdidnotreportthemoneyreceived asdamagesfromthesettlementinitsincometax return.TheCommissionerassessedGlenshawfor thedeficiency.Glenshawcontendedthatpunitive damages, as windfalls flowing from culpable conduct ofthirdpartiesarenottaxableincome.TheUS SupremeCourtheldthatmoneyreceivedas damagesmustbereportedastheyconstitute income.Themerefactthatsuchpaymentswere extractedfromwrongdoerscannotdetractfromtheir characterastaxableincome.TheCourtalsostated that punitive damages cannot be classified as gifts. InMURPHYV.IRS[493F.3d170],theUSCourtof Appeals(DistrictofColumbia),heldthattheamount receivedascompensatorydamagesforemotional distressandlossofreputationconstitutestaxable income.

4Theexceptiontotherulethatstockdividendsdonotconstitute incomeshallbediscussedmoreextensivelylater.Knowingthat there is an exception exists will suffice for now. Q3.3.Whatistheconstructivereceipt doctrine? The constructive receipt doctrine provides than an itemistreatedasincomewhenitiscreditedtothe accountofthe,ormadeunconditionallyavailableto the taxpayer; no physical possession is required. Incomeisreceivednotonlywhenitisactually handedtoataxpayerbutalsowhenitismerely constructively received by him. In LIMPAN INVESTMENT V.CIR[JULY26,1966],thelesseesoptedtodeposit their payments when the lessor refused to accept the samein1957.Thelessordidnotreportthese paymentsinhis1957incometaxreturn.The Supreme Court held that the failure to report the said rentalincomeisunjustifiedas,whenthepayments weredeposited,thelessorwasdeemedtohave constructive received such rentals. OverviewofthePhilippineIncomeTax System Q4. What are the features of the Philippine tax system? The Philippine tax system is: 1.Direct5 2.Progressive6 3.Semi-schedular, semi-global Q4.1.Whatarethekindsofincometax systems? Thetypesofincometaxsystemsadoptedareas follows: 1.GlobalTaxSystemwherethetaxpayeris requiredtolumpupallitemsofincomeearned duringataxableperiodandpayunderasingle set of income tax rates on these different items of income.(Simplyput,varyingtaxesareimposed on passive income) 2.SchedularTaxSystemwherethereare differenttaxtreatmentsofdifferenttypesof incomesothataseparatetaxreturnisrequired to be filed for each type of income and the tax is computed on aper returnorper schedule basis.

5 Direct taxes are those taxes wherein both the tax liability as well as the impact or burden of the tax falls on the same person 6Progressivetaxesarethosetaxesimposedwherethetaxrate increases as the tax base increases PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES3(Simplyput,onerateforalltypesofgross income). 3.Semi-Schedular or Semi-Global Tax System wherethetaxsystemiseither(a)global(e.g. taxpayerwithcompensationincomenotsubject tofinalwithholdingtaxorbusinessor professionalincomeormixedincome compensationandbusinessorprofessional income)or(b)schedular(e.g.taxpayerwith compensation,capitalgains,passiveincome,or otherincomesubjecttofinalwithholdingtax)or (c)bothglobalandschedularmaybeapplied dependingonthenatureoftheincomerealized bythetaxpayerduringtheyear. Q4.2.Howdoyoudistinguish schedulartreatmentfromglobal treatmentasusedinincome taxation? Under the schedular tax system, the various types of income(i.e.compensation;business/professional income)areclassifiedaccordinglyandareaccorded differenttaxtreatments,inaccordancewith schedulescharacterizedbygraduatedtaxrates. Sincethesetypesofincomearetreatedseparately, theallowabledeductionsshalllikewisevaryforeach type of income. Ontheotherhand,undertheglobaltaxsystem,all incomereceivedbythetaxpayeraregrouped together,withoutanydistinctionastotypeornature oftheincome,andafterdeductingtherefrom expensesandotherallowabledeductions,are subjected to tax at a graduated or fixed rate (see TAN VS. DEL ROSARIO [OCTOBER 3, 1994]). Q4.3.WhatarethetypesofPhilippine IncomeTax(underTitleIIofthe NIRC)? ThetypesofIncometaxunderTitleIIoftheNIRC are: 1.Graduated income tax on individuals 2.Normal corporate income tax on corporations 3.Minimum corporate income tax on corporations 4.Specialincometaxoncertaincorporations(e.g. privateeducationalinstitutions,FCDUs,and international carriers) 5.Capital gains tax on sale or exchange of unlisted sharesofstockofadomesticcorporation classified as a capital asset 6.Capitalgainstaxonsaleorexchangeofreal propertylocatedinthePhilippinesandclassified as a capital asset 7.Finalwithholdingtaxoncertainpassive investment incomes 8.Fringe benefit tax 9.Branch profit remittance tax; and 10.Tax on improperly accumulated earnings. Definition of Terms Q5. Define the following terms: InSection22(A)to(I),(Z),(GG),and(HH),Tax Code: PersonAnindividual,atrust,estateor corporation CorporationIncludespartnerships,nomatter howcreatedororganized,joint-stock companies, joint accounts, associations,orinsurance companiesbutdoesnotinclude generalprofessional partnershipsandajointventure orconsortiumformedforthe purposeofundertaking constructionprojectsor engaging in petroleum and other energyoperationspursuantto an operating agreement under a servicecontractwiththe Government General Professional Partnerships (GPPs) Partnershipsformedbypersons forthesolepurposeof exercisingtheircommon profession, no part of the income ofwhichisderivedfrom engaginginanytradeor business Domestic (Corporation) Whenappliedtoacorporation, meanscreatedororganizedin the Philippines or under its laws Foreign (Corporation) Whenappliedtoacorporation, meansacorporationwhichis not domestic Nonresident citizen Theterm meansacitizenofthe Philippines: 1.whoestablishestothe satisfactionofthe Commissioner the fact of his physicalpresenceabroad withintentiontoreside therein PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES42.wholeavesthePhilippines duringthetaxableyearto resideabroadeitherasan immigrant or for employment on a permanent basis 3.whoworksandderives incomefromabroadand whoseemploymentthereat requires him to be physically presentabroadmostofthe time during the taxable year. 4.whohasbeenpreviously consideredanon-resident citizenandwhoarrivesin thePhilippinesatanytime duringthetaxableyearto residepermanentlyinthe Philippineswithrespectto hisincomederivedfrom sourcesabroaduntildateof his arrival in the Philippines Resident alienAn individual whose residence is within the Philippines and who is not a citizen thereof Nonresident alien An individual whose residence is notwithinthePhilippinesand who is not a citizen thereof Resident foreign corporation A foreign corporation engaged in tradeorbusinesswithinthe Philippines Nonresident foreign corporation Aforeigncorporationnot engagedintradeorbusiness within the Philippines Ordinary Income Includesanygainfromthesale or exchange of property which is notacapitalassetorproperty described in Section 39(A)(1)7 Statutory Minimum Wage Referstotheratefixedbythe RegionalTripartiteWageand ProductivityBoar,asdefinedby theBureauofLaborand Employment Statistics (BLES) of DOLE.Minimum Wage earner Aworkerintheprivatesector paidthestatutoryminimum wageortoanemployeeinthe publicsectorwithcompensation incomeofnotmorethanthe statutoryminimumwageinthe non-agriculturalsectorwhere he/she is assigned

7 which defines what capital assets are and those which are not. In Section 31, 35(B), and 39(A), Tax Code: Taxable Income thepertinentitemsofgross incomespecifiedintheNIRC lessthedeductionsand/or personalandadditional exemptions,ifany,authorized forsuchtypesofincomebythe NIRC or other special laws Dependentalegitimate,illegitimateor legallyadoptedchildchiefly dependentuponandlivingwith thetaxpayerifsuchdependent is not more than twenty-one (21) years of age, unmarried and not gainfullyemployedorifsuch dependent, regardless of age, is incapableofself-support becauseofmentalorphysical defect Capital Assetspropertyheldbythetaxpayer (whetherornotconnectedwith his trade or business, EXCEPT: 1.Stockintradeofthe taxpayerorotherproperty ofakindwhichwould properlybeincludedinthe inventoryofthetaxpayerif onhandatthecloseofthe taxable year 2.Propertyheldbythe taxpayer primarily for sale to customersintheordinary courseofhistradeor business 3.Propertyusedintradeor businessof a characterthat issubjecttoallowancefor depreciation 4.Realpropertyusedintrade or business of the taxpayer NetCapital Gain theexcessofthegainsfrom salesorexchangesofcapital assets over the losses from such sales or exchanges NetCapital loss theexcessofthelossesfrom salesorexchangesofcapital assetsoverthegainsfromsuch sales or exchanges PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES5Q6. What are the kinds of income taxpayers?8 ThekindsofincometaxpayersunderTitleIIofthe NIRC are: A.Individuals 1.Citizens (Section 24, NIRC) a.Resident Citizens b.Nonresident Citizens 2.Aliens a.Resident Aliens(Section 24, NIRC) b.NonresidentAliens(Section25, NIRC) i.Engagedintradeorbusinessin the Philippines ii.Not engaged in trade or business in the Philippines 3.Estates and Trusts (Section 60, NIRC) a.Revocable trust b.Irrevocable trust B.Corporations 1.DomesticCorporations(Section27, NIRC) 2.Foreign Corporations (Section 28, NIRC) a.Resident foreign corporations b.Nonresident foreign corporations 3.Partnerships a.Taxablepartnership(Section73(D), NIRC) b.Exempt partnership i.General Professional Partnership (Section 26, NIRC) ii.Jointventureorconsortium undertakingconstructionactivity orengagedinpetroleum operationswithoperating contract with the government Resident citizens and resident aliens Q7. Who are citizens of the Philippines?9 Thefollowingareconsideredcitizensofthe Philippines:

8Beforeproceedingtoincomeproper,itisimportanttoknowthe differentkindsof taxpayersfirst. This isbecauseinanalyzingany probleminvolvingincometaxation,thefirstthingtodoisto determinewhothetaxpayeris.Theonlytwoexceptionswhere knowingthetaxpayerisimmaterialarewherethetransaction involvessalesofsharesofstockofadomesticcorporation becauseitissubjectto1%ofstocktransactiontaxor5%/10% capitalgainstaxonnetcapitalgainwhetherthesellerisan individual, citizen or alien or a corporation, domestic or foreign and (2)wheretherealpropertysoldisacapitalassetlocatedinthe Philippines which is subject to 6% capital gains tax. 9 To determine if the taxpayer is a resident citizen, just refer to the enumeration of what constitutes a non-resident citizen. 1.ThosewhoarecitizensofthePhilippinesat the time of the adoption of the Constitution 2.Those whose fathers or mothers are citizens of the Philippines 3.ThosebornbeforeJanuary17,1973of Filipinomothers,whoelectPhilippine Citizenshipuponreachingtheageof majority; and 4.Thosewhoarenaturalizedinaccordance with law Q8. Who is a non-resident alien? A non-resident alien is an individual whose residence iswithinthePhilippinesandwhoisnotacitizen thereof. Q8.1.Howistheresidencyofanalien determined? An alien is considered a non-resident if he stays here for a definite short period of time. An alien will be considered a resident if the stay here is either: 1. definite and extended; 2. indefinite InGARRISONV.CA[JULY19,1990],inresolvingthe contentionofUSnationalsthattheycannotbe consideredresidentaliensastheyintendtogoback totheUSonterminationoftheiremploymentinthe Philippines,theSupremeCourtheldthatwhatthe law requires is merely physical or bodilypresence in a given place for a period of time, not the intention to make it a permanent place of abode. The Supreme Court further held that, as laid clearly in RRNo.2,whetheranalienisatransientornotis determined by his intentions with regard to the length andnatureofhisstay.Amerefloatingintention indefiniteastotime,toreturntoanothercountryis notsufficienttoconstitutehimasatransient.Ifhe livesinthePhilippinesandhasnodefiniteintention astohisstay,heisaresident.10Onewhocomesto thePhilippinesforadefinitepurpose,whichinits naturemaybepromptlyaccomplished,isa transient.11 But if his purpose is of such a nature that anextendedstaymaybenecessaryforits accomplishment, and to that end the alien makes the

10 In other words, stay is indefinite.11 In other words, the stay is for a definite short period of time.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES6Philippineshistemporaryhome,hebecomesa resident, although he intends to return to his domicile abroad.12 Q8.2.Whenistheresidenceofanalien considered lost? RR2providesthatanalienwhohasacquired residenceinthePhilippinesretainshisstatusasa residentuntilheabandonsthesameandactually departsfromthePhilippines.Anintentionto changehisresidencedoesnotchangehisstatusas a resident alien to that of a nonresident alien. Non-resident citizens Q9. Who is a non-resident citizen? Thetermnon-residentcitizenmeansacitizenof the Philippines: 1.whoestablishestothesatisfactionofthe Commissionerthefactofhisphysical presenceabroadwithintentiontoreside therein 2.whoisanonewholeavesthePhilippines duringthetaxableyeartoresideabroad eitheras an immigrant or foremployment on a permanent basis 3.whoisonewhoworksandderivesincome from abroad and whose employment thereat requireshimtobephysicallypresent abroad most of the timeduring the taxable year. 4.whohasbeenpreviouslyconsideredanon-residentcitizenandwhoarrivesinthe Philippinesatanytimeduringthetaxable yearto residepermanently in thePhilippines withrespecttohisincomederivedfrom sourcesabroaduntildateofhisarrivalin the Philippines (See Section 22E, NIRC and Section 2, RR No. 01-79 [January 8, 1979]) Q9.1.Shouldanon-residentcitizenfile anincometaxreturnor informationreturncoveringhis income earned abroad? No.Previously,underRRNo.01-79,non-resident citizens were required to do so. In RR No. 9-99, non-residentcitizenswererequiredtofileaninformation

12 In other words, the stay is definite but extended.return.However,underRR05-01[July31,2001], non-resident citizens are no longer required to file the sameontheirincomederivedfromsourcesoutside the Philippines. Q9.2.Whatismeantbythephrase mostofthetimeasusedin determining whetheracitizen who derives income from abroad and is physicallypresentabroadisa non-resident? RRNo.01-79statesthattobephysicallypresent abroadmostofthetimeduringthetaxableyear,a contractworkermusthavebeenoutsidethe Philippines for not less than 183 days during such taxable year. Note:AscanbeseenfromthewordingofRRNo. 01-79, most of the time applies to a contract worker. In BIR Ruling 33-00 [September 5, 2000], however, theCIRheldthatforoverseascontractworkers,the timespentabroadisnotmaterialasallthatis requiredisfortheworkersemploymentcontractto pass through and be registered with the POEA. Q9.3.Ifanatural-bornPhilippinecitizen who became a citizen of the United Statesislaterongranted Philippinedualcitizenshipunder RA9225,isherequiredtopay taxesforincomeearnedinthe United States? No. In BIR Ruling DA-095-05 [March 29, 2005], the CIR held that such a person would be a non-resident citizen,andhence,willnotberequiredtopay Philippine tax for income earned in the United States. Non-resident aliens engaged in business in the Philippines Q10.Who is a non-resident alien? A non-resident alien is an individual: 1. whose residence is not within the Philippines; and 2. who is not a citizen thereof PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES7Q10.1. Howdoyoudetermineifanon-residentalienisengagedintrade or business? Onceataxpayerisdeterminedtobeanon-resident alien,thetesttodeterminewhetherthealienisa non-residentalienengagedintradeorbusinessis whether his total aggregate stay for a taxable year exceeds 180 days. Corporations Q11.Differentiatethekindsofcorporate taxpayers. A corporation is itself a taxpaying entity and speaking generally,forpurposesofincometax,corporations are classified into (a) domestic corporations and (b) foreigncorporations.Foreigncorporationsare furtherclassifiedinto(1)residentforeign corporationsand(2)non-residentforeign corporations. A domestic corporation is one created or organized inthePhilippinesorunderitslaws.Aforeign corporationisonecreatedororganizedunderthe laws of a foreign country. Aresidentforeigncorporationisaforeign corporationengagedintradeorbusinesswithinthe Philippinesorhavinganofficeorplaceofbusiness therein.Anon-residentforeigncorporationisa foreign corporation not engagedin tradeorbusiness withinthePhilippinesandnothavinganyofficeor place of business therein. A domestic corporation is taxed on its income from sourceswithinandwithoutthePhilippines,buta foreign corporation is taxed only on its income from sourceswithinthePhilippines.However,whilea foreigncorporationdoingbusinessinthe Philippines is taxable on income solely from sources withinthePhilippines,itispermittedtodeductions fromgrossincomebutonlytotheextentconnected withincomeearnedinthePhilippines.Ontheother hand,foreigncorporationsnotdoingbusinessin thePhilippinesaretaxableonincomefromall sources within the Philippines, as interest, dividends, rents,salaries,wages,premiums,annuities Compensations,remunerations,emoluments,or otherfixedordeterminableannualorperiodicalor casual gains, profits and income and capital gains. (seeN.V.REEDERIJAMSTERDAMVS.CIR[JUNE23, 1988]) Q12.Is a partnership liable for income tax? Yes.Thetermcorporationsincludespartnerships, no matter how created or organized. Q12.1. Is a GPP13 liable for income tax? No.AGPPisnotconsideredataxableentityfor incometaxpurposes.Section26oftheNIRC providesthatpersonsengaginginbusinessas partners ina GPP shall be liable forincome tax only intheirseparateandindividualcapacitiescomputed ontheirrespectivedistributivesharesofthe partnership profit. Q12.2. Distinguish between a GPP and an ordinary business partnership. A general professional partnership, unlike an ordinary businesspartnership(whichistreatedasa corporationforincometaxpurposesandsosubject tothecorporateincometax),isnotitselfanincome taxpayer.Theincometaxisimposednotonthe professional partnership, which is tax exempt, but on thepartnersthemselvesintheirindividualcapacity computedontheirdistributivesharesofpartnership profits(seeCARAG,CABALLES,JAMORAANDSOMERA LAW OFFICES VS. DEL ROSARIO [OCTOBER 3, 1994]) Q12.2.1.AandB,co-owners,bought3 parcelsoflandinone transaction and bought 2 more parcelsoflandinanother. Theydecidedtosellthe3 parcelstoCandthe2parcels to D. They realizeda netprofit gainandpaidCGT.CIR assessedthemfordeficiency corporateincometax.Isthe co-ownershiptaxableasa corporation? No.ACo-Ownershipwhoownpropertieswhich produceincomeshouldnotautomaticallybe consideredpartnersofanunregisteredpartnership, or a corporation, within the purview of the income tax law.The essential elements of a partnership are two, namely:(a)anagreementtocontributemoney,

13 General professional partnership (GPP) are partnerships formed bypersonsforthesolepurposeofexercisingtheircommon profession,nopartoftheincomeofwhichisderivedfrom engaging in any trade or business. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES8property or industry to a common fund; and (b) intent todividetheprofitsamongthecontracting parties. Here,thereisnoevidencethatpetitioners enteredintoanagreementtocontributemoney, property or industry to a common fund, and that they intended to divide the profits among themselves. The sharingofreturnsdoesnotinitselfestablisha partnershipwhetherornotthepersonssharing therein have a joint or common right or interest in the property.Theremustbeaclearintenttoforma partnership,theexistenceofajuridicalpersonality differentfromtheindividualpartners,andthe freedom of each party to transfer or assign the whole property.(seeOBILLOSv.CIR[OCTOBER29,1985] and PASCUAL V. CIR [OCTOBER 18, 1988]). Q12.2.2.Agroupofinsurance companiesinthePhilippines decidedtoformapooland enteredintoareinsurance treatywithanon-resident reinsurancecompany.Issuch apoolsubjecttocorporate taxesandwithholdingtaxes ondividendspaidtothenon-residentreinsurance company? Yes.Whereseverallocalinsuranceceding companiesenterintoaPoolAgreementoran associationthatwouldhandlealltheinsurance businessescoveredundertheirquota-share reinsurancetreatyandsurplusreinsurancetreaty

with a non-resident foreign reinsurance company, the resultingpoolhavingacommonfund,andfunctions throughanexecutiveboardanditsworkis indispensable,beneficialandeconomicallyusefulto the business of the ceding companies and the foreign firm, such circumstances indicate a partnership or an associationtaxableasacorporation(seeAFISCO INSURANCECORPORATIONVS.CIR[JANUARY25, 1999]) Q12.2.3.AandBinheritedproperties. Theydidnotpartitionthe sameandinsteadinvested themtoacommonfundand dividetheprofitstherefrom. Shouldtheybeclassifiedas anunregisteredpartnership subjecttocorporateincome tax? Yes.Theincomefrominheritedpropertiesmaybe consideredasindividualincomeoftherespective heirsonlyaslongastheinheritanceorestateisno distributed,or,atleast,partitioned.Butthemoment their respective known shares are used as part of the common assets of heirs to be used in making profits, itisbutproperthattheincomefromsuchshares should be considered as part of the taxable income of anunregisteredpartnership.(seeONAV.CIR[MAY 25, 1972]). Q12.3. Are joint ventures taxable? Generally,yes.However,ajointventureor consortiumundertakingconstructionprojectsor engagedinpetroleumoperationswithan operatingcontractwiththegovernmentarenot liable for income tax. Q12.3.1.Whataretherequirementsin orderforajointventure formedforconstruction purposesbenotliablefor income tax? InRRNo.010-12[JUNE1,2012],ajointventureor consortiumformedforthepurposeofundertaking constructionprojectswhichisnotconsideredasa taxable corporation should be: 1.For the undertaking of a construction project; 2.Should involve joining or pooling of resources by licensedlocalcontractors,licensedbythe PhilippineContractorsAccreditationBoard (PCAB) of the DTI; 3.The local contractors are engaged in construction business; 4.Thejointventureitselfmustlikewisebeduly licensed as such by the PCAB Absentoneoftherequirements,thejointventure formed for construction purposes shall be considered a taxable corporation. Q12.3.2.Mayjointventuresinvolving foreigncontractorsbetreated as a non-taxable corporation? Yes, provided that the member foreign contractor is: 1.covered by a special license as contractor by the PCAB; and 2.construction project is certified by the appropriate governmentofficeasaforeign financed/internationally-fundedprojectandthat international bidding is allowed under the bilateral agreementbetweenthePhilippinegovernment; and foreign/international financing institution. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES9 Q12.3.3.Twolocalcontractorsentered intoajointdevelopment agreementtoconstructa residentialsubdivision.One localcontractorshall contributetheparcelofland whiletheothershall contributetheconstruction and development of the parcel oflandintoasubdivision. Eachshallreceivean allocationofsaleablehouse andlotunitsfromtheproject. Isthejointventureliablefor income tax? No.InBIRRulingNo.108-2010[October19, 2010],14involvingajointventurebetweenAvidaand Aurora,theCIRheldthatthejointdevelopment agreement between thetwo isnot subject to income taxbecausejointventuresformedbylocal contractors for construction purposes are deemed as notfallingunderthedefinitionofataxable corporation. Income15 Statutory Inclusions Q13.Whataredeemedincludedin(gross) income? All income derived from whatever source, including, but not limited to, the following items: 1.Compensationforservicesinwhateverform paid,including,butnotlimitedtofees, salaries,wages,commissionsandsimilar items; 2.Grossincomederivedfromtheconductof tradeorbusinessortheexerciseofa profession; 3.Gains derived from dealings in property 4.Interests 5.Rents 6.Royalties 7.Dividends

14ItisalsoimportanttonoteinthisBIRRulingthattheCIRheld that the allocation of saleable units does not constitute as a taxable event as no income is actually realized by Avida or Aurora.15Previously,welookedintothetypesoftaxpayers.Now,before proceeding to general principles and source of income rules, let us lookintowhatisincludedinthetermincome;andwhatis excluded therefrom. 8.Annuities 9.Prizes and winnings 10.Pensions; and 11.Partnersdistributivesharefromthenet income of the GPP (see Section 32(A), NIRC)16 Q13.1. Istheenumerationprovidedin Section 32(A) exclusive? No. Section 32(A) does not intend the enumeration to beexclusive.Itmerelydirectsthatthetypesof incomelistedthereinbetreatedasincomefrom sources within the Philippines (see CIR VS. AMERICAN AIRLINES [DECEMBER 19, 1989]) Compensation for services Q13.2. Ifanemployerpaystheincome taxesassessableagainstan employee,isthepaymentbythe employertaxableincomeonthe part of the employee? Yes.InOLDCOLONYTRUSTCO.V.COMMISSIONER [279U.S.716],theUSSupremeCourtheldthatthe paymentofthetaxbytheemployerwasin considerationofservicesrenderedbytheemployee. Thepaymentconstitutedincometotheemployee. TheCourtalsoaddedthatitcannotbearguedthat thepaymentwasagift.Thepaymentforservices, eventhoughvoluntary,wasnevertheless compensation for services rendered. Rents Q13.3. Areimprovementsmadeby lesseestaxableasincomeonthe part of the lessor? Yes,providedthesuchbuildingsorimprovements arenotsubjecttotheremovalbythelessee.The lessormayeither:(1)reporttheimprovementsas incomeatthetimewhensuchimprovementsare completedbasedonitsfairmarketvalue;or(2) spreadthelifeoftheleasetheestimateddepreciate value of the improvements at termination of the lease

16 The above answer is the definition of gross income. This will be discusses in greater detail later. For now, we focus on determining whatisconsideredincomeandwhatisnotconsideredincomeor excluded therefrom. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES10andreportasincomeforeachyearoftheleasean aliquot part thereof (Section 49, RR No. 2) Q13.3.1. Shouldtheimprovementbe capableofbeingseparated fromthelandinordertobe considered a taxable gain? No.TheUSSupremeCourtinHELVERINGV.BRUUN [309US461]statedthatitisnotnecessaryto recognitionoftaxablegainthatthelessorbeableto severtheimprovementbegettingthegainfromhis original capital. Dividends Q13.4. What are dividends? Thetermdividendsmeansanydistributionmade byacorporationtoitsshareholdersoutofits earningsorprofitsandpayabletoitsshareholders, whether in money or in other property.17 Q13.5. Are property dividends taxable? Yes. As provided in Section 251, RR No. 2, dividends paid in securities or other property (other than its own stock),inwhichtheearningsofacorporationhave beeninvested,areincometotherecipientstothe amountofthefullmarketvalueofsuchproperty when receivable by individual stockholders. Q13.6. Arestockdividendssubjectto income tax? No.Asdiscussedearlier,astockdividendonly representsthetransferofsurplustocapitalaccount and, as such, is not subject to income tax. Q13.6.1.What is the exception to therulethatstock dividendsarenot subject to income tax? Stock dividends constitute as income if a corporation redeemsstockissuedsoastomakeadistribution. Thisisessentiallyequivalenttothedistributionofa taxabledividendtheamountsodistributedinthe redemptionconsideredastaxableincome.(see

17Ifinmoney,itiscalledacashdividend.Ifitisinproperty,itis called a property dividend.COMMISSIONER VS. MANNING [AUGUST 7, 1975]) Theredemptionconvertsintomoneythestock dividends which become a realized profit or gain and consequently,thestockholder'sseparate property.Profitsderivedfromthecapitalinvested cannotescapeincometax.Asrealizedincome,the proceedsoftheredeemedstockdividendscanbe reachedbyincometaxationregardlessofthe existenceofanybusinesspurposeforthe redemption. (see CIR VS. CA [JANUARY 20, 1999]) AsprovidedinSection252,RRNo.2:Astock dividendconstitutesincomeifitsgivesthe shareholderaninterestdifferentfromthatwhichis formerstockholdingsrepresented.Astockdividend doesnotconstituteincomeifthenewsharesconfer no different rights or interests that did the old. Q13.7. Areliquidatingdividendssubject to income tax? Yes.Whereacorporationdistributesallofits propertyorassetsincompleteliquidationor dissolution,18thegainrealizedfromthetransaction by the stockholder, whether individual or corporate, is taxableincomeoradeductibleloss,19asthecase may be.20 From whatever source Q13.8. Whatismeantbythephraseall incomederivedfromwhatever source" Thephraseallincomederivedfromwhatever sourceencompassesallaccessionstowealth, clearlyrealized,andoverwhichthetaxpayershave completedominion.Againconstitutestaxable income when its recipient has such control over it that asapracticalmatter,hederivesreadilyrealizable economic value from it.

18Theremustbeabonafideplanofliquidationinvolvingthe transfer of all assets.19Iftheamountreceivedbythestockholderinliquidationisless than the cost or other basis of the stock, the loss in the transaction is deductible.20 Previously, the CIR has ruled in BIR RULING 039-02 [NOVEMBER 11,2002]andotherpreviousrulingsthatthetransferbya liquidatingcorporationofitsremainingassetstoitsstockholders andthereceiptofthesharessurrenderedbytheshareholderare notsubjecttoincometax.However,inBIRRULING479-11 [DECEMBER5,2011],theCIRreversedandsetasidetheabove-citedrulingandallpreviousrulingstothateffect.Therulenowis that they are subject to income tax. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES11Q13.8.1.Is an unlawful gainsubject to income tax? Yes.InJAMESV.US[366US213],theSupreme Courtruledthatembezzledmoneyconstitutesgross income. It opined that unlawful, as well, as lawful gain arecomprehendedwithinthetermgrossincome. TheCourthasgivenaliberalconstructiontogross income in recognition of the intent of Congress to tax all gains except those specifically exempted.

Q13.8.2.Maycancellationor forgivenessof indebtednessamounttoa gain subject to income tax? Yes.If,forexample,anindividualperformsservices foracreditor,who,inconsiderationthereofcancels thedebt,incometothatamountisrealizedbythe debtorascompensationforhisservices.(see Section 50, RR No. 2).21 Q13.8.3.Shouldtaxespreviously claimedandallowedas deductionsbut subsequentlyrefundedor grantedastaxcreditbe consideredpartofgross income? Yes.RMCNo.13-80[April10,1980]providesthat taxespreviouslyclaimedandallowedasdeductions butsubsequentlyrefundedorgrantedastaxcredit should be declared as part of the gross income of the taxpayerintheyearofreceiptoftherefundortax credit.However,taxeswhicharenotallowableas deductions,whenrefundedorcredited,arenot declarable for income tax purposes.22

Inventories Q13.9. Explaintheuseofinventoriesto determinetheincomeofa taxpayer. For certain businesses, the use of inventories may be deemednecessaryinordertodetermineclearlythe

21If,however,acreditormerelydesirestobenefitadebtorand without any consideration therefor cancels the debt, the amount of the debt is a gift. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend.22Theenumerationoftaxesnotallowableasdeductionswillbe provided later.income of a taxpayer. If such is the determination, the taxpayershalltakeinventoriesuponsuchbasisas theSecretaryofFinance,uponrecommendationof theCIR,mayprescribeasconformingasnearlyas may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

Q13.9.1.Is there a particular method ofvaluinginventorythata taxpayer should follow? No. The taxpayer may choose the method of valuding itsinventoryforanytaxableyear,andsuchmethod should be used in all subsequent years unless: 1.WiththeapprovaloftheCIR,achangetoa different method is authorized; or 2.TheCIRfindsthatthenatureofthestockon handissuchthatinventoryainsshouldbe consideredrealizedfortaxpurposesand thereforeitisnecessarytomodifythevaluation method.23 Thus,inBIRRULINGDA-128-08[AUGUST11,2008], PilipinasShellrequestedtochangeitsvaluation method from the Weighted Average Method (WAVE) totheFirst-In-First-Out(FIFO)toconformwiththe adoptionbyanewcomputerizedaccountingsystem basedontheGlobalSystemsApplicationand ProductDataProcessing(GSAP)byitsparent companyanditsaffiliates,includingPilipinasShell. They system uses FIFO. The CIR approved the shift toFIFOnotingthattheWAVEmethodisnolonger compatiblewiththenewaccountingsystemtobe introducedandtobeconsistentwiththeinventory method used by its parents company and affiliates all over the world. Exclusions Q14.What are exclusions? Thetermexclusionsreferstoitemsthatarenot includedinthedeterminationofgrossincome because: 1.Theyrepresentreturnofcapitalorarenot income, gain or profit (e.g. life insurance) 2.Theyaresubjecttoanotherkindofinternal revenue tax (e.g. gifts, bequests, devices) 3.Theyareincome,gainorprofitsthatare expresslyexemptfromincometaxunderthe

23 The CIR shall not exercise this authority more often than every 3 years.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES12Constitution,taxtreaty,TaxCode,orgeneralor special law.(e.g. PEZA) Q15.Whataredeemedexcludedfrom (gross) income? AsprovidedinSection32(B),NIRC,thefollowing items shall not be included in gross income and shall be exempt from income tax 1.Proceedsoflifeinsurance,24payableuponthe death of the insured to the heirs or beneficiaries, butnottheinterestpaymentsthereonifsuch amountsareheldbytheinsurerunderan agreement to pay interest. 2.Amounts received by the insured as return of premiums paid under life insurance, endowment orannuitycontracts,eitherduringthetermorat the maturity of the contract or upon the surrender thereof. 3.Gifts,bequests,anddevises25butnotthe incomefromsuchproperty;iftheamount receivedisonaccountofservicesrendered whetherconstitutingademandabledebtornot suchasremuneratorydonationsortheuseor opportunityoruseofcapital,thereceiptis income. 4.Compensationforinjuriesorsickness whetherbysuitoragreementincludingamounts receivedthroughaccidentorhealthinsuranceor underthe WorkmenscompensationAct,butnot damagesorcompensationrecoveredforlossof profitinlossordamagetopropertywhichwould be taxable 5.Incomeexemptundertreatybindinguponthe Government of the Philippines. 6.Certainretirementbenefits,pensions, gratuities, more particularly: a.RetirementbenefitsreceivedunderRA 7641andthosereceivedbyofficialsand employeesofprivatefirms,whether individualorcorporate,inaccordancewitha reasonableprivatebenefitplan26maintained by the employer provided:

24 It is considered as indemnity rather than income 25Theyareinsteadsubjecttoestateorgifttaxes(seePIROVANO VS. COMMISSIONER [JULY 31, 1965]) 26 Reasonable private benefit plan means a pension, gratuity, stock bonusorprofit-sharingplanmaintainedbyanemployerforthe i.thattheretiringofficialoremployeehas been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement ii.That the benefits granted shall be availed of by an official or employee only once. b.Anyamountreceivedbyanofficialor employeeorbyhisheirsfromthe employerasaconsequenceof separationofsuchofficialoremployee from the service of the employer because ofdeathsicknessorotherphysical disabilityorforanycausebeyondthe control of the said official or employee. c.Theprovisionsofanyexistinglawtothe contrary notwithstanding, social security benefits,retirementgratuities, pensionsandothersimilarbenefits receivedbyresidentornon-resident citizensofthePhilippinesoralienswho cometoresidepermanentlyinthe Philippinesfromforeigngovernment agencies and other institutions, private or public. d.Paymentsofbenefitsdueorto become due to any person(residingin thePhilippines)underthelawsofthe UnitedStatesadministeredbythe United States Veterans Administration. e.Benefitsreceivedfromorenjoyed undertheSocialSecuritySystemin accordancewiththeprovisionsof Republic Act No. 8282. f.Benefits received from the GSIS under RepublicActNo.8291,including retirementgratuityreceivedby government officials and employees. 7.Miscellaneousitems,likewiseexempt, including: a.Incomeofforeigngovernmentsor financing institutions owned, controlled or enjoyingrefinancingfromsuchforeign benefitofsomeorallofhisofficialsoremployees,wherein contributionsaremadebysuchemployerfortheofficialsor employees, or both, for the purpose of distributing to such officials andemployeestheearningsandprincipalofthefundthus accumulated,andwhereinitsisprovidedinsaidplanthatatno time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES13governmentsandofinternationalor regionalfinancialinstitutionsestablished byforeigngovernmentsfromtheir passive investments in the Philippines b.IncomeofthePhilippinegovernment anditspoliticalsubdivisionsderived frompublicutilitiesorintheexerciseof essential governmental functions c.Prizesandawardsmadeprimarilyin recognitionofreligious,charitable, scientific,educational,artistic,literaryor civic achievement but only if: i.Therecipientwasselectedwithout anyactiononhisparttoenterthe contest or proceedings; and ii.Therecipientisnotrequiredto rendersubstantialfutureservicesas aconditiontoreceivingtheprizeor award d.Allprizesandwardsgrantedto athletesinlocalandinternationalsports competitionswhetherheldinthe Philippines or abroad. e.Grossbenefitsreceivedbyofficials andemployeesofpublicandprivate entities provided, however, that the total exclusionshallnotexceedP30,000 which shall cover: i.Benefitsreceivedbyofficialsand employeesofthenationalandlocal government pursuant to RA 6686 ii.Benefitsreceivedbyemployees pursuant to PD 851 iii.Benefitsreceivedbyofficialsand employees not covered by PD 851 iv.Otherbenefitssuchasproductivity incentivesandChristmasbonus providedthattheceilingofP30,000 maybeincreasedthroughtherules andregulationsissuedbythe SecretaryofFinance,upon recommendationofthe Commissioner,afterconsidering, amongothers,theeffectonthe sameoftheinflationrateattheend of the taxable year. f.GSIS,SSS,MedicareandPag-ibig contributionsandunionduesof individuals g.Gainsfromthesaleofbonds, debenturesorothercertificateof indebtednesswithamaturityofmore than 5 years h.Gainsfromtheredemptionofshares of stock in a mutual fund company Also, under Section 33(C), NIRC, the following fringe benefits27 are not taxable: 1.Fringebenefitsauthorizedandexemptedfrom tax under special laws; 2.Contributionsoftheemployerforthebenefitof theemployeetoretirement,insuranceand hospitalization plans; 3.Benefitsgiventorankandfileemployees, whether granted under a CBA or not; 4.De minimis benefits. Retirement benefits Q15.1. Whataretherequirementsto exemptretirementbenefitsfrom income tax? For the retirement benefits to be exempt from income tax,thetaxpayerisburdenedtoprovethe concurrence of the following elements: 1.areasonableprivatebenefitplanis maintained by the employer; 2.theretiringofficialoremployeehasbeenin the service of the same employer for at least ten (10) years; 3.theretiringofficialoremployeeisnotless thanfifty(50)yearsofageatthetimeofhis retirement; and 4.the benefit had been availed of only once 5.Theretirementplanmustbesubmittedto andapprovedbytheBIR(see INTERCONTINENTALBROADCASTING CORPORATIONVS.AMARILLA[OCTOBER 29, 2006]) Q15.2. Anemployermaintainsan employeestrusttoprovide retirement,pension,disability benefitstoitsemployees.The trustmadeinvestmentsand earnedtherefrominterestincome. Isitpropertosubjecttheinterest income to withholding tax? No.AsheldbytheSupremeCourtinCIRV.CA& GCLRETIREMENTPLAN[MARCH23,1992],said retirementbenefitsreceivedbyofficialsand

27Fringebenefitsmeansanygoods,serviceorotherbenefit furnishedorgrantedincashorinkindbyanemployertoan individualemployee(exceptrankandfileemployees).Thiswill discussed more later. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES14employeesofprivatefirmsinaccordancewitha reasonableprivatebenefitplanmaintainedbythe employer shall be exempt from all taxes Q15.3. Agovernmentemployee,retired fromservice.Uponretirement,he received,amongotherbenefits, terminalleavepaywhichtheCIR withheldaportionallegedly representingincometaxthereon. Isterminalleavepayconsidered partofgrossincomeofthe recipient? No. In COMMISSIONER OF INTERNAL REVENUE VS. CA & EFREN CASTANEDA [OCTOBER 17, 1991], the Supreme Courtheldthatterminalleavepayreceivedbya governmentofficialoremployeeisnotsubjectto withholding(income)tax.Therationalebehindthe employeesentitlementtoanexemptionfrom withholdingtaxonhisterminalleaveisthat commutation of leave credits, more commonly known asterminalleave,isappliedforbyanofficeror employeewhoretires,resignsorisseparatedfrom theservicethroughnofaultofhisown.Inthe exerciseofsoundpersonnelpolicy,theGovernment encouragesunusedleavestobeaccumulated. Terminalleavepaymentsaregivennotonlyatthe sametimebutalsoforthesamepolicy considerationsgoverningretirementbenefits.Infine, notbeingpartofthegrosssalaryorincomeofa governmentofficialoremployeebutaretirement benefit,terminalleavepayisnotsubjecttoincome tax.(seeRE:REQUESTOFATTY.BERNANDINO ZIALCITA [OCTOBER 18, 1990]). Q15.4. ArecontributionstoSSS,GSIS, PHICandPag-Ibiginexcessof themandatorycontributions subject to income tax? Yes.Previously,SSS,GSIS,PHICandPag-Ibig contributionsinexcessofthemandatory contributionswereconsideredexemptfromincome tax.However,becauseitwasdeemedtohavebeen abused and the excess contributions are being made asaformofinvestment,RMCNo.027-11[JULY1, 2011]now considers theexcess contributions as not excludiblefromgrossincomeandnotexemptfrom income and withholding tax. Income derived by foreign government Q15.5. Adomesticcorporationentered into a loan and sales contract with aforeigncorporationwherethe lattershallextendaloantothe former and the former shall sell to thelatterallcopperconcentrates tobeproducedfromthemachine tobepurchasedusingtheloaned amount.Theforeigncorporation applied for the loan from one of its governmentfinancinginstitutions. Istheinterestincomefromthe loansautomaticallyexemptfrom withholding tax? No.AsheldinCIRV.MITSUBISHIMETAL CORPORATION[JANUARY22,1990],theburdenof proofrestsuponthepartyclaiminganexemptionto provethatitisinfactcoveredbytheexemption.In thesaidcase,theSupremeCourtfoundthatthe foreigngovernmentfinancinginstitutionhadnothing todowiththesalesandloansagreement.Itisthe foreigncorporation,nottheforeigngovernment financinginstitutionthatisthesolecreditorofthe domestic corporation. De Minimis/PERA Q15.6. What are de minimis benefits? AsdefinedbyRR3-98[MAY21,1998],deminimis benefitsare benefits of relatively small value offered or furnished by the employer to his/her employees as ameansofpromotingthehealth,goodwill, contentment,efficiencyofhis/heremployees.These benefitsareexemptfromthewithholdingtaxon compensationincome,andconsequentlyfrom incometax,regardlessofwhetherornotthe recipients of the benefits are managerial or rank-and-file employees. Q15.6.1.Whataredeemeddeminimis benefits? As providedinRR No. 005-11 [March16, 2011], as amended recently by RR No. 008-12 [MAY 11, 2012], the following shall be considered de minimis benefits notsubjecttoincometaxaswellaswithholdingtax oncompensationincomeofbothmanagerialand rank and file employees: PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES151.Monetizedunusedvacationleavecreditsof privateemployeesnotexceedingten(10)days during the year;28 2.Monetizedvalueofvacationandsickleave creditspaidtogovernmentofficialsand employees;29 3.Medicalcashallowancetodependentsof employees,notexceedingP750peremployee per semester or P125 per month; 30 4.Rice subsidy of P1,500 orone (1) sack of 50 kg. ricepermonthamountingtonotmorethan P1,500;31 5.Uniformandclothingallowancenotexceeding P5,000 per annum;32 6.Actualmedicalassistance,e.g.medical allowancetocovermedicalandhealthcare needs,annualmedicalcheck-up,maternity assistance,androutineconsultations,not exceeding P10,000 per annum;33 7.LaundryallowancenotexceedingP300per month;34 8.Employeesachievementawards,e.g.forlength of serviceorsafetyachievement, with an annual monetary value not exceeding P10,000;35 9.GiftsgivenduringChristmasandmajor anniversarycelebrationsnotexceedingP5,000 per employee per annum;36 10.Dailymealallowanceforovertimeworkand night/graveyardshiftnotexceeding25%ofthe basic minimum wage per region basis.37 Q15.6.2.Istheenumerationofde minimis benefits exclusive?

28 This was included in RR 3-98 and in RR 8-00 [August 21, 2000] butreferredtoemployeesingeneral.RRNo.005-11[March16, 2011] specifically provided private employees.29 Introduced by RR 10-00 [December 14, 2000] 30 Provided under RR 3-98 and RR 8-00 [August 21, 2000] 31UnderRR3-98,theamountwasP350.RR8-00[August21, 2000] increased this to P1,000 and added the alternative 1 sack of 50kg of rice. This was increased by RR 5-2008 [APRIL 17, 2008] to P1,500.32RR3-98didnotprovideforanamount.RR8-00[August21, 2000]providedforanamountofP3,000.RRNo.005-11[March 16,2011]providedforanamountofP4,000.Thiswasagain increased by RR No. 008-12 [MAY 11, 2012] to P5,000. 33RR3-98simplysaidmedicalbenefitswithnocorresponding amount.RR8-00[August21,2000]providedtheamountof P10,000 as the ceiling.34RR3-98providedforanamountof P150.RR8-00 [August21, 2000] increased it to P300. 35 RR 3-98 provided for a ceiling of month of the basic salary of theemployee.RR8-00[August21,2000]changedtheceiling amount to P10,000. 36RR3-98didnotprovideforaceilingamount.RR8-00[August 21, 2000] introduced the P5,000 ceiling.37 Introduced by RR 8-00 [August 21, 2000]. Yes.AsprovidedinRRNo.005-11[March16, 2011],allotherbenefitsgivenbyemployerswhich arenotincludedintheenumerationshallnotbe considered de minimis benefits, and, hence, shall be subjecttoincometaxaswellaswithholdingtaxon compensation income. Q15.7. Isincomeearnedbyacontributor fromtheinvestmentsand reinvestmentsofhisPersonal EquityandRetirementAct(PERA) assets subject to income tax? No.AsprovidedinRRNo017-11[OCTOBER27, 2011],implementingthetaxprovisionsofRA9505, otherwiseknownasthePersonalEquityand RetirementAccount(PERA)Actof2008,investment incomeofacontributorconsistingofallincome earnedfromtheinvestmentsandreinvestmentsof hisPERAassetsinthemaximumamountallowed shallbeexemptfromthefollowingtaxesasmaybe applicable: 1.Finalwithholdingtaxoninterestfromany currencybankdeposit,yieldoranyother monetarybenefitfromdepositsubstitutesand fromtrustfundsandsimilararrangements, including a depository bank under the EFCDS; 2.Capitalgainstaxonthesale,exchange, retirementormaturityofbonds,debenturesor other certificates of indebtedness; 3.10%taxoncashand/orpropertydividends actuallyorconstructivelyreceivedfroma domesticcorporation,includingamutualfund company; 4.Capitalgainstaxonthesale,barter,exchange, orotherdispositionofsharesofstockina domestic corporation; 5.Regular income tax. General Principles Q16. Whatarethegeneralprinciplesof incometaxationinthePhilippines (Section 23, Title II, NIRC)? ExceptasotherwiseprovidedinthisCode,the general principles are: Resident Citizen taxableonallincomederived fromsourceswithinandoutside the Philippines Non-Resident Citizen taxableonlyonincomederived fromsourceswithinthe PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES16Philippines [Bydefinitionofanon-resident citizen,thisappliestoan overseascontractworker(a citizenworkingandderiving income from abroad)] Alien(whether residentor non-resident) taxableonlyonincomederived fromsourceswithinthe Philippines Domestic corporation taxableonallincomederived fromsourceswithinandoutside the Philippines Foreign corporationtaxableonlyonincomederived fromsourceswithinthe Philippines (This applies whether the foreign corporationisengagedornotin tradeorbusinessinthe Philippines) Simplyput,onlyresidentcitizensanddomestic corporationsaretaxableontheirworldwideincome whiletheothertypesofindividualandcorporate taxpayersaretaxableonlyonincomederivedfrom sources within the Philippines. Additionally,itmustbenotedthatonlyanon-resident alien not engaged in trade or business in thePhilippinesandnon-residentforeign corporationsaretaxedongrossincomewhileall othertypesoftaxpayersaresubjecttotaxonnet income (i.e. may claim deductions). Source of Income Rules38 Q17. What is meant by source of income? Thesourceofanincomeistheproperty,activityor servicethatproducedtheincome.Itisthephysical sourcewheretheincomecamefrom.(seeCIRVS. BAIER-NICKEL [AUGUST 29, 2006]). Q18. Whatarethesourceofincomerulesin thePhilippines?(Section42,TitleII, NIRC)

38Forthesourceofincomerules,myreferenceISMICHAELJ. MCINTYRE,INTERNATIONALTAX:TEXT,CASES,PROBLEMS,AND QUESTIONS(2013).Most,ifnotall,ofourtaxbooksfailto sufficiently explain source of income rules and, thus, recourse to a foreign material is warranted. The rules are applicable as they are basedontheUSTaxCode,ofwhichourowntaxlawsare modeled after.InterestsThe source of an interest payment is the place of residence of the person obligatedtomakethatpayment (residence-of-the-obligor rule). ItisincomewithinthePhilippinesif the residence of the obligor is in the Philippines. It is income without the Philippines if theresidenceoftheobligoris abroad. DividendsGenerally,adividendhasitssource in the country where the corporation paying the dividend is incorporated. Thus, if the dividend is received from adomesticcorporation,itisincome within the Philippines. If the dividend isfromtheforeigncorporation,itis income without the Philippines. Theexceptiontothegeneralrule thatdividendspaidbyaforeign corporation are from sources without thePhilippinesiswhenaforeign corporation derives50 percent of its grossincomefromsourceswithin thePhilippinesforathree-year periodendingwiththecloseofits taxableyearprecedingthe declaration of its dividends Services Incomefromservicesissourcedin thecountrywheretheservicesare performed. Thus,itisincomewithinthe Philippinesiftheserviceis performedinthePhilippines.Itis income without the Philippines if it is performed abroad. Rentsand RoyaltiesTherentalincomeandroyalty incomederivedfromtheuseof propertyhasitssourceinthe country where the property is used. Fortangibleproperty,theplaceof useistheplacewherethetangible property is actually located. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES17Thus,itisincomewithinthe Philippinesifrentsandroyaltiesare derivedfrompropertylocatedinthe Philippines Forintangibleproperty,thecountry ofuseisthecountrythatprotects the owner of that property against its unauthorizedusebyother persons.39 Thus,itisincomewithinthe Philippinesifitisusedinthe Philippinesandtheunauthorized useofsuchintangiblepropertyis protected by Philippine law. Saleof Real Property Incomefromthesaleofreal propertyissourcedinthecountry where the real property is located. Thus,itisincomewithinthe Philippinesiftherealpropertyis locatedinthePhilippines.Itis income without if the real property is located abroad. Saleof Personal Property Theincomefromthesaleof personalpropertyhasitssourcein thecountrywherethepersonal property is sold.40 Thus, if the personal property is sold in the Philippines, it is income within thePhilippines.Ifsoldabroad,itis income without the Philippines. Notethatgainsfromsaleofshares ofstockofadomesticcorporation aretreatedasderivedentirelyfrom sourceswithinthePhilippines regardlessofwherethesaidshares are sold.

39 This is the generally accepted rule.40 In the US, the rule is that income from sale of personal property issourcedinthecountrywherethesellerisresident(residence-of-the-seller rule) Q18.1. InCIRv.MARUBENI[DECEMBER18, 2001],assumingthatMarubeni wasdisqualifiedfromavailingof the income tax amnesty, would the income from the services rendered inconnectionwiththeturn-key projects constitute as income from Philippine sources? Theanswerisbothyesandno.Theanswerisyes withregardtothoseservicesperformedinthe Philippines.Theansweris,however,nowithregard tothoseservicesrenderedinJapan.Suchservices were rendered outside the taxing jurisdiction and thus constituteasincomewithoutthePhilippines. Marubeni, being a foreign corporation, is taxable only on income within the Philippines and, hence, income from services rendered in the Philippines. Q18.2. ABCAirwaysisaforeignairline.41 Whileitdidnotcarrypassengers and/orcargotoorfromthe Philippines,ABCmaintainsa general sales agent of its tickets in thePhilippines.Isthesaleofthe ticketstaxableasincomefrom sources within the Philippines? Yes.Forthesourceofincometobeconsideredas comingfromthePhilippines,itissufficientthatthe income is derived from activity within the Philippines. In ABCs case, the sale of tickets in the Philippines is theactivitythatproducestheincome.Thetickets exchangedhandshereinthecountryandthe paymentsforfareswerealsomadewithPhilippine currency.Thesiteofthesourceofpaymentsisthe Philippines.Theabsenceofflightoperationstoand fromthePhilippinesisnotdeterminativeofthe sourceofincome/siteofincometaxationforthetest oftaxabilityisthesource.(seeCIRVS.JAPAN AIRLINES[MARCH6,1991];CIRVS.BOAC[APRIL30, 1987]) Q18.3. XYZenteredintoreinsurance contractswithforeigninsurance companiesnotdoingbusinessin

41Itisaresidentforeigncorporation.Inorderthataforeign corporationmayberegardedasdoingbusinesswithinaState, theremustbecontinuityofconductandintentiontoestablisha continuousbusiness,suchastheappointmentofalocalagent, andnotoneofatemporarycharacter.ABC maintainedageneral sales agent and it was engaged in selling or issuing tickets, which is considered the main lifeblood of an airline. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES18thePhilippines.XYZwastocede portions of premiums underwritten inthePhilippinestotheforeign corporationsinconsiderationfor theassumptionofrisk.Isthe cessionofthepremiumstaxable as income from sources within the Philippines? Yes.Sourcesmeanstheactivity,property,or servicegivingrisetotheincome.Theoriginal insurance undertakings took place in the Philippines. Itisnotrequiredthattheforeigncorporationbe engagedinbusinessinthePhilippines.Whatis controllingisnotheplaceofbusiness,buttheplace of activity that created theincome. Thus, the income is subject to income tax. (see PHILIPPINE GUARANTY V. CIR[APRIL30,1965]andHOWDEN&CO.V.CIR [APRIL 14, 1965]). Q18.4. ABC,adomesticcorporation, enteredintoaManagement ServiceAgreementwithXYZ,a non-residentforeigncorporation underwhichthelattershall provideservicesforABCsUS branchandadviceonABCs corporatestructure,allperformed abroad.Isthecompensationfor servicestaxableasincomefrom sources within the Philippines? Yes.Theservicescoveredbythemanagement serviceagreementfallunderthemeaningof royalties.Itisimmaterialifthenon-residentforeign corporationhasnopropertiesinthePhilippines.The testoftaxabilityisthesourceandthesourceofan income is that activitywhich produced the income. It isnotthepresenceofanypropertyfromwhichone derivesrentalsandroyaltiesthatiscontrolling,42but rather as expressed underthe expanded meaning of royalties,itincludesroyaltiesforthesupplyof scientific,technical,industrial,orcommercial, knowledgeorinformation;andthetechnicaladvice, assistanceorservicesrenderedinconnectionwith thetechnicalmanagementandadministrationofany scientific,industrialorcommercialundertaking, venture,projectorscheme.(seePHILAMLIFEV.CTA [CA-GR SP. NO. 31283, APRIL 25, 1995]).

42 This confirms the acceptance of the Philippine taxing jurisdiction oftherulethatastointangibleproperty,the countryofuseis the countrythatprotectstheownerofthatpropertyagainstits unauthorized use by other persons. Q18.5. A,anon-residentcitizen,was engagedbyadomestic corporationasacommission agent.Awillreceiveasales commissiononallsalesactually concluded.Aarguesthatthe incomeisnottaxableasAdoes notresideinthePhilippinesand thattheplaceofpaymentofthe incomeisoutsidethePhilippines. Is As contention correct? No.Thesourceofanincomeistheproperty, activity or service that produced the income. With respectofrenditionoflabororpersonalservice, asintheinstantcase,itistheplacewherethe labor or service is performed that determines the source of income. There is therefore no merit in As interpretationwhichequatessourceofincomein labororpersonalservicewiththeresidenceofthe payorortheplaceofpaymentoftheincome.(see CIR VS. BAIER-NICKEL [AUGUST 29, 2006])43 Q18.6. QuillCorpisanofficesupply retailerwithnophysicalpresence inNorthDakotabutithasa licensedcomputersoftware programthatitscustomersin NorthDakotauseforchecking Quillscurrentinventoriesandfor placingordersdirectly.North Dakotaattemptedtoimposea usetax44onQuill.IsQuillliable for the tax? Yes.InQUILLCORPV.NORTHDAKOTA[504US298, MAY26,1992],theUSSupremeCourtruledthat theremustbephysicalpresenceinastateforthe corporationtobeliableforsalesandusetaxes.It applieditsrulinginNATIONALBELLASHESSV. DEPARTMENTOFREVENUEOFILLINOIS[386US753] where it held that a seller whose only connection with customersintheStateisbycommoncarrierorthe maillackedtherequisiteminimumcontactswiththe

43 Note that in this case, Baier-Nickel argued that the services were doneinGermany.However,she failedtoprovehatsuchwasthe fact. Thus, the services were deemed performed in the Philippines, and, as such, is subject to income tax.44AusetaxisatypeofexcisedtaxleviedintheUnitedStates upon otherwise "tax free" tangible personal property purchased by aresidentoftheassessingstate foruse,storageorconsumption ofgoodsinthatstate(notforresale),regardlessofwherethe purchase took place.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES19State.Thus,suchvendorsarefreefromstate-imposeddutiestocollectsalesandusetaxes. Nevertheless,theUSSupremeCourtopinedthatif interstatecommercewouldbesubjecttointolerable orundesirableburdensbecauseofthis,Congress hasthepowertolegislatemakesuchvendorsliable for sales and use taxes.45 Q18.7. VodafoneInternationalHoldings (VIH),acorporationinthe Netherlands,acquireda controllinginterestofCGP holdings,acompanyinthe CaymanIslands.Byvirtueofthis controlling interest, VIH acquired a 52%stakeinHutchinsonEssar Limited(HEL)46inIndiafrom HutchinsonTelecomInternational Limited(HTIL).Simplystated,VIH acquiredcontroloverCGPandits subsidiaries,includingHEL.The Indiantaxauthoritiescontended thatthetransferofshareswas subjecttoincometax.VIHargues thatthetransferofsharestook placeoutsidetheIndiantaxing jurisdiction,and,hence,isnot taxable.Whichcontentionis correct? ThecontentionofVIHwasheldtobecorrect.In VODAFONE INTERNATIONALHOLDINGS B.V. V. UNION OF INDIA(SUPREMECOURTOFINDIA,CIVILAPPEALNO. 733OF2012,JANUARY20,2012),47theIndian SupremeCourtruledthatVIHhadnoliabilityto withhold tax as the transaction was between two non-residentswithnotaxablepresenceinIndia.Under Section9(1)oftheIncomeTaxActofIndia,all incomeaccruingorarising,whetherdirectlyor

45 Note that, as of this updated version, the BIR plans to impose a sales tax on online retailers in the opinionthat such sellers are no different from merchants who sell their goods in physical stores. A RR on the matter is forthcoming.46 HEL was an Indian joint venture between HTIL, a corporation in Hong Kong, and Essar, an Indian corporation. 47 It is also important to note, that in this case, the Indian Supreme Court stated that, on the context of taxation of a holding company structure,thecorporateveilmaybeliftedonlyifitisestablished that the transaction was a sham or there was abuse. In this case, the shares of CGP were transferred only for a commercial benefit andnotwiththeobjectoftaxevasion.Thestructurewasin existenceoveradecade,itwasnotcreatedorusedasan instrumentfortaxavoidance,VIHwasnotashort-timeinvestor anditdidnotintroduceanynewpracticetograntitselfa controlling interest. indirectly through transfer of capital assets situated in IndiashallbedeemedtoaccrueorariseinIndia.48 TheSupremeCourtstatedthatthesectionclearly applied to a transferof capital asset situated in India and could not be expanded to cover indirect transfers ofcapitalassetsorpropertysituatedinIndia.The wordsdirectlyorindirectlygowiththeincomeand not with the transfer of a capital asset.49

Q18.8. Is the gross income of branches of foreigncorporationsgenerated fromsolicitationofordersfrom localimporterswherethe branchesmerelyrelaytoitshead office abroad said purchase orders andwheretheheadofficeisthe entitywhichactually consummatesthesaleliablefor income tax? Yes.ByvirtueofRAMONo.1-86[April25,1986], anincometaxisimposedonthegrossincome generatedfromconstructivetradingand commissionincomederivedfrombrokeringactivities ofPhilippinebranchesofforeigncorporations engagedintradingactivities.RAMONo.01-95 [March 21, 1995] expanded RAMO No. 1-86 to cover taxationofPhilippinebranchesofforeign corporations engaged in soliciting orders, purchases, servicecontracts,trading,constructionandother activities. Q18.9. ABC,amultinationalcompany, claimedasdeductionfromgross incomeitsshareoftheoverhead expensesofitsforeignhead office.Cantheseoverhead expensesoftheforeignhead officebedeductedfromthegross income of the Philippine branch? It depends. Either it can be deducted in full or partly. Where an expense is clearly related to the production ofPhilippine-derivedincomeortoPhilippine operations(e.g.salariesofPhilippinepersonnel,

48TheIndiantaxingauthoritiesarguedthatthiswasalook-through provision a look through provision so that if there was a transfer, of a capital asset, situated in India, it meant income from capital gains accruing or arising outside Indiawould be fictionally deemed to accrue or arise in India. 49TheIndianSupremeCourtalsonotedthattheexistenceofthe DirectTaxCodeBillof2010whichexpresslystatedthatincome accuringevenfromindirecttransferofcapitalassetssituatedin IndiawouldbedeemedtoaccrueinIndiabutthisisnotyetin force. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES20rentalofofficebuildinginthePhilippines),that expensecanbedeductedfromthegrossincome acquiredinthePhilippineswithoutresortingto apportionment.However,wherethereareitems includedintheoverheadexpensesincurredbythe parentcompany,allofwhichcannotbedefinitely allocatedoridentifiedwiththeoperationsofthe Philippinebranch,thecompanymayclaimasits deductiblesharea ratablepartofsuchexpenses basedupontheratioofthelocalbranch'sgross incometothetotalgrossincome,worldwide,ofthe multinationalcorporation.(seeCOMMISSIONERVS. CTA&SMITHKLINE[JANUARY17,1984];seealso RAMO 4-86 [April 5, 1986]) Deductions Q19. What are the kinds of deductions? 1.Deductionsfromcompensationincome referstothepersonalandadditionalexemptions inSection35,NIRCandpremiumpaymentson health and/or hospitalization insurance which are allowed to be deducted by an individual taxpayer whoreceivesincomeforpersonalservices renderedunderanemployer-employee relationship 2.Deductionsfrombusinessand/or professionalincomereferstotheitemized deductionsinSection34(A)to(M)including thosedeductiblefromcompensationincome, whichaself-employedindividualorprofessional engagedinthepracticeofaprofessionmay deduct. 3.Deductionsfromcorporateincomerefersto theitemizeddeductionsinSection34(A)to(J) whichcorporations(includingpartnershipsother thanGPPs)engagedintradeorbusinessare authorized to claim 4.Specialdeductionsrefertothedeductions allowedinadditiontotheitemizeddeductions allowabletocorporationswhichmaybeavailed ofbyinsurancecompaniesandproprietary educationalinstitutionsandnon-profithospitals as well as estates and trusts. Q19.1. Whocanavailofthedeductions provided for under the law? All taxpayers except: 1.Nonresidentaliensnotengagedintradeor business; and 2.Nonresidentforeigncorporationsorthose corporations not engagedin trade orbusiness in the Philippines With respect to the itemized deductions, they cannot beavailedbycitizensandresidentalienswhose incomeispurelycompensationincomefromwhich onlythepersonalandadditionalexemptionsand premiumpaymentsonhealthandhospitalization insurance are deductible. Sections 34 and 35, Tax Code Q20. Whataretheallowableanditemized deductions under the Tax Code? The allowable and itemized deductions include: 1.Business Expenses (Expenses in connection with taxpayers trade, business or profession) 2.Interest on Indebtedness 3.Taxesinconnectionwithtaxpayers business, trade or profession [except income taxes,estateanddonorstaxes,special assessments,andforeignincometaxes (unlessthetaxpayerdoesnotmakeuseof the tax credit privilege)] 4.Losses 5.Bad debts 6.Depreciation 7.Depletion 8.Charitable and other contributions 9.Research and development expenditures 10.Contributions to pension trusts Business expenses Q21. What are the requisites for deductibility of business expenses?50 The requisites are: 1.Theexpensemustbeordinaryand necessary 2.Paid or incurred during the taxable year 3.Incarryingonthetradeorbusinessofthe taxpayer 4.Reasonable in amount 5.Substantiated by sufficient evidence

50Thisisthegeneralrulewhichistobefollowedforallbusiness expenses. The enumeration provided in certain business expenses provide for additional requisites.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES216.Mustnotbeagainstlaw,morals,public policy, or public order Q21.1. Whatismeantbyordinaryand necessary expenses? Anexpenseis'ordinary'whenitconnotesa payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. Anexpensewillbeconsidered'necessary'where theexpenditureisappropriateandhelpfulinthe development of the taxpayer's business Q21.2. What is meant by paid or incurred during the taxable year? Paidorincurredduringthetaxableyearmeansthat thedeductionshallbetakenforthetaxableyearin which paidoraccrued orpaid orincurred dependent ontheaccountingmethodinwhichnetincomeis computed Q21.2.1.ABCCorpfailedtoclaim expensesforprofessional servicesthataccruedinpast years.MayABCCorpstill claimtheseexpensesas deductions? No.InCOMMISSIONEROFINTERNALREVENUEVS. ISABELACULTURALCORPORATION(FEBRUARY12, 2007),IsabelaCorpfailedtoclaimtheexpensesfor professionalservicesthataccruedin1984and1985 during the said years. Instead, it sought to claim them asdeductionsduringthetaxableyearof1986.The Supreme Court held that one of the requisites for the deductibilityofabusinessexpensesisthatitmust havebeenpaidorincurredduringthetaxableyear. Hence,theprofessionalfeesshouldhavebeen claimedasdeductionsduringtheyearswherethey were paid or incurred. Q21.3. Whatarethetypesofbusiness expensesspecificallyincludedin the Tax Code as deductions? As provided in Section 34(A)(1)(a), these are: 1.Reasonableallowanceforsalariesorother compensationforpersonalservices actually rendered to the taxpayer 2.Reasonableallowancefortravelexpenses in the pursuit of trade, business or profession 3.Reasonableallowanceforrentalsandor otherpaymentsrequiredforthecontinued useorpremiumofthepropertyforthe purposeofthetradeorbusinessandto which property the taxpayer has not taken or isnottakingtitleorinwhichhehasno equity.51

4.Reasonableallowanceforentertainment, amusementandrecreationexpenses providedthattheyareconnectedtothe developmentandoperationofthetrade, businessorprofessionandthatitisnot contrary to law, morals, public policy or public order. Q21.4. Istheenumerationofbusiness expensesprovidedintheTax Code exclusive? No. Ataxpayeris entitled to deduct the ordinary and necessary expenses paid in carrying on his business from his gross income from whatever source. Q21.4.1.Namesomespeciallaws whichprovidefordeductible business expenses. 1.RepublicAct10028(ExpandedBreastfeeding Promotion Act) Thelawprovidesthattheexpensesincurredbya privatehealthandnon-healthfacility,establishment orinstitution,incomplyingwiththeprovisionsofthis Act,shallbedeductibleexpensesforincometax purposesuptotwicetheactualamountincurred provided: 1.That the deduction shall apply for the taxable period when the expenses were incurred 2.Thatallhealthandnon-healthfacilities, establishmentsandinstitutionsshallcomply withtheprovisionsofthisActwithinsix(6) months after its approval 3. Thatsuchfacilities,establishmentsor institutionsshallsecurea"WorkingMother-Baby-FriendlyCertificate"fromthe DepartmentofHealthtobefiledwiththe Bureau of Internal Revenue, before they can avail of the incentive. 2.RepublicAct8502(JewelryIndustry Development Act)

51 In the latter case, he may claim depreciation allowance PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES22The law provides for a deduction from taxable income of fifty percent (50%) of expenses incurred in training schemesinconnectionwiththeActandwhichshall bedeductibleduringthefinancialyeartheexpenses were incurred. 3. Republic Act 8525 (Adopt a school act) Thelawprovidesforadeductionfromthegross income equivalent to fifty percent (50%) of expenses incurred in connection with the said act. 4. Republic Act 9999 (Free Legal Assistance Act) Thelawprovidesthatalawyerorprofessional partnershipsrenderingactualfreelegalservices,as defined by the Supreme Court, shall be entitled to an allowabledeductionfromthegrossincome,the amount that could have been collected for the actual freelegalservicesrenderedoruptotenpercent (10%)ofthegrossincomederivedfromtheactual performanceofthelegalprofession,whicheveris lower Q21.4.2.Namesomerevenue regulationsimplementing special laws which provide for deductible business expenses. 1. RR 1-2009 [December 9, 2008] TheRRprovidesthatsalesdiscountsgivento personswithdisabilitiesshallbedeductiblefrom gross income subject to certain conditions. 2. RR 7-2010 [July 20, 2010] TheRRprovidesthatdiscountsgiventosenior citizensoncertaingoodsandservicesshallbe deductiblefromgrossincome.Also,private establishmentsemployingseniorcitizensshallbe entitledtoadditionaldeductionsfromgrossincome equivalent to fifteen (15%) of the total amount paid as salaries and wages to senior citizens. Q21.4.3.Areadvertisingexpenses deductiblefromgross income? It depends on the nature of the advertising expense. In COMMISSIONER OF INTERNALREVENUE VS. GENERAL FOODS(PHILS.)INC.[APRIL24,2003],General Foods claimed as deductions its advertising expenses for its productTang.TheCIRdisallowedthededuction arguingthattheadvertisingexpensesarenot business expenses but capital expenditures. TheSupremeCourtruledinfavoroftheCIR. Advertisingisgenerallyoftwokinds:(1)advertising to stimulate the current sale of merchandise or use of servicesand(2)advertisingdesignedtostimulate the future saleofmerchandiseoruseofservices. Thesecondtypeinvolvesexpendituresincurred,in wholeorinpart,tocreateormaintainsomeformof goodwillforthetaxpayerstradeorbusinessorfor theindustryorprofessionofwhichthetaxpayerisa member. If the expenditures are for the advertising of thefirstkind,then,exceptastothequestionofthe reasonablenessofamount,thereisnodoubtsuch expendituresaredeductibleasbusinessexpenses. If,however,theexpendituresareforadvertisingof the second kind, then normally they should be spread outoverareasonableperiodoftimeTheprotection ofbrandfranchiseisanalogoustothemaintenance of goodwillortitle to ones property. This is a capital expenditurewhichshouldbespreadoutovera reasonableperiodoftime. Thiswasakintothe acquisitionofcapitalassetsandthereforeexpenses relatedtheretowerenottobeconsideredas businessexpensesbutascapitalexpenditures.The advertisingexpenseincurredbyGeneralFoodsfall under the second type. Q21.4.4.ABCCorporationpaidaPR firmtocampaignforthesale ofABCsadditionalcapital stock.Isthecompensation paidtothePRfirmdeductible as a business expense? No.InATLASCONSOLIDATEDMINING&DEVELOPMENT CORPORATIONVS.COMMISSIONEROFINTERNAL REVENUE(JANUARY27,1981),theSupremeCourt held that this is not deductible because it is a capital expenditure. Expenses relating to the recapitalization andreorganizationofthecorporation,promotion expensesandcommissionorfeesforthesaleof stock reorganization are capital expenditures. Q21.4.5.Arelitigationexpenses deductibleasabusiness expense? No.AsheldinATLASCONSOLIDATEDMINING& DEVELOPMENTCORPORATIONVS.COMMISSIONEROF INTERNALREVENUE(JANUARY27,1981),litigation expenses incurred in defense or protection of title are capital in nature and not deductible. PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES23Q21.4.6.A,ahotelowner,claimedas deductionpromotion expensesincurredbyhiswife forthepromotionofthehotel. Half of the said expenses were disallowedasdeductions because on the finding that his wifewentabroadona combinedbusinessand medicaltrip.Isthe disallowance proper? Yes.InZAMORAVS.COLLECTOROFINTERNAL REVENUE [MAY 31, 1963],Zamora, a hotel owner, claimedasdeductionpromotionexpensesincurred by his wife for the promotion of the hotel. On appeal, theCTAonlyallowed50%ofthepromotional expenses as deductions because itwasfoundin the CentralBankdollarallocationthathiswifewent abroad on a combined business and medical trip. TheSupremeCourtstatedthatpromotional expensesaredeductiblebutmustbesubstantiated. Whensomeoftherepresentationexpensesclaimed by the taxpayer were evidenced by vouchers or chits, but others were without vouchers or chits, documents orsupporting papers; that there is no more than oral proof to the effect that payments have been made for representationexpensesallegedlymadebythe taxpayerandaboutthegeneralnatureofsuch allegedexpenses;thataccordingly,itisnotpossible todeterminetheactualamountcoveredby supporting papers and the amount without supporting papers,the court shoulddetermine from allavailable data,theamountproperlydeductibleas representationexpenses.Inviewofthis,the SupremeCourtheldCTAdidnotcommiterrorin allowingaspromotionexpensesinAsincometax returns at merely one-half. Q21.4.7.Arepoliceprotectionfeesand giftsforanexhibitionfor charitablepurposes deductibleasabusiness expense? No.InCALANOCVS.COLLECTOROFINTERNAL REVENUE[NOVEMBER29,1961],atissueinthiscase is the deductibility of the expenses incurred for police protection and for gifts and parties in connection with theboxingandwrestlingexhibitionthatCalanoc financedandpromotedwhoseproceedswouldbe giventotheorphansanddestitutechildrenofthe ChildWelfareWorkersCluboftheSocialWelfare Commission. The Supreme Court held that the police protection fees were not deductible as they are illegal sinceitwasconsiderationfortheperformanceof functions required of policemen by law. As to the gifts andparties,theyweredeemedexcessive considering that the purpose of the exhibition was for a charitable cause. Q21.5. Whatistheruleonthe deductibilityofcompensation payments? Thetestofdeductibilityinthecaseofcompensation paymentsiswhethertheyarereasonableand paymentspurelyforthepersonalservicesactually rendered. Q21.5.1.A,anexperiencerealtor,was paidsupervisionfeesinthe amountofP100,000annually byXYZCorporationfora three-yearproject,anamount when combined with his salary andbonusesisdoublethe XYZsincome.Arethe supervision fees deductible? No. In C.M. HOSKINS & CO., INC. VS. COMMISSIONER OF INTERNALREVENUE[NOVEMBER28,1969],Hoskins& Co. claimed as deductions the payment of P100,000 toitsfounderandcontrollingstockholder,Hoskins representing50%ofthe8%supervisionfeesthe companyreceivedasmanagingagentforParadise Farms.Inthiscase,theSupremeCourtheldthat suchwasnotdeductibleforfailingtopassthe reasonablenesstest.Ifallowed,Hoskinwouldbe receivingonhissalary,bonus,andsupervisionfees attotalofP185,000whichisdoublethecompanys reportednetincome. The Supreme Court stated that ifitwasaone-timepayment,itcouldhavebeen deductedsinceHoskinwasanexperiencedrealtor. However,theP100,000supervisionfeewasbeing paideveryyear(forthreeyears)fortheentire durationofthecompanysprojectwithParadise Farms. Q21.6. Are salaries deductible? Yesprovidedthattheycomplywiththefollowing requisites: 1.Theexpensemustbebothordinaryand necessary 2.Thesalariesmustbepaidorincurredwithin the taxable year PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES243.Thesalariesmustbeincurredincarryingon a trade or business 4.Thesalariesmustbeforpersonalservices actually rendered 5.The salaries must be reasonable in amount. Q21.7. Arebonusestoemployees allowabledeductionsfromgross income? Yes provided that: 1.They are made in good faith2.They are given for personal services actually rendered3.Theydonotexceedareasonable compensationfortheservicesrendered when added to the stipulated salaries. Q21.7.1.Canabonusgivento corporate officers be deducted fromgrossincomefromthe sale of one of its properties on therepresentationthat corporate officers, by virtue of theirpositions,contributedto the consummation of the sale? No.InAGUINALDOINDUSTRIESCORPORATIONVS. COMMISSIONEROFINTERNALREVENUE[FEBRUARY25, 1982],AguinaldoIndustriessoughttoclaimas deductions the bonuses given to its corporate officers fromthesaleofoneofitsproperties.TheSupreme Court held that the said bonuses cannot be deducted becausethereisnoevidencethatthesaidofficers did any work which would be the basis of the grant of thebonuses.Oneoftherequisitesforthe deductibilityofbonusesisthattheyaregivenfor personal services actually rendered. Q21.7.2.ABCCorporationclaimedas deductionsbonusesitgaveto itsnon-residentpresidentand vice-presidentandthe bonuses it gave to its resident officersandemployees.The companygaveitsresident officersandemployeesmuch more.Thedeductionsfor bonusesgiventoresident officersandemployeeswere disallowed for being excessive andfornospecialreason.Is the disallowance proper? Itwould dependon the nature, extent, and quality of the services actually rendered by the resident officers andemployees.InKUENZLE&STREIFF,INC.VS. COLLECTOROFINTERNALREVENUE[OCTOBER20, 1959],theSupremeCourtheldthatthebonusesto itsresidentofficersandemployeeswerereasonable taking into account the situation at the time when the serviceswererendered:unsettlingconditionsafter thewar,theimpositionofcontrolsonexportsand imports,andheuseofforeignexchangewhich resulted in diminution of the amount of business. Q21.8. What are some factors that may be consideredindeterminingthe reasonablenessofthe compensation paid for services? They are: 1.The payment must be made in good faith 2.The character of the taxpayers business 3.The volume and amount of its net earnings 4.The locality in which the business is in 5.The type and extent of the services rendered 6.The salary policy of the corporation 7.The size of the particular business 8.Theemployeesqualificationsandbusiness venture 9.The general economic conditions Thereisnofixedtestindeterminingthe reasonablenessofagivenbonusascompensation. This depends on many factors and the situation must be considered as a whole. Q21.9. Whatistheruleonthe deductibilityofrepresentationor entertainment,amusementand recreation expenses? Such expenses must: 1.bedirectlyrelatedtoorinfurtheranceofthe conduct of the trade, business orexerciseof the profession 2.notbecontrarytolaw,morals,publicpolicy or public order 3.notexceedsuchceilingsprescribedbythe Secretary of Finance. Q21.9.1.Isthereaceilingon entertainment,amusement and recreational expenses? Yes.RR10-2002[JULY10,2002]providesthat sellersofgoodsorpropertiesareallowedtodeduct PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES250.5%oftheirnetsalesasrepresentationexpenses whilesellersofservicesaregranted1%oftheirnet revenuesasrepresentationexpenses.However, whensupportingdocumentsreflectaloweramount, then such lower amount shall be used. Interest (as amended by Republic Act 9337) Q22. HowisinterestdefinedundertheTax Code? Interestshallrefertothepaymentfortheuseor forbearance or detention of money, regardless of the nameitiscalledordenominated.Itincludesthe amountpaidfortheborrowersuseofmoneyduring thetermoftheloan,aswellasforhisdetentionof money after the due date for its repayment. Q23. What is indebtedness? Indebtednessissomethingownedbyonewhois unconditionally obligated or bound to pay Q24. Whataretherequisitesforthe deductibilityofinterestexpensesfrom gross income? The requisites are: 1.There must be indebtedness 2.Theindebtednessmustbeconnectedwith thetaxpayerstrade,businessorexerciseof profession 3.The interest must be legally due 4.The interest expense must have been paid or incurred during the taxable year. 5.Theinterestmusthavebeenstipulatedin writing Q24.1. Dotaxobligationsconstitute indebtedness? Yes. In COMMISSIONER OF INTERNAL REVENUE VS. VDA. DEPRIETO[SEPTEMBER30,1960],Vda.dePrieto conveyedrealpropertybywayofgiftstoherfour children.Shewasassessedfordonorsgifttaxes includinginterestsduethereon.Sheclaimedas deductionthetotalinterestonaccountofthe delinquency.Shecontendsthattheinterestsdue fromhertaxobligationsaredeductiblefromgross income. TheSupremeCourtheldthatalthoughinterest payment for delinquent taxes is not deductible as tax under Section 34(C) of the Tax Code, the taxpayer is notprecludedtherebyfromclaimingsaidinterest paymentasdeductionunderSection34(B)ofthe sameCode.Itisawell-settledrulethattax obligationsconstituteindebtednessforpurposesof deductionfromgrossincomeoftheamountof interest paid on indebtedness. Q24.2. Arethereanyadditional requisites provided for revenue regulations for the deductibility of interest expenses? Yes.RR13-2000[NOVEMBER20,2000]provides three more, namely: 1.theinterestpaymentarrangementmustnotbe between related taxpayers 2.theinterestmustnotbeincurredtofinance petroleum operations 3.incaseofinterestincurredtoacquireproperty used in trade, business, or exercise of profession, the same was not treated as a capital expenditure TheRRalsoprovidesforalimitationinthatthe amountofinterestexpensepaidorincurredbya taxpayerinconnectionwithhistrade,business,or exerciseofaprofessionfromanexisting indebtedness shall be reduced by an amount equal to 38%oftheinterestincomeearnedwhichhadbeen subject to final withholding taxes.52 Q24.3. Whataretherulesonthe deductibilityofInterest expenses? Thegeneralruleisthattheamountofinterest expensepaidorincurredwithinataxableyearon indebtedness in connection with the taxpayers trade, businessorexerciseofprofessionshallbeallowed asadeductionfromthetaxpayersgrossincome providedthatthetaxpayersotherwiseallowable deductionforinterestexpenseshallbereducedby 38% of the interest income subject to final tax. Theexceptions(whereinterestexpenseisnot deductible from gross income) are: 1.Ifwithinthetaxableyearanindividual reporting income on the cash basis incurs an indebtedness on which an interest is paid in advancethroughdiscountorotherwise. Such interest shall be allowed as a deduction intheyeartheindebtednessispaid.Ifthe

52 This will be further discussed under tax arbitrage.PM REYES NOTES ON TAXATION I: INCOME TAX PIERRE MARTIN DE LEON REYES26indebtednessispayableinperiodic amortization,theamountofinterestwhich correspondstotheamountoftheprincipal amortizedorpaidduringtheyearshallbe allowed as deduction in such taxable year. 2.If both the taxpayerand the person to whom the payment has been made or is to be made arerelatedpersonsspecifiedunder Section 36(B). 3.Iftheindebtednessisusedtofinance petroleum exploration. Q24.4.1.Enumeratethecaseswhenno deductionisallowedbecause theloanisbetweenrelated taxpayers. 1.Between members of the family 2.Betweenanindividualandacorporation wheretheindividualpaidinterestonaloan granted by the corporation more than 50% of thecapitalstockofwhichisownedbythe individual 3.Betweentwocorporationswhereone corporationownsmorethan50%ofthe other53 4.Between a grantor and fiduciary of a trust 5.Betweenthefiduciaryofatrustandthe fiduciaryofanothertrustwiththesame grantor 6.Betweenafiduciaryofatrustanda beneficiary of such trust Q25. Maythetaxpayerchoosetotreat interestexpenseascapital expenditure? Yes.Section 34(B)(3)provides thatat theoptionof thetaxpayer,interestincurredtoacquireproperty usedintrade,businessorexerciseofaprofession may be allowed as a deduction or treated as a capital expenditure. However,shouldthetaxpayerelecttodeductthe interestpaymentsagainstitsgrossincome,the taxpayercannotatthesametimecapitalizethe interestpaymentsbecausethatwouldconstitute double tax benefits which is not authorized by law

53Thecaseofaparentcompany-subsidiaryloanwillnotbe disallowedbecauseitdoesnotrefertoacaseofacommonly-owned entity (commonly owned at 50%) but one where one entity owns the other.InPAPERINDUSTRIESCORPORATIONOFTHE PHILIPPINESVS.COURTOFAPPEALS[DECEMBER 1,1995],PaperIndustriesclaimedasdeductions againstgrossincomeinterestpaymentsonloansfor thepurchaseofmachineryandequipment.TheCIR disallowed the deduction on the ground that because theloanshadbeenincurredforthepurchaseof machineryandequipment,theinterestpaymentson thesaidloansshouldhavebeencapitalizedinstead andclaimedasadepreciationdeductiontakinginto accounttheadjustedbasisofthemachineryand equipment(originala